Tax Equity Structures in U.S. – DRO’s, Stop Loss, Outside Capital Account …

The structure uses a flip structure where the Tax Equity Investor partner that can use the tax benefits receives much of the negative taxable income. After a target yield is met, the allocation changes and cash flow accrues to the second developer/sponsor investor. The flip can be designed with a fixed time flip or an IRR target (known as a yield) flip. This yield based flip structure can be modelled using a little trick with MAX and MIN where you set-up the tax equity investment in two pieces. The first piece is represented a lot like subordinated debt that does not receive cash interest but instead receives a cash sweep. The second issues involves esoteric issues associated with the tax code. If a partnership is established, then taxes can be allocated in alternative ways to the partners where the amount of the income attributed to the partners must be tabulated along with the dividends that are not related to the tax benefits themselves.

If capital that is computed using the pre-tax income (less depreciation deductions) and the non-tax related dividends falls to zero, a partner is not allowed to continue receiving tax benefits. It is not surprising that the partner that is exposed to limits on tax is the tax equity investor. To compute the potential exposure, two different capital accounts can be be set-up and something called deficit reduction obligations may be used.

 

Power Point Slides that Work Through Modelling and Accounting Issues Associated with Tax Equity Financing