Tax Law and Business Organization Strategy

Wind Energy Part 7 -- Tax Partnerships in Wind Energy Development

Could the use of an arrangement that is taxed as a partnership result in better tax outcome for landowners and/or the wind developers?

Frankly this occurred to me as I was comparing a wind development to a sharing arrangement in the mineral production arena. Sharing arrangements have always struck me as sort of a “frontier” partnership arrangement. And, now, at least in joint operations among “economic interest” holders, they appear to be considered partnerships for tax purposes, to which Subchapter F applies if they do not elect out. I do not think that the typical arrangement between a wind developer and a landowner would be considered a partnership for federal income tax purposes. But might some of the preceding uncertainties be cured by the use of a partnership?

Joint operations of mineral properties are considered partnerships for tax purposes because of the joint operations they undertake – and, perhaps more importantly, because of the joint ownership interests involved. While I, personally, have basically concluded that the owner of the wind rights does have an “economic interest” in those wind rights, I do not think that there is a joint ownership of those rights. Stated another way, the developer makes his income from selling electricity produced by the combination of wind turbines (owned by the developer) and wind (purchased by the developer from the surface owner). The surface owner makes his income from allowing the developer to use his wind. In the case of joint operators in mineral production, they are all considered to own part of the mineral being produced and their joint income comes from the sale of that jointly owned mineral.

Nonetheless, it is possible that they could be considered to be a partnership for tax purposes, particularly where the lease is for a long term. After all, the use of property for 50 years does start to look like an equity contribution to a joint enterprise rather than allowing the use of property as a lessor.

But even if the arrangement is not already considered a partnership for tax purpose, should the landowner and developer consider an arrangement treated as a partnership for tax purposes instead of a landlord/tenant arrangement? I don’t intend to go into the detail necessary to adquately discuss the pros and cons of (or the arrangement necessary for) the creation of a tax partnership. Partnership taxation has many consequences and might require many local law consequences that are unacceptable to the parties. So, I simply raise the question for now.

One should also consider, apart from the possible forced or voluntary partnership of the parties to the entire wind development, whether a partnership produces certainty out of uncertainty when attempts are made to carve-out differing rights to the lessor’s income in a wind energy development. For example, instead of trying to carve out a "royalty" in wind rights, might it be better to form a partnership, create a class of interests with "royalty-like" rights, and convey those interests? Partnership tax law certainly provides more certainty in the face of the questions of what bundles of rights actually create property for tax purposes. Is there a benefit of sounder footing for tax purposes if one were to convey all surface rights, including “ventian” rights, to a partnership that allocates income in whatever fashion is desired (within the strictures of “substantial economic effect”), and then to convey partnership interests in the partnership to reach the desired economic division of those rights, rather than attempting to “carve out” those income rights from the real estate?

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