Deloitte tax presentation (Final)

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Deloitte FanTAXtic Regional Competition Syracuse University Presented by: Tonghui Xu, Jiahui (Helen) Lu, Yang Yang, Savannah Crocetti, Shoshana Tracy

Transcript of Deloitte tax presentation (Final)

Deloitte FanTAXtic Regional CompetitionSyracuse University

Presented by:Tonghui Xu, Jiahui (Helen) Lu, Yang Yang, Savannah Crocetti, Shoshana Tracy

Overview 1. Tax classification & treatment of project costs

Classification of depreciable and amortizable property

ITC eligibility

Depreciable and amortizable basis

2. Evaluation of Alternative 1

Alternative 1 overview

Calculation of IRR

Pros/cons of Alternative 1

3. Evaluation of Alternative 2

Alternative 2 overviewCalculation of IRRPros/cons of Alternative 2Recommendation for Peach Power

4. Q&A

Depreciable Properties under MACRS

Tangible Assets

● Revenue Procedure 87-56 for the asset classes of personal properties

● Internal Revenue Code § 168 for the asset class of

non-residential real property

Tax classification & treatment

IRR evaluationRecommenda

tions for Peach Power

Q & A

Depreciable Properties MACRS LifeOffice building and storage facilities

39-year

Landscaping 15-yearModules, piles, trackers, etc. 5-yearSite preparation and grading for substation and panel areas

5-year

Transformers, inverters, substation, and related costs

5-year

Equipment and property not otherwise classified

7-year

Dead-end insulators 20-yearTransmission equipment(high voltage)

15-year

Access road grading 15-yearAccess road construction 15-yearPerimeter fencing 15-year

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Amortizable ItemsIntangible itemsCode section 197 & 195• Formation cost • Preopening expense• Interconnection cost• Power purchase agreement• Loan financing

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Alternative 1 – PeachPower Alternative 2 – Joint Venture

Amortization property category

Total expenditures

(basis)

Amortization period

(if any)

Total expenditures

(basis)

Amortization period (if any)

Formation - - $ 300,000 15

Preopening (Startup)

- - - -

Interconnection costs

$ 1,100,000 20 $ 1,100,000 20

Power purchase

agreement(PPA)

$ 1,200,000 21 $ 1,200,000 21

Loan financing $ 2,500,000 20 $ 2,250,000 20

Total amortizable costs(basis)

$ 4,800,000 - $ 4,850,000 -

Formation Expense • The cost of obtaining the LLC’s

operating agreement and forming the LLC to be about $300,000

Code Section 197 • Trade/business asset• Limited useful life• Reasonable to estimate• Straight-line amortization for 15

years

Preopening ExpenseCode Section 162• Preopening Expenditure of

$600,000• A continuous current business• Not under Code Section 195

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Investment Tax Credit Eligibility

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Code Section 46• Eligible for investment credit, such as energy

creditCode Section 48• ITC= 30% (energy percentage) * basis of

energy property• Energy property: equipment which uses solar

energy to generate electricity, to heat or cool a structure, or to provide solar process heat

Code Section 38• Carry forward 20 years if we have no tax

liability to offset the credit

Depreciable Properties Eligible for ITC

Not Eligible for ITC

Office Building and storage Facilities

Landscaping ✔

Modules, piles, trackers, etc. ✔

Site preparation and grading for substation and panel areas

Transformers, inverters, substation, and related costs

Equipment and property not otherwise classified

Dead-end insulators ✔

Transmission equipment (high voltage)

Access road grading ✔

Access road construction ✔

Perimeter fencing ✔

Determination of IRR• Discounted rate of return that makes the net present value (NPV) of all cash flows

from the 21-year period of the project equal to zero• Pros & Cons• Pros: • Excellent guidance on a project's value and associated risk

• Cons:• Multiple or no rates of return• Changes in discount rates • IRRs do not add up

• Annual Return = Cash Flow (after debt service)+ Utility Savings + Tax Savings (Expenses) + ITC

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Taxable Income & Tax Expenses - NOLs

Year Taxable Income

NOLs Utilization of NOLs

Adjusted Taxable Income

Net Income Tax (40%)

2017 (Year 1) $(58,009,476) $58,009,476 - - -

2018 (Year 2) $(91,081,604) $91,081,604 - - -

2019 (Year 3) $(53,672,382) $53,672,382 - - -

2020 (Year 4) $(30,672,769) $30,672,769 - - -

2021 (Year 5) $(29,188,391) $29,188,391 - - -

2022 (Year 6) $(11,812,533) $11,812,533 - - -

Total 274,437,154 - - -

Code Section 172• NOLs carried back 2 years and/or forward up to 20 years

This total NOLs will carryover to

future years.

• Year 1-6: negative taxable income; net operating losses

Taxable Income & Tax Expenses – NOLs Utilization

Year Taxable Income

NOLs Utilization of NOLs Adjusted Taxable Income

Net Income Tax (40%)

2017 – 2022 - - -

2023 (Year 7) 5,617,702 - (5,617,702) - -

2024 (Year 8) 7,357,181 - (7,357,181) - -

2025 (Year 9) 9,175,798 - (9,175,798) - -

2026 (Year 10) 10,750,044 - (10,750,044) - -

2027 (Year 11) 12,429,538 - (12,429,538) - -

2028 (Year 12) 14,226,050 - (14,226,050) - -

2029 (Year 13) 16,147,973 - (16,147,973) - -

2030 (Year 14) 18,209,054 - (18,209,054) - -

2031 (Year 15) 20,419,858 - (20,419,858) - -

2032 (Year 16) 22,946,880 - (22,946,880) - -

2033 (Year 17) 25,653,461 - (25,653,461) - -

2034 (Year 18) 28,406,731 - (28,406,731) - -

2035 (Year 19) 31,375,459 - (31,375,459) - -

2036 (Year 20) 34,580,121 - (34,580,121) - -

2037 (Year 21) 38,289,894 - (17,143,303) 21,148,590 8,036,464

• Year 7-20:no taxable income

• NOLs utilized against taxable income

• NOLs used up in Year 21

taxable income = $21,148,590tax liability = $8,036,464

ITC - Utilization Year ITC Carryforward2017 (Year 1) $102,546,000 2018 (Year 2) $102,546,000 2019 (Year 3) $102,546,000 2020 (Year 4) $102,546,000 2021 (Year 5) $102,546,000 2022 (Year 6) $102,546,000 2023 (Year 7) $102,546,000 2024 (Year 8) $102,546,000 2025 (Year 9) $102,546,000

2026 (Year 10) $102,546,000 2027 (Year 11) $102,546,000 2028 (Year 12) $102,546,000 2029 (Year 13) $102,546,000 2030 (Year 14) $102,546,000 2031 (Year 15) $102,546,000 2032 (Year 16) $102,546,000 2033 (Year 17) $102,546,000 2034 (Year 18) $102,546,000 2035 (Year 19) $102,546,000 2036 (Year 20) $102,546,000

2037 (Year 21) $0

• ITC incurred in Year 1 = depreciable basis * 30% (energy percentage) = $102,546,000

Code Section 38

• Cannot not be utilized when there is no tax liability; carryforward 20 years

• ITC expires after 20 years in year 21

Cash Flow

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Year Cash Flow after debt 2017 (Year 1) ($4,736,406)2018 (Year 2) ($3,591,836)2019 (Year 3) ($3,036,375)2020 (Year 4) ($2,469,804)2021 (Year 5) ($1,891,902)2022 (Year 6) ($1,302,442)2023 (Year 7) ($701,193)2024 (Year 8) ($87,918)2025 (Year 9) $537,6212026 (Year 10) $1,175,6722027 (Year 11) $1,826,4832028 (Year 12) $2,490,3112029 (Year 13) $3,167,4162030 (Year 14) $3,858,0622031 (Year 15) $4,562,5212032 (Year 16) $5,281,0702033 (Year 17) $6,013,9892034 (Year 18) $6,761,5672035 (Year 19) $7,524,0972036 (Year 20) $8,301,8772037 (Year 21) $38,460,119

• Net cash flow available for sale = taxable income + depreciation + amortization – debt service(principle)

• Negative net cash flows from Year 1 to Year 7

• Positive net cash flows from Year 8 to Year 21

PeachPower’s Internal Rate of Return under Alternative 1

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Year Cash Flow after debt service

Utility Savings Tax Savings (Expense) ITC Annual Return for PeachPower

Initial Contribution (103,700,000)

2017 (Year 1) (4,736,406) 1,765,140 0 0 (2,971,266)

2018 (Year 2) (3,591,836) 1,800,443 0 0 (1,791,393)

2019 (Year 3) (3,036,375) 1,836,452 0 0 (1,199,923)

2020 (Year 4) (2,469,804) 1,873,181 0 0 (596,623)

2021 (Year 5) (1,891,902) 1,910,644 0 0 18,742

2022 (Year 6) (1,302,442) 1,948,857 0 0 646,415

2023 (Year 7) (701,193) 1,987,834 0 0 1,286,642

2024 (Year 8) (87,918) 2,027,591 0 0 1,939,673

2025 (Year 9) 537,621 2,068,143 0 0 2,605,764

2026 (Year 10) 1,175,672 2,109,506 0 0 3,285,178

• Annual Return for Peach Power = Cash Flow (after debt service)+ Utility Savings + Tax Savings + ITC

• Annual Return for PeachPower

Tax classification & treatment

Evaluation of Alternative 1

Evaluation of Alternative 2 Q & A

Year Cash Flow after debt service Utility Savings Tax Savings (Expense)

ITC Annual Return for PeachPower

2027 (Year 11) 1,826,483 2,151,696 - - 3,978,179

2028 (Year 12) 2,490,311 2,194,730 - - 4,685,041

2029 (Year 13) 3,167,416 2,238,624 - - 5,406,040

2030 (Year 14) 3,858,062 2,283,397 - - 6,141,459

2031 (Year 15) 4,562,521 2,329,065 - - 6,891,586

2032 (Year 16) 5,281,070 2,275,646 - - 7,656,716

2033 (Year 17) 6,013,989 2,423,159 - - 8,437,148

2034 (Year 18) 6,761,567 2,471,622 - - 9,233,189

2035 (Year 19) 7,524,097 2,521,055 - - 10,045,151

2036 (Year 20) 8,301,877 2,571,476 - - 10,873,352

2036 (Year 21) 38,460,119 2,622,905 (8,036,464) - 33,046,560

Internal Rate of Return 0.3099%

PeachPower’s Internal Rate of Return under Alternative 1

Used out all the NOL carried

forward

Sun Bank's Internal Rate of Return

Year Loan Payment and Loan Origination Fees Received Tax Expense on Loan Origination Fees and Interest Income Annual Return for Sun Bank

Initial contribution $ (247,500,000) $ (1,000,000) $ (248,500,000)Year 1 2017 29,364,906 (10,000,000) 19,364,906 Year 2 2018 29,364,906 (9,825,404) 19,539,502 Year 3 2019 29,364,906 (9,633,348) 19,731,558 Year 4 2020 29,364,906 (9,422,086) 19,942,820 Year 5 2021 29,364,906 (9,189,699) 20,175,207 Year 6 2022 29,364,906 (8,934,072) 20,430,834 Year 7 2023 29,364,906 (8,652,883) 20,712,023 Year 8 2024 29,364,906 (8,343,576) 21,021,331 Year 9 2025 29,364,906 (8,003,337) 21,361,569

Year 10 2026 29,364,906 (7,629,074) 21,735,832 Year 11 2027 29,364,906 (7,217,385) 22,147,521 Year 12 2028 29,364,906 (6,764,528) 22,600,378 Year 13 2029 29,364,906 (6,266,384) 23,098,522 Year 14 2030 29,364,906 (5,718,426) 23,646,480 Year 15 2031 29,364,906 (5,115,673) 24,249,233 Year 16 2032 29,364,906 (4,452,644) 24,912,262 Year 17 2033 29,364,906 (3,723,312) 25,641,594 Year 18 2034 29,364,906 (2,921,047) 26,443,859 Year 19 2035 29,364,906 (2,038,555) 27,326,351 Year 20 2036 29,364,906 (1,067,815) 28,297,091

IRR 6.0694%

Sun Bank’s Internal Rate of Return under Alternative 1

Meet the target IRR: 6%

Pros/Cons of Alternative 1• Pros:• PeachPower is the sole owner of the Solarity• Lower risk for Sun Bank compared with althernative 2

(partnership flip)• Achieve IRR target for Sun Bank

• Cons:• PeachPower will be wasting the investment tax credit (ITC)• Negative taxable income and net cash flow for more than 6 years

for PeachPower because of heavy debt• A lower IRR for PeachPower

Evaluation of Alternative 2

Partnership Flip with

ITC

IRR of PeachPower & Sun Bank

Capital Basis

of Sun Bank

Pros/cons of Alternative 2

Overview of Alternative 2

• PP(38%) & SB (40%) S, cost $300,000 to form the entity

$160 million capital SB’s contribution of LLC interest $250 million SB $90 million loan standard commercial bank loan

• S obtains

$103.75 million PP

• S’s activities are conducted through two-member LLC S default treated as partnership

10% interest rate with 10-year amortization; Loan original fee of 2.5% (2.25 million)

PP – PeachPower, IncS – Solarity, LLCSB – Sun BankSSF – Solarity Solar FieldSMLLC – single-member LLCITC – Investment tax creditDRE – disregarded entity

Partnership FlipParticipant Role ScenarioTax Investor:Sun Bank

Possess sufficient taxable income to monetize tax benefits (both tax and accelerated MACRS tax depreciation)

SB has substantial income from its other operations

Funds a percentage of total project costs SB will contribute $160 million capitalTarget IRR earned through allocation of 99% of tax credits and taxable losses/income and distribution cash

During Year 1 to Year 5, income, gains, losses, deductions, and credits will be allocated 99% to SB

Typically exits the project after the flip when the Developer/Sponsor exercises FMV purchase option

In Y7, PP will purchase the LLC interest from SB at its fair market value of $26 million

Developer:PeachPower

ROI earned through cash flows Y1 - Y6, 85% of cash flows will be allocated to PP

minimum 1% allocation of tax benefits and long-term ownership

Y1 - Y5, income, gains, losses, deductions, and credits will be allocated 1% to PP

FMV purchase option on Tax investor’s residual interest In Y7, PP will purchase the LLC interest from SB at its fair market value of $26 million

Key Points of Partnership FlipYear Allocation Cash flow

Year 1 – Year 5

99% SB 15% SB85% PP1% PP

Year 6 5% SB

95% PP“Cut-off”

Year 7 • PP buys LLC interest from SB at FMV $26 million

• PP will payoff remaining loan balance and close the partnership

Year 8 PP operates S (a DRE) as an SMLLC for 21 years

PP – PeachPower, IncS – Solarity, LLCSB – Sun BankSSF – Solarity Solar FieldSMLLC – single-member LLCITC – Investment tax creditDRE – disregarded entity

As partnership dissolved, loan payment can be written off

Terminate partnership for tax purpose under

Rev.Proc.99-6

Section 1.741 – 1(b) provides that section 741 applies to the transferor partner in a two-person partnership when one partner sells a partnership interest to the other partner

Legitimate partnership• Rev. Proc. 2007 – 65 outlines a safer harbor that applies to

partnerships for qualified wind energy facilities and Section 45 production tax credits• CCA 201524024 indicates Rev. Proc. 2007-65 does not apply to

partners or partnerships with Code section 48 energy credits. Further, LLC does not satisfy all of the safe harbor requirements of Rev. Proc. 2007 - 65

Consider the likelihood that A2 transaction would be considered a financing transaction rather than a legitimate partnership

Capital Basis for Sun BankBasis Adjustment RulesBasis is increased by: • Contributions and increases in share of partnership debt • Taxable income and gains • Tax-exempt income and gains • Certain depletion adjustments

Basis is decreased by: • Distributions and decreases in share of partnership debt • Separately stated deductions • Nondeductible items not chargeable to the capital account • Certain depletions adjustments

Beginning BalanceLess: Beginning Liability AllocationPlus: Ending Liability Allocation Plus: Income AllocationLess: Utilization of Suspended Loss______________________________Subtotal Before Cash DistributionLess: Cash Distribution______________________________SubtotalLess: Gain Recognized______________________________Basis Before Loss AllocationsPlus: Loss Allocation______________________________Ending Tax Basis

In Year 6, Sun Bank’s subtotal is -17,195,941, since basis can never be

negative, Sun Bank has to recognize gain

IRRs of the three options (25% efficiency)

Original Cash Flow Changes

LLC Interest Changes

Contributed Capital Changes($140 million)

Contributed Capital Changes($150 million)

PeachPower 14.5878% 11.2510% 12.6525% 12.0606% 13.2303%

Sun Bank 14.3846% 18.0406% 15.9982% 18.5033% 16.3208%

Pros/cons of Alternative 2 (25% efficiency)

Cons Pros

PP only bears 1% of risk for 5 years

PP has higher IRR in the original scenario

ITC credits could be utilized

SB bears 99% of risk for 5 years

PP is not the sole owner from Y1- Y6

IRRs of the three options (30% efficiency)

Original Cash Flow Changes

LLC Interest Changes

Contributed Capital Changes($140 million)

Contributed Capital Changes($150 million)

PeachPower 14.5878% 14.2221% 17.3183% 16.0307% 17.4926%

Sun Bank 14.3846% 19.1373% 15.5270% 18.1660% 16.0709%

Risk of calculated purchase/sale price rather than FMV – inconsistent with partnership flip requirements

Recommendation for PeachPower

• Choose Alternative 2 to utilize ITC credits• Achieve IRR target (8%) under Alternative 2

(about 14%) • Mitigate risk for 5 years• PP has the highest IRR under original

assumption if 25% efficiency• PP has the highest IRR if SB contributed

capital is $150 million and 30% efficiency

Take Alternative 2!

Recommendation for PeachPower & Sun BankTake Alternative 2, SB’s contributed capital $150 million!

25% efficiency Original Cash Flow Changes

LLC Interest Changes

Contributed Capital Changes($140 million)

Contributed Capital Changes($150 million)

PeachPower 14.5878% 11.2510% 12.6525% 12.0606% 13.2303%

Sun Bank 14.3846% 18.0406% 15.9982% 18.5033% 16.3208%

30% efficiency Original Cash Flow Changes

LLC Interest Changes

Contributed Capital Changes($140 million)

Contributed Capital Changes($150 million)

PeachPower 14.5878% 14.2221% 17.3183% 16.0307% 17.4926%

Sun Bank 14.3846% 19.1373% 15.5270% 18.1660% 16.0709%

Original Delayed Placed in Service Dates

• No environmental assessment required

• Solar field is constructed in 2017

• Environmental assessment before the TVA can sign the PPA with PeachPower

• Solar field is constructed and place in service in 2018 or 2019 or even 2020

Delayed Placed in Service Dates

• Less taxable income due to the delay in service in both alternative 1 & 2• Time value of money: • If spend more, worth it• If earn more, not worth it

• ITC will not be eligible until 2018 • IRR• PeachPower’s IRR• Sun Bank’s IRR

Delayed Placed in Service Dates

Thank you!