On April 15, 2013, the U.S. Internal Revenue Service issued Notice 2013-29, addressing the new requirement under Section 45 of the Internal Revenue Code that certain renewable energy projects must “begin construction” in 2013 to qualify for the Section 45 production tax credit (“PTC”) or for the Section 48 investment tax credit (“ITC”). The IRS guidance closely follows the standards previously developed by the U.S. Department of Treasury for determining whether an eligible renewable energy project qualified for a cash grant (in lieu of tax credits) under the Section 1603 program that was part of 2009’s American Recovery and Reinvestment Act. While the similarities to the Treasury cash grant program will bring much-needed certainty for project developers and investors, there are also a number of new wrinkles in the Notice that will raise interpretive questions for credit-eligible projects.
The American Taxpayer Relief Act, enacted in late December 2012, modified the basis for qualifying for PTCs and ITCs (where the ITC is available by election of the taxpayer pursuant to Section 48(a)(5)(C)). Previously, an otherwise eligible project was required to be “placed in service” by a specified date to earn the tax credit. The Act extended the credit expiration deadline for wind energy facilities through 2013 (the deadline for other eligible technologies remains 2014), but more significantly changed the eligibility criteria so that qualifying projects need not be “placed in service” by the end of 2013, but instead need only “begin construction” this year. This change was intended to address industry concerns that the last-minute deadline extension would not allow enough time for otherwise eligible wind projects to be completed before the end of 2013, given the lengthy development and construction schedule for such projects.
Like the Section 1603 program guidance, the Notice provides two methods by which a taxpayer can establish that it “began construction” of an eligible renewable project in 2013. A taxpayer may establish the start of construction on a project by (i) performing “physical work of a significant nature” on the project in 2013, or (ii) paying or incurring at least five percent of the total costs of the project in 2013. In each case, the taxpayer must thereafter make a “continuous effort to advance towards completion” of construction of the project. Notably, the “continuous construction” condition was not present in the Section 1603 guidance for use of that program’s five percent “safe harbor.”
Whether a taxpayer makes continuous efforts to advance completion of a renewable energy facility will depend on the relevant facts and circumstances, and according to the Notice, the IRS will “closely scrutinize” whether such a continuous program has been maintained by the taxpayer. The Notice does provide that events outside the developer’s control that impede construction, such as severe weather, permitting delays, or equipment supply shortages, will be taken into account in determining whether there was a continuous program of construction. Financing delays may also be treated as outside the developer’s control, but only for delays of up to six months. Nevertheless, this new condition injects an element of subjectivity, and hence greater risk, into what was a straightforward, bright-line test for the five percent safe harbor as developed under the former cash grant program.
The Notice also includes a number of factors—most of which were part of the Section 1603 guidance—that will help clarify the kinds of off-site and on-site work that would constitute “physical work of a significant nature.” For example, “preliminary activities” such as permitting, testing, clearing or grading the site, or removing existing turbines or towers do not constitute “physical work” under the Notice, but work on a stepup transformer or structures integral to the power generation activity of the renewable project would qualify.
Similar to the Section 1603 program, a taxpayer may rely on “physical work” performed by another person under a “binding written contract” entered into before such work commenced. As with the Section 1603 guidance, the Notice states that such a contract may not limit damages to a specified amount, such as by use of a liquidated damages provision, but a provision limiting damages to at least five percent of the contract price will not run afoul of this restriction.
The Notice also includes a special provision defining “facility” that may benefit wind project developers in particular. Specifically, the Notice states that where multiple “facilities” (e.g., wind turbine generators) are operated as part of a “single project” (based on various factors spelled out in the Notice), commencing construction on only a portion of such project will be sufficient to qualify for the PTC, as long as the taxpayer thereafter completes construction of the entire facility pursuant to a continuous program of construction. Consequently, it is not necessary, for example, for a wind project developer to excavate foundations for each wind turbine generator and tower that comprises a single project to have “commenced construction” on the project.
These significant changes to the tax credit eligibility criteria should provide an immediate boost to a wind power sector facing uncertain growth prospects in an environment of low power prices. Developers can take comfort that the IRS in its Notice has largely mimicked the rules that governed the highly successful Treasury cash grant program. However, by introducing a new requirement for continuous construction of projects that seek to qualify for tax credits under the five percent safe harbor, the Notice adds a dose of uncertainty to the process for securing tax credits. The potential risk of losing tax benefits could cause concerns for project developers and especially their tax equity investors. It may be possible to obtain clarification by seeking a private letter ruling or additional public guidance from the IRS. Since either type of IRS action can take three to six months on average, developers and industry groups may need to act promptly to get answers within a meaningful time frame.