Tax Credit Bonds are taxable obligations issued by state and local governments and governmental entities for a wide array of qualifying purposes. Unlike bonds that bear interest that is exempt from federal gross income tax, Tax Credit Bonds entitle the bondholder to a direct subsidy in the form of a federal tax credit, and in some cases receipt of interest that is includable in gross income for federal income tax purposes, rather than the issuer paying the bondholder tax‑exempt interest. There are a variety of purposes for which Tax Credit Bonds can be issued, two of which relate to the areas of renewable energy and conservation: (1) new clean renewable energy bonds (“New CREBs”)* and (2) qualified energy conservation bonds (“QECBs”). Both New CREBs and QECBs are subject to certain rules applicable to tax credit bonds and to federal labor standards. See General Tax Credit Bond Rules and Davis‑Bacon Labor Standards below.
New Clean Renewable Energy Bonds (New CREBs)
A New CREB is a type of Tax Credit Bond issued to provide “qualified renewable energy facilities.” The annual tax credit allowed to the holder of New CREBs is equal to 70% of the applicable bond credit rate on the New CREBs. The method for determining the applicable bond credit rate is discussed below under General Tax Credit Bond Rules.
New CREBs may be issued by a “qualified issuer,” which includes (1) public power providers, (2) cooperative electric companies, (3) governmental bodies, (4) clean renewable energy bond lenders, or (5) not‑for‑profit electric utilities that have received a loan or loan guarantee under the federal Rural Electrification Act.
“Public power providers” include any state utility with a service obligation, as such terms are defined in Section 217 of the Federal Power Act. “Governmental bodies” are any state (including the District of Columbia and any possession of the United States) or Indian tribal government, or any political subdivision thereof. “Cooperative electric companies” are mutual or cooperative electric companies described in Section 501(c)(12) or Section 1381(a)(2)(C) of the Internal Revenue Code of 1986, as amended (the “Code”). “Clean renewable energy bond lenders” include any lender that is a cooperative that is owned by, or has outstanding loans to, 100 or more cooperative electric companies and was in existence on February 1, 2001, and any affiliated entities controlled by such lender.
All of the Available Project Proceeds (as defined below under General Tax Credit Bond Rules) of New CREBs must be used for capital expenditures incurred for one or more “qualified renewable energy facilities” owned by a public power provider, a governmental body or a cooperative electric company. A facility financed with New CREBs may be leased to or managed by a private business, or the output of the facility may be purchased by a private business, provided that such arrangements do not transfer tax ownership of the facility.
The term “qualified renewable energy facilities” includes any of the following facilities:
(1) Wind Facilities – a “wind facility” is any facility using wind to produce electricity. The published position of the Internal Revenue Service (“IRS”) is that a wind facility includes the wind turbine (including the blades, gear box, generator and a control and communication mechanism), together with the tower on which the wind turbine is mounted and the pad on which the tower is situated. Excluded are transformers, on‑site power collection systems, site improvements and monitoring and meteorological equipment.
(2) Closed‑Loop Biomass Facilities – a “closed‑loop biomass facility” is any facility using organic material from a plant that was planted exclusively for the purpose of being used at a qualifying facility to produce electricity. In addition, a facility qualifies if modified to use closed‑loop biomass to co‑fire with coal, with other biomass, or with both coal and other biomass, but only if the modification is approved under the federal Biomass Power for Rural Development Program or is part of a pilot project of the federal Commodity Credit Corporation.
(3) Open‑Loop Biomass Facilities – an “open‑loop biomass facility” is any facility using open‑loop biomass to produce electricity. “Open-loop biomass” includes (a) any agricultural livestock waste nutrients, or (b) any solid, nonhazardous, cellulosic waste material or any lignin material which is derived from (i) any of the following forest-related resources: mill and harvesting residues, pre‑commercial thinnings, slash and brush, (ii) solid wood waste materials, including waste pallets, crates, dunnage, manufacturing and construction wood wastes (other than pressure-treated, chemically-treated or painted wood wastes), and landscape or right-of-way tree trimmings, but not including municipal solid waste, gas derived from the biodegradation of solid waste or paper which is commonly recycled, or (iii) agriculture sources, including orchard tree crops, vineyard, grain, legumes, sugar, and other crop by‑products or residues.
(4) Geothermal or Solar Energy Facilities – a “geothermal facility” is a facility that uses geothermal energy to produce electricity. A “solar facility” is a facility that uses solar energy to produce electricity.
(5) Small Irrigation Power Facilities – a “small irrigation power facility” is a facility that generates electric power through an irrigation system canal or ditch without a dam or impoundment of water. The nameplate capacity must be equal to or greater than 150 kilowatts, but less than 5 megawatts.
(6) Landfill Gas Facilities – a “landfill gas facility” is a facility that uses landfill gas to produce electricity. Landfill gas is methane gas derived from the biodegradation of municipal solid waste.
(7) Trash Combustion Facilities – a “trash combustion facility” is a facility that uses municipal solid waste to produce steam to drive a turbine for the production of electricity.
(8) Qualified Hydropower Production Facilities – a “qualified hydropower production facility” is any facility (a) that produced hydroelectric power (a hydroelectric dam) prior to August 8, 2005, and that subsequently produces incremental hydropower production, but only to the extent that such incremental hydropower production is attributable to efficiency improvements or additions to capacity added after August 8, 2005, or (b) that produces hydroelectric power if (i) the hydroelectric project installed on the non‑hydroelectric dam is licensed by the Federal Energy Regulatory Commission and meets all other applicable environmental, licensing and regulatory requirements, (ii) the non‑hydroelectric dam is operated for flood control, navigation or water supply purposes and did not produce hydroelectric power on October 3, 2008, and (iii) the hydroelectric project is operated so that the water surface elevation at any given location and time that would have occurred in the absence of the hydroelectric project is maintained, subject to any license requirements imposed under applicable law that change the water surface elevation for the purpose of improving environmental quality of the affected waterway.
(9) Marine and Hydrokinetic Renewable Energy Facilities – a “marine and hydrokinetic renewable energy facility” is a facility with a nameplate capacity rating of at least 150 kilowatts that produces electricity from marine and hydrokinetic renewable energy. “Marine and hydrokinetic renewable energy” is energy derived from (a) waves, tides and currents in oceans, estuaries and tidal areas, (b) free flowing water in rivers, lakes and streams, (c) free flowing water in an irrigation system, canal or other man‑made channel, including projects that utilize non‑mechanical structures to accelerate the flow of water for electric power production purposes, or (d) differentials in ocean temperature (ocean thermal energy conversion), but not include any energy derived from any source which utilizes a dam, diversionary structure (except as provided in (c) above), or impoundment for electric power production purposes.
New CREBs are subject to volume cap, and the amount, currently a nationwide aggregate of $2.4 billion, was to be allocated one‑third to each of public power providers, governmental bodies and cooperative electric companies. The allocation of volume cap to governmental bodies and cooperative electric companies provides priority to the smallest projects. The volume cap allocation for public power providers was to be allocated on a pro rata basis that encourages submission of applications for larger projects. The original window for receipt of an application for volume cap allocation expired on August 4, 2009. Under a program yet to be announced, the IRS plans to reallocate any unallocated volume cap and any allocated volume cap that has been relinquished or that has reverted to the IRS. An allocation of authority to issue New CREBs is valid for three years after the IRS issues the letter granting the allocation.
Qualified Energy Conservation Bonds (QECBs)
A QECB is a type of Tax Credit Bond issued for one or more “qualified conservation purposes.” The annual tax credit allowed to the holder of QECBs is equal to 70% of the applicable bond credit rate on the QECBs.
QECBs may be issued by state or local government issuers. Generally, QECBs are subject to the private business tests and private loan test of Section 141 of the Code. However, up to 30% of a state’s QECB volume cap authority can be used for private activity bonds. For example, up to 30% of a state’s allocation can be applied to finance eligible projects owned and operated by a private business.
“Qualified conservation purposes” include any of the following:
(1) Capital Projects – capital expenditures incurred for purposes of (i) reducing energy consumption in publicly-owned buildings by at least 20%, (ii) implementing green community programs, (iii) rural development involving the production of electricity from renewable energy resources, or (iv) any qualified facility (those facilities authorized to be financed with New CREBs);
(2) Research – expenditures with respect to research facilities, and research grants, to support research in (i) development of cellulosic ethanol or other non‑fossil fuels, (ii) technologies for the capture and sequestration of carbon dioxide produced through the use of fossil fuels, (iii) increasing the efficiency of existing technologies for producing non‑fossil fuels, (iv) automobile battery technologies and other technologies to reduce fossil fuel consumption in transportation, or (v) technologies to reduce energy use in buildings;
(3) Mass Commuting – mass commuting facilities and related facilities that reduce the consumption of energy, including expenditures to reduce pollution from vehicles used for mass commuting;
(4) Demonstration Projects – demonstration projects designed to promote the commercialization of (i) green building technology, (ii) conversion of agricultural waste for use in the production of fuel or otherwise, (iii) advanced battery manufacturing technologies, (iv) technologies to reduce peak use of electricity, or (v) technologies for the capture and sequestration of carbon dioxide emitted from combusting fossil fuels in order to produce electricity; and
(5) Public Education – public education campaigns to promote energy efficiency (other than movies, concerts and other events held primarily for entertainment purposes.
QECBs are subject to volume cap, and the amount, currently a nationwide aggregate of $3.2 billion, is allocated to the states according to population. The District of Columbia and the possessions of the United States are considered states for QECBs. Certain large local governments, defined as any municipality or county with a population greater than 100,000, are eligible for a direct allocation. Counties that contain a large city are eligible for a direct allocation if its population minus the large city population is still greater than 100,000.
Effect of HIRE Act on New CREBs and QECBs
On March 18, 2010, the President signed into law the Hiring Incentives to Restore Employment Act (“HIRE Act”) which, among other things, allows certain Qualified Tax Credit Bonds (“QTCBs”) issued after March 18, 2010 to receive, in lieu of tax credits, direct subsidy payments from the federal government similar to those made available to issuers of Build America Bonds (“BABs”) and Recovery Zone Economic Development Bonds (“RZEDBs”) issued under the provisions of the American Recovery and Reinvestment Act of 2009 (“ARRA”). Issuers of BABs and RZEDBs have the option of receiving a direct payment from the U.S. Treasury instead of making tax‑exempt interest payments or providing tax credits for bondholders. The direct payment subsidy is equal to 35% of the taxable interest payment for BABs and 45% for RZEDBs.
Similarly, the HIRE Act permits QTCB issuers to elect to either receive direct subsidy payments or permit holders of the QTCBs to receive tax credits. Eligible QTCBs include New CREBs and QECBs. Issuers of New CREBs and QECBs can elect to receive direct subsidy payments equal to the lesser of (1) 100% of the amount of interest the issuer pays on each interest payment date, or (2) 70% of the amount of interest that would have been payable if such interest had accrued at the applicable credit rate under the tax credit option.
General Tax Credit Bond Rules
The amount of tax credit applicable to a Tax Credit Bond is determined by multiplying the applicable bond “credit rate” by the face amount of the bond. The applicable bond “credit rate” is determined by the U.S. Treasury Department on the date the Tax Credit Bonds are sold, varies by the specific type of bond issued, and is intended to allow issuers of Tax Credit Bonds to sell their bonds at par (face value) and without additional interest cost to the issuer. If, however, the applicable bond credit rate is not sufficient to permit the Tax Credit Bonds to be sold at par (or close to par), the issuer is expected to pay a supplemental interest coupon as necessary to enable such a par sale, and any such interest paid by the issuer will be includable in federal gross income to the bondholder. The tax credit accrues quarterly, is includable in gross income (as if it were a regular interest payment on a bond) and can be claimed against regular income tax liability and alternative minimum tax liability.
Tax Credit Bonds are generally structured as “bullet” maturity bonds. The U.S. Treasury Department establishes the maximum maturity on a monthly basis, which is typically between 14 and 15 years.
Issuers of Tax Credit Bonds must reasonably expect to spend 100% of the Available Project Proceeds for qualified expenditures within three years after the issue date and enter into a binding contract with a third party to spend at least 10% of the Available Project Proceeds within six months after the issue date. “Available Project Proceeds” are the sale proceeds of the bonds, less sale proceeds up to 2% used to pay bond issuance costs, plus investment earnings. If any Available Project Proceeds remain unspent three years after the issue date, the issuer must use all of those proceeds to redeem Bonds within 90 days, unless the IRS grants an extension. Proceeds can be treated as spent if they are used to reimburse the issuer for amounts paid after the date that an allocation of Tax Credit Bond limitation is made with respect to the issue, but only if (1) prior to or not later than 60 days after payment of the original expenditure the issuer declared its intent to reimburse such expenditure with the proceeds of Tax Credit Bonds, and (2) the reimbursement is made not later than 18 months after the date the original expenditure is paid.
Issuers of Tax Credit Bonds are allowed to invest the proceeds of the bonds for up to three years after issuance at an unrestricted yield, and provided that 100% of the Available Project Proceeds are spent on qualified costs within such timeframe the earnings are not subject to rebate to the federal government. In addition, issuers of Tax Credit Bonds are allowed to set aside funds to pay the bonds which may be invested up to the “permitted sinking fund yield” provided that the issuer does not contribute more to the fund than is necessary to repay the bonds and contributes to the fund no more rapidly than in equal annual installments. The “permitted sinking fund yield” is determined by the U.S. Treasury by using an interest rate equal to 110% of the long‑term adjusted federal rate (as published by the IRS in accordance with Section 1274(d) of the Code), compounded semiannually, for the month in which the issue of Tax Credit Bonds was sold.
Tax Credit Bonds are subject to volume cap, which is a limit on the maximum amount of bonds that may be issued. The total amount of volume cap authorized and the method for allocation is set by Congress and varies by the type of Tax Credit Bond to be issued.
The tax credits with respect to Tax Credit Bonds may be “stripped” or separated from the underlying bonds. Accordingly, the holder of the tax credit may be a different party from the holder of the Tax Credit Bond.
Davis‑Bacon Labor Standards
The ARRA included a provision that requires issuers of some Tax Credit Bonds to abide by the labor standards mandated under the Davis‑Bacon Act of 1931 (“Davis‑Bacon”). Generally, Davis‑Bacon requires that contractors pay workers wages that are not less than certain prevailing wages for comparable work. New CREBs and QECBs are subject to Davis‑Bacon.
Charles P. Shimer, Esquire
Federal law previously authorized the issuance of clean renewable energy bonds (“CREBs”) to finance certain qualified energy production projects; however, the authorization for such original CREBs does not apply to bonds issued after December 31, 2009.