PLR 200408004: Coal facility purchase and partnership changes preserve credit

Plain-English summary

A partnership bought a coal-to-synthetic-fuel facility and asked whether its fuel and ownership arrangements qualified for the section 29 credit. The IRS ruled that the described process produces qualifying fuel and that the partnership may claim the credit on sales to unrelated buyers. It also found that the facility's construction contract satisfied the statutory binding-contract requirement and that members may share the credit based on valid allocations of fuel sale receipts. A later relocation or parts replacement would not reset the service date if the facility was originally placed in service before July 1, 1998, and original property remained more than 20 percent of its value. A termination and reconstitution of the partnership under section 708 would not itself end the credit. The ruling requires ongoing testing and supporting records.

Ruling snapshot

• Question: Do the facility, construction contract, and possible ownership changes meet the section 29 credit rules?
• Outcome: Approved, subject to the original service date, property value, and testing conditions.
• Key authorities: IRC §§ 29, 702, 704, 708(b)(1)(B); Rev. Rul. 94-31.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200408004
Release Date: 2/20/04
Index Number: 29.00-00

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Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B07 – PLR-154175-02
Date:
November 06, 2003
In Re:
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Legend

P = ----------------------------------------------------------- X = ------------------------------------ Y = ------------------------------------- A = --------------------------------- B = ----------------------------------------------- C = ---------------- Location 1 = --------------- Date 1 = --------------------------- Date 2 = ---------------------------

Dear ----.------------:

This letter responds to a letter dated October 1, 2002, submitted on behalf of P by its authorized representative, requesting rulings under section 29 of the Internal Revenue Code.

The facts as represented by P and P's authorized representative are as follows: P is a Delaware limited liability company, taxable as a partnership. The partners of P are X and Y. Y is a wholly owned subsidiary of X. X has complete and exclusive control of the management of P. X has extensive experience in energy, coal, and related businesses. P was formed by X to purchase from A and its affiliates a synthetic fuel facility (the Facility) that produces a solid synthetic fuel from coal (the Product).

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On Date 1, P purchased the Facility from A pursuant to a purchase agreement. In consideration for the Facility, P made a cash payment at closing. As members of P, X and Y have made (and are expected to continue to make) periodic capital contributions to P to enable it to pay its operating costs and other obligations. A proforma attached to the ruling request indicates that the projected expenses are projected to exceed revenues. The Facility was constructed pursuant to a construction contract between A and B entered into on Date 2. The construction contract is for a synthetic fuel production facility consisting of a single production line for producing a solid synthetic fuel from coal using A's patented process. The construction contract provides a guaranteed maximum price and a completion date. The construction contract provides that any damages recoverable by B against A shall not be less than six percent of the total contract price. P provided an opinion of counsel that the construction contract constitutes a binding contract under state law. Certain adjustments, repairs and improvements have been made to the Facility, material preparation, handling and sampling systems, and the site. P has provided an expert report which states that many of these adjustments, repairs and improvements are not part of the Facility necessary to produce synthetic fuel. The expert report concludes that the remaining adjustments, repairs and improvements to the Facility necessary to produce synthetic fuel do not affect the production capacity of the Facility.

The Facility is currently located on property near Location 1 (the Site) owned by C and leased to P under a site lease agreement. P operates the Facility as a merchant plant and will purchase coal feedstock for the Facility from various coal producers or from traders or brokers of coal pursuant to various coal feedstock purchase agreements. P will sell the Product produced at the Facility to various third party customers pursuant to various synthetic fuel supply agreements.

P entered into an operation and maintenance agreement with A regarding the Facility. A=s compensation will be a quarterly fee adjusted over time for inflation. P will pay all operating costs as set forth in the annual budget. In addition, any capital costs associated with the Facility will be paid by P, and must be authorized by P.

P entered into a license agreement with A granting to P the right to use A=s technology, trade secrets, and other intellectual property for producing synthetic fuel from coal. P will pay A a royalty of a fixed dollar amount per ton of the Product produced and sold by P for use of the technology. The license agreement also provides that A will sell to P all of P=s requirements of chemical reagent for the Facility. The price of the chemical reagent is A=s cost to produce the chemical reagent plus a fixed amount.

P has supplied a detailed description of the process employed at the Facility. P also has proposed that, from time to time, one of two chemical reagents may be used in the process for the production of Product. As described, the Facility and the process

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implemented in the Facility, including the chemical reagents, meet the requirements of Rev. Proc. 2001-34, 2001-22 I.R.B. 1293.

A recognized expert in combustion, coal, and chemical analysis has performed numerous tests on the coal used at the Facility and the Product produced at the Facility and has submitted reports in which the expert concludes that significant chemical changes take place with the application of the process to the coal, including the alternative chemical reagents. P, with use of the process, expects to maintain a level of chemical change in the production of synthetic fuel that is determined through similar analysis by experts to be a significant chemical change. You have requested the following rulings:
1. P, with use of the enumerated process, will produce a Aqualified fuel@ within the meaning of section 29(c)(1)(C).

2. Production from the Facility will be attributable solely to P within the meaning of section 29(a)(2)(B), and P will be entitled to the section 29 credit for qualified fuel from the Facility that is sold to an unrelated person.

3. The construction contract constitutes a Abinding written contract in effect before January 1, 1997@ within the meaning of section 29(g)(1)(A).

4. The section 29 credit attributable to P may be allocated to the members of P in accordance with the members= interests in P when the credit arises. For the allocation of the section 29 credit, a member=s interest in P is determined based on a valid allocation of the receipts from the sale of the section 29 qualified fuel.

5. Provided the Facility was Aplaced in service@ prior to July 1, 1998 within the meaning of section 29(g)(1), relocation of the Facility to a different location after June 30, 1998, or replacement of part of the Facility after that date, will not result in a new placed in service date for the Facility for purposes of section 29 provided the fair market value of the original property is more than 20 percent of the Facility=s total fair market value at the time of relocation or replacement.

6. A termination of P under section 708(b)(1)(B) will not preclude the reconstituted partnership from claiming the section 29 credit on the production and sale of synthetic fuel to unrelated persons.

RULING REQUESTS #1 AND #2
Section 29(a) allows a credit for qualified fuels sold by the taxpayer to an unrelated person during the taxable year, the production of which is attributable to the taxpayer. The credit for the taxable year is an amount equal to $3.00 (adjusted for inflation) multiplied by the barrel-of-oil equivalent of qualified fuels sold.

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Section 29(c)(1)(C) defines "qualified fuels" to include liquid, gaseous, or solid synthetic fuels produced from coal (including lignite), including such fuels when used as feedstocks. In Rev. Rul. 86-100, 1986-2 C.B. 3, the Internal Revenue Service ruled that the definition of the term "synthetic fuel" under section 48(l) and its regulations are relevant to the interpretation of the term under section 29(c)(1)(C). Former section 48(l)(3)(A)(iii) provided a credit for the cost of equipment used for converting an alternate substance into a synthetic liquid, gaseous, or solid fuel. Rev. Rul. 86-100 notes that both section 29 and former section 48(l) contain almost identical language and have the same overall congressional intent, namely to encourage energy conservation and aid development of domestic energy production. Under section 1.48-9(c)(5)(ii) of the Income Tax Regulations, a synthetic fuel "differs significantly in chemical composition," as opposed to physical composition, from the alternate substance used to produce it. Coal is an alternate substance under section 1.48-9(c)(2)(i). Based on the representations of P and P's authorized representative, including the preponderance of the test results, we agree that the fuel to be produced in P's Facility using the described process on the coal will result in a significant chemical change in coal, transforming the coal fines into a solid synthetic fuel from coal. Because P will own the Facility and operate and maintain the Facility through its agent, we conclude that P will be entitled to the section 29 credit for the production of the qualified fuel from the Facility that is sold to an unrelated person. RULING REQUEST #3 Sections 29(f)(1)(B) and (f)(2) provide that section 29 applies with respect to qualified fuels which are produced in a facility placed-in-service after December 31, 1979, and before January 1, 1993, and which are sold before January 1, 2003. Section 29(g)(1) modifies section 29(f) in the case of a facility producing qualified fuels described in section 29(c)(1)(C). Section 29(g)(1)(A) provides that for purposes of section 29(f)(1)(B), a facility shall be treated as placed-in-service before January 1, 1993, if the facility is placed-in-service before July 1, 1998, pursuant to a binding written contract in effect before January 1, 1997. Section 29(g)(1)(B) provides that if the facility is originally placed-in-service after December 31, 1992, section 29(f)(2) shall be applied by substituting "January 1, 2008" for "January 1, 2003". A contract is binding only if it is enforceable under local law against a taxpayer, and does not limit damages to a specified amount, e.g., by use of a liquidated damages provision. A contract provision limiting damages to an amount equal to at least five percent of the total contract price, for example, should be treated as not limiting damages. The construction contract, executed prior to January 1, 1997, includes such features as a description of the facility to be constructed, a completion date, and a maximum price. The contract also provides that damages shall not be less than six percent of the total contract price. P provided an opinion of counsel that the contract is binding under applicable law. Therefore, the contract is a binding written contract for purposes of section 29(g)(1).

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RULING REQUEST #4
Section 29(a) allows a credit for qualified fuels sold by the taxpayer to an unrelated person during the taxable year, the production of which is attributable to the taxpayer. Section 7701(a)(14) provides that "taxpayer" means any person subject to any internal revenue tax. Generally, under section 7701(a)(1), the term "person" includes an individual, a trust, estate, partnership, association, company, or corporation. Section 702(a)(7) provides that each partner determines the partner's income tax by taking into account separately the partners distributive share of the partnership's other items of income, gain, loss, deduction, or credit to the extent provided by regulations prescribed by the Secretary. Section 1.702-1(a) provides that the distributive share is determined as provided in section 704 and section 1.704-1. Section 704(a) provides that a partner's distributive share of income, gain, loss, deduction, or credit is, except as otherwise provided in chapter 1 of subtitle A of title 26, determined by the partnership agreement. Section 704(b) provides that a partner's distributive share of income, gain, loss, deduction, or credit (or item thereof) is determined in accordance with the partners interest in the partnership (determined by taking into account all facts and circumstances) if (1) the partnership agreement does not provide as to the partners distributive share of income, gain, loss, deduction, or credit (or item thereof), or (2) the allocation to a partner under the agreement of income, gain, loss, deduction, or credit (or item thereof) does not have substantial economic effect. Section 1.704-1(b)(4)(ii) provides that allocations of tax credits and tax credit recapture (except for section 38 property) are not reflected by adjustments to the partners' capital accounts. Thus, these allocations cannot have economic effect under section 1.704- 1(b)(2)(ii)(b)(1), and the tax credits and tax credit recapture must be allocated in accordance with the partners' interests in the partnership as of the time the tax credit or credit recapture arises. If a partnership expenditure (whether or not deductible) that gives rise to a tax credit in a partnership tax year also gives rise to valid allocations of partnership loss or deduction (or other downward capital account adjustments) for the year, then the partners' interests in the partnership with respect to such credit (or the cost giving rise to it) are in the same proportion as the partners' respective distributive shares of the loss or deduction (and adjustments). See section 1.704-1(b)(5), example (11). Identical principles apply in determining the partners' interests in the partnership with respect to tax credits that arise from receipts of the partnership (whether or not taxable). Based on the information submitted and the representations made, we conclude that the section 29 credit attributable to P may be allocated to the members of P in accordance with the members' interests in P when the credit arises. For the allocation of the section 29 credit, a member's interest in P is determined based on a valid allocation of the receipts from the sale of the section 29 qualified fuel. RULING REQUEST #5

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To qualify for the section 29 credit, P's facility must be placed-in-service before July 1, 1998, pursuant to a binding written contract in effect before January 1, 1997. While section 29 does not define "placed-in-service," the term has been defined for purposes of the deduction for depreciation and the investment tax credit. Property is "placed-in- service" in the taxable year the property is placed in a condition or state of readiness and availability for a specifically assigned function. Section 1.167(a)-11(e)(1)(i) and section 1.46-3(d)(1)(ii) of the Income Tax Regulations. "Placed in service" has consistently been construed as having the same meaning for purposes of the deduction for depreciation and the investment tax credit. See Rev. Rul. 76-256, 1976-2 C.B. 46. Rev. Rul. 94-31, 1994-1 C.B. 16, concerns section 45, which provides a credit for electricity produced from certain renewable resources, including wind. The credit is based on the amount of electricity produced by the taxpayer at a qualified facility during the 10-year period beginning on the date the facility was originally placed in service, and sold by the taxpayer to an unrelated person during the taxable year. Rev. Rul. 94-31 holds that, for purposes of section 45, a facility qualifies as originally placed in service even though it contains some used property, provided the fair market value of the used property is not more than 20 percent of the facility's total value (the cost of the new property included in the facility plus the value of the used property). Rev. Rul. 94-31 describes a windfarm that consists of an Aarray of wind turbines, towers, pads, transformers, roadways, fencing, on-site power collection systems, and monitoring and meteorological equipment.@ Notwithstanding that the windfarm consisted of all of these items, the ruling concludes that the Afacility@ for purposes of section 45 is confined to Athe property on the windfarm necessary for the production of electricity from wind energy.@ (emphasis added.) The present situation is similar to Rev. Rul. 94-31. Thus, for purposes of determining the Facility=s total fair market value at the time of relocation or replacement, the Facility consists of the process equipment directly necessary for the production of the qualified fuel, starting at the immediate input of the coal and chemical reagents to the pug mills or mixers (including any coal hoppers and reagent tanks directly feeding the pug mills or mixers) through the output from the briquetters or other forming equipment (including output hoppers, if any). Hence, the Facility=s total fair market value includes the process equipment such as pugmills or mixers, the briquetters or other forming equipment, the equipment necessary to interconnect such equipment, the electrical, instrumentation, control systems and auxiliaries related to such equipment (including the structures that house such electrical, instrumentation and control systems), the foundation platform(s) for the above- referenced equipment, and an appropriate allocation of the engineering, project management, overhead, and other costs assignable to the relocation of such equipment and construction. The Facility=s total fair market value does not include costs associated with the purchase and installation of equipment that supports the operation of the Facility but is not directly necessary for the production of the qualified fuel, such as coal beneficiation, or preparation equipment (e.g., crushers, screens, dryers, or scales), other material handling or conveying equipment (e.g., stacking tubes, transfer towers, storage bunkers, mobile equipment, or conveyors), certain site improvements (e.g.,

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fencing, lighting, earthwork, paving), separate office and bathhouse trailers for facility personnel, and buildings (if a Abuilding@ for purposes of section 168 of the Code). Sampling and quality control are necessary for operational control of a production facility. However, a particular type of sampling equipment generally is not necessary for the production of qualified fuel. Thus, the costs of sampling equipment are excluded from the Facility=s total fair market value unless the particular sampling equipment is necessary for operational control of the facility. Consistent with the holding in Rev. Rul. 94-31, provided P's Facility was "placed in service" prior to July 1, 1998, within the meaning of section 29(g)(1), relocation of the Facility to a different location, or replacement of part of the Facility after June 30, 1998, will not result in a new placed in service date for the Facility for purposes of section 29 provided the fair market value of the original property is more than 20 percent of the Facility's total fair market value at the time of relocation or replacement (the cost of the new equipment included in the Facility plus the value of the used property). RULING REQUEST #6 Section 708(b)(1)(B) provides that a partnership shall be considered as terminated if within a twelve-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits. Section 1.708-1(b)(1)(iv) provides that if a partnership is terminated by a sale or exchange of an interest, the following is deemed to occur: The partnership contributes all of its assets and liabilities to a new partnership in exchange for an interest in the new partnership; and, immediately thereafter, the terminated partnership distributes interests in the new partnership to the purchasing partner and the other remaining partners in proportion to their respective interests in the terminated partnership in liquidation of the terminated partnership, either for the continuation of the business by the new partnership or for its dissolution and winding up. Section 1.708-1(b)(1)(iv) applies to terminations of partnerships under section 708(b)(1)(B) occurring on or after May 9, 1997. As discussed above, the placed-in-service deadline in sections 29(f)(1)(B) and 29(g)(1)(A) must be read as applying to when the facility is first placed in service within the applicable dates. The placed-in-service deadlines contained in sections 29(f)(1)(B) and 29(g)(1)(A) focus on the facility, and not the taxpayer owning the facility. Accordingly, the determination of whether a facility has satisfied the placed-in-service deadline under sections 29(f)(1)(B) and 29(g)(1)(A) is made by reference to when the facility is first placed in service, not when the facility is placed in service by a transferee taxpayer. Therefore, we conclude that a termination of P under section 708(b)(1)(B) will not preclude the reconstituted partnership from claiming the section 29 credit on the production and sale of synthetic fuel to unrelated persons. CONCLUSIONS Accordingly, based on the representations of P and P's authorized representative, we conclude as follows:

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1. P, with use of the enumerated process, will produce a Aqualified fuel@ within the meaning of section 29(c)(1)(C).

2. Production from the Facility will be attributable solely to P within the meaning of section 29(a)(2)(B), and P will be entitled to the section 29 credit for qualified fuel from the Facility that is sold to an unrelated person.

3. The construction contract constitutes a Abinding written contract in effect before January 1, 1997@ within the meaning of section 29(g)(1)(A).

4. The section 29 credit attributable to P may be allocated to the members of P in accordance with the members= interests in P when the credit arises. For the allocation of the section 29 credit, a member=s interest in P is determined based on a valid allocation of the receipts from the sale of the section 29 qualified fuel.

5. Provided the Facility was Aplaced in service@ prior to July 1, 1998 within the meaning of section 29(g)(1), relocation of the Facility to a different location after June 30, 1998, or replacement of part of the Facility after that date, will not result in a new placed in service date for the Facility for purposes of section 29 provided the fair market value of the original property is more than 20 percent of the Facility=s total fair market value at the time of relocation or replacement.

6. A termination of P under section 708(b)(1)(B) will not preclude the reconstituted partnership from claiming the section 29 credit on the production and sale of synthetic fuel to unrelated persons.

The conclusions drawn and rulings given in this letter are subject to the requirements that the taxpayer (i) maintain sampling and quality control procedures that conform to ASTM or other appropriate industry guidelines at the facility or facilities that are the subject of this letter, (ii) obtain regular reports from independent laboratories that have analyzed the fuel produced in such facility or facilities to verify that the coal used to produce the fuel undergoes a significant chemical change, and (iii) maintain records and data underlying the reports that taxpayers obtain from independent laboratories including raw FTIR data and processed FTIR data sufficient to document the selection of absorption peaks and integration points.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

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PLR-154175-02

This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Sincerely,

/s/
Joseph H. Makurath
Senior Technician Reviewer, Branch 7
Office of Associate Chief Counsel
(Passthroughs & Special Industries)