On September 20, 2013, the Internal Revenue Service (“IRS”) released Notice 2013-601 (the “Notice”), which significantly clarifies and expands the eligibility rules applicable to the investment tax credit (“ITC”) and production tax credit (“PTC”) for wind and certain2 other renewable energy facilities.
The IRS previously issued guidance (hereinafter, the “Prior Guidance”) providing two alternative methods by which a taxpayer can demonstrate that construction on a renewable energy facility has begun before January 1, 2014, which is a prerequisite to claim the ITC or PTC.3 The first method requires a taxpayer to begin physical work of a significant nature before January 1, 2014 (the “Physical Work Test”). The second method provides a safe harbor if at least 5% of the total cost of the facility is paid or incurred before January 1, 2014 (the “Safe Harbor”). The Prior Guidance requires that for purposes of the Physical Work Test, taxpayers must maintain a “continuous program of construction” (the “Continuous Construction Test”) and for purposes of the Safe Harbor, taxpayers must make “continuous efforts to advance toward completion of the facility” (the “Continuous Efforts Test”). Satisfaction of the Continuous Construction Test and the Continuous Efforts Test are otherwise dependent on all facts and circumstances, but the Prior Guidance contains a limited list of permissible delays that would not cause a taxpayer to fail either test.
Although the additional guidance regarding when construction has begun was helpful, practitioners have had a number of questions regarding the application of the Prior Guidance including what activities would constitute continuous progress toward completion, the applicability of the Safe Harbor to equipment purchased under a master contract for a number of components, and the effect that a transfer of a facility after construction has begun will have on its ability to qualify for the ITC or PTC. While it does not provide answers to all questions raised in connection with determining when construction has commenced, the Notice provides welcome guidance on those important unresolved matters.
The uncertainty arising from the use of a facts and circumstances test was the subject of much discussion and uneasiness for tax practitioners, developers and investors since the issuance of the Prior Guidance. The subjective standard for what qualifies as continuous construction has made it difficult for tax advisors to issue tax opinions regarding the eligibility of a facility for the ITC or PTC. As a result of the difficulty of obtaining a tax opinion and the risk of IRS audit, banks and tax equity investors have been reluctant to provide financing to renewable energy facilities that needed to commence construction prior to January 1, 2014. Moreover, developers had cause for concern with respect to any delays in construction or the availability of equipment such as turbines.
The Notice provides a safe harbor that will allow taxpayers to be deemed to satisfy both the Continuous Construction and Continuous Efforts Tests. Under the Notice, if a facility is placed in service before January 1, 2016, the facility will be deemed to have satisfied the Continuous Construction Test and the Continuous Efforts Test. If a facility is not placed in service before January 1, 2016, whether the facility satisfies the Continuous Construction or Continuous Efforts Tests will be determined by the relevant facts and circumstances, as described in the Prior Guidance. This bright-line standard should greatly increase the confidence of parties to renewable energy transactions that facilities under development will be eligible to claim the ITC or PTC. In particular, for wind facilities which can be developed within a fairly short timeframe, the two-year safe harbor should provide significant comfort.
TRANSFERS AFTER CONSTRUCTION BEGINS.
The Prior Guidance raised a number of questions regarding whether a transfer of a facility or an interest in a limited partnership or LLC that was developing a facility after construction begins would affect the facility’s qualification for the ITC or PTC. The Notice clarifies that a taxpayer seeking to claim the PTC or ITC with respect to a particular facility need not be the same taxpayer that began construction. Thus, the Notice makes clear that a taxpayer that owns a qualified facility during the 10-year period beginning with the date the facility is originally placed in service may claim the PTC and, alternatively, a taxpayer that owns a qualified facility on the date the facility is originally placed in service may claim the ITC, even if the taxpayer did not own the facility when construction began. This clarification is significant because, without it, facilities would have required the tax equity investors to effectively acquire their interest at the beginning of development in order to claim the ITC or PTC which is not a commercial reality. The change made by the Notice is consistent with the statutory language and removes an unnecessary impediment for transfers of facilities after construction has commenced.
MASTER CONTRACT RULE.
The Prior Guidance included a rule for taxpayers wishing to satisfy the Physical Work Test that provides generally that if a taxpayer enters into a binding written contract for a specified number of components to be manufactured, constructed or produced for the taxpayer by another person, and then through a new binding written contract assigns its rights with respect to certain of its components to an affiliated special purpose vehicle that will own the facility, work performed with respect to the master contract will be taken into account in determining when physical work begins with respect to the facility. The prior guidance did not expressly apply this special rule to taxpayers seeking to apply the Safe Harbor. The Notice makes clear that the master contract rule applies for purposes of both the Physical Work Test and the Safe Harbor. The costs associated with the assigned components therefore will be taken into account in determining whether 5% of the costs of the facility have been incurred before January 1, 2014.
The Notice provides welcome guidance to developers and investors with respect to renewable energy facilities’ satisfaction of the beginning of the Continuous Construction Test and Continuous Efforts Test, the applicability of the Safe Harbor to equipment purchased under a master contract for a number of components, and the effect that a transfer of a facility after construction has begun will have on its ability to qualify for the PTC or ITC. The new guidelines should give parties to renewable energy transactions greater certainty to ensure a facility’s qualification for the PTC or ITC with respect what constitutes a facility that is placed in service prior to January 1, 2016.