In a case decided on July 27, 2018, the U.S. Court of Appeals for the Federal Circuit (the Court of Appeals) reversed the Court of Federal Claims' (the Claims Court) decision in Alta Wind I Owner-Lessor C et al v. United States, 128 Fed. Cl. 702 (2016), and held that, in the case of renewable energy property sold prior to such property's in-service date at a price in excess of the seller's cost, the basis of property eligible for the 30 percent cash grant available under Section 1603 of the American Recovery and Reinvestment Act of 2009 (the Section 1603 Grant), should be determined under Section 1060 of the Internal Revenue Code1 and, as such, a portion of such basis may be allocable to intangibles.
At issue in the case were six wind farms (the Wind Farms) developed by an established wind developer (the Seller). The Seller developed the Wind Farms and entered into long-term agreements for the sale of the electricity generated by each of the Wind Farms (the PPAs).2 Prior to placing the Wind Farms "in service" for income tax purposes, the Seller sold the Wind Farms to the plaintiffs in the case (collectively, the Plaintiffs)3 and leased back five of the Wind Farms under long term net leases while the sixth one was retained by a Plaintiff for direct operation. The Plaintiffs claimed that the entire purchase price of each Wind Farm represented eligible basis for purposes of the Section 1603 Grant (less minor amounts allocable to ineligible tangible property). The Government, however, only paid Section 1603 Grants based on the Seller's actual construction and development costs of the Wind Farms. In response, the Plaintiffs filed a lawsuit against the Government for the full amounts of the claimed Section 1603 Grants (less the amounts previously paid by the Government) and the Government counter-claimed for a refund of the portion of the amount previously paid on the grounds that the bases on which it allowed the Section 1603 Grants were overstated.
The Claims Court sided with the Plaintiffs and found that the cost bases of the Wind Farms (i.e., the full purchase prices the Plaintiffs paid the Seller)—less minor amounts allocable to ineligible tangible property—were the appropriate bases for determining the Section 1603 Grant amounts. In so finding, the Claims Court rejected the Government's argument that the Plaintiffs' acquisitions of the Wind Farms were "applicable asset acquisitions" subject to Section 1060 because,4inter alia, (i) the Wind Farms were not operational at the time they were sold to the Plaintiffs, (ii) each PPA related only to a specific Wind Farm and was not transferrable or assignable, and (iii) there were no "peculiar circumstances" which otherwise mandated the application of Section 1060. Although the Claims Court acknowledged that the purchase prices were above the hard development and construction costs, it viewed such value as turn-key value that is considered part of the tangible assets.
The Government appealed the Claims Court's decision to the Court of Appeals. The Court of Appeals disagreed with much of the Claims Court's holdings and reversed the lower court's decision on the law and remanded the case for further factual findings. In examining the Treasury Regulations under Section 1060, the Court of Appeals determined that the Plaintiffs' purchases of the Wind Farms fell squarely within the definition of applicable asset acquisitions,5 finding that—1. there were intangible assets present (the PPAs and transmission rights), 2. the purchase prices for the Wind Farms were in excess of their book values (defined in the opinion as the construction and development costs), and 3. the transactions involved related transactions (the sale-leaseback in all but one of the transactions and indemnities provided by the Seller for the Section 1603 Grants).6 The Court of Appeals concluded that it was immaterial that the Wind Farms were not operational at the time acquired by the Plaintiffs, reasoning that "[a]lthough it may be that there was technically no goodwill at the time of the transaction, it was readily apparent that goodwill could attach once the windfarms began operation—which was to occur immediately after the transaction—and this expectation of goodwill was baked into each purchase price."7 The Court of Appeals was also not convinced that the PPAs lacked intangible value given that the purchase prices of the Wind Farms were determined in large part by the future expected cash flows which, of course, were dependent on the existence of the PPAs, and the PPAs had value in the "continued customer patronage" by the offtaker.
The Court of Appeals agreed with the Claims Court that there may be turn-key value attached to the Wind Farms' tangible assets—but emphasized that turn-key value must be distinguished (and allocated separately) from goodwill and going concern value—and remanded the case to the Claims Court (but reassigned the case to a different judge)8 to make a factual determination as to the appropriate allocation of the purchase price.
The Court of Appeals' determination that the sale of the Wind Farms is subject to Section 1060 ignores the fundamental issue of whether renewable energy offtake agreements such as the PPAs actually have any economic value. While investors and purchasers of renewable facilities may require a facility to have an offtake agreement for internal credit purposes, these offtake agreements are often procured as part of a competitive RFP (i.e., request for proposal) process or utility mandate (such that they are available to any similarly situated energy facility) and are often priced at or below expected merchant pricing. It seems inappropriate to apply Section 1060 on the basis that there may be intangible value by virtue of the mere existence of the PPAs when the PPAs have no economic value to an investor or purchaser (and in fact may be of negative value where, for example, power sells at a higher price in the merchant market).9 In addition, the fact that the purchase price of the Wind Farms was determined in part by the expected cash flows generated by the PPAs is irrelevant. It is perfectly reasonable for the Plaintiffs to take into account the contracted cash flows of the Wind Farms, but that does not mean that the PPAs actually add any value; the relevant inquiry should be whether the PPAs create incremental value by virtue of above market pricing and/or terms.
It is also a stretch to conclude as a threshold matter that the sale (and sale-leasebacks with respect to all but one of the six Wind Farms) is an applicable asset acquisition. Although the Treasury Regulations provide a fairly expansive definition of a trade or business, we do not believe it extends to circumstances such as these. While it may be true that the Wind Farms would be operational shortly after being sold to the Plaintiffs, the fact that they were not yet operational should not be entirely ignored and, even more importantly, once they became operational the Wind Farms are not assets to which goodwill or going concern value attaches. Purchasers of electricity generated by renewable energy facilities such as the Wind Farms do not do so out of any sort of customer loyalty or preference for one facility over another. There is no reputational or brand value with respect to the Wind Farms. Moreover, in the context of a sale-leaseback, it is quite extraordinary to conclude that the purchaser/lessor acquired a trade or business and then turned around and leased the trade or business along with the potential for profit in the trade or business (i.e., the Plaintiffs stood to make no profits from the PPAs during the terms of the lease).
That said, assuming arguendo, that Section 1060 applies to transactions such as these, we believe any value in excess of the hard construction costs should be allocated to turn-key value which the Government and the courts agreed is separate and apart from goodwill and going concern. For the same reasons described above, there was little—if any—intangible value present in the Wind Farms when they were sold to the Plaintiffs. Instead, the purchase price paid by each Plaintiff more appropriately represented the value of the applicable Wind Farms as a whole (i.e., the turn-key value); particularly given the significant amount of development action, permitting, studies, testing, etc. that was performed by the Seller in developing, construction and financing the Wind Farms.10
Given that this decision is only days old, its impact on renewable energy investors and developers (not to mention appraisers) is uncertain. It also remains to be seen how much of the purchase prices will be attributed by the Claims Court to turn-key value and whether that decision will be appealed.
5 An applicable asset acquisition is any transfer (whether directly or indirectly) of assets which constitute a trade or business, and with respect to which the transferee's basis in such assets is determined wholly by reference to the consideration paid for such assets. Section 1060(c). Treasury Regulations under Section 1060 explain that a group of assets constitutes a trade or business if the use of such assets would constitute an active trade or business under Section 355 or its character is such that goodwill or going concern value could under any circumstances attach to such group. Regulation § 1.1060-1(b)(2)(i).
Goodwill is the value of a trade or business attributable to the expectancy of continued customer patronage. This expectancy may be due to the name or reputation of a trade or business or any other factor. Going concern value is the additional value that attaches to property because of its existence as an integral part of an ongoing business activity. Going concern value includes the value attributable to the ability of a trade or business (or a part of a trade or business) to continue functioning or generating income without interruption notwithstanding a change in ownership. It also includes the value that is attributable to the immediate use or availability of an acquired trade or business, such as, for example, the use of the revenues or net earnings that otherwise would not be received during any period if the acquired trade or business were not available or operational. Regulation § 1.1060-1(b)(2)(ii).