Accounting for Treasury Grants & Grant-eligible Investment Tax Credits

Tom Keefe
Deloitte & Touche LLP

Mike Reno
Deloitte Tax LLP 9/20/11

Agenda
Overview of Treasury Grants Relevant Accounting Guidance Common Accounting Issues
Timing of Recognition Financial Statement Presentation Accounting for Uncertainties

Accounting Examples Non-consolidated Accounting

Overview of Treasury Grants

Treasury Grant Basics

Available in lieu of Production Tax Credit (PTC) or Investment Tax Credit (ITC), under Section 1603 of the American Recovery and Reinvestment Act of 2009
PTC: Available for qualified resources under IRC Section 45, based on levels of production ITC: Available for qualified facilities under IRC Section 48, based on investment cost

Qualifying Resources and Facilities

Qualified Resources/ Facilities Solar Fuel cell Stationary microturbine Geothermal heat pump Small wind Combined heat/power Geothermal Credit Amount for 2010 30% 30% 10% 10% 30% 10% 10% Placed-in-Service Date Before 1/1/2017 Before 1/1/2017 Before 1/1/2017 Before 1/1/2017 Before 1/1/2017 Before 1/1/2017 N/A 30% ITC Election N/A N/A N/A N/A N/A N/A Section 45 PTC is available Treasury Grant 30% 30% 10% 10% 30% 10% 10%

Qualifying Resources and Facilities

Qualified Resources/ Facilities Wind Geothermal (new facilities) Closed-loop biomass Credit Amount for 2010 2.2 cents/kwh* (10 years) 2.2 cents/kwh* (10 years) 2.2 cents/kwh* (10 years) 1.1 cent/kwh* (10 years) 1.1 cent/kwh* (10 years) 1.1 cent/kwh* (10 years) 1.1 cents/kwh* (10 years) Placed-in-Service Date 30% ITC Election 2009-2012 2009-2013 Treasury Grant Before 1/1/2013 Before 1/1/2014 30% 30%

Before 1/1/2014

2009-2013

30%

Open-loop biomass Municipal solid waste (landfill gas, trash) Hydropower Marine and hydrokinetic renewables (including small irrigation power)

Before 1/1/2014

2009-2013

30%

Before 1/1/2014

2009-2013

30%

Before 1/1/2014

2009-2013

30%

Before 1/1/2014

2009-2013

30%

* Adjusts for inflation. 2010 rate.

Similarities Between Treasury Grants and ITC

Payment is not included in Federal taxable income Payment is for 10 percent or 30 percent of qualifying property at a qualified facility
Property basis must be subject to depreciation or amortization in lieu of depreciation Property must be originally placed in service by the taxpayer Property must be tangible personal property or other tangible property

Similarities Between Treasury Grants and ITC (cont.)

Restrictions on ownership by tax-exempt or governmental entities Depreciable basis in property is reduced by 50 percent of grant payment Five-year recapture window from the time property is placed in service Payment is subject to the normalization requirements

Differences Between Treasury Grants and ITC

Cash payment within 60 days of completed application Construction must begin during 2009, 2010 or 2011 and be completed by required date Payment may be taxable in certain jurisdictions Cost certification must be completed by independent auditor Recapture of payment only occurs upon change in use or disposition to disqualified person Blocker corporation serves to protect grant for taxexempts invested indirectly in the project

Relevant Accounting Guidance

Accounting for ITC

Taxpayer must make policy election under ASC 740-10-25-45 and -46 (originally, APB No. 2 and APB No. 4)
Flow-through method: benefit of credit is recognized for accounting purposes in the year received Deferral method: benefit of credit is recognized for accounting purposes over life of asset through: Plant reduction, or Unamortized deferred ITC

ITC Normalization Requirements

Regulated taxpayers are mandated to share the benefit of the ITC over the life of the property with ratepayers:
Option 1: Rate base offset for balance unamortized ITC Option 2: Reduction to cost of service

Similar rules are applicable for Treasury Grants

Accounting for Treasury Grants

Grants related to capital expenditures are generally recorded as a reduction to depreciable basis in plant under principles of IAS 20 It is permissible to record grant as an item of deferred revenue Amortization of deferred grant is not a component of income tax expense

Accounting for Grant-eligible ITC

Generally, ITC that is eligible for a Treasury Grant would be accounted for as a grant
ITC that is grant eligible is essentially akin to a refundable tax credit

Exception to grant accounting would relate to an ITC that is not economically equivalent to the Treasury Grant

Accounting for Book-Tax Basis Differences

For both the credit and the grant, taxpayers must determine how to record the deferred tax expense/ benefit resulting from the net book and tax basis reduction
Simultaneous Equations Method: The net book and tax basis reduction is recognized as a further reduction to plant Immediate Recognition Method: Deferred tax expense/ benefit resulting from the net book and tax basis reduction is recognized at the time of origination of the basis difference

Common Accounting Considerations

Timing of Recognition
Grant is typically recognized as a receivable when property is placed in service
Receivable is cleared when grant actually received Basis reduction is typically recognized when grant is received

Grant-eligible ITC is typically recognized as a receivable or reduction in payable when included in estimated tax calculations
Basis reduction is typically recognized when receivable or reduction in payable is recorded

Interim Reporting
Grant and Grant-eligible ITC are recorded in the interim period in which amounts are properly determined to be receivable The recordation of tax benefit attributable to the basis difference arising from the Grant-eligible ITC or the Grant is recorded in accordance with ASC 740-270 (FIN 18)
Deferred tax benefit on basis difference is included in estimated annual effective tax rate utilized to compute tax expense for interim periods

Financial Statement Presentation

Balance Sheet
Grant-eligible ITC and Treasury Grants are presented as either as an item of deferred revenue or as a direct reduction to plant

Income Statement
The amortization of Grant-eligible ITC and Treasury Grants deferred is generally presented as a reduction to depreciation and amortization expense Deferred tax expense/ benefit as deferred taxes are recorded is reported as component of income tax expense

Financial Statement Presentation

Statement of Cash Flows
Grants received are typically classified as investing cash flows (i.e., grant is reduction of cash paid for assets) Grant-eligible ITC generally follows the same presentation

Accounting for Uncertainties

Grant-eligible ITC
ITC, despite accounting and financial reporting treatment, is a tax position under the guidance provided in ASC 740 (FIN 48) ASC 740 (FIN 48) governs accounting for income tax uncertainties

Treasury Grants
Treasury Grants are not part of the income tax system (i.e., not a tax position) ASC 450 (FAS 5) governs accounting for nonincome tax loss contingencies

Accounting Examples: Grant Eligible ITC and Treasury Grants

Grant or Grant-eligible ITC Examples Common Facts

Cost of Facility = $10,000,000 Credit or Grant Amount = $1,000,000 (10%) Tax Basis Reduction = 50% Tax Rate = 35% Book Life of Property = 10 years Tax Life of Property = 10 years

Summary of Relevant Facts

Example No. #1 #2 #3 #4 #5 #6 Plant Reduction or Deferred Revenue? Plant Reduction Plant Reduction Deferred Revenue Deferred Revenue Plant Reduction Deferred Revenue Immediate Recognition or Simultaneous Equations? Immediate Recognition Simultaneous Equations Immediate Recognition Simultaneous Equations Immediate Recognition Immediate Recognition Public Utility Property?

No No No No Yes Yes

Example #1
Grant/ ITC accounted for as plant basis reduction Immediate recognition of deferred tax Not public utility property for normalization purposes
Year 1 Dr. Plant Cr. Cash Dr. Cash Cr. Plant Dr. Deferred Tax Asset Cr. Deferred Tax Benefit 10,000,000 10,000,000 1,000,000 1,000,000 175,000* 175,000

*($500,000 Book-Tax Difference X 35% = 175,000)

Example #1 (cont.)
Subsequent Years
Annual book depreciation = $900,000 Annual current tax benefit = $332,500 Annual deferred tax expense = $17,500

Example #2
Grant/ ITC accounted for as plant basis reduction Simultaneous equations used to defer deferred taxes Not public utility property for normalization purposes
Year 1 Dr. Plant Cr. Dr. Cash Cr. Plant 269,231* 269,231 Cash 1,000,000 1,000,000 10,000,000 10,000,000

Dr. Deferred Tax Asset Cr. Plant

*($500,000 Book-Tax Difference X 35% = $175,000 X 1/(1 35%) = $269,231)

Example #2 (cont.)
Subsequent Years
Annual book depreciation = $873,077 Annual deferred tax expense = $26,923 Annual current tax benefit = $332,500

Example #3
Grant/ ITC accounted for as deferred revenue Immediate recognition of deferred tax Not public utility property for normalization purposes
Year 1 Dr. Plant Cr. Dr. Cash Cr. Deferred Revenue 350,000 * 175,000 ** 175,000 Cash 1,000,000 1,000,000 10,000,000 10,000,000

Dr. Deferred Tax Asset (Def. Rev.) Cr. Cr. Deferred Tax Liability (Plant) Deferred Tax Benefit

*(1,000,000 Book-Tax Difference X 35% = $350,000) **($500,000 Book-Tax Difference X 35% = $175,000)

Example #3 (cont.)
Subsequent Years
Annual book depreciation = $1,000,000 Annual credit to book depreciation = $100,000 Annual current tax benefit = $332,500 Annual deferred tax expense = $17,500

Example #4
Grant/ ITC accounted for as deferred revenue Simultaneous equations used to defer deferred taxes Not public utility property for normalization purposes
Year 1 Dr. Plant Cr. Dr. Cash Cr. Deferred Revenue 269,231* 269,231 Cash 1,000,000 1,000,000 10,000,000 10,000,000

Dr. Deferred Tax Asset Cr. Plant

*($500,000 Book-Tax Difference X 35% = $175,000 X 1/(1 35%) = $269,231)

Example #4 (cont.)
Subsequent Years
Annual book depreciation = $973,077 Annual credit to book depreciation = $100,000 Annual deferred tax expense = $26,923 Annual current tax benefit = $332,500

Example #5
Grant/ ITC accounted for as plant basis reduction Immediate recognition of deferred tax Property is public utility property for normalization purposes
Year 1 Dr. Plant Cr. Dr. Cash Cr. Plant 269,231* 269,231 Cash 1,000,000 1,000,000 10,000,000 10,000,000

Dr. Deferred Tax Asset Cr. Regulatory Liability

*($500,000 Book-Tax Difference X 35% = $175,000 X 1/(1 35%) = $269,231)

Example #5 (cont.)
Subsequent Years
Annual book depreciation = $900,000 Annual current tax benefit = $332,500

Example #6
Grant/ ITC accounted for as deferred revenue Immediate recognition of deferred tax Property is public utility property for normalization purposes
Year 1 Dr. Plant Cr. Cash Dr. Cash Cr. Deferred Revenue

10,000,000 10,000,000 1,000,000 1,000,000 350,000 94,231 175,000 269,231

Dr. Deferred Tax Asset (Deferred Revenue) Dr. Deferred Tax Asset (Regulatory Liability) Cr. Deferred Tax Liability (Plant) Cr. Regulatory Liability

Example #6 (cont.)
Computation of DTA/DTL
$1,000,000 excess of tax basis over book basis X 35% = $350,000 DTA $500,000 excess of book basis over tax basis in plant X 35% = $175,000 DTL Regulatory Liability = $175,000 net DTA X 1/(1- 35%) = $269,231 DTA on Regulatory Liability = $269,231 X 35% = $94,231

Subsequent Years
Annual book depreciation = $1,000,000 Annual credit to book depreciation = $100,000 Annual current tax benefit = $332,500

Impact on Operating Expenses

Example 1 Example 2 Example 3 Example 4 Example 5 Example 6 Depreciation Expense ITC Tax Benefit Depreciation Current Tax Benefit 3,325,000 Initial Deferred Tax Benefit 175,000 (9,000,000) (8,730,769) (9,000,000) (8,730,769) (9,000,000) (9,000,000) 3,325,000 (269,231) -

3,325,000 3,325,000 175,000

3,325,000 3,325,000 -

Subsequent Deferred Tax Expense (175,000) Total Expense

(269,231) (175,000)

(5,675,000) (5,675,000) (5,675,000) (5,675,000) (5,675,000) (5,675,000)

Grant or Grant-eligible ITC Summary

Determine proper accounting treatment
Assess the economic equivalency of the ITC to the grant, including impact of state taxation Determine historical accounting policies

Understand the impact of the accounting treatment

Evaluate differences in plant balances Assess differences in relevant financial ratios and effective tax rates Consider the impact of the normalization requirements

Non-consolidated Accounting

Non-consolidated Accounting Examples Additional Assumptions

Company does not apply HLBV accounting for the non-consolidated investment Company is on the flow-through method of accounting for investment tax credits (i.e., recognizes benefit in the year the property is placed in service) Company owns 40% of partnership investing in the project

Non-consolidated Accounting Grants

If assets are held in a non-consolidating partnership, grants received attributable to assets placed in service by the partnership are recorded as a reduction in the investment in the partnership
Record Investment in Project Company Dr. Investment Cr. Cash Record Distribution of Grant Proceeds Dr. Cash Cr. Investment Record Deferred Taxes on Investment Dr. Deferred Tax Asset (Investment) Cr. Income Tax Benefit 4,000,000 4,000,000

400,000 400,000

70,000 70,000

Non-consolidated Accounting Grants

Record Distribution of Grant Proceeds
Partnership receives $1,000,000 ($10,000,000 eligible costs X 10% grant percentage) Company receives $400,000 ($1,000,000 grant X 40% ownership percentage) from the investment grant proceeds, reducing investment

Record Deferred Taxes on Investment

Company records deferred tax asset on investment of $70,000 ($200,000 net basis difference X 35% tax rate)
Tax basis in investment is reduced by $200,000 (basis in investment is reduced by of grant ($400,000 X basis reduction) under Section 50(c)(5) Book basis in investment is reduced by distribution of cash of $400,000

There is no basis difference on cash

Non-consolidated Accounting ITC

If ITC claimed on assets placed in service by the partnership, ITC is a flow-through item to the partners
Record Investment in Project Company
Dr. Investment Cr. Cash Record ITC Dr. Taxes Payable Cr. Tax Benefit - Credit 4,000,000 4,000,000

400,000 400,000

Record Deferred Taxes on Investment Dr. Deferred Tax Expense 70,000 Cr. Deferred Tax Liability (Investment)

70,000

Non-consolidated Accounting Grants

Record ITC reported on Form K-1
Credit of $1,000,000 ($10,000,000 X 10% credit percentage) is generated on partnership assets Company reduces income taxes payable by $400,000 ($1,000,000 total credit X 40% ownership percentage) and recognizes benefit of the credit

Record Deferred Taxes on Investment

Company records deferred tax liability on investment of $70,000 ($400,000 credit X basis reduction X 35% tax rate)
Tax basis in investment is reduced by of credit under Section 50(c)(5) Book basis in investment is unchanged

There is no basis difference on credit (no book basis, no tax basis) under flow-through method

Questions?

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