On May 21, 2020, the Court of Appeals for the Federal Circuit upheld the decision of the Court of Federal Claims in the consolidated cases of California Ridge Energy, LLC v. US1 and Bishop Hill Energy, LLC v. US.2 The cases concern the inclusion of developer fees in cost basis for purposes of determining the eligible basis of a renewable energy project for the 1603 cash grant. In upholding the Court of Federal Claims, the Federal Circuit focused on three points: the round-tripping of cash, the substance of the development agreements, and the execution of the development agreements.
Eversheds Sutherland Observation: Although these cases involve the 1603 cash grant, they will have significant implications for taxpayers claiming an investment tax credit (ITC) under section 48 of the Internal Revenue Code. In addition, in light of current legislative proposals for cash payments in lieu of tax credits, this case may become relevant to those programs as well.
The 1603 cash grant program was part of the American Recovery and Reinvestment Tax Act of 2009 and provided a grant equal to 30% of the cost basis of a qualifying renewable energy project to owners of wind, solar and certain other renewable energy facilities. The 1603 cash grant was available in lieu of the production tax credit (PTC) under section 45 or the ITC. Because the 1603 cash grant program guidance generally looked to the relevant rules for PTCs and ITCs, the treatment of development fees under the program is of significance for parties involved in the development of wind, solar, and other renewable energy projects.
California Ridge Energy, LLC and Bishop Hill Energy, LLC (Plaintiffs), both wholly owned by Invenergy Wind, LLC, applied for 1603 cash grants with respect to wind energy facilities. In their applications to the Treasury to receive 1603 grant payments, California Ridge Energy and Bishop Hill Energy included in their cost basis a developer fee in the amounts of $50 million and $60 million, respectively, paid to a related person. With respect to those developer fees, Treasury allowed a cash grant for just a portion of the amounts claimed. The Plaintiffs sued for a cash grant for the remainder of the grant related to the developer fees, and the government countersued for the amounts that had previously been paid with respect to the developer fees. In short, the dispute was whether, or the extent to which, the related party development fees were includible in cost basis for purposes of determining the amount of available cash grant. The Court of Federal Claims held for the government, disallowing any amount of 1603 cash grant with respect to the developer fees.
The Federal Circuit affirmed the decision of the Court of Federal Claims, and in doing so, focused on three aspects of the developer fees:
- Round- tripping: The Federal Circuit found that because the fee was negotiated between related parties, payment was made in a round-trip transaction, and neither party was materially affected by the fee, the arrangement constituted “peculiar circumstances.” The court also rejected Plaintiffs’ contention that the reflection of the payments in their accounting books should negate any adverse inference arising from the circular cash flow.
- Substance of the Development Agreements: The Federal Circuit observed that the development agreements did not have any meaningful description of the services to be provided that would support the amount of development fees charged by the related party.
- Execution of the Development Agreements: The Federal Circuit noted that the development agreements were executed after the development services were substantially completed which was indicative of the negotiated price not being a reliable indicator of market value.
The Plaintiffs also argued the amount of developer fees was within the range of appropriate markups identified by Treasury in its published guidance. The Federal Circuit rejected that position stating that such fees are only appropriate when they are consistent with the scope of the work for which the markup is received. As the development services were described generically in the development agreements, the Federal Circuit determined that the Plaintiffs were unable to support a position that the work performed was consistent with the amount of developer fee charged.
|Eversheds Sutherland Observation: The issue of the amount of developer fees properly includible in cost basis has been the subject of much discussion both with respect to section 1603 cash grants and the ITC. As illustrated by these cases, especially when developer fees are paid to related parties, it is important to timely document the specific services that will be performed by the developer, to ascertain the fair value for such services, to ensure that those services are not provided under another pre-existing developer agreement, to avoid circular cash flows, and to document that the specified services were actually performed.