The IRS has released Notice 2016-31, which extends and modifies the “continuity safe harbor” for purposes of the “begun construction” requirement applicable to the renewable electricity production tax credit (PTC) under §45 of the Internal Revenue Code of 1986, as amended (Code) or the energy investment credit (ITC) under §48 of the Code.
This guidance, released on May 5, 2016, provides additional certainty regarding qualification for the PTC or ITC that should benefit both developers and investors, particularly with regard to facilities that typically have construction periods that exceed two years. Additional guidance in the Notice concerns the continuity safe harbor and physical work test used in determining eligibility for the PTC, including a re-clarification of how the physical work test and 5 percent safe harbor may be met for both the PTC and ITC; revisions to the types of “interruptions” that will not prevent a project from being treated as under continuous construction; and a re-clarification providing examples of preliminary activities that do not qualify as physical work for purposes of the safe harbor.
As extended by the Protecting Americans from Tax Hikes Act of 2015, the PTC applies to certain facilities the construction of which begins before January 1, 2017 (before January 1, 2020 in the case of wind facilities, including a four-year phaseout). Prior guidance allows a taxpayer to establish the beginning of construction by beginning physical work of a significant nature or by meeting a 5 percent of expenditures safe harbor. Both methods require that a taxpayer meet a “continuity requirement” by making continuous progress towards completion once construction has begun. The continuity requirement was considered or deemed satisfied under a “continuity safe harbor” if the facility was placed in service before January 1, 2016. If a facility was not placed in service before January 1, 2016, whether the facility satisfies the continuity requirement is determined by the relevant facts and circumstances under respectively either the physical work test or the 5 percent safe harbor test.
Continuity safe harbor
Notice 2016-31 extends and modifies the continuity safe-harbor provision, which is now satisfied if a taxpayer places a facility in service during a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began. For example, if construction begins on a facility on January 15, 2016, and the facility is placed in service by December 31, 2020, then the facility satisfies the safe harbor. The IRS has expanded this “vintaging” approach to satisfying the continuous effort requirement of either the physical work test or 5 percent safe harbor test, now allowing four years (rather than the previous two) to place such projects in service. This change may prove particularly useful for facilities other than solar and wind, which may have longer construction periods, as well as revived projects that originally satisfied the begin construction requirement with either the physical work test or 5 percent safe harbor test but then whose activity became dormant or intermittent to the extent where it may fall short on the continuous efforts requirement − so long as such a project can achieve a placed-in-service date within the newly established four-year time frame.
The latest guidance also clarifies that a taxpayer may not rely upon the physical work test and the 5 percent of expenditures safe harbor in alternating calendar years to satisfy the beginning of construction requirement or the continuity requirement. For example, if a taxpayer performs physical work of a significant nature on a facility in 2015, and then pays or incurs 5 percent or more of the total cost of the facility in 2016, then the continuity safe harbor will be applied beginning in 2015 and not in 2016. A representative of the IRS Office of Chief Counsel has indicated, however, that the Service may reconsider this aspect of the Notice.
Physical work test
Prior guidance provided a nonexclusive list of construction disruptions that will not cause a taxpayer to fail the requirement of maintaining a continuous program of construction or continuous efforts to advance towards completion of a facility. The latest guidance revises that list, which remains nonexclusive, and provides additional excusable disruptions.
Also, the nonexclusive list of preliminary activities − those activities not taken into account in determining whether physical work of a significant nature has begun − has been expanded and clarified.
Further, a nonexclusive list of specific examples is now provided to illustrate physical work of a significant nature for different types of renewable energy facilities, including wind facilities, hydropower facilities, biomass and trash facilities, and geothermal facilities. For wind, the listed examples include the same ones found in previous IRS Notices: (i) excavation for the foundation; (ii) setting anchor bolts into the ground; or (iii) pouring the concrete pads of the foundation. Previously referred to qualifying activities that are not specifically mentioned in this Notice are (iv) roads that are integral to the facility are integral to the activity performed by the facility − these include onsite roads that are used for moving materials to be processed (for example, biomass) and roads for equipment to operate and maintain the qualified facility; and (v) work on a custom-designed transformer that steps up the voltage of electricity produced at the facility to the voltage needed for transmission (power conditioning equipment is an integral part of the activity performed by the facility).
Activities listed as qualifying as onsite physical work of a significant nature for other renewable energy projects include (a) hydropower facilities − the excavation for or construction of a penstock, power house, or retaining wall structure; (b) biomass and trash facilities − the performance of site improvements (as opposed to site clearing) such as filling or compacting soil, or installing stack piling; and (c) geothermal facilities − physical activities that are undertaken at a project site after a valid discovery
Single project rule
The rule which treats multiple facilities operated as part of a single project as a single facility for purposes of determining whether construction has begun is clarified to provide that it applies to facilities that rely upon either the physical work test or the 5 percent of expenditures safe harbor to satisfy the continuity requirement. In addition, whether multiple facilities are operated as part of a single project must now be determined in the calendar year during which the last of the multiple facilities are placed in service.
Multiple facilities treated as a single facility for purposes of determining whether construction has begun may now be disaggregated and treated as multiple separate facilities for purposes of determining whether the continuity safe harbor is satisfied. Disaggregated facilities that are placed in service prior to the continuity safe harbor deadline are eligible for the continuity safe harbor. The remaining disaggregated facilities may satisfy the continuity requirement under a facts and circumstances determination. The disaggregation rule may be applied to facilities that rely upon either the physical work test or the 5 percent of expenditures safe harbor to satisfy the continuity requirement.
The updated guidance provides that a retrofitted facility may qualify as originally placed in service by a taxpayer even though it contains some used property. The fair market value of the used property, however, may not exceed 20 percent of the facility’s total value (the cost of the new property plus the value of the used property). If this 80/20 rule applies, then only expenditures paid or incurred that relate to new construction are taken into account for purposes of the 5 percent of expenditures safe harbor.
We anticipate that the IRS will be releasing separate guidance addressing the extension of the ITC for solar energy facilities the construction of which begins before January 1, 2022.