The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

Overview

I continue today with my perusal of the biggest developments in agricultural law and taxation from 2020 with the second installment of the “almost top 10” of 2020.  In part one, I covered deprioritization (or the lack thereof) of withheld taxes in a Chapter 12 bankruptcy; the preferential payment rule in bankruptcy involving the Dean Foods matter; the significant ag nuisance jury verdict in North Carolina involving Murphy Brown; and a recent federal court opinion holding that filing a tax return with false information on

Part two of the “almost top ten of 2020” (in no particular order) – that’s the topic of today’s post.

“Renewable” Energy Cash Grants

Section 1603 of the American Recovery and Reinvestment Tax Act (ARRTA) was a green energy subsidy program created by the Congress and signed into law as a part of the 2009 economic “stimulus” package.  The program created a system of cash grants in lieu of investment tax credits for entities that installed various types of alternative energy property such as solar, wind, geothermal, biomass, and hydropower.  The purpose of payments (which were made after a qualified energy system was installed) was to reimburse grant recipients for a portion of the cost they incurred to install the energy systems at business locations.  The program started in 2009 and ended in 2012.

The program is not without criticism and IRS scrutiny.  The IRS rigorously audits companies utilizing the grants and, in some instances, the courts have ruled for the companies when the IRS partially denied the grants.  Those cases primarily involved indemnity agreements that allowed the financiers of the projects to recover their funds elsewhere if the grant was improperly disallowed.  In such “tax equity” deals it is common for the developer that finances a project to indemnify the tax equity investors if the tax benefits are less than expected. See, e.g., Alta Wind I Owner Lessor C v. United States, No. 13-402, 2020 U.S. Claims LEXIS 2071 (Fed. Cl. Oct. 21, 2020).  In Alta, the wind energy company plaintiff claimed that the government underpaid on the Sec. 1603 grant.  The court ruled that the company had alleged sufficient facts and injury to satisfy the constitutional standing requirement for the court to hear the case because the company had purchased the energy facilities at issue via a negotiated business transaction and alleged it had not been paid in full under Sec. 1603.

The IRS also won a significant case in 2020.  In early 2012, the plaintiff placed a qualified wind facility into service at a cost of $433,077,031. The plaintiff applied for a Section 1603 grant (in lieu of tax credits) of $129,923,109. As part of the grant application, the plaintiff submitted a development agreement that claimed to show a “proof of payment” in support of a $60 million development fee. The plaintiff, a “project company,” paid the development fee to its parent company, Invenergy, LLC. The U.S. Treasury awarded the plaintiff a grant of $117,216,098. The Treasury explained that the reason for the $12.7 million shortfall was based on the plaintiff’s excessive cost basis in the facility based on the inclusion of the development fee in the cost basis calculation. The Treasury asserted that the development fee transaction was a sham lacking economic substance shaped solely by tax avoidance motives.

The court agreed. Bank records showed that money passed through the bank accounts of several entities related to the plaintiff by wire transfer and then back into the original account. The court determined that the plaintiff could not establish any business purpose or economic substance to the banking transactions. A CPA from a national firm, as the result of an audit, testified that the development agreement contained no quantifiable services. Invenergy, LLC, was not able to produce any accounting journal entries showing a business purpose for the banking transactions. Thus, the court determined that the evidence showed a development fee with no quantifiable services, circular wire transfers that started and ended in the same bank account on the same day, none of which were corroborated by independent testimony. The court denied the plaintiff reimbursement of the $12,707,011 cash grant, and the U.S. Treasury was entitled to recover an overpayment of $4,380,039. Bishop Hill Energy, LLC, et al. v. United States, 143 Fed. Cl. 540 (2019). The court also reached the same conclusion in California Ridge Wind Energy, LLC v. United States, 143 Fed. Cl. 757 (2019).

The appellate court affirmed, upholding the trial court’s finding that amounts stated by the plaintiff in development agreements pertaining to the wind farms did not reliably indicate the development costs. The appellate court, on a consolidated appeal of the two cases, noted the “round-trip” nature of the payments; the absence in the agreements of any meaningful description of the development services to be provided, and the fact that all, or nearly all, of the development services had been completed by the time the agreements were executed. The appellate court also determined that the services were not quantifiable. As a result, the government could recover $10 million in cash grants from the two companies. California Ridge Wind Energy, LLC v. United States, 959 F.3d 145 (Fed. Cir. 2020).

The case is significant because it could impact the computation of tax credits for future projects. 

Trust Income Tax Regulations

On May 7, 2020, the IRS issued proposed regulations providing guidance on the deductibility of expenses that estates and non-grantor trusts incur.  REG-113295-18. The reason for the proposed regulations is that the Tax Cuts and Jobs Act (TCJA), effective for tax years beginning after 2017 and before 2026, bars individual taxpayers from claiming miscellaneous itemized deductions.  I.R.C. §67(g).  This TCJA suspension of miscellaneous itemized deductions for individuals raised questions as to whether and/or how estates and non-grantor trusts are impacted.  In late September, the IRS finalized the regulations.  TD 9918 (Sept. 21, 2020).

The Final Regulations affirm that deductions for costs which are paid or incurred in connection with the administration of an estate or trust and which would not have been incurred if the property were not held in such trust or estate remain deductible in computing AGI.  In other words, I.R.C. §67(e) overrides I.R.C. §67(g).  However, the Final Regulations do not provide any guidance on whether these deductions (including those under I.R.C. §§642(b), 651 and 661) are deductible in computing alternative minimum tax for an estate or trust.  That point was deemed to be outside the scope of the Final Regulations. 

As for excess deductions, the Final Regulations confirm the position of the Proposed Regulations that excess deductions retain their nature in the hands of the beneficiary.  Treas. Reg. §1.642(h)-2(a)(2).   Excess deductions passing from a trust or an estate have their nature pegged by Treas. Reg. §1.652(b)-3. The nature of excess deductions of a trust or an estate is determined by a three-step process:  1) direct expenses are allocated first (e.g., real estate taxes offset real estate rental income); 2) the trustee can exercise discretion when allocating remaining deductions – in essence, offsetting less favored deductions for individuals by using them against remaining trust/estate income (also, if direct expenses exceed the associated income, the excess can be offset at this step); 3) once all of the trust/estate income has been offset any remaining deductions constitute excess deductions when the trust/estate is terminated that are allocated to the beneficiaries in accordance with Treas. Reg. §1.642(h)-4.  Treas. Reg. 1.642(h)-2(b)(2).   

Lying With Purpose of Harming Livestock Facility is Protected Speech

Animal Legal Defense Fund v. Schmidt, 434 F. Supp. 3d 974 (D. Kan. 2020)

Beginning with Kansas in 1990, several states have enacted legislation designed to protect confined animal production facilities from sabotage activity from groups and individuals opposed to animal agriculture.  The laws generally forbid undercover filming or photography of activity on farms without the owner's consent.  They have been challenged as unconstitutional on numerous occasions. 

In this federal case involving Kansas law, the plaintiffs are a consortium of activist groups regularly conduct undercover investigations of livestock production facilities. Some of the plaintiffs gain access to farms through employment without disclosing the real purpose for which they seek employment (and lie about their ill motives if asked) and wear body cameras while working. For those hired into managerial and/or supervisory positions, they gain the ability to close off parts of the facility to avoid detection when filming and videoing. The film and photos obtained are circulated through the media and with the intent of encouraging public officials, including law enforcement, to take action against the facilities. The employee making the clandestine video or taking pictures, is on notice that the facility owner forbids such conduct via posted notices at the facility. The other plaintiffs utilize the data collected to cast the facilities in a negative public light but do no “investigation.”

In 1990, Kansas enacted the Kansas Farm Animal and Field Crop and Research Facilities Protect Act (Act). K.S.A. §§ 47-1825 et seq.  The Act makes it a crime to commit certain acts without the facility owner’s consent where the plaintiff commits the act with the intent to damage an animal facility. Included among the prohibited acts are damaging or destroying an animal facility or an animal or other property at an animal facility; exercising control over an animal facility, an animal from an animal facility or animal facility property with the intent to deprive the owner of it; entering an animal facility that is not open to the public to take photographs or recordings; and remaining at an animal facility against the owner's wishes. K.S.A. § 47-1827(a)-(d). In addition, K.S.A. § 47-1828 provides a private right of action for "[a]ny person who has been damaged by reason of a violation of K.S.A. § 47-1827 against the person who caused the damage." For purposes of the Act, a facility owner’s consent is not effective if it is induced by force, fraud, deception duress or threat. K.S.A. § 47-1826(e). The plaintiff challenged the constitutionality of the Act, and filed a motion for summary judgment. The defendant also motioned for summary judgment on the basis that the plaintiffs lacked standing or, in the alternative, the Act barred trespass rather than speech.

On the standing issue, the trial court held that the plaintiffs lacked standing to challenge the portions of the Act governing physical damage to an animal facility (for lack of expressed intent to cause harm) and the private right of action provision, However, the trial court determined that the plaintiffs did have standing to challenge the exercise of control provision, entering a facility to take photographs, etc., and remaining at a facility against the owner’s wishes to take pictures, etc. The plaintiffs that did no investigations but received the information from the investigations also were deemed to have standing on the same grounds. On the merits, the trial court determined that the Act regulates speech by limiting what the plaintiffs could say and by barring pictures/videos. The trial court determined that the provisions of the Act at issue were content-based and restricted speech based on viewpoint – barring only that speech that would harm an animal facility. The trial court determined that barring lying is only constitutionally protected when it is associated with a legally recognizable harm, and the Act is unconstitutional to the extent it bars false speech intended to damage livestock facilities. Because the provisions of the Act at issue restrict content-based speech, its constitutionality is measured under a strict scrutiny standard. As such, a compelling state interest in protecting legally recognizable rights must exist. The trial court concluded that even if privacy and property rights involved a compelling state interest, the Act must be narrowly tailored to protect those rights. By focusing only on those intending to harm owners of a livestock facility, the Act did not bar all violations of property and privacy rights. The trial court also determined that the Governor was a proper defendant. 

In a later action, the court entered a permanent injunction against enforcement of Kan. Stat. Ann. §§47-1827(b)-(d).  Animal Legal Defense Fund v. Kelly, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 58909 (D. Kan. Apr. 3, 2020).  A notice of appeal of the court’s decision was filed on May 1, 2020.  In July, the court trimmed-down the plaintiff’s request of attorney fees and costs from almost $250,000 to slightly over $176,000.  Animal Legal Defense Fund v. Kelly, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 124,480 (D. Kan. Jul. 15, 2020). 

Conclusion

In the next post, I will continue the look at the “almost Top 10” of 2020 with Part 3.