A recent Internal Revenue Service ruling discussed the importance of PPAs to a taxpayer that purchased a renewable energy project developer and its affiliates (“Target”).  According to the ruling, Target had entered into several PPAs with various third parties.  These PPAs were clearly important assets in the Taxpayer’s decision to purchase the Target.  The ruling answered the taxpayer’s question: Whether any portion of the purchase price of Target should be allocated to the PPAs? 

Attributes of the PPAs

The ruling discussed some of the important attributes of PPAs that are commonly found in PPAs for traditional and renewable power.  For instance, the PPAs were considered to be facility-specific PPAs, which means Target was required to sell – and purchasers were required to purchase – power from a specific generation facility.  In fact, under the PPAs, Target was prohibited from obtaining capacity, energy, or environmental attributes from other sources.

In addition to energy output, these PPAs provided for the sale and purchase of capacity.  That is, in addition to the purchase of power actually generated by the facility (MWh), the PPAs also required the purchase of the facilities’ output potential.  Finally, because the facilities were powered by wind, these PPAs provided for the transfer of environmental and renewable attributes (e.g., green tags).

The ruling even discussed, to a limited extent, the pricing mechanism of the PPAs.  They contained a specified price up to the maximum amount of output.  For any amount of output delivered in excess of the maximum, the PPAs provided for a pricing adjustment to account for the then-current market price.

Allocation of Purchase Price to PPAs?

The primary issue of the ruling involved the allocation of the purchase price among the assets of the Target, including the PPAs.  Taxpayer asked the Service to determine if any portion of the purchase price of Target should be allocated to the PPAs.  The Service ruled that no portion of the purchase price should be allocated to the PPAs in this particular circumstance.

The Taxpayer was obviously concerned with the allocation of purchase price to the PPAs because it would have an impact on depreciation.  The Service compared the facility-specific PPAs to leased property.  Where acquired property is subject to a lease, the Code provides that no amount of the adjusted basis is allocated to the leasehold interest, and that for depreciation purposes, the entire adjusted basis is attributed to the property itself.

Relying on the particular attributes of the PPAs, the Service ruled that the facility-specific PPAs in this ruling should not be treated as assets separate from the facilities themselves.  Specifically, for depreciation purposes, any amount of the purchase price that would otherwise be attributed to the facility-specific PPAs should be taken into account as part of the basis of the facilities.

Conclusion

The ruling provides a rare insight into the common provisions of PPAs that involve the purchase of renewable energy.  It also serves as a reminder of the importance of PPAs for renewable energy project development, and the importance of including crucial provisions in renewable energy PPAs.  Finally, purchasers of energy companies may find the ruling helpful in forecasting after-tax net income, including the tax effects of depreciation. 

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Accountants and chief financial officers provide essential information to the board.  Without the information provided by accountants, the cooperative could not function as a cooperative, or as a viable business entity.  The board relies heavily on accountants and the information they provide to make informed decisions that benefit the cooperative and its members.

They also help assist the board in complying with its own duties to the cooperative, such as the duty of good faith, due care, loyalty, and compliance.  The board’s ability to make good and informed decisions depends on cooperative accountants providing accurate, relevant, reliable, and timely data.

Accountants, therefore, play a critical role in cooperative operation and are essential to fulfilling the core cooperative principles. 

The presentation also focused on duties that accountants (who may or may not be directors or offices) owe to the cooperative.  To illustrate the importance of accountants and their duties, David discussed several important real-life cases in which officers and accountants fulfilled their duties and failed to fulfill their duties.  Finally, he also discussed real-life examples of the particularly important role that accountants play in cooperative operation.

In addition to the presentation, David has also written an article in the upcoming edition of The Cooperative Accountant (a publication by The National Society of Accountants for Cooperatives) which discusses ways to effectively manage capital credits, and the role cooperative accountants play in this process.  As a former auditor and accountant for cooperatives, David is keenly aware of the importance and necessity of cooperative accountants in fulfilling the cooperative’s duties to its members. 

Be sure to frequently check the AHC Cooperative Law and Energy Blog for a link to the article when it is published.

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To view the brief, click here.

To learn more about cooperative taxation, or to view other Cooperative Tax Briefs, click here.

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A cooperative, by definition, is an association of people voluntarily united to meet a common goal through democratic process and voluntary membership. Democratic cooperative governance requires an elected board that sets policies and makes decisions that are in the best interest of its members. In order for this to happen, members must have the opportunity to participate in well-run, open elections.

Executing a cooperative election requires substantial staff time and energy. When planning your election, make sure to prepare your staff for the following tasks: 

• Database Management. Designate staff or a partner to ensure that member information and contact numbers are up-to-date and current. Your election communications require accurate contact info to ensure deliverability of election messages.
• Coordinating Voting Materials. Assign a manager or agency dedicated to the content and design of ballot materials, including: nominee profiles, proposed policy/by-law changes, voting instructions and the ballot.
• Delivery of the Ballots. Ensuring voters receive their ballots is a critical part of the voting/election process. For an on-site election, make ready an area for voting and distribution of the ballots. For mail-in ballots, have your staff or vendor order mail materials, fill packets, arrange postage and place envelopes in the mail according to schedule. For online voting, ballot delivery will need to be coordinated with the database manager.
• Forming a Registration and Credentials Committee. Form a group that is responsible for facilitating on-site election and tabulation. This step includes checking-in members, passing out ballots and providing voting instructions.
• Analyzing Results. Arrange for a resource to be in charge of tabulating and reporting results. Instruct this party to pay close attention to security and confidentiality of the ballots.    

Facilitating a well-run cooperative election is no small task – but when assessing the potential risks associated with poorly run elections with the rewards of a well-run election, the choice is clear:

Faulty elections:

Low voter turnout -> unengaged members -> discontent & speculation

Well-run elections:

Increased voter turnout -> engaged members -> stronger cooperative

 About Survey & Ballot Systems

Since 1990, Survey & Ballot Systems (SBS) has been helping cooperatives connect with their members through efficient and fair elections. Commitment to data security and individualized design, combined with unparalleled customer service, has made SBS a trusted partner in election management. SBS election services include: traditional paper ballot elections, online voting, telephone voting and hybrid voting systems. If your organization could benefit from conducting the highest quality election available, with guaranteed and certified results, make sure to visit www.surveyandballotsystems.com for more information.

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The telephone cooperative received a substantial amount of income from universal service funds because it served a very rural area.  Because most of its income was derived from universal service funds, the treatment of such funds under the Member Income Test was extremely important to the cooperative.  Fortunately, as expected, the Service ruled that such funds were excluded under a special exception for telephone cooperatives under the Member Income Test.

View the latest Cooperative Tax Brief by clicking here.

View other Cooperative Tax Briefs by clicking here.

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Background on Section 179D

Section 179D of the tax code provides a deduction for installation of “energy efficiency commercial building property” (“Eligible Property”).  Eligible Property includes property involved with improving energy efficiency of:

• interior lighting systems;
• heating, cooling, ventilation, and hot water systems; or
• building envelopes.

The deduction amount is equal to the cost of Eligible Property, subject to a maximum of $1.80 per square foot.   In addition, installation of Eligible Property must result in a minimum percentage of energy savings. 

 In certain circumstances, however, Eligible Property that does not meet the minimum energy-savings percentage may still qualify for a tax deduction.  The partial deduction is limited to $0.60 per square foot. 

Recent Guidance

The IRS recently modified guidance for these partial deduction projects in Notice 2012-22.  The Notice provides an additional set of energy savings percentages that, if met, will qualify a project for a partial Section 179D deduction. 

While the guidance increases the energy-savings percentage for interior lighting systems, it reduced the percentage for heating, cooling, ventilation, and hot water systems.  The percentage for building envelopes stayed the same.  A chart is provided on page 7 of the Notice for quick reference.  

Implications

Owners and facilities managers should consider the Section 179D deduction as an additional incentive to implement their energy efficiency projects.  Furthermore, contractors and design-builders may even qualify for the deduction for energy efficiency projects on public buildings.  Whoever gets the deduction, they should get started soon: the Section 179D deduction will sunset on December 31, 2013.

For additional resources on energy efficiency projects, click here.

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The tax credits in question are the Production Tax Credit (PTC) and the 1603 grant program.  The PTC provides a credit of 2.2 cents per kWh of energy produced in a wind or solar project for the first 10 years of operation.  This credit has been instrumental in project creation, especially for wind projects, but is set to expire in 2012.  One estimate from a study by Navigant Consulting is that if the credit expires, investment in the industry will drop from a predicted $15.6 billion in 2012 to $5.5 billion in 2013.  Trade groups attempted to have a one-year extension included in the proposed payroll tax cut extension bill this month, but were unsuccessful.

The PTC was attractive to investors seeking to reduce their tax bill.  Because the recession greatly decreased the demand for tax credits in the renewable energy market, the 1603 program was enacted in 2009 to encourage continued financing of renewable energy projects.  Under this program, companies investing in renewable energy would receive a one-time cash payment in lieu of the credit.  The 1603 program was very popular, and paid out over $3 billion in 2011.  It caused a decided uptick in renewable projects, including solar projects, but expired at the end of 2011.

Because developers must line up financing well in advance of breaking ground on new projects, the expiration of the 1603 program and the impending expiration of the PTC for wind projects has already dampened project planning and capital investment.  Regardless of changes in the political climate, it seems certain that over time, regulators will require increased use of renewable energy generation.  In light of this certainty, it makes economic sense to provide incentives to assist the renewable energy industry in obtaining private investment, lowering costs per kWh and providing a more competitive product.

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Eligibility:
All cooperatives that are members of the National Rural Electric Cooperative Association are eligible for nomination and award.  There is no cost for nomination.

Nomination and Award:
To nominate a cooperative for the award, click here.  Entries will be judged in four areas:

• Corporate leadership
• Innovative marketing
• Benefits to customers
• Project creativity

For more information, click here.
Past award recipients are listed here.

Good luck to all nominees!

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The 1603 program is designed to work like the 30% federal investment tax credit (ITC) offered for certain types of energy assets. In brief, Treasury awards a grant in the amount of 30% of all “eligible” expenditures used to build the renewable energy asset, shortly after it is placed in service.  The grants are cash-flow neutral to the federal government; instead of an owner of an energy asset paying less in taxes (by claiming an ITC), they receive a government grant.  Another important part of the program is that wind energy assets are eligible to receive the cash grant in lieu of production tax credits (PTC).  PTC’s give tax credits for every kWh of energy produced by the wind energy asset.  Because the grant amount is derived from how much eligible money is spent building these assets, the more eligible money spent the larger the grant award.   Particular attention is thus paid to what costs are eligible.

Disagreements between Treasury and grant recipients regarding the calculation of the 1603 grants appeared shortly after the program began. The Treasury department faced legal challenges for refusing to pay part or all of the grants it deemed ineligible.  On January 18, 2011, in the case ARRA Energy Co. I v. United States, the court ruled that Treasury could not simply refuse to award grants it deemed ineligible.  This finding raised the question of how much Treasury is allowed to scrutinize the reported cost of a system.  Some have argued that the court decision directed the Treasury department not to withhold grants; instead they must determine whether each reported cost should be included or excluded from the eligible basis.  This argument is supported by the document released June 30, 2011 by Treasury which provides guidance on how it reviews grant applications.

In the guidance document, Treasury discusses how it determines what costs are eligible to be included in the basis. One focus of the document is energy generating systems in which the owner of the asset is also the entity that built the asset and/or procured/produced the equipment.  In these situations many applicants have used the “Fair Market Value” (FMV) of the system to determine what is the eligible basis of the project.  The document makes clear Treasury is focusing attention on costs calculated by FMV in which there was not an arms-length transaction.  Treasury is also attempting to create a sound legal footing in the event they are challenged in court again.  ”The courts have determined that in certain circumstances, a taxpayer’s stated cost for an asset does not reflect the true economic cost of that asset to the taxpayer and will be ignored for purposes of determining the basis of the asset.”

However, scrutiny of the grants do not end after they are given.  Treasury has recently released reports on projects that have received treasury grant awards and been subsequently audited to determine whether the award amount is correct.  The released audits indicate that Treasury has determined some of the grant awards were too large and money should be returned.

The IRS is also investigating whether grant amounts awarded are correct.  This is apparent in the IRS’s memo, released September 30, 2011, discussing how to treat the portion of the 1603 grant deemed as “excessive”.  The memo found that the portion of the grant deemed as “excessive” should be treated as income and any portion subsequently returned should then be deducted from a company’s income (in addition, the depreciation basis should be adjusted to reflect the correct deductable basis).

However, this guidance is not very impactful.  The part of a grant deemed ineligible must be returned to the Treasury department.  If the ineligible portion is returned the same year as the grant is awarded it is a non-event.  The only time it is reported as income is if a grant is returned in a later tax year.  Under those circumstances, a company would report the excessive part of the grant as income in the year it was awarded, and report it as a deduction the year it is returned.  Presumably it would cost the company the imputed interest by the government between the two years.  The important part of the IRS memo is that it indicates the IRS is reviewing the Treasury grant awards after they are given.

There is a tremendous amount of scrutiny to the 1603 program’s grants.  Treasury department has felt that certain companies are overstating the costs of projects in order to receive a higher award.  Because the Treasury department and the IRS want to make sure that government funds are being distributed legally they are paying particularly close attention to how  the cost of systems are calculated.  If there was an error in the calculation before or after the award, practices have been put in place to make corrections.  Although these processes create more of a burden and uncertainty for everyone participating in the program, in light of the tough budget decisions the U.S. government is currently facing, Treasury is attempting to make sure the funds appropriated are distributed as they were intended.

David Feldman works for the National Renewable Energy Laboratory, which provides technical assistance to the Treasury Department  for the Section grant 1603 program. View David’s blog post on NREL’s blog.
Read more about Section 1603.

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