1. The Greening of the Federal Tax Code Renewable Energy Tax Credits

2. Presented By: Nate Smithson Jackson Walker L.L.P. 901 Main Street Suite 6000 Dallas, Texas 75202 (214) 953-5641 nsmithson@jw.com © December 5, 2011 nsmithson@jw.com

3. This presentation represents only a summary of the applicable provisions with respect to renewable energy tax credits and related matters set forth in the Internal Revenue Code of 1986, as amended from time to time (the “Code”), revenue rulings and administrative interpretations (all as currently in effect and all of which are subject to change, possibly with retroactive effect). This presentation does not constitute tax, legal or other advice from Nathan Smithson or Jackson Walker L.L.P., and neither assumes any responsibility with respect to assessing or advising the reader as to tax, legal or other consequences arising from the reader’s use of the information. This presentation is not intended or written to be used, and may not be relied upon, by any person for the purpose of avoiding penalties that may be imposed under any federal tax law or otherwise.

4. The Push for Renewables Federal Government: –The Carrot: Tax Credits for investment and production –The Stick: EPA limits on pollutants Local Governments: –Renewable Energy Standards across all states that provide fungible, valuable energy credits.

5. Personal Choices More people looking to reduce their carbon footprint (i.e., global warming fears) Reduce dependency on foreign resources.

6. Wind Farm Scenario

7. Why a Wind Farm? Many opportunities in west Texas and the panhandle. Can build and co-exist on land currently used for ranches, among other things –Benefit for the land owner Relatively quick to set up – purchase to generation within a few months

8. Wind Farm Facts Over 35,000 electricity producing wind turbines in the world 800 wind farms within the US for a total of 43,000 Megawatts of capacity (3.25% of US total energy capacity) Texas has the most wind farms of any state, with a total capacity of over 10,000 Megawatts -- Enough to power: –100,000 100w light bulbs

9. Current Drawbacks to Wind Power Efficiency: Wind has to be blowing over 20mph to cause a 2 MW wind turbine to generate 2MW of electricity –Efficiency of 30% is pretty good Timing: Wind is at its highest at night, and due to lack of storage for the wind, its peak comes when most homes do not need it.

10. Drawbacks cont’d Transmission: As wind farms are generally located in more remote areas, the ability to get the electricity to the hubs in hampered: –Dearth of transmission capacity currently; –Loss of strength in transmission.

11. Turbine Facts A 2MW turbine costs approximately $3.5 million, delivered and installed 3 main components: –Tower: 80-100 meters –Nacelle: 8-10 tons –Blades: 35-55 meters

12. Our Wind Farm The “Dallas Bar Wind Farm”

13. Dallas Bar Wind Farm 10 2MW Wind Turbines located on a farm in west Texas. Total cost: $35 million Estimated start of construction: December 15, 2011

14. Dallas Bar Wind Farm 20 MW of total capacity At 45% efficiency: 78,750 MWh per year –Serving 7000 “average” households At 30% efficiency: 52,500 MWh per year –Serving 4700 “average” households At 15% efficiency: 26,250 MWh per year –Serving 2350 “average” households

15. Federal Tax Opportunities Production Tax Credit Investment Tax Credit Section 1603 Cash Grant Accelerated Depreciation

16. Production Tax Credit PTC = 2.17¢ * kWh produced from Qualified Energy Resources at a Qualified Facility

17. Production Tax Credit Available over the 10 year period starting on the date the Qualified Facility was originally placed in service. Electricity must be sold to an unrelated person. Electricity must be produced in the US or a US possession.

18. “Sold to an Unrelated Person” Where electricity is ultimately sold to an unrelated person, an intermediate sale of the electricity to a related person for resale will still qualify for the Production Tax Credit. –OK to sell to a partner in a partnership that ultimately resells this on the market

19. Qualified Energy Resources Wind, solar energy, geothermal energy, hydropower production, etc... –See Appendix A to the outline for a description of the type of facilities associated with these resources.

20. Qualified Facility Facilities producing electricity from qualified energy resources –more specifically set forth in Code section 45(d) (and Exhibit A) A wind facility placed in service after December 31, 1993 and before January 1, 2013 constitutes a qualified facility –Placed in service = placed in a condition or state of readiness and available to produce electricity –Note – extended through 2012 by the American Recovery and Reinvestment Act of 2009 (the “ARRA”)

21. DBA Wind Farm 30% Efficiency = 52,500 MWh Results in a credit of: –$1.14 million annually, or –$11.4 million over the 10 year PTC period. Approximately 33% of the total cost is returned Estimated Present Value: $8.8 million –25% return on investment

22. DBA Wind Farm 45% Efficiency = 78,750 MWh –“Rock Star” –$1.7 million annual credit –Estimated Present Value: $13.2 million 15% Efficiency = 26,250 MWh –“Basement Band” –$570,400 annual credit –Estimated Present Value: $4.4 million

23. Investment Tax Credit ITC = Energy Percentage * Basis of Energy Property Placed in Service ITC = Energy Percentage * Basis of Energy Property Placed in Service

24. Energy Percentage Either: –30% for certain enumerated property; or –10% for all other property

25. 30% Property Initially, this was certain limited scope property that was generally not included within the ambit of Code section 45. ARRA added the provision: “Qualified Property” that is part of a “Qualified Investment Credit Facility”

26. Qualified Property that is part of a Qualified Investment Credit Facility Qualified Property: Depreciable or amortizable personal property, or other tangible property if used as part of a Qualified Investment Credit Facility. Qualified Investment Credit Facility: –A wind facility placed in service by December 31, 2012. –Any other qualified facility described in Code sections 45(d)(2) – (4), (6), (7), (9) OR (11) that is placed in service between January 1, 2009 and December 31, 2013.

27. Energy Property Certain energy property described in Code section 48(a)(3); provided that such property: –Was either constructed and completed by the taxpayer requesting the credit, or acquired by such taxpayer, if the original use of such property commences with such taxpayer; –Is subject to deprecation or amortization; and –Meets certain performance and quality standards set forth by the Department of the Treasury; and Qualified Property that is part of a Qualified Investment Credit Facility.

28. Basis Only the cost of the property and installation. Basis does not include the cost of any property to which it is attached (e.g., cost of the solar panel placed on a building, but not the cost of the building itself). Basis of the Energy Property will be reduced by 50% of the Investment Tax Credit allowed.

29. Recapture Applies to the ITC, but not the PTC The ITC will be recaptured if the Energy Property is sold or ceases to be eligible for the credit 100% of the credit is due if the disqualifying event happens within 1 year of placed in service. –Reduced by 20% per each year thereafter. –Thus, after the 5th year placed in service, the Recapture Percentage is 0%.

30. ITC for the DBA Wind Farm 30% * cost basis of $35 million = $10.5 million

31. Section 1603 Cash Grant Grant = Applicable Percentage * Eligible Basis of Specified Energy Property Placed in Service

32. Cash Grant Highlights Direct payment of cash to the taxpayer once property is placed in service (within 60 days) Not includable within the gross income of the taxpayer

33. Cash Grant Facts 22,747 projects funded to date $9.6 billion in grants made –At up to 30% of the eligible basis, this reflects $32.9 billion in total federal and private investments –$1.6 billion in funding in Texas alone for 288 projects 14.3 GW of installed capacity resulting from grant funded projects 36.8 TWh of estimated electricity generation –3.3 million “average” homes

34. Applicable Percentage Either 30% or 10%, as set forth in Program Guidance from the Department of the Treasury, revised as of April, 2011. Generally mirrors the ITC Energy Percentage

35. Specified Energy Property Certain Qualified Facility Property eligible for the Production Tax Credit; and Certain Energy Property eligible for the Investment Tax Credit –Both are further set forth in Program Guidance from the Department of the Treasury, revised as of April, 2011.

36. Eligible Basis The cost of the Specified Energy Property –Includes installation and shipping costs. –Also includes roads and parking areas to be used for the transportation of material for processing or equipment for maintenance and operation of the facility –Does not include roadways and parking that are provided for employees and visitors.

37. Non-Eligible Basis Costs that will be deducted in the year in which they are paid or incurred: –Code section 179 deduction. –Election to expense intangible drilling and development costs.

38. Basis As with the ITC, the basis of Specified Property will be reduced by 50% of the amount of the Cash Grant.

39. Eligibility Must: –Own and continue to own the eligible property; and –Originally place it in service A lessee of property can apply too, provided that: –A valid lease is included in application; –The owner/lessor waives its right to the payment; –Both lessor and lessee are otherwise eligible to receive the credit; and –Lessee agrees to include ratably in gross income over the five years an amount equal to 50% of the grant amount.

40. Eligibility Cannot be an exempt entity, a governmental entity, an energy co-op or a partnership with a such an entity as an owner, unless owned through a blocker. OK to have a foreign owner provided that 50% of the gross income of such foreign owner with respect to the project is subject to taxation at the federal level.

41. Eligibility Original use of the property must start with the applicant. –Less than 20% of the total cost of the facility can be made up of used parts. –OK to use a sale-leaseback if within 3 months of original placing in service.

42. Eligibility Property must be used predominantly in the US. Project must have started by 12/31/11

43. When to Apply Application Deadline: October 1, 2012 –If not placed in service by the application deadline, then additional information must be submitted within 90 days after being placed in service –Credit terminates if not placed in service by the credit termination date – January 1, 2013 for wind.

44. Documentation Requirements Must show that: –1) the property is eligible; –2) it has been placed in service; and –3) the amount is accurate.

45. Documentation Eligibility of the property – design plans stamped by a licensed professional engineer

46. Documentation Placed in Service: –Commissioning report from an engineer, vendor or qualified 3rd party that equipment works for its intended purpose; and –an interconnection agreement for facilities interconnected with a utility.

47. Documentation Accuracy – Detailed breakdown of all costs, and an independent accountant’s certification if basis is over $500,000

48. Documentation If the property will be placed in service after December 31, 2011, must demonstrate that “physical work of a significant nature” has begun on or before December 31, 2011 –This is the beginning of construction

49. Physical Work of a Significant Nature Includes work both at the site as well as the prep work with respect to the facility. Does not include preliminary activities such as planning or designing, clearing a site, acquiring financing, changing the contour of land.

50. Physical Work of a Significant Nature – Wind Turbine Examples for a wind turbine: –On-site: excavation of foundation, setting anchor bolts or pouring concrete pads. –Off-site: the beginning of the manufacturing of the component parts of the turbine – **The component being manufactured must be associated with the applicable facility being constructed.

51. Physical Work of a Significant Nature – Work Under Contract Contracted work qualifies if: –Entered into prior to the start of such work; –The contract is binding and enforceable under state law against the applicant; and –Does not limit damages to a specified amount.

52. Physical Work of a Significant Nature – Safe Harbor Safe Harbor: Physical work of a significant nature has begun when 5% of the total cost of the property has been paid or incurred. –When constructed by the applicant – when paid or incurred by the applicant. –When constructed for the applicant under a contract – the contractor must itself incur such costs to be effective. The above costs can be combined. This requires substantiation.

53. Physical Work of a Significant Nature – Multiple Units An applicant can elect to treat multiple independent units as a single unit for purposes of determining the beginning of construction (e.g., an applicant building a wind farm can treat all turbines as a single unit).

54. Physical Work of a Significant Nature – Continuity Work must be continuous – cannot start work in 2011 to meet the “beginning of work” requirement followed by a long hiatus. –OK to stop because of conditions relating to the time of year. –Not OK to stop because of lack of funds/supply.

55. Recapture The Cash Grant will be recaptured if the Energy Property ceases to be eligible for the grant. –This differs from the ITC in that a sale of the property will not necessarily cause a recapture event. Similar to the ITC, 100% of the grant amount is due if the disqualifying event happens within 1 year of placed in service, reduced by 20% per each year thereafter.

56. DBA Wind Farm Cash Grant 30% * cost basis of $35 million = $10.5 million

57. Adjustments to Basis

58. Basis PTC – No adjustment Required ITC – Basis is reduced by 50% of the ITC amount Cash Grant – Basis is reduced by 50% of the Cash Grant Recapture – Basis will be increased by 50% of the recapture amount.

59. Bonus Depreciation

60. Code section 168(k) – deduction of 50% of the adjusted basis of property in the first year qualified property is placed in service after December 31, 2007 and before January 1, 2013. *** 100% if placed in service before January 1, 2012*** –relates to the original use of property Qualified property includes property that has a recovery period of 20 years or less. –Both solar and wind energy property are treated as “5 year property” for purposes of Code section 168.

61. Bonus Depreciation The lessor of property may also use bonus depreciation if: –If all of the 168(k) requirements are otherwise met; and –The property is sold and leased back within a 3 month period of being placed in service.

62. DBA Wind Farm Bonus Depreciation (assume placed in service in 2012) If using the PTC: $35 million depreciable basis * 50% = $17.5 million depreciable currently If using the ITC or Cash Grant: $29.75 million depreciable basis (reduced by $5.25 million required adjustment) * 50% = $15 million depreciable currently

63. Summary of Federal Benefits for DBA Wind Farm

64. DBA Wind Farm Summary If efficiency is 30% and the PTC is used: –Annual Credit of $1.14 million for 10 years (Present Value: $8.8 million) –2011 Accelerated Depreciation: $17.5 million * 35% = $6,125,000 –2011 benefit = $7.2 million If efficiency is 45%, 2011 benefit = $7.8 million If efficiency is 15%, 2011 benefit = $6.7 million

65. DBA Wind Farm Summary If the ITC or Cash Grant is used: –Credit/Grant of $10.5 million –2011 Accelerated Depreciation: $15 million * 35% = $5,250,000 –2011 benefit = $15.75 million

66. Financing Opportunities

67. Solo Financing The Cash Grant program provides direct funding to a developer –Reduces the ultimate amount of financing necessary to develop a project.

68. DBA Wind Farm Solo Financing Our initial outlay of $35 million is really a $24.5 million outlay following the receipt of cash. –The $5.25 million accelerated depreciation deduction doesn’t do much good: we don’t yet have the income to be offset by the deduction.

69. Flip Partnership

70. By bringing in investor partners, the developer of a project has the opportunity to pass through to the investors certain of the currently recognizable benefits.

71. Flip Partnership General Structure: –Investor puts in money; –Developer puts in know-how and some capital; –Allocations: 99-1 between investor and developer so that investor receives the credits, along with income items; –Distributions: First to developer until it receives its return; Then to investor until it receives the negotiated return – taking in to consideration the allocation of credits; Then flip to developer – possibly with purchase right

72. Flip Partnership – Safe Harbor Treasury has established, under Notice 2007-65, a safe harbor for “wind farm” partnerships, so that if the terms of the safe harbor are met, the IRS will respect the allocation of Production Tax Credits.

73. Safe Harbor Requirements 1) Partnership must own the applicable wind property; 2) Developer must have at least 1% interest in partnership income, gain, loss, deduction, and credit at all times; 3) Each investor must have minimum interest in each material item of income and gain equal to 5% of such investor’s percentage interest in partnership income.

74. Safe Harbor Requirements 4) Each investor must maintain a minimum investment in the partnership of 20% of its capital requirements. –Can be reduced by cash flow distributions. –Such amount must not be protected against loss. 5) Any purchase right with respect to the partnership property must: –Be either: The fair market value of the property determined at the time of exercise; or If the purchase price is determined prior to exercise, the estimated fair market value of the property at the time the right may be exercised. –Not be exercisable by the developer earlier than 5 years after the facility is first placed in service.

75. Safe Harbor Requirements No investor may have a “put” right with respect to its partnership interest, and the partnership may not have a “put” right with respect to the partnership property. Each partner must fully bear the risk of the investment in the property (no guarantees)

76. Sale-Leaseback

77. Sale-Leaseback Typical Steps: –Developer builds and places the applicable property in service; –Developer sells the property to an investor; –Investor leases the property back to developer in a “true lease;” –Investor avails itself of a Credit or the Cash Grant and the accelerated depreciation.

78. Timing Investor must acquire the applicable property within 3 months of it being placed in service in order to receive the Credit or Cash Grant.

79. “True Lease” Treasury guidance: Revenue Procedure 2001-28 1) The lessor must have made a minimum unconditional “at risk” investment in the property at the outset and such minimum investment must remain throughout the entire lease term until the end. –Minimum investment -- at least 20% of the cost of the property –Must be unconditional (i.e., lessor must not be entitled to a return of any portion of the minimum investment from lessee).

80. True Lease 2) The lease term (including all renewals or extensions) must be at fair rental value (determined at the time of such renewal or extension). 3) Lessee cannot have a contractual right to purchase the property at a price less than its fair market value, determined at the time the right is exercised.

81. True Lease 4) Lessor may not have a “put” right with respect to the property (when placed in service). 5) Lessee cannot make nonseverable improvements. 6) Lessee may not loan money to lessor with respect to the property, or guarantee any loans with respect thereto.

82. True Lease 7) Lessor expects to make a profit on the ownership and lease of the property, which profit shall not take in to consideration any tax benefits. 8) The lease period must be less than the entire useful life of the property.

83. Flip Partnerships v. Sale- Leasebacks Sale-leaseback does not work for PTCs as they can only be claimed by an owner and operator of the facility; Lessor can receive 100% of the tax benefits, whereas in a partnership, the developer would be required to have at least a 1% interest therein; Sale-leasebacks with ITC and accelerated depreciation generate upfront tax benefits to an equity investor and do not directly depend on productivity of the facility or demand for the energy.

84. Flip Partnership v. Sale Leaseback Easier for the developer to benefit in a flip partnerships following the full realization of the credits (can end up with a 95% interest post-flip); Fair market value of the property upon a developer buyout must be determined at the time of exercise in a sale-leasebacks, instead of pre-determined based on estimates in a flip partnership; Investor need not participate in the operations of the project in a sale-leasebacks. Investor doesn’t need a profit motive in a flip-partnership.

85. Inverted Lease

86. Developer leases the applicable property to an investor, who sells the electricity generated therefrom. Developer may pass through the Investment Tax Credit or the Cash Grant, subject to a valid election, provided: –the investor is eligible to receive such benefit; and –in the case of the Cash Grant, the investor agrees to return 50% of the amount of the grant over the recapture period.

87. Inverted Lease Developer would receive rent and be able to take depreciation deductions. At the end of the lease term the developer owns the property.

88. Texas Specific Impact

89. Texas’ grid: –Isolated – ERCOT relies almost entirely on internal resources to serve its load and reserves. –A report from the North American Electric Reliability Corporation suggests that Texas may not have the electrical reserves to meet peak demand by 2013. New environmental regulations will result in the mothballing of generating units, and added to the current drought, the power supply in the next year may soon fall short of ERCOT’s minimum target.

90. Texas Specific Impact Texas Renewable Portfolio Standard - enacted in 1999 –The program required electricity providers collectively generate 2,000 megawatts (MW) of additional renewable energy by 2009 (met in 6 years). –The 2005 Texas Legislature increased the state's total renewable-energy mandate to 5,880 MW by 2015 (500 of which must not be from wind) (also surpassed) and a target of 10,000 MW in 2025.

91. Renewable Portfolio Standard Each provider is required to obtain new renewable energy capacity based on their market share of energy sales times the renewable capacity goal. Example: a retailer with 10 percent of the Texas retail electricity sales in 2011 would be required to obtain 200 megawatts of renewable energy capacity

92. Renewable Energy Credits One REC represents one megawatt-hour of qualified renewable energy that is generated and metered in Texas. –No requirement to actually take delivery – highlights the transmission problem out in west Texas The REC trading system created great flexibility in the development of renewable energy projects.

93. Competitive Renewable Energy Zones Public Utility Commission has been assigned almost $5 billion of CREZ transmission projects to be constructed by 7 transmission and distribution utilities (such as Oncor) Intended to transmit almost 18,500 MW of wind power from west Texas and the panhandle to the highly populated areas Currently working, but much is not expected to be completed until 2013

94. Nate Smithson nsmithson@jw.com (214) 953-5641 nsmithson@jw.com