Earlier in the year, the IRS released Revenue Procedure 2020-12,1 which establishes a safe harbor for the allocation of section 45Q credits in so-called "partnership flip structures" and the equity treatment of tax equity investments in such vehicles. Such structures are already prevalent in the wind production credit ("PTC") and solar investment tax credit ("ITC") space, where they are governed, either directly or by analogy, by the principles of Revenue Procedure 2007-65 (the "Wind PTC Guidance").2 While the general approach of Revenue Procedure 2020-12 is very similar to that of the Wind PTC Guidance, certain aspects of the guidance may potentially signal a growing openness in the IRS' attitude toward certain key features of partnership flip structures.
Similarities to Existing Guidance-A Safe Harbor Partnership Flip Structure and Historic Boardwalk Guidelines
Similar to the Wind PTC Guidance, Revenue Procedure 2020-12 generally provides a safe harbor for a standard situation where a project developer ( "Developer") enters into a tax partnership with an investor ("Investor"), with Developer never taking less than 1% of all partnership items and Investor never taking less than 5% of all partnership items. Investor, who typically has greater tax capacity than Developer, takes 99% of gross income and loss (and thus, under Treas. Reg. § 1.704-1(b)(4)(ii), 99% of all section 45Q credits) until a date determined by reference to either partner's after-tax return, or a fixed date, known in common parlance as the "flip date." Investor may also take significant pre-flip cash allocations during one or more pre-flip periods. Post-flip, Developer takes 95% of the gross income and loss allocations, as well as 95% of the cash, leaving Investor with a 5% residual interest.3 Under these circumstances, subject to the various rules described below, the IRS generally will treat Investor as a partner in the project company (i.e. respect that Investor's investment is equity, not debt for tax purposes) and respect the partnership allocations for section 704(b) purposes.4
Revenue Procedure 2020-12 also contains certain additional guidelines to ensure that Investor retains the risks and rewards of an equity investment in the project company. Investor's partnership interest must not be substantially fixed in value nor insulated from economic loss, nor can Investor's upside be limited via a preferred return "representing a payment for capital" or eroded with artificial mechanisms such as non-market fees paid to Developer.5 Developer guarantees of the Investor's ability to claim the credit, or recover its investment from the project company due to its inability to claim the credit, are also banned, although third-party insurance is permitted.6 While not explicitly stated in the Wind PTC Guidance, such guidelines are consistent with existing market practice as informed by the principles of Historic Boardwalk Hall, LLC v. Commissioner7 and Revenue Procedure 2014-128 (the "Historic Boardwalk Guidance"), which post-date the Wind PTC Guidance by several years.
Differences from Wind PTC Guidance: Evolving Views on Debt-Equity, or Carbon Capture Credit Exceptionalism?
Notwithstanding the obvious similarities, Revenue Procedure 2020-12 contains several deviations from the Wind PTC Guidance that are of interest to wind PTC and solar ITC watchers as well as section 45Q specialists:
- Development-stage equity. As with the Wind PTC Guidance,9 Revenue Procedure 2020-12 decrees that Investor must make and maintain a minimum unconditional investment in the project company, equal to at least 20% of the fixed capital investment plus reasonably anticipated contingent investments required to be made by Investor under the partnership agreement.10 Whereas the Wind PTC Guidance allows such minimum unconditional investment to be made upon the later of placed in service or Investor's acquisition of its interest, however, Revenue Procedure 2020-12 on its face requires the 20% minimum unconditional investment to be made upon Investor's acquisition of its interest-even if Investor is taking development or construction risk during a period when placed in service has not yet occurred.
- PAYGO cap. Under the Wind PTC Guidance, reasonably anticipated contingent investments by Investor must not exceed 25% of the sum of fixed investments plus reasonably anticipated contingent investments.11 Revenue Procedure 2020-12 has a similar rule, but the cap on reasonably anticipated contingent investments is increased to an amount below 50% of fixed plus reasonably anticipated contingent investments. It is also stated that contributions to the project company to pay ongoing operating expenses are not treated as contingent investments-a rule that, while arguably consistent with the market's current interpretation of what constitutes a "reasonably anticipated" investment under the Wind PTC Guidance, may create some scrutiny of what constitutes an "ongoing" operating expense.12
- Put and call options. Under the Wind PTC Guidance, a call option giving Developer, Investor, or a related party the right to purchase project assets or a partnership interest in the project company is generally permitted, so long as it has arms-length terms, a valid non-tax business reason, and an exercise price that is at or above fair market value at the time of exercise; by contrast, put options, held by any party, for the sale of project assets or a partnership interest in the project company, are forbidden.13 For reasons that are not immediately clear, Revenue Procedure 2020-12 has an almost diametrically opposite rule. Call options giving Developer, Investor, or a related party the right to purchase project assets or a partnership interest in the project company at a future date are generally forbidden, while put options, held by any party, for the sale of project assets or a partnership interest in the project company, are apparently allowed unless the exercise price is greater than fair market value.14
- Tax insurance. The Wind PTC Guidance states that no person may "guarantee or otherwise insure the Investor the right to any allocation of the credit under section 45"-thus creating, in the past, an undercurrent of debate in the market as to whether tax equity investors are permitted to take out third-party tax insurance on their investments, with most practitioners now concluding that the guidance does not bar investors from obtaining tax insurance on whether a project is eligible for the PTC (e.g., whether start of construction occurred before the relevant deadline).15 Revenue Procedure 2020-12 settles this question by restricting only persons "involved in any part of the Project Company" from guaranteeing or otherwise insuring the taxpayer's ability to claim the section 45Q credit and clearly stating that Investors are not prohibited from "procuring insurance, including recapture insurance, from persons not related to the Developer, any other Investor, an Emitter, or an Offtaker."16 On the other hand, Revenue Procedure 2020-12 also expands the restriction on guarantees by persons "involved in any part of the Project Company" to include not only Investor's ability to claim the credit, but also Investor's ability to enjoy the economic benefits associated with the credit (either through the ability to claim the cash equivalent of the credits, a repayment of its contribution in the event of an IRS challenge, a distribution from the project company, or a disposition of its interest).17
- Guarantees. The Historic Boardwalk Guidance explicitly permits guarantees provided to Investor or the project company for either the performance of acts necessary to claim the tax credit (in that case, the rehabilitation credit under section 47) or the avoidance of any act (or omissions) that would cause the project company to fail to qualify for the credit or that would result in a recapture of the credit, but only to the extent that such guarantees are unfunded (i.e. no money or property is set aside to fund all or any portion of the guarantee, and the guarantor has not agreed to maintain a minimum net worth in connection with the guarantee).18 Revenue Procedure 2020-12 also explicitly permits such guarantees-which, as in the Historic Boardwalk Guidance, include "completion guarantees, operating deficit guarantees, environmental indemnities, and financial covenants"-but does not require that they be unfunded.19
- Related party contracts. The Wind PTC Guidance views take-or-pay contracts (i.e. contracts where an offtaker commits to purchase all of the energy produced up to a certain point) between related parties to be guarantees and impermissible.20 By contrast, Revenue Procedure 2020-12 not only explicitly permits related-party take-or-pay contracts between the project company and a purchaser of carbon oxide, but also blesses a wide variety of other related-party agreements between the project company and a purchaser of carbon oxide or an emitter of carbon oxide, and between a purchaser and an emitter of carbon oxide.21
- Section 704(b) safe harbor. Many commentators believe that the Wind PTC Guidance does not provide assurance as to when allocations of the PTC have substantial economic effect for section 704(b) purposes, and indeed the Wind PTC Guidance states only that the PTC must be allocated in accordance with Treas. Reg. § 1.704-1(b)(4)(ii).22 Under that rule, a credit (other than the investment tax credit) generally can be allocated according to the deductions, losses, or capital account decreases associated with the capital expenditures giving rise to the credit; if the credit arises from partnership receipts, however, the credit can be allocated according to the income or capital account increases associated with such receipts. Revenue Procedure 2020-12 does purport to analyze Treas. Reg. § 1.704-1(b)(4)(ii), probably because the section 45Q credit is not obviously based on receipts or expenditures, but rather on the amount of carbon captured. The guidance takes the two-pronged approach that if the project company generates receipts from its carbon oxide sequestration activities (e.g. from being paid to capture carbon oxide or selling carbon oxide), the credit can be allocated according to each partner's share of income from such receipts; however, if the project does not receive such receipts, the credit can be allocated according to each partner's share of loss, deduction, or capital account decrease associated with the relevant section 45Q activities.23
- Section 469 "passive loss" rules. The Wind PTC Guidance confirms that each "qualified facility" is treated as a separate activity, and can be grouped together only with other qualified wind facilities, for purposes of the passive activity loss rules of section 469.24 Revenue Procedure 2020-12 contains no such guidance, perhaps because it is less pressing in the carbon capture context: as each wind turbine is a "qualified facility" under section 45, investors in wind projects are almost certain to invest in multiple qualified facilities.
In some cases, as in the section 45Q revenue procedure's analysis of the section 704(b) allocations and its silence on section 469 passive losses, differences between Rev. Proc. 2020-12 and Rev. Proc. 2007-65 can be attributed to the differences between the economic and statutory framework of carbon capture projects versus wind projects. The more liberal attitude in Revenue Procedure 2020-12 towards related-party take-or-pay contracts also can plausibly be attributed to the different economic dynamics associated with the purchase of carbon oxide. Other differences between the two revenue procedures may simply arise from Revenue Ruling 2020-12 explicitly addressing certain situations and topics-such as tax insurance-that have become more prominent since 2007.
Another subset of differences, intriguingly, cannot be easily explained. Is it intentional that a section 45Q tax equity investor's minimum 20% unconditional investment must be made upon acquisition, even if placed in service occurs much later? Why are the rules for put and call options almost diametrically different from the rules in the Wind PTC Guidance? Why is the PAYGO cap 50% for carbon capture tax credit projects, but 25% for PTC projects? Does the lack of explicit restrictions on funded completion guarantees and related-party take-or-pay contracts point to an evolution in the IRS' post-Historic Boardwalk views on debt-equity generally-or something else? Such distinctions between the two revenue procedures merit further consideration by tax practitioners in the wind and solar space, and it would be useful for the IRS to shed some light on these questions as well.
1. 2020-11 I.R.B.
2. 2007-2 C.B. 967.
3. Rev. Proc. 2020-12 at § 4.02, § 5.
4. Id. at § 3.02.
5. Id. at § 4.02(2)(b), (c).
6. Id. at § 4.08.
7. 694 F.3d 425, 455 (3d Cir. 2012).
8. 2014-3 I.R.B. 415.
9. Rev. Proc. 2007-65 at § 4.03.
10. Rev. Proc. 2020-12 at § 4.03.
11. Rev. Proc. 2007-65 at § 4.04.
12. Rev. Proc. 2020-12 at § 4.04.
13. Rev. Proc. 2007-65 at §§ 4.05, 4.06.
14. Rev. Proc. 2020-12 at §§ 4.05, 4.06.
15. Rev. Proc. 2007-65 at § 4.07.
16. Rev. Proc. 2020-12 at § 4.08(1).
18. Rev. Proc. 2014-12 at § 4.05(1).
19. Rev. Proc. 2020-12 at § 4.08(2).
20. Rev. Proc. 2007-65 at § 4.07.
21. Rev. Proc. 2020-12 at § 4.08(3).
22. Rev. Proc. 2007-65 at § 4.08.
23. Rev. Proc. 2020-12 at § 4.09.
24. Rev. Proc. 2007-65 at § 4.09.
Originally published July 06, 2020 .
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