The US Court of Federal Claims awarded damages of more than $206 million to Plaintiffs/applicants in a case with respect to the cash grant (the Section 1603 Grant) under Section 1603 of the American Recovery and Reinvestment Act of 2009 (the ARRA). In its opinion, which was unsealed on Monday, October 31, the court held that the US Department of the Treasury (Treasury) had underpaid the Section 1603 Grants arising from projects in the Alta Wind Energy Center because it had incorrectly reduced Plaintiffs' eligible basis in the projects. The court rejected the Treasury's argument that the applicants' basis in the facilities was limited to development and construction costs, and accepted Plaintiffs' position that the arm's-length purchase price of the projects prior to their placed-in-service date was a reasonable starting place for the projects' value. Importantly, the court also held that the power purchase agreements (PPAs) relating to the facilities should not be treated as ineligible intangible property for purposes of the Section 1603 Grant. This significant decision is welcomed by the renewable energy industry and an affirmation of a long held view by taxpayers as to an appropriate measure of cost basis in both the context of the Section 1603 Grant and the Investment Tax Credit (ITC) under Section 48 of the Internal Revenue Code of 1986, as amended (the Code).
The ARRA was signed into law by President Barack Obama on February 17, 2009. The purpose of the ARRA was to create jobs and promote economic recovery in the wake of the 2008 financial crisis. Section 1603 of the ARRA appropriated funds for payments to persons who place in service certain renewable energy projects during 2009, 2010 or 2011, or after 2011 if construction began during one of those years and the project was subsequently placed in service by a certain date. The Section 1603 Grant amount was based on a percentage of the "basis" of the project (30 percent, in the case of wind, biomass, solar, landfill gas and fuel cells, and 10 percent in the case of microturbines, combined heat and power and certain geothermal applications). The Section 1603 Grant was available in lieu of the ITC or the production tax credit (PTC) under Code Section 45, and had the added benefit of being a cash grant (compared with a non-refundable tax credit, like the ITC and PTC).
Pursuant to Treasury guidance released in 2009, the basis of property for purposes of the Section 1603 Grant is determined in accordance with the general rules for determining the basis of property for federal income tax purposes. Thus, the basis of property generally is its cost, and includes all items properly included by the taxpayer in the depreciable basis of the property, such as installation costs and the cost for freight incurred in construction of the specified energy property. The eligible basis of a qualified facility only includes costs relating to qualified property, and does not include the portion of the cost of the facility that is attributable to a non-qualifying activity. For example, for a biomass facility that burns fuel other than open-loop biomass or closed-loop biomass, the eligible cost basis is the percentage of total eligible costs that is equal to the percentage of the electricity produced at the facility that is attributable to the open-loop biomass and closed-loop biomass. In the case of costs that relate to both a non-qualifying activity and a qualifying activity, the costs must be reasonably allocated between the non-qualifying and qualifying activities. In subsequent guidance released in 2011, the Treasury indicated that power purchase agreements were ineligible assets for purposes of the Section 1603 Grant.
Background of the Alta Wind Case
Alta Wind is the owner of 11 wind farm facilities (Altas I through XI) near Los Angeles, California, which together comprise the largest wind center in North America. The wind projects at the center of the lawsuit were developed in two stages. In the first stage, Oak Creek Energy Systems (Oak Creek) and Allco Wind Energy Management Pty. Ltd. (Allco) financed the projects' development. During this stage, a subsidiary of Oak Creek and Allco entered into a Master PPA, which provided that all output would be sold to Southern California Edison (SCE) for a period of 24 years. The second stage commenced in July 2008, when Terra-Gen Power LLC (Terra-Gen) acquired Allco's US wind energy business, including the Alta Wind projects. Terra-Gen acquired the projects from Allco in mid-development, and thereafter sold the finished products to Plaintiffs prior to their placed-in-service dates. Of the 11 Alta facilities, Alta I through Alta VI are the subject of the lawsuit.
Terra-Gen thereafter continued development and construction work on the projects, at a total cost of more than $2 billion relating to Altas I through VI. Because Terra-Gen was ineligible for the Section 1603 Grant (because certain of its indirect owners were disqualified persons under the Section 1603 Grant rules), it sold the projects. Alta VI was sold in an outright sale in 2012 to EverPower. Altas I through V were sold in sale-leaseback transactions between December 2010 and June 2011 to Citi, GE, UBOC and additional investors. The projects were held by the purchasers through trusts and other special purpose vehicles, which entities are the plaintiffs in the litigation. In the case of Altas II through V, the purchase prices reflected only property that the parties deemed eligible for the Section 1603 Grant, and ineligible property was acquired pursuant to separate agreements. Under the purchase agreements, Terra-Gen agreed to indemnify the purchasers for the anticipated Section 1603 Grant amount based on the foregoing purchase prices (the Purchase Prices).
In their Section 1603 Grant applications, the Plaintiffs claimed pro rata allocations of eligible property among the Purchase Prices of Altas I and VI (93.1 percent and 96.9 percent, respectively). In particular, Plaintiffs calculated the percentage of construction and development costs related to eligible property at each facility, and then applied those percentages to each facility's Purchase Price to determine the eligible basis for those two facilities. Plaintiffs claimed basis in the amount of the entire Purchase Prices of Altas II through V, since the parties intended that those Purchase Prices reflected only eligible property. Thus, Plaintiffs' Section 1603 Grant applications were for amounts equal to 30 percent of the Purchase Prices, adjusted in Altas I and VI by pro rata allocations of eligible property. However, the Treasury only paid cash grants equal to 30 percent of Terra-Gen's construction and development costs for each facility. Plaintiff's filed their lawsuit in 2013 seeking reimbursement for the difference between those amounts.
Court of Federal Claims Decision
As discussed above, the Treasury had taken the position that, for purposes of the Section 1603 Grant, basis only includes development and construction costs of each facility. Plaintiff's position was that basis was equal to the Purchase Prices, minus reasonable allocations for ineligible property.
In its opinion, the court noted that both parties agreed that the Purchase Prices were higher than the mere costs of developing and assembling the facilities. It therefore focused the first half of its analysis on whether such excess reflected an eligible versus ineligible cost for purposes of the Section 1603 Grant. The court first considered whether some portion of the Purchase Prices constituted "goodwill" or "going concern value," in which case Code Section 1060 and the accompanying "residual method" under Code Section 338(b)(5) would apply in valuing the assets. Under the residual method, value is allocated on a waterfall basis among several categories of tangible and intangible assets, and the Treasury argued that much of the value in Altas I through VI would be allocated to ineligible intangible assets (such as goodwill or going concern value) if such method applied. The court noted that, at the time of the sale of the projects, (1) the facilities were not yet operational, (2) had lined up only one long-term customer (SCE) to buy the entirety of their electricity output for the foreseeable future and (3) were not capable of taking on any other customers, so that goodwill could not have yet attached. The court also rejected the Treasury's argument that goodwill attached because of the facilities' prime location. Likewise, the court held that there was no going concern value at the time of the sales because there was not yet a going concern as the facilities were not yet operational. Because there was neither goodwill nor going concern value at the time of the sales, neither Code Section 1060 nor the residual method applied to the sales of the transactions.
The court instead characterized the excess of the Purchase Prices over the sum of construction and development costs as "turnkey value," which it said "essentially describes value a facility has when it is ready for immediate use after purchase." Where a property has turnkey value, the court noted, its tangible assets are more valuable than they would have been if the facilities were not ready to operate.
The court then analyzed whether the Purchase Prices were an appropriate measure of the fair market value of the properties, noting that the Tax Court may look to other measures where the transaction was not conducted at arm's length by two economically self-interested parties or where a transaction is based on "peculiar circumstances" which influence the purchaser to agree to a price in excess of fair market value. "Peculiar circumstances" exist if the parties appear to be unduly manipulating the purchase price by entering into separate agreements at or near the time of purchase, causing the purchase price to be highly inflated. The court found that all of the Alta transactions occurred at arm's-length between sophisticated and self-interested parties, so it then considered whether there were any peculiar circumstances that resulted in a highly inflated purchase price. It concluded that no peculiar circumstances arose from the sale-leaseback transactions or related prepayments, the Section 1603 indemnities provided by Terra-Gen, or any of the other various side agreements to the transactions.
In the absence of peculiar circumstances that highly inflated the purchase prices, the court determined that the Purchase Prices were the appropriate starting place for determining basis for the Section 1603 Grant. With respect to Altas I and VI, the court had to determine if the pro rata allocation between eligible and ineligible property, as described above, was reasonable. The court noted that pro rata allocations are permissible in certain situations, and the percentages here appeared reasonable given that they were certified by a large accounting firm and were within industry standards (as testified to by Plaintiffs' expert witness).
The court also rejected the Treasury's argument that PPAs are intangible, ineligible property and should be classified as "customer-based intangibles" within the meaning of Code Section 197(d)(2)(A)(iii). If PPAs were so treated, their value would be excluded from the facilities' cost basis for determining the Section 1603 Grant amount. The court held that PPAs were more like land leases which should not be viewed as separate assets from the underlying facilities, and are thus eligible property for purposes of the Section 1603 Grant.
Based on the foregoing analysis, the court awarded damages to Plaintiffs of $206,833,364. The case, Alta Wind I Owner-Lessor C, Alta Wind I Owner-Lessor D, et al v. United States is available here. The US Department of Justice can appeal the case to the Federal Court.
GUSC Energy Decision
On November 8, 2016, the court issued another favorable decision in the Section 1603 Grant context. In GUSC Energy, Inc. v. United States, Plaintiff is the owner and operator of an open-loop biomass facility in New York state. The facility is a combined heat and power plant, and produces both steam heat and electricity for use at an associated business and technology park. Plaintiff had argued that the entire cost basis of the facility was eligible for the Section 1603 Grant. Although the Treasury agreed that all of the property in the facility was integral to the production of electricity, it reduced Plaintiff’s Section 1603 Grant because the facility produced both electricity and heat, the latter of which is not eligible for the Section 1603 Grant. Specifically, the Treasury determined that only 6.6 percent of the cost basis of the facility was eligible for the Section 1603 Grant, because only 6.6 percent of the facility’s total steam energy was converted to electricity. The court rejected both parties’ positions, and applied the “efficiency method” of allocation, which looks at the electricity generated by the facility relative to the electricity it would generate if it only generated electricity. Accordingly, the court determined that 15.24 percent of the cost basis of the facility was eligible for the Section 1603 Grant. The resulting grant amount was significantly less than the amount claimed by Plaintiff, but more than the initial award from the Treasury. The court awarded an additional $450,000 to Plaintiff based on this allocation method.Significance of the Decisions The decision in Alta Wind has obvious significance for the many renewable energy projects that received lower-than-expected payments under the Section 1603 Grant program, and is a welcomed result by the renewable energy industry in general. The court's decision is a strong rebuke to the Treasury's position on what constitutes eligible property basis, which left many Section 1603 Grant applicants with unexpectedly small payouts. The decision is also noteworthy because the court held that PPAs should not be treated as ineligible intangible property for purposes of the Section 1603 Grant. This decision is a welcomed affirmation of a long-held view by many in the renewable energy sector and is consistent with the basic economics of a renewable energy project. The decision may also serve as much-needed support for purposes of determining cost basis for purposes of the ITC under Code Section 48, where taxpayers have been concerned that the Internal Revenue Service could take a similarly limited view as to what costs and valuations will be taken into account for determining cost basis of renewable projects. The Alta Wind and GUSC Energy decisions also suggest a cautiously optimistic climate with respect to the Treasury’s earlier hair-cutting decisions in the Section 1603 Grant context.