Distribution utilities are well positioned to provide tax equity for renewable projects, but some state laws prevent it. Tapping the potential will require progressive leadership by utility...
Green REITs, MLPs, and Up-Cs
One question does, however, deserve additional attention: If MLPs are so much more flexible than REITs, why would a REIT ever be used instead of an MLP? The answer is that, although REITs and MLPs share the advantage of not paying corporate-level tax, REITs are much more investor-friendly vehicles in the case of certain classes of investors, namely tax-exempt investors, foreign investors, and U.S. retail investors:
- Tax-Exempt Investors: REITs eliminate tax exposure. If a tax-exempt investor were to invest in renewable energy assets through an MLP, it would generally be subject to the 35 percent unrelated business income tax (UBIT) on operating income and, in certain circumstances, could be subject to the UBIT on a portion of the gain realized on exit. If, however, the tax-exempt investor holds the renewable energy assets through a REIT, then the UBIT generally will not apply to either distributions received by the investor from the REIT or gain recognized by the investor on the sale of REIT stock. When combined with the REIT-level exemption from tax, the use of a REIT to hold renewable energy assets reduces the tax exposure of a tax-exempt investor on both operating income and exit gain from 35 percent to 0 percent.
- Foreign Portfolio Investors: REITs substantially reduce tax on operating income and potentially eliminate tax on exit. If a foreign portfolio investor ( e.g., a foreign pension or sovereign wealth fund) were to invest in renewable energy assets through an MLP, it would generally be treated as recognizing “effectively connected income” (ECI). As a result, the investor would be subject to U.S. tax at varying rates as high as 55 percent on both operating income and gain realized on exit 3 and would generally be required to file U.S. tax returns. A foreign investor in a REIT, however, is generally not required to file U.S. returns as a result of its investment and, depending on its circumstances, can enjoy two types of tax-rate benefits, one that applies to operating income and another that applies to gain realized on exit. First, distributions made by a REIT to a foreign investor will be subject to either 30-percent or 15-percent withholding tax, depending on whether the foreign investor is eligible for tax treaty benefits. Second, a foreign investor in a REIT enjoys two exceptions to the tax that is generally imposed on foreigners that sell U.S. real property investments. Under the first exception, a foreign shareholder is not subject to tax on the sale of stock in a “domestically controlled” REIT ( i.e., a REIT more than 50 percent of the value of which is owned by U.S. persons at all times during a 5-year look-back period). Under the second exception, a foreign shareholder than owns less than 5 percent of the stock of a publicly traded corporation, including a public REIT, is not subject to tax on the sale of that stock even if the REIT is foreign controlled. Thus, from the perspective of a foreign investor, holding renewable energy assets through a REIT can reduce the tax on operating income from