The IRS recently released Notice 2014-46 (the Notice) which provides welcome guidance to tax equity investors and developers on the construction of wind, geothermal, biomass, landfill gas and certain hydropower and marine hydrokinetic energy projects for purposes of qualifying for the section 45 renewable electricity production tax credit (PTC), or the section 48 investment tax credit (ITC) in lieu of the PTC.
For these types of projects, in order to take advantage of the PTC or ITC, construction of the facility must have begun prior to January 1, 2014. As provided in earlier guidance released by the IRS (Notice 2013-29), taxpayers may demonstrate that they started construction timely either by beginning physical construction of a significant nature (the Physical Work Test) or incurring at least 5% of the total costs of the eligible property (the 5% Safe Harbor). In all cases, taxpayers must make continuous progress toward completion of the facility once construction has begun, or otherwise place the facility in service before January 1, 2016 (in which case continuous progress will be considered satisfied, pursuant to clarifications to Notice 2013-29 that were provided by the IRS in Notice 2013-60).
The Notice clarifies and modifies Notices 2013-29 and 2013-60 by addressing the following questions and also by modifying the 5% Safe Harbor:
- How much physical work is required to be performed prior to 2014 in order to satisfy the Physical Work Test?
The Notice states that the Physical Work Test focuses on the nature of the work performed. As long as the work relates to items that are integral to the activity performed by the facility, there is no fixed minimum amount of work or a monetary or percentage threshold.This clarification is intended to address concerns by tax equity investors reluctant to invest in projects that rely on the Physical Work Test based on subjective interpretations of whether the requisite amount of work has been performed to meet the test. Taxpayers now have the assurance that the focus for this test is on the type of work performed and not the amount of work or costs.
- May an otherwise qualified facility be transferred before it is placed in service without jeopardizing eligibility?
The Notice restates the IRS’ position that there is no statutory requirement that the taxpayer which places the facility in service also be the taxpayer which begins construction of the facility. It also provides that a fully or partially developed facility may be transferred without losing its qualification under the Physical Work Test or the 5% Safe Harbor with a single exception: In the case of a transfer consisting solely of tangible personal property (including contractual rights to such property under a binding written contract) to an unrelated transferee (defined as a transferee that has less than a 20% interest in the transferor ), any work performed or amount paid or incurred by the transferor with respect to such property will not be taken into account with respect to the transferee.The Notice also explains that taxpayers which originally intended to develop a facility at a certain site may later relocate eligible facilities, equipment and components to a new site and still satisfy the Physical Work Test or 5% Safe Harbor.
While the Notice could have better addressed a taxpayer’s use of tangible personal property acquired prior to 2014 to qualify a yet-to-be-identified project, we believe the Notice provides sufficient comfort to conclude that “grandfathered” property may be used to extend PTC or ITC eligibility for a taxpayer’s facilities, provided the other requirements for eligibility are satisfied.
- How is the 5% Safe Harbor modified?
The Notice also modifies the 5% Safe Harbor with respect to projects comprised of multiple facilities (like wind farms with multiple turbines, each of which is considered a separate facility for tax purposes). The Notice provides that a taxpayer that incurs less than 5% of the total costs of a project prior to January 1, 2014, but more than 3% of the total cost, the 5% Safe Harbor may be satisfied and the PTC or ITC may be claimed with respect to some, but not all, of the individual facilities comprising the project. In this situation, a taxpayer may claim the PTC or ITC on any number of individual facilities as long as the total aggregate cost of those individual facilities at the time the project is placed in service is not greater than twenty (20) times the amount the taxpayer paid or incurred before January 1, 2014. This rule is not available to qualify a project that cannot be separated into individual facilities.
Takeaways: The Notice provides sufficient additional clarifications to get projects constructed that were relying solely on the Physical Work Test to qualify for the PTC or ITC. The Notice should also allow projects to be transferred without creating much concern for the buyer or seller. We do not believe the modified 5% Safe Harbor will have a material impact on project development.