As Mark Twain once said, “News of the recent death of the partnership flip for solar transactions is greatly exaggerated.”
Okay, he didn’t exactly refer to partnership flips; he was talking about a newspaper article that prematurely reported his death. But in the case of the partnership flip in solar transactions, stray reports since last summer that partnership flips are not permitted under the Internal Revenue Code (IRC) in solar transactions have confused some developers and investors. As it turns out, the reports of the partnership flip’s demise for solar transactions are “greatly exaggerated.”
Historically, solar investors have relied on two IRS Revenue Procedures for solar-based partnership flip transactions. Rev. Proc. 2007-65 established safe harbor requirements for the use of a partnership flip with respect to investments in wind facilities qualifying for IRC §45 Production Tax Credits (PTC). Rev. Proc. 2014-12 did the same for investments in historic building rehabilitation qualifying for IRC §48 historic building investment tax credits (ITC).
So, what about the partnership flip in the context of a solar transactions relying on IRC §48 ITC? To date, the IRS has not issued a Revenue Procedure that specifically addresses solar and the ITC. This has left tax practitioners to work by analogy from the two Revenue Procedures noted above. But last summer, the IRS’s Chief Counsel Office issued a memo (Chief Counsel Advice Memorandum 201524024, or “CCA”).
The CCA Memo is an internal IRS memo that was made public several months after it was issued by the IRS national office to one of the IRS’s local field auditors. The CCA addresses questions from the field auditor concerning a taxpayer’s use of a partnership flip in a complex solar ITC transaction. Though heavily redacted, the auditor’s inquiry apparently cited the safe harbor requirements for a partnership flip carved out by Rev. Proc. 2007-65 (that was the one for the §45 PTC in wind transactions). In the CCA Memo, the IRS stated that Rev. Proc. 2007-65 “does not apply to partners or partnerships with [IRC] §48 energy credits.” Oddly enough, though, the IRS went on to apply the very same safe harbor requirements of Rev. Proc. 2007-65 to the solar transaction at issue, and concluded that the taxpayer did “not satisfy all of the safe harbor requirements of Rev. Proc. 2007-65.”
Since that CCA issued last summer, a few writers have published notes, articles and blogs focusing on the CCA’s statement that Rev. Proc. 2007-65 did not apply to the §48 energy ITC. From these publications, some developers and investors have begun to question whether the partnership flip is therefore not permitted in solar transactions structured to take advantage of the ITC.
This interpretation of the CCA and its implications for the partnership flip transaction are misplaced. To understand why the partnership flip remains a viable — even popular — approach to solar transactions looking for a mechanism to monetize tax benefits, we must first understand three key tax concepts: safe harbors, tax credits and how a solar partnership flip fits within the IRC.
First, lets start with safe harbors. Because tax laws are written broadly, they often leave taxpayers unclear on exactly how a tax law’s provisions apply to real-life transactions. So, to help taxpayers understand how the IRS will interpret the general requirements of a tax law, the IRS defines a “safe harbor” by issuing a Revenue Procedure or other similar publication.
A safe-harbor is a set of administratively defined specific requirements that, if satisfied, entitle the taxpayer to the benefit of the law. Picture a Venn diagram in which the general legal requirements for a tax credit lie in a large circle defined by a fuzzy border. The safe harbor is a smaller circle within the larger one, and its crisp, sharp borders give taxpayers certainty about how to structure their transactions.
One nice thing about a safe harbor is that if a taxpayer fails the safe harbor test, it might still argue that it meets the general requirements of the broader law. That is, the taxpayer claims that although the transaction lies outside the clearly defined inner circle, it still fits within the larger circle created by the general requirements of the law. In such a case, the taxpayer may be no less qualified for the tax credits, but there is less certainty because the IRS has not ruled on that specific type of transaction.
Let’s now look at tax credits. Under the IRC, there are many different kinds of tax credits of which two are relevant here. An ITC, authorized under §48 of the IRC, works by giving the owner of a qualifying asset an immediate, one-time credit based upon the dollar value of the qualifying investment. For example, a 30 percent ITC means an owner can claim a 30-cent tax credit for each $1 of qualifying investment. By contrast, a PTC authorized by §45 of the IRC (and the focus of Rev. Proc. 2007-65) works by giving the operator of a qualifying energy asset a tax credit of a specific dollar amount for each unit of energy produced during a given tax year. For projects entering service in 2016, the PTC credit is approximately $.023 per kWh of qualifying wind energy.
Note that these two tax credits operate in very different ways. The ITC is based on a percentage of the qualifying costs of the investment. The ITC entitles an owner to a full credit immediately upon the project being placed in service, and is subject to a five-year re-capture period. The PTC, on the other hand, is driven by asset performance measured annually over a 10-year period.
The critical point here is that tax credits under the IRC can vary in their purpose, methodology and application. For this reason, and similar to any other provision of law, those charged with interpreting or enforcing legal requirements are cautious that any precedent or official interpretation apply only in the context in which it is issued, and extension to new scenarios with differing facts and differing legal requirements be done so cautiously with great attention to detail.