Hunton & Williams Renewable Energy Quarterly, September 2009

Renewable Energy Quarterly
private funds are already subject to the antifraud rules of
the Advisers Act, if they are required to register as investment
advisers, they will become subject to all provisions of
the Advisers Act, including its rules relating to client asset
custody, recordkeeping, advisory contracts, limitations on
performance fees, ethics and personal trading policies,
investment and financial reporting, and advertising.
In addition to the regulation of fund managers under the
Advisers Act, another recent proposal would subject private
investment funds to additional regulation as “investment
companies” under the Investment Company Act of 1940
(the “Investment Company Act”). Also under this proposal,
“large investment companies” (those with assets under
management of $50 million or more) would be required to
register with the SEC under the Investment Company Act
and comply with other disclosure, reporting and examination
requirements.
Another proposal, the “Corporate and Financial Institution
Compensation Fairness Act of 2009” (H.R. 3269), which was
passed by the House of Representatives on July 31, 2009,
includes a requirement that the SEC and other federal regulators
adopt rules requiring investment advisers and other
covered financial institutions with assets of at least $1 billion
to disclose incentive-based compensation arrangements and
prohibiting certain incentive-based payment arrangements.
As of this writing, there is little information regarding the
disclosure rules and types of incentive-based compensation
practices that would be prohibited by investment advisers,
such as fund sponsors. The Senate has not approved
comparable legislation and the prospects for the bill being
enacted into law are uncertain as of this writing.
In addition, the SEC has proposed for comment rules placing
restrictions on political contributions and the use of placement
agents in connection with soliciting investments from
governmental plans. These restrictions may make it harder
for first-time fundraisers, but would only impact marketing
to public pensions. For the reasons discussed below, these
public pensions may be less likely candidates for investment
in Project Funds.
Changing Tax Rates
Once again, Congress is attempting to increase taxes on
the lucrative incentive compensation that private equity fund
managers receive from the funds they manage. Currently,
the character of income received from a partnership such as
a private equity fund is determined at the partnership level,
so that partners report ordinary income, capital gain and/or
qualified dividend income depending on the character of the
income received by the partnership. Thus, if the partnership
recognizes long-term capital gains and qualified dividends,
the individual partners would be subject to tax on that
income at capital gains rates. Recently, the U.S. Treasury
Department (“Treasury”) proposed to tax income and gain
from a partnership profits interest received in exchange for
services (known as “carried interest”) as ordinary income
regardless of the character at the partnership level, unless
the income or gain was attributable to the partner’s “invested
capital.” The income from a carried interest would also be
subject to self-employment taxes. The carried interest proposal
would apply to all partnerships and would be effective
for taxable years beginning after December 31, 2010. In
addition, the proposal would eliminate the current 33 percent
and 35 percent tax brackets and would add tax rate
brackets of 36 percent and 39.6 percent for individuals with
income over $250,000 (or $200,000 for single taxpayers).
The proposal would increase the tax rate on capital gains
and dividends to 20 percent for individuals with income over
$250,000 (or $200,000 for single taxpayers), effective for
taxable years beginning after December 31, 2010. Due to
the number of recent proposals to modify the tax treatment
of carried interest and the lack of any apparent significant
political opposition to such a proposal, it seems likely that
some form of the current proposals to tax carried interest at
ordinary income rates will be approved in the near future.
Potential Investors
Sponsors considering investment of existing funds in renewable
energy projects, and those raising new Project Funds,
should focus on whether their current or anticipated investor
base can benefit from relevant government programs, the
incentives from which often make the difference between
viable and nonviable projects. Project Funds and renewable
project investments were traditionally sought mostly
by tax equity investors. The Project Fund could allocate
the federal tax credits and accelerated depreciation to the
taxable investors seeking an after-tax return. However, in
mid to late 2008, the traditional tax equity investors found
themselves without a tax reduction appetite and equity
investment in these projects stalled. The Obama administration
and Congress offered some help in the form of the
ARRA. The ARRA permits taxpayers to claim cash grants in
lieu of production or investment tax credits for certain types
of renewable energy facilities, such as wind, closed-loop
biomass, open-loop biomass, geothermal, solar, landfill gas,
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