June 26, 2018

IRS Issues Notice 2018-59: "Begun Construction" Guidance for the Investment Tax Credit

Gregory Broome, Lauren Collins, Nicole Gambino, Sean Moran, Stuart Odell

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On June 22, 2018, the IRS issued Notice 2018-59 (ITC Guidance), providing long-awaited guidance on the "begun construction" requirements for facilities qualifying for the Section 48 investment tax credit (ITC). The ITC is a tax credit equal to the "energy percentage" of the basis of qualifying energy property placed in service in a taxable year. As currently drafted,¹ Section 48 provides that certain qualifying energy facilities are eligible for the ITC, in most cases on a phased-down schedule, if construction of such facility begins before January 1, 2022.²

The ITC Guidance largely follows the "begun construction" guidance that the IRS has previously issued for energy facilities that qualify for the production tax credit (generally referred to herein as the "PTC Guidance").³

As with the PTC Guidance, the ITC Guidance proffers two alternative methods to determine when construction has begun: (1) the physical work test (i.e., physical work of a significant nature has begun and the taxpayer maintains a continuous program of construction); and (2) the five percent safe harbor (i.e., at least five percent of the total cost of energy property has been paid or incurred and the taxpayer makes continuous efforts to advance towards completion of the energy property).

The physical work test described in the ITC Guidance is similar to the PTC Guidance in that it provides that whether physical work of a significant nature has begun depends on the relevant facts and circumstances and may include work performed by the taxpayer, work performed for the taxpayer by another person under a binding written contract (provided the contract is entered into prior to the manufacture, construction, or production of the energy property or components of energy property for use by the taxpayer in the taxpayer's trade or business (or for the taxpayer's production of income)), and work both on-site⁴ and off-site.⁵ The ITC Guidance also specifies that there is no fixed minimum amount of work or monetary or percentage threshold that is required to satisfy the physical work test.⁶ As with the PTC Guidance, preliminary activities (e.g., planning or designing, securing financing, obtaining permits or licenses, clearing a site, etc.) and work performed on components that are existing in inventory or are normally held in inventory are not taken into account in determining whether physical work has occurred.

Also similar to the PTC Guidance, the ITC Guidance's five percent safe harbor is determined by reference to the total depreciable basis of energy property, not including the cost of land or any property not integral to the energy property.⁷ And, as with the PTC Guidance, for a single project comprised of multiple facilities, the ITC Guidance permits a taxpayer to disaggregate certain energy facilities that experience cost overruns.⁸

As noted above, the physical work method requires that a taxpayer maintain a continuous program of construction and the five percent safe harbor requires that the taxpayer maintains continuous efforts towards completion of the facility (collectively, the "Continuity Requirements"). As set forth in the ITC Guidance, whether the applicable Continuity Requirement is met is determined by the relevant facts and circumstances.⁹ But, if energy property is placed in service by the end of the calendar year that is no more than four calendar years after the calendar year in which construction of the energy property begins, the safe harbor established by the ITC Guidance provides the Continuity Requirement will be deemed to have been met.¹⁰

Importantly, the ITC Guidance clarifies that, for purposes of determining whether construction of energy property has begun for purposes of the ITC, multiple energy properties that are operated as part of a single project will be treated as a single energy property, and whether multiple energy properties are operated as part of a single project will depend on the relevant facts and circumstances.¹¹ Whether multiple energy properties are treated as part of a single project is determined in the calendar year during which the last of the properties is placed in service.

The ITC fundamentally differs from the PTC in that it requires a taxpayer to own the qualifying facility at the time it is placed in service (rather than owning the qualifying facility during the time it produces and sells energy). That said, the ITC Guidance is consistent with the PTC Guidance in that it generally allows a taxpayer to acquire the "begun construction" qualification of a fully or partially developed energy facility without losing its ITC qualification—provided the acquisition occurs prior to the date the facility is placed in service and does not consistent solely of trafficking of components that may satisfy the five percent safe harbor.

While the ITC Guidance is likely to be further refined and amended, it is a welcome clarification of the amended terms of Section 48 and allows an additional degree of confidence for developers, lenders, and investors of ITC-eligible property.

¹ The ITC was extended at the end of 2015 and, as part of that extension, the begun construction requirement was made available. See https://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert-solar-wind-tax-extenders.htm.

² The "energy percentage" depends on the type of qualifying energy property, the year construction of such property begins, and the year such property is placed in service. For solar property, for example, the energy percentage is (A) 30% for solar property the construction of which begins before January 1, 2020 and which is placed in service by January 1, 2024, (B) 26% for solar property the construction of which begins before January 1, 2021 and which is placed in service by January 1, 2024, (C) 22% for solar property the construction of which begins before January 1, 2022 and which is placed in service by January 1, 2024, and (D) 10% for solar property (i) the construction of which begins before January 1, 2022 and which is placed in service on or after January 1, 2024 or (ii) the construction of which begins on or after January 1, 2022.

³ Notice 2013-29, 2013-20 I.R.B. 1085, as clarified by Notice 2013-60, 2013-42 I.R.B. 1, as clarified and modified by Notice 2014-46, 2014-35 I.R.B. 1, as updated by Notice 2015-25, 2015-13 I.R.B. 814, as updated and modified by Notice 2016-31, 2016-23 I.R.B. 1025, and as clarified and modified by Notice 2017-4, 2017-4 I.R.B. 41. A taxpayer who qualifies for production tax credits under Section 45 may make an election to instead claim the ITC with respect to the facility, so the PTC Guidance is applicable for ITC property to the extent such election is made.

⁴ The ITC Guidance describes various examples of on-site physical work of a significant nature. For solar property, for example, on-site physical work of a significant nature includes the installation of racks or other structures to affix photovoltaic panels, collectors, or solar cells to a site.

⁵ Off-site physical work of a significant nature includes the manufacture of components, mounting equipment, support structures such as racks and rails, inverters, and transformers (used in electrical generation that step up the voltage to less than 69 kilovolts) and other power conditioning equipment.

⁶ Notwithstanding this statement, care should be taken to ensure that the level of investment or work performed is not immaterial in relation to the size of the overall project.

⁷ The definition of integral property in the ITC Guidance is similar to the PTC Guidance – generally, it includes property integral to the production of electricity, but does not include property used for the transmission of electricity or property such as roads for access to the site, fencing, and buildings.

⁸ In other words, for a single project comprised of multiple facilities, if the total depreciable basis of energy property exceeds its anticipated total costs, such that the five percent safe harbor is not satisfied, the taxpayer may claim the ITC with respect to some, but not all, of the energy properties comprising the project (i.e., those properties whose total cost does not exceed 20 times the amount the taxpayer paid or incurred in the year construction began). However, if a single facility is not comprised of multiple facilities and cannot be separated into multiple energy properties, a taxpayer will not satisfy the five percent safe harbor unless it is met with respect to the entire facility.

⁹ For purposes of the five percent safe harbor, the ITC Guidance provides a number of examples of continuous efforts to advance towards completion of the facility, including paying or incurring additional amounts, entering into binding contracts, obtaining permits, and performing physical work of a significant nature.

The ITC Guidance also clarifies that certain excusable disruptions (e.g., weather delays, interconnection related delays, financing delays, etc.) may be taken into account in determining whether the Continuity Requirement has been met (but are not taken into account in determining whether the Continuity Requirement safe harbor (discussed below) is met). Unlike the PTC Guidance, the ITC Guidance further clarifies that, in the case of a single project comprised of a single energy property, whether an excusable disruption has occurred is determined in the calendar year the property is placed in service and in the case of a single project comprised of multiple properties, whether an excusable disruption has occurred is determined in the calendar year the last of the properties is placed in service.

¹⁰ Note, however, that this Continuity Requirement safe harbor does not impact whether the qualifying property is subject to the phase down described in footnote 2.

¹¹ Examples of relevant facts and circumstances include whether the properties are owned by a single legal entity, the properties are constructed on contiguous pieces of land, the properties are described in a common power purchase agreement(s), the properties have a common intertie, whether the properties have a common substation, the properties are described in common environmental or regulatory permits, the properties are described in a single master construction contract, and the construction was financed pursuant to the same loan agreement.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.