The Section 1603 cash grant program has encouraged investments in solar, wind, and other non-traditional energy projects since its enactment in 2009. The latest U.S. Treasury estimates indicate that nearly 20,000 grants have been awarded with total funding in excess of $9 billion. These grant payments have aided the renewable energy sector considerably. For example, as reported by the Solar Energy Industries Association (SEIA), the U.S. solar industry grew by 69 percent in 2010, doubling the nation's installed solar energy generation capacity over the prior year. Apparently, the Section 1603 program is one of those good things that must come to an end; the program is scheduled to expire at the end the year. After 2011, only eligible energy projects that began construction during 2009 – 2011 and are “placed in service” (meaning, ready and available for their intended use) prior to the property's assigned “credit termination date” may qualify for a Section 1603 cash grant. This means that for projects currently on the drawing board, developers need to make sure they are taking sufficient actions now in order for such projects to qualify for Section 1603 cash grants.
Begin Construction in 2011
Section 1603 requires that the grant applicant “begin construction” on specified energy property prior to the end of 2011. As provided in the Section 1603 guidance from Treasury (issued in 2010), to demonstrate the commencement of construction, one (and only one) of the following must be satisfied:
1. Actual Physical Activity. The applicant will satisfy the construction commencement requirement if “physical work of a significant nature” has started on the specified energy property. Physical work of a significant nature includes any physical work on the specified energy property either on-site or off-site. It also includes physical work under a binding written contract with another person (e.g., a vendor), provided the contract is entered into prior to the work taking place. While any physical work on the specified energy property will be treated as the beginning of construction (even if such work relates to only a small part of the facility), Treasury will closely scrutinize any construction activity that does not involve a continuous program of construction. In other words, once physical work begins on the specified energy property at issue, it should continue through completion of construction. That said, events beyond the applicant's control — like weather disruptions — will be taken into account by Treasury in determining whether construction is continuous.
The Section 1603 guidance makes clear that to demonstrate the commencement of construction, only physical work performed with respect to “specified energy property” will qualify. As defined in related Treasury regulations, this is limited to tangible personal property and other tangible property used as an integral part of the qualifying energy project and located at the site of the project.
The Section 1603 program guidance provides the following clarifications that are helpful to applicants seeking to demonstrate actual physical activity:
- Physical work of a significant nature does not include preliminary activities such as planning or designing, securing financing, exploring, researching, clearing a site, obtaining permits, test drilling of a geothermal deposit, test drilling to determine soil condition, or excavation to change the contour of the land (as distinguished from excavation for footings and foundations).
- Starting work on roads on the site is physical work of a significant nature if such roads are integral to the qualified facility (such as roads used for equipment to operate and maintain the facility), because such roads constitute specified energy property. Roads for access to the site, or roads used solely for employee or visitor vehicles are not specified energy property and thus do not demonstrate that construction has commenced.
- Beginning construction of a building that will be used for operations and maintenance is not physical work of a significant nature, because such building is not specified energy property.
- Work performed under a binding written contract does not include work to produce components or parts that are in existing inventory or are normally held in inventory by a manufacturer.
- Work performed under a binding written contract does not include work on property that will not become specified energy property of the applicant.
- If an applicant has a binding written contract with a contractor that is manufacturing specified energy property for a number of customers, physical work on the property will only be considered work performed under the applicant's binding written contract if the contractor can reasonably demonstrate that physical work has started on components that will become specified energy property of the applicant. The contractor may use any reasonable, consistent method to allocate work it performs among its customers.
- If work performed under a binding written contract otherwise meets the requirements for physical work of a significant nature and work on the project is continuous, the fact that the specific site of the project has not been identified at the time of the initial application (or changes after the initial application) does not impact whether or not construction has begun.
2. Actual Cash Expenditure. As an alternative to demonstrating actual physical activity, an applicant may satisfy the construction commencement condition by demonstrating that it has paid or incurred five percent or more of the total cost of the specified energy property prior to the end of 2011 (the 5% Safe Harbor). Only costs that are included in the eligible basis of the specified energy property are taken into account in determining if the 5% Safe Harbor has been satisfied.
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 (e.g., making a nonrefundable deposit) is generally sufficient to establish that such expense has been paid. In contrast, 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 is fixed, 2) the amount of the liability is determinable with reasonable accuracy, and 3) either a) the contracted-for services or property have been provided to the taxpayer or b) the taxpayer has paid for such services or property and reasonably expects such services or property to be provided within three and a half months of payment.
The Section 1603 program guidance provides a special rule for property that is the subject of a binding written contract that is entered into prior to the manufacture, construction, or production of the specified energy property at issue. In this case, for periods before the property is delivered to the applicant, costs paid or incurred by the contractor with respect to the property are treated as costs that are paid or incurred by the applicant.
For projects relying on the 5% Safe Harbor that have an estimated eligible cost basis of $1 million or more, the applicant must submit with the grant application a report from an independent accountant verifying that the 5% Safe Harbor has been satisfied.
The Section 1603 guidance provides the following additional clarifications for demonstrating construction commencement by satisfying the 5% Safe Harbor:
- For property manufactured, constructed, or produced by a contractor under a binding written contract, the applicant may rely on a statement by such contractor, signed under penalty of perjury, as to the amount incurred by the contractor with respect to such property under the contract. The contractor may use any reasonable, consistent method to allocate the costs incurred by the contractor among the units of property to be manufactured, constructed, or produced by such contractor. Only costs incurred by the contractor after the binding written contract is entered may be reasonably allocated to the property provided under that contract.
- Property is considered to have been provided to the applicant either when title to the property passes to the applicant or when it is delivered to or accepted by the applicant, depending on the applicant's method of accounting.
- Costs paid or incurred by a developer under a master contract entered into prior to the manufacture, construction, or production of property may be allocated to an affiliated special purpose entity (such as a new LLC) that will own the project for which such property is to be used, where the developer has assigned to such entity its rights to certain units of property under the master contract.
- To satisfy the 5% Safe Harbor, applicants must demonstrate that costs paid or incurred before the end of 2011 are equal to or greater than five percent of the actual total costs of the specified energy property. If the project's total costs are more than expected, then the 5% Safe Harbor may not be satisfied (depending on the actual amount expended before the end of 2011). However, if the applicant's project includes multiple units of specified energy property, the applicant may opt to apply for a Section 1603 grant based on some, but not all, units of property (thereby satisfying the 5% Safe Harbor).
Be Mindful of the Credit Termination Date
Notwithstanding when construction commences, for specified energy property to qualify for a Section 1603 grant, it must be placed in service no later than the “credit termination date” assigned to such property. The following chart lists the credit termination dates for each specified energy property:
Click here to see table
For large-scale wind projects, the credit termination date of January 1, 2013 obviously will create tremendous pressure on developers that are still in the planning stages to complete these projects in time to qualify for the Section 1603 grant.
Submit a Preliminary Grant Application
The Section 1603 program requires the applicant to submit a grant application after construction has begun but in no event later than September 30, 2012. This requirement applies to all specified energy property, whether or not such property is placed in service by the application deadline. 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 approaching expiration of the Section 1603 program underscores the importance of taking actions today to ensure that an otherwise qualifying energy project will be eligible for a cash grant. Because applicants will need to demonstrate that construction of their projects began in 2011 — either by undertaking actual physical activities or by satisfying the 5% Safe Harbor — the applicant's actions needed today depend on the specified energy property at issue.
Get Working! For wind projects that must be completed by January 1, 2013 (and similarly, for projects with a credit termination date of January 1, 2014), developers may want to double their efforts to ensure that the projects will be placed in service in time to qualify for the Section 1603 grant. For borderline projects, the developer may want to consider whether the project can be broken into components to allow part of the project to be placed in service prior to the credit termination date. A partial Section 1603 grant is better than none at all!
Start Stockpiling! For solar and other specified energy property that must be completed by January 1, 2017, developers should focus on satisfying the 5% Safe Harbor in 2011. The 5% Safe Harbor is preferable in these cases to demonstrating actual physical work because the 5% Safe Harbor does not require continuous construction. Purchased specified energy property in amounts sufficient to demonstrate that the 5% Safe Harbor has been satisfied can then be incorporated into future development projects. Because a grant application relying on the 5% Safe Harbor requires a report from an independent accountant verifying that the 5% Safe Harbor has been satisfied in 2011 — if the project has a cost of $1 million or more — it is important to get the accountants involved as soon as possible to ensure that they are comfortable with the applicant's plan for establishing that construction has commenced. Similarly, if the developer intends to satisfy the 5% Safe Harbor by relying on a statement from its contractor establishing that the contractor has paid or incurred costs under a binding written contract, the developer should verify now that 1) the contractor will be willing to sign this statement under penalty of perjury and 2) the developer's independent accountant is comfortable relying on the contractor's statement for purposes of preparing its report.
By being attentive to these requirements, developers may qualify projects for the Section 1603 program and receive cash grants that would otherwise be unavailable