Solar equipment sale-leaseback may be financing

Plain-English summary

This advice addresses a proposed transaction in which a taxpayer would buy solar energy equipment and lease it back to the seller. The IRS says the arrangement could be recharacterized as financing if the taxpayer is effectively assured of recovering its investment regardless of the equipment's residual value. If recharacterized, tax credits and depreciation deductions would be disallowed, and rent would be treated as principal and interest. The advice distinguishes the transaction from a SILO because the proceeds would refinance existing construction debt rather than primarily monetize tax benefits.

Ruling snapshot

• Question: Should a solar-equipment sale and leaseback be treated as a financing rather than a true sale and lease?
• Outcome: Advice given
• Key authorities: Estate of Thomas v. CIR, 84 T.C. 412 (1985); Swift Dodge v. CIR, 692 F.2d 651 (9th Cir. 1982)

Full text (IRS public release)

ID: CCA_2013070109445842
Office: -----------------
UILC: 61.16-03
Number: 201351022
Release Date: 12/20/2013
From: ----------------------
Sent: Monday, July 01, 2013 9:44:59 AM
To: -----------------------------
Cc: ---------------------
Subject: RE: Fact Draft

You have asked for our advice regarding certain transactions in which taxpayer purports
to acquire solar energy equipment and lease it back to the seller. The seller has
entered into service agreements with end users of the equipment. At or about the time
these service agreements expire and some five years before the end of the leaseback
term, the seller has the option of "repurchasing" the equipment. If seller does not
exercise this option, it is required to secure replacement service agreements with end
users or otherwise provide security for rent for the remaining five years of the leaseback
term. We understand that irrespective of whether seller exercises the repurchase
option, taxpayer will recover its investment in the equipment on a pre-tax basis, i.e.,
without regard to credits and depreciation deductions taken on the premise that it
acquires ownership of the equipment. In other words, taxpayer will earn a pre-tax return
either through the purchase option price or rent for the remainder of the leaseback term.

Under these facts, the transactions can be recharacterized as financings, with the result
that credits and depreciation deductions are disallowed, and rent is recharacterized as the
payment of principal and interest. Taxpayer lacks a key attribute of tax ownership,
residual value risk. Compare Estate of Thomas v. CIR, 84 T.C. 412 (1985), and Swift
Dodge v. CIR, 692 F.2d 651 (9th Cir. 1982). Residual value risk would be present if
taxpayer's recovery of its investment depended on the value of the equipment at the
end of the leaseback term. As noted, we understand that taxpayer will earn a pre-tax
return either upon exercise of seller's purchase option or, in the event the option is not
exercised, through rent paid over the remaining term of the leaseback.

While the Service has a basis for recharacterizing the transactions as financings, we
would not characterize the transactions as SILOs. Here, the proceeds of the purported
sale and leaseback transaction are used to retire pre-existing construction debt. The
seller presumably made use of the construction loan proceeds, and the transactions
represent a refinancing of the construction loans. SILOs, on the other hand, represent
little more than a sale of tax benefits.

Thank you.