NOVEMBER 2005 Energy Alert Energy Policy Act of 2005 On August 8, 2005, President Bush signed the Energy Policy Act of 2005 into law (the Act ). The Act is the first major energy legislation enacted since 1992, and it includes provisions affecting many aspects of the energy industry. Title XIII of the Act entitled Table of Contents SUBTITLE A Electricity Infrastructure... 1 Renewable Energy Production Credit... 1 Clean Renewable Energy Bonds... 2 Disposition of Transmission Property... 2 Advanced Nuclear Power Production Tax Credit... 2 Credit for Investment in Clean Coal Facilities... 2 for Transmission Property... 2 Expansion of Amortization for Certain Atmospheric Pollution Control Facilities... 2 Nuclear Decommissioning Funds... 3 Net Operating Loss Carryback... 3 SUBTITLE B Domestic Fossil Fuel Security... 3 Extension and Modification of Credit for Coke and Coke Gas... 3 Temporary Expensing for Equipment Used in Refining Liquid Fuels... 3 for Natural Gas Distribution Lines... 3 Seven-Year Recovery Period for Natural Gas Gathering Lines... 4 Exception to Arbitrage Rules for Prepayments for Natural Gas... 4 Two-Year Recovery Period for Geological and Geophysical Expenses... 4 SUBTITLE C Conservation and Energy Efficiency Provisions... 4 Energy Efficient Commercial Buildings Deduction... 4 Credit for New Energy Efficient Homes... 5 Credit for Business Installation of Qualified Fuel Cells and Stationary Microturbine Power Plants... 5 Business Solar Investment Tax Credit... 5 SUBTITLE D Alternative Motor Vehicles and Fuels Incentives... 5 Credit for Installation of Alternative Fueling Stations... 5 Modifications to Small Ethanol Producer Credit... 5 Sunset of Deduction for Clean-Fuel Vehicles and Certain Refueling Property... 5 Energy Policy Tax Incentives contains $14.5 billion in tax incentives designed to promote domestic energy production and conservation and improve the reliability of the nation s energy infrastructure. This article summarizes certain key provisions of Title XIII. Subtitle A ELECTRICITY INFRASTRUCTURE Renewable Energy Production Credit The Section 45 production tax credit provided by the Internal Revenue Code (the Code ) has been extended for two (2) years and is now applicable to facilities placed in service through December 31, 2007. The credit applies to electric energy produced by qualifying facilities, including wind, closed-loop biomass, open-loop biomass, geothermal, small irrigation power, landfill gas, and trash combustion. The Section 45 credit is not extended for solar or refined coal facilities. A qualifying facility will receive a per kilowatt-hour tax credit for electricity produced over a 10-year period. The Act adds hydropower and coal produced from Native American lands to the list of qualifying energy resources. The credit for hydropower applies to incremental production attributable to efficiency improvements or capacity expansions to existing facilities after the date of enactment and before SUMMARY... 6
January 1, 2008. A taxpayer may claim a credit for sales of coal from Native American lands from a facility that produces coal from reserves that, as of June 14, 2005, were owned by a federally recognized tribe of Native Americans, or were held in trust by the United States for a tribe or its members, for the sevenyear period beginning on January 1, 2006 and ending on December 31, 2012. The credit for such sales is $1.50 per ton for the first four (4) years and $2.00 per ton for the last three (3) years. Clean Renewable Energy Bonds The Act creates a new category of tax credit bonds. Any Section 45-eligible facility (other than one selling coal produced from Native American lands) can be funded through Clean Renewable Energy Bonds ( CREBs ). CREBs are defined as bonds issued by a qualified issuer if, in addition to other requirements, 95 percent or more of the proceeds of such bonds are used to finance capital expenditures for Section 45 facilities within the five-year period that begins on the date of issuance. CREBs may be issued between December 31, 2005 and December 31, 2007, up to a national maximum of $800 million. Disposition of Transmission Property Current tax law permits taxpayers to elect to recognize gain from qualifying electric transmission transactions over an eight-year period if the amount realized from the sale is used to purchase exempt utility property. A qualifying transaction is the sale or other disposition of property used by the taxpayer to provide electric transmission services to an independent transmission company prior to January 1, 2007. The Act extends the present deferral provision to sales or other dispositions occurring prior to January 1, 2008. Advanced Nuclear Power Production Tax Credit There currently is no tax credit for electricity produced at nuclear power facilities. The Act establishes a production tax credit of 1.8 cents per kilowatt hour for electricity produced at advanced nuclear facilities placed in service between the date of enactment and 2021. An advanced nuclear facility is any nuclear facility featuring a reactor design approved by the Nuclear Regulatory Commission after 1993. The credit is available for eight (8) years following commercial operation and is subject to an annual limitation and a cap based on the facility s allocated capacity. The national limitation is 6,000 megawatts, which will be allocated by the Secretary of Energy (the Secretary ). Credit for Investment in Clean Coal Facilities Current law does not provide an investment tax credit for electric production facilities that use coal as a fuel or for the gasification of coal. The Act establishes the following investment tax credits for clean coal facilities: (i) a 20 percent credit for facilities producing electricity through integrated gasification combined cycle ( IGCC ) technology, reduced to 15 percent for other advanced coal-based projects, and; (ii) a 20 percent credit for certified gasification projects. The credits apply to periods after the date of enactment. The Secretary may allocate $800 million in credits to facilities generating power via IGCC technology and $500 million in credits to projects using other advanced coal-based technologies. for Transmission Property Assets used in the transmission and distribution of electricity for sale and related land improvements currently are assigned a 20-year recovery period for depreciation purposes by the Internal Revenue Service (the IRS ). The Act shortens the recovery period to 15 years for these assets. Section 1245 property used in the transmission of 69 or more kilovolts of electricity for sale will qualify for the new recovery period, so long as the original use of such assets commences after April 11, 2005. The extended recovery period does not apply to property that is the subject of a binding construction contract on or before April 11, 2005. Expansion of Amortization for Certain Atmospheric Pollution Control Facilities Currently, a taxpayer may elect to recover the cost of any certified pollution control facility over a 60- month period. Subject to certain limitations on its other purposes, a certified facility is a new treatment facility that is certified by appropriate state and federal authorities and which is used, in connection with a plant in operation before January 1, 1976, to abate or control water or atmospheric pollution or contamination via specified methods. 2 NOVEMBER 2005
Under the Act, a certified facility used in connection with a coal-fired electric generation plant that was not in operation before January 1, 1976 will be eligible for 84-month amortization. Nuclear Decommissioning Funds The Deficit Reduction Act of 1984 provides that a taxpayer responsible for nuclear power plant decommissioning may elect to deduct contributions made to a qualified nuclear decommissioning fund (a qualified fund ) for future decommissioning costs. Contributions to a qualified fund are deductible in the year made to the extent that they were collected as part of the cost of service to rate payers. The Act repeals the cost of service requirement for contributions to a qualified fund. Therefore, even unregulated taxpayers may deduct the amounts contributed to a qualified fund. The Act also permits the transfer of pre-1984 decommissioning costs to a qualified fund. Net Operating Loss Carryback The Act allows the taxpayer in any taxable year ending after December 31, 2005 and before January 1, 2009 to claim a net operating loss carryback to each of the five (5) years preceding the taxable year of such loss, up to 20 percent of the cost of electric transmission capital expenditures and pollution control capital expenditures. The carryback applies to losses incurred in 2003, 2004, and 2005. Subtitle B DOMESTIC FOSSIL FUEL SECURITY Extension and Modification of Credit for Coke and Coke Gas Section 29 of the Code provides a tax credit equal to $3 per barrel or Btu oil barrel equivalent (generally adjusted for inflation) for certain fuels produced within the United States from nonconventional sources. Qualified fuels currently include, but are not limited to, oil produced from shale and tar sands and coal seams, and liquid, gaseous, or solid synthetic fuels produced from coal (including lignite). Generally, the Section 29 credit has expired, except for certain biomass gas and synthetic fuels sold before January 1, 2008. The Act makes the credit for producing fuel from a nonconventional source part of the general business credit; thus the credit will be subject to the limitations applicable to that credit, and any unused credits may be carried back one (1) year and forward 20 years. The Act also adds a production credit for qualified facilities that produce coke or coke gas. Qualified facilities must have been placed in service before January 1, 1993, or after June 30, 1998 and before January 1, 2010. The credit may be claimed with respect to coke and coke gas sold during the period beginning on the later of January 1, 2006 or the date such facility is placed in service and ending on the date that is four (4) years after such period began. The credit is capped at a barrel of oil equivalent of 4,000 barrels per day. A facility that has claimed a credit under Section 29(g) of the Code is not eligible to claim the new credit for producing coke or coke gas. Temporary Expensing for Equipment Used in Refining Liquid Fuels Petroleum refining assets are currently depreciated over a 10-year recovery period. The Act provides a temporary election to expense qualified refinery property, which includes assets located in the United States and used in the refining of liquid fuels that are subject to a binding construction contract before January 1, 2008 and placed in service before January 1, 2012. Qualified refinery property must increase the capacity of an existing refinery by at least five (5) percent or increase the throughput of qualified fuels by at least 25 percent. A business may expense 50 percent of its qualifying expenditures with the remainder recovered as under present law. As a condition of eligibility, refineries of liquid fuels must report to the IRS on refinery operations, such as production and output. for Natural Gas Distribution Lines Gas distribution lines must be depreciated over 20 years under current law. The Act shortens the depreciation period to 15 years for any gas distribution lines which are originally placed in service between April 11, 2005 and January 1, 2011. The provision does not apply to any property for which the taxpayer entered into a binding construction contract on or before April 11, 2005. 3 NOVEMBER 2005
Seven-Year Recovery Period for Natural Gas Gathering Lines Revenue Procedure 87-56 includes two asset classes that could potentially describe natural gas gathering lines owned by non-producers of natural gas. The ambiguity regarding the appropriate recovery period for natural gas gathering lines has resulted in litigation between taxpayers and the IRS. The Act clarifies that seven (7) years is the appropriate recovery period for natural gas gathering lines placed in service, in the taxpayer s original use, after April 11, 2005. The provision does not apply to property subject to a binding construction contract on or before that date. The Act exempts natural gas gathering lines from the application of the alternative minimum taxable income rules. Exception to Arbitrage Rules for Prepayments for Natural Gas The general rule is that investment of tax-exempt bond proceeds for profit including use of the proceeds to acquire investment-type property violates arbitrage restrictions, thus requiring a rebate of arbitrage profits to the United States Government. As currently defined, investment-type property includes the acquisition of property in a transaction involving a prepayment where the purpose of the prepayment is to receive an investment return. The Act creates a safe harbor exception to the general rule, providing that prepayments under a qualified natural gas supply contract are not investment-type property. A contract qualifies for the exception if the volume of natural gas secured for any year covered by the prepayment does not exceed the sum of (i) the average annual natural gas purchased by customers of the utility within the service area during a five-year testing period and (ii) the amount of natural gas that is needed to fuel transportation of the natural gas to the governmental utility. Two-Year Recovery Period for Geological and Geophysical Expenses Courts have held that geological and geophysical expenses ( G&G costs ) incurred in connection with oil and gas exploration or development are capital in nature and allocable to the cost of the property acquired or retained. The Act provides that G&G costs incurred in connection with oil and gas exploration in the United States may be amortized over two (2) years. In the case of abandoned property, any remaining basis may no longer be recovered in the year of abandonment, as all basis is recovered over the twoyear amortization period. The provision is effective for costs paid or incurred in taxable years beginning after the date of enactment. Subtitle C CONSERVATION AND ENERGY EFFICIENCY PROVISIONS Energy Efficient Commercial Buildings Deduction The Act provides a deduction for energy efficient commercial building property expenditures. Energy efficient building property is property (i) installed on or in any building that meets certain standards and is located in the United States, (ii) which is installed as part of the interior lighting systems, the heating, cooling, ventilation, and hot water systems, or the building envelope (everything that separates the interior of a building from the outdoor environment), and (iii) which is certified as being installed as part of a plan designed to reduce the total annual energy and power costs of the building by 50 percent or more in comparison to a reference building that meets the minimum requirements for the design of energy efficient buildings (other than low-rise residential buildings) set forth by the American Society of Heating, Refrigerating and Air Conditioning Engineers and the Illuminating Engineering Society of North America. The deduction is limited to $1.80 per square foot of the property for which such expenditures are made and is allowed in the year in which the property is placed in service. The basis of the property is then reduced by the amount of the deduction. If the building does not meet the 50 percent energy savings requirement, a partial deduction is allowed for each separate building system (interior lighting system, heating, cooling, ventilation and hot water systems, and building envelope) that comprises energy efficient property and which is certified as energy efficient. The maximum allowable deduction is $0.60 per square foot for each separate system. The deductions for qualifying property expenditures are effective for property placed in service between January 1, 2006 and December 31, 2007. 4 NOVEMBER 2005
Credit for New Energy Efficient Homes An eligible contractor (i.e., the person who constructed a home or the producer of a manufactured home) can receive a tax credit for the construction of an energy efficient new home. To qualify, the home must be located in the United States, substantially completed after December 31, 2005, purchased between January 1, 2006 and December 31, 2007, and certified to have a projected level of annual heating and cooling energy consumption that meets the standards for either a 30- or 50-percent reduction in energy usage in comparison with a comparable dwelling. For homes that meet the 30 percent standard, one-third of the savings must come from the building envelope (e.g., insulation, windows, and doors) for the home to be eligible for a $1,000 credit. Homes that meet the 50 percent standard must have one-fifth of the savings come from the building envelope and are eligible for a $2,000 credit. The credit is part of the general business credit and cannot be carried back. Credit for Business Installation of Qualified Fuel Cells and Stationary Microturbine Power Plants The Act provides a 30 percent business energy credit for the purchase of qualified fuel cell power plants for businesses and a 10 percent credit for the purchase of qualified stationary microturbine power plants. The credit for any qualified fuel cell property cannot exceed $500 for each 0.5 kilowatts of capacity of such property, and the credit for qualified microturbine plants is limited to the lesser of 10 percent of the basis of the property or $200 for each kilowatt of capacity of such property. The provision also removes the Section 48 restriction that would prevent telecommunication companies from claiming the new credit. The credit is effective from January 1, 2006 to December 31, 2007. Business Solar Investment Tax Credit A 30 percent nonrefundable business energy credit is allowed for the cost of new solar energy property. Solar energy property includes equipment that uses solar energy to generate electricity, to heat or cool a structure, to provide solar process heat, to produce distribute, or use energy derived from a geothermal deposit (subject to certain restrictions), or that uses fiber-optic distributed sunlight to illuminate the inside of a structure. Property used to generate energy to heat a swimming pool is not eligible. The provision is effective from January 1, 2006 to December 31, 2007. Subtitle D ALTERNATIVE MOTOR VEHICLES AND FUELS INCENTIVES Credit for Installation of Alternative Fueling Stations The Act creates a 30 percent credit for the cost of installing clean-fuel vehicle refueling property, which includes property used to store or dispense a cleanburning fuel or to recharge electric vehicles, if the property is located where the vehicle is recharged. Clean fuels are those that are at least 85 percent ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas, and hydrogen and any mixture of diesel fuel and biodiesel containing at least 20 percent biodiesel. The credit may not exceed $30,000 for retail clean-fuel vehicle refueling property and $1,000 for clean-fuel vehicle property located at a taxpayer s principal residence. The taxpayer s basis in the property is reduced by the amount of the credit, and the taxpayer may not claim deductions for the property under Section 179A of the Code. A taxpayer that installs the refueling property on property owned or used by a tax-exempt person may claim the credit. The property must be placed in service between December 31, 2005 and December 31, 2009 (2014 for qualified refueling property relating to hydrogen). Unused credits may be carried forward for 20 years. Modifications to Small Ethanol Producer Credit The Act increases the limit on production capacity for small ethanol producers from 30 million gallons to 60 million gallons per year. Small ethanol producers can pass a 10-cent per gallon tax credit through to cooperative patrons so long as the cooperative provides patrons timely written notice of the apportionment of the credit. Sunset of Deduction for Clean-Fuel Vehicles and Certain Refueling Property The Act amends Section 179A of the Code by moving the termination date of the deduction for clean-fuel vehicles and certain refueling property from 5 NOVEMBER 2005
December 31, 2006 to December 31, 2005. The Section 179A deduction is unavailable for any property placed in service after December 31, 2005. SUMMARY The Act includes $14.5 billion in tax credits and other financial incentives designed to improve transmission reliability and increase investment in domestic energy production from a wide variety of traditional and nontraditional technologies and fuels. It creates additional opportunities for existing businesses as well as incentives for new market entrants. Kirkpatrick & Lockhart Nicholson Graham LLP s energy practice serves U.S. and international clients engaged in energy financing, development, production, distribution, and purchasing. Our practice includes energy project finance, construction matters, environmental and regulatory law, and natural resource development. STEVEN J. ADELKOFF 412.355.6325 212.536.4844 sadelkoff@klng.com ROGER D. STARK 202.778.9435 rstark@klng.com JAMIE L. BURCHIANTI LOPEZ 412.355.6292 jburchiantilopez@klng.com RENÉE T. CAVALOVITCH 412.355.6286 rcavalovitch@klng.com If you have questions or would like more information about K&LNG, please contact one of our lawyers listed below: Harrisburg Daniel P. Delaney 717.231.4516 ddelaney@klng.com R. Timothy Weston 717.231.4504 tweston@klng.com London Richard Herbert 44.20.7360.8104 rherbert@klng.com Pittsburgh Steven J. Adelkoff 412.355.6325 sadelkoff@klng.com 212.536.4844 Daniel J. Sponseller 412.355.8650 dsponseller@klng.com San Francisco Peter W. Sheats 415.249.1030 psheats@klng.com Washington H. Russell Frisby, Jr. 202.778.9415 rfrisby@klng.com Roger D. Stark 202.778.9435 rstark@klng.com www.klng.com BOSTON DALLAS HARRISBURG LONDON LOS ANGELES MIAMI NEWARK NEW YORK PALO ALTO PITTSBURGH SAN FRANCISCO WASHINGTON Kirkpatrick & Lockhart Nicholson Graham LLP (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market companies, capital markets participants, and leading FORTUNE 100 and FTSE 100 global corporations nationally and internationally. K&LNG is a combination of two limited liability partnerships, each named Kirkpatrick & Lockhart Nicholson Graham LLP, one qualified in Delaware, U.S.A. and practicing from offices in Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco and Washington and one incorporated in England practicing from the London office. This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Data Protection Act 1988 - We may contact you from time to time with information on Kirkpatrick & Lockhart Nicholson Graham LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please e-mail cgregory@klng.com if you would prefer not to receive this information. 2005. ALL RIGHTS RESERVED.