Since the creation of the grant in lieu of tax credit program in the Recovery Act of February 2009, representatives of the IRS and U.S. Department of the Treasury have spoken frequently at public forums and received substantial public feedback on the program. In an apparent recent effort to improve the effectiveness and applicability of the Grant program, two significant clarifications were announced. One defines "commencement of construction," which affects Grant eligibility. The other allows tax-exempt entities to benefit indirectly from program participation.
The Grant program provides a grant in lieu of tax credit equal to 30 percent of the project costs for solar, wind, biomass, geothermal, fuel cell, waste energy, hydropower, and marine power projects, and 10 percent of the project costs for microturbines, thermal heat pump systems, and combined heat and power (cogeneration) systems. Projects must either have begun operation in 2009 or 2010 or commence construction by the end of 2010 to qualify for the Grants, which are paid within 60 days of the later of a project’s completion or submission of a Grant application to the Treasury.
When Construction Begins
On March 15, 2010, the Treasury revised the Grant program guidelines to help applicants determine whether the project will satisfy the requirement to commence construction before the end of 2010. The revised guidelines state that the date construction begins can be determined either by showing that physical work of a significant nature occurred in 2010 or that more than 5 percent of the total project costs were incurred during 2010.
In a welcome expansion of the previous guidelines, both on-site and off-site work is considered in determining whether physical work of a significant nature occurred during 2010. As an example, the guidance states that significant physical work for a wind turbine begins at the site when the foundation is excavated, anchor bolts are set into the ground, or the foundation's concrete pads are poured. Significant physical work begins for components that are manufactured off site and delivered to the site when the components begin to be manufactured at the off-site location. Preliminary activities such as designing or planning the project, obtaining project financing, drilling test wells, or general site preparation, however, are not considered significant physical work, although those expenses, assuming they are included in the tax basis of the project, will be included in the calculation of total project costs.
The guidelines provide for different rules depending on whether the applicant is self-constructing the project or constructing the project by contract with another party. If the applicant is self-constructing, manufacturing, or producing property for use by the applicant in its trade or business or for the production of income, the work performed by the applicant is taken into account in determining when significant physical work begins.
When the work is performed for the applicant by another person under a written contract, that work is taken into account in determining when significant physical work begins, as long as the contract is considered binding. A contract is typically considered binding if it meets the following conditions: (i) it is enforceable under state law, (ii) damages are not limited to 5 percent or less of the total contract amount, (iii) the contract does not provide for a full refund of the contract price in case of breach or cancellation, (iv) any condition in the contract is not within the control of either party, and (v) only insubstantial changes to terms and conditions of the contract are subsequently made to the contract by the parties.
Safe Harbor. In addition, the guidelines describe a safe harbor—significant physical work is considered to have begin when more than 5 percent of the total cost of the property has been paid or incurred. Costs incurred on a project for both self-constructed components and components constructed by others may be combined to determine whether more than 5 percent of the total costs have been paid or incurred. Under these guidelines, it is extremely important to have methods of tracking both on-site and off-site expenses for the project property to ensure that the costs have been properly paid or incurred to satisfy the safe harbor requirements beforethe end of 2010. The safe harbor is applied to the total actual project costs, not the budgeted costs, so it is essential to build in a cushion for cost overruns when complying with the safe harbor guidelines.
In addition to providing broader criteria under which a project may qualify for a Grant due to the determination of whether construction has started, rules related to the involvement of tax-exempt entities have also been expanded.
Lease Arrangements for Tax-exempt Lessees
Under federal tax law, if a developer of renewable energy equipment leases the equipment to a tax-exempt entity it may not claim a 30 percent investment tax credit (ITC) because the property would be considered "tax-exempt use property." In addition, five -year accelerated depreciation may not be claimed by the lessor/owner on the property.
The legislation creating the 1603 Grant provided that the Secretary of the Treasury must apply rules "similar" to the ITC rules in administering the Grant. Many practitioners had expected that the same rule would apply to the Grant program. In the official guidance issued by Treasury related to the Grant program, however, there is no discussion of the tax-exempt use property rule. Earlier this year, however, a response to a question about property leased to a tax-exempt or otherwise ineligible entity was posted on the Frequently Asked Questions section of the official Treasury Grant program Web site, indicating that if an energy property owner "is otherwise eligible, the fact that the property is being leased to an ineligible entity does not impact the eligibility of the owner/applicant provided it is a true lease and not a disguised sale."
Although this response appears to be inconsistent with the tax-exempt use property rules applicable to the ITC, we understand that Treasury was specifically aware of this inconsistency when it posted the Frequently Asked Questions response. Of course, while the posted Web site response constitutes "guidance" from the Treasury, it is not a formal ruling issued by the IRS, and it should be applied cautiously. Nevertheless, this new guidance, though informal, constitutes a change of policy that may be extremely beneficial to schools, churches, and governments. We recommend that those interested in pursuing this new lease option seek legal advice regarding how to structure the lease within the IRS "true lease" guidelines consistent with the requirement that the project commence construction by December 31, 2010.