2019 Deloitte Renewable Energy Seminar · 2019-07-15 · 2019 Deloitte Renewable Energy Seminar Powering a bright future October 2-4, 2019

2019 Deloitte Renewable Energy SeminarPowering a bright futureOctober 2-4, 2019

Tax hot topics –

Controversy and tax reform

Brian Americus, Deloitte Tax LLPTom Stevens, Deloitte Tax LLPDave Yankee, Deloitte Tax LLP

Copyright © 2019 Deloitte Development LLC. All rights reserved. 32019 Deloitte Renewable Energy Seminar

Section 163(j) business interest expense limitation

Proposed Section 451(b) and 451(c) regulations

Section 168(k) bonus depreciation

Tax Controversy – court cases, IRS audit observations, IRS guidance update

Partnership IRS audit rules

Contents


Section 163(j) business interest expense limitation


Section 163(j) overviewLimitation on deductibility of net business interest expense

Section 163(j) General rules

Section 163(j) applies to every business – regardless of its form – and disallows the deduction for business interest expense (“BIE”) in excess of the sum of:

(i) “business interest income” (“BII”),

(ii) 30% of the business’s “adjusted taxable income” (“ATI”), and

(iii) floor plan financing interest (“FPFI”)


Section 163(j) overview (cont.)Limitation on deductibility of net business interest expense

Adjusted taxable income is computed as taxable income without regard to:

− For all tax years

◦ Any item of income, gain, deduction, or loss which is not properly allocable to a trade or business,

◦ Any business interest or business interest income,

◦ The amount of any Section 172 net operating loss (NOL) deduction, and

◦ The amount of any deduction allowed under Section 199A related to qualified business income

− For tax years beginning before January 1, 2022

◦ Any deduction allowable for depreciation, amortization, or depletion

− Impact of the Proposed Regulations?

§ IRS takes the position that electricity is inventory

§ Taxpayers not adopting the Proposed Regulations…

§ How will the Final Regulations address amounts capitalized to inventory?


Determined at the partnership levelLimitation on deductibility of net business interest expense

ATI calculation at partnership level;Partnership determines if it has deductible

BIE, ETI, EBIE, and EBII

Partnership allocates deductible BIE,ETI, EBIE, and EBII, if any, to partners

using 11-step calculation

Partnership


Determined at the partnership level (cont.)Limitation on deductibility of net business interest expense

Defined terms

• Excess Taxable Income (“ETI”)

o Generally, amount of the partnership’s ATI in excess of the ATI needed to support the partnership’s interest deduction

• Excess Business Interest Expense (“EBIE”)

o If BIE is limited at the partnership level, partners receive an allocation of EBIE that is carried forward at the partner level.

o If a partnership has excess ATI (excess capacity to deduct interest), partners receive an allocation of ETI. ETI frees up EBIE previously allocated from that partnership and is included in the partner’s ATI.

o BIE that is deductible at the partnership level is taken into account in determining non-separately stated income or loss and is not subject to the section 163(j) limit at the partner level.

• Excess Business Interest Income (“EBII”)


Section 163(j) excepted trades or businessesLimitation on deductibility of net business interest expense

Excepted trades or businesses

• Trade or business of performing services as an employee

• Electing real property trade or business (“RPTOB”)

• Electing farming business

• Utility trade or business


Scope of regulated public utility exceptionsBonus depreciation eligibility and interest deduction limitation

• Section 163(j) statutory language

−The amount allowed as a deduction under this chapter for any taxable year for business interest shall not exceed . . .

−For purposes of this subsection, the term "business interest" means any interest paid or accrued on indebtedness properly allocable to a trade or business.

−The term "trade or business" shall not include . . .

• Trade or business v. entity v. asset

− Is a power plant that does not constitute “public utility property” for normalization purposes owned by a regulated, vertically-integrated utility part of a rate-regulated utility trade or business?

• Section 163(j)(7)

−Whether “rates . . . established or approved” has the same meaning in Section 163(j)(7) as it does for normalization purposes

−Significance of “public utility property” definitions under Section 167 and Section 46 regulations and private letter rulings

◦ PLRs 201544018, 201619005, 201718017, 201722006, 201825025, 201825026 and 201923019


Section 163(j)(7)(A)(iv) – utility industry exemption(7) TRADE OR BUSINESS.—For purposes of this subsection—(A) IN GENERAL.—The term ‘trade or business’ shall not include — . . .(iv) the trade or business of the furnishing or sale of—

(I) electrical energy, water, or sewage disposal services,(II) gas or steam through a local distribution system, or(III) transportation of gas or steam by pipeline,

if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, by a public service or public utility commission or other similar body of any State or political subdivision thereof, or by the governing or ratemaking body of an electric cooperative.

Prop. Reg. Sec. 1.163(j)-1(b)(13) (13) Excepted regulated utility trade or business--(i) In general. The term excepted regulated utility trade or business means a trade or business-- (A) That furnishes or sells:

(1) Electrical energy, water, or sewage disposal services; (2) Gas or steam through a local distribution system; or (3) Transportation of gas or steam by pipeline; and

(B) To the extent that the rates for the furnishing or sale of the items in paragraph (b)(13)(i)(A) of this section-- (1) Have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any State or political subdivision thereof and are determined on a cost of service and rate of return basis; or (2) Have been established or approved by the governing or ratemaking body of an electric cooperative.

TCJA definition of regulated utility trade or businessBonus depreciation and interest deduction limitation


Consolidated tax returnsLimitation on deductibility of net business interest expense

• Consolidated group

−The computations required by Section 163(j) and the proposed Section 163(j) regulations generally are made for a consolidated group on a consolidated basis

−The group (rather than a particular member) is treated as engaged in excepted or non-excepted trades or businesses

• Based on the principle that money is fungible

−Uses as asset basis approach to allocate interest expense, rejects tracing

• Intercompany debt transactions

− Intercompany obligations (as defined in Reg. Sec. 1.1502-13(g)(2)(ii)) would be disregarded for purposes of determining a member’s current-year business interest expense and business interest income and for purposes of calculating the consolidated group’s ATI

− Intercompany items and corresponding items (within the meaning of Reg. Sec. 1.1502-13(b)(2)(i) and (b)(3)(i), respectively) would be disregarded for purposes of calculating the group’s ATI to the extent those items offset in amount


Allocating interest expense and interest income between excepted and non-excepted trades or businesses

• Relative amounts of the taxpayer’s adjusted basis in the assets

−Non-depreciable property other than land

−Depreciable property other than inherently permanent structures – alternative depreciation system

−Land and inherently permanent structures

−Depreciable or amortizable intangible property and depreciable income forecast method property

−Partnership interests and stock in non-consolidated domestic corporations

• Assets not taken into account

−Self-created intangibles

−Assets not yet used in a trade or business (e.g., construction work in progress)

−Trusts established to fund specific liabilities

−Stock of subsidiaries


Special rule for land and inherently permanent structuresAllocating interest expense and interest income

• Prop. Reg. Sec. 1.163(j)-10(c)(5)(i)(C)

−Except as otherwise provided in paragraph (c)(5)(i)(E) of this section,* for purposes of this section, the adjusted basis of any asset that is land, including nondepreciable improvements to land, or an inherently permanent structure is its unadjusted basis.

• The term “inherently permanent structure” has the meaning provided in Reg. Sec. 1.856-10(d)(2)

−The term “inherently permanent structure” means any permanently affixed building or other permanently affixed structure. Affixation may be to land or to another inherently permanent structure and may be by weight alone. If the affixation is reasonably expected to last indefinitely based on all the facts and circumstances, the affixation is considered permanent. A distinct asset that serves an active function, such as an item of machinery or equipment, is not a building or other inherently permanent structure.

−Examples

◦ Solar energy site – land, photovoltaic modules (PV modules), mounts and an exit wire

◦ Pipeline transmission system – underground pipelines, isolation valves and vents, pressure control and relief valves, meters, and compressors

* Note – Construction work in progress is not taken into account.


Allocating interest expense and interest income between excepted and non-excepted trades or businesses (cont.)

• Asset used in more than one trade or business – allocate basis between/among trades or businesses

−Relative amounts of gross income that an asset generates, has generated, or may reasonably be expected to generate

− If the asset is land or an inherently permanent structure, the relative amounts of physical space used by the trades or businesses

− If the trades or businesses generate the same unit of output, the relative amounts of output of those trades or businesses

◦ Permissible method for allocating asset basis for utility trades or businesses. In the case of a utility trade or business described in paragraph (c)(3)(iii)(C)(1) of this section, and except as provided in the de minimis rule in paragraph (c)(3)(iii)(C)(3) of this section, the method described in paragraph (c)(3)(ii)(C) of this section is the only permissible method for allocating the taxpayer’s basis in assets used in the trade or business between the taxpayer’s excepted and non-excepted trades or businesses of selling or furnishing the items described in §1.163(j)-1(b)(13)(i)(A).

• Consistency requirement


Example — Prop. Reg. Sec. 1.163(j)-10(c)(3)(iii)(C)(4) Utility asset used in more than one trade or business

• (4) Example. The following example illustrates the principles of this paragraph (c)(3)(iii)(C):

i. Facts. X, a C corporation, is engaged in the trade or business of generating electrical energy. During each determination period in the taxable year, 80 percent of the kilowatts generated in the electricity generation trade or business is sold at rates established by a public utility commission on a rate of return basis. The remaining 20 percent of the kilowatts is sold on the wholesale markets at rates not established on a rate of return basis or by the governing or ratemaking body of an electric cooperative. None of the assets used in X’s utility generation trade or business are used in any other trade or business.

ii. Analysis. For purposes of section 163(j), under paragraph (c)(3)(iii)(C)(1) of this section, 80 percent of X’s electricity generation business is an excepted regulated utility trade or business, and the remaining 20 percent of X’s business is a non-excepted utility trade or business. Under paragraph (c)(3)(iii)(C)(2) of this section, X must allocate 80 percent of the basis of the assets used in its utility business to excepted trades or business and the remaining 20 percent of the basis in its assets to non-excepted trades or businesses.


Allocation of interest expense, interest income, and other itemsDe minimis exceptions provided by Prop. Reg. Sec. 1.163(j)-10

• Prop. Reg. Sec. 1.163(j)-10(c)(1)(ii) De minimis exception

− If 90 percent or more of the taxpayer’s basis in its assets for the taxable year is allocable to either excepted or non-excepted trades or businesses pursuant to this paragraph (c), then all of the taxpayer’s interest expense and interest income for that year that is properly allocable to a trade or business is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

• Prop. Reg. Sec. 1.163(j)-10(c)(3)(iii)(C)(3) De minimis rule for excepted utility trades or businesses

− If a taxpayer is engaged in a utility trade or business described in paragraph (c)(3)(iii)(C)(1) of this section, and if more than 90 percent of the items described in §1.163(j)-1(b)(13)(i)(A) are furnished or sold at rates determined in the manner described in §1.163(j)-1(b)(13)(i)(B), the taxpayer’s entire trade or business is an excepted regulated utility trade or business, and paragraph (c)(3)(iii)(C)(2) of this section does not apply.

• Prop. Reg. Sec. 1.163(j)-10(c)(3)(iii)(B)(2) De minimis amount of asset basis allocable to a trade or business

− If 90 percent or more of the taxpayer’s basis in an asset would be allocated to either excepted trades or businesses or non-excepted trades or businesses during a determination period pursuant to this paragraph (c)(3), the taxpayer’s entire basis in the asset for the determination period must be allocated to either excepted or non-excepted trades or businesses, respectively.


Utility industry discussion items – After issuance of the proposed regulationsLimitation on deductibility of net business interest expense

• Allocations for assets employing market-based rates and traditional ratemaking

• Is any indebtedness considered qualified nonrecourse indebtedness within the meaning of Reg. Sec. 1.861-10T(b) that must directly allocate?

• Computing adjusted tax basis under the alternative depreciation system

• Are electric distribution and generation plant considered inherently permanent structures as defined?

• Computing adjusted taxable income for excepted businesses and businesses subject to the limitation

• No depreciation addback for depreciation capitalized to inventory

• Deemed assets sale taxpayer was eligible to make an election but was actually or effectively precluded from doing so by a regulatory agency with respect to an excepted regulated utility trade or business

• How to apply the 90/10 de minimis tests

− Interaction with the Section 168(k) bonus depreciation


Proposed section 451(b) and 451(c) regulations


AgendaProposed section 451(b) and 451(c) regulations

• Overview of revenue recognition for tax purposes

• Section 451(b) amendments and proposed regulation section 1.451-3

• Section 451(c) amendments and proposed regulation section 1.451-8

• 2018 tax return preparation


Tax analysisRevenue recognition

• Whether an item is taxable or excludable

−Section 61 and related provisions

−Exclusion provisions and case law

−Amended returns, affirmative claims

• If taxable, when is it included in income?

−Section 451 and related provisions

−Form 3115, Application for Change in Accounting Method


General timing rules – Historical analysisRevenue recognition for accrual basis taxpayers

• Section 451(a) provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period

• All-events test under Reg. Sec. 1.451-1(a) for accrual basis taxpayers

−All the events have occurred which fix the right to receive such income

◦ Rev. Rul. 74-607 provides that income fixes upon the earliest of

−Payment is received

−Payment is due

−Required performance takes place

−When goods are shipped, delivered, or accepted

−As services are provided

−Amount can be determined with reasonable accuracy


Amendments to section 451(b) by the Tax Cuts and Jobs ActRevenue recognition for accrual basis taxpayers

• Section 451(a) provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period

• Section 451(b)(1) requires accrual basis taxpayers with an applicable financial statements (AFS) to recognize income no later than the taxable year in which such income is taken into account as income on the taxpayer’s AFS (the AFS income inclusion rule)

• Section 451(b)(2) provides that the AFS income inclusion rule does not apply with respect to any item of gross income for which the taxpayer uses a special method of accounting provided under any other provision of IRC Sections 1 – 1400Z-2, other than specific provisions related to certain debt instruments

• Taxpayers with contracts containing multiple “performance obligations” will allocate the transaction price to each performance obligation in accordance with financial statement treatment

−Appears to be a conforming provision to Accounting Standards Codification 606

• Effective for the taxable year beginning after December 31, 2017


Amendments to section 451(c) by the Tax Cuts and Jobs Act Revenue recognition for accrual basis taxpayers

• Provides an election to apply the deferral method is made with respect to a category of advance payments in the year in that category of advance payments is first received and is effective in that year and prospectively

− Irrevocable election with respect to that category of advance payment

−Essentially codifies the deferral method of accounting for advanced payments for goods and services currently provided under Rev. Proc. 2004-34

◦ AFS deferral method

◦ Non-AFS deferral method

• Effective for the taxable year beginning after December 31, 2017


Former Reg. Sec. 1.451-5Amendments to section 451 by the tax cuts and jobs act

• Final regulations remove Reg. Sec. 1.451-5, and its cross-references, relating to the treatment of advance payments for goods and long-term contracts under IRC Section 451

• October 15, 2018 – notice of proposed rulemaking published (REG-104872-18) in the Federal Register (83 FR 51904) containing proposed regulations under IRC Section 451 (proposed regulations)

−Proposed applicability date – The removal of these regulations would apply as of the date the Treasury decision adopting this notice of proposed rulemaking is published in the Federal Register.

• July 11, 2019 – final regulations (T.D. 9870) released removing Reg. Sec. 1.451-5

−This document contains final regulations that streamline IRS regulations by removing regulations that are no longer necessary after the enactment of recent tax legislation. Specifically, these final regulations remove existing regulations regarding advance payments for goods and long-term contracts. These final regulations affect accrual method taxpayers who receive advance payments for goods, including those for inventoriable goods.

−Effective/applicability date – final regulations apply for taxable years ending on or after July 15, 2019


Rev. Proc. 2019-37Procedural guidance for making method changes to comply with sections 451(b) and (c)

• Statutory language, Notice 2018-35 and Rev. Proc. 2018-60

• Rev. Proc. 2019-37 modifies the method change guidance for changes to comply with section 451(b) proposed regulations (previously added by Rev. Proc. 2018-60)

−Permits change to be made on a cut-off basis or with section 481(a) adjustment

−Provides back-year audit protection for taxpayers under exam

◦ However, section 481(a) spread period determined as if no audit protection

• Rev. Proc. 2019-37 provides automatic consent to change to proposed section 451(c) regulations

−Permits change to be made on a cut-off basis or with section 481(a) adjustment

−Provides back-year audit protection for taxpayers under exam

◦ However, section 481(a) spread period determined as if no audit protection

• The proposed regulations will be effective when published as final regulations, but the proposed regulations are reliance guidance


The first financial statement listed is the AFSApplicable financial statements for purposes of sections 451(b) and 451(c)

• A financial statement which is certified as being prepared in accordance with US GAAP and which is—

−A Form 10–K required to be filed by the taxpayer with the US Securities and Exchange Commission,

−An audited financial statement of the taxpayer which is used for—

◦ Credit purposes,

◦ Reporting to shareholders, partners, or other proprietors, or to beneficiaries, or

◦ Any other substantial nontax purpose,

◦ But only if there is no SEC Form 10-K, or

−Filed by the taxpayer with any other Federal agency for purposes other than Federal tax purposes

• A financial statement which is made on the basis of international financial reporting standards (IFRS) and is filed by the taxpayer with an agency of a foreign government, or

• A financial statement filed by the taxpayer with any other regulatory or governmental body specified by the Secretary

−Proposed regulations – also includes a state government, state agency or a self-regulatory organization


Coordination with special methods of accounting – Section 451(b)(2)AFS inclusion rule

• Statutory language – “. . . shall not apply with respect to any item of gross income for which the taxpayer uses a special method of accounting provided under any other provision of this chapter, other than . . .”

• Committee reports – “The Committee intends that the financial statement conformity requirement added to section 451 not be construed as preventing the use of special methods of accounting provided elsewhere in the Code, other than . . . . For example, it does not preclude the use of the installment method under section 453 or the use of long-term contract methods under section 460.”

• JCT Blue Book – “Congress has prescribed the proper time for including sales, gross receipts, and other items of income in gross income by providing special methods of accounting774 for such items in the Code. For example, Congress has provided special methods of accounting for (i) amounts received by accrual method taxpayers in the year of the taxpayer’s death, (ii) employee tips, (iii) crop insurance proceeds and disaster payments, (iv) proceeds from livestock sold on account of drought, flood, or other weather-related conditions, (v) income from the sale or furnishing of utility services, (vi) interest on frozen deposits in certain financial institutions, (vii) qualified prizes including a cash option, and (viii) sales or dispositions to implement Federal energy regulatory commission or State electric restructuring policy.775 Congress has also prescribed the proper time for including gross profit from installment sales,776 prepaid subscription income, 777 prepaid membership dues, 778 and adjustments for certain returned merchandise779 in gross income. In addition, Congress has prescribed the proper time for including in gross income any income from certain long-term contracts780 and rental income from certain arrangements for the use of property or services.781“


Coordination with special methods of accounting – Section 451(b)(2) (cont.)AFS inclusion rule

• Proposed regulations – The following are examples of special methods of accounting to which the AFS income inclusion rule generally does not apply:

−Crop method of accounting

−Methods provided in §§453 through 460

−Hedging transactions under §1.446-4

−REMIC inducement fees under §1.446-6

−Gain on shares in a money market fund under §1.446-7

−Section 467 rental payments

−Section 475 mark-to-market method

−Specific timing rules for income and gain associated with a transaction that is nonfunctional currency under §1.988-5 or contingent payment debt instrument rules under §1.988-5

−Specific timing rules for original issue discount, contingent payment debt instruments, variable rate debt instruments, inflation-indexed debt instruments, de minimis market discount, accrued market discount

−Consolidated return methods provided in sections 1502 and 1503, including the method of accounting relating to intercompany transactions under §1.1502-13.


451(h) Special rule for utility servicesUnbilled revenue

451(h)(1) In general — In the case of a taxpayer the taxable income of which is computed under an accrual method of accounting, any income attributable to the sale or furnishing of utility services to customers shall be included in gross income not later than the taxable year in which such services are provided to such customers.

451(h)(2) Definition and special rule — For purposes of this subsection —

A. Utility services — The term "utility services" includes –

i. the providing of electrical energy, water, or sewage disposal,

ii. the furnishing of gas or steam through a local distribution system,

iii. telephone or other communication services, and

iv. the transporting of gas or steam by pipeline.

B. Year in which services provided — The taxable year in which services are treated as provided to customers shall not, in any manner, be determined by reference to —

i. the period in which the customers' meters are read, or

ii. the period in which the taxpayer bills (or may bill) the customers for such service.


Examples of utility industry transactionsAdvance receipts for goods and/or services

• Budget billing arrangements

• Long-term prepayments under purchased power agreements

− Industrial customers

−Governmental customers


Tax analysis (through 2017) Advance receipts for utility goods and/or services

• Is the prepayment for goods, services or bundled goods and services

−Examples of goods — electricity gas

−Examples of services — distribution, transmission

• Financial reporting – deferral

• Tax reporting

−Former Reg. Sec. 1.451-5 — applied to goods

◦ Full inclusion method, income deferral method or inventoriable goods exception

−Rev. Proc. 71-21 — applied to services

◦ Deferral of gross income if services must be performed by the end of the tax year immediately after the year of receipt

−Rev. Proc. 2004-34 (modifies and supersedes Rev. Proc. 71-21) — applies to both goods and services

◦ One-year deferral for agreements extending beyond the year following year of receipt


• Services

• Sale of goods

• Use, including by license or lease, of intellectual property

• Occupancy or use of property if the occupancy or use is ancillary to the provision of services (e.g., hotel rooms, booth space at a trade show)

• Sale, lease, or license of computer software

• Guaranty or warranty contracts ancillary to an item or items described above

• Subscriptions in tangible or intangible format unless a Section 455 election is in effect

• Memberships in an organization unless a Section 456 election is in effect

• Eligible gift card sale

• Any other payment specified by the Secretary in other guidance published in the Internal Revenue Bulletin, or

• Any combination of items described

Payments within the scope of the proposed section 451(c) regulationsAdvance payments for goods, services, and other items


Payments excluded from the scope of the proposed section 451(c) regulationsAdvance payments for goods, services, and other items

• Rent, except for amounts paid with respect to intellectual property, occupancy or use of property ancillary to the provision of services or the sale/lease/license of software

• Insurance premiums, to the extent the inclusion of those premiums is governed by subchapter L

• Payments with respect to financial instruments (for example, debt instruments, deposits, letters of credit, notional principal contracts, options, forward contracts, futures contracts, foreign currency contracts, credit card agreements (including rewards or loyalty points under such agreements), financial derivatives, or similar items), including purported prepayments of interest

• Payments with respect to service warranty contracts for which the taxpayer uses the accounting method provided in Revenue Procedure 97-38

• Payments with respect to warranty and guaranty contracts under which a third party is the primary obligor;

• Payments subject to section 871(a), 881, 1441, or 1442

• Payments in property to which section 83 applies

• Payments received in a taxable year earlier than the taxable year immediately preceding the taxable year of the contractual delivery date for a specified good


2018 tax reportingAmendments to section 451

• Companies that used the deferral method under Regulation Section 1.451-5 in prior years

• Deferral election under Section 451(c)(1)(B)

−Section 451(c)(2)(a) provides that, except as otherwise provided in this paragraph, the election under Section 451(c)(1)(B) shall be made at such time, in such form and manner, and with respect to such categories of advance payments, as the Secretary may provide

−The preamble to the proposed Section 451(c) regulations indicates that the Treasury Department and the IRS anticipate that these proposed regulations would require an accrual method taxpayer that receives an advance payment and chooses to make an election to use the deferral method described in proposed §1.451-8(c) or (d) to file a Form 3115 to change the method of accounting to comply with these proposed regulations

• AFS income inclusion method under Section 451(b)

−Form 3115 under Rev. Proc. 2019-37


Section 168(k) bonus depreciation


AgendaSection 168(k) bonus depreciation

• Overview

• Proposed regulations – August 2018

• Final regulations – September 2019

• Proposed regulations – September 2019

• Analysis of project with construction or acquisition before September 28, 2017


Major developments since late 2017Bonus depreciation

• Tax Cuts and Jobs Act (P.L. 115-97) – enacted December 22, 2017

−Effective dates tied to September 27, 2017

• Tax Technical Corrections Act of 2018 (Consolidated Appropriations Act, 2018) (P.L. 115-141) – enacted March 23, 2018

−Clarification of Section 168(k) amendments by the Protecting Americans from Tax Hikes Act of 2015

−Affects bonus depreciation recovery percentages for 2018-2020 additions with construction beginning before September 28, 2017

• Proposed regulations issued August 3, 2018

−Written or electronic comments and requests for a public hearing were due by October 9, 2018

−Public hearing held November 28, 2018

• Rev. Proc. 2019-33 issued July 31, 2019

• Final regulations issued September 13, 2019

• Proposed regulations issued September 13, 2019

−Written or electronic comments must be received by November 25, 2019

−Public hearing scheduled for November 13, 2019, unless no requests to testify are received by October 23, 2019


• 2001-2004 — 30/50 percent bonus depreciation

• 2008-September 27, 2017 — 50 percent bonus depreciation

−2010-2011 — 100 percent bonus depreciation

• After September 27, 2017

* Reflects the general rules, not the transitional guidance under each depreciation system

Bonus depreciation dates and rates*

−Rate-regulated utilities

◦ 100% expensing for property acquired after September 27, 2017, and placed in service in a tax year beginning before January 1, 2018

◦ 50%-40%-30% phase-down for property acquired before September 28, 2017, and placed in service in 2017-2019 (generally)

−Longer production period property (2018-2020)

−Other taxpayers

◦ 100% expensing through 2022 with phase-downs through 2026 (generally)

−Longer production period property (2023)

◦ 80%-60%-40%-20% phase-down for additions in 2023 2026 (generally)

−Longer production period property (2024-2027)


Longer production period property (LPPP)Bonus depreciation

• Key criteria from the definition of longer production period property

−Recovery period of at least 10 years or transportation property,

−Subject to Section 263A, and

− Interest capitalization criteria

◦ Estimated production period > 2 years OR

◦ Estimated production period > 1 year AND cost > $1 million

• Purpose of the rule


LPPP prior to the Tax Technical Corrections Act of 2018Bonus depreciation

Placed in service Recovery percentage (general rule) Recovery percentage (LPPP)

2018 40 percent No special rule for LPPP (40 percent)2019 30 percent 40 percent for LPPP to the extent of the adjusted basis

thereof attributable to manufacture, construction, or production before January 1, 2019

2020 No bonus depreciation 30 percent for LPPP to the extent of the adjusted basis thereof attributable to manufacture, construction, or production before January 1, 2020, no bonus depreciation for remainder

Section 168(k)(6) as in effect on the day immediately before enactment of the TCJA


LPPP after the Tax Technical Corrections Act of 2018Bonus depreciation

• Amendment to Section 168(k)(6) by Tax Technical Corrections Act of 2018

−TTCA Section 101(d)(3) – For purposes of applying section 168(k) of the Internal Revenue Code of 1986, as in effect on the day before the date of the enactment of the TCJA, with respect to property acquired before September 28, 2017, paragraph (6) thereof shall be treated as reading as follows (and as having been included in section 143 of the Protecting Americans from Tax Hikes Act of 2015):

Placed in service Recovery percentage (general rule) Recovery percentage (LPPP)

2018 40 percent 50 percent2019 30 percent 40 percent2020 No bonus depreciation 30 percent for LPPP to the extent of the adjusted basis

thereof attributable to manufacture, construction, or production before January 1, 2020, no bonus depreciation for remainder


Regulated public utility exceptions – IRC Section 168(k)(9) cross-reference to IRC section 163(j)(7)(A)(iv)

TCJA effective dates

IRC Section 168(k)(9) EXCEPTION FOR CERTAIN PROPERTY.—

The term ‘qualified property’ shall not include—

(A) any property which is primarily used in a trade or business described in clause (iv) of section 163(j)(7)(A) . . .

TCJA Section 13301(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2017.

TCJA Section 13201(h) EFFECTIVE DATE.—

(1) IN GENERAL.—Except as provided by paragraph (2), the amendments made by this section shall apply to property which—

(A) is acquired after September 27, 2017, and

(B) is placed in service after such date.

For purposes of the preceding sentence, property shall not be treated as acquired after the date on which a written binding contract is entered into for such acquisition.

(2) SPECIFIED PLANTS.—The amendments made by this section shall apply to specified plants planted or grafted after September 27, 2017.


Post-2017 additions with pre-September 28, 2017 constructionBonus depreciation for regulated utilities

• Proposed Regulation Section 1.168(k)-2(c)(7)(i)

(i) Example 1. (A) BC, a calendar year taxpayer, is engaged in a trade or business described in section 163(j)(7)(A)(iv). In December 2015, BC decided to construct an electric generation power plant for its own use. This plant is property described in section 168(k)(2)(B) as in effect on the day before the date of the enactment of the Act. However, the turbine for the plant had to be manufactured by another person for BC. In January 2016, BC entered into a written binding contract with CD to acquire the turbine. BC received the completed turbine in August 2017 at which time BC incurred the cost of the turbine. The cost of the turbine is 11 percent of the total cost of the electric generation power plant to be constructed by BC. BC began constructing the electric generation power plant in October 2017 and placed in service this new power plant, including all component parts, in 2020.

(B) BC uses the safe harbor test in §1.168(k)-1(b)(4)(iii)(B)(2) to determine when physical work of a significant nature begins for the electric generation power plant. Because the turbine that was manufactured by CD for BC is more than 10 percent of the total cost of the electric generation power plant, physical work of a significant nature for this plant began before September 28, 2017. None of BC’s expenditures for components of the power plant that are acquired or self-constructed after September 27, 2017, are eligible for the election specified in this paragraph (c) because the power plant is described in section 168(k)(9)(A) and paragraph (b)(2)(ii)(F) of this section and, therefore, are not eligible for the election pursuant to paragraph (c)(2)(ii)(D) of this section. Assuming all requirements are met under section 168(k)(2) as in effect on the day before the date of the enactment of the Act, the unadjusted depreciable basis of the power plant, including all components, attributable to its construction before January 1, 2020, is eligible for the 30-percent additional first year depreciation deduction pursuant to section 168(k)(8).


• Election out of bonus depreciation – Section 168(k)(7)

• In the case of qualified property placed in service by the taxpayer during the first taxable year ending after September 27, 2017, if the taxpayer elects to have this paragraph apply for such taxable year, paragraphs (1)(A) and (5)(A)(i) shall be applied by substituting "50 percent" for "the applicable percentage“ – Section 168(k)(10)

−A taxpayer may make an election to deduct 50 percent, instead of 100 percent, additional first year depreciation for all qualified property acquired after September 27, 2017, by the taxpayer and placed in service by the taxpayer during its taxable year that includes September 28, 2017 – Prop. Reg. Sec. 1.168(k)-2(e)(3)

−Because section 168(k)(10) does not state that the election may be made “with respect to any class of property” as stated in section 168(k)(7) for making the election out of the additional first year depreciation deduction, the proposed regulations provide that the election under section 168(k)(10) applies to all qualified property

−The election is made separately by each person owning qualified property (for example, for each member of a consolidated group by the common parent of the group, by the partnership, or by the S corporation)

−Applies to all qualified property (not by class of property)

• Election to 150 percent declining balance depreciation – Section 168(b)(2)(C)

• Election to use straight-line depreciation – Section 168(b)(3)(D)

• Election to use ADS depreciation – Section 168(g)(7)

MACRS and bonus depreciation elections for 2017


Overview of Revenue Procedure 2019-33MACRS and bonus depreciation elections for 2017

• Commentators to the proposed Section 168(k) regulations requested relief to make late elections under section 168(k) because some taxpayers had already filed their federal tax returns for that tax year before the proposed regulations were issued or may not have had enough time to analyze the proposed regulations to make a timely election

−Section 168(k)(5) allows a taxpayer to elect to deduct additional first-year depreciation for any specified plant that is planted or grafted after September 27, 2017, and before 2027

−Under Section 168(k)(7), a taxpayer may elect not to deduct the additional first-year depreciation for all qualified property that is in the same class of property and placed in service by the taxpayer in the same tax year

−Section 168(k)(10) allows a taxpayer to elect to deduct 50 percent, instead of 100 percent, additional first-year depreciation for all qualified property acquired and placed in service by specified dates


Potential changesRevenue Procedure 2019-33

• Rev. Proc. 2019-33 allows a taxpayer to make a late election, or to revoke an election, under Section 168(k) for property acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer during its year that includes September 28, 2017

• Taxpayers that want to effectuate the late election or revocation by filing an amended return (or Administrative Adjustment Request (AAR) by a partnership subject to the centralized audit regime of the Bipartisan Budget Act of 2015 (BBA) must file the amended return (or AAR by a BBA partnership) before the taxpayer files its return for the first taxable year succeeding its 2016 or 2017 tax year

• Taxpayers are also permitted to revoke or make late elections under sections 168(k)(5), 168(k)(7), and/or 168(k)(10) by filing a method change

−This change is only available for a taxpayer’s first, second, or third tax year succeeding the its 2016 or 2017 tax year

• Deemed elections

−A taxpayer is treated as having made a timely election not to claim 100% bonus depreciation for a class of property under Section 168(k)(7) in specific situations

−A taxpayer is treated as having made a timely election to claim 50% in lieu of 100% bonus depreciation under Section 168(k)(10) in specific situations


Pre-TCJA bonus depreciation

• Codified acquisition date requirement until the Protecting Americans from Tax Hikes Act of 2015

• Written binding contracts

−Liquidated damages

−Conditions not within the control of either party or a predecessor

−Options

−Supply agreements

−Components

Post-TCJA bonus depreciation

• Non-codified acquisition date in TCJA Section 13201(h) effective date provision

• Written binding contracts

−Liquidated damages

−Conditions not within the control of either party or a predecessor

−Options

−Letter of intent

−Supply agreements

−Components

Acquisition date requirement for acquired propertyBonus depreciation effective dates


Written binding contracts – 2019 final and proposed regulationsAcquisition date requirement for acquired property

• Final regulations

−The acquisition date of property acquired pursuant to a written binding contract is the later of:

◦ Date contract is entered into,

◦ Date contract is enforceable under state law,

◦ Date all cancellation periods end, or

◦ Date all contingency clauses are satisfied.

◦ A cancellation period is the number of days under the contract terms for any party to cancel the contract without penalty

◦ A contingency clause is a condition or action within the control of the party or predecessor

− If a contract has multiple provisions that limit damages, only the provision with the highest damages is taken into account in determining whether the contract limits damages

• Proposed regulations

−The acquisition date of property acquired pursuant to a contract that is not a written binding contract is the date on which the taxpayer paid or incurred more than 10 percent of the total cost of the property, excluding the cost of any land and preliminary activities such as planning and designing, securing financing, exploring, or researching

◦ Same rule as the safe harbor provided in Reg. Sec. 1.168(k)-2(b)(5)(iv)(B)(2)



• Prop. Reg. Sec. 1.168(k)-2(b)(5) Acquisition of property

(ii) Acquisition date.—

. . . Property that is manufactured, constructed, or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business or for its production of income is acquired pursuant to a written binding contract. . . .


• Reg. Sec. 1.168(k)-2(b)(5) Acquisition of property

(ii) Acquisition date.—(A) In general

. . . Property that is manufactured, constructed, or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business or for its production of income is not acquired pursuant to a written binding contract but is considered to be self-constructed property under this paragraph (b)(5). . . .

Property produced for the taxpayer by another person under a written binding contract Acquisition date requirement


• Reg. Sec. 1.168(k)-1(b)(4)(iii) Self-constructed property

(A) In general.—

. . . Property that is manufactured, constructed, or produced for the taxpayer by another person under a written binding contract (as defined in paragraph (b)(4)(ii) of this section) that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business (or for its production of income) is considered to be manufactured, constructed, or produced by the taxpayer. . . .

• PLRs 201210004, 201214003 and 201313012



• Pre-PATH statutory rules for self-constructed property applicable to December 31, 2007, and January 1, 2014

• Reg. Sec. 1.168(k)-1(b)(4)(ii)(E) and (iii)(C)(1)

−Components acquired (or for which construction began) before the applicable date, but construction of the larger self-constructed property began after the applicable date

−Construction of larger self-constructed property began before the applicable date but components acquired (or construction of components began) after the applicable date.

• Component examples included turbines and power plants

• Rev. Proc. 2011-26 component election


• Statutory rules for self-constructed property applicable to January 1, 2027

• Prop. Reg. Sec. 1.168(k)-1(b)(5)(iii)(F) and (iv)(C)

−Components acquired (or for which construction began) before the applicable date, but construction of the larger self-constructed property began after the applicable date

−Construction of larger self-constructed property began before the applicable date but components acquired (or construction of components began) after the applicable date.

• Component election in the 2019 proposed regulations

Acquisition date requirement for self-constructed propertyBonus depreciation


• The 2019 Proposed Regulations permit taxpayers to elect to treat one or more components of a larger self-constructed property are that acquired or self-constructed after September 27, 2017, as eligible for 100% bonus depreciation

−Larger unit of property must be eligible for bonus depreciation under pre-TCJA law

−Applies to components acquired pursuant to a written binding contract entered into after September 27, 2017

−Acquisition date determined using rules for self-constructed property

− Installation costs (including labor) to install a component of a larger self-constructed property are eligible for bonus depreciation only if the components being installed meet the component election eligibility requirements

• Bonus depreciation for the component is determined by multiplying the basis in the component by the bonus depreciation percentage for the placed-in-service taxable year of the larger self-constructed property

• Election made by attaching statement to the timely-filed return (including extensions) for the placed in service year

− Include affirmative statement and whether the election is for one or more component(s)

• Election is made separately by each person that owns qualified property (e.g., each member of a consolidated group)

Component electionAcquisition date requirement


• The component election under the 2019 proposed regulations does not apply to larger acquired or self constructed property that is—

−Placed in service before September 28, 2017,

−Placed in service after December 31. 2019 (or December 31, 2020 for certain LPP or transportation property),

−Not original use property under pre-TCJA section 168(k),

−Described in section 168(k)(9) (includes rate-regulated utilities),

−Described in section 168(g)(1)(F) (electing farming business) or section 168(g)(8) (electing real property trade or business),

−Qualified improvement property, or

−Any property included in any class of property that taxpayer made an election not to claim bonus depreciation

Component election (continued)Acquisition date requirement


ExampleComponent election in the 2019 proposed regulations

In August 2017, X, a calendar-year taxpayer, entered into a written binding contract with Y for Y to manufacture a locomotive for X for use in its trade or business. Before September 28, 2017, X incurred $500,000 of expenses for the locomotive, which is more than 10% of the total cost of the locomotive. After September 27, 2017, X incurred $4,000,000 of expenses for components of the locomotive. These components were acquired or self-constructed after September 27, 2017. In February 2019, Y delivered the locomotive to X and X placed it in service. The total cost of the locomotive is $4,500,000. The locomotive is property described in Section 168(k)(2)(B) as in effect on the day before the date of the enactment of the TCJA. On its timely-filed 2019 U.S. federal income tax return, X made the Component Election.

X uses the 10% safe harbor to determine when physical work of a significant nature begins for the locomotive. Because X had incurred more than 10% of the total cost of the locomotive before September 28, 2017, physical work of a significant nature for this locomotive began before September 28, 2017. Because X made the Component Election, the cost of $4,000,000 for the locomotive’s components acquired or self-constructed after September 27, 2017, qualifies for 100% bonus depreciation, assuming all other requirements are met. The remaining cost of the locomotive is $500,000 and such amount qualifies for 40% bonus depreciation.


Analysis of post-9/27/17 additionsBonus depreciation

• Tax analysis

−Does all of the basis qualify for 100% bonus depreciation? Does any of the basis qualify for 100% bonus depreciation?

−Property constructed for the taxpayer under a contract with construction beginning after the date of the binding contract

− Identification of components and written binding contracts for components and the larger self-constructed property

−Materials and supplies, construction work in progress, off-site construction of components

−When did construction of the larger self-constructed property begin?

−Coordination with Section 45 production tax credit and Section 48 investment tax credit begun construction rules

− Is the asset longer production period property?

Construction work in progress balance

9/27/2017 12/31/2022

Placed into service

Materials and supplies on hand Contract to acquire asset

or components

Construction is completed


Tax controversy trends


Section 1603 grant controversyTax controversy trends

• Many taxpayers were challenged on Section 1603 grant requests

• Issues raised by Treasury

−Valuation

−Purchase price allocations

−Eligible basis

−Development fees

−Affiliated party transactions

• Projects awarded grants on a “cost-plus” basis

• Treasury white paper “Evaluating Cost Basis for Photovoltaic Properties”

−“While appropriate markups are case-specific and can depend on the ultimate transaction price, the 1603 review team has found that appropriate markups typically fall in the range of 10 to 20 percent.”


IRS audits Tax controversy trends

• Starting to see more audit activity, particularly solar ITC

• Issues raised by IRS

−Reconciling 1603 grant award “haircuts” with the ITC claimed on substantially similar installations

−Understanding tax equity structures

−Valuation

−Purchase price allocations

−Eligible basis

−Development fees

−Affiliated party transactions

• Long process/multiple IDRs

• Unlike 1603 grant program hazards of litigation must be taken into account by IRS (at least at the Appeals level)


• Tax Structure Risk – NO

• Begun Construction Risk – NO

• ITC Basis Risk - YES

• Fair Market Value

• Development fee

• Affiliated party transactions

• Eligible basis

• ITC Recapture Risk – YES, but only to the extent attributable to actions undertaken by the Sponsor

Typical tax indemnities provide by sponsor


Court cases - 1603 Grant litigation


California Ridge Wind Energy, LLC, et al. v. United States; No. 14-250; and Bishop Hill Energy, LLC, et al. v. United States; No. 14-251.

1603 Grant litigation

Background

• California Ridge and Bishop Hill are both wind projects developed by Invenergy. Invenergy sued the government alleging it was owed more Section 1603 grant awards than were paid. The government countersued alleging the projects received more 1603 grant awards than were entitled to.

• The cases went to trial in July 2018 in the Court of Federal Claims and the trial judge ruled in favor of the government.

Facts

• In 2012 Bishop Hill and California Ridge placed $433 and $456 million wind facilities into service and applied for 1603 grants of approximately $129 million and $136 million respectively, which represented 30% of the eligible basis. $60 million and $50 million developments fees were included in the eligible basis for the grant.

• The Treasury Department awarded $127 million and $124 million in grants respectively, approximately $9 and $12 million less than was sought. Treasury stated it believed the cost basis was higher than similarly sized projects and the beneficiary of some of the transactions were related parties.

• California Ridge and Bishop Hill sued for the difference. The government countersued for $5.6 and $4.3 million in overpayments alleging “sham transactions.”


California Ridge and Bishop Hill (cont.)1603 Grant litigation

Takeaways from the Case1. The Government Believes Determining Development Fees is a Science not an Art

− During the trial the government stated it believes development fees are for verifiable costs only and not for capturing added value.

− Invenergy maintained development fees are to capture added value and are “more of an art than science.”

“It seems to me that one of the key issues here… is a substantial difference in the understanding of the parties…The United States, I believe, has taken the position that the development fee is just like any other fee, that in order to – for it to be legitimate, the Plaintiff has to show that it actually represented some particular costs or charges or fees that you might get an invoice for, and, ideally, you could actually produce that invoice. The Plaintiff, I believe, has a much more general view of this indirect cost in that it's, as we've generally, variously described it, a value added to the project, and that's simply -- I mean, those positions are irreconcilable in my mind… in the Government's view, it's a real cost. It's not indirect. It's just a real cost, as anyone else would pay to a consultant and in response to a bill, based on their time or whatever measure, and I believe that the Plaintiff -- the Plaintiffs view it…much less formally.”

- United States Court of Federal Claims Judge Robert Hodges during the trial.



2. Quantify as Much of the Development Fee as Possible− Judge Hodges noted in his opinion the lack of quantifiable services in the development agreement as one of the main reasons he found against California Ridge and Bishop Hill.◦ During the trial the Judge asked Invenergy to quantify the cost of each development service provided, and if those costs were totaled to arrive at the number provided to Treasury.

◦ Invenergy explained that it arrived at the amount of fees based on marketplace input, Invenergy’s experience, and past Treasury guidance.

3. Inconsistent Use of Development Fees Can Be a Problem− Invenergy did not produce satisfactory evidence of any projects prior to the 1603 program that used development fees according to the Court, which led the Court to believe the fees were created to increase eligible basis.



4. Development Agreements Signed After the Fact Could Be a Red Flag For the Government − The government stated during the trial that is would question a development services agreement signed after the majority of the development work was completed. In California Ridge, development began in 2008 but the development services agreement wasn’t signed until 2012.

5. The Judge and Government Questioned the Movement of the Funds in These Projects− The government stated during the trial that the direction in which the funds flowed caused it concern.◦ In California Ridge, there were 3 wire transfers all on November 19, 2012.− Transfer 1: Wire transfer of $50 million from Invenergy Wind Development North America to Bishop Hill.

− Transfer 2: Immediate wire transfer of $50 million from Bishop Hill energy to Invenergy Wind North America.

− Transfer 3: Immediate wire transfer of $50 million from Invenergy Wind North America back to Invenergy Wind Development North America.


Alta wind update1603 Grant litigation

Background

• The Alta Wind Energy Center contains six wind facilities. Alta Wind applied for 1603 grant awards for the facilities and alleged the government underpaid by more than $206 million.

• At the trial level, Alta Wind argued that basis meant the purchase price of their wind power facilities less small allocations for ineligible property, such as, land and energy transmission lines.

• The Government argued that basis should be calculated from the value of each wind farm’s grant-eligible constituent parts and their respective development and construction costs.

• The trial court ruled in favor of Alta Wind.

Federal Circuit Court of Appeals Decision – Alta Wind I Owner Lessor C v. United States, No. 17-1410 (Fed. Cir. 2018)

• On appeal, the Federal Circuit vacated the taxpayer-favorable Claims Court decision and remanded, with specific instructions to reassign the case to a different Claims Court Judge.


Alta wind update (cont.)1603 Grant litigation

Background cont.

• The Federal Circuit ruled that acquisition of the six completed windfarms constituted “applicable asset acquisitions” to which the residual allocation method of § 1060 applies, notwithstanding that none of the windfarms had been placed in service for tax purposes prior to the sale transaction.

• The Federal Circuit also directed the Claims Court, upon remand, to distinguish between “turn-key value” and “goodwill and other intangibles.” According to the Federal Circuit, tax basis in turn-key value falls within Class V of the § 1060 waterfall whereas goodwill and other intangibles falls within Class VI and VII.

−Turn-key value would be eligible for the Section 1603 Grant, while goodwill and other intangibles would not constitute eligible basis for the Section 1603 Grant.

Current Status of Alta Wind

• The case is still pending in the Court of Claims and was reassigned last month to Judge Ryan T. Holte, a new Judge that was just confirmed in July.

• The retrial was previously assigned to Judge Hodges, the same Judge that ruled in favor of the government in the California Ridge and Bishop Hill trial.


WestRock Virginia Corp. v. United States, 2018-1877 (Fed. Cir. June 28, 2019)1603 Grant litigation

Background

• In 2013 WestRock placed a cogeneration facility into service that burns open loop biomass.

−The facility uses two boilers to provide steam—a new biomass-fired boiler and an old boiler from WestRock’s paper mill.

◦ The steam produced from both boilers is comingled and then fed into a steam turbine generator.

◦ The generator uses the steam to generate electricity, but only after WestRock diverts some of the steam from the generator to the paper mill for use in the industrial paper process.

• WestRock requested $85.9 million in 1603 Grant awards from the Treasury Department, which represented 30% of the $286 million it claimed in qualified costs.

• WestRock was awarded approximately $38 million by Treasury (which was 48.8% of the $85.9 million it sought) after the National Renewable Energy Laboratory determined during its review of the grant application that only 48.8% of the steam was used to produce electricity.


WestRock Virginia Corp. (cont.)1603 Grant litigation

Background cont.

• WestRock argued to the Court that while the relevant part of the statute establishes that a qualifying facility must use open-loop biomass to produce electricity, it does not allow Treasury to discount the grant award based on the percentage of steam actually used to produce electricity.

− In their view, once it is established that the qualified property uses biomass to produce electricity Treasury must award the full 30 percent of the eligible costs.

Court’s Findings

• The Court of Appeals disagreed with Westrock and found that such a reading would read out the “integral part” phrase from the Internal Revenue Code and would produce “an absurd result” where any owner that uses its property to produce even a small amount of electricity would be reimbursed for a full 30 percent of the cost of that property even if the property is in large part used for purposes unrelated to the production of electricity.


Other court cases


Cross Refined Coal, LLC, et al. v. Commissioner, No. 19502-17 – BackgroundOther court cases

• Internal Revenue Code Section 45 provides a credit to taxpayers that produce qualified refined coal and sell the coal to an unrelated person during a 10-year period, provided the coal meets specific requirements.

• In 2017 Cross Refined Coal, LLC, et al. filed a petition in the Tax Court seeking a redetermination of partnership adjustments determined by the IRS.

• The IRS had adjusted partnership items for the 2011-2012 tax years after it determined the partnership was not a partnership for Federal tax purposes because it was not formed to carry on a business or for the sharing of profits and losses from the production or sale of refined coal by its partners.

• The IRS contended the partnership was instead created to facilitate the monetizing of refined coal tax credits provided under section 45(e)(8).

• The IRS based its decision on what it believed was the partnership’s failure to satisfy two of the eight factors laid out in Luna v. Commissioner, 42 T.C. 1067 (1964):

−capital contributions to the venture, and

−meaningful sharing in the profits and losses.

• Trial was held in the Tax Court in August of 2019 and the decision was released by the Tax Court on August 29, 2019.


Cross Refined Coal, LLC, et al. – Findings of the courtOther court cases

• For the first factor, the court examined the contributions by the members of the partnership and concluded that, for example:

−USARC and Schneider Electric’s contributions , including the purchase price and additional contributions, make them appear as bona fide partners.

−Fidelity’s liquidated damages provision wasn’t “inconsistent with its status as a partner”, and

−Schneider Electric was at risk for its entire initial investment.

• The IRS argued the contributions were de minimis, but the court disregarded the IRS’s view that contributions that were recovered promptly from business profits should be disregarded in assessing the contributions factor.

• The court found that even for large companies like Fidelity and Schneider, the investment amounts are hardly negligible and in their oversight of Cross they showed themselves genuinely interested in expenditures of much smaller amounts.

• For the second factor, the court looked to the post-tax profits that the members anticipated and held they did indeed share in the profits. The court also concluded the partners shared in the losses because they bore risk of loss from the operation.


Cross Refined Coal, LLC, et al. – Takeaways Other court cases

• Interestingly, the Tax Court distinguished the Historic Boardwalk Hall case writing that the nature of the risks to investors in investment tax credit transactions are different than in PTC transactions in which the credits are earned over 10 years.

• The Tax Court also dismissed an argument by the IRS that the transaction was a mere sale of the tax credits, stating:

”Congress created the refined coal credit for the purpose of incentivizing the refined coal activity; it did so because the market, unassisted by credits, was not producing refined coal on the scale that Congress thought beneficial. Congress manifestly decided that, if refined coal was to be produced in sufficient quantity, money beyond that which the market would offer would need to be added to the mix. The intended result of the credit was that investors, knowing they could obtain the credits, made decisions to produce refined coal — decisions that they did not make and would not make unless they could be sure that they would receive the credits. And rational investors, having made that decision, would of course work to assure that they maintained the right to receive those credits. Without the credits, the refined coal activity was a losing proposition; but that fact cannot mean that the activity, undertaken by someone who gains by claiming the credits, lacks economic substance; rather, that fact is the reason for the credits.”


Partnership IRS audit rules


TEFRA BBAScope Partnership items All Partnership-Related Items such as character, timing, source

and amount of partnership income, gain loss, deductions and credits (see Treas. Reg. 301.6241-1(a)(6)(ii)) only if those items or amounts are shown, or required to be shown, on the partnership return or are required to be maintained in the partnership’s books and records.

Who Represents the Partnership

Tax Matters Partner (TMP), but other partners could participate in exams, appeals and litigation

Partnership Representative (PR) possess the sole authority to act on behalf of the partnership and bind all partners; if PR is an entity, a Designated Individual (DI) must be appointed

Notice Requirements Detailed notice requirements for the TMP and the IRS

No notice of IRS exam activities needs to be provided to anyone other than the PR

Payment of Partnership Adjustments

Partners pay tax, penalties and interest Default rule – the partnership pays, unless a valid election to push out the adjustment is made

Treatment of Penalties

Determined both at the partnership and partner levels

Penalties and defenses are determined at the partnership level

Statute of Limitations on Assessments

Generally three years from the filing of the partnership return

No adjustment for any partnership taxable year may be made after the later of:• Three years after the return is filed• Three years after the return was due• Three years after the partnership filed an AAR

Comparison of key changes to prior law (TEFRA) made by the BBA


Partnership Files Tax Return

Receipt of Notice of Administrative

ProceedingIRS Issues NOPPA

Section 6225: No Push-Out Election

Section 6226: Push-Out Election***

IRS Issues Notice of FPA*

Period of opportunity for request for modification.Notice of FPA is mailed no earlier than 270 days after NOPPA is mailed. Section 6231(b)(2)(A).

Push-out election must be made no later than 45 days after date of the notice of FPA. Section

6226(a)(1).

Each partner’s share of the adjustments will affect its tax imposed in the reporting year

BBA IRS examination timeline

Reviewed year partners required

to pay

Assessment of tax, interest, and

penalties upon partners**

Partnership required to pay


Notes from previous slide:

* Partnership has 90 days after the date the notice of FPA is mailed to file a petition for readjustment with the Tax Court, the district court of the United States, or the Court of Federal Claims under section 6234. Otherwise the FPA become final and assessment and collection is due. Section 6232(b).

** If any amount of the imputed underpayment is not paid within the 10 day period, an overpayment rate of interest shall be applied to the amount due and the Secretary may assess upon each partner a tax equal to the partner’s proportionate share of the remaining amount due, including any other interest or penalties determined. See section 6232(f).

*** Partnership must furnish statements to its reviewed year partners within 60 days after the date the FPA becomes final. Treas. Reg. § 301.6226–2(b). Each reviewed year partner’s tax imposed for the reporting year will be adjusted under section 6226(b)(2) to take into account its share of the adjustments to partnership-related items for the reviewed year.

BBA IRS examination timeline (cont.)


Questions and discussion

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