2019 Deloitte Renewable Energy Seminar Powering a Bright Future October 2-4, 2019 Avoiding Purchasing Project Traps - Before, During, and After Construction

2019 Deloitte Renewable Energy Seminar Powering a bright future October 2-4, 2019 Avoiding purchasing project traps - before, during, and after construction

Mike Kohler, Managing Director, Deloitte Tax LLP Tom Stevens, Partner, Deloitte Tax LLP Patty Tuite, Managing Director, Deloitte Transactions and Business Analytics LLP Discussion topics—purchasing projects before, during and after construction

Purchase model vs. contribution model

• Property acquired

• Single project

• Development pipeline

• Tangible and intangible assets

• Alta Wind case

• California Ridge and Bishop Hill cases

Acquiring projects before, during, and after construction

• When does cost basis ”attach” to the property acquired?

• Cost basis

• Carryover basis

• Step-up The form of the acquisition structuring • Development fee has tax consequences • Bottom-up or Top-down Understand the: • Inside basis • Equity Capital Contribution Agreement (ECCA) • Outside basis • Membership Interest Purchase Agreement (MIPA) • Disguised sale • Limited Liability Company Agreement (LLCA) • Revenue Ruling 99-5

• IRC section 1060 allocation

• IRC section 743(b) adjustment

Partner 1 Partner 2

outside basis outside basis

Partnership

inside basis

membership interest Partner 1 Partner 2 purchase price $

Partnership

Partner 2 buys Partner 1 Partner 1 an LLC interest Partner 2 in the DRE

100% Retained portion: Sold portion: asset contribution to asset purchase newly formed and deemed partnership contribution DRE (carryover basis) (cost basis) Partnership

new partnership formed for tax purposes

membership interest Partner 1 Partner 1 Partner 3 purchase price $

IRC section 743(b) adjustment (IRC section 754 election) Partnership

inside basis

Partner 1 Partner 2

cash contribution

membership interest

Partnership

Partner 1 Partner 1 Partner 2

100% Retained portion: Partner 2 asset contribution to contributes cash newly formed to acquire LLC partnership interest in the DRE (carryover basis) DRE Partnership

new partnership formed for tax purposes

Partner 1 Partner 2

cash contribution

distribution contribution $ $

Partnership

Disguised Sale? • Potential exceptions: − Preformation CapEx − Qualified Liabilities

Partner 1 Partner 2

cash contribution

contribution of cash $

Construction Lender Partnership repay construction debt $

Developer 2 buys Fair Market Valuation to Original pre-developed Developer 2 Third Party Buyer Developer project for $45m

Spends $20m on developing Cost Approach the project (pre-construction) • Total Developer 2 Spend = $180m Allocates purchase price as follows: • Capitalized Interest = $5m • $12m PPA • 10% Entrepreneurial Incentive = $18.5m • $8m Land Leases • $15m Engineering/Permitting • $10m Interconnection Agreement • $45m Total Cost Approach $203.5m Additional costs incurred by Developer 2 to build facility Income Approach $206.5m • $10m Utility Owned Upgrades Concluded FMV $205m • $125m Buildout Cost • $135m Total Total Developer 2 Spend = $180m

Sale by Developer 2 to a Original Developer 2 third party buyer Developer

Purchase Price = $205m Developer 2 Total Spend = $180m • $0m FMV for at-market land leases • Purchase price to Original Developer = $45m • $5m FMV for PPA (above market) • Additional Spend = $135m • $0m FMV for utility owned upgrades • $11m FMV for interconnection agreement Bottom-up approach ($180m) Top-down purchase price allocation • $12m PPA amortized over 15 years ($205m) • $8m land leases amortized over the life of the lease • $0m land leases • $10m interconnection agreement amortized over 15 years • $5m PPA agreement • $10m utility owned upgrades amortized over 20 years • $0m utility owned upgrades • $140m of other costs (cost segregation) • $11m interconnection agreement −5-Year MACRS • $189m of other costs (cost segregation) −15-Year MACRS −5-Year MACRS −39-Year SL −15-Year MACRS Development fee? −39-Year

Sometimes a developer holds the project in a disregarded entity (DRE) and seeks to recover its development costs upon the partnership formation with as little taxable gain as possible

On a sale of an interest in a DRE, the seller recognizes gain under Rev. Rul. 99-5, Situation 1 as though it sold a proportionate share of the assets of the DRE

The seller must calculate its gain using a proportionate amount of its basis in the assets

Alternative to actual sale is a disguised sale

• Sponsor contributes property to partnership and Tax Equity Investor contributes money that is distributed by the partnership to the Sponsor

• Treas. Reg. § 1.707-4(d) generally provides that a partnership is allowed to reimburse preformation capital expenditures without the contributing partner being treated as selling property to the partnership if the expenditures were incurred during the two years preceding the contribution

Before Structure • Tax Equity Investor purchases $100m of Developer’s interest in Tax Equity DRE Developer $100m Investor After Structure • Basic Rev. Rul. 99-5, Situation 1 —No disguised sale analysis

Tax Equity DRE Developer • Treated for tax purposes as Investor though Tax Equity Investor purchased an interest in $100m FMV $120m Basis of DRE assets and then both $100m parties contributed their assets to (costs incurred a new partnership within • Developer can only use $83.3m the last 2 years) Project Entity of its basis because it is treated as selling a proportionate share FMV $120m Basis $116.7m of the DRE assets, so it (costs incurred within the last recognizes $16.7m of gain for tax 2 years) purposes

• Developer contributes DRE and Tax Equity Investor contributes $100m to Project Entity FMV $120m Basis $100m • Immediately or within 2 years, Project (costs incurred Entity distributes $100m to Developer within the last 2 Tax Equity Developer • Under section 1.707-4(d), Project years) 2 Investor Entity is allowed to reimburse all preformation capital expenditures $100m incurred within the last two years

DRE • The limitation on preformation capital $100m expenditure reimbursement does not apply because the value of DRE assets 1 1 Project does not exceed 120% of the Entity Developer’s basis in the assets at the time of the contribution • There is no gain on the transaction done in this way

• Because the value of DRE assets exceed 120% of the Developer’s basis in DRE assets at the time of the FMV $125m Basis $100m contribution, reimbursement of (costs incurred preformation expenditures is limited within the last 2 Tax Equity under section 1.707-4(d)(ii) to 20% of Developer years) 2 Investor the value DRE assets • $25m of the distribution is $100m reimbursement (20% of $125m) DRE • The excess distribution of $75m is a $100m disguised sale that triggers $15m of 1 1 gain (disguised sale of 60% of $125m Project of value, so allowable basis is $60m), Entity leaving $40m of outside basis • Then the $25m reimbursement reduces outside basis to $15m

• ITC recapture

• Basis risk and developer fees

• PTC and ITC begun construction qualification

• California property tax exclusion (change in control issues and planning)

• Indemnities

• Offshore wind

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.

Copyright © 2019 Deloitte Development LLC. All rights reserved. 2019 Deloitte Renewable Energy Seminar 21 1603 Grant Litigation Alta Wind Update cont. 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.

Copyright © 2019 Deloitte Development LLC. All rights reserved. 2018 Deloitte Renewable Energy Seminar 23 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.

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.”

Takeaways from the Case

1. 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.

Projects acquired before construction • Only predevelopment rights established (e.g., PPA, interconnection, land rights) • Premium paid for turn-key value expected to be realized at project completion (”hypothetical CWIP”) • Must be allocated to identifiable assets existing on the acquisition date −Intangible property, goodwill, going concern value? −1060 residual method vs. 1012 specific asset allocation Projects acquired during construction • Predevelopment rights established (e.g., PPA, interconnection, land rights) • Tangible property and CWIP established • Premium paid for turn-key value expected to be realized at project completion (“hypothetical CWIP”) • Must be allocated to identifiable assets existing on the acquisition date −Tangible property (CWIP), intangible property, goodwill, going concern value? −1060 residual method vs. 1012 specific asset allocation

Projects acquired after Construction and COD

• Predevelopment rights established (e.g., PPA, interconnection, land rights)

• Tangible property and going concern established

• Premium paid for value established and demonstrated from operations

• Must be allocated to identifiable assets existing on acquisition date

−1060 residual method

−Tangible property, intangible property, goodwill and going concern value

Copyright © 2019 Deloitte Development LLC. All rights reserved. 2019 Deloitte Renewable Energy Seminar 30 This publication contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication.

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