Renewable Energy for Hospitals and Health
Care Providers: Solar, Wind and Cogeneration
Henry C. Fader; Marc D. Machlin; Todd B. Reinstein; Mark A. Solomon | May 5, 2011
We will be starting momentarily…
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Moderator: Henry C. Fader
• Corporate and health care partner in the Philadelphia office
• Chair of the firm’s health care practice
• Practice includes counseling health care providers of all types
and sizes – physicians, hospitals, integrated delivery systems,
academic medical centers and medical schools, service
providers and long-term care providers
215.981.4640
faderh@pepperlaw.com
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• Focuses on organizational structuring and advises clients on
tax-exempt financing, the formation and governance of
nonprofit organizations, corporate governance and regulatory
issues, as well as reimbursement, antitrust, antifraud and
contractual matters, adapting new concepts to delivery, such
as joint ventures and accountable care organizations to assist
in developing more efficient relationships between physicians
and institutional providers.
Speaker: Marc D. Machlin
• Partner in the Washington office of Pepper
Hamilton LLP
• Head of the Regulatory Section within the firm's
Commercial Litigation Practice Group
• Practice covers a broad range of areas, including
environmental and energy; infrastructure projects
and renewable energy projects; transportation and
NHTSA; public utility regulation and railroad
202.220.1439
machlinm@pepperlaw.com
regulation
• Member of the firm’s Sustainability, CleanTech
and Climate Change Team.
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Speaker: Todd B. Reinstein
• Partner in the Washington office of Pepper
Hamilton LLP
• Practice focuses on advising clients on federal
corporate tax and advocates for taxpayers on
federal (before the IRS Examination and Appeals
levels) and international (Competent Authority
Assistance) tax controversies, including collection
issues
202.220.1520
reinsteint@pepperlaw.com
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• Member of the firm’s Sustainability, CleanTech
and Climate Change Team.
Speaker: Mark A. Solomon
• Partner in the Princeton office of Pepper
Hamilton LLP
• Concentrates his practice in real estate
development, land use and zoning, commercial
real estate, redevelopment, environmental law,
and real estate-related litigation, including
condemnation and tax appeals
• Member of the firm’s Sustainability, CleanTech
and Climate Change Team.
609.951.4131
solomonma@pepperlaw.com
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INTRODUCTION
• Recent survey indicated that 58% of respondents
consider energy management to be a top priority
• Same survey reported that 67% of those
responding were intending to make a facility
improvement in energy management in the next
year
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INTRODUCTION
• Reasons
− Concern for the environment
− Expectations to be a community leader
− Cost savings
− Expectation of future increased energy costs
− Desire to enhance the reliability of the energy
supply to health care facilities
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INTRODUCTION
• Many organizations have already obtained cost-savings
from more energy efficient fixtures, bulbs, and HVAC
improvements
• Such energy saving activities have been implemented
independently by some organizations; others have entered
into agreements with ESCOs, which need to be carefully
structured
• Other facilities are building new systems or retrofitting
current ones
• Types of facilities: hospitals, long term care providers,
retirement communities, outpatient facilities, residential
care facilities
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INTRODUCTION
• Challenges include:
− Evaluating risks and benefits of various types of
renewable energy facilities: solar, wind,
cogeneration, geothermal, or other
− Deciding upon an appropriate transaction structure;
selecting a supplier or a contractor
− Preparing contractual documents
− Financing alternatives
− Evaluation of tax issues, compliance with tax
incentives
• Our faculty today will deal with each of these issues
• Questions will be taken throughout the program
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EVALUATING RENEWABLE ENERGY ALTERNATIVES:
COGENERATION OR COMBINED HEAT AND POWER (CHP)
• Benefits Of CHP For Hospitals, Health Care Facilities
− Capable of supplying electricity, steam, and chilled
water
− Operates effectively during black-outs, brown-outs on
the grid
− Capable of meeting all or a substantial portion of a
facility’s electric power and thermal requirements
− Production not driven by sunlight levels, wind levels
− Once constructed, power produced during all time
periods when this is economically advantageous
− Hospital typically maintains interconnection with the
grid, allowing use of externally generated power when
this is economically advantageous
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EVALUATING RENEWABLE ENERGY ALTERNATIVES,
COGENERATION OR COMBINED HEAT AND POWER
• Benefits Of CHP For Hospitals, Health Care Facilities
− Effectively locks in a long-term pricing arrangement
for a substantial portion of the facility’s energy
requirements; may facilitate budgeting, insulate facility
from short-term pricing swings in area power markets
− CHP is a green energy source, favored under many
State programs, because (a) CHP captures a much
higher percentage of the BTU value of natural gas
than a centralized utility scale plant; and (b) CHP
lessens the need for costly expansion of the electric
grid.
− Hospitals and health care facilities often fit the ideal
profile for CHP because they have substantial electric
and thermal energy use, on a 24 hour, 7 day per
week basis
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EVALUATING RENEWABLE ENERGY ALTERNATIVES:
COGENERATION OR COMBINED HEAT AND POWER (CHP)
• Disadvantages Of CHP For Hospitals, Health Care
Facilities
− Substantial capital investment
− Must have access to local gas distribution system
capable of delivering a substantial volume of gas
− Operation and maintenance is complex; typically
requires on-site staffing
− Typically must be housed inside a building, near the
hospital
− Air permitting required
− Noise issues must be evaluated if a gas compressor is
required
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SCHEMATIC DIAGRAM OF COGENERATION
SYSTEM AND RELATED EQUIPMENT
Source: http://www.kga.com.my/products.html
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EVALUATING RENEWABLE ENERGY
ALTERNATIVES: WIND POWER
• Benefits Of Wind Power For Hospitals, Health Care
Facilities
− No air emissions; no production of greenhouse gases
− Production continues at night and during times when it
is cloudy or rainy
− Does not require installation on or inside a building; no
roof upgrades needed
− Can be configured to provide electric power during
black-outs or brown-outs on the grid
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EVALUATING ENERGY ALTERNATIVES:
WIND POWER
• Disadvantages Of Wind Power For Hospitals, Health
Care Facilities
− Production is intermittent and may vary from year to
year
− Wind levels vary from region to region; wind projects
more economic where wind levels are high on a
consistent basis
− Maintenance is more complex on wind projects than
on solar photovoltaic projects; more moving parts
− Must evaluate impacts to birds, bats
− Permitting and interconnection may take more time
than is required for a solar project
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EVALUATING RENEWABLE ENERGY
ALTERNATIVES: WIND POWER
− Due in part to the intermittent nature of wind power,
wind turbines typically cannot be used to meet a
substantial percentage of a hospital’s requirements
− Small-scale wind projects typically are less economic
than large utility-scale projects
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Wind Speeds In U.S. - Wind Power
Classes
Source: U.S. Dep’t of Energy - Energy Efficiency and
Renewable Energy – Wind Technologies Program
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U.S. WIND POWER CAPACITY AND
PROJECTS
Source: American Wind Energy Association, AWEA Annual Market Report – Year Ending 2010
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U.S. WIND POWER CAPACITY AND
PROJECTS
Source: American Wind Energy Association, AWEA Annual Market Report – Year Ending 2010
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WIND POWER: ROTOR SIZE
Source: Coast Guard Wind Images
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WIND POWER: HEIGHT
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EVALUATING RENEWABLE ENERGY
ALTERNATIVES: SOLAR POWER
• Benefits Of Solar Power For Hospitals, Health Care
Facilities
− Solar photovoltaic panels can be installed in many
locations: roof-tops, parking lots, and adjacent land
− Production levels can be projected with reasonable
certainty
− Operations and maintenance is relatively straightforward
− Numerous suppliers and installation companies
− In many States, permitting and interconnection are
relatively straightforward
− No air emissions
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EVALUATING RENEWABLE ENERGY
ALTERNATIVES: SOLAR POWER
• Disadvantages Of Solar Power For Hospitals, Health Care
Facilities
− Production of power is intermittent and seasonal
− As typically configured, solar power is delivered only
when the surrounding power grid is operational
− Technology is improving, which means that costs
continue to decline; technology installed today may
become obsolete long before the end of the system’s
lifespan
− Depending upon the size of available roofs, and
depending upon the amount of land available, a solar
array may be able to meet only a small portion of the
facility’s requirements
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TERMINOLOGY; SOLAR POWER
TECHNOLOGIES
• There Are Three Principal Technologies
− Solar Thermal Systems: Sunlight used to heat water
− Concentrating Solar Power Systems (CSPS): Sunlight is
concentrated by using mirrors; solar energy is converted
to heat; thermal energy used to produce electricity using
a steam turbine or heat engine driving a generator
− Solar Photovoltaic Systems (PVs): Solar energy is
collected in solar panels or modules, which are made of
smaller solar cells; this solar energy is used to produce
electricity
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TERMINOLOGY; SOLAR POWER
TECHNOLOGIES
• Large end users typically install PV systems.
• There are three basic types of PV technologies.
− Thin film (10 percent conversion efficiency; energy
captured with coating on glass, such as cadmium and
telluride; the coating or film may be sandwiched
between two layers of untempered glass)
− Standard Efficiency (14 percent conversion efficiency;
energy captured with polycrystalline silicon)
− High Efficiency (18 percent conversion efficiency;
energy typically captured with monocrystalline silicon)
32
TERMINOLOGY; SOLAR POWER
TECHNOLOGIES
• Thin film is the cheapest, but has less proven
durability; often used in very large utility-owned
systems and in areas where land is cheap.
• High efficiency modules provide more energy
production in a given area of land or roof top space.
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2010 U.S. PV INSTALLATIONS BY STATE
AND MARKET SEGMENT
Source: Solar Energy Industries Association, U.S. Solar Market Insight – 2010 Year In Review
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INSTALLED PV CAPACITY IN TOP 10
STATES, 2009-2010
Source: Solar Energy Industries Association, U.S. Solar Market Insight – 2010 Year In Review
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NATIONAL WEIGHTED AVERAGE
SYSTEM PRICES, 2010
Source: Solar Energy Industries Association U.S. Solar Market Insight – 2010 Year In Review
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AVERAGE PV INSTALLED COST
Source: Solar Energy Industries Association
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TYPES OF PV INSTALLATIONS
• Roof – Mounted
− Used in urban, suburban areas
− Requires evaluation of roof
• Ground – Mounted
− Used where land is available, preferably within a
short distance of the end user’s operating facilities
• Solar Trees
− Used to provide shade in parking lots, other areas
• End users generally able to mix and match
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PHOTOGRAPHS OF SOLAR INSTALLATION
ROOF-MOUNTED SYSTEM
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PHOTOGRAPHS OF SOLAR INSTALLATION
GROUND-MOUNTED SYSTEM
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PHOTOGRAPHS OF SOLAR INSTALLATION
SOLAR TREES
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CRITICAL ECONOMIC FACTORS DRIVING USE OF CHP, WIND,
OR SOLAR BY HOSPITALS AND HEALTH CARE PROVIDERS
• Ability to produce, sell renewable energy credits (“RECs”) or
solar renewable energy credits (“S-RECs”) under State law
• Ability to interconnect with local electric utility, without
substantial investment in new infrastructure; adequate
existing transformers to allow step-up in voltage of power
transmitted back to grid
• Ability to utilize net metering
• Ability to use, install a system large enough to interest wind
power providers, cogeneration providers, solar power
providers
• Adequate credit rating for hospital, sufficient either to use
the power purchase agreement model or to obtain
necessary capital for direct investment
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OTHER ECONOMIC FACTORS
• Plan to utilize hospital or health care facility for at least
10 years
• Availability of wind if installing wind turbines
• Availability of natural gas pipeline capacity if installing
a cogeneration unit
• Assured availability of sunlight if installing solar; ability
to prevent construction of structures that would block
sunlight in the future
• Ability to obtain any necessary consents from existing
lenders, landlords, and tenants
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OVERVIEW OF OWNERSHIP
STRUCTURES
• Two Approaches Used For Most Renewable Energy
Projects
• Option 1:
− Third party designs, builds, and maintains renewable
energy system
− Third party leases land or roof-top space from end user
− End user purchases output under long-term power
purchase agreement (PPA)
• Option 2:
− Third party designs, builds, and usually maintains
renewable energy system
− End user becomes the owner of the system upon
completion
44
RISKS AND BENEFITS OF OPTION 1 –
THE PPA MODEL
• Principal Benefits Of PPA Model
− No direct commitment of capital by end user
− Pay only for power (and/or thermal energy) actually
delivered, metered
− Achieves cost savings, lower energy costs
− Green image from being a renewable energy host
− Ownership risks (including risks from equipment
failures, hail damage, obsolescence) largely assigned
to third party
− Allows non-profit entities, governmental organizations
to obtain economic benefits of investment tax credit,
REC or SREC revenue; these benefits largely passed
through by the solar provider
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RISKS AND BENEFITS OF OPTION 1 –
THE PPA MODEL
• Principal Risks, Disadvantages Of PPA Model
− Economic benefits of project must be shared with third
party provider and its lender(s)
− Cost savings may be based upon projections relating to
future energy prices, delivered utility prices
− Project may be fully paid off in 5 to 10 years but provider
retains benefits of ownership
− Loss of control stemming from having a third party
operating a system on the roof-top, or on adjacent land
or parking lots
− Default by end user may trigger requirement to
purchase system
− Third party provider may have differing priorities in
obtaining interconnection, resolving land use issues,
and avoiding damage to facilities
46
RISKS AND BENEFITS OF OPTION 1 –
THE PPA MODEL
• Principal Risks, Disadvantages Of PPA Model
− Many PPA terms, lease terms may be dictated by
provider’s lender(s)
− Requires monitoring of insurance policies, coverage
held by provider
− Provider may or may not be willing to commit to specific
output levels
− Complications may arise if end user moves or ends
operations
47
RISKS AND BENEFITS OF OPTION 2 –
THE OWNERSHIP MODEL
• Principal Benefits Of Ownership Model
− Higher rate of return for end user
− Greater control over system once operational
− More input into selection of technology, components
vendors
− Project costs paid in large part by investment tax
credit, S-REC or REC revenue, and other grants and
subsidies
− Owner decides whether to sell S-RECs or RECs in
spot market or enter into long-term sales agreements,
or use a combination of approaches
− More control over level, frequency of maintenance
activities
48
RISKS AND BENEFITS OF OPTION 2 –
THE OWNERSHIP MODEL
• Principal Risks, Disadvantages Of Ownership Model
− Must commit, raise necessary capital
− Risks of system failure, system damage fall entirely
on end user
− Still probably need to pay for design, installation,
procurement, O&M services; may or may not have
internal engineering capacity to evaluate, oversee
these services effectively
− If relying on spot market REC or S-REC sale, must
bear risks associated with price fluctuations
− If selling RECs or S-RECs on a long-term basis, must
confirm credit-worthiness of buyer
49
RISKS AND BENEFITS OF OPTION 2 –
THE OWNERSHIP MODEL
• Principal Risks, Disadvantages Of Ownership Model
− If system fails, component manufacturers and
installation firm may each seek to deny
responsibility
− Long-term durability of certain equipment may not
be established; lifespan may not be known with
precision
− Not all entities able to utilize investment tax credit
or U.S. Treasury grants in lieu of this credit
50
NEGOTIATING THE AGREEMENTS
KEY PROVISIONS UNDER THE PPA MODEL
•
•
•
•
Duration of PPA, Lease
Purchase Option(s) And Termination Values
Liability, Indemnification, And Insurance
Use Of A Project Company, Combined With A Parent
Guaranty For Specified Obligations
• Commitments From The Provider On
Design Standards, Operating Standards, Avoiding
Disruption Of The Host’s Ongoing Operations
• Parent Guaranty
51
NEGOTIATING THE AGREEMENTS
KEY PROVISIONS UNDER THE PPA MODEL
• Ability Of Provider To Sell, Transfer, Assign System To
Its Lender(s)
• Security Interest Of Provider’s Lender(s); Primacy Of
Host’s Existing Lenders
• Solar Easements; Preservation Of Sunlight
• Insurance Coverage For Provider, Host
− Liability insurance
− Property damage and casualty
− Automobile
− Workmen’s compensation
− Umbrella
• Property Access For The Provider
52
NEGOTIATING THE AGREEMENTS
KEY PROVISIONS UNDER THE PPA MODEL
• Deadline For Starting, Completing Construction
• Conditions Precedent For Provider
− Interconnection
− Financing
− Zoning, land use approvals
• Output Levels; Degradation Or Decreases In
Production Over Time
• Maintenance, Repairs, Replacement Parts, Monitoring
53
PPA MODEL
SITE LEASE AGREEMENT
• Lease Provisions Follow PPA, Facilitate PPA
• Term: Tracks PPA Or System Lifespan
• Leased Premises; Leased Area
− Rooftop/Condition; when last repaired, replaced?
− Weight of system; ability to support
− Special circumstances with environmentally
impaired properties
− Vacant land; any grading required; wetlands or
wetlands buffers
54
NEGOTIATING THE AGREEMENTS - KEY
PROVISIONS UNDER THE OWNERSHIP MODEL
• Price For Installed System And Pricing Adjustments
− Ability of provider to submit change orders
− Ability of owner to accept, reject change orders
− Progress payments over a suitable time frame
• Deadline For Initiating On-Site Work And For Completion
• Responsibility For Interconnection, Ensuring That Net
Metering Is Available
− Interface with utility
− Interconnection delays, costs for upgrades
• Liability, Indemnification, And Insurance
• Responsibility For Ensuring That AECs, SRECs Are
Provided
55
NEGOTIATING THE AGREEMENTS - KEY
PROVISIONS UNDER THE OWNERSHIP MODEL
•
•
•
•
•
Responsibility For Land Use Approvals
Owner Review, Approval Of Designs
Owner Review, Approval Of Permit Applications
Preservation Of Manufacturer Warranties
Warranties From The Provider
− Duration
− Scope
− Need for continued O&M
56
NEGOTIATING THE AGREEMENTS - KEY
PROVISIONS UNDER THE OWNERSHIP MODEL
• Obligations Relating To O&M Services
• Obligations Relating To Spare Parts
• Output Levels; Degradation Over Time
57
GRANTS AND SUBSIDIES FOR
RENEWABLE ENERGY PROJECTS
• State Grant Programs, Loan Programs And Loan
Guarantee Programs; Eligibility Issues; Evaluation
Criteria
• Utility Financing For Renewable Energy Facilities
Owned, Constructed By End Users
• Regulatory Policies That Generate Supportive REC or
S-REC Prices
• Conditions Associated With State Grants, Loans,
Loan Guarantees
• USDA Programs Available In Rural Areas: Grants,
Loans And Loan Guarantees
58
GRANT CONDITIONS
• State Grants Come With Conditions, Restrictions
• Hospitals And Health Care Institutions Should
Carefully Review These Conditions, Restrictions
Before Applying For Or Accepting State Grant Funds
• Restrictions May Be Embedded In The Grant
Agreement And/Or Regulations And Guidelines
Promulgated By The State
59
GRANT CONDITIONS
• State Policies Vary, But There Are Common Threads
• Common Grant Conditions (Imposed By The
Commonwealth Financing Authority Pursuant To The
Alternative Energy Investment Act):
− Grant applicant must provide copies of all executed
contracts for Project-related work; contracts must
contain specific provisions
− Depending upon the size of the grant, and depending
upon the percentage of Project costs covered, and
subject to waiver or modification or good cause,
competitive bidding requirements may have to be
followed
− Use of illegal alien labor prohibited
60
GRANT CONDITIONS
• The State’s Prevailing Wage Act May Apply If The
Grant Exceeds $25,000
• The State’s Right-to-Know Law May Apply To The
Grant, Which Means That Certain Information About
The End User’s Project May Become Public
• Compliance With Non-Discrimination Laws, Sexual
Harassment Policies, Americans With Disabilities Act
61
GRANT CONDITIONS
• Progress Reports Required
• Project Audit By A CPA For Grants In Excess Of A
Certain Size
• Grants Subject To Termination At Any Time By The
State; Termination Generally Prospective, Not
Retroactive
• No Financial Interest In Contractor; No Kickbacks Or
“Gratuities” To State Officials
• Grant Funds May Be Disbursed Over Time, As
Progress Is Made
62
UTILITY FINANCING PROGRAMS
• Individual Utilities May, With State Approval, Provide
Loans For Solar PV Systems Or Other Renewable
Energy Projects
• One Prominent Example: PSE&G
• The New Jersey BPU Has Authorized PSE&G To
Provide Loans Covering 50 To 60 Percent Of The
Capital Costs Of Solar PV Projects
− Customers may then repay the loan using S-REC
revenue produced by their solar PV systems
• Other New Jersey Utilities Have Programs Providing For
Long Term Purchase Of S-RECS From Owners Of Solar
PV Systems
63
U.S. DEPARTMENT OF AGRICULTURE
(USDA) FINANCING
• USDA Has Several Programs That May Potentially Be
Used In Support Of Solar PV Systems And Certain
Other Renewable Energy Projects
• Applicants And Systems Generally Must Be In Rural
Areas
− Cities or towns with less than 50,000 inhabitants
− Not adjacent to a larger municipality
• Different Programs For Loan Guarantees, Business
And Industry Guaranteed Loans
64
FINAL COMMENTS ON GOVERNMENT
GRANTS, LOANS, LOAN GUARANTEES
• Assess Program Requirements Carefully
• Evaluate Impacts, If Any, On Ability To Generate, Sell
S-RECs
• Be Sure To Comply With All Conditions, Restrictions
• Confer Early And Often With Advisors And With
Agency Staff
65
FEDERAL TAX INCENTIVES:
TAX CREDITS
• Tax credits reduce a taxpayer’s tax liability “dollar for
dollar”
− e.g., if TP owes $1M of taxes, and has $500K of tax credits,
then TP only has to pay $500K in cash, and the rest is paid
with the credits
• So, it can be a good deal if TP can obtain credits for less
than $1
• Tax rules generally make tax credits a bad investment for
individuals due to passive activity rules
• Tax credits are not actually bought and sold - Instead, the
investor becomes a partner of a partnership or member of
an LLC, and gets a Schedule K-1 telling it how much in
tax credits it has been allocated for the year
66
PRODUCTION TAX CREDIT
• Credit for the production and sale of electricity
produced from qualified renewable energy resources
or refined coal
• Must be produced at a qualified facility
• Credit is equal to the kWh produced times a fixed
price over 10 year period
67
PRODUCTION TAX CREDIT
• Renewable Energy Sources:
− Wind
− Closed-loop biomass
− Open-loop biomass
− Geothermal
− Solar (pre-2006)
− Small irrigation power
− Municipal waste
− Qualified hydro
− Marine & hydro-kinetic
68
ENERGY CREDIT
• Credit equal to the basis of energy property multiplied by
the energy percentage
− For periods after December 31, 2005 the energy
percentage is 30% for equipment which uses solar
energy to
• Generate electricity
• To heat or cool a structure
• Provide solar process heat (swimming pools do not
count)
69
ENERGY CREDIT
• 30% of the facility’s basis, if placed in service prior to
January 1, 2017
• 10% of the facility’s basis, if placed in service after
December 31, 2016
− Includes Eligible Combined Heat and Power
system property (48(c)(3))
• Can claim energy credit in lieu of production tax credit
70
U.S. TREASURY GRANT PROGRAM
• Enacted in Section 1603 of the American Recovery
and Reinvestment Tax Act of 2009
• 10% or 30% cash grant is provided for renewable
energy facilities in lieu of Energy Credit
• Treasury Grant Program is administered by U.S.
Treasury Department
• Extended Through 2011
71
PLACED IN SERVICE DATES
•
•
PTC or ITC projects are eligible
Qualifying projects must begin construction in 2011
− Costs “paid or incurred” and the 5% safe harbor
− Possibility of extension?
• Placed in service dates:
2010
2011
Begin Construction
72
2012
2013
Wind
2014
All other
PTC projects
2015
2016
ITC projects
BONUS DEPRECIATION
• Prior law generally allowed additional 30% or 50%
depreciation deduction (i.e., bonus depreciation) for
certain property acquired and placed in service during
a specified eligibility window
– Tax Relief, Unemployment Insurance Reauthorization
and Job Creation Act of 2010 provides extension and
increase in top level of bonus depreciation
− 100% - 9/9/2010 – 12/31/2011
− 50% - 2012
• Rev. Proc. 2011 – 26
− Ordering rules
73
DEAL STRUCTURES
•
Wind projects are eligible per
•
•
Developer
Investor
PRS
Income,
Losses,
Credits
DRE
•
Rev. Proc. 2007-65
Ann. 2009-69
Solar?
• Investor buys interest in PRS:
− Allocated substantially all (e.g., 99%) of
partnership items (income, gains, deductions,
losses and credits) until IRR is reached
− Allocation “flips” to small portion (e.g., 5-10%) of
these items after Investor IRR is reached
− Cash Distributions:
• 100% to Developer until Developer’s capital
account reduced to zero
• Then, 100% to Investor until capital account
goes to zero
• After the flip, cash distributions follow income
allocations
− Interest usually subject to FMV buy-out after IRR
is reached
− May make “pay-as-you-go” contributions to PRS
• Permits Investor to fund its investment with
reductions in future federal income tax
liability, and
• Places part of the risk of the investment on
the developer
• 2011 Bonus Depreciation
74
POWER PURCHASE AGREEMENT
TAX ISSUES
• Section 7701(e) serves to determine whether a
contract that purports to be a service or other
agreement should be re-characterized as a lease
• “A contract that purports to be a service contract shall
be treated as a lease of property if such contract is
properly treated as a lease of property, taking into
account all relevant factors. . .”
− Statute lists six factors under its general rule and
four conditions for specific items of property
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SECTION 7701(E)(3) – SAFE HARBOR
• No regulations have ever been promulgated or
proposed
− Legislative history, case law, and a handful of
rulings provide only guidance
• Safe harbor exists for an alternative energy facility
that produces “electrical or thermal energy if the
primary energy source for the facility is not oil, natural
gas, coal, or nuclear power”
• A purported service agreement will not meet the safe
harbor if any of four features are present:
− The service recipient (or a related entity) operates
the facility;
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SECTION 7701(E)(3) – SAFE HARBOR
− The service recipient (or a related entity) bears a
significant financial burden if there is
nonperformance under the contract (other than for
reasons beyond the control of the service provider);
− The service recipient receives any significant
financial benefit if the operating costs of such
facility are less than the standards of performance
or operation under the contract; or
− The service recipient has an option or obligation to
purchase all or part of the facility at a fixed and
determinable price (other than at then fair market
value)
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SECTION 7701(E) AND ENERGY CREDITS
• Section 7701(e) needs to be carefully applied in a
context in which the economics of a transaction may
depend on the availability of a 30% credit and bonus
depreciation
• Safe harbor issues:
− Service recipients are often interested in
negotiating for fixed price purchase options for the
property, and as a result the safe harbor is
unavailable and the general rules must be applied
− What operating cost savings can and cannot be
passed on to the service recipient adds to the
uncertainty whether the safe harbor applies
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TAX EXEMPT BOND FINANCING
• Effect of installing solar panels or other renewable
energy facilities on tax-exempt bond financed facilities
• Section 145(a)(2) limits the amount of “private use” to
5%
• Is the energy producer on the roof creating a
problem?
− Would have built a roof anyway
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Question and Answers
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For more information, visit
www.pepperlaw.com.
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