On June 20, 2019, the Court of Federal Claims finally released its previously sealed opinions in the companion cases of Bishop Hill Energy, LLC and California Ridge Wind Energy, LLC.1 Both cases are substantially similar, were decided in favor of the government, and denied the taxpayer, a renewable energy developer, reimbursement for a portion of previously claimed Section 1603 grants.
While the court stated that Section 1603 permits an applicant to include a "Development Fee" as a part of a wind energy project's cost basis, it applied the economic substance and sham transaction doctrines2 and determined that the Development Fees at issue in each case should not be included in cost basis for purposes of the Section 1603 grant.
The opinions are remarkably short but powerful. The court states,
In sum, plaintiff proffered: an independent certification of the Development Fee that is based on information from Invenergy management; a development agreement without quantifiable services; and a round-trip wire transfer that began and ended in the same bank account, on the same day, none of which were corroborated by independent testimony. This falls well short of the burden under the sham transaction doctrine.
What remains is the uncontested fact that plaintiff benefitted from the round-trip transaction; a higher cost basis results in an increased Section 1603 payment. The sham transaction on which [the Development Fee] is based lack a business purpose or economic substance. Therefore, defendant is entitled to recapture the amount of the counterclaim.3
The opinion also noted that the associated Development Services Agreement was three pages in length and listed services that include negotiating construction and financing terms and negotiating project and operational documents related to the project. Based on testimony from both the taxpayer's chief development officer and the project's appraiser, the development services were not "quantifiable."4 Also important was that the taxpayer's chief development officer seemed largely unaware of the existence of the Development Services Agreement and that the appraiser relied on information from the taxpayer to determine the Section 1603 basis without independent verification.
Based on these facts, the court determined that the taxpayer "failed to show business purpose or the economic substance of the Development Fee."
These opinions may cause taxpayers with development fee arrangements that have substance (i.e., that are based on the actual performance of quantifiable and significant development services pursuant to agreements negotiated with third parties) to breathe a sigh of relief. However, given scrutiny of development arrangements and cost basis, generally,5 taxpayers may be reticent to use development fees as a mechanism for increasing cost basis where it cannot be verified that the services provided are commensurate with the value ascribed.
For taxpayers that elect to use development fee arrangements, these cases make clear that the scope of services upon which the fee is based should add real value to the project and be in proportion to the fee being charged. Taxpayers should also avoid arrangements which are not subject to real, third-party negotiation and transactions which are little more than a circular flow of cash.6 In addition, the party providing the development services should be, at minimum, in the business of performing development services and be able to timely and skillfully perform such services. These cases also signal that appraisers should be mandated to review these arrangements and provide independent verification of the eligibility for Section 1603 grants or tax credits.
