On September 20, 2013, the IRS released Notice 2013-60 (the “Notice”), clarifying the requirements that must be satisfied in order for certain renewable energy facilities to qualify for the Production Tax Credit (“PTC”) and the 30-percent Investment Tax Credit in lieu of the PTC (“ITC”).
Clarification of the Commencement of Construction Test
As part of the resolution of the fiscal cliff crisis at the end of 2012, Congress passed the American Taxpayer Relief Act of 2012 (the “ATRA”), which extended and modified the PTC and ITC. Under prior law, renewable energy facilities must have been “placed in service” before the applicable expiration date, which effectively required these facilities to have achieved commercial operation prior to that date. The ATRA modified these rules so that these facilities would be eligible for the PTC or ITC without regard to when the projects were placed in service so long as construction had begun before the end of 2013. However, the ATRA did not provide guidance for determining when construction begins.
On April 15, 2013, the IRS released Notice 2013-29, which was intended to clarify when construction begins. The guidance provided by Notice 2013-29 was the subject of a prior client update we issued on April 17, 2013, which can be found here.
Notice 2013-29 adopted a structure very similar to that used in connection with the grant program established as part of the Troubled Asset Relief Program in 2008 (the “1603 Grant Program”), which also had a “commencement of construction” requirement. The 1603 Grant Program adopted two alternative methods an applicant for the grant could use to satisfy the commencement of construction test: (i) an applicant could show that physical work of a significant nature had begun (the “Physical Work Test”) or (ii) an applicant could pay or incur 5% or more of the total cost of the specified energy project before the deadline (the “5% Safe Harbor”).
Treasury guidance implementing the 1603 Grant Program imposed on the Physical Work Test a requirement that, once physical work of a significant nature had begun, the applicant had to maintain a continuous program of construction. Because this requirement was a facts and circumstances test, and no such requirement was imposed in connection with the 5% Safe Harbor, many project sponsors found that tax equity investors much preferred the bright line test of the 5% Safe Harbor. As a result, most projects relied on the 5% Safe Harbor in order to qualify for the 1603 Grant Program prior to its expiration.
In Notice 2013-29, the IRS imposed a similar continuous construction requirement on the Physical Work Test for purposes of qualifying for the PTC or ITC. In addition, and unlike the 1603 Grant Program, Notice 2013-29 also imposed on the 5% Safe Harbor a requirement that the taxpayer maintain continuous efforts to complete the project. This was presumably intended to limit the ability of taxpayers to grandfather projects on a long-term basis by satisfying the 5% Safe Harbor in 2013 (e.g., by buying up wind turbines) but not constructing such projects until a later time period – a concern that did not exist under the 1603 Grant Program since that program had a specified deadline by which a project much have been placed in service, regardless of whether the applicant used the Physical Work Test or the 5% Safe Harbor. The imposition of the continuous efforts requirement on the 5% Safe Harbor by Notice 2013-29 generated a good deal of commentary, as it appeared to eviscerate the benefits of the safe harbor.
Resolving concerns raised by this commentary, Notice 2013-60 provides that, if a project satisfies either the Physical Work Test or the 5% Safe Harbor prior to January 1, 2014, such project will be deemed to satisfy the applicable continuous construction/continuous efforts test set forth in Notice 2013-29 if such project is placed in service prior to January 1, 2016. This change significantly liberalizes the requirements for qualifying for the ITC or PTC, especially since the construction horizon for most projects is considerably shorter than two years.
We expect these changes to ease the financing process for many project sponsors, since they will no longer be subject in all cases to the uncertainty of a “facts and circumstances” determination by the IRS, but instead should be able to rely upon the much clearer “placed in service” test.
Use of Master Contracts to Satisfy the 5% Safe Harbor
In Notice 2013-29, the IRS provided guidance that the use of a master contract in connection with the development of a project was permitted to be counted for purposes of satisfying the Physical Work Test. For example, a developer could enter into a master contract for the purchase of wind turbines and subsequently assign the rights to certain wind turbines under the master contract to a project-specific special purpose vehicle. The work performed under the master contract prior to such assignment could count towards satisfaction of the Physical Work Test for the applicable project. In Notice 2013-60, the IRS has clarified that the foregoing analysis also works for purposes of satisfying the 5% Safe Harbor.
In Notice 2013-60, the IRS has also clarified that the transfer of facilities after the commencement of construction and prior to the time they are actually placed in service does not affect the ability to qualify for the ITC or PTC. This is a change from the 1603 Grant Program, in which the IRS placed various limits on the ability of taxpayers to transfer facilities without disqualifying them from the ITC or PTC.
This Tax and Alternative Energy update is intended only to provide a general summary of certain tax provisions and the Notice. If you have any questions about any of these tax provisions or the Notice, please contact any Baker Botts tax or alternative energy lawyer, including the authors of this update listed above.
IRS Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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