On September 20, 2013, the US Internal Revenue Service (the IRS) released Notice 2013-60 (the Notice) to clarify certain aspects of Notice 2013-29 (the Original Notice), which provided guidance on the “beginning of construction” requirement to qualify for the Section 45 production tax credit (the PTC) and the election to claim the Section 48 investment tax credit (the ITC).
The American Taxpayer Relief Act of 2012 (the 2012 Act) changed the requirement under Section 45 that a facility be placed in service before January 1, 2014, with the requirement that construction of the facility must have begun before January 1, 2014. This modification applies to wind, closed-loop biomass, open-loop biomass, geothermal energy, landfill gas, municipal solid waste, qualified hydropower and marine and hydrokinetic facilities that claim the PTC under Section 45 or that instead elect to claim the ITC under Section 48(a)(5).1
The Original Notice, which was published on April 15, 2013, provides two alternative methods to establish that construction of a qualified facility has begun before January 1, 2014: (i) starting physical work of a significant nature before January 1, 2014 (the Physical Work Method) or (ii) paying or incurring at least 5 percent of the total cost of the facility before January 1, 2014 (the 5% Safe Harbor). Pursuant to the Original Notice, the Physical Work Method requires that the taxpayer maintain a continuous program of construction after starting physical work (the Continuous Construction Test), and the 5% Safe Harbor requires that the taxpayer maintain continuous efforts to advance towards completion of the facility after paying or incurring 5% of the total costs (the Continuous Efforts Test).2
Continuous Construction Test and Continuous Efforts Test
Under the Original Notice, whether the taxpayer satisfies the Continuous Construction Test or the Continuous Efforts Test is determined by the relevant facts and circumstances. However, this facts and circumstances determination created a lot of uncertainty for the industry. The Notice addresses this uncertainty by creating a safe harbor under which a taxpayer will be deemed to satisfy one of the tests if a facility is placed in service before January 1, 2016. If a facility is not placed in service before that date, the safe harbor does not apply and satisfaction of the Continuous Construction Test or Continuous Efforts Test will be determined under the facts and circumstances, as described in the Original Notice. The Notice did not provide further guidance on what activities (e.g., negotiation of a power purchase agreement) would qualify under the facts and circumstances test.
This aspect of the Notice is favorable for the industry and goes a long way toward eliminating any concern about the pace of, or pauses in, construction. As a result of the safe harbor, developers may begin projects even where they do not see a clear and continuous path to completion, as long as they are confident construction will be completed by the end of 2015.
Master Contract Provision
Under the Original Notice, if a taxpayer enters into a binding written contract for a specific number of components to be manufactured, constructed or produced for the taxpayer by another person (a master contract), and then, through a new binding written contract (a project contract), the taxpayer assigns its rights to certain components to an affiliated special purpose vehicle that will own the facility for which such property is to be used, then, the work performed under the master contract may be taken into account in determining when physical work of a significant nature begins with respect to the facility.
The Notice instructs that this master contract provision also applies to the 5% Safe Harbor for purposes of demonstrating commencement of construction.
Transfer of a Facility
As a result of some ambiguous language in the Original Notice, some industry participants were concerned that the qualified status resulting from the commencement of construction of a facility related to the taxpayer that commenced construction rather than the facility. Thus, there was a perceived risk that a transfer of a facility with respect to which construction had begun before January 1, 2014, could negate its qualified status.
The Notice clarifies that the qualified status resulting from the commencement of construction relates to the facility rather than the taxpayer that commenced construction. The Notice notes that the statutory language requires only that construction of a facility begin before January 1, 2014: it does not require the construction to be begun by the taxpayer claiming the PTC or ITC. The Notice includes an example where a developer begins construction of a facility through a disregarded entity and then subsequently sells 95 percent of the interests in the disregarded entity; the sale is treated for tax purposes as a sale of a 95 percent undivided interest in the disregarded entity’s assets followed by the creation of a new partnership. The example concludes, assuming the facility is otherwise qualified, the partnership is eligible to claim the PTC or elect the ITC in lieu thereof. The Notice does not address what constitutes a facility.