The IRS has released Notice 2017-04, providing additional guidance concerning satisfaction of the “begun construction” requirements for production tax credit (PTC) eligibility (and eligibility to elect the investment tax credit [ITC] in lieu of the PTC).
As noted in prior client alerts, in June 2016, the IRS released Notice 2016-31 to provide taxpayers with additional guidance in respect of the new begun construction deadlines and phase-outs introduced by the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”). Notice 2017-04 further clarifies and modifies this guidance in three respects:
(i) the notice modifies and extends the means by which taxpayers can be deemed to satisfy the existing requirement that the taxpayer demonstrate continuous construction of a project for purposes of begun construction requirements;
(ii) the notice clarifies the application of certain prohibitions set forth in the prior notice regarding combining multiple methods of satisfying the begun construction requirement; and
(iii) the notice clarifies which costs are included in applying the “5% safe harbor” described below in the case of retrofitted facilities.
On December 18, 2015, the PATH Act extended PTC eligibility for facilities that are under construction before 2020, but introduced a phase-out that reduces the rate of the PTC based on the year in which construction of the facility began. In particular, the rate of the PTC is reduced to 80% of the current rate for facilities beginning construction in 2017, 60% of the current rate for facilities beginning construction in 2018, and 40% of the current rate for facilities beginning construction in 2019. Facilities that do not begin construction prior to 2020 would be ineligible for the PTC. The current rate of the 30% ITC for facilities claiming the ITC in lieu of the PTC is similarly phased down based on when construction of the relevant facility began. That is, the 30% ITC in lieu of the PTC would be reduced by the same phase-out percentages based on when construction of the facility began: (i) 24% if construction begins in 2017; (ii) 18% if construction begins in 2018; and (iii) 12% if construction begins in 2019.
IRS guidance issued prior to the PATH Act provided two methods for establishing that construction had begun on a facility for purposes of this requirement: (a) beginning physical work of a significant nature on the facility (the “Physical Work Test”) or (b) paying or incurring five percent or more of the total costs of the facility (the “5% Safe Harbor”), in each case, prior to the then-current deadline. Both methods also require that a taxpayer make continuous progress toward completion of the facility after commencing construction (the “Continuous Construction Requirement”). In subsequent IRS guidance, the IRS provided that facilities were “deemed” to satisfy the Continuous Construction Requirement if they were placed in service within two years of the then-current deadlines for having commenced construction (the “Continuity Safe Harbor”). Thus, the Continuity Safe Harbor provided a useful exception to certain facts and circumstances tests that a taxpayer would otherwise have to meet in order to demonstrate satisfaction of the Continuous Construction Requirement.
II. Continuity Safe Harbor Extension
Prior IRS guidance provided that a taxpayer would be deemed to satisfy the Continuous Construction Requirement by placing a facility in service by the later of (i) a calendar year that is no more than four calendar years after the calendar year in which construction of the facility began or (ii) December 31, 2016. Notice 2017-04 retains the first part of the existing Continuity Safe Harbor for facilities placed in service within four calendar years of the calendar year the facility begins construction, but extends the alternative deadline from December 31, 2016 to December 31, 2018.
Thus, a facility will satisfy the Continuity Safe Harbor if the facility is placed in service by the later of (i) a calendar year that is no more than four calendar years after the calendar year in which construction of the facility began or (ii) December 31, 2018. One upshot of this extension is that the change eliminates the need for sponsors to demonstrate that construction of a project did not begin prior to the four-calendar-year window in the case of projects that are placed in service prior to 2019.
III. Combining Methods to Satisfy the Begun Construction Requirement
Notice 2016-31 specified that a taxpayer may not satisfy the Continuous Construction Requirement by applying the Physical Work Test and the 5% Safe Harbor in alternative years. This prohibition is intended to prevent a taxpayer from extending the four-year tolling period for the new Continuity Safe Harbor by relying on one test in a given year and thereafter applying the other test in a subsequent year. For example, under this rule, if a taxpayer satisfied the Physical Work Test in 2015 and then satisfied the 5% Safe Harbor in 2016, the four-year period for the Continuity Safe Harbor would begin in 2015. The latest guidance modifies this rule such that the rule is only applicable to facilities that began construction after June 6, 2016 (the date of Notice 2016-31); thus, projects that began construction prior to this rule being issued are relieved of its impact. For instance, using the example above, if a project satisfied both the Physical Work Test and the 5% Safe Harbor prior to June 6, 2016, the taxpayer should be able to use the date on which the later test was deemed to have been satisfied to determine when the four-calendar-year tolling period begins under the Continuity Safe Harbor.
IV. Retrofitted Facilities
Earlier IRS guidance on the begun construction rules provided that “retrofitted” facilities that contain some used property may also qualify for PTCs under the 5% Safe Harbor where the fair market value of any used property in a facility does not constitute more than 20% of the facility’s value after completion of the retrofit (the “80/20 Rule”). Notice 2016-31 clarified that, with respect to a “retrofitted” facility that satisfies the 80/20 Rule, the 5% Safe Harbor is applied only with respect to the cost of the new property. That is, only costs paid or incurred that relate to the new property are taken into account for purposes of the 5% Safe Harbor. Notice 2017-04 further elaborates on this clarification to state that, for purposes of this rule, the “costs of new property” include all costs that are properly included in the depreciable basis of the new property.
The changes made by Notice 2017-04 to the existing begun construction guidance generally represent modest clarifications and updates to prior notices. However, although the changes do not have a drastic impact on existing guidance, the changes are consistently taxpayer-favorable. Furthermore, the new notice reiterates that the Treasury anticipates issuing separate guidance to address the begun construction issues in the context of solar facilities.