On May 5, 2016, the Internal Revenue Service (the “IRS”) issued Notice 2016-31 (the “Notice”), which extends safe harbors available for determining when construction of a facility has begun such that the taxpayer is eligible for the renewable electricity production tax credit (“PTC”). The Notice also clarified the application of the safe harbors and the tests used to determine when construction has begun. The IRS revised the Notice on May 18, 2016, to make certain clarifications and corrections and to provide that the guidance applies to projects placed into service after January 2, 2013. This update discusses the Notice as revised.
In December 2015, Congress extended the PTC under Section 45 of the Internal Revenue Code of 1986, as amended (the “Code”), for two years with respect to certain facilities (e.g., biomass facilities, geothermal facilities and certain hydropower facilities) the construction of which begins before January 1, 2017, and wind facilities the construction of which begins before January 1, 2020. Congress also extended the investment tax credit (“ITC”) under Section 48 of the Code for solar energy facilities the construction of which begins before January 1, 2022. (We discussed these Congressional extensions in a prior client update, which can be found here.) The Notice does not address the extension of the ITC for solar facilities, which the IRS intends to address in separate guidance. However, the Notice does affect taxpayers that are eligible for the PTC but elect instead to use the ITC.
To be eligible for the PTC, construction of the qualifying facility must begin before the appropriate date (the “Construction Requirement”). In Notice 2013-29, the IRS provided two alternative tests under which a taxpayer may meet the Construction Requirement: the “Physical Work Test” and the “Five Percent Safe Harbor.” In either case, the taxpayer must make continuous progress towards completion of the facility (the “Continuity Requirement”). (Notice 2013-29 was the subject of a prior client update we issued on April 17, 2013, which can be found here.)
In Notice 2013-60, the IRS provided safe harbors (the “Continuity Safe Harbor”) under which a taxpayer is deemed to meet the Continuity Requirement if the facility was placed into service before January 1, 2016. If the taxpayer does not qualify for the Continuity Safe Harbor, whether the taxpayer meets the Continuity Requirement will be based on the relevant facts and circumstances. (Notice 2013-60 was the subject of a prior client update we issued on October 2, 2013, which can be found here.)
In Notice 2015-25 and as a result of the Congressional extension of the PTC, the IRS extended the Continuity Safe Harbor by one year to include facilities placed into service before January 1, 2017 if construction began before January 1, 2015.
2. Extension of the Continuity Safe Harbor
The Notice extends the Continuity Safe Harbor to four years from the end of the year in which construction began. Thus, a taxpayer who begins construction, as measured under either the Physical Work Test or the Five Percent Safe Harbor, will be deemed to meet the Continuity Requirement if the facility is placed into service by the later of (1) a calendar year that is no more than four calendar years after the year during which construction began or (2) December 31, 2016. For example, if a taxpayer began construction on January 15, 2016, and if the facility is placed into service on December 31, 2020, then the facility satisfies the Continuity Safe Harbor.
3. Clarification of the Continuity Requirement
The Notice prohibits a taxpayer from effectively extending the Continuity Safe Harbor period by using the Physical Work Test in one year then using the Five Percent Safe Harbor in a following year with respect to the same facility. Thus, a taxpayer cannot claim to have started physical construction in the first year but then choose to measure its Continuity Safe Harbor period from a subsequent year in which the taxpayer first meets the Five Percent Safe Harbor. In recent public comments following the issuance of the Notice, an IRS official indicated that the IRS may reconsider this rule.
For taxpayers who do not qualify for the Continuity Safe Harbor, the Notice expands limited relief to such taxpayers that experience excusable disruptions. Such excusable disruptions are not considered an indicator that the taxpayer has failed the Continuity Requirement. The non-exhaustive list in the Notice updated the list first provided in Notice 2013-29 by adding the following new excusable disruptions: (a) interconnection-related delays and (b) delays in the manufacture of component parts. In addition, while Notice 2013-29 listed financing delays of less than six months as an excusable disruption, the Notice lists financing delays generally as an excusable disruption without any reference to the length of such disruption.
4. Clarification of the Physical Work Test
The Physical Work Test requires that a taxpayer begin physical work of a significant nature. The Notice reiterates statements made in prior guidance that no fixed amount of work or monetary or percentage threshold is needed to satisfy the Physical Work Test provided that the work performed is of a “significant nature.” The Notice also expands upon earlier guidance as to the types of work that are of a significant nature and the types of work that are merely preliminary activities and not of a significant nature. Preliminary activities include, but are not limited to, planning and designing, securing financing, exploring, researching, geologic mapping and modeling, obtaining permits and licenses, conducting certain surveys and studies, clearing a site, conducting test drilling, excavating for contour purposes (as opposed to foundation and footing excavation), and removing existing components that will no longer be a part of the facility.
5. Aggregation/Disaggregation Guidance
The Notice provides guidance on the treatment of multiple facilities as a single facility for the purpose of determining whether construction has begun either under the Physical Work Test or the Five Percent Safe Harbor. Generally, whether multiple facilities are operated as part of a single project will be based on the relevant facts and circumstances. If multiple facilities are aggregated for the purpose of determining whether construction has begun, then the facilities may be disaggregated for the purpose of determining whether a disaggregated facility satisfies the Continuity Safe Harbor. If some disaggregated facilities do not meet the Continuity Safe Harbor, then the facts and circumstances test will be applied to determine whether those facilities meet the Continuity Requirement.
6. Five Percent Safe Harbor & Retrofitted Facilities
The Notice provides guidance as to the application of the Five Percent Safe Harbor to determine whether construction has begun on facilities that contain some used property. Generally, a facility may be a qualified facility despite having used property if the fair market value of such used property is not more than 20 percent of the facility’s total value. Nevertheless, in determining whether a taxpayer has satisfied the Five Percent Safe Harbor, the taxpayer can take into account only the expenditures paid or incurred with respect to new construction.
This update is intended only to provide a general summary of certain tax provisions and not to constitute tax advice for any particular situation. If you have any questions about any of these tax provisions or their applicability to your particular circumstances, please contact any of the authors of this update.