In response to the COVID-19 pandemic, the Internal Revenue Service (“IRS”) has issued Notice 2020-41 (the “Notice”) giving taxpayers an additional year to complete qualifying renewable energy projects that must otherwise have been placed in service in 2020 or 2021 in order to be certain of the projects’ eligibility for the expected tax credits. The IRS is also allowing taxpayers that acted to avoid a credit sunset at the end of 2019 by prepaying costs for property or services, initially for receipt in early 2020, until October 15, 2020 to receive such property or services and still lock in the 2019 credit amount.
Background—Beginning of Construction and Continuity Requirements
Sections 45 and 48 of the Internal Revenue Code (the “Code”) generally provide for, respectively, production tax credits (“PTCs”) and investment tax credits (“ITCs”) with respect to renewable energy projects, such as wind, solar, hydropower, and biomass facilities, among others. For purposes of determining the amount of the available PTC or ITC, construction on the energy project must have begun by a certain date.
The IRS had previously issued guidance providing that a taxpayer could show that construction had begun in a relevant year generally under one of two methods: (1) the “Physical Work Test” or (2) the “Five Percent Safe Harbor.” The Physical Work Test is generally met when physical work of a significant nature has begun with respect to the project, and the Five Percent Safe Harbor is generally met where the taxpayer pays or incurs 5 percent or more of the total cost of certain property integral to the project.
For purposes of the Five Percent Safe Harbor, a taxpayer generally may not treat a prepayment for property or services as an amount “paid or incurred” unless the taxpayer reasonably expects the property or services to be provided within 3 ½ months after the payment date (the “3 ½ Month Rule”).
Additionally, under either the Physical Work Test or the Five Percent Safe Harbor, the taxpayer generally must satisfy an applicable requirement for demonstrating continuous steps towards completing the project (the “Continuity Requirements”), which are facts and circumstances tests. A disruption beyond a taxpayer’s control generally should not cause a taxpayer to fail the applicable Continuity Requirement, including licensing delays, labor stoppages, financing delays, natural disasters, certain component manufacturing delays, and delays at the written request of a state or federal agency regarding matters of safety and security. However, the IRS has also provided a safe harbor, pursuant to which the Continuity Requirements are considered to be met if the project is placed into service by the end of a calendar year no more than four calendar years after the calendar year during which construction of the project began (the “Continuity Safe Harbor”).
Extension of Continuity Safe Harbor
In recognition of expected development and construction delays caused by the COVID-19 pandemic, in the Notice the IRS extended the Continuity Safe Harbor from four calendar years to five calendar years for projects which began construction in either 2016 or 2017. As a result, renewable energy projects that began construction in in 2016 and 2017 will satisfy the Continuity Safe Harbor if such projects are placed into service by the end of 2021 and 2022, respectively.
The Notice should provide significant relief to taxpayers who are currently developing renewable energy projects that were facing 2020 or 2021 placed-in-service deadlines. For example, wind developers rushing to complete projects in 2020 that were begun in 2016 now have until the end of 2021 to complete such projects and claim unreduced PTCs. While these taxpayers likely would have had strong arguments under the general facts-and-circumstances analysis of the Continuity Requirements that COVID-19-related delays were reasonable, the IRS has graciously saved taxpayers the worry of needing to substantiate and document the source and cause of such delays and allowed parties to focus on more pressing issues regarding the development of their projects. Because the amount of the PTC for qualifying wind facilities has been stepped down from 100% for projects begun after 2016, however, the extension granted to 2017 projects means that a 2017 project eligible for an 80% PTC and a 2018 project eligible for a 60% PTC would both be required to be placed in service by the end of 2022 to satisfy the Continuity Safe Harbor.
Deemed Satisfaction of 3 ½ Month Rule
The Notice provides that, in applying the Five Percent Safe Harbor, the 3 ½ Month Rule will be considered satisfied for all property or services paid by the taxpayer on or after September 16, 2019, as long as the taxpayer receives such property or services by October 15, 2020. While the Notice’s relief will not apply for property or services received after October 15, 2020, the 3 ½ Month Rule may still be satisfied based on the reasonable expectation of the taxpayer at the time of prepayment.
Developers who faced delivery delays in early 2020 may have already taken steps to ensure timely receipt of property, or alternatively may have taken the position that their originally anticipated date of receipt was and remained “reasonable” as of the date payment was made in 2019. Nevertheless, the Notice should give welcome comfort to such taxpayers that such delays did not jeopardize the intended tax treatment of their prepayments.
Considerations for Renewable Energy Projects
The extension granted by the Notice may make projects begun in 2016 and 2017 somewhat more attractive relative to 2018 and later projects. Notably, the 2022 deadline for these projects now overlaps with the deadlines for projects that began construction in 2018, which were not extended by the Notice and which offer only a 60% PTC.
Developers and tax equity investors working on renewable energy projects facing tight (or even already missed) 2020 or 2021 tax-driven deadlines should review their agreements with tax equity investors and other project-related contracts to determine whether the deadline relief affects conditions precedent or default provisions that were tied to the prior deadlines, such as specific reference to December 31, 2020. If so, the parties may want to revise their contractual arrangements in light of the Notice.
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