SolarCity in the name of two special purpose entities filed a complaint in February in the Court of Federal Claims. The complaint alleges that the United States Treasury failed to follow applicable law in administering the Cash Grant program. The complaint seeks in excess of $8 million dollars in damages. The complaint is available here.
Below are excerpts from the key allegations in the complaint:
- “Section 1603 did not grant Treasury authority to promulgate rules … for determining “cost basis,” because Congress dictated that [the investment tax credit (ITC)] definitions would govern. Treasury nonetheless did issue such rules and regulations, most problematically in the form of so-called “guidance” for the determination of cost basis: “Evaluating Cost Basis for Solar Photovoltaic Property” (‘Cost Basis Evaluation Process Guidance’) available here.
- “Treasury’s ‘Cost Basis Evaluation Process Guidance’ is not consistent with the ITC program that it is supposed to mimic.”
- “The ‘Cost Basis Evaluation Process Guidance’ purports to establish ‘benchmark’ values for residential and commercial solar energy facilities. [S]ince its inception, the solar energy ITC program has never included benchmark values against which a would-be ITC recipient’s cost basis is examined. [This is] inconsistent with Congress’s intent that the program incorporate the tax and evaluation concepts of the ITC program.”
- “Treasury’s practice of delaying, and then rejecting claims in excess of benchmarks coerces applicants to undervalue their solar facilities simply to get paid part value of their project. As a result, Treasury’s tactics have skewed the data on which Treasury purportedly relies to set its benchmarks.”
- Treasury’s guidance provides that the “benchmark rates are ‘constantly updated (as warranted) drawing on relevant publicly available information and analyses by various experts, data from existing 1603 applications and other confidential sources, and the 1603 review team’s experience with solar PV properties.’ By comparing an applicant’s cost basis to a fluctuating benchmark, premised in part upon ‘confidential sources,’ the ‘Cost Basis Evaluation Process Guidance’ introduces great uncertainty into the Section 1603 program, contrary to Congress’s desire that the program simply mimic the ITC. This uncertainty surrounding the cash grant program made it less likely that entities would be willing to invest in solar energy projects, the direct opposite of what Congress intended.”
- The “Cost Basis Evaluation Process Guidance states that determining the fair market value of energy properties under the Section 1603 program may be evaluated using one of three methods: the ‘Cost Approach,’ the ‘Market Approach’ or the ‘Income Approach,’ but then declares that the income approach is ‘the least reliable method of valuation.’ This instruction cannot be reconciled with either the Internal Revenue Service’s guidelines governing valuation, or decisions of this and other courts that have recognized the Income Approach as a legitimate means of valuation, without preemptively declaring it ‘less reliable.’”
- The “Cost Basis Evaluation Process Guidance made it all but impossible for a cash grant applicant to be paid within 60 days of the later of the submission of the application or the facility’s in service date, in violation of Section l603(c), unless the applicant simply capitulated to the improper and invalid benchmark valuation. Even where there is no question that the applicant is entitled to at least the benchmark valuation, Treasury does not pay the undisputed amount while reviewing the evidence offered for a higher basis.”
- “December 5, 2012, Treasury stated in an email that it was revising downward its ‘Guidance’ for California and Arizona residential systems, that the revision was retroactive, and that it would apply to pending applications. The reduction was substantial, reducing benchmark values for California from $7 per watt of generating capacity to $6 per watt and reducing benchmark values for Arizona from $7 per watt to $5 per watt – resulting in drastic decreases in the size of cash grants for pending applications that had been made in reliance on the purported Guidance. Treasury gave no explanation for the change at the time, and has given none since. It made this change without even revising the Guidance.”
All of the allegations above raise legitimate concerns. There are four that are of particular note. First, the Cost Basis Evaluation Process Guidance on its face provides that the benchmarks will be updated periodically. Almost two years later and after substantial changes in solar panel prices, Treasury has yet to publish an update. Treasury effectively reduced the cost basis guidance for residential solar in California and Arizona. This change was only communicated by Treasury by an email to SolarCity. The industry learned of it from a SolarCity. If Treasury changed its published guidance, it at least should have published the revision.
Second, it appears to violate administrative law principles for the Treasury to promulgate the Cost Basis Evaluation Process Guidance without notice and comment, particularly when the document on its face purports to be based on “confidential information.”
Third, the Cash Grant statute clearly provides that grants are to be paid within 60 days of the application. Treasury avoids violating that rule by requesting additional information that is not specified in the application or the instructions and taking the position that the application is not complete until the information is provided. Examples include information about solar projects that affiliates of the applicant bid on or detail about contracts the construction company entered into with parties other than the applicant. Treasury is violating the statute by delaying the start of the 60-day clock by requesting information not specifically provided for in the instructions or the application.
Finally, the statement in the Cost Basis Evaluation Process Guidance that the Income Approach is “the least reliable method of valuation” is inconsistent with case law, and IRS publications. Outside of the energy area there are tax cases in which courts have endorsed the Income Approach. For instance, the 10th Circuit affirmed a Tax Court decision in which the Tax Court judge developed his own Income Approach calculation. The 10th Circuit wrote:
[The appraisers] constructed discounted cash-flow models to determine the present value of the ranch’s future revenue. This remains an acceptable method for determining the value of a real estate interest where no comparable sales are available.1
As different solar projects have different state and utility incentives, different levels of exposure to the sun and different qualities of solar panels, it often is difficult to find “comparable sales” within the same time period. Thus, the 10th Circuit’s opinion would suggest that the Income Approach is appropriate for solar projects.
In addition, the Tax Court has accepted the Income Approach as a means to value Federal Communication Commission licenses (“FCC”).2 The IRS has even noted this case for this proposition in one of its publications.3 The IRS manual provides:
Some fundamental methods utilized to value intangible property include: … Income-based methods focus on the income-producing capacity of intangible property. … The income approach usually computes the net present value of the intangible by use of the discounted cash flow approach.4
An IRS training guide provides: “Widely accepted appraisal theory suggests that the market value can be estimated using one of three methods: the sales comparison approach, the cost approach, and the income capitalization approach.”5 Another IRS document provides: “To determine whether the fair market value claimed is correct, the following steps should be taken: … Determine the fair market value of the property received using the discounted cash flow value [(which is synonymous with the Income Approach)] of the property.”6 Finally, in the business world major asset acquisitions are typically evaluated using the Income Approach.7
Treasury is correct in criticizing the Income Approach for the fact that small changes in economic assumptions can result in large variations in the values generated by the Income Approach. However, Treasury should have addressed this weakness by promulgating guidance with respect to the application of the Income Approach. Examples of areas that Treasury could have addressed include:
How should renewable energy certificates for which there is not an established market to sell them be valued?
How should the discount rate used in the Income Approach compare to the returns earned by the parties to the transaction?
How should “bonus depreciation” be valued when few taxpayers have appetite for it?
How should state tax benefits and costs be evaluated?
By providing guidance on these issues, Treasury could have eliminated some of the variability in the Income Approach without dismissing the valuation method most predominate in the business world and supported by court cases and IRS publications.
Recently, Treasury officials speaking on their own behalf have made remarks that suggest Treasury is now less critical of the Income Approach and gives it credence in some circumstances.8 However, Treasury has not updated its guidance to reflect that change in view.
One possible outcome of this case is that SolarCity’s allegations in this case are settled in conjunction with the government’s investigation that SolarCity made misrepresentations in its Cash Grant applications. If this case does progress to a public resolution, that resolution is likely to have broad implications for the solar industry. If SolarCity prevails it is likely to spur other developers to bring similar actions and will likely mute the IRS’ investment tax credit audit activities. In contrast, if the government prevails, it is likely to spur the IRS to handle investment tax credit audits in a similar manner that Treasury handles Cash Grant applications.
1 Trout Ranch v. Commissioner, 2012 WL 3518564 (10th Cir. 2012) (determining the fair market value of conservation easements).
2 Jefferson-Pilot Corp. v. Commissioner, 98 T.C. 435, 452-53 (1992), aff’d 995 F.2d 530 (4th Cir. 1993).
3 IRS, Coordinated Issues Papers, Media and Communications, Like-Kind Exchanges Involving FCC License (Apr. 2, 2007).
4 Internal Revenue Manual, Intangible Property Valuation Guidelines, 18.104.22.168.4.
5 IRS MSSP Training Guide, Diminution of Fair Market Value (FMV): Verification.
6 IRS MSSP Training Guide, Oil and Gas Audit Techniques.
7 Robert B. Dickie, Financial Statement Analysis and Business Valuation for the Practical Lawyer 295 (2006) (“Other than the use of comparables … the most widely used methods of valuation are the discounted cash flow method and methods essentially derived from it”.)
8 See http://www.akingump.com/en/news-publications/final-sequestration-alert-burotn.html (Mar. 4, 2013).