The Treasury Department recently revised its guidance concerning the "beginning of construction" requirement for qualifying for the cash grant in lieu of tax credits (the Treasury Grant) for certain renewable energy projects placed in service after 2010. The revised guidance is generally favorable to applicants.
Overview of the Beginning of Construction Requirement
The American Recovery and Reinvestment Act of 2009 (ARRA) provides that a project qualifies for the Treasury Grant if, among other requirements, the project is placed in service in 2009 or 2010 or, if construction begins in 2009 or 2010, is placed in service by the applicable credit termination date (currently the end of 2012 for wind, the end of 2013 for biomass, geothermal and other resources, and the end of 2016 for solar).
With the December 31, 2010 placed-in-service deadline looming, the beginning of construction requirement has become increasingly important to developers, lenders and investors alike. Written guidance published by the Treasury Department in July 2009 and revised earlier this month provides generally that construction begins when "physical work of a significant nature begins." The guidance also provides a safe harbor pursuant to which an applicant may treat construction as beginning when the applicant pays or incurs more than 5 percent of the total cost of the property.
Physical Work of a Significant Nature
The revised guidance clarifies that off-site work may be taken into account for purposes of demonstrating that physical work of a significant nature has begun. For example, if wind turbine generators are to be assembled on site from components manufactured off-site, the manufacture of the components at the off-site location is taken into account in determining whether such physical work is significant. The guidance also provides that if a manufacturer produces components for multiple facilities, "reasonable methods" must be used to associate individual components with particular facilities.
Pursuant to the prior guidance, an applicant could treat construction as beginning when the applicant paid or incurred more than 5 percent of the total cost of the property. However, the guidance required that the so-called "economic performance" requirements be met for a cost to be treated as paid or incurred. As a result, pursuant to the prior guidance, an applicant on the accrual method of accounting would not have incurred a cost until the relevant property was provided to the applicant.
The revised guidance significantly expands the safe harbor by allowing certain costs incurred by a manufacturer or contractor to be taken into account. To qualify for this special rule, the property must be manufactured or constructed for the applicant by another person under a "binding written contract" as defined in the guidance. In addition, the contract must be entered into before the property is manufactured or constructed (i.e., the property cannot be inventory already on the manufacturer's shelf). If these conditions are met, costs paid or incurred by the manufacturer or contractor are taken into account when paid or incurred by the manufacturer or contractor. A Treasury official has indicated informally that the costs taken into account under the special rule will include material and labor costs but will not include the manufacturer's profit margin. (There also has been some speculation that Treasury will adopt a rule pursuant to which costs paid or incurred by the manufacturer or contractor will be taken into account as long as property is delivered before 3 ½ months after the time of payment. A Treasury official has informed us that Treasury has not yet adopted such a rule.)
The revised guidance clarifies that if the property includes both self-constructed components and components constructed by someone other than the developer under a binding contract, the costs of both are combined for purposes of determining whether the 5-percent threshold has been met. The new guidance also provides that all costs, and only those costs, that are included in the grant-eligible basis are taken into account in determining whether the 5-percent threshold has been met.
The changes made in the revised guidance will help provide certainty to developers of and investors in projects that will not be placed in service by the end of 2010. As with the prior guidance, however, the revised guidance does leave some questions unanswered (e.g., how an applicant is to determine the amount of costs incurred by the manufacturer or contractor). Treasury is continuing to meet with interested parties and is expected to release additional guidance in due course.