In the aftermath of the Third Circuit Court of Appeal’s decision in the Historic Boardwalk Case, investors, accountants, attorneys, and developers have been analyzing and discussing the ramifications of this case for the Historic Tax Credit industry. Several historic tax credit investors have indicated that they are on hold for future historic tax credit investments and many tax counsels to historic tax credit investors have indicated challenges to their ability to issue tax benefit legal opinions to their clients. Some of the preliminary pronouncements from the Historic Tax Credit industry are that future deals will need to generate real cash flow which will not be paid for by investors, non-profit deals will be challenging because of the real lack of upside potential, and for tax opinions to be issued deals may need to be structured to follow the safe harbor provided by the Internal Revenue Service in Revenue Procedure 2007-65 which addressed the partnership flip with the wind production tax credit. In a nutshell, it may be a period of time before the historic tax credit syndication market opens again and when it does it may look a lot different than before the Historic Boardwalk Case.
Court of Appeals Reverses Tax Court Decision in the Historic Boardwalk Case
Dealing a blow to the Historic Tax Credit syndication industry, the Third Circuit Court of Appeals on August 27th reversed the Tax Court decision in the Historic Boardwalk Case. In siding with the Internal Revenue Service, the Court of Appeals examined a partnership structure commonly used in the syndication of federal Historic Tax Credits and ruled that the tax credit investor was not partner in the entity generating the Historic Tax Credits. The Court of Appeals concluded that the tax credit investor “did not have any meaningful downside risk or any meaning upside potential in HBH [the entity generating the historic tax credits].” Citing a tax credit recapture guaranty in favor of the tax credit investor to protect its capital contributions and a guaranteed investment contract in favor of the tax credit investor to guaranty its 3% preferred return, the Court of Appeals determined there was no downside risk to the tax credit investor. In a similar vein, the Court of Appeals concluded that the consideration contained in the put and call agreements for the sale of the tax credit investor’s partnership interest had no bearing to the economic reality of the transaction. While the Internal Revenue Service appealed the Tax Court decision on several grounds, the Court of Appeals assumed for purposes of its opinion that the transaction had economic substance and based its decision on one issue – whether the tax credit investor was a partner. Although the Court of Appeals acknowledged sensitivity that “… we may jeopardize the viability of future historic rehabilitation projects,” the Court found that “[w]here we confront taxpayers who have taken a circuitous route to reach an end more easily accessible by a straightforward path we look to substance over form” and the Court concluded that the tax credit investor was not a bona fide partner.
Private Equity Roll Ups for Small Scale Renewable Energy Projects
Renewable Energy projects can be viewed as falling into one of three categories. A large and growing industry is the residential solar project market. This market consists of large operators which through their dealer networks have developed a very popular and profitable model for homeowner installation. A well-established market is the utility-scale projects. This market benefits from the demand from traditional owners of energy plants, infrastructure funds and private-equity funding. The third category is the small scale commercial market. While the economics of the small scale market are strong, the market suffers from the inability of sponsors to access the debt and tax credit markets for small commercial projects. In addition, the complexity of renewable energy projects generates substantial transactional costs which are more difficult to be absorbed by smaller commercial projects. Attorneys in the interdisciplinary renewable energy group at Duane Morris are working with middle-market renewable energy sponsors to aggregate small scale renewable energy projects to a critical mass. These projects will then be rolled up to a private equity fund which has access to capital at very favorable interest rates. In addition, the aggregation of the projects generates a larger renewable energy investment tax credit which is more attractive to tax credit investors.
CDFI Fund Encourages Deployment of NMTC proceeds to Underserved States
In its New Markets Tax Credit 2012 Application Q & A issued last week the CDFI Fund identified those states receiving fewer New Markets Tax Credit proceeds in proportion to its state population. The CDFI Fund indicated that the deployment of New Markets Tax Credit proceeds to these underserved states would be considered an innovative us of New Markets Tax Credit Allocation and favored by the CDFI Fund. Since the inception of the New Markets Tax Credit Program, “qualified low-income community investments” have been made in all 50 states, the District of Columbia, and Puerto Rico. However, the CDFI Fund has identified Puerto Rico, along with the following 10 states, as areas that have received fewer dollars of “qualified low-income community investments” in proportion to their statewide population residing in Low-Income Communities: Alabama, Arkansas, Florida, Georgia, Idaho, Kansas, Nevada, Tennessee, Texas, and West Virginia. The CDFI Fund also considers the Island Areas of the United States (American Samoa, Guam, Northern Mariana Islands, and the U. S. Virgin Islands) to have received lower levers of NMTC investment, as these four territories have not received any “qualified low-income community investments.”
CDFI Fund Issues 2012 Application Q and A
The CDFI Fund recently issued a New Markets Tax Credit 2012 Application Q and A. Contained within this document is guidance provided by the CDFI Fund as a result of two conference calls held on July 24th and July 26th 2012 for potential 2012 Round New Markets Tax Credit allocation applicants. The participants on these calls asked for additional clarification on specific questions within the application to which the New Markets Tax Credit Program team responded. Additional guidance and clarification is provided in the Q and A with respect to what the CDFI Fund considers as innovative uses of NMTCs which includes but is not limited to: investing in Unrelated CDEs that do not have a NMTC Allocation; targeting states identified by the CDFI Fund as having received fewer dollars of QLICIs; providing QLICIs in amounts of $2 million or less; revolving QLICIs to serve more QALICBs; and providing non-real estate financing such as working capital or equipment loans. The CDFI Fund also provided examples of uses of NMTCs that would not be considered innovative which include the use of the leverage structure, combining NMTCs with historic tax credits, and investments in real estate (either to real estate QALICBs or non-real estate QALICBs) in states other than the 10 states and territories identified in the Application Q&A.
Senate Finance Committee Approves Two Year Extension of NMTC Program
Senate Finance Committee Chairman Max Baucus (D-Mont.) released a summary of the Family and Business Tax Cut Certainty Act of 2012, as approved by the Senate Finance Committee. The Senate Finance Committee approved a package of more than $205 billion in tax cut extensions for families and businesses by a bipartisan vote of 19-5. The Bill, once finalized, will be posted on the Committee’s legislation website. The summary of the proposed Family and Business Tax Cut Certainty Act of 2012 describes an extension of the Federal New Markets Tax Credit Program for two additional years at $3.5 billion dollars of New Markets Tax Credit allocation each year.
New Jersey’s Urban Transit Tax Credit Program Provides Job Incentive
The New Jersey Urban Transit Tax Credit Program provides an average incentive to a company of $167,000 for every job created in or saved from leaving the state. The tax credit is for projects of $50 million or more within a half mile to one mile radius of transportation centers in nine cities such as Camden, Newark, Jersey City, Hoboken, Elizabeth, Paterson, East Orange and Trenton. The development’s “multiplier effect” of new employment and commerce must generate 10% more in new tax revenue than the amount of the tax credit. Residential projects do not have to have the same job creation effect, but they also do not qualify for as generous a subsidy.
The program started small, with state officials estimating that only a few businesses would qualify, but it has expanded into the state’s most important business incentive program. Since 2010, 18 residential, commercial and mixed-use projects have been awarded $977 million under the program. The recipients have pledged to invest $2.1 billion, create 2,910 jobs and retain 2,935 others deemed at risk of moving out of state.
Proposal to Extend Wind Production Tax Credit
On August 2nd the Senate Finance Committee voted to renew the wind power production tax credit that is set to expire at the end of this year with the proposed Wind Powering America Jobs Act. The bill is expected to go to the Senate floor when Congress returns from summer recess. Wind farms can generally choose to receive a continuing credit of 2.2 cents per kilowatt-hour of electricity produced or receive a one-time payment equivalent to 30 percent of the cost of developing a project. Currently the production tax credit and the option to elect the 30 percent renewable energy investment tax credit will expire at the end of 2012. In contract, the renewable energy investment tax credit for solar projects will continue through the end of 2016. However, it is unclear if the House will support a renewal of the wind production tax credit.
Duane Morris Works with Potential Middle Market Energy Tax Credit Investors
The expiration of the Section 1603 grant in lieu of the federal renewable energy tax credit has had a substantial adverse impact on the development of renewable energy projects in the Country. While some projects were able to grandfather the benefits of the Section 1603 grant by incurring the required costs in 2011, these projects will disappear during the year. In addition, although the grant provides money in lieu of the tax credit it does not monetize the losses associated with the project which most developers do not have the taxable income to use. As a result, less equity is generated for these projects. Historically the renewable tax credit investment community has serviced the very large utility size projects and not the middle market. Duane Morris attorneys are working with investors in the low-income housing, historic, and new markets tax credit industries to educate these investors to the structures and opportunities available for middle market renewable energy tax credit transactions. It is hoped that in the near future a group of investors will emerge to service middle market renewable energy tax credit transactions.
Pennsylvania Passes State Historic Tax Credit
On June 30, Pennsylvania became the 30th state in the Country to have a state historic tax credit with the passage of the Pennsylvania Historic Preservation Incentive Act. The Act will provide a 25% state tax credit for the rehabilitation of qualified income-producing buildings that also use the federal historic tax credit. The State tax credit will be equal to 25% of the “qualified expenditures” (as defined under Section 47(c)(2) of the Internal Revenue Code) incurred by the taxpayer. In order to qualify projects must be commercial in nature. To qualify as a historic structure, the building must be listed in the National Register of Historic Places or be part of a historic district listed in the National Register. The “qualified rehabilitation plan” itself must also be approved by the Pennsylvania Historical and Museum Commission, as reviewed against the Secretary of the Interior’s Standards and Guidelines of Rehabilitation. The Pennsylvania historic tax credit program is limited to $3,000,000 annually with an individual project cap of $500,000. The Pennsylvania Historical and Museum Commission and the Department of Economic Development will develop the program guidelines. The credit goes into effect July 1, 2012 but the first tax credits will not be issued until after July 1, 2013.