Federal Courts of Appeals Consider Interplay Between Environmental Laws and Federal Tax Code

On August 14, two U.S. Court of Appeals released decisions regarding the interplay between environmental law and the federal tax code.

In the case of Green Gas Delaware Statutory Trust, et al. v. Commissioner of IRS. The Court of Appeals for the District of Columbia Circuit affirmed the ruling of the Tax Court that the appellants could not claim federal tax credits connected with the generation and sale of “landfill gas” that is produced from decomposing landfill waste. Chief Judge Garland’s opinion begins with

Rumpelstiltskin could spin straw into gold. Rumpelstiltskin, Inc. thought it could do the same for garbage, spinning it into tax credits. The Commissioner of the Internal Revenue Service disagreed. So did the Tax Court. So do we.

Huge amounts of this gas are produced every year, and there are plans to capture and process this gas, turning it into a potential energy source. Federal tax credits are available to encourage the production and sale of energy from unconventional sources.

In the Green Gas case, Resource Technology Corporation (RTC) entered into agreements with several landfills to produce and sell electricity from landfill gas, and RTC agreed to pay the landfill owners royalties measured as a percentage of electricity sales. The trusts that are the appellants in this case entered into separate agreements by which RTC sold the rights to produce the gas to the trusts, which then agreed to sell all produced landfill gas back to RTC. The Court of Appeals asks, “What was the purposed of these byzantine arrangements?” The answer, “to monetize tax credits.”

Along the way, only five landfills were able to produce this gas, the other 19 were forced to vent or flare this gas into the atmosphere. Nevertheless, the trusts claimed a tax credit of $11.7M on their returns, which the Internal Revenue Service (IRS) almost wholly rejected after an audit. The IRS also rejected their business expense deductions and assessed a 20% “accuracy penalty.”

The Court of Appeals upheld the determination of the Tax Court, noting flaring and venting landfills do not qualify as a facility for producing qualified fuels under the applicable Internal Revenue Code. Also the appellants failed to maintain proper records documenting their activates, which also disqualified their business-deduction claims. Finally, the accuracy penalty was warranted because of the appellants failure to “submit hardly any documentation of the key facts underlying their credit and deduction claims”

The same day, the U.S. court of Appeals for the Fifth Circuit decided the case of PBBM-Rose Hill, Ltd., et al. v. Commissioner of IRS, which involved the valuation of an environmental easement for tax purposes. The appellant, PBBM-Rose Hill, Limited (PBBM) claimed a deduction of over $15M for its donation of a conservation easement to the North American Land Trust in 2008. The IRS disallowed this charitable contribution deduction, and even assessed a penalty for misstating the value of the easement.

In 1996, the Rose Hill Plantation Development Company, which developed property in South Carolina, conveyed 241 acres of real property to the Rose Hill Country Club (Country Club), and the deed contained a 30-year use restriction. In 2002, the Country Club conveyed this property to PBBM for +$2.4M, and the use restriction was invalidated and removed by a bankruptcy court in 2007. Thereafter, in December 2007, PBBM conveyed a conservation easement to the North American Land Trust, which also contained several “Conservation Purposes.”

PBBM’s partnership tax return for 2008 PBBM claimed the charitable deduction under the Internal Revenue Code, but in 2014, the Service determined that PBBM was not entitled to the deduction because all of the relevant regulatory criteria were not satisfied; a gross valuation misstatement penalty was assesses as well. The appellants’ appeals to the Tax Court were unsuccessful, as was their appeal to the Fifth Circuit. While the Court of Appeals was satisfied that the easement was exclusively for conservation purposes, as required by the Internal Revenue Code, it did not satisfy the requirement that the easement be granted in perpetuity. The Court of Appeals also affirmed the Tax Court’s finding that the easement should have been valued at $100,000, thus triggering the valuation-related penalty.