LEGAL PERSPECTIVES: New Possibilities in the Hunt for Biomass Project Financing
A lack of financing for biomass projects is a common lament for most biomass developers. As many developers already know, new market tax credit financing is a great way to obtain financing at better than market rates for biomass projects, if you can get the attention of a small group of banks with interest. Fortunately, a recent taxpayer-friendly ruling by the IRS creates new opportunities to attract individual investors to serve as the tax credit investor.
The new market tax credit program was created more than a decade ago as a way to direct funds to businesses located in low-income census districts. The program provides an investor with a federal income tax credit equal to 39 percent of an investment in an intermediary entity (referred to as a community development entity), which loans the investor's fund to the biomass project. This loan must be interest-only for at least seven years and have an interest rate at least 25 percent below a market rate. Under certain structures, a lender typically will discharge a substantial portion of the principal after seven years (after all, the lender has recouped its investment from the generous 39 percent tax credit and often doesn't also need a return of all of the principal).
A biomass project will qualify for this financing as long as the project is located in a low-income census district. A liberal definition of "low-income" covers almost 40 percent of the United States, including many rural districts. A federal website mapping feature identifies whether an address is in a low-income census district (www.cdfifund.gov/what_we_do/mapping.asp).
New market tax credit financing can also be coupled with traditional waste-to-energy financing, such as the production tax credit (PTC), investment tax credit (ITC), or the federal 1603 grant.
Current Tax Credit Problems
To state the obvious, the tax credit appetite of banks has declined sharply in recent years. Nonetheless, there are still plenty of individual investors who are interested in offsetting taxable income. Until now, individual investors have shied away from investing in new market tax credits, because it has been assumed that these credits were subject to the restrictive passive activity tax limits (as is the case with the PTC and ITC), which limits the use of these credits for most individuals.
In a June 2010 ruling, the IRS clarified that new market tax credits are not subject to these passive activity rules. This ruling creates opportunities for project developers to raise funds by finding one (or likely multiple) individual investors who could serve as new market tax credit investors. From the perspective of an individual investor, the return on a new market credit investment is comparable to a market-rate loan, but with a portion of the return coming in the form of tax credits. An individual investor's evaluation of this return would not be conceptually dissimilar from the way in which he or she would approach tax-exempt municipal bonds (i.e., the return should be calculated on an after-tax basis). While the task of finding financing for a biomass project is still not easy, this recent ruling at least opens new financing sources for a developer.
Author: Hamang Patel
Attorney, Michael Best & Friedrich LLP