The US Internal Revenue Service (the IRS) has released Notice 2014-46 (the Notice), which provides further clarification about how a taxpayer can satisfy the requirement that construction of a renewable energy project began before January 1, 2014. The Notice, released on August 8, 2014, is welcome news for the renewable energy industry, which has been anxiously awaiting further guidance with respect to two aspects of the so-called “begin construction” requirement. The Notice addresses those two aspects and modifies a third aspect of the requirement.
The American Taxpayer Relief Act of 2012 (the2012 Act) changed the requirement underSection 45 of the Internal Revenue Code of 1986 (the Code) that a facility be placed in servicebefore January 1, 2014, to the requirementthat construction of the facility must havebegun before January 1, 2014. This modificationapplies to wind, closed-loop biomass, open-loopbiomass, geothermal energy, landfill gas,municipal solid waste, qualified hydropower andmarine and hydrokinetic facilities that claim theproduction tax credit (the PTC) under Section 45 of the Code or that, instead, elect toclaim the investment tax credit (the ITC) under Section 48(a)(5) of the Code.
Notice 2013-29,1 as clarified by Notice 2013-602 (together, the Original Notice), provides two alternative methods to establish that construction of a qualified facility began before January 1, 2014: (i) starting physical work of a significant nature before January 1, 2014 (the Physical Work Test) or (ii) paying or incurring at least 5 percent of the total cost of the facility before January 1, 2014 (the Safe Harbor). Pursuant to the Original Notice, the Physical Work Test requires that the taxpayer maintain a continuous program of construction after starting physical work (the Continuous Construction Test), and the Safe Harbor requires that the taxpayer maintain continuous efforts to advance toward completion of the facility after paying or incurring 5 percent of the total costs (the Continuous Efforts Test). Notice 2013-60 clarified that a facility will be considered to satisfy the Continuous Construction Test (for purposes of satisfying the Physical Work Test) or the Continuous Efforts Test (for purposes of satisfying the Safe Harbor) if the facility is placed in service before January 1, 2016.
How Much Physical Work?
Under the Physical Work Test, construction of a facility begins when physical work of a significant nature begins. The Physical Work Test does not require that a significant amount of physical work begin. Nevertheless, many industry participants erroneously read the example in Section 4.04(3) of Notice 2013-29, which illustrates what constitutes a single facility, as requiring a minimum amount of physical work in 2013 to demonstrate that physical work of a significant nature began. In the Notice, the IRS clarifies that the Physical Work Test “focuses on the nature of the work performed, not the amount or cost.” To support that clarification, the Notice quotes three examples from the Original Notice:
Section 4.02 of Notice 2013-29 provides:[I]n the case of a facility for the production of electricity from a wind turbine, on-site physical work of a significant nature begins with the beginning of the excavation for the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation.
Section 4.05(1) of Notice 2013-29 provides: [P]hysical work on a custom-designed transformer that steps up the voltage of electricity produced at the facility to the voltage needed for transmission is physical work of a significant nature with respect to the facility because power conditioning equipment is an integral part of the activity performed by the facility.
Section 4.05(2) of Notice 2013-29 provides:Roads that are integral to the facility are integral to the activity performed by the facility; these include onsite roads that are used for moving materials to be processed (for example, biomass) and roads for equipment to operate and maintain the qualified facility. Starting construction on these roads constitutes physical work of a significant nature with respect to the facility.
The Notice underscores the point by stating that “[b]eginning work on any one of the activities described above will constitute physical work of a significant nature” (emphasis added). The Notice also dispels any notion that the example in Section 4.04(3) of Notice 2013-29, which described excavation of sites for 10 out of 50 turbines in a project, was “intended to indicate that there is a 20% threshold or minimum amount of work required to satisfy the Physical Work Test.”
Notice 2013-29 addresses the effect of a transfer of a facility by stating that Section 45(d)(1) “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 credit.” Notwithstanding this statement, uncertainty remained in the industry regarding what constitutes a facility—including whether certain equipment constitutes a facility that can be transferred and used in a project, thereby qualifying the project under the Safe Harbor. The Notice reiterates that “there is no statutory requirement that the taxpayer that places the facility in service also be the taxpayer that begins construction of the facility.” The Notice also clarifies that, subject to a significant limitation on transfers of equipment between unrelated parties, “a fully or partially developed facility may be transferred without losing its qualification under the Physical Work Test or the Safe Harbor for purposes of the PTC or ITC.”
The limitation on transfers is with respect to “a transfer consisting solely of tangible personal property,” or what is sometimes referred to as “naked equipment” or “golden turbines.” In such cases, the Notice provides that the work performed or amounts paid or incurred may not be taken into account by a transferee that is not related to the transferor. For this purpose, the Notice incorporates a standard by which a transferor that owns 20 percent or less of the transferee (and a transferee that owns 20 percent or less of the transferor) generally will be considered unrelated. Thus, in general, either the transferor must own more than a 20 percent interest in the transferee, or the transferee must own more than a 20 percent interest in the transferor, in order for the transferee to be able to take into account work performed or amounts paid or incurred by the transferor. This limitation effectively precludes outright sales of any naked equipment or golden turbines.
The Notice also clarifies that a taxpayer may relocate equipment and other components of the facility to a different site, complete development and place it in service.
Safe Harbor Modification
The Notice modifies the Safe Harbor in the case of a single project comprised of multiple facilities. In such cases, if the taxpayer paid or incurred at least 3 percent of the total cost of the project before January 1, 2014, the Safe Harbor may be satisfied with respect to some, but not all, of the 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 20 times the amount the taxpayer paid or incurred before January 1, 2014. This is a new standard that appears to impose a new, 3 percent minimum on the ability of a taxpayer to redefine a project where the Safe Harbor is not satisfied for the entire project but may be satisfied with respect to individual facilities in such project.
The Notice reiterates that the Safe Harbor will not apply if the amount a taxpayer paid or incurred before January 1, 2014, with respect to the total cost of a single facility that cannot be separated into individual facilities is less than 5 percent of the total cost of the facility.
1 See our prior Legal Update on Notice 2013-29 at http://www.mayerbrown.com/files/Publication/4b61449f-ad77-4294-bfd0-4fcb96dc8405/Presentation/PublicationAttachment/82e93b2b-7b8d-4b68-b9fb-5a07b7687ceb/Renewable_Energy_041613%20.pdf2 See our prior Legal Update on Notice 2013-60 at http://www.mayerbrown.com/IRS-Clarifies-Beginning-Construction-Guidance-For-Renewable-Energy-Projects-09-23-2013/