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Wednesday, April 17, 2013

Guest Post: IRS Notice 2013-29 on “Begun Construction” for certain renewable energy facilities

My colleague Forrest Milder, an attorney in the Renewable Energy Tax Credits and Finance practice here at Nixon Peabody, authored the following client alert describing the IRS' April 15, 2013 Notice on what it means to have "Begun Construction" for the purpose of establishing eligibility for tax credits.  

The IRS' April 15 Notice sheds much needed light on this critical threshold that renewable energy developers must meet in order to incorporate tax credit financing as part of their financing structures.  Developers of offshore wind projects that are essentially ready-to-build once financing is established (i.e., all state and federal permitting hurdles have been cleared), including Cape Wind, Deepwater Wind's Block Island project, and Fishermen's Energy's Atlantic City project, will be looking to meet the December 31, 2013 deadline to take advantage of the tax incentives. In other words, the goal of meeting the "Begun Construction" test is one more reason to believe that we may see steel in the water before the end of 2013.

Although IRS Notice 2013-29 offers some guidance with respect to the eligibility criteria, other questions still remain.  For example, under the "Physical Work" test described below, the work must be a “continuous program of construction,” subject to a list of  permitted disruptions such as“severe weather conditions”, “natural disasters”, “labor stoppages” and “financing delays of less than six months."  Since offshore wind construction is subject to seasonal restrictions, it is not clear whether a work stoppage for winter would qualify as a permitted disruption.  

 The original version of this article reprinted below is available here.  For the benefit of the Ocean and Offshore Renewables blog readers, I have hyperlinked a few of the key documents discussed in Forrest's article.

This client alert addresses an IRS notice issued on April 15, 2013, with great significance to projects that generate electricity from wind, geothermal, biomass, landfill gas, municipal solid waste, hydroelectric production, and marine and hydrokinetic energy.

You will remember that before the American Taxpayer Relief Act of 2012 (ATRA) each of these technologies was eligible for a production tax credit (PTC) or investment tax credit (ITC) only if the facility was placed in service by the end of 2013 (except wind, which had to be placed in service by the end of 2012, and geothermal, which can also qualify for a 10% credit beyond that date). ATRA changed the sunset provision to depend on when the facility begins construction, rather than when the facility is placed in service. Now, if one of the facilities described above begins construction by December 31, 2013, it will be eligible for the applicable PTC or the 30% investment tax credit.

On April 15, 2013, the IRS published Notice 2013-29, providing the tests that must be passed in order for these facilities to have “begun construction” by the end of 2013 and still qualify for tax credits. You will note that these tests are very similar to the Section 1603 Grant-in-lieu-of-tax-credit rules published by Treasury in connection with that program, which also has a begun construction requirement, albeit for projects placed in service after December 31, 2011.

Like the Section 1603 program, there are two tests under the notice—the “physical work” test, and the “five percent safe harbor.” Passing either of these tests will be treated as beginning construction under the PTC and ITC rules. A very quick summary—

The Physical Work Test. The work must be “physical,” such as setting anchor bolts or pouring concrete pads. The property must be “integral” to the activity, e.g., a transmission tower is not eligible. Note that “preliminary activities,” like designing the facility or securing financing do not qualify. Manufacturing components pursuant to a “binding written contract” is also includible, but not if the property is “in existing inventory or normally held in inventory by a vendor.” The work must also be a “continuous program of construction,” and the IRS has provided a list of  permitted disruptions that range from “severe weather conditions” and “natural disasters” to “labor stoppages” and “financing delays of less than six months.”
The Five Percent Safe Harbor. Like Section 1603, the amount must be paid or incurred in accordance with the Section 461 regulations. Here, too, costs can be incurred pursuant to a binding written contract. An important new requirement states that the taxpayer must also make “continuous efforts to advance toward completion of the facility.” This is a significant change from the Section 1603 rules, which potentially allowed grandfathered equipment that met the five percent test to be warehoused and used years later. This new continuous efforts test is not unlike the rules that apply to the physical work test, bearing in mind that under the five percent test, the efforts do not have to be “physical”; illustrations include “paying or incurring additional amounts,” and “obtaining necessary permits,” as well as “performing physical work of a significant nature.” The notice repeats the exact same list of permitted disruptions that will not affect passing the “continuous efforts” test as applied to the “physical work” test.
Four other things worth noting—first, there is no pre-approval process, like there was with the “preliminary applications” required under Section 1603. Second, there is no statement in the notice that a project must be specifically identified; it remains to be seen if that was an intentional omission. Third, the definition of “binding contract” is different from what it was under Section 1603; in the IRS notice, a contract is binding 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).” Of course, under the Section 1603 rules, a provision limiting damages to five percent of the contract amount was specifically permitted. Finally, the notice gives two illustrations of the effect of cost overruns where the five percent safe harbor has been used—if the project consists of multiple facilities that could be operated independently (e.g., a wind farm), then the project may be scaled back (if necessary) to ensure that the smaller project passed the five percent test by the end of 2013. On the other hand, if the project is only one facility, e.g., a boiler and turbine generator, then it cannot be scaled back, and a cost overrun can be fatal. Other renewables that are still subject to the old rules. Thus, the tax credit rules for solar, fuel cells, small wind, microturbines, combined heat and power facilities, geothermal that generates heat, and geothermal that generates electricity, but that begins construction after 2013, continue to have the same placed-in-service tests as before ATRA. For example, solar facilities must still be placed in service by the end of 2016 to qualify for the thirty percent ITC. There is not a “begun construction” test for these facilities.

For more information about renewable energy tax credits and/or IRS Notice 2013-29, please contact Forrest Milder at 617-345-1055 or fmilder@nixonpeabody.com, or Jennifer Simon Lento via this blog, at 617-345-1352, or at jsimonlento@nixonpeabody.com.

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