Chris Lord discusses partnership flips under the IRC

As Mark Twain once said, “News of the recent death of the partnership flip for solar transactions is greatly exaggerated.”

Okay, he didn’t exactly refer to partnership flips; he was talking about a newspaper article that prematurely reported his death. But in the case of the partnership flip in solar transactions, stray reports since last summer that partnership flips are not permitted under the Internal Revenue Code (“IRC”) in solar transactions have confused some developers and investors. As it turns out, the reports of the partnership flip’s demise for solar transactions are “greatly exaggerated.”

Historically, solar investors have relied on two IRS Revenue Procedures for solar-based partnership flip transactions. Rev. Proc. 2007-65 established safe harbor requirements for the use of a partnership flip with respect to investments in wind facilities qualifying for IRC §45 Production Tax Credits (“PTC”). Rev. Proc. 2014-12 did the same for investments in historic building rehabilitation qualifying for IRC §48 historic building investment tax credits.

So, what about the partnership flip in the context of a solar transactions relying on IRC §48 investment tax credits (“ITC”)? To date, the IRS has not issued a Revenue Procedure that specifically addresses solar and the ITC. This has left tax practitioners to work by analogy from the two Revenue Procedures noted above. But last summer, the IRS’s Chief Counsel Office issued a memo (Chief Counsel Advice Memorandum 201524024, or “CCA” for our purposes).

The CCA Memo is an internal IRS memo that was made public several months after it was issued by the IRS national office to one of the IRS’ local field auditors.  The CCA addresses questions from the field auditor concerning a taxpayer’s use of a partnership flip in a complex solar ITC transaction. Though heavily redacted, the auditor’s inquiry apparently cited the safe harbor requirements for a partnership flip carved out by Rev. Proc. 2007-65 (that was the one for the §45 PTC in wind transactions). In the CCA Memo, the IRS stated that Rev. Proc. 2007-65 “does not apply to partners or partnerships with [IRC] §48 energy credits. Oddly enough, though, the IRS went on to apply the very same safe harbor requirements of Rev. Proc. 2007-65 to the solar transaction at issue, and concluded that the taxpayer did “not satisfy all of the safe harbor requirements of Rev. Proc. 2007-65.”

Since that CCA issued last summer, a few writers have published notes, articles and blogs focusing on the CCA’s statement that Rev. Proc. 2007-65 did not apply to the §48 energy ITC. From these publications, some developers and investors have begun to question whether the partnership flip is therefore not permitted in solar transactions structured to take advantage of the ITC.

This interpretation of the CCA and its implications for the partnership flip transaction are misplaced. To understand why the partnership flip remains a viable – even popular – approach to solar transactions looking for a mechanism to monetize tax benefits, we must first understand three key tax concepts: safe harbors, tax credits and how a solar partnership flip fits within the IRC.


First, lets start with safe harbors. Because tax laws are written broadly, they often leave taxpayers unclear on exactly how a tax law’s provisions apply to real-life transactions. So, to help taxpayers understand how the IRS will interpret the general requirements of a tax law, the IRS defines a “safe harbor” by issuing a Revenue Procedure or other similar publication.

A safe-harbor is a set of administratively defined specific requirements that, if satisfied, entitle the taxpayer to the benefit of the law. Picture a Venn diagram in which the general legal requirements for a tax credit lie in a large circle defined by a fuzzy border. The safe harbor is a smaller circle within the larger one, and its crisp, sharp borders give taxpayers certainty about how to structure their transaction.

One nice thing about a safe harbor is that if a taxpayer fails the safe harbor test, it might still argue that it meets the general requirements of the broader law. That is, the taxpayer claims that although the transaction lies outside the clearly defined inner circle, it still fits within the larger circle created by the general requirements of the law. In such a case, the taxpayer may be no less qualified for the tax credits, but there is less certainty because the IRS has not ruled on that specific type of transaction.


Let’s now look at tax credits. Under the IRC, there are many different kinds of tax credits of which two are relevant here. An investment tax credit (ITC), authorized under §48 of the IRC, works by giving the owner of a qualifying asset an immediate, one-time credit based upon the dollar value of the qualifying investment. For example, a 30% ITC means an owner can claim $.30 tax credit for each $1 of qualifying investment. By contrast, a PTC authorized by §45 of the IRC (and the focus of Rev. Proc. 2007-65) works by giving the operator of a qualifying energy asset a tax credit of a specific dollar amount for each unit of energy produced during a given tax year. For projects entering service in 2016, the PTC credit is approximately $.023 per kWh of qualifying wind energy.

Note that these two tax credits operate in very different ways. The ITC is based on a percentage of the qualifying costs of the investment. The ITC entitles an owner to a full credit immediately upon the project being placed in service, and is subject to a five-year re-capture period. The PTC, on the other hand, is driven by asset performance measured annually over a ten-year period.

The critical point here is that tax credits under the IRC can vary in their purpose, methodology and application. For this reason, and similar to any other provision of law, those charged with interpreting or enforcing legal requirements are cautious that any precedent or official interpretation apply only in the context in which it is issued, and extension to new scenarios with differing facts and differing legal requirements be done so cautiously with great attention to detail.


Finally, lets look at the partnership flip and its relationship with the IRC.

The partnership flip is a business arrangement where the allocations of profits and losses are shared among the partners on a certain percentage basis for a period of time, and then shared on a different percentage basis after that period ends.   These business arrangements have been used for decades in real estate partnerships.

For example, the most common arrangement in partnerships investing in low-income housing is for the primary capital investor to receive 99% of the profits and losses for a 15 year period and then for that investor to flip down to only 10% of profits and losses thereafter.. Although, there is no section of the tax code that specifically mandates or even acknowledges a partnership flip structure, the IRS has acknowledged through Revenue Procedures, CCA Memoranda and the like that a properly-structured partnership flip works to shift most economic benefits, including tax benefits, to one designated investor (often called a Tax Equity Investor), and post-flip to shift the economics back to favor the other investor (often called a Cash Equity Investor or Sponsor).  In addition, there is support in the regulations under IRC §704(b) where the initial allocation lasts at least 5 years.

We know from Rev.Proc. 2007-65 that in a partnership flip involving a wind energy PTC, the Tax Equity Investor may before the flip be allocated up to 99% of the income and deductions, with the Cash Equity Investor receiving the remaining 1% or more. After a date certain (a “Time-Based Flip”) or after the Tax Equity Investor has achieved a target return on its investment (a “Yield-Based Flip”), the allocations “flip” so that the Tax Equity Investor receives 5% of the income and deductions with the balance allocated to the Cash Equity Investor. Under the safe harbor of Rev. Proc. 2007-65, the percentage allocations may vary provided that before the flip the Cash Equity Investor does not receive less than a 1% allocation of the income and deductions, and after the flip not more than 95% of the allocation of income and deductions. That broad outline of the safe harbor rule set forth in Rev. Proc. 2007-65 is mirrored in Rev. Proc. 2014-12 for investment in historic property rehabilitations.

So, through Revenue Procedures, the IRS has acknowledged that a properly structured partnership flip works under the IRC to shift economic benefits, including tax benefits, to one designated investor, and post-flip to shift the economics back to favor the other investor; provided, however, that the Cash Equity investor has at least 1% pre-flip and not more than 95% post flip. If the percentage allocations give Cash Equity Investors less than 1% pre-flip, then the taxpayer is no longer in the safe harbor and must argue the less certain position that it still fits within the legal requirements of §48 of the IRC to qualify for the ITC.


With this background on safe harbors, tax credits and the partnership flip, we can now revisit the IRS’s statement in CCA 201524042 that Rev. Proc. 2007-65 “does not apply to partners or partnerships with § 48 energy credits.“ Rev. Proc. 2007-65 dealt with a partnership flip structure in a wind project looking to benefit from the §45 Production Tax Credit. Viewed in the proper context, it is clear that the IRS is noting that Rev. Proc. 2007-65 addressed tax credits that fundamentally differ in their requirements from the ITC. Its comment did not address the partnership flip structure, per se, but rather addressed the obvious fact that the Rev. Proc. 2007-65 dealt with a Production Tax Credit under §45 of the IRC, and not the Investment Tax Credit favored by solar projects and found under §48 of the IRC. In other words, because certain technical aspects of the two tax credits differ in material ways, the IRS was alerting taxpayers that they cannot mechanically apply the requirements of one to the other – a critical warning given that IRS went on to conclude in CCA 201524042 that the taxpayer did not properly apply the requirements of the safe harbor outlined in Rev. Proc. 2007-65 to the solar transaction. This is consistent with our earlier observation that those charged with interpreting or enforcing legal requirements, such as the IRS, approach precedent and other official interpretations of law cautiously. That is, legal conclusions are only valid for the specific facts analyzed, and any extension of those conclusions in other cases must be done so thoughtfully and carefully.

This reading of CCA 201524042 also explains why, after noting that Rev. Proc. 2007-65 “does not apply to partners or partnerships with §48 energy credits”, the IRS nonetheless went on to apply the fundamental principles of the partnership flip safe harbor requirements to the solar transaction in the CCA memo. Incidentally, those same safe harbor requirements are also the same ones applied by the IRS in Rev. Proc. 2014-12 for tax credits involving investments in the rehabilitation of historic properties, another tax credit found under §48 of the IRC. Unfortunately, the CCA Memo dealt with a complex solar transaction that clearly failed the requirements of the safe harbor, and so it does not offer the clarity and certainty that a case in which the IRS approved the taxpayer’s transaction structure would have.

Sophisticated and experienced tax counsel and tax equity investors have always understood CCA 201524042 in its context. At the Cost of Capital – 2016 Outlook Roundtable, hosted by Chadbourne Parke in January, 2016, the Managing Director and Head of Renewable Energy at JP Morgan, John Eber, estimated that transaction parties invested over $5 billion in solar financings in 2015. At the same event, Jack Cargas, Managing Director of Renewable Energy at Bank of America, estimated that the leading finance structure of choice for 2015 was the partnership flip structure.


For these reasons, it seems safe to conclude that a solar partnership flip transaction involving energy investment tax credits under §48 of the IRC remains alive and well. That said, the real lesson from CCA 201524042 is that an investor must always look closely at the factual and legal basis underlying any precedent on which it relies, and consult experienced tax practitioners when faced with any uncertainty.

Christopher Lord, 2016

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