The Court of Federal Claims has awarded nearly $207 million to the owners of six connected wind farms who sued to recover grant payments the U.S. Treasury Department declined to make under Section 1603 of the American Recovery and Reinvestment Act. The decision, in Alta Wind I, et al. v. United States, is of particular note to project developers and other Section 1603 applicants, as the court’s detailed opinion clarifies several open questions about the determination of cost basis in the context of the Section 1603 program.
The Internal Revenue Code provides an investment tax credit for a large number of renewable technologies. The credit is generally equal to 30 percent of the cost of the facility, and investors often make substantial capital contributions to entities that own these facilities in exchange for an allocation of the resulting tax credits. Unfortunately, on account of the financial crisis of 2007–08, there was a significant reduction in this investing, and Congress established the Section 1603 program as a way for developers of renewable projects to apply to the Treasury for a cash grant intended to largely mimic what the developer hoped to get from an investor’s capital contribution. Like the tax credit, the grant was generally 30 percent of the facility’s cost (or in some cases, value). Accordingly, the owner of the facility (or in some cases, the lessee) would apply to the Treasury for a grant, filing paperwork intended to show the eligible costs, and then the government would review the application and issue a grant to the applicant. Over the years that the Section 1603 program has been in existence, the Treasury’s standards for review of applications have evolved, and for some time the Treasury has substituted its own judgment of costs and value in computing the amount of the grant. As a result, applicants would submit grant applications demonstrating a certain amount of grant-eligible costs, but the Treasury would frequently disallow costs or revise the amount downward, and then issue a grant based on 30 percent of a smaller number than the applicant had claimed in its applications. This has led to a large number of lawsuits in the federal courts in which grant applicants have sought a larger grant amount than the Treasury had paid.
The plaintiffs, part of the Alta Wind Energy Center near Los Angeles, had sought government grants under Section 1603 amounting to 30 percent of their claimed cost bases in the six facilities. Five of the six projects were sale-leaseback transactions, and the sixth was an outright sale. The plaintiffs’ claimed cost bases equaled the prices they paid to acquire the facilities from the developers of the facilities, minus small amounts for ineligible property such as land and transmission lines. These purchase prices were larger than the developer’s costs to build each facility and were instead based on the value of the completed facility that was about to be placed in service.
The Treasury awarded grants significantly smaller than the plaintiffs had applied for. The government argued that that the purchase prices were unfair measures of the facilities’ values, and that the cost bases instead should be calculated by summing the facilities’ grant-eligible construction and development costs, which led to a much lower amount. In the government’s view, a substantial part of the purchases’ prices was attributable to intangibles such as goodwill and going concern value, which were not grant eligible.
The court disagreed, finding that the government’s valuation approach “improperly excludes value” from the plaintiffs’ cost bases in a way that is not supported by either Section 1603 or existing tax law. The court confirmed the long-settled tax principle that, in a typical arm’s length transaction, the basis of property is equal to the amount paid to acquire it.
The government first argued that the plaintiffs’ grant-eligible assets should be valued using the “residual method” of allocation under Section 1060 of the Internal Revenue Code. Section 1060 applies to transfers of trades or businesses, where part of the value of the transferred asset is so-called “goodwill” or “going concern value.” In those cases, value is allocated on a waterfall basis among several “buckets” of assets, some grant eligible and some not. In the government’s view, a substantial portion of the value of the plaintiffs’ transactions was allocable to goodwill and going concern value, neither of which is a grant-eligible cost.
The court held that Section 1060 did not apply to the plaintiffs’ transactions because the facilities did not constitute a “trade or business.” Since the plaintiffs’ facilities were “not yet operational when purchased,” the court reasoned, neither goodwill nor going concern value could attach to the transactions. This was true even though the facilities all had entered into long-term contracts to sell their power output, since they had not yet begun performing under those contracts.
The court also endorsed the inclusion of so-called “turn-key” value in a Section 1603 applicant’s grant-eligible cost basis, noting that the plaintiffs’ facilities “had additional value over their development and construction costs because they were ready-to-use wind farm facilities located in the windy Tehachapi Region, not just collections of turbines lying on the ground somewhere.” In so ruling, the court distinguished the concept of turn-key value from the concept of going-concern value, stating that “[i]n a turn-key transaction, the buyer is not purchasing an operating business; rather, he is purchasing a put-together facility that is ready for operation.” The court analogized the plaintiffs’ transactions to the purchase of new radio facilities that had already been tested, which were held to have turn-key value in Miami Val. Broad. Corp. v. United States, 499 F.2d 677, 680 (Ct. Cl. 1974). The distinction between turn-key and going-concern value is important, the court noted, because turn-key value is considered part of a transaction’s tangible assets, whereas going-concern value is not.
The government’s fallback argument in the case was that, even if Section 1060 did not apply, several “peculiar circumstances” existed that inflated the plaintiffs’ purchase prices. In such situations, tax courts have disregarded purchase price and looked to other measures of fair market value to determine a party’s cost basis. The government pointed to three alleged “peculiar circumstances” in the plaintiffs’ transactions: the fact that five of the six projects involved sale-leaseback transactions, several side agreements between the parties and the seller’s agreements to indemnify the plaintiffs’ Section 1603 payments. The court held that none of those facts constituted “peculiar circumstances” such that the plaintiffs’ purchase prices should be disregarded as the appropriate measures of their cost bases.
Regarding the sale-leaseback transactions, the court noted that such structures were “commercially acceptable device[s]” and were “explicitly envisioned” by the Section 1603 program. Significantly, the purchase prices for the five sale-leaseback facilities were essentially the same on a per-kilowatt basis as the purchase prices for three other Alta Wind Energy Center facilities sold in outright sales by unrelated third parties, and several other factors showed the prices were more or less consistent with fair market value. The court noted that to disregard purchase price as basis, the evidence must show the parties used the sale-leaseback structure to highly inflate the purchase price, which was not the case here. Similarly, the court held that various side agreements between the parties, such as so-called “wake payments” and certain land transfers, did not “highly inflate” the value of the transactions and therefore did not constitute peculiar circumstances.
Nor did the court find it peculiar that the seller agreed to indemnify the plaintiffs’ for any claimed Section 1603 grant amounts the Treasury Department chose not to award. To the contrary, the court held that it was appropriate for the parties to ascribe value to the availability of Section 1603 grants when negotiating the purchase prices of the facilities. The indemnities, the court found, “simply confirmed the fair market value of the facilities once expected grant amounts were taken into account.”
The government also took issue with the method the plaintiffs’ used to allocate their purchase prices among grant-eligible and grant-ineligible assets. Since not all construction and development costs are eligible for inclusion in a Section 1603 applicant’s cost basis, applicants who acquire qualifying property in transactions that also include ineligible property must allocate the purchase price among the two types of assets. In this case, the two plaintiffs to whom this scenario applied used a pro rata method by which they determined the percentage of construction and development costs that applied to eligible property, then claimed the same percentage of the purchase prices as their eligible bases. The court found that the resulting allocations (93.1 percent of purchase price for one facility and 96.9 percent for the other) were reasonable, especially since a government witness had testified that both the energy industry and the Section 1603 program followed a “rule of thumb” that 95 percent of wind farm construction costs were grant-eligible.
Finally, the court approved of the plaintiffs’ inclusion of value attributable to long-term power purchase agreements (PPAs) as part of the facilities’ grant-eligible assets, citing the “close nexus between the wind farm facilities and their respective PPAs.” The court analogized PPAs to land leases, which for tax purposes are not considered separate assets from the underlying land. This is true, the court noted, even if the lease terms are better than market. Citing Schubert v. Comm’r, 33 T.C. 1048, 1053 (1960), aff’d, 286 F.2d 573 (4th Cir. 1961).
There’s a lot to digest in the court’s decision, and a lot for developers and investors to be happy about. We expect that tax advisors will rely on this decision to support the valuation of tax credit and grant transactions, while recognizing that, for now at least, this is the decision of a trial-level court in one circuit. Plainly, the court was very supportive of the structure of tax credit/grant transactions, in which a developer builds a facility and then an investor acquires the facility for a price significantly larger than cost, supported by an appraisal, and thereby generates a corresponding tax credit. The government offered numerous opportunities for the court to disagree with the plaintiffs’ valuations, but at each turn, the court declined to follow that lead. Of particular note, the court plainly took the ability of the facilities to generate income into account in computing value (while refusing to allocate any of this larger number to “going concern” or “goodwill”), and it approved a valuation that was approximately a third beyond the actual cost of turbines, wire, inverters and steel associated with the facilities. Of course, the markup cannot be unlimited; the court noted one case with a 500 percent markup as having gone too far. Nonetheless, the court did approve an eight-figure change in the eligible cost of the facilities, and more than $200 million of additional grants. Finally, while the case involved the Section 1603 grant program, it also provides obvious approval for the same kinds of valuations when the investment tax credit is involved.
The government has 60 days to appeal the court’s decision. The full text of the opinion can be found here.
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