IRS Releases Updated Guidance Further Clarifying 'Beginning of Construction' for Renewable Energy Facilities
On August 8, 2014, the Internal Revenue Service (IRS) issued Notice 2014-46, clarifying and modifying Notice 2013-29, 2013-20 I.R.B. 1085 and Notice 2013-60, 2013-42 I.R.B. Notice 2014-46 clarifies that the Physical Work Test described below is a qualitative rather than a quantitative test, provides that a project may be relocated after construction has begun, imposes limitations on certain transfers of projects, and imposes a limitation on the application of the Safe Harbor described below to wind farms and other projects comprised of multiple facilities.
The American Taxpayer Relief Act of 2012 (ATRA) extended the sunset date for the production tax credit (PTC) for wind projects until January 1, 2014, and adopted a “beginning of construction” deadline in place of the placed in service deadline for wind, closed and open loop biomass, geothermal, landfill gas, trash, hydropower and marine and hydrokinetic facilities. ATRA also extended the sunset date for the election to take the energy investment tax credit (ITC) in lieu of PTC to match that for the PTC and adopted the “beginning of construction” standard. Notices 2013-29 and 2013-60 provide guidance on the beginning of construction of a qualified facility for purposes of section 45 of the Internal Revenue Code. Please see our previous client alerts for Notice 2013-29 and Notice 2013-60.
Overview of Prior Guidance
Notices 2013-29 and 2013-60 provide guidance on when construction of a qualified facility will have begun for purposes of the PTC under section 45 of the Internal Revenue Code (the “Code”) and the ITC under section 48 of the Code. Notice 2013-29 provides two methods by which a taxpayer can satisfy the beginning of construction requirement: (i) starting physical work of a significant nature (the “Physical Work Test”) or (ii) incurring 5% or more of the costs of the facility (the “Safe Harbor”).
Physical Work Test
Notice 2014-46 clarifies that the Physical Work Test is a qualitative rather than a quantitative test. An example in Notice 2013-29 had raised concerns that a minimum quantitative threshold of physical work might be necessary to meet the Physical Work Test. In that example, a developer of a 50-turbine wind farm satisfied the beginning of construction requirement by excavating the sites for the foundations and pouring concrete for the supporting pads of 10 turbines. Notice 2014-46 clarifies that the example is “not intended to indicate that there is a 20% threshold or minimum amount of work required to satisfy the Physical Work Test.” The notice further states that “there is no fixed minimum amount of work or monetary or percentage threshold required to satisfy the Physical Work Test.” As long as the work performed is of a significant nature, the Physical Work Test will be satisfied. Notice 2013-29 provides a non-exclusive list of work that is physical work of a significant nature. That list includes: (i) physical work on a custom-designed transformer that steps up the voltage of electricity produced at the facility to the voltage needed for transmission; and (ii) constructing roads that are integral to the facility. Notice 2014-46 concludes that beginning construction on either of these activities constitutes physical work of a significant nature.
Relocations of Projects
Notice 2014-46 clarifies that work performed or amounts paid or incurred before 2014 by a taxpayer may be taken into account for purposes of determining whether the facility satisfies the Physical Work Test or the Safe Harbor, even if the location of a facility changes after construction has begun.
Transfers of Projects
Notice 2014-46 states, with one exception, that a fully or partially developed project may be transferred to a new, unrelated owner without losing its qualification under either the Physical Work Test or the Safe Harbor. The exception is if a transferor transfers only tangible personal property (or contractual rights to the property under a binding written contract) to an unrelated transferee. In that case, the transferee cannot take into account any work performed or amounts paid or incurred by the transferor with respect to the property for purposes of the Physical Work Test or the Safe Harbor. A transferor and a transferee are “related” for this purpose if they are related under section 197(f)(9)(C) of the Code. This limitation is similar to the limitation that the U.S. Department of the Treasury applied to transfers of “safe harbored” assets for Section 1603 purposes and appears to be motivated by the same concern (viz., the “trafficking” in safe harbored assets).
Safe Harbor
Notice 2014-46 introduces a new rule limiting the application of the Safe Harbor to single projects comprised of multiple facilities (e.g., wind farms). Notice 2013-29 provides a taxpayer-favorable rule pursuant to which if the amount paid or incurred by a taxpayer before 2014 with respect to a single project is less than 5% of the total cost of the project, the Safe Harbor will be satisfied with respect to some (but not all) of the individual facilities as long as their total aggregate cost of those individual facilities is not more than 20 times greater than the amount paid or incurred before 2014. Under Notice 2014-46, this favorable rule is available only if the total amount paid or incurred before 2014 with respect to the project is at least 3% of the total cost of the project. Notice 2014-46 provides no rationale for the introduction of this new limitation.
The new guidance in Notice 2014-46 is generally favorable and provides clarity with respect to the Physical Work Test that should make financing of certain projects easier. The clarification that there is not a quantitative component to the Physical Work Test and the guidance on the ability to relocate a project during development are welcome ones. Although the new limitations applicable to transfers of safe harbored equipment and to the Safe Harbor for single projects with multiple facilities are generally unfavorable, these limitations are unlikely to be a significant impediment for most projects.
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