The NC Department of Revenue sought to throw some shade at the financing regimes through which solar farm and other renewable energy projects are built by challenging the flow of tax credits from LLC developers to their partners. In McCabe v. N.C. Dep’t of Revenue, 2023 NCBC 28, DOR and a state administrative law judge barred LLC owners from claiming their share of distributed, pass-through tax credits on a finding that the financial structure amounted to the impermissible buying and selling of energy tax credits “to offset their state income tax liability.” Id. ¶ 25.
To incent alternative energy development, the General Assembly approved a 35% tax credit (with a 2017 sunset) “if the property is placed in service in this State during the taxable year.” N.C.G.S. § 105-129.16A(a). The rub, as Judge Conrad observed, is that “[i]n practice, few taxpayers that qualify for this credit can directly take advantage of it” because they are LLCs or other entities treated as partnerships. Id. ¶ 7. To address these “stranded” credits, the statutes also provide that a credit “passes through to each of its partners the partner’s distributive share of the credit.” N.C.G.S. § 105-269.15(a).
The Court observed that “[t]his arrangement benefitted the investors and sponsors alike,” as the developers secured capital to balance the debt financing taken on and investors received a proportionate share of credits. That last part is the soft underbelly for DOR because the tax credits are keyed to total project cost (including equity and debt); thus, the credits returned to investors can far exceed their investment capital. In the solar development deals at issue in McCabe, that meant for one project investors anticipated a $1 credit for every 35 cents contributed, and in another $1 for every 58 cents. Id. ¶ 12.
Even in rejecting the taxpayer’s argument, the ALJ conceded that plaintiffs’ investment (¶ 25):
“mirrored the ‘partnership structure commonly used throughout the United States for renewable energy tax equity financing projects under federal and various state laws.’”
It took the Business Court exactly one paragraph to eviscerate the core of DOR’s disallowance of the credits. The headline? The transaction worked just like the legislature intended (¶ 38):
“[T]here is no serious dispute about the form of this transaction. The undisputed evidence shows that the McCabes claimed a share of tax credit received in the form of a partnership allocation, not in the form of a sale. The Department acknowledges as much. Accordingly, there is no basis to disallow the McCabe’s claim on the ground that it arose from an ‘actual sale’ of the credit.”
Judge Conrad noted that the General Assembly decided to encourage renewable energy development, and “offered tax credits as incentives.” It set the rules for how a credit may be received, and how it may be passed through to entity partners. “There is little room for judicial meddling,” the Court held, “if a transaction checks these boxes.” See Summa Holdings, Inc. v. Comm’r, 848 F.3d 779, 787 (6th Cir. 2017) (“it’s odd to reject a Code-compliant transaction in the service of general concerns about tax avoidance.”). Id. ¶ 41. (In a parallel decision issued on the same day, N.C. Farm Bureau Mut. Ins. Co. v. N.C. Dep’t of Revenue, 2023 NCBC 29, the Business Court similarly decided in favor of Farm Bureau concerning its nearly $27 million in investments that secured more than $37 million in tax-credit allocations.)
Judge Conrad noted that “judicial guardrails” might be prudent where there was evidence of fraud or a sham transaction. Here, though, the Court held that:
“[t]hese transactions were real, not fake. The McCabes invested real money in real renewable energy properties that were placed in service and that generated tax credits.”
Id. ¶ 43. Where investors generated profit by risking capital to develop alternative energy, they engaged in “exactly the kind of economic activity that the General Assembly deemed socially desirable and sought to encourage[.]” Id.
DOR also argued that federal standards, instead of those in North Carolina, should be imported to judge whether the McCabes were actually bona fide partners in the venture and whether the pass-through credit regime was actually a “disguised sale.” The Court rejected the argument, concluding that simply because the General Assembly incorporated parts of federal law for determining the amounts of a partner’s distributive share it did not occasion a broader adoption of federal rules unless it was evident it was intended. As Judge Conrad noted, “when the General Assembly intends to adopt provisions or definitions from other sources of law into a statute, it does so by ‘clear and specific reference.’” Id. ¶ 49 (quoting Fidelity Bank v. N.C. Dep’t of Revenue, 370 N.C. 10, 19 (2017).
Takeaways
- While DOR conceded the McCabes maintained their records, provided them to the agency, and that it was not aware of any requests they declined to meet, it nonetheless argued the claimed credit was not substantiated under N.C.G.S. § 105-129.18. The Court derided that position as “inscrutable,” and criticized DOR’s “conclusory, one-paragraph argument [that] cite[d] no evidence and offers no reasonable basis”in support. Id. ¶ 55.
- The Court twice called out DOR for skirting Business Court rules that disallow incorporation of other briefs. “The attempt to incorporate arguments made below violates the Business Court Rules that set out word limits for briefs . . . and that require parties to cite supporting materials with specificity.” ¶¶ 59, 67.
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