1. L UP DATE
SP ECIA
Can Indian Tribes Own Renewable
Power Projects? IRS says yes; not a Pickle!
by John Marciano III and Amanda Forsythe, in Washington
The IRS released a ruling this week that opens the door to subsidies, directly or indirectly. The rules do not apply to per-
Indian tribes playing a much larger role in renewable power sons that could be taxpayers if they only had income.
projects. The rules (and similar later rules) stretch out depreciation
It allows an Indian tribal government to be an owner or les- and disallow certain tax credits for property considered to be
see of these projects. The rationale: An Indian tribal govern- used by these nontaxpayers. For example, solar property,
ment is not a governmental unit or tax-exempt organization which is normally depreciated over 5 years on an accelerated
for purposes of tax subsidies. basis, instead would be depreciated over 12 years on a
The taxpayer in the ruling leased a power plant from an straight-line basis to the extent it is used by one of these enti-
Indian tribe and planned to sell power to a third party. The tax- ties. Investment tax credits are disallowed to the same
payer and tribe agreed to let the taxpayer (the lessee) claim an extent. Tax credits based on production generally are still
investment tax credit. The option to let a lessee claim an available, but without accelerated depreciation, deals with
investment credit is not available if the lessor could not have nontax-exempts become hard to pencil.
claimed the credit. The IRS ruled that the tribal government Property subject to this rule is called “tax-exempt use prop-
could have claimed the credit. erty.” That is, property leased to such a nontaxpayer and prop-
erty owned by a tax-exempt through a partnership with
Why do we care? shifting profit sharing ratios.
First, the industry had assumed that, because they do not pay Where a nontaxpayer owns an interest in a partnership, the
taxes, Indian tribal governments could not effectively partici- rules extemd tax-exempt taint to the extent of the high-
pate in renewables projects. watermark of its interest in the partnership’s profits if the
Second, the rationale used raises some questions about partners’ shares of profits are slated to change during the deal.
other potential structures involving tax-exempts and govern- This rule was designed to prevent tax-exempts from mone-
mental entities. tizing tax benefits, but never paying the government back
through taxes. One way the tax-exempt could do this was to
The Pickle Rules develop a project and barter away the tax benefits to an insti-
The US government subsidizes renewable power projects by tutional investor by giving the investor most of the profits
providing tax benefits to their owners. These benefits mainly (and tax benefits) for a short period of time. Then, the inves-
are tax credits and accelerated depreciation (i.e., the ability to tor’s interest would be reduced substantially, leaving the
write-off the cost of a project over time). future profits largely with the tax-exempt. These profits
Tax-exempt and governmental entities generally do not pay wouldn’t be taxed and the government would get no return
taxes, so the benefits present little value to them. At the same on its investment. For leases transactions, Congress presumed
time, these entities are facing increasing pressure to cut power that lease payments would be reduced artificially, causing the
costs and make their operations more green. lessor to have reduced income on which to pay taxes.
Congress wants to provide tax benefits as an inducement On their face, the rules do not prohibit a tax-exempt from
to build projects, but it views the benefits as an investment. taking a bare ownership interest in a project or a nonshifting
That is, it wants to be paid back with taxes in the long term. It interest in a partnership. Presumably, this is because the gov-
is not in the business of handing out free money. ernment either earned its return through a taxable lessee’s
So, in 1984, it passed a series of rules — the Pickle rules — income derived from the use of the property (where the lessee
that make it difficult for nontaxpayers to get the benefit of claimed a tax credit) or the / continued page 2

2. Pickle
continued from page 1 interest in a limited liability company that owns the facility or
make a contribution to the LLC in exchange for an interest in
government never needed to earn a return since tax-exempt’s the LLC. For tax purposes, the LLC would turn into a partner-
would not claim the benefits because they do not pay taxes. ship when the investor becomes a member.
This is supported by some exceptions to the rule that permit The economic returns (including the tax credit), except pos-
a tax-exempt entity to claim the tax benefits if it would have to sibly cash, would be allocated 99% to the investor. Once the
claim income from the use of the project as unrelated business investor reaches its specified return, its share of the deal
taxable income (UBTI) and thus pay tax on the income. would flip down to 5%. Because an Indian tribe is not a tax-
exempt entity, its participation in a partnership with shifting
Potential Implications profits will not cause the project to be tax-exempt use prop-
The IRS reasoned in the ruling that the tribal government erty, and the tax benefits will be preserved.
could join with the lessee to permit the lessee to claim the In a sale-leaseback, the tribe would place the facility into
investment credit. A lessor may let a lessee claim a credit only service. The tribe would then sell the equipment to an investor
if the lessor was eligible for the credit itself. within the next three months and lease it back. (In a partner-
The IRS ruled that the tribe was not a “governmental entity,” ship flip, the investor must be a partner before the project is
and since the income tax rules do not apply to tribes, there placed in service. In a sale-leaseback, he has up to three
was nothing from which the tribe could be exempt. This months after the project is completed to invest.) The investor
meant that the Pickle rules described above did not apply to would own 100% of the equipment. The tribe, as lessee, pays
the tribe and it was eligible for the credit. rent and shares the value of the government subsidies (tax
It is curious that the IRS did not answer the question by rul- credits and depreciation) with the investor in the form of a
ing that the tribe was not “using” the property under the reduced rent.
Pickle rules. This would have been consistent with the statu- An inverted lease passes the tax credit to an investor who
tory rules on tax-exempt use property, on which the tax credit leases the facility from the tribe. This is the structure described
rules are based. The project was not leased to a tax-exempt in the IRS ruling. The tribe generally maintains operating con-
person. It also was not owned by a partnership where a tax- trol of the facility. After the five-year tax credit period is over,
exempt partner had a shifting interest. the lease term ends, and the facility is returned to the tribe.
By choosing to rule that the tribe was not subject to the In addition, by choosing to conclude based on the fact that
Pickle rules, the IRS made way for increased opportunities for the tribe was not a governmental or tax-exempt entity, rather
Indian tribes to participate in renewable energy projects. than that the tribe was not “using” the project, the IRS seems
Although Indian tribes cannot take advantage of the tax bene- to suggest that it believes no tax-exempt ownership is per-
fits because they do not pay taxes, we now know that the IRS missible. This is contrary to the Pickle rules that apply to
believes a tribe can own a renewable project without causing depreciation.
it to be considered tax-exempt use property. If the IRS were to apply to the investment tax credit the
Like tax-exempt and governmental entities, most develop- same rules that apply to depreciation (arguably, it is required
ers cannot use tax benefits efficiently, either because they do to do so), a church, school or pension fund could participate in
not have tax liabilities or they are subject to special rules that an inverted lease in ways other than merely as a power pur-
make it hard for all but the wealthiest of individuals and large chaser. It would also permit these entities to purchase operat-
corporations to use them. Large corporations are usually the ing renewable power assets and lease them back to the
best users of tax benefits because they have very few limita- original owner. These structures effectively would provide
tions on using tax credits. For this reason, developers often financing to true taxpayers. Plus, and more importantly, they
barter the tax benefits to someone who can use them imme- would give the tax benefits to a person that would pay the
diately as an efficient way to raise capital. Indian tribes should government a return on its investment in the end.
be able to raise capital the same way. This reading would expand participation in renewables,
There are three common ways to barter tax benefits AND which is a goal of the Obama administration, and it would not
still retain control over the facility: a partnership-flip transac- violate the policy of giving benefits to nontaxpayers. 
tion, a sale-leaseback transaction or an “inverted” lease.
In a partnership flip, an investor either would purchase an March 12, 2013
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