KPMG-Workshop-PPT-Nov-7th

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KPMG-Workshop-PPT-Nov-7th

  1. 1. 47thBANK & CAPITAL MARKETS TAX INST IT U T Eannual Pre-Conference Workshop CAPITAL MARKETS WORKSHOP Fantasia Q/P November 7th, 8:30am – 12:00pm 47th ANNUAL BANK & CAPITAL MARKETS TAX INSTITUTE DISNEY CONTEMPORARY HOTEL Speakers: MARK H. PRICE KEVIN JURAN MARK E. HARRISON ELIZABETH L’HOMMEDIEU JUSTIN WEISS Sponsored by: 47 BANK I N S T I T U MARKET th annual TA X & CAPITAL TE NOVEMBER 7-9, 2012 E.COM WWW.BANKTAX I N ST I T U T D I S N E Y C O N T E M P O R A RY H OT E L | ORLANDO
  2. 2. Bank Tax Institute Mark H. Price Principal, Washington National Tax Kevin Juran Principal, Washington National Tax Mark E. Harrison Partner, Tax Elizabeth L’Hommedieu Managing Director, Tax Justin Weiss Managing Director, Tax November 7 – 8, 2012 Orlando, FL ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 2 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Agenda  Low Income/New Markets credits  Energy Credits  Leasing  Section 475  Hedging  Bad Debts  Q&A © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 3 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 1
  3. 3. Tax Credit Transactions Low-Income Housing Tax Credit Low-Income Housing Tax Credit - Introduction  The low-income housing tax credit is a federal income tax credit intended to attract private investment to finance the development of affordable housing − TPs may claim the credit annually over ten years (the “credit period”)  Credit is a percentage of “qualified basis” in project  LIHTC is approximately a $7 - $9 billion market − Banks and GSEs are largest purchasers − Market is/will be affected by CRA reform, Basel III, and tax reform © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 6 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 2
  4. 4. Low-Income Housing Tax Credit Overview Although the IRC sets the requirements to qualify for the credit, the States administer the program e.g., − Congress annually sets the amount of the credit for each State − Each State has an agency that allocates and issues the credit to “qualified low-income housing projects” in that State − TPs apply to State agency to invest in a project  Consequently, there are both federal and State eligibility requirements © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 7 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Federal Eligibility IRC § 42 provides the federal requirements that govern the credit The requirements turn on numerous statutory and regulatory definitions The requirements include: − Project eligibility  Must be met throughout the “compliance period” to obtain the credit and avoid credit recapture  Annual certification  Computation of the credit  Credit recapture © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 8 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Project Eligibility Requirements − The residential rental property used in the project must be a “qualified low-income building” − A qualified low-income building must be a part of a “qualified low-income housing project” during the “compliance period” − A qualified low income housing project is a project that meets certain percentage tests used to determine if the project reserves enough residential units for tenants with certain incomes (also known as set asides) Generally, a project must comply with the project eligibility requirements throughout the “compliance period” − The compliance period is 15 tax years beginning with the first tax year of the credit period (the ten-year period over which the TP takes the credit) © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 9 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 3
  5. 5. Annual Certification Requirements − The owner of the project must annually certify to the State agency that certain of the eligibility requirements are met − Each building or single project must be certified © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 10 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Computation of the Credit Again, IRC § 42 permits the credit over the 10-year period generally beginning the year that the property is placed in service The amount of the credit for a tax year equals the “applicable percentage” of the “qualified basis” of the building The applicable percentage is a rate that will generate 10 equal annual installments that have a present value that equals either: − 70% of the qualified basis of the building’s low-income units if the building is new and is not federally subsidized − Not less than 9% through 12/31/2013  30% of the qualified basis of the building’s low-income units for a used or federally subsidized building © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 11 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Computation of the Credit (cont’d) In turn, qualified basis equals “eligible basis” multiplied by the TP’s “low income occupancy percentage” − Qualified basis may increase after the first year in the ten-year credit period − Increases often stem from increases in the “low-income occupancy percentage” of the building Finally, eligible basis equals the depreciable basis of the building eligible for the credit − Measured at the end of the first year of the credit period © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 12 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 4
  6. 6. Credit Recapture Although TPs take the credit over ten years, it is “earned” over the 15-year compliance period In this way, a portion of the credits are received in advance A TP may be required to recapture a portion of the credit if: − A building or a part of a building is disposed of before the end of the 15-year period and it is no longer a low-income building in the new owner’s hands; or − A building is no longer a low-income building in the TP’s hands Generally, a TP may be required to recapture the difference between: − The credit that would have been earned over the period that the building qualified for the credit based on a 15 year credit period; and − The credit the TP took over the same period, − Plus non-deductible interest © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 13 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Syndication A common structure uses a limited partnership − The GP owns just .01% but controls and operates − The LP is a passive investor (may be investor partnership) that invests equity in return for 99.99% ownership  Return is almost exclusively from the tax credits and losses © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 14 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Investing in LIHTCs - Common InvestmentStructure  Direct investment in an Upper Tier LIHTC Fund which owns many different lower tier funds that own qualifying properties (The Upper Fund may be an established fund in which the investor is either acquiring its interest directly from another investor or as part of a syndication purchase. Also, the interest in the fund may vary.) Developer/ Investor Syndicator .1% G.P. 99.9% L.P. .1% Managing Upper Tier Member LIHTC Fund, L.P. 99.9% Property Management Company Lower Tier LIHTC Fund, LLC Real Estate © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 15 15 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 5
  7. 7. New Markets Tax CreditBackground IRC § 45D governs the New Markets Tax Credit Its purpose is to attract capital to facilitate economic and community development It is a 39% general business tax credit under IRC § 38 It is taken over a seven-year period © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 17 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Qualified Community Development Entity The credit is available to a TP who makes a “qualified equity investment” in a “qualified community development entity” Qualified Community Development Entity (CDE) − A domestic corporation or a domestic partnership − Treasury must certify the entity − The entity’s primary mission must be to serve or provide investment capital to low-income persons or communities © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 18 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 6
  8. 8. Qualified Equity Investment Qualified Equity Investment (QEI) has 4 requirements − Requirement 1  The investment must be in exchange for stock in a corporation or a capital interest in a partnership (not certain disqualified preferred stock)  Thus, a business trust or LLC may qualify if it constitutes a corporation or partnership for tax purposes © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 19 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Qualified Equity Investment (cont’d) Requirement 2 − The TP must acquire the investment solely for cash − The IRS has ruled that a TP may include cash received from nonrecourse borrowing. Rev. Rul. 2003-20. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 20 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Qualified Equity Investment (cont’d) Requirement 3 − The CDE must use “substantially all” of the cash to make qualified investments known as “qualified low- income community investments” (QLICI) − This means at least 85% of the entity’s assets − The 85% test must be met for each annual period in the seven-year credit period © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 21 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 7
  9. 9. Qualified Equity Investment (cont’d) Requirement 4 − The CDE must so designate the investment as being QLICI on its books and records © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 22 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Qualified Low-Income Community Investment An investment will be QLICI in 4 circumstances: − First, the entity invests in, or loans to, a qualified active low-income community business (QLICB)  This definition has numerous requirements  Very generally, the requirements ensure that the CDE invests in businesses in a low-income community − Second, the entity can purchase a loan from another CDE if the acquired loan is itself QLICI − Third, the entity can provide financial counseling to businesses and residents of low-income communities − Fourth, the entity can invest in, or loan to, another CDE © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 23 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Credit Amount The credit taken over a seven-year period − 5% in each of the first 3 years  6% in each of the final 4 years  Equal to 39% of amount of original investment − The credit is a general business credit under IRC § 38 credit  Carryback 1 year – Forward 20 years − Note, the PAL rules apply and may disallow a credit  The credit is based on a percentage of the amount the TP paid to the CDE  Raises Issue of whether TP acquired interest in CDE in connection with passive activity  Issue is not extent of TP’s participation in CDE’s trade or business • Rev. Rul. 2010-16 © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 24 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 8
  10. 10. Recapture  Recapture − The credit may be recaptured during the seven-year period − Recapture events include:  The entity no longer qualifies as a CDE;  The investment is redeemed  The CDE no longer invests substantially all of the cash for qualified low-income community investments © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 25 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. Process Overview  Step 1: Entities locate or are approached by a CDE with available allocation  Step 2: Entities fund/invest in CDE  Step 3: CDEs use proceeds to make QLICIs © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 26 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. Summary Graphic – Leveraged Investment CDEs must make QLICIs w/in 12 months of receipt of QEI Lender Investor 1 1 Investing in or Lending toNMTC Application: $3m loan $7m equity QLICB investment1) Business Strategy ($3.9m NMTC)2) Management Capacity Leveraged Financial3) Capitalization Strategy Entity Counseling4) Community Impact C-Corp or LLC $10m equity Investing in Or Lending To CDEs Qualified Community CDFI Development Fund-U.S. Tres. Entity (For-profit only) Purchasing Loans from $10m QEI generates $3.9m in CDEs NMTC. Entire credit goes to Investor 1 © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 27 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 9
  11. 11. Partnership Structure – Leveraged Investment Investor Managing Member 99.99% 0.01% $9M $900 Investment Managing Fund$21M interest-only MemberLoans at market rate 99.99% 0.01%from Bank $30M $3000 CDE LLC NMTC credit allocation $11.7M from Treasury Dept. $30M interest-only Loans at below-market rate QLICB © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 28 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. Technical Issues – Leveraged Investment  Will leveraged structures be respected as partnerships? − Debt vs. Equity  0.01% partners • Guaranteed rates of return to investor − Distributions in excess of income  § 45D(h) basis reduction rule  Negative basis in a partnership? − Economic Substance © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 29 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. New Markets Tax Credit  Limitations − Intangibles, certain leasing activities, gambling, and certain “pleasure businesses”  Dual Opportunities − Couple with Historic Tax Credits and State & Local Incentives – Most ‘Low Income Communities’ Identified for both Federal and State purposes © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 30 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 10
  12. 12. New Final Regulations  Proposed regulations became final on Sept. 28, 2012  Final regulations focus on requirement that CDE receiving return on investment invest proceeds in other QLICI during 7-year credit period − Difficult to provide capital to non-real estate businesses because those loans ordinarily amortize over 5-year term  Final regulations permit CDEs that invest in non-real estate businesses to invest certain returns of capital in unrelated community development financial institutions that are themselves CDEs − The regulations deem these amounts to be continuously invested during the seven-year credit period © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 31 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Energy Credits andOther Incentives Production Tax Credit  Section 45 provides a production tax credit (PTC) for the production of electricity from renewable resources  Must produce electricity from an eligible renewable resource and sell the electricity to an unrelated party  Different credit rates for different resources: − 2.2 cents per kilowatt hour for wind and geothermal − 1.1 cents per kilowatt hour for other renewable resources  Available for facilities placed in service before January 1, 2014 (12/31/13 for wind)  Credit is available for a 10-year period beginning with the year the facility is placed in service © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 33 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 11
  13. 13. Production Tax Credit (cont’d)  Eligible renewable resources − Wind − Geothermal − Landfill gas − Trash combustion − Open-loop biomass − Closed-loop biomass − Hydropower − Marine and Kinetic Energy − Refined coal – placed in service date before 2012 © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 34 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Production Tax Credit (cont’d)  Miscellaneous: − AMT  PTC may be used to offset AMT during the first 4-years of production − Credit amount reduced for:  Grants  Tax-exempt bonds  Subsidized energy financing  Other credits © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 35 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Investment Tax Credit Section 48 provides an investment tax credit (ITC) for qualifying energy property The ITC for any taxable year is the energy percentage of the basis of each energy property placed in service during the taxable year Energy property: − Solar − Small wind − Geothermal − Qualified fuel cell or mircoturbine property − Combined heat and power system − Geothermal heat pumps Section 45 facilities placed in service after 2008 and before 2014 (2013 for wind) Credit amount − 30% of costs for purchase of fuel cell, solar, and small wind property − 10% of costs for purchase of combined heat and power and geothermal heat pumps © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 36 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 12
  14. 14. Investment Tax Credit (cont’d)  General eligibility restrictions, e.g., ITC is not allowed for property − Used predominantly outside the U.S. − Used by a tax-exempt entity, unless property used predominantly in an unrelated trade or business which is subject to tax − Used by a domestic governmental entity or foreign entity  Recapture − The ITC is recaptured in whole or in part if the property is disposed of within 5 years after it is placed in service − Recapture is also required if, during these 5 years, the property ceases to qualify as property eligible for the credit − Recapture increases the TP’s tax in the year of recapture by the portion of the credit required to be recaptured  AMT − The ITC may be used to offset AMT  Basis Reduction − The basis of the energy property is reduced by 50% of the amount of credit received © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 37 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Differences Between PTC and ITC PTC ITC 10 year credit period for  Credit for qualified property qualified resources when placed in service Credit reduction for  No credit reduction for subsidized or tax-exempt subsidized or tax-exempt financing financing 3rd party sales requirement  No 3rd party sales requirement Ownership requirement  ITC can be claimed by owner or passed to lessee Partnership structuring  Partnership and leasing available for monetization structure available for No basis reduction of monetization property  Basis reduction of property for 50% of ITC © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 38 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Bonus Depreciation  Available for property acquired and placed in service on or after January 1, 2008 and before January 1, 2013  Qualified property − MACRS property with a recovery period of 20 years or less − Water utility property − Computer software − Qualified leasehold improvement property  Qualified property acquired and placed in service after September 8, 2010, and prior to January 1, 2012, was eligible for a 100 percent first year depreciation deduction. 50% for property placed in service in 2012.  Other conditions and limitations apply © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 39 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 13
  15. 15. Energy Incentive Monetization Structures Typical Partnership Flip Structure Investor buys interest in PRS:Developer Investor − Allocated substantially all (e.g., 99%) of partnership items (income, gains, deductions, losses and credits) until IRR is reached − Allocation “flips” to small portion PRS Income, (e.g., 5%) of these items after Investor IRR is reached Losses, − Cash Distributions: Credits  100% to Developer until Developer’s capital account reduced to zero  Then, 100% to Investor until DRE Investor IRR is reached  After the flip, cash distributions follow income allocations e.g., Wind Farm − Investor’s interest usually subject to purchase option after IRR is reached (i.e., after the flip). © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 41 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. Partnership Flip Structure – Rev. Proc. 2007-65 (as revised)  IRS guidance provides a safe harbor for partnership flips related to wind PTC projects − 20% Minimum Unconditional Investment. − 75% of sum of: (i) fixed capital contributions plus (ii) reasonably anticipated contingent capital contributions to be contributed by an investor, must be fixed and determinable obligations that are not contingent in amount or certainty of payment. − Limits “Pay-as-you-go” payments − Call options  FMV at time of exercise or fixed but reasonable estimate of FMV.  5-year restriction before exercise. − Put options prohibited − Maximum 99/1 allocations − No guarantees of allocations of Section 45 credit. − No guarantees of “windiness” (except weather derivate contract) − No Developer loans © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 42 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 14
  16. 16. Sale-Leaseback Rental Income Depreciation Investor/ Funding Deductions Tax Owner Residual Value Credits Non-recourse Purchaser/ Lenders P&I Lessor (Trust/LLC) Leaseback Rent (w/debt equity Sale components) Developer/ Rental Deduction Lessee Gain or loss on sale © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 43 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.New Developments – Grants etc.  The section 1603 grant application period expired on October 1, 2012.  Property for which a timely application is made can still receive a grant if placed in service by the relevant credit date – for example, 2013 for wind.  Property must also have begun construction before 2012.  Other issues/stresses − Looming expiration of credits for Wind − Debates in press and in Washington about need for continued government subsidies. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 44 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.New Developments – Historic Boardwalk Appeals Court for the Third Circuit determines that tax investor was not a true partner in a rehab credit partnership with a tax exempt agency. − The decision was based on the court’s determination that the tax investor did not acquire the risk and reward of a true equity partner − Did not address whether the overall transaction had economic substance  Determination that the risk and reward elements were lacking » No genuine upside potential » Court also felt that if there were any such potential, the agency could manipulate circumstances to trigger a fixed price buy-out of the investor » No downside » No project risk – pay as you go » No audit risk – broad tax indemnity from NJSEA » No investment risk – transaction was fully funded © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 45 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 15
  17. 17. New Developments – Historic Boardwalk  Limited to its facts or relevant to other credit deals?  Court expressly did not seek to determine in the abstract what constitutes a true equity partner. − Facts were emphasized that the court felt indicated taxpayer’s relying on form rather than substance? − Where draw the line? Congress clearly intends to incentivize certain activity but doing so through tax credits requires the credits be used by a party with tax capacity. − How get comfortable going forward?  Follow the wind PTC safe harbor in other contexts  Follow the true lease guidelines © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 46 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Leasing Basics Common Lessor and Lessee Objectives  Lessor Objectives − Banks use leasing as another product offering for borrowers − Earn lease rents; residual value opportunities; tax benefits  Lessee Objectives − Reduce net cost of using new assets − Monetize tax benefits of assets already placed in service − Operating lease/ off-balance sheet treatment for GAAP − Shift residual risk to lessor © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 48 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 16
  18. 18. EconomicsLoanCost $100Int. Rate 10%Term 5 YearsResidual 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 ResidualRent/P&I 26.4 26.4 26.4 26.4 26.4 0Tax (paid) (3.5) (2.9) (2.3) (1.6) (0.8)Net Cash 22.9 23.5 24.1 24.8 25.6IRR 6.5% © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 49 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.EconomicsLeaseCost $100Int. Rate 10%Term 5 YearsResidual 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 ResidualRent 26.4 26.4 26.4 26.4 26.4 0MACRS -60 -16 -9.6 -5.76 -5.76 -2.9Tax (paid) 11.8 (3.6) (5.9) (7.2) (7.2) 0Net Cash 38.2 22.8 20.5 19.2 19.2 0IRR 7.3% © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 50 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Basic Lease Structure Purchase Price Rental Income Depreciation Equipment Residual Value Asset Lessor Vendor Rent Lease Lessee Rental Deduction Gain on Sale if Sale-Leaseback © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 51 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 17
  19. 19. Leveraged Lease Structure Lender Interest Income Note Loan Purchase Price Interest Deductions Equipment Rental Income Vendor Lessor Depreciation Residual Value Asset Rent Lease Rental Deduction Lessee Gain on Sale if Sale-Leaseback © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 52 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Principal Tax Issues Lessor/Tax Owner − Is it a “true lease”? − If so, what’s my cost recovery (depreciation, amortization) schedule? − What’s the timing of income and deductions (section 467, Pickle rules, section 470)? Lessee − What’s the timing of rent deduction?  Book v. tax − How much gain on sale in a sale-leaseback and do I have NOLs or other attributes to shelter gain? © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 53 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.True Lease IssuesFor the lessor to be eligible for accelerated depreciation and othertax benefits the lease must be a “true lease” IRS Guidelines for Advance Ruling Purposes (Rev. Procs. 2001-28; 2001- 29) − Do not represent substantive law, but are a useful, conservative starting point in a true lease analysis − At least 20% equity investment at inception and throughout the lease term − At least 20% expected remaining useful life at the end of the lease term − At least 20% expected residual value − Lessee has no investment in property  No part of the cost of the property – or cost of improvements – are furnished by lessee (in practice, lessees typically fund required or desirable improvements) − No lessee loans or other furnishing of lessor costs  Lessee can’t provide or guarantee any debt borrowed in connection with lessor’s acquisition © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 54 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 18
  20. 20. True Lease Issues IRS Guidelines (continued) − Lessor cannot “put” the property to the lessee − Call option in favor of lessee must be exercisable at then FMV  A fixed price call option based on a reasonable estimate of the property’s future FMV has been generally accepted by the courts.  Early buy-out options are considered by the IRS to increase economic compulsion on lessee to exercise the option and thus raise true lease issues. − No limited use property  Rev. Procs.: use by the lessor or some other person (other than the lessee) who can lease or use the property for its own use must be commercially feasible  Case law: No specific limited use prohibition but tends to be considered when determining the feasibility of property being returned to a lessor at the end of the lease term © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 55 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.True Lease Issues IRS Guidelines (continued) − Economic profit  Lessor must have expectation of profit without regard to tax benefits and have “reasonable” cash flow  Profit satisfied if rent plus residual value exceeds aggregate disbursements required to be paid in connection with lessor’s ownership of the property  Cash flow satisfied if rents exceed by reasonable amount the aggregate lessor disbursements • “Reasonable” cash flow – average of 2-4% of equity times the number of years in the lease has been viewed as sufficient  Case law – similar analysis with respect to overall profit but lack of cash flow during the lease term is generally not material  Calculating profit • The credit/grant often needs to be taken into account to pass profit and cash flow tests in renewable energy transactions © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 56 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.True Lease Issues Residual Value Considerations − Renewal options not at then FMV rent should be counted for purposes of the true lease tests. − Residual value needs to be lessor’s commercial risk – onerous return conditions or other contractual terms that may economically compel the lessee to purchase or renew the property rather than return it to lessor at lease-end are potential true lease issues. − For big-ticket deals, need third-party appraisal reports to demonstrate to IRS that, inter alia, property was acquired at FMV; there is a reasonable expectation of a meaningful residual value and useful life at lease-end; purchase options are not bargains or economically compelled, and that the property is not limited use. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 57 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 19
  21. 21. Characterization if not a True Lease If a lease is not respected as a true lease, possible characterizations include: − Sham – disregard the elements of the transaction  LILO/SILOs − Secured financing rather than a lease  Rent would be recharacterized as debt service – OID principles may need to be taken into account. − If the leaseback is not a true lease in a sale-leaseback?  Not treated as a sale and then a sale back. See Rev. Rul. 72-543. Just a secured financing. − Generally a timing issue for both lessor and lessee  If true lease lessor recovers cost as depreciation; if financing recovers as principal repayment. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 58 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Economic Substance Doctrine – Codification Section 7701(o) − If doctrine is applicable, conjunctive test applies  Resolves split among circuits − Transaction has economic substance if  Transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and  Taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into transaction − Potential for economic profit may be taken into account to establish economic substance only if pre-tax profit potential is “substantial” in relation to expected net tax benefits on a present value basis © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 59 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Economic Substance Doctrine – Codification Strict liability penalty for underpayment with respect to transactions lacking economic substance − 20 percent penalty if transaction adequately disclosed  Section 6662(b)(6) − 40 percent penalty if not adequately disclosed  Section 6662(i) − Reasonable cause exception under section 6664(c) is not available  Section 6664(c)(2) © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 60 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 20
  22. 22. Economic Substance Doctrine – Codification Whether economic substance doctrine applies is not affected by codification − Case law still applies − July 15th LB&I Directive JCT Explanation: leasing transactions will continue to be scrutinized based on all facts and circumstances IRS guidance: Notice 2010-62 − IRS will not issue PLRs or determination letters on whether economic substance doctrine is relevant − No intention to issue an “angel list” © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 61 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Economic Substance Doctrine – Tax Credits /Grants Elements of Economic Profit? Historic Boardwalk – Tax Court reverses its position in Sacks and finds that targeted tax credits can be counted for purposes of determining whether a transaction has economic substance. − In Sacks the Ninth Circuit reversed the Tax Court and held that targeted tax credits (solar energy credit) could be considered an element of economic profit. − Compare Friendship Dairies – regular (old) ITC not counted as “economics.” − LB&I Directive  “Does the transaction involve tax credits (e.g., low income housing credit, alternative energy credits) that are designed by Congress to encourage certain transactions that would not be undertaken but for the credits? If so, then the application of the doctrine should not be pursued without specific approval of the examiner’s manager in consultation with local counsel.” − © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 62 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Open Questions Will LILO/SILO analyses be applied across the board in lease transactions? − Are they now part of the pre-existing case law that section 7701(o) is to be applied against? What is “substantial” pre-tax profit in any given context? − Guidelines focus on 20% in any number of tests  Should there be a safe harbor if PV of profit at least 20% of the PV of the tax benefits? © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 63 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 21
  23. 23. Open Questions What discount rate? − 110% of the AFR? − Wells Fargo and Altria – consider the investor’s cost of funds? Allocate “profit” pro rata over the term or recover all costs first? Expected “net” tax benefits – seems reasonably clear that tax detriments need to be considered in the present value calculations. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 64 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Main Restrictions Affecting Leasing Pickle Rules Section 470 © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 65 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Pickle Rules Decreased depreciation deductions for certain leased property used by tax-exempt entities – No ITC available. − Property: all personal property and certain real property leased to a tax-exempt entity − Method: straight-line − Recovery period: the greater of the ADR recovery period or 125% of the lease term − Lease term: Stated lease term, any extension within the realistic contemplation of the parties, lessee renewal option (whether or not exercised) − Important distinction between lease and service contract  Statutory definition – section 7701(e) © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 66 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 22
  24. 24. Pickle Rules – EconomicsLeaseCost $100Int. Rate 10%Term 5 YearsResidual 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 ResidualRent 26.4 26.4 26.4 26.4 26.4 0ADS -8.0 -16.0 -16.0 -16.0 -16.0 -28Tax (paid) (6.4) (3.6) (3.6) (3.6) (3.6) 9.8Net Cash 20.0 22.8 22.8 22.8 22.8 9.8IRR 6.2% © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 67 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Section 470 – General Focus “Tax-exempt use loss” for any taxable year is disallowed and is treated as a deduction for the next year. − Property-by-property analysis with regulatory authority to aggregate properties subject to the same lease. Rules similar to section 469 to recognize deferred loss when property is disposed of. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 68 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.Section 470 – Exception Section 470(d) – exception for leases meeting all four requirements below: − Not more than an allowable amount of funds is subject to certain arrangements or set aside to satisfy lessee’s obligations or options under the lease. − Lessor must make a substantial equity investment. − Lessee must not bear more than a minimal risk of loss. − Certain long-term leases cannot have fixed price purchase options. © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 69 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 23
  25. 25. Section 475 Introduction to Section 475  What makes a taxpayer subject to section 475? − Merely originating loans?  How does being subject to section 475 affect timing and character? − Generally mark-to-market, ordinary for all securities (including loans)  Exceptions?  Valuation?  Interaction with sections 1091, 1092, and 1256?  Special related party/consolidated return rules?  Which consequences are elective? − Elections at the entity/group level − Identifications at the security level © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 71 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. Section 475 Basics  Section 475 (a) generally requires dealers in securities to use the mark-to-market method of accounting for their securities  Dealer in Securities - A securities dealer is a taxpayer that either: - Regularly purchases securities from or sells securities to customers OR - Regularly offers to enter into, assume, offset, assign or otherwise terminate positions  Purchases? - Purchase includes originating loans  Customers? - Related parties may be customers © 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY. 72 Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 24

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