Third Circuit Court of Appeals Strikes Down Tax Credit Transaction, Reverses Tax Court

Keywords: Renewable Energy, Tax credit, rehabilitation tax credits

On August 27, 2012, the US Court of Appeals for the Third Circuit struck down a historic rehabilitation tax credit transaction, handing a victory to the government and dealing a blow to the taxpayer. In reversing the US Tax Court, the Third Circuit held that the private investor in a public private partnership was not a "true" partner because it had "no meaningful stake" in the success or failure in the partnership's enterprise, essentially disallowing the tax credits allocated to the private investor.

The decision, Historic Boardwalk Hall LLC v. Commissioner, No. 11-1832 (3d Cir. 2012), may have far reaching implications for developers, sponsors and investors involved in transactions involving tax credits, including not only historic rehabilitation tax credits, but low income housing tax credits, new markets tax credits and renewable energy tax credits.

Factual Overview

The New Jersey Sports and Exposition Authority (NJSEA), an agency of the state of New Jersey, was tasked with renovating the historic Atlantic City convention center known as Historic Boardwalk Hall or the East Hall (the Project). Upon learning about the market for historic rehabilitation tax credits (HRTCs), NJSEA explored using a partnership to raise additional capital by taking advantage of the HRTCs. It ultimately decided to enter into a partnership with Pitney Bowes Inc. (PB).

NJSEA transferred its interest in the Project to Historic Boardwalk Hall LLC (HBH). PB was admitted to HBH as a 99.9 percent investor, and NJSEA retained a 0.1 percent interest as the manager. PB agreed to make a series of capital contributions to HBH in the aggregate amount of approximately $19.3 million. The capital contributions were contingent upon the Project reaching certain completion milestones, including verification that rehabilitation expenditures that qualified for HRTCs had been incurred. PB's interest entitled it to an allocation of 99.9 percent of the HRTCs to be generated by the Project as well as a distribution of 99.9 percent of residual cash flow. PB's interest also entitled it to a 3 percent preferred return on its investment.

Under the partnership agreement, NJSEA had the option to purchase PB's interest if NJSEA wanted to take actions that were prohibited or that required PB's consent, with the purchase price being an amount equal to the present value of any yet-to-be realized projected tax benefits and cash distributions. PB had the option to sell its interest to NJSEA for that same price if NJSEA committed a material default. In addition, there were...