The United States Court of Federal Claims recently released two anticipated opinions, Bishop Hill Energy, LLC v. United States and California Ridge Wind Energy, LLC v. United States, which were issued under seal on January 7, 2019, and are essentially identical.
The issue in the cases was whether development fees paid to an affiliate for qualified wind energy projects are properly includable in cost basis for purposes of the now expired Section 1603 cash grant. The court concluded that although an applicant for the Section 1603 grant is permitted to include a development fee in its cost basis, the project owners in the cases did not substantiate the development fees in question. The court in both cases applied the “sham transaction” doctrine to conclude that the development fees lacked independent economic substance. The court concluded in both opinions:
In sum, [the project owner] proffered: an independent certification of the Development Fee that is based on information from [an affiliated development company]; a development agreement without quantifiable services; and a round-trip wire transfer that began and ended in the same bank account, on the same day, none of which were corroborated by independent testimony. This falls well short of the burden under the sham transaction doctrine.
Although Bishop Hill and California Ridge address developer service agreements and development fees in the context of the cash grant, the rules of that program were intended to operate in the same manner as the rules applicable to the investment tax credit under Section 48 of the Internal Revenue Code.
The Department of Justice asserted among other things, that the development services agreements were not bona fide agreements with a legitimate business purpose because the project companies did not seek competitive bids from third parties to perform the development services or negotiate the amount of the development fees. The Justice Department also argued that the affiliated development company did not perform many of the services described in the agreement.
The court reached its conclusion primarily on the facts presented (and not based on a legal conclusion that related-party development fees could never be added to basis). The court found that (i) the project companies did not produce sufficient evidence of services actually provided, (ii) the development services agreement did not identify quantifiable services, and (iii) the developer fee was paid by round-tripping cash that ended up in the same bank account where it started on the same day. In addition, the court noted that the accounting firm for the affiliated development company testified about the development company’s accounting practices but did not show any journal entries for the transactions.
At a high level, the court’s conclusions in Bishop Hill and California Ridge are favorable to the renewable energy industry in that the court appears to accept the common practice of including development fees in eligible basis. The opinions also serve as a reminder of the importance of ensuring that developer fees reflect an arm’s-length charge for services actually rendered by the recipient that are properly documented by the taxpayer.
Nevertheless, the opinions may also create uncertainties. For instance, the court determined that the “development agreement contained no quantifiable services,” which may suggest that specificity as to the value of each service is required for a valid development services agreement. However, the court fails to explain why the absence of such specificity should invalidate the entire development fee. The court also does not explain why a “round trip” of funds is problematic, other than implying that such round trip supported the holding that the development services agreements were sham transactions. Finally, the court not only held that the grant applicants failed to carry their burden of proof that the development fees were for Section 1603 grant-eligible costs but went a step further and held that the development services agreements were “sham transactions.” Without a further explanation of exactly why the agreements were sham transactions, it is difficult to draw helpful guidance from the cases.