On July 9, 2009, the U.S. Treasury Department issued Program Guidance for Payments for Specified Energy Property in Lieu of Tax Credits (“Section 1603 payments”) under the American Recovery and Reinvestment Act of 2009.

Section 1603 payments will be made to eligible persons who place in service specified energy property (“qualified renewable energy facility”), in lieu of both the Energy Credit (Investment Tax Credit) and the Production Tax Credit. The guidance was released together with the Application and additional Terms and Conditions.

Key features of the guidance were highlighted in our July 9, 2009, alert. Today's alert provides more details from the guidance and an analysis of its practical implications. We have incorporated all of the information contained in our earlier alert.

Application procedures

Statement of Treasury guidance

All applications for Section 1603 payments will be made online. For a qualified renewable energy facility placed in service in 2009 or 2010, an application can be submitted only after the facility is placed in service. For a qualified renewable energy facility not placed in service in 2009 or 2010 but by the applicable credit termination date, and for which construction begins in 2009 or 2010, an application can be submitted only when the facility is under construction; supplemental information must be submitted within 90 days after the facility is placed in service.

Treasury will begin accepting applications on Aug. 1, 2009, and cannot accept them after Sept. 30, 2011. An estimated $3 billion will be awarded under the program, but there is no cap on the total amount of Section 1603 payments that can be made. Treasury officials have emphasized that the Section 1603 program is not a competitive program (i.e., every applicant/facility that qualifies will receive a Section 1603 payment).

Practical application

Treasury’s willingness to review applications for qualified renewable energy facilities not placed in service by Dec. 31, 2010, but under construction as of that date, and notify applicants if all eligibility requirements that can be determined before a facility is placed in service have been met, should provide valuable assurance to other funding sources that a Section 1603 payment will be received when the facility is placed in service.

Applicant eligibility

Statement of Treasury guidance

Four types of persons are disqualified from receiving Section 1603 payments: (1) Federal, state or local governments (including any political subdivision, agency or instrumentality thereof); (2) tax-exempt Code Section 501(c) organizations; (3) Code Section 54(j)(4) entities; and (4) any partnership or other pass-thru entity in which any such entity described in (1) through (3) above is a direct or indirect equity owner. These four types of persons are considered “disqualified persons” and are not eligible to receive Section 1603 payments. The guidance contains a limited exception to this rule: disqualified persons may own interests in applicants that are partnerships or other pass-thru entities indirectly through taxable C corporations without affecting the eligibility of the partnership or other pass-thru entity for a Section 1603 payment. Neither a REIT nor a subchapter T cooperative is a pass-thru entity for this purpose. Foreign persons generally are not eligible to receive a Section 1603 payment unless a significant portion of the income generated by the facility is subject to U.S. federal income tax.

Practical application

Disqualified persons may invest in pass-thru entities owning qualified renewable energy facilities indirectly through the formation and operation of taxable C corporations (which include LLCs electing to be classified as corporations for federal income tax purposes but not electing S corporation status). Thus, the use of a taxable C corporation will be important for any disqualified person choosing to invest in or own a qualified renewable energy facility that expects to receive a Section 1603 payment.

Qualified renewable energy facility

Statement of Treasury guidance

A qualified renewable energy facility includes only tangible property (other than a building) that is both used as an integral part of the activity performed by the facility and located at the site of the facility. Treasury has clarified that roadways and paved parking areas at the qualified renewable energy facility site used for transport of material to be processed at the facility or equipment to be used in maintaining and operating the facility are integral and thus treated as property that is part of a qualified renewable energy facility, but roadways and parking lots for employees or visitors are not.

The qualified renewable energy facility must be used predominantly inside the United States in a trade or business or for the production of income and must be “originally placed in service” by the applicant unless it is transferred in a sale-leaseback transaction (see “Leased property” below).

Treasury has provided guidance with respect to which components of different types of renewable energy facilities qualify as property for purposes of Section 1603 payments. For example, qualified renewable energy facility property includes storage devices, power conditioning equipment and transfer equipment, but not electrical transmission equipment or any equipment beyond the electrical transmission stage. Certain modifications to an existing qualified renewable energy facility qualify for Section 1603 payments, even if the facility was placed in service before 2009. Practical application

The inclusion of roadways and parking areas integral to the operation and maintenance of a qualified renewable energy facility is an applicant-favorable rule because such areas might not have otherwise been included by applicants. In addition, identification of specific components of qualified renewable energy facilities that are considered integral will reduce disputes over application of this test.

Applicable payment percentage

Statement of Treasury guidance

To qualify for a Section 1603 payment, a qualified renewable energy facility must be either: (1) originally placed in service between Jan. 1, 2009, and Dec. 31, 2010 (regardless of when construction begins); or (2) placed in service after 2010 and before the credit termination date, if construction of the property begins between Jan. 1, 2009, and Dec. 31, 2010. Expansions of existing facilities can qualify for a Section 1603 payment with respect to that portion of the improvement.

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Practical application

Section 1603 payments will be made for qualified renewable energy facilities placed in service after Dec. 31, 2010, but only if physical work of a significant nature has begun before this date. See “Beginning of construction,” below, for a detailed summary of the guidance with respect to commencing construction during the Jan. 1, 2009, through Dec. 31, 2010, period. By making expansions of facilities previously placed in service eligible for Section 1603 payments, Treasury has significantly broadened the group of facilities that may receive such payments.

Beginning of construction

Statement of Treasury guidance

Construction begins when physical work of a significant nature begins. Separate guidance is provided for “self construction” and “construction by contract.” For self-constructed projects, construction begins when physical work of a significant nature begins, generally at the site. Preliminary activities, such as planning, designing and securing financing do not constitute physical work. Furthermore, preliminary work, such as clearing a site, test drilling to determine soil conditions, or excavating to change the contour of the land does not constitute the beginning of construction. However, excavating for foundations, setting anchor bolts in the ground or pouring concrete foundations is considered the beginning of construction.

For projects constructed by contract, construction begins when physical work of a significant nature begins under a “written binding contract.” To be considered a written binding contract, in addition to other requirements, the contract must be enforceable against the applicant under state law and not limit damages to a specified amount (e.g., by use of a liquidated damages provision), of less than 5 percent of the total contract price.

The guidance contains a “safe harbor” providing that an applicant may treat physical work of a significant nature as beginning when the applicant incurs or pays more than 5 percent of the total cost of the property (excluding the cost of land and preliminary activities). The safe harbor test applies to both self-constructed property and property constructed by contract. Treasury has indicated it will apply the economic performance standards of Code Section 461(h) in determining when a cost is incurred.

Practical application

The safe harbor should be helpful for qualified renewable energy facilities that are not placed in service but are under construction by Dec. 31, 2010. Note that an election to treat multiple units of property at a single site as a single unit of property will apply for purposes of determining the beginning of construction of the property (see “Placed in service” below). This applicant-favorable rule should maximize the number of units meeting the “beginning of construction” deadline.

Placed in service

Statement of Treasury guidance

A qualified renewable energy facility is “placed in service” when it is ready and available for its specific use. The owner of multiple units of property that are located at the same site and that will be operated as a larger unit may elect to treat the units as a single unit of property for purposes of determining the date the property is placed in service (as well as the beginning of construction, as discussed above), but cannot include within this larger unit any property that was placed in service before Jan. 1, 2009. Failure to complete the entire planned unit will not preclude receipt of a Section 1603 payment for the units actually placed in service by the applicable deadline.

Practical application

The ability to treat multiple units of property at a single site as a single unit of property eliminates much uncertainty as to when each of the units is placed in service when they are commissioned at different times and the project as a whole has not begun operations. Furthermore, the ability to receive a Section 1603 payment for units actually placed in service, even though the entire single unit is not, will provide applicants with flexibility in making such elections.

Eligible basis

Statement of Treasury guidance

The basis of a qualified renewable energy facility is determined in accordance with the general rules for determining the basis of property for federal income tax purposes (i.e., generally its “cost”). Costs that will be deducted for federal income tax purposes in the year in which they are paid or incurred, however, are not includible in the basis on which the Section 1603 payment is determined (e.g., Code Section 179 deductions).

Practical application

The exclusion from eligible basis of costs deducted in the year in which the qualified renewable energy facility is placed in service should have minimal impact on the amount of a Section 1603 payment. Furthermore, the rule with respect to Code Section 179 expensing (maximum $250,000 in 2009 and $125,000 in 2010) mirrors a similar rule for the Investment Tax Credit.

Leased property

Statement of Treasury guidance

A lessor who is eligible to receive a Section 1603 payment may irrevocably elect to pass through the payment to a lessee, but only if the qualified renewable energy facility would be eligible for a Section 1603 payment if owned by the lessee (i.e., cannot elect to pass through the Section 1603 payment to a disqualified person and a disqualified person cannot make an election). If this election is made, the lessee is treated as having acquired the qualified renewable energy facility for an amount equal to the independently assessed fair market value of the facility on the date it is transferred to the lessee. With this election, the lessor is not required to reduce its basis in the facility by one-half of the Section 1603 payment; instead, the lessee is required to include ratably in its gross income over the five-year recapture period one-half of the Section 1603 payment.

Guidance is also provided allowing sale-leaseback transactions to occur within three months following the date the original user placed the qualified renewable energy facility in service. Unless the lessor and lessee elect otherwise, the applicant-lessor is considered the original user of the facility and it is considered to be placed in service not earlier than when it is first used under the leaseback.

Practical application

Passing the Section 1603 payment to a lessee may allow for a larger Section 1603 payment if the independent appraised value of the qualified renewable energy facility exceeds the lessor’s tax basis in the facility. Sale-leaseback transactions might be used in situations where investors cannot be identified and in place at the time a facility reaches commercial operation, thus allowing for a transfer of the facility within three months following the initial placed-in-service date without triggering joint liability for recapture, as discussed below (see "Recapture").

Recapture

Statement of Treasury guidance

If an applicant disposes of a qualified renewable energy facility to a disqualified person or the facility ceases to be a qualified renewable energy facility within five years from the date it is placed in service, a prorated amount of the Section 1603 payment must be repaid; applicants must certify annually for the first five years after a facility is placed in service that a recapture event has not occurred. The recapture periods are:

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 Selling or otherwise disposing of a qualified renewable energy facility to an entity other than a disqualified person does not result in recapture, provided the facility continues to be a qualified renewable energy facility, and provided the purchaser of the facility agrees to be jointly liable with the applicant for any recapture. Recapture will occur if the facility ceases to be a qualified renewable energy facility (e.g., permanent cessation of energy production unless caused by a natural disaster) or is sold to a disqualified person.

Also, the guidance states that a recapture event will occur if an ownership interest in an applicant—or in any pass-thru entity that has an ownership interest in an applicant—changes during the recapture period so that the applicant becomes a disqualified person.

In leasing structures, if the lessor has passed the Section 1603 payment to the lessee, and the lessor then sells the qualified renewable energy facility to a disqualified person, the lessee is liable for recapture even if the lessee maintains control of the facility. Similarly, if after passing the Section 1603 payment to the lessee, the lease is terminated and possession of the facility is transferred by the lessee to the lessor or any other person, the lessee is liable for the recapture amount if the use of the facility changes during the recapture period so that it is no longer a qualified renewable energy facility. Recaptured amounts are debts owed to the United States and if not paid are enforceable by the U.S. Department of Justice.

Practical application

Limiting recapture to transfers to disqualified persons or events where the facility is no longer a qualified renewable energy facility should provide liquidity to facility owners during the recapture period and provide lenders with the ability to lend to renewable energy projects without limiting their foreclosure rights during the recapture period.

Required documentation

Statement of Treasury guidance

Applicants must submit supporting documentation demonstrating that the qualified renewable energy facility has been placed in service, and, if applicable, that construction began before Dec. 31, 2010. This documentation includes final engineering design documents, commissioning reports, interconnection agreements, paid invoices and binding contracts and leases. In addition, documentation supporting the basis of the qualified renewable energy facility must be submitted; for a facility with a basis in excess of $500,000, applicants must submit an independent accountant’s certification attesting to the accuracy of all costs claimed as part of the basis.

Practical application

Before the American Recovery and Reinvestment Act of 2009, many of the facilities eligible for Section 1603 payments were only eligible to claim the Production Tax Credit and thus there is no authority regarding their eligible basis either for Section 1603 payments or the Investment Tax Credit. The emphasis on documenting eligible basis for purposes of Section 1603 payments is consistent with the focus in IRS Notice 2009-52 on accounting for and documenting the basis of property for which an election is made to claim the Investment Tax Credit in lieu of the Production Tax Credit.

Miscellaneous

A Section 1603 payment does not make the property subject to the requirements of the National Environmental Protection Act and similar laws or the requirements of the Davis-Bacon Act.

Reporting

Applicants will be required to provide reports, as required by Treasury, including an annual project performance report for each of the first five years after the facility is placed in service, together with the certification described above that a recapture event has not occurred (see “Recapture”).