FINANCIAL MANAGEMENT/Absolute power
To spur increased use of alternative power sources, Congress included provisions in the Energy Policy Act of 2005 that allow government utilities to issue tax credit bonds to finance renewable energy projects. Known as clean renewable energy bonds (CREBs), they provide a very low cost financing tool for local governments to build power generation facilities.
As a new form of municipal bonds, CREBs are an incentive to governments and rural electric cooperatives to finance alternative energy projects that produce electricity using wind, biomass, geothermal, solar, landfill gas, trash combustion, hydropower or small irrigation power sources. Typically, municipalities issue bonds that bear interest at a tax-exempt rate that depends on the term of the bonds, the issuer’s credit standing and the structure of the financing.
CREBs, on the other hand, are taxable bonds, and bondholders receive a credit against their regular income tax liability, so they forgo the interest. The U.S. Treasury Department will establish the amount of the tax credit with the goal of achieving a zero interest rate and a purchase price of the bonds at par. Therefore, a municipal issuer can borrow money for a qualifying project with an interest-free loan, which is big savings on multi-year financing.
The concept of using tax credit bonds for special projects came from a similar tax incentive program known as qualified zone academy bonds (QZABs), which have helped finance public school projects. The total amount of CREBs that may be issued ($800 million overall and $500 million for governmental issuers) has been limited by Congress initially. To receive an allocation, a CREBs issuer must have filed an application with the IRS before April 26, 2006, with smaller projects receiving priority in case of over subscription. Though the program is set to expire on Dec. 1, 2008, CREBs are popular with local officials, and Congress is being asked to renew the authorization to allow issuance of further amounts in future years.
Before paying for any expenditures on a particular project, IRS rules require that a local government adopt a resolution expressing the intention to issue CREBs for the projects. The IRS also requires that an engineer help determine if a project fits within one of the qualifying categories and uses a viable technology.
Following the adoption of CREBs legislation, the IRS issued two explanatory notices in December 2005 and February 2006 stating its intention to release regulations that would answer technical questions about the new program. Fortunately, the IRS has said that it will broaden the scope of facilities that qualify for CREBs financing, allowing for additional components that are considered “functionally related and subordinate” to the actual generation project. For example, internal roads leading to towers or tool sheds for turbine maintenance also might be included as an integral part of a wind farm project.
The IRS also has promised to clarify the types of governmental entities that may issue CREBs, outline remedial actions to take if a project changes and establish the method of calculating the credit, the bond term and the yield restrictions that will apply to the program. Exploring fossil fuel alternatives has generated enthusiasm among public utilities about CREBs’ interest-rate break for financing renewable energy projects.
The author is a public finance attorney for the Chicago-based law firm of Chapman and Cutler.