The Treasury Department recently issued guidance on determining the basis of property eligible for ARRA Section 1603’s grant-in-lieu program. The guidance specifically covers solar photovoltaic property; however, it is instructive for any type of “specified energy property.”
Scrutiny of Section 1603 Applications
The guidance identifies several circumstances in which the Section 1603 review team will closely scrutinize data provided by an applicant. In situations involving related parties, or other parties not at arm’s-length, the team will pay very close attention to the cost data arising from such relationships. The team will also look for other “peculiar circumstances” which may influence the purchaser to agree to a price in excess of the property’s fair market value.
Cautionary Signs:
- The applicant is related to the developer, installer, or supplier.
- Common ownership or control exists between the applicant and the developer, installer, or supplier.
- Related transactions have occurred between the applicant, developer, installer, or supplier indicating that the interests of the parties may not be arm’s-length.
- As an example, the applicant and the developer, installer, or supplier have entered into a sale-leaseback transaction.
The review team will also scrutinize extraordinarily high markups. The guidance provided a helpful range of between 10 and 20 percent markup. In any event, the applicant should explicitly address the appropriateness of the markup in light of the activity, capital investment, and risk for what the markup is compensating.
The Treasury Department reminds all applicants that it has the authority to decide whether “an applicant has miscalculated or misrepresented the basis of the property.” Interestingly, the Treasury Department cited ARRA Energy Company I v. U.S., 97 Fed.Cl. 12 (2011), which was previously addressed in another post on this blog.
Review of Section 1603 Applications
The guidance explained how the review team will assess the data provided by applicants. The first step will involve a comparison of the data to established benchmarks. The benchmarks purportedly include “publicly available information and analyses by various experts, data from existing 1603 applications and other confidential sources, and the 1603 review team’s experience.” It also provided an example benchmark for solar PV market expectations.
Next, the review team will focus on the other costs (e.g., indirect costs and allocable costs) claimed by applicants. It will also look for cost items that are presented too generally or are improperly aggregated with other costs. In such cases, the review team will require further detail from applicants. For example, applicants should not try to lump ineligible costs, such as operations and maintenance or the installation of a security fence, with eligible costs.
The Importance of Fair Market Value
As most tax counsel previously understood, the guidance confirms that the review team will look to the applicant’s actual cost data in determining the eligible basis for the property. However, the guidance explains that in certain circumstances, it may consider the fair market value in assessing or determining the proper basis. In any event, the cost data presented by applicants must be consistent with the property’s fair market value.
Applicants may demonstrate that properties’ cost is consistent with fair market value by three different methods: the cost approach, market approach, and income approach. In most instances, the cost approach will reflect the fair market value because the property is new and purchased from an independent third party. For this reason, the review team has a strong preference for cost-based data.
The market approach focuses on the sale of comparable properties. The income approach focuses on the discounted value of future cash flows generated by and appropriately allocable to the specified energy property. As expected, the review team will focus on, and will expect the applicant to detail, key assumptions relied upon in developing the value by the income approach.