With the approaching expiration of the Section 1603 cash grant program, renewable energy developers are scrambling to begin construction of grant-eligible equipment by the end of the year. Assuming they can satisfy the 2011 construction requirements, this grandfathered equipment can be incorporated into one or more of their future energy projects, thus enabling otherwise ineligible projects to receive cash grant proceeds.
A reading of the Section 1603 program guidance from the U.S. Treasury Department reveals several techniques for maximizing the availability of grant-eligible equipment. It also underscores the importance of careful planning to avoid any unwelcome surprises.
Overview of the Cash Grant Program
The Section 1603 cash grant program was enacted in 2009 to encourage investments in solar, wind, and other non-traditional energy projects. For qualifying projects, Treasury will provide a cash grant of either 10 percent or 30 percent of the basis of eligible energy property, depending on the type of property at issue. By receiving the cash grant, the grant applicant is electing to forgo investment and production tax credits with respect to the property. The Section 1603 grant proceeds are not subject to federal income tax.
Intended to temporarily fill the gap created by diminished investor demand for tax credits, the Section 1603 program is scheduled to expire at the end of 2011. After this year, only qualifying energy projects that began construction during 2009 – 2011 and are placed in service (meaning ready and available for their intended use) before the end of 2016 in the case of solar and certain geothermal projects, 2012 for wind, or 2013 for most other renewables, will be eligible for the grant.
Focus on Satisfying the 5% Safe Harbor
Section 1603 requires the grant applicant to begin construction of qualifying energy property prior to the end of 2011. The applicant must establish construction commencement by either beginning actual physical work on the property — which work must continue through project completion — or demonstrating that the applicant has paid or incurred more than five percent of the total cost of the property (5% Safe Harbor).
For projects past the planning stage, demonstrating actual physical work during 2011 may be the most attractive way to satisfy the construction condition, as it does not require 2011 costs to exceed a minimum threshold. However, for projects still on the drawing board, including those that are merely speculative, developers are better served satisfying the 5% Safe Harbor, as continuous construction is not required. In other words, as long as the 5% Safe Harbor is satisfied before 2012, developers may thereafter prudently and diligently pursue further development and construction of these projects, but without imminent deadlines other than the requirement to be placed in service by the relevant expiration date.
A developer can satisfy the 5% Safe Harbor by establishing that it has paid or incurred sufficient costs for grant-eligible property during 2011. Whether a taxpayer has paid or incurred an expense depends on method of accounting the taxpayer uses for tax purposes. For cash method taxpayers, the payment of an expense (for example, making a nonrefundable deposit) generally is sufficient to establish that such expense has been "paid." For accrual method taxpayers, mere payment of an expense generally is insufficient for the expense to have been "incurred." Rather, a cost is incurred for tax purposes when 1) the fact of the liability becomes fixed, 2) the amount of the liability is determinable with reasonable accuracy, and 3) economic performance has occurred.
For Section 1603 purposes, if property is being manufactured for the grant applicant by another person (such as a vendor) pursuant to a binding written contract, the costs of that property are treated as paid or incurred when the property is provided to the applicant. For periods before the property is provided to the applicant, the vendor's costs that are paid or incurred to manufacture the property are deemed to be costs of the applicant that are paid or incurred at the time they are paid or incurred by the manufacturer. This means that the grant applicant may rely on the vendor's costs to satisfy the 5% Safe Harbor.
Understand the Base Case
Before considering planning opportunities for maximizing the availability of grandfathered property, it is important to understand a base-case scenario from which all variations can then be evaluated. The following can be considered a standard method for a developer seeking to qualify one or more projects for the Section 1603 cash grant:
- Developer establishes a wholly owned limited liability company to serve as the project holding entity and eventually, the grant applicant (Project LLC).
- Project LLC enters into a binding written contract with a vendor to manufacture eligible energy equipment, the cost of which is expected to exceed five percent of the total cost of the qualifying energy project into which such equipment will be incorporated. (To prevent the risk of cost overruns or scope changes causing the project to fail the 5% Safe Harbor, Project LLC will want to target a seven to 10 percent threshold, instead of the bare minimum.)
- During 2011, Project LLC will title to, and delivery of, the manufactured property at a location controlled by Project LLC.
- After the equipment is provided to Project LLC, the property is dedicated to one or more projects, ensuring that sufficient grandfathered equipment is included in each project to satisfy the 5% Safe Harbor for each project.
- Project LLC files separate grant applications for each project by the grant application deadline of September 30, 2012. If a project is not placed in service by such date, Project LLC provides additional information to complete the application within 90 days of the project's placed in service date.
Consider Variations to the Base Case
While the base-case scenario represents a straightforward method of satisfying the 5% Safe Harbor and qualifying eligible projects for the cash grant, the Section 1603 program guidance allows for several variations that do not violate grant eligibility:
- Taking "delivery" of the property, just not at Project LLC's location. The 5% Safe Harbor can be satisfied if the eligible equipment is provided to the applicant during 2011. As stated in the Section 1603 program guidance (and consistent with tax accounting rules), property is considered to have been provided to a taxpayer either when title to the property passes to the applicant or when the property is delivered to or accepted by the applicant, depending on the applicant's method of accounting. Storing the property at a location not controlled by Project LLC (such as the vendor's warehouse) does not violate this requirement, as long as Project LLC has sufficient rights and obligations with respect to the equipment to demonstrate that the transfer of the property has occurred. Factors supporting that the property has been provided to Project LLC include: 1) Project LLC bears the risk of the loss for the equipment; 2) the property is segregated from other equipment in the vendor's warehouse and is identified as owned by Project LLC; 3) Project LLC pays market rent for storage of the property; 4) Project LLC is provided a detailed manifest identifying its property; and 5) Project LLC is granted inspection rights. The more extensive Project LLC's rights and responsibilities, the more likely Treasury will respect the property transfer.
- Using vendor financing. As long as the eligible equipment is provided to Project LLC prior to the end of 2011, the parties can arrange for vendor financing to cover the manufacturing costs while still satisfying the 5% Safe Harbor. The Section 1603 program guidance makes clear that providing the property to Project LLC during 2011 is sufficient to demonstrate that costs have been paid or incurred for the equipment at issue. That said, Project LLC should remain at risk for a material portion of the purchase price.
- Accepting delivery of the property in early 2012, as long as payment for the property is made in 2011. For accrual method taxpayers, the tax accounting rules provide a special rule for determining when an expense has been incurred. If the taxpayer pays for services or property and reasonably expects such services or property to be provided within 3.5 months of payment, then the cost is considered to have been incurred as of the date of payment, notwithstanding that economic performance has not yet occurred. As applied to the Project LLC, a payment on December 31, 2011 could be included as satisfying the 5% Safe Harbor, as long as the property or services paid for are provided by April 15, 2012. However, if the Project LLC wishes to utilize vendor financing, this special tax accounting rule would not be available, as the payment requirement would not be satisfied. That said, the Project LLC could use third-party financing to cover the 2011 manufacturing costs without losing the benefit of the 3.5-month rule.
- Relying on a vendor's costs to satisfy the 5% Safe Harbor. As described above, for periods before the eligible equipment is delivered to the applicant, costs paid or incurred by the manufacturer under the contract are treated as costs that are paid or incurred by the applicant. As such, if the manufacturer pays or incurs sufficient costs during 2011 in its production of the equipment, the Project LLC can establish that it has satisfied the 5% Safe Harbor. However, before the Project LLC could treat these costs as its own, the manufacturer would need to provide a certification (made under penalties of perjury) that such costs were in fact paid or incurred by the manufacturer during such period.
- Using a master "Holdco" to contract for eligible equipment. The Section 1603 program guidance indicates that costs paid or incurred by a developer under a master vendor contract may be allocated to one or more Project LLCs for purposes of satisfying the 5% Safe Harbor. The guidance illustrates that an allocation is accomplished by having Holdco partially assign its rights under the master contract to Project LLCs (a pre-delivery assignment). While not specifically addressed, arguably, a post-delivery assignment to one or more Project LLCs is consistent with the guidance and thus, should also be respected by Treasury. That said, Treasury has not released written authority verifying this view.
Get an Independent Accountant Involved Early
For projects with an estimated eligible cost basis of $1 million or more, a grant applicant must include with its application a statement from an independent accountant supporting, among other things, the applicant's claim that the 5% Safe Harbor has been satisfied. Specifically, the statement must 1) attest to the method of accounting used by the applicant for federal tax purposes; 2) state the amount that has been paid or incurred before the end of 2011; 3) provide a detailed description of the costs that have been paid or incurred; and 4) provide an estimate of the total cost of the specified energy property. If an applicant is relying on costs paid or incurred by a vendor or other manufacturer, the grant application also must include a copy of the relevant binding written contract and a statement from such person, signed under penalties or perjury, of costs paid or incurred by such person and allocated to applicant's project.
Requiring an independent accountant to certify the costs paid or incurred by the applicant during 2011 emphasizes the importance of getting the independent accountant involved as soon as possible. No developer trying to maximize its grant-eligible property should risk having the accountant disagree with the techniques relied upon by the developer after it is too late to change strategies.
Apply for the Grant
The Section 1603 program requires the applicant to submit a grant application no later than September 30, 2012. This deadline applies to all grant-eligible property, whether or not such property is placed in service by such date. If the property is expected to be placed in service on or after October 1, 2012, then the applicant has 90 days after the property is placed in service to provide Treasury with any supplemental information necessary to complete the application.
The grant application provides considerable flexibility for property not yet placed in service. For example, while the applicant must be identified and the project described, at least in general terms, the actual physical location of the project does not have to be settled. That said, to qualify for a cash grant, the developer would need to ensure that the project ultimately is placed in service in time to qualify for the grant.
The approaching expiration of the Section 1603 program underscores the importance of taking actions today to make available grandfathered equipment that can then be used to qualify future energy projects for the cash grant. A developer can begin construction of grant-eligible property in 2011 and assign such equipment to these future projects to enable them to satisfy the 5% Safe Harbor. While the Section 1603 program guidance allows for several planning opportunities to maximize the availability of grandfathered property, in all cases, eligibility depends on taking action before 2012.