2016
TAXEQUITY
INVESTMENTS
OVERVIEW
FrequentlyAskedQuestions
preparedby
DistributedSun&DLAPiperLLP(US)
February 25, 2016
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TableofContents
Disclaimer.....................................................................................................................................................2
Whatarethetax-basedincentivesavailabletoinvestorsinsolarsystems?................................................3
DoIneedtobequalifiedtomonetizetheITC?.............................................................................................3
Arethereothertax-basedincentivesavailabletoaPVsystemowner?.......................................................3
WhenistheITCavailabletoanownerorinvestor?.....................................................................................4
MayalloftheITCbemonetizedimmediately?............................................................................................4
Whataredisqualifyingevents?....................................................................................................................4
WhatisthevestingschedulefortheITC?....................................................................................................4
Whathappensiftheownerdoesnothavetopaytaxes?............................................................................4
WhathappenswhentheownercannotusetheITCimmediately?..............................................................5
WhatareTaxEquityInvestments?...............................................................................................................5
Whatisthepartnership-flipstructure?........................................................................................................5
AreotherStructuresusedforTaxEquityInvestments?...............................................................................5
WhatistheSponsor’smotivation?...............................................................................................................6
WhatkindofreturnstoTaxEquityInvestmentsprovide?...........................................................................6
WhatisthedifferencebetweenInternalRateofReturnandCumulativeReturn?......................................6
WhatistheResidualValueofOwnershipaftertheownershipflip?............................................................6
WhatrisksdoTaxEquityInvestmentscarry?...............................................................................................6
CantheSponsorguaranteethattheInvestorwillreceivetheITCorthatitwillnotberecaptured?...........7
Whatmeasuresareavailabletominimizerisksofrecapture?.....................................................................7
ArecorporatefinancialstatementsaffectedbytheITCandMACRSdeductions?.......................................8
ArePVsystemsconsolidatedonbooksofthecorporatetaxequityinvestor?.............................................8
HaveothercorporationsinvestedtaxequityinPVsystems?.......................................................................8
Disclaimer
THISDOCUMENTHASBEENPREPAREDTOPROVIDESOMEBACKGROUNDANDCONTEXTTOTAXEQUITY
INVESTMENTS GENERALLY. THIS IS NOT A SOLICITATION AND NO FACTS RELATING TO ACTUAL
INVESTMENTS ARE PRESENTED. THE DISCUSSION OF U.S. FEDERAL TAX IMPLICATIONS OF SUCH
INVESTMENTS IS MEANT TO BE GENERAL IN NATURE AND DOES NOT DISCUSS ALL ASPECTS OF U.S.
FEDERAL INCOME TAXATION THAT MAY BE RELEVANT TO A PROSPECTIVE INVESTOR IN LIGHT OF ITS
PARTICULAR CIRCUMSTANCES. IN ADDITION, THE DISCUSSION DOES NOT DESCRIBE ANY TAX
CONSEQUENCESARISINGUNDERTHELAWSOFANYLOCAL,STATE,ORFOREIGNJURISDICTIONSANDDOES
NOT ADDRESS ANY ASPECTS OF U.S. FEDERAL TAX LAW OTHER THAN INCOME TAXATION. ANYONE
CONSIDERINGMAKINGATAXEQUITYINVESTMENTSHOULDCONSULTITSOWNINDEPENDENTTAX,LEGAL
ORFINANCIALADVISOR.THROUGHTHISDOCUMENT,NEITHERDISTRIBUTEDSUNNORDLAPIPERLLP(US)
ISMAKINGANYREPRESENTATIONSORWARRANTIESTOANYONE.THISDOCUMENTISNOTINTENDEDTO
BEANOFFERTOSELLORASOLICITATIONOFANOFFERTOPURCHASEANYSECURITIES.THISDOCUMENT
ISNOTINTENDEDTOPROVIDEANYLEGAL,TAXORINVESTMENTADVICE.
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TaxEquityInvestmentsOverview–FAQs
Whatarethetax-basedincentivesavailabletoinvestorsinsolarsystems?
To incentivize more investments in renewable energy, the Internal Revenue Code provides
ownersofsolarphotovoltaicarrayswiththerighttoclaimanInvestmentTaxCredit(“ITC”)equal
to30%oftheeligiblecostsincurredinplacingasolarPVarrayinservice(i.e.,thedepreciable
tangiblepersonalpropertythatisapartoftheproject).WhilethelawsgoverningtheITChave
beenamendedseveraltimes,mostrecentlyin2015,thelatestamendmentsetstheITCatthe
currentlevelof30%forprojectsonwhichconstructionbeginsbytheendof2019,decreasingto
26%forprojectsonwhichconstructionbeginsin2020,22%forprojectsonwhichconstruction
beginsin2021and10%forprojectsonwhichconstructionbeginsin2022andanyprojectthatis
notplacedinservicebytheendof2023.
DoIneedtobequalifiedtomonetizetheITC?
Forindividualinvestors,includingindividualswhoarepartnersinapartnership,membersinan
LLC or shareholders of S Corporations: The individual partner/member/shareholder of the PV
systemownercanmonetizealloftheITCprovidedthattheITCisnotmorethantheamountthat
theindividualhasatriskintheinvestment(i.e.,theamountofcapitalinvestedanddebtforwhich
thelenderhasrecoursetotheindividual)andthatthetaxesowedareonpassiveincome.Consult
youradvisortodeterminewhetheryourincomeisfrompassivesources.
ForCcorporationinvestorswithfewerthan5ownersowning50%ormoreoftheoutstanding
stock:TheCcorporationmayclaimalloftheITCprovidedthattheITCisnotmorethanthe
amountthatthecorporationhasatriskintheinvestmentandnotmorethanthecorporation’s
passiveactivitygrossincomeplusits“netactiveincome.”(“Netactiveincome”iscomputedby
makingcertainadjustmentstothecompany’sgrossincomebyexcludingpassiveactivitygross
incomeandpassiveactivitydeductions.)
ForCcorporationinvestorswithmorethan5ownersowning50%oftheoutstandingstock:The
CCorporationcanusetheITCagainsttaxesowedbythecorporationandthetaxlossescanbe
usedagainsttaxableincome.
Investorshavetobe“accreditedinvestors”asdefinedbytheSecuritiesExchangeCommissionin
SectionRule501ofRegulationD.
Arethereothertax-basedincentivesavailabletoaPVsystemowner?
TheOmnibusSpendingBill,passedinDecember2015,allowsthePVsystemownertodepreciate
50% of the system’s eligible depreciable basis in the first year. The owner is also allowed to
depreciate the PV system under an accelerated 5-year Modified Accelerated Cost Recovery
System.Cumulatively,theownermaydepreciate60%ofthedepreciablebasisinthefirstyear,
providingasizabletaxbenefittotheowner.
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TaxEquityInvestmentsOverview–FAQs
WhenistheITCavailabletoanownerorinvestor?
The ITC is available to the legal owner (or partners/members in an owner organized as a
partnershiporLLC)ofaPVsystemonthedatethePVsystemis“placedinservice.”TheITCis
claimed on the federal income tax return for the year in which the “placed-in-service” date
occurs.Thetaxlawdefinestheplaced-in-servicedateasthedatewhenallofthefollowinghave
occurred with respect to the system: (1) passage of control to the legal owner/operator, (2)
successfulcompletionofcriticaltests,(3)systemisavailabletooperateregularlyorcontinuously
to serve its intended purpose, (4) receipt of all the licenses and permits to operate, and (5)
synchronizationtothegridorpoweroff-taker.
MayalloftheITCbemonetizedimmediately?
Yes.OnceclaimedonthefederalincometaxreturnfortheyearinwhichthePVsystemisplaced
inservice,theentireITCisavailablefortheowner’suseimmediatelyandcanbecrediteddollar
fordollaragainsttheowner’staxes,subjecttothelimitationsdiscussedabove.However,theITC
vests,ratablyoverthefirstfive(5)yearsafterthePVsystemisplacedinservice(the“Recapture
Period”).TherecipientsoftheITCwillhavetorecapture,byreimbursingtheIRSforanyunvested
portion of the ITC, if any disqualifying events occur during the Recapture Period. This
reimbursementobligationisreferredtoas“recapture.”
Whataredisqualifyingevents?
The Treasury Regulations establish certain disqualifying events resulting in recapture. The
prospectivePVsystemownershouldbeconcernedabouttheseeventsandshouldensurethat
theseeventsdonotoccur,orhaveanextremelylowlikelihoodofoccurring.Twoeventsthatcan
triggerdisqualificationandrecaptureareachangeinownershipofthesystemandthesystem
failingtooperate(orbeavailableforoperation,iftheoutageisfromforcemajeureevents)during
theRecapturePeriod.AnotherdisqualifyingeventistheITCrecipientbecomingadisqualified
person,suchasatax-exemptentityoraREIT.
WhatisthevestingschedulefortheITC?
ForeachfullyearofoperationafterthePVsystemisplacedinservice,20%ofthevalueofthe
ITC(6%oftheeligiblecosts)willbevested.Forexample,ifadisqualifyingeventhappens3years
and11monthsafterthePVsystemisplacedinservice,60%oftheITCwillhavevestedandthe
ownerwillhavetoreimburse,totheIRS,40%oftheITCthathasnotvested.Afterfive(5)years,
100%oftheITCwillvestandnoportionwillbeatrisk.
Whathappensiftheownerdoesnothavetopaytaxes?
AnyunusedITC,fromthecurrenttaxyear,canbecarriedbacktotheprevioustaxyear,iftheITC
cannot be monetized in the current year and if taxes were owed in the previous year (again,
subjecttothelimitationsdescribedabove).AnyunusedITCcanthenbecarriedforwardforup
to20yearsaftertheyearinwhichthePVsystemisplacedinservice.
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TaxEquityInvestmentsOverview–FAQs
WhathappenswhentheownercannotusetheITCimmediately?
IntheeventanownerofaPVsystemdoesnothavethetaxexposurenecessarytoutilizetheITC
efficiently,avarietyoffinancestructuresareavailabletofacilitateinvestmentbytaxpayersthat
can efficiently use the ITC. The ultimate choice of the finance structure is determined by the
investorandtheiradvisors.
WhatareTaxEquityInvestments?
InvestorsthatmakeequitycontributionsandreceiveallocationsoftheITCandothertaxbenefits
suchasdepreciationarecalledtaxequityinvestors(the“Investors”).Theseinvestmentsmadeby
Investorsarecalledtaxequityinvestments.
Whatisthepartnership-flipstructure?
PartnershipflipstructuresareusedcommonlybyInvestorstomonetizetheITCanddepreciation
benefitsfromPVsystems.Inthisstructure,theInvestorcontributesapredeterminedamount
ofcapitalrequiredbyaproject.Theremainingcapitalisusuallyfundedbyotherequityinvestors
(typicallytheprojectsponsorsor“Sponsors”)throughamixofequitycontributionsanddebt.In
returnforitscontributions,theInvestorreceives99%oftheownershipoftheprojectcompany
owningthePVsystem.Duringeachofthefirstfive(5)years,theInvestorreceivesanallocation
of99%oftheITC,99%ofalltaxableincome(orlosses,whichistypicalinthefirstfewyearsof
the project as a result of depreciation deductions) and a small stream of cash flow annually
(typically2–4%ofthevalueoftheinvestment).After5yearsorwhentheInvestor’stargetyield
(usuallybaseduponaspecifiedinternalrateofreturn)hasbeenachieved(whicheverislater),
theownershipoftheprojectcompanyowingthePVsystem“flips,”causingtheSponsortoown
95%andtheInvestortoown5%.TheSponsortypicallyhasarightoncethefliphasoccurredto
acquiretheInvestor’s5%residualinterestatthefairmarketvalueofthatresidualinterestat
thetimeoftheacquisitionbytheSponsor.
AreotherstructuresusedforTaxEquityInvestments?
OtherstructuresusedforTaxEquityInvestmentsaretheso-calledinvertedleaseorlease-passthrough structure and the sale-leaseback structure. As the names denote, both of these
structures involve the creation of a lessor-lessee relationship, with the Tax Equity Investor
investinginthelesseeentityintheinvertedleasestructureandthepurchaser-lessorentityin
thesale-leasebackstructure.Eachofthesestructureshasadvantagesanddisadvantageswhen
comparedtothepartnershipflipstructurediscussedabove.Investorsshouldcarefullyconsider
theseadvantagesanddisadvantagesinselectingthestructuretheywishtouse,andshouldalso
consider the compatibility of the structure selected with future modifications in the capital
structureoftheprojectorprojectsthatmaybecontemplated.Forexample,assecuritization
becomesamorecommonmeansofrefinancingsolarPVportfolios,thecompatibilityofeachof
thesestructureswithsecuritizationstructuresshouldbeconsidered.
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TaxEquityInvestmentsOverview–FAQs
WhatistheSponsor’smotivation?
Sponsors seek a return on their capital over the life of a PV system, typically over 20 years.
Sponsorsareresponsiblefor,motivatedandincentivizedtokeepaPVsystemoperatinginoptimal
conditionoveritslifetimeinordertoreceivetheirintendedreturnoncapital.BecauseSponsors
typicallydonothaveenoughtaxliabilitytoutilizetheITCortheaccelerateddepreciationbenefits
efficiently,theyareincentivizedtoofferTaxEquityInvestmentstotheInvestorandtooffera
preferredreturnontheircapitaltohelpfinancetheproject.
WhatkindofreturnsdoTaxEquityInvestmentsprovide?
Investorsreceivetheirreturnthroughthetaxbenefitsdescribedabove,pluscashdistributions
fromthePVsystemowner.ThefollowingtableshowsahypotheticalillustrationofanInvestor’s
after-taxreturnassumingaTaxEquityInvestmentof$1,000,000:
Timeline
Investment
Year1
InvestmentandReturnExample
Returnon
After-TaxReturn
Investment
($1,000,000)
$820,685
InternalRateof
Return
82.1%
-47.3%
Year2
Year3
$166,667
$25,000
98.7%
101.2%
-2.39%
2.18%
Year4
$25,000
103.7%
5.99%
Year5
$25,000
106.2%
8.99%
Year6
$25,000
108.7%
11.29%
InvestmentReturned
ReturnMultiple
IRR
$1,087,351 108.7%
11.29% WhatisthedifferencebetweenInternalRateofReturnandCumulativeReturn?
AnInternalRateofReturn(“IRR”)istheannualizedinterestrate,overtheinvestmentperiod,
paid to the investor on the investment made. In the example above, the IRR, or annualized
interest rate, is 30.44% in part because the ITC is available to be monetized by the Investor
immediatelywhenthePVarrayiscommissioned.
TheCumulativeReturnistheratiooftheTotalCapitalReturnedtotheTotalInvested,providing
the Investor with an overall idea of the quantum of cash flows during the same period of
investment.Inthisexample,theCumulativeReturn,ortheinvestmentreturnmultiple,is112.3%
-meaningthat$1millioninvestedreceives$1.123MM(rounded)overthesix-yearperiod.
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TaxEquityInvestmentsOverview–FAQs
WhatistheResidualValueofOwnershipaftertheownershipflip?
Typically,investmentswillbemadeunderapartnership-flipstructure.Asstatedabove,under
thisinvestmentstructure,theInvestor’sshareofownershipandbenefitsfromthePVsystemwill
“flip”from99%(forthefirstsixyears)to5%(fortheremainderoftheterm,usually14years).
Afterthisflipinownershipoccurs,theprojectSponsor(orthelong-termequityinvestor)hasthe
righttobuytheInvestor’sresidual5%ownershipatfairmarketvalue(“FMV”).TheFMVisusually
the net present value of the future benefits attributable to the 5% residual interest, using a
discountrateappropriateatthetimetheFMViscalculated.
WhatrisksdoTaxEquityInvestmentscarry?
Typically, Investors may be concerned by project cost overruns, loss of revenue agreements,
lesser-than-expectedsolarresourceavailability,equipmentmalfunctionandforeclosureofthe
PVsystembyaprojectlender.
CantheSponsorguaranteethattheInvestorwillreceivetheITCorthatitwillnotbe
recaptured?
No. No party, including the Sponsor, may guarantee that the Investor will receive the ITC, or
indemnifytheInvestor,iftheITCisunavailable.ThisismandatedbytheIRS.
Whatmeasuresareavailabletominimizerisksofrecapture?
Itispossibletomitigaterisksbycontractingtheriskawaytodifferentcounterparties.Typically,
the Sponsor is responsible under an Operating Agreement to prevent any disqualifying events
from occurring. A skilled investment manager can navigate these risks and mitigate them
cost-effectively.
RISK
MITIGATION
CostOverruns
Fixedpriceorguaranteedmaximumpricecontractsforprocurement
andconstruction.
Counterparty
Payment
Rigorouscreditassessmentsofcreditupfrontdeterminethenatureofcredit
worthinessofthelong-termbuyer.Creditenhancementsaresoughtifthecredit
worthinessofacounterpartyisnotuptoinvestmentstandards.
RevenueLoss
Duediligenceonrevenuecontracts–modificationsifnecessary.Contractsare
executedonlywithcredit-worthycounterparties.Additionalcreditenhancements
aresoughtwhencounterpartycreditisless-than-optimal(belowinvestmentgrade).
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TaxEquityInvestmentsOverview–FAQs
RISK
MITIGATION
Equipment
Malfunction
Typically,PVpanelscarrya25-yearpowerwarrantyandPVinverterscarrya
warrantyof5–10yearsfromtherespectivemanufacturers.Theinstallationcarries
a5-yearwarrantyfromtheinstaller.Adetailedcommissioningprocesswill
minimizeanyriskofequipmentmalfunction.
Reduced
Resource
Availability
Priortomakingtheinvestment,rigorousanalysesareconductedto
calculatetheprobabilitiesofexceedance–P50,P75,P99estimates,from
over60yearsofhistoricalresourcedata.
Foreclosureby
Lender
Priortomakingtheinvestment,thecoverageratiosondebtservice(principaland
interest)areverifiedandstress-tested.Inaddition,structureastandstillperiod
duringwhichthelendermaynotforecloseontheproject.(Note:intheinvertedlease
structurereferredtoabove,foreclosureonthePVassetswillnotnormallytrigger
recapturefortheInvestoraslongastheInvestor’slesseepositionisnotdisturbed.)
ArecorporatefinancialstatementsaffectedbytheITCandMACRSdeductions?
The ITC and deductions from owning PV systems are typically not reported on GAAP-basis
financialstatementsofacorporation,eventhoughitreceives99%oftheITCanddeductions.The
currentanddeferredtaximpact,ifany,onaccountofthedeductionsisrecordedonthefinancial
statementsbelowthelineandtypicallydonotaffectearnings.
ArePVsystemsconsolidatedonbooksofthecorporatetaxequityinvestor?
No.ThefinancialsofthePVsystemowner(typicallyorganizedasaspecialpurposeentity)are
typicallyconsolidatedonthestatementsoftheSponsor.ThisisbecausetheInvestordelegates
the responsibility to make decisions concerning day-to-day operations, under an operating
agreement,totheSponsorbasedonamutuallyagreed-uponrule-set.
HaveothercorporationsinvestedtaxequityinPVsystems?
Yes,severalcorporationshavemadetaxequityinvestments.GeneralElectric,Microsoft,Google,
Honda,andWashingtonGasareexamplesofcorporationsthathavemadetaxequityinvestments
inPVsystems.BankssuchasJPMorgan,Citi,BankofAmerica,PNC,StateStreet,WellsFargo,US
Bank,NationalBankofArizona,GoldmanSachs,Rabobank,andMorganStanleyareexamplesof
financial institutions that have made tax equity investments in PV systems. New investors
routinelyinvesttaxequityinPVsystemsandperceivetheinvestmentprofiletobeverysimilar
toinvestinginmortgageswhereanassetownerseeksareturnoninvestedcapitalbasedonlongtermcashflowsfromtheunderlyingasset.
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