On Thursday, January 17, 2013, a petition for a writ of certiorari was filed with the United States Supreme Court seeking reversal of the U. S. Third Circuit Court of Appeals’ opinion in the Historic Boardwalk Hall case. With no conflict in the circuits on the issues of the case, the petition contends that Supreme Court review is needed because of the issues are of first impression and have potentially broad ramifications the Third Circuit had reversed the U. S. Tax Court decision and ruled that the investor in a tax equity partnership was not a true partner largely because it “lacked a meaningful stake in the success or failure” of the project. The result was the reallocation of all of the historic rehabilitation tax credits to the tax-exempt developer. The taxpayer submitting the petition contends that “…this is the first litigated case in the country in which the IRS has made a sweeping challenge to the allocation of federal HRTCs from a partnership to a partner in the very type of rehabilitation project that formed the basis for Congressional enactment of the HRTC statute.”
There is no question that the outcome of this case could have far-reaching implications for tax equity financing. By way of background, tax equity financing is a type of financing structure that permits investors, usually as a partner or member of a pass-through entity, to efficiently and economically utilize federal tax benefits generated by the investment available in projects. While Congress enacts tax credits specifically to generate investment in high risk project areas, as recognized by the Third Circuit, the ruling in the Historic Boardwalk Hall case renders it extremely difficult for taxpayers to pursue these types of transactions on an after-tax basis.
The ruling dictates that practitioners, at a minimum, reexamine their tax equity financing arrangements and engage in careful tax planning with regard to tax credit transactions. This is the case even though the informal announcements by the IRS that support the position that a partnership interest may involve only a small economic interest as well as its guidance that the economic substance does not apply if the tax structure advances the intent of a federal tax credit program, fly in the face of the HBH decision.
The Historic Boardwalk Hall case involved the redevelopment of Historic Boardwalk Hall, an “iconic venue” and historic home to the Miss America beauty pageant, by the New Jersey Sports and Exposition Authority (NJSEA), a state agency. To defray project costs, NJSEA solicited bids for federal rehabilitation tax credit investors. Pitney Bowes Inc. (PB) was the winning bidder. Historic Boardwalk Hall, LLC, (HBH) was formed to be the tax owner of the building and to complete the renovation of Historic Boardwalk Hall.
In summary, the Third Circuit Court of Appeals, in reversing the U.S. Tax Court holding, decided that a tax credit investor was not a partner because it “lacked a meaningful stake in the success or failure” of the project owner. Consequently, the investor was not entitled to any rehabilitation tax credits. Unfortunately, this decision largely ignores recent informal IRS guidance that an interest as small as 0.1% in a partnership would be acceptable as to the owner's status as a partner for federal income tax purposes. Accordingly, the ruling issued by the Court of Appeals in Historic Boardwalk Hall brings into question whether one can rely on such informal guidance that an interest as small as 0.1% in a partnership may be a partnership interest.
In addition, with regard to the structure of transactions that allow an investor to use federal historic rehabilitation tax credits such as in Historic Boardwalk Hall, Congress has stated it is not intended that a tax credit, such as the low-income housing credit or the electricity production tax credit, be disallowed in a transaction in which, in form and substance, a taxpayer makes the type of investment or undertakes the type of activity that the credit was intended to encourage. Joint Comm Staff, Tech Expln of the Revenue Provisions of the Reconciliation Act of 2010, as Amended, in Combination With the Patient Protection and Affordable Care Act (JCX-18-10), 3/21/2010, p. 152. In the vein of such directive, the IRS adopted Rev. Proc. 2007-20, it appears at least partially in furtherance of this directive from Congress, that exempted a number of tax credit transactions from disclosure requirements associated with “reportable transactions.” While, Rev. Proc. 2007-20 provided some indication that the IRS would limit application of the economic substance doctrine (as codified in Section 7701(o) of the Internal Revenue Code) so as not to encompass federal tax credit investments, the ruling in Historic Boardwalk Hall curtails reliance on such indications.