PTC Start of Construction Guidance Worth the Wait
If you had to mail a check with your 2012 tax return yesterday, you may feel better about the IRS after reading the IRS’ start of construction guidance published in Notice 2013-29.
The Notice specifies the requirements taxpayers must meet to be deemed to “begin construction” with respect to a renewable energy project before January 1, 2014, one of the conditions for eligibility for the production tax credit (PTC). The Notice generally adopted Treasury’s 1603 Cash Grant rules for start of construction.
Taxpayers may begin construction in 2013 in one of two ways under the Notice: (i) by undertaking physical work of a significant nature or (ii) by incurring five percent of the cost of the project. However, all PTC project owners (even those that elect the five percent safe harbor) must demonstrate that, starting January 1, 2014, that they continuously constructed their projects until the point of completion. It appears the IRS added this “continuously construct” requirement for all projects, which was not present in the Cash Grant rules, because the PTC statute does not contain a deadline by which eligible projects must be complete.
Five Percent Safe Harbor
Typically, developers prefer to opt for the five percent safe harbor as it is relatively objective. Thus, the developer’s tax equity investors and their law firms are able to be relatively certain that the safe harbor was met.
The details of the five percent safe harbor are that the taxpayer must incur five percent of the cost of the project in 2013. Typically, developers opt to purchase equipment, because it is generally straight forward as to when equipment is delivered (which is not the case for services). Under the Notice, the equipment must be delivered by the later of December 31, 2013, and 3.5 months after executing the purchase contract. If the developer opts for the 3.5 month rule, the developer may not use vendor financing for the purchase. In addition, the purchase contract must be a “binding written contract”. In a change from the Cash Grant rules, the Notice provides that the binding written contract may not limit damages by use of a liquidated damages clause or otherwise.
It appears the IRS did not want to give taxpayers an open ended invitation to meet the five percent safe harbor by purchasing parts delivered to a warehouse and then using those parts over decades to build wind farms that are PTC eligible. Therefore, the Notice requires that, as of January 1, 2014, that “continuous efforts to advance towards completion of the facility” are made. This is a requirement did not apply to the five percent option in the Cash Grant rules and adds a layer of subjectivity to the five percent safe harbor.
The Notice specifies four facts that suggest that continuous construction is underway: (i) paying additional amounts that are capitalized into depreciable basis; (ii) entering into binding written contracts for components or future work; (iii) obtaining necessary permits; and (iv) performing work of a physical nature (see the discussion below).
The Notice provides developers with nine reasons that continuous work may be paused: (i) severe weather conditions; (ii) natural disasters; (iii) licensing and permitting delays; (iv) delays at the written request of a state or federal agency regarding matters of safety, security or similar concerns; (v) labor stoppages; (vi) inability to obtain specialized equipment of limited availability; (vii) the presence of endangered species; (viii) financing delays of less than six months; and (ix) supply shortages.”
More details as to what constitutes continuous work are provided in the IRS’ Notice than were provided in the Treasury’s Cash Grant guidance. The hope is that the additional details will enable tax equity investors to conclude that continuous work occurred after January 1, 2014, and thus that projects are PTC eligible
There was concern that in light of a 1994 ruling, the IRS would require the five percent option to be met on a turbine-by-turbine basis. Fortunately, the IRS did not do that. The Notice provides that the start of construction rules may be applied to a project as a whole (as opposed to on an individual turbine basis) based on an analysis of the following factors with respect to the turbines: (i) ownership by a single legal entity; (ii) constructed on a contiguous land; (iii) described in a common power purchase agreement; (iv) sharing a common intertie; (v) sharing a common substation; (vi) described in common environmental or regulatory permits; (vii) constructed pursuant to a common contract; and (viii) financed pursuant to the same loan agreement.
Physical Work of a Significant Nature Option
Instead of the five percent safe harbor, developers may start physical work of a significant nature in 2013. The developer may start such work on or off-site, and either do the work itself or enter into a binding written contract (see above) for another party to do the work. Specified examples of on-site work include “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.” It is not necessary to do this work for all of the turbines in the project: an example provides that performing the work for 20 percent of the turbines in 2013 is sufficient.
The work must be on property that is integral to the facility. For instance, work on transmission lines does not qualify but work on step-up transformers does qualify. Work on roads only qualify if the roads “are used for moving materials to be processed (for example, biomass)” or “for equipment to operate and maintain the facility”. It should be noted roads for employees and visitors were expressly excluded, and roads for moving equipment to build the facility were not referenced one way or another. Buildings are only included if the structure “is essentially an item of machinery or equipment” or the building is expected to be replaced when the equipment it initially houses is replaced. Fencing was expressly excluded.
Certain preliminary activities do not constitute start of construction. The non-qualifying activities include: planning, designing, securing financing, conducting surveys and engineering studies, clearing a site, and removing outdated turbines and towers from the site.
Work performed by another does count, if the work is performed pursuant to a binding written contract. Further, if the contract is to produce property, the property may not be in inventory at the time the contract is executed. Construction of turbines, which would by its nature occur off-site, constitutes the start of construction provided the binding written contract and inventory rules are met. Thus, in December a developer could enter into a binding written contract for turbines (that are not in the manufacturer’s inventory) and have its project qualify for PTCs, so long as (i) the manufacture of the turbines starts in 2013, (ii) there is continuous construction of such turbines starting January 1, 2014 and (ii) once the turbines are manufactured the developer engages in other activities to continuously construct until the project is complete.
As discussed above, the IRS will scrutinize as to whether the work was in fact continuous. The same exceptions enumerated above apply for this purpose (e.g., severe weather).
There are unanswered questions about the availability to transfer entities holding safe harbored projects or the project themselves. In coming months, we will likely see further guidance on that issue. Overall we expect today’s Notice to encourage development of additional wind, biomass and geothermal projects. The new “continuous construction” starting in 2014 requirement for the five percent safe harbor will require developers and tax equity investors to be pragmatic but with a modicum of caution in their application of the rules.
 Rev. Rul. 94-31, 1994-1 C.B. 16.
If you have any questions regarding this alert, please contact -
Adam S. Umanoff
Jacob J. Worenklein