The IRS today issued much anticipated guidance regarding the new "beginning of construction" requirement for qualifying for the production tax credit (PTC) under Section 45 of the Internal Revenue Code (the Code) and the investment tax credit (ITC) under Section 48 of the Code. Prior to enactment of the American Taxpayer Relief Act of 2012 (the Act) in early January 2013, an otherwise qualified facility was required to be "placed in service" prior to the applicable credit termination date to qualify for the PTC or the ITC. The Act extended the credit termination date for wind facilities to January 1, 2014 and substituted the new beginning of construction requirement for the previous placed-in-service requirement. Now for an otherwise qualified wind, open- or closed-loop biomass, geothermal, landfill gas, trash, marine and hydrokinetic, or qualified hydropower facility to be eligible for the PTC or the ITC, as applicable, construction of the facility must begin before January 1, 2014.
Prior to the release of the IRS guidance, there was general uncertainty regarding exactly what it means to "begin construction" for purposes of qualifying for the PTC or the ITC and whether the IRS would follow the U.S. Department of the Treasury's previously issued guidance regarding a similar requirement under the Section 1603 Grant. The new IRS guidance is very similar to the beginning of construction guidance previously issued under the Section 1603 Grant. The guidance provides two alternative methods for satisfying the beginning of construction requirement: (i) by beginning "physical work of a significant nature" or (ii) by satisfying a safe harbor based on the amount paid or incurred with respect to a project.
Physical Work of a Significant Nature. The guidance provides that whether and when physical work of a significant nature begins will be depend on all the relevant facts and circumstances. Both on-site and off-site work generally may be taken into account (including, for example, off-site assembly of components of the facility). Physical work does not include preliminary activities such as planning or designing, securing financing, exploring, researching, obtaining permits, licensing and other preliminary activities. In addition, physical work of a significant nature does not include work to produce property that is either in existing inventory or normally held in inventory by a vendor. Work performed by someone other than the taxpayer pursuant to a contract entered into before the work commences generally is taken into account. The physical work of a significant nature requirement will not be satisfied unless the taxpayer maintains a continuous program of construction after beginning work.
Safe Harbor. The new IRS guidance also creates a safe harbor under which a taxpayer will be considered to have begun construction if the taxpayer pays or incurs 5% or more of the total cost of a facility before January 1, 2014 and thereafter makes continuous efforts to advance toward completion of the facility. Apart from the requirement that the taxpayer make continuous efforts to advance toward completion of the facility, this is very similar to the safe harbor that was adopted for qualifying for the Section 1603 Grant, with some minor modifications and clarifications. The new IRS guidance describes guidelines that will be used to ensure that continuous efforts are made to advance toward the completion of a facility. These guidelines include descriptions of certain types of disruptions that are beyond the taxpayer's control that will not be considered in determining whether a taxpayer has failed to make continuous efforts to advance toward completion of a facility. The guidance also addresses the impact of cost overruns on the 5% threshold.
Project-Wide Determination Possible. Before the IRS guidance was issued, a significant area of concern was whether the IRS would follow previous federal income tax precedent and treat each separate item of generating equipment (such as each turbine in a wind facility) as a separate facility for purposes of applying the beginning of construction requirement, or whether the IRS would adopt a project-wide approach similar to the Treasury Department's approach in the Section 1603 Grant guidance. Fortunately for developers and investors, the IRS guidance adopts an approach similar to the Treasury Department's approach in the Section 1603 Grant guidance. The new IRS guidance provides that, solely for purposes of determining whether construction of a facility has begun for purposes of Sections 45 and 48, multiple facilities that are operated as part of a single project will be treated as a single facility. Thus, a taxpayer can be considered to have begun construction on a single turbine if construction of the larger project has begun. The guidance provides a list of factors that will be used to determine whether multiple facilities are operated as part of a single project for this purpose. This rule should make it easier for developers of large projects to meet the beginning of construction requirement.
The new guidance is very helpful and answers a number of questions regarding the new beginning of construction requirement.