Solar Finance: Considerations for Tax-Exempt Entities and Government Organizations James F. Duffy, Esquire Nixon Peabody LLP 100 Summer Street Boston, MA 02110-2131 (617) 345-1129 jduffy@nixonpeabody.com FINANCING SOLAR ENERGY IPED, INC. Alexandria, Virginia May 21-22, 2009

Investment Tax Credits The principal federal incentive for the development of solar facilities remains the investment tax credit (energy tax credits under Section 48 of the Internal Revenue Code), known as “ITCs” But tax-exempt entities and governmental organizations generally do not pay federal income taxes

Treasury Grants Section 1603(g) of the American Recovery and Reinvestment Act of 2009 (“ARRA”) specifically provides that the Treasury grants which are available in lieu of ITCs cannot be made to tax-exempt entities, to governments or subdivisions, agencies or instrumentalities thereof, or to any partnership or other pass-through entity any partner or equity holder of which is such an entity

Section 168 Elections So, without being able to utilize ITCs or claim Treasury grants, how does a tax-exempt entity or governmental organization finance a solar facility? One mechanism is to set up a subsidiary and elect under Section 168(h)(6)(F)(ii) of the Internal Revenue Code to have the subsidiary treated as a for-profit entity

Section 168 Elections Check to see if having a for-profit subsidiary is allowed under local law for governmental organizations or under the organizational documents of a tax-exempt entity Any ultimate collapse of the for-profit subsidiary into the tax-exempt entity will be a taxable event (deemed sale at fair market value with basis of zero by then), so careful tax planning is required

CREBs Clean Renewable Energy Bonds (“CREBs”) may be an option Under Section 54 of the Internal Revenue Code, CREBs were designed to provide an incentive for governmental bodies (including Indian tribes) and cooperative electric companies to produce renewable energy CREBs were addressed in detail on a previous panel on Thursday morning

Tax-Exempt Use Property Any leasing of the solar facility to a tax-exempt entity will cause the facility to be deemed “tax-exempt use property” under Section 168(h)(1) of the Code Tax-exempt use property will not be eligible for the ITC This does not mean that you cannot lease a rooftop from and sell solar electricity to a tax-exempt entity

Section 7701 Section 7701(e)of the Code deals with the classification of a contract as either a service contract or a lease In the case of a solar company leasing space from a tax-exempt entity and selling solar electricity to that entity, the preferred treatment is as a service contract, not as a lease of the facility

Section 7701 Section 7701(e)(1) provides a facts and circumstances test as to whether a contract which purports to be a service contract is to be treated as a lease of property, taking into account all relevant factors, including those listed in that Section of the Code

Section 7701 The facts and circumstances listed in Section 7701(e)(1) include whether or not: the service recipient has physical possession of the property or controls the property, the service recipient has a significant economic interest in the property or bears the economic risk of diminished receipts or increased expenditures if there is nonperformance under the contract, the service provider uses the property only to provide services to the service recipient, and the total contract price does not substantially exceed the rental value of the property for the contract period

Section 7701 In contrast to the facts and circumstances test of Section 7701(e)(1), Sections 7701(e)(3) and (4) provides a safe harbor for certain contracts, including those with respect to the sale to the service recipient of electricity produced a solar facility As long as none of the circumstances listed in Section 7704(e)(4) is present, the contract will be deemed to be a service contract

Section 7701 In order to qualify under Section 7701(e)(4), the service recipient (or a related entity) cannot: Operate the facility, Bear any significant financial burden if there is nonperformance under the contract (other than for reasons beyond the control of the service provider), Receive any significant financial benefit if the operating costs of the facility are less than the standards of performance or operation under the contract, and Have an option to purchase, or be required to purchase, all or a part of the facility at a fixed and determinable price other than for fair market value 12560510.1