Recent documents released from the IRS and the U.S. Department of Treasury show increased scrutiny on Treasury’s 1603 Cash Grants in Lieu of Energy Tax Credits program. The program has awarded a significant amount of money to renewable energy project owners. From September 1, 2009 through September 9, 2011, the 1603 program issued around $9 billion to 20,000 projects. This large government expenditure has put an equally large responsibility on the Treasury department to ensure the funds are used correctly.
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.