The petition for rehearing filed by taxpayer in the Historic Boardwalk case was reviewed the Third Circuit Court of Appeals judges who participated in the Historic Boardwalk case and the other available circuit judges of the Third Circuit Court of Appeals. The Third Circuit Court of Appeals noting that no judge who concurred in the Historic Boardwalk decision asked for a rehearing, and a majority of the circuit judges of the circuit in regular service did not vote for rehearing, denied the petition for rehearing by the panel and the Third Circuit Court of Appeals en banc. The only appeal left to the taxpayer in the Historic Boardwalk case is to the United States Supreme Court.
Following the reversal by the Third Circuit Court of Appeals of the Tax Court’s decision in the Historic Boardwalk case, the taxpayer has filed a petition for a rehearing or rehearing en banc of the Historic Boardwalk Hall case. The taxpayer’s brief in support of the petition asserts that the Third Circuit Court of Appeals misapplied the reasoning of the U. S Supreme Court case of Commissioner v. Culbertson. Under Culbertson, a partnership exists if, based on the totality of the facts and circumstances, it is determined that “the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise.” The brief also contends that the Court of Appeals made a fundamental error in treating the historic tax credits as a return of capital. It is not common for cases to be reheard especially when there was no dissent on the panel. If the petition is denied the only appeal remaining is to the United States Supreme Court.
In the aftermath of the Historic Boardwalk case, the Historic tax credit investment community is struggling with a partnership investment structure which will not be challenged by the Service. Conceptually one may only need to look to Rev. Proc. 2007-65 in which the Service set forth a safe harbor for investors in partnerships owning qualified energy facilities. The positions advanced by the Service in its appeal of the Tax Court decision in the Historic Boardwalk case mirrored many of the safe harbor requirements of the Rev. Proc. 2007-65. As a result, to follow the safe harbor of Rev. Proc. 2007-65 one would conclude at a minimum future historic tax credit partnership agreements should: (1) provide both cash flow and tax credits to the investor; (2) no longer be structured as “pay as you go” transactions; (3) no longer have tax credit indemnities in favor of the investor; and (4) no longer have an investor “put” to the developer for nominal consideration. To sum up, developers and investors looking for guidance after the Historic Boardwalk Case may find comfort in the “safe harbor” of Rev. Proc. 2007-65
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.
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.
On June 25th in Philadelphia Pennsylvania a three judge panel of the Third Circuit Court of Appeals heard oral argument on the appeal by the Internal Revenue Service of the Tax Court decision in the Historic Boardwalk case. The Tax Court had upheld the allocation of a Federal Historic tax credit to the tax credit investor member. One of the primary issues on appeal is whether the tax credit investor member had risk in the transaction. The Service argued that the tax credit investor was not at risk in the transaction and consequently was not a “partner” in the Historic Boardwalk investment entity and entitled to the allocation of the Federal historic tax credit. While it is clearly the intent of Congress that the Federal historic tax credit serve as an incentive for the rehabilitation of historic buildings, there is very little guidance on how the tax credit can be syndicated to investors. The historic tax credit industry has developed a structure in which the investor is a “partner” in the ownership entity, receives a preferential return, and is bought out of the investment entity through a put/call agreement after the expiration of the tax credit compliance period. The decision of the Court of Appeals may affect the structure of the syndication of future historic tax credit transactions.
The Internal Revenue Service has appealed the decision of the Tax Court in the Historic Boardwalk Case to the Third Circuit Court of Appeals. The Tax Court decision upheld the allocation of 99.99% of the rehabilitation tax credits to a corporate investor, which contributed capital of over $18 million to the historic rehabilitation project in consideration for 99.99% of the tax credits, profits and losses including any residual. The basic structure of the Historic Boardwalk Case is typical of many historic rehabilitation transactions. A reversal by the Court of Appeals of the Historic Boardwalk Case may have severe negative implications for the historic tax credit industry. Oral argument in the Third Circuit in Philadelphia is scheduled for June 25, 2012.