Global Project Finance > Tax Equity Telegraph > Effect of Potential Passthrough Reform on Renewables Industry
18 Apr '13

On March 12, Dave Camp (R-MI), who is chair of the House of Representatives’ Ways & Means Committee, released a revised discussion draft for tax reform focusing on simplifying the taxation of small business owners.  Part of the proposed reform is to bring closer together both passthrough regimes:  the “partnership” and “S-corporation” regimes under subchapter K and subchapter S, respectively. 

The Committee is currently looking into two options for making this passthrough reform. The second proposal, which is discussed below, has raised some concerns within the renewable energy industry about whether flip partnerships with tax equity investors would be permissible.  Recent comments by government officials during a KPMG webinar suggest that flip partnerships would continue to be a viable structure. 

Option One

Option One would involve making certain isolated and targeted modifications to key provisions of both subchapters K and S.  A few of the particular changes that have been proposed for subchapter K are the repeal of the “guaranteed payment” rules and the rules relating to payments made to retiring partners. Further, Section 754-type inside basis mark-to-market adjustments would become mandatory for all partnerships upon distributions in kind and transfers of partnership interests, and require corresponding adjustments to lower-tier partnerships.  Revisions would also be made to the rules applicable to distributions of unrealized receivables and inventory items, and the timing limitation of the so-called “mixing bowl” transaction rules would be eliminated.

Option Two

Option Two of the Camp proposal is far more ambitious and would entail a full repeal of current subchapters K and S.  Contemporaneously, a new “unified passthrough regime” would be introduced applicable to entities treated as “passthroughs” for U.S. federal income tax purposes. 

The scope of the entities eligible for passthrough treatment would be broadened, and would become elective for certain corporations that are currently subject to subchapter C, but not for publicly traded corporations.

Implications for Renewables under Option Two

Significantly for renewable energy tax equity partnerships, the new distributive share of a partner would generally be computed pursuant to the partnership agreement; however, there would be a restriction on making “special allocations.” Creating different distributive shares of certain items to the same owner would not be possible within each of three specified categories: (i) ordinary income items (including Section 1231 gain or loss (i.e., gains and losses realized with respect to certain property used in a trade or business)); (ii) capital gain or loss items; and (iii) tax credits.  This means special allocations of investment or production tax credits would continue to be possible, but the allocation percentage would apply for all allocations of tax credits that the partnership’s business gives rise to.  It is not clear if the scope of this requirement would include state credits.  The same approach would likely apply to depreciation deductions, (i.e., they would be part of the first category of allocations). It remains to be seen what this proposal means for the current rules, which provide that the allocation of production and investment tax credits must follow the allocation of profit and loss for the year in question.

New also would be that withholding would apply to the distributive share of net passthrough income to each partner, with an exception for interest holders already subject to Section 1446 withholding (i.e., withholding on income of the partnership which is effectively connected with the conduct of a U.S. trade or business). This withholding would be treated as a deemed distribution and owners would be entitled to a refundable income tax credit for the amount withheld.

Although many of the operative provisions of the unified regime would more closely resemble the provisions of current subchapter K, a significant departure would be that partnerships would be required to recognize gain on distributions of either cash or property in excess of a partner’s outside tax basis. 

Conclusion

The Camp proposal is interesting and will spark debate about passthrough reform.  Harold Hancock, tax counsel to the Ways & Means Committee, has recently confirmed that the Committee welcomes comments from interested parties on virtually all aspects of the proposal.  Since broader tax reform can be expected sooner rather than later, it will be interesting to see which elements of the proposed reform are favored in the relevant industries. 

For more information on the proposal, officially entitled “Strengthening the Economy and Increasing Wages by Making the Tax Code Simpler and Fairer for America’s Small Businesses,” click here.