On June 22, 2018, the IRS issued Notice 2018-59 (the “Notice”), which provides much anticipated guidance for determining when construction has begun under Section 48 of the Internal Revenue Code for taxpayers seeking investment tax credits (“ITCs”) for certain solar (and other) energy property. The Notice substantially mirrors the guidance previously issued by the IRS in the context of wind energy facilities (the “Wind Guidance”) and provides taxpayers with some much-needed certainty for the solar energy industry in determining eligibility for the ITC. Please see our prior discussions of the Wind Guidance, here (Notice 2017-04), here (Notice 2016-31), here (Notice 2013-60), and here (Notice 2013-29).
Solar energy property developers and tax equity investors should be particularly pleased to see that the Notice adopts the “Five-Percent Safe Harbor” and the “Continuity Safe Harbor” from the Wind Guidance, each of which is discussed below. Both safe harbors are taxpayer friendly and should go a long way to bring clarity as to qualification of solar energy projects for the ITC.
Preliminary industry response has generally been positive, with many expecting increased investment in solar energy projects as taxpayers begin to take advantage of the safe harbors. We expect that the Continuity Safe Harbor in particular will be beneficial for taxpayers seeking to maximize their ITC amount.
While the discussion below is a high-level summary of the Notice and generally focuses on solar energy property, the Notice is applicable to certain other energy property, including fiber-optic solar energy, geothermal property, qualified fuel cell property, qualified microturbine property, combined heat and power system property, qualified small wind energy property and geothermal heat pump property.
Should you have any questions or concerns about the impact the Notice may have on your business, please contact any of the authors of this update.
I. Background of the ITC for Solar Property
A taxpayer is entitled to an ITC equal to a certain percentage (the “Energy Percentage”) of the basis of qualifying energy property placed in service during the taxable year. For solar energy property, the Energy Percentage is 30 percent if the taxpayer begins construction on the solar energy property (the “Commencement of Construction Standard”) before January 1, 2020, if the solar energy property is placed in service before January 1, 2024, and if the taxpayer makes continuous progress towards completion. The Energy Percentage phases down depending on when the taxpayer commences construction and when the solar energy property is placed in service, bottoming out at 10% for projects that commence after 2021.
For years, the solar energy industry has requested that the IRS issue guidance on certain requirements to qualify for the ITC, including what it means for a taxpayer to commence construction on solar energy property. Taxpayers were optimistic that, when the IRS issued the first piece of the Wind Guidance in 2013, guidance for solar energy property was imminent. Until the Notice was issued, however, taxpayers have had to rely on analogies to the Wind Guidance, even though such guidance expressly stated that it did not apply to solar energy property, and to guidance under Section 1603 of the American Recovery and Reinvestment Tax Act of 2009 (the “ARRTA Guidance”), which created a cash grant in lieu of an ITC or a production tax credit for specified energy property placed into service in certain years.
II. The Notice
A. The Commencement of Construction Standard
In order to meet the Commencement of Construction Standard, the Notice provides two alternative tests, based on the tests from the Wind Guidance: the “Physical Work Test” or the “Five-Percent Safe Harbor.” Under the Physical Work Test, taxpayers generally must show that physical work of a significant nature has begun on the solar energy facility—a facts and circumstances inquiry. Under the Five-Percent Safe Harbor, a taxpayer can satisfy the Commencement of Construction Standard if the taxpayer has paid or incurred five percent or more of the total cost of the solar energy project before the deadline. The total cost of the project generally includes all costs paid or incurred by the taxpayer properly included in the depreciable basis of the project, but does not include the cost of land or any property not integral to the activity performed by the facility. The Notice also provides helpful guidance for applying these tests when the work is being performed for the taxpayer by a third party under a binding written contract, when the final costs exceed prior estimates, when multiple solar energy properties compose a single project, and when projects incorporate used components that, in each case, generally incorporate standards in the Wind Guidance.
B. The Continuity Requirement
Once the Commencement of Construction Standard is met under either the Physical Work Test or the Five-Percent Safe Harbor, the taxpayer must maintain a continuous program of construction (the “Continuity Requirement”). For the Physical Work Test, a continuous program involves continuing physical work of a significant nature—another facts and circumstances inquiry. For the Five-Percent Safe Harbor, the taxpayer must also demonstrate continuous efforts to advance towards completion, including the payment of additional amounts included in the costs of the energy property, entering into binding written contracts for additional property or work, obtaining necessary permits and performing physical work of a significant nature.
C. The Continuity Safe Harbor
As mentioned, one of the most taxpayer friendly and welcome provisions of the Notice is the safe harbor pursuant to which a taxpayer may satisfy the Continuity Requirement (the “Continuity Safe Harbor”). Under this safe harbor, a taxpayer is deemed to satisfy the Continuity Requirement if it places into service the energy property within the end of the calendar year that is no more than four calendar years after the calendar year during which construction began. For example, if construction began on January 15, 2018, the Continuity Safe Harbor is satisfied if the property is placed in service by December 31, 2022. If a taxpayer cannot meet the Continuity Safe Harbor, the taxpayer may still be able to show that the Continuity Requirement is met under the either the Physical Work Test of the Five-Percent Safe Harbor through the relevant facts and circumstances.
D. Energy Property
The Notice provides some limited guidance as to what constitutes solar energy property (and other energy property eligible for the ITC). Consistent with the Wind Guidance and the ARRTA Guidance, energy property generally includes property up to, but not including, the transmission stage, with a bright line drawn at the inverter, transformer or other power conditioning equipment.
E. Other Aspects of the Notice
In addition to the big items—the Physical Work Test, Five Percent Safe Harbor and the Continuity Safe Harbor—the Notice imports numerous other concepts from the Wind Guidance, such as guidance on transfers of energy property and the impact of certain excusable disruptions.
Overall, the Notice provides certainty and welcome guidance to the solar industry. Not only does the Notice provide that the physical work of a significant nature standard in the Wind Guidance and the ARRTA Guidance can be used in the context of solar energy property (and other ITC-eligible energy property), but it also extends the safe harbors provided for wind energy facilities. As the result of these safe harbors, solar energy property sponsors and investors can act with greater certainty in making solar investments.
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