After several months of anxious anticipation, yesterday the IRS released guidance on its interpretation of certain provisions relating to Congress’ extension of the federal Production Tax Credit (“PTC”).
Specifically, the provisions in question relate to how far along in development a project will need to be in order to qualify for the PTC before the credit expires on January 1, 2014. In January of 2013, Congress passed the American Taxpayer Relief Act of 2012. Among the many provisions in that legislation, Congress agreed to extend the then-expired PTC so that it would include projects that have begun construction before January 1, 2014. This represented a welcome departure from prior versions of the PTC statute, which required projects to be “placed in service” by the deadline, as opposed to having to “begin construction.”
Though this modification was excellent news for the wind industry, replacing the “placed in service” requirement with a “begin construction” requirement created some ambiguities in how the statute would be interpreted and applied by the IRS. What does it mean to “begin construction” in this context? How much money will need to be spent? What kinds of activities will qualify? While there was some previous precedent for a similar “begin construction” requirement with the Section 1603 Grant program, there was no guarantee that the IRS would apply a similar rationale to the PTC extension. Though it is impossible to measure the exact impact of this ambiguity, there is little doubt that the uncertainty about what it means to “begin construction” created some degree of a chilling effect on wind developments in the first quarter of 2013.
In an effort to resolve this issue, IRS has released Notice 2013-29, entitled “Beginning of Construction for Purposes of the Renewable Electricity Production Tax Credit and Energy Investment Tax Credit.” Using the Section 1603 standards as a guide, IRS states that there are two methods for satisfying the “begin construction” requirement:
1.) Starting physical work of a significant nature; or
2.) Meeting a safe harbor threshold by paying or incurring 5% of more of the total cost of the facility and thereafter making continuous efforts to advance towards completion.
Physical Work of a Significant Nature
The first alternative is to begin construction before January 1, 2014. The IRS Notice makes clear that “[c]onstruction of a qualified facility begins when physical work of a significant nature begins,” whether performed by the taxpayer or by other persons for the taxpayer under a binding written contract.
Ultimately, the determination of whether activities qualify as “physical work of a significant nature” is a judgment call by the IRS based upon the relevant facts and circumstances of a particular project. However, IRS does provide the following guidelines:
- Both on-site work (excavation of the faoundation, setting of anchor bolts, pouring of concrete pads) and off-site work (manufacturing of components if performed pursuant to a binding contract and not held in manufacturer’s inventory) may be taken into account;
- Production of property that is held or normally held in inventory by a vendor does not qualify; and
- Preliminary activities do not qualify, including the following:
The second alternative is to qualify for the PTC safe harbor by paying or incurring 5% or more of the total cost of the facility before January 1, 2014, and thereafter making continuous efforts to advance towards completion of the facility.
For the purposes of calculating the 5% threshold, all costs properly included in the depreciable basis of the facility are to be taken into account, not including the cost of land or any property not integral to the facility.
Construction of Individual Portions of Larger Projects
Answering a question that has been posed by many industry insiders over the past few months, the IRS Notice specifies that, for the purposes of determining whether construction of a facility has begun, work on individual turbines that are part of a larger project can qualify as work on the entire project. For example, a wind developer may commence work on some but not all of the planned turbines for a wind project and qualify as having begun construction for the entire project. It is not necessary to have begun construction of each individual turbine within that larger project. Whether a single facility will be deemed to be part of a larger project will be a question left to the discretion of the IRS, but the major factors considered are as follows:
Integral Versus Non-Integral Property
Construction of a wind project involves numerous small tasks, some of which are integral to the production of electricity and some are not. For the purposes of determining whether construction of a facility has begun, only tasks that are integral to the production of electricity will be counted.
Finally, in order to qualify the “physical work of a significant nature” standard, the taxpayer must engage in a continuous program of construction. As with many of the other requirements discussed above, this is determined through a facts and circumstances analysis by the IRS.
In regards to the “continuous efforts” standard for the 5% safe harbor, the IRS Notice provides the following list of factors which may be considered in determining whether there have been continuous efforts:
However, for both the Physical Work and theSafeHarboralternatives, the IRS does allow certain disruptions in construction that are beyond the taxpayer’s control, such as:
The IRS Notice briefly touches on one final point relating to situations where the costs of a single facility that is part of a larger project (i.e., a single wind turbine) ends up costing more than anticipated, and causes the total project cost to rise by the placed-in-service date such that the safe harbored funds no longer satisfy the 5% threshold. In that event, the Notice state that IRS will allow the PTC to be claimed with regards to some, but not all, of the individual turbines, but the total aggregate cost of the individual facilities for which the PTC will apply cannot be more than twenty times the amount of safe harbor funds that the taxpayer claimed prior to January 1, 2014.
If you have any questions about the IRS Notice or the requirements discussed therein, please feel free to leave a comment below or contact the Polsinelli Energy Group at (913)234-7416 or firstname.lastname@example.org.