Guidance Appears to Reflect an Emphasis on Enforcement over Development of Alternative-Energy Projects
In October 2007, the Internal Revenue Service issued Revenue Procedure 2007-65, establishing safe-harbor provisions under which the IRS will respect the allocation of IRS Code Section 45 wind energy production tax credits by partnerships to parties who invest primarily to receive an allocation of the tax credits (often called, tax equity investors). The revenue procedure is intended to provide guidance in lieu of the IRS issuing individual rulings under Subchapter K (as indicated in Notice 2006-88, I.R.B. 2006-42) to taxpayers establishing or participating in wind-energy partnerships. As long as the partnership meets each of the safe-harbor requirements of Revenue Procedure 2007-65, the IRS has indicated that it will not further scrutinize the allocation of claimed credits.
On the other hand, Rev. Proc. 2007-65 also contains a number of positions and requirements that are inconsistent with prior guidance issued by the IRS or long-standing authority in the partnership area. The inclusion of these requirements suggest a level of inflexibility and an emphasis on enforcement that may have the unintended effect of limiting, rather than encouraging, investments by partnerships and tax-equity investors in wind-energy projects.
Stringent Guidelines of Rev. Proc. Are Inflexible and Suggest Increased Scrutiny of Wind Partnerships
Rev. Proc. 2007-65 applies to partnerships between a project developer and one or more tax equity investors in which the partnership owns and operates the qualified energy facilities and is effective for transactions entered into on or after November 5, 2007. On its face, the revenue procedure is designed to create a bright line within which partnerships may, with certainty, qualify for the wind-energy production tax credits.
However, many commentators and experienced tax advisors in the wind and energy tax credit area have been extremely critical of Rev. Proc. 2007-65 because of its inflexibility, departure from prior authority and lack of practical application. For example, the revenue procedure contains statements such as the following found in Section 3:
"[The] Service generally will closely scrutinize a Project Company as a partnership or Investors as partners if a Project Company's partnership does not satisfy each requirement of this revenue procedure."
Similarly, in Section 5, Rev. Proc. 2007-65 also provides two hypothetical examples of partnership transactions: one that clearly meets each of the safe-harbor requirements and another that meets all of the safe harbors but one (and which is just slightly outside of that particular requirement). The revenue procedure reemphasizes that the latter transaction will be "closely scrutinized."
This emphasis is in direct contrast to the balanced language of earlier revenue procedures, in which safe harbor and other requirements were offered as guidance rather than absolutes. In the past, transactions were typically evaluated on the sum of their merits rather than being thoroughly tested and potentially rejected on the basis of whether or not they met each and every provision.
Likewise, earlier guidance in the energy tax credits and partnership areas were designed to provide both clarification and to encourage new investment activity. However, the unintended, but practical, effect of the current inflexible and all or nothing-focused approach of Rev. Proc. 2007-65 may be to discourage project developers, investors and other wind-energy project participants from entering into transactions.
Bracewell will continue to monitor developments in the regulation of wind-energy production tax credits.
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