IRS Provides Guidelines as to Beginning of Construction for Purposes of the Renewable Electricity Production Tax Credit and Energy Investment Tax Credit
***Update effective May 13, 2013***
Section 4.03(1) of Notice 2013-29 originally stated: “(1) Binding written contract. A contract is binding only if it is enforceable under local law against the taxpayer or a predecessor and does not limit damages to a specified amount (for example, by use of a liquidated damages provision).”
Due to taxpayer confusion regarding whether that meant that any contractual provision that limited damages would cause a contract not to constitute a binding written contract for investment tax credit and production tax credit purposes, on May 13, 2013, the IRS revised the Notice to provide “For this purpose, a contractual provision that limits damages to an amount equal to at least five percent of the total contract price will not be treated as limiting damages to a specified amount. For additional guidance regarding the definition of a binding contract, see §1.168(k)-1(b)(4)(ii)(A)-(D).” This revision conforms the Notice with the cash grant guidance.
On Monday, April 15, 2013, in Notice 2013-29 the IRS provided guidelines and a safe harbor to determine when construction has begun on a qualified facility eligible to receive the renewable electricity production tax credit (“PTC”) or the energy investment tax credit (“ITC”). The American Taxpayer Relief Act of 2012 extended the PTC and the ITC for a qualified facility where construction of the facility begins before January 1, 2014. A qualified facility includes a wind facility, closed-loop biomass facility, open-loop biomass facility, geothermal facility, landfill gas facility, trash facility, hydropower facility and marine and hydrokinetic facility.
For those familiar with the applicable guidance and terms and conditions for cash grants issued by Treasury pursuant to Section 1603 of the American Recovery and Reinvestment Act of 2009, as amended by Section 707 of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (collectively the “ARRA”), the new guidelines and safe harbor are very similar to the cash grant rules with respect to establishing that construction has begun on a qualified facility.
The Notice provides a new beneficial rule, especially for wind farms, for projects having multiple facilities. A facility generally includes all components of property that are functionally interdependent. Components of property are functionally interdependent if the placing in service of each of the components is dependent upon the placing in service of each of the other components in order to generate electricity.
Multiple facilities that are operated as part of a single project (along with any property, such as a computer control system, that serves some or all such facilities) will be treated as a single facility. Factors indicating that multiple facilities are operated as part of a single project include:
the facilities are owned by a single legal entity;
the facilities are constructed on contiguous pieces of land;
the facilities are described in a common power purchase agreement or agreements;
the facilities have a common intertie;
the facilities share a common substation;
the facilities are described in one or more common environmental or other regulatory permits;
the facilities were constructed pursuant to a single master construction contract; and
the construction of the facilities was financed pursuant to the same loan agreement.
The Notice has an example that treats each wind farm as a single facility. Thus, construction started on part of a wind farm will be treated as the beginning of construction on the whole facility.
A taxpayer may establish that construction of a qualified facility has begun before January 1, 2014 if either of the following tests are satisfied:
Physical Work of a Significant Nature; or
5% Safe Harbor.
Physical Work of a Significant Nature
Work performed by the taxpayer and work performed for the taxpayer by other persons under a binding written contract that is entered into before the manufacture, construction, or production of the property for use by the taxpayer is taken into account in determining whether construction has begun. A contract is binding only if it is enforceable under local law against the taxpayer or a predecessor and does not limit damages to a specified amount (for example, by use of a liquidated damages provision). Note that, unlike the cash grant guidance, the new guidelines fail to specifically state that a contractual provision that limits damages to an amount equal to at least 5% of the total contract price will not be treated as limiting damages to a specified amount. The relevance of this omission is uncertain at this time. Whether a taxpayer has begun construction of a facility before January 1, 2014 will depend on the relevant facts and circumstances.
Both on-site and off-site work (performed either by the taxpayer or by another person under a binding written contract) may be taken into account.
For example, in the case of a facility for the production of electricity from a wind turbine, on-site physical work of a significant nature begins with the beginning of the excavation for the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation. If the facility’s wind turbines and tower units are to be assembled on-site from components manufactured off-site by a person other than the taxpayer and delivered to the site, physical work of a significant nature begins when the manufacture of the components begins at the off-site location, but only if (i) the manufacturer’s work is done pursuant to a binding written contract and (ii) these components are not held in the manufacturer’s existing inventory or are normally held in inventory by a vendor. If a manufacturer produces components for multiple facilities, a reasonable method must be used to associate individual components with particular facilities.
Preliminary activities are not taken into account.
Preliminary work includes planning or designing, securing financing, exploring, researching, obtaining permits, licensing, conducting surveys, environmental and engineering studies, clearing a site, test drilling of a geothermal deposit, test drilling to determine soil condition, excavation to change the contour of the land (as distinguished from excavation for footings and foundations), or removal of existing turbines and towers.
Work on inventory is not taken into account.
Physical work of a significant nature does not include work to produce property that is either in existing inventory or is normally held in inventory by a vendor.
Only physical work of a significant nature on tangible personal property and other tangible property used as an integral part of the activity performed by the facility is taken into account.
This includes property integral to the production of electricity but does not include property used for electrical transmission.
Starting construction on onsite roads that are used for moving materials to be processed (for example, biomass) and roads for equipment to operate and maintain the qualified facility constitutes physical work of a significant nature with respect to the facility. Physical work of a significant nature on roads primarily for access to the site or for employee or visitor vehicles is not considered starting construction of a facility.
Fencing generally is not an integral part of the facility because it is not integral to the activity performed by the facility.
Generally, buildings are not integral parts of the facility because they are not integral to the activity of the facility. However, the following structures are not treated as buildings: (i) a structure that is essentially an item of machinery or equipment, or (ii) a structure that houses property that is integral to the activity of the facility if the use of the structure is so closely related to the use of the housed property that the structure clearly can be expected to be replaced when the property it initially houses is replaced.
Continuous Program of Construction
Generally a taxpayer must maintain a “continuous program of construction” after the work is commenced. However, certain disruptions in the taxpayer’s construction of a facility that are beyond the taxpayer’s control are not treated as failing to maintain a continuous program of construction, such as severe weather conditions, natural disasters, licensing and permitting delays and financing delays of less than six months.
If a taxpayer enters into a binding written contract for a specific number of components to be manufactured, constructed, or produced for the taxpayer by another person under a binding written contract (a “master contract”), and then through a new binding written contract (a “project contract”) the taxpayer assigns its rights to certain components to an affiliated special purpose vehicle that will own the facility for which such property is to be used, work performed with respect to the master contract may be taken into account in determining when physical work of a significant nature begins with respect to the facility.
5% Safe Harbor
Construction of a facility will be considered as having begun before January 1, 2014 if (i) a taxpayer “pays or incurs” five percent or more of the total cost of the facility before January 1, 2014, and (ii) thereafter, the taxpayer makes “continuous efforts to advance” towards completion of the facility. The same tax accounting rules apply to determine whether a cost has been “paid or incurred” as under the cash grant rules.
All costs properly included in the depreciable basis of the facility are taken into account to determine whether the 5% Safe Harbor has been met. The total cost of the facility does not include the cost of land or any property not integral to the facility. For property that is manufactured, constructed, or produced for the taxpayer by another person under a binding written contract with the taxpayer, costs incurred with respect to the property by the other person before the property is provided to the taxpayer are deemed incurred by the taxpayer when the costs are incurred by the other person under applicable tax accounting rules.
Continuous Efforts to Advance towards Completion
Whether a taxpayer makes continuous efforts to advance towards completion of the facility will be determined by the relevant facts and circumstances which include:
paying or incurring additional amounts included in the total cost of the facility;
entering into binding written contracts for components or future work on construction of the facility;
obtaining necessary permits; and
performing physical work of a significant nature.
Certain disruptions in the taxpayer’s construction of a facility that are beyond the taxpayer’s control will not be considered as indicating that a taxpayer has failed to make continuous efforts to advance towards completion of the facility, such as severe weather conditions, natural disasters, licensing and permitting delays and financing delays of less than six months.
Single Project. If the total cost of a facility that is a single project comprised of multiple facilities exceeds its anticipated total cost, so that the amount a taxpayer actually paid or incurred with respect to the facility before January 1, 2014, is less than 5% of the total cost of the facility at the time the facility is placed in service, the 5% Safe Harbor is not fully satisfied. However, the 5% Safe Harbor will be satisfied and the PTC or ITC may be claimed with respect to some, but not all, of the individual facilities comprising the single project, as long as the total aggregate cost of those individual facilities is not more than 20 times greater than the amount the taxpayer paid or incurred before January 1, 2014.
Single Facility. If the total cost of a single facility that is not a single project comprised of multiple facilities, and cannot be separated into smaller facilities, exceeds its anticipated total cost so that the amount a taxpayer actually paid or incurred with respect to the facility before January 1, 2014, is less than 5% of the total cost of the facility at the time the facility is placed in service, then the taxpayer will not satisfy the 5% Safe Harbor with respect to any portion of the facility.
Aside from the continuous efforts to advance towards completion and the cost overrun provisions applicable to the 5% safe harbor, taxpayers should find the guidance and safe harbor set forth in Notice 2013-29 very similar to the guidance and terms and conditions applicable to cash grants under Section 1603 of the ARRA as it relates to determining whether construction has begun. A taxpayer must only satisfy one of two tests to establish that construction of a qualified facility has begun before January 1, 2014: (i) physical work of a significant nature, or (ii) the 5% safe harbor.