IRS Issues Notice on "Beginning of Construction" Requirement for PTC and ITC Purposes

by Wilson Sonsini Goodrich & Rosati
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On April 15, 2013, the IRS released Notice 2013-29, which addresses the requirement that construction of a qualified facility must begin before January 1, 2014, in order to be eligible for the renewable electricity production tax credit (PTC) or the 30 percent investment tax credit for energy property (ITC).1

Background

A taxpayer can claim the PTC with respect to electricity produced at a "qualified facility" within the meaning of Section 45(d) of the Internal Revenue Code of 1986, as amended. If the taxpayer makes an election under Section 48(a)(5) of the code, the taxpayer may instead claim the ITC with respect to that facility. Pursuant to changes made by the American Taxpayer Relief Act of 2012, in order to be a "qualified facility," construction of the facility must begin before January 1, 2014.

Notice 2013-29

The notice provides two methods that a taxpayer may use to establish that construction of a qualified facility has begun: (1) by starting "physical work of a significant nature" before January 1, 2014, and maintaining a continuous program of construction until the facility's completion or (2) by meeting the safe harbor set forth in the notice, which requires that the taxpayer pay or incur 5 percent or more of the total costs of the facility before January 1, 2014, and thereafter make continuous efforts to advance towards completion of the facility. While the two methods in the notice are similar to the cash grant program guidance provided under Section 1603 of the American Recovery and Reinvestment Act of 2009, there are a few important differences, as noted below.2

Physical Work of a Significant Nature

When determining whether construction has begun, both work performed by the taxpayer and work performed for the taxpayer by other persons under a binding written contract that is entered into prior to the work taking place are taken into account. For these purposes, whether a contract is binding is generally a matter of state law. However, under the notice, a contract only is binding if, among other requirements, it does not limit damages to a specified amount (e.g., by use of a liquidated damages provision).3

Both on-site work and off-site work are considered to determine whether physical work of a significant nature has occurred. For example, in the case of a wind turbine, on-site physical work of a significant nature can begin by excavating for the foundation, setting anchor bolts into the ground, or pouring concrete pads of the foundation. If the property is to be assembled on-site from components manufactured off-site, physical work of a significant nature generally begins when the manufacture of the components begins at the off-site location.

Additionally, the IRS will now treat multiple facilities that are operated as a part of a single project as a single facility for purposes of determining whether construction has begun. For example, if a wind farm is considered to be a single project, laying the foundation for a few of the wind turbines that will be part of the larger wind farm can be considered sufficient activity to begin construction of the entire wind farm.4

However, physical work of a significant nature does not include "preliminary activities" (even if the cost of those activities is properly included in the depreciable basis of the facility), such as planning or design, securing financing, clearing a site, obtaining permits, erecting a fence, or excavation to change the contour of the land (as distinguished from excavation for footings and foundations).

Only physical work on tangible property used as an integral part of the activity performed by the facility is considered for purposes of determining whether a taxpayer has begun construction of a facility. For example, roads used primarily for access to the site, as well as fencing and buildings, are not generally considered integral to the activity performed by the facility.

A taxpayer must engage in "a continuous program of construction" in order to satisfy the physical work requirement. The notice provides that construction delays beyond a taxpayer's control will not cause a taxpayer to fail the requirement that the construction be continuous and lists several examples of matters that will usually not be considered to be within the control of a taxpayer:

  1. severe weather conditions
  2. natural disasters
  3. licensing and permitting delays
  4. delays at the written request of a state or federal agency regarding matters of safety, security, or similar concerns
  5. labor stoppages
  6. inability to obtain specialized equipment of limited availability
  7. the presence of endangered species
  8. financing delays of less than six months
  9. supply shortages.

5 Percent Safe Harbor

Under the 5 percent safe harbor, construction of a facility will be considered as having begun before January 1, 2014, if a taxpayer pays (in the case of a cash-basis taxpayer) or incurs (in the case of an accrual-basis taxpayer) 5 percent or more of the total cost of the facility before that date. As with the "physical work" test, a taxpayer relying on the 5 percent safe harbor must also make continuous efforts thereafter to advance towards completion of the facility.5 All costs properly included in the depreciable basis of the facility are taken into account to determine whether the safe harbor has been met.

When property is being manufactured or produced by another person under a binding written contract with a taxpayer, costs incurred with respect to the property by the other person (e.g., the manufacturer) before the property is provided to the taxpayer are treated as incurred by the taxpayer.

Whether a taxpayer has "incurred costs" requires a sometimes-nuanced analysis under Treasury Regulations Sections 1.461 and 1.446 and will depend on whether the taxpayer is on the cash or accrual basis of accounting, when goods are delivered (and services are rendered) to the taxpayer, and how payment is actually made. The Section 1603 guidance includes examples in a question-and-answer format to help explain when costs were incurred for purposes of the Section 1603 cash grant; however, the notice itself does not contain any specific guidance. Accordingly, taxpayers should not rely on the examples in the 1603 guidance without first speaking with their advisors.


1 Please visit http://www.irs.gov/pub/irs-drop/n-13-29.pdf to access the notice.

2 To view a previous WSGR Alert discussing the guidance under the Section 1603 cash grant program, please visit http://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert_energy_property_construction.htm.

3 Note that this rule is more restrictive than the guidance under the Section 1603 cash grant program, which allowed contracts to contain liquidated damages provisions as long as the contracts did not limit damages to less than 5 percent of the total contract price.

4 The notice provides a specific example in which physical work of a significant nature is treated as beginning for an entire 50 turbine wind farm with the completion of foundation work on 10 turbines in such wind farm.

5 Note that this is again more restrictive than the guidance under the Section 1603 cash grant program, which did not contain a requirement that continuous efforts be made to complete the facility. Under the Section 1603 cash grant program, it was generally permissible for an applicant to incur 5 percent of project costs by purchasing eligible assets and later transfer those assets to a related person without any requirement that construction be continuous. The "continuous construction" requirement would appear to limit that practice.

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.

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