On August 8, 2014, the Internal Revenue Service (“IRS”) issued Notice 2014-46 (the “Notice”), which clarified certain aspects of the beginning of construction requirement that must be satisfied for taxpayers to qualify for production tax credits (“PTCs”) or investment tax credits (“ITCs”) for certain renewable energy facilities.
PTCs are available for wind, biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic facilities, if construction of the facility began before January 1, 2014. Alternatively, taxpayers can elect to take ITC in lieu of PTC.
Notice 2013-29, issued April 15, 2013, provided guidance on what it means to begin construction for purposes of PTC and ITC qualification. In general, a taxpayer can establish that it has begun construction of a project either by starting physical work of a significant nature prior to January 1, 2014 (the “Physical Work Test”), or by paying or incurring (depending on its method of accounting) 5 percent or more of the total cost of the facility prior to January 1, 2014 (the “Safe Harbor”).
Both the Physical Work Test and the Safe Harbor require the taxpayer to make continuous progress toward completion of a project once construction has begun. In the case of the Physical Work Test, the requirement is that the taxpayer must maintain a continuous program of construction (the “Continuous Construction Test”). In the case of the Safe Harbor, the requirement is that the taxpayer must make continuous efforts to advance toward completion of the facility (the “Continuous Efforts Test”).
Notice 2013-60, issued September 20, 2013, adopted a safe harbor providing that the Continuous Construction and Continuous Efforts Tests will be deemed to be satisfied for a facility if the facility is placed in service before January 1, 2016. In addition, Notice 2013-60 clarified that certain project transfers after construction has begun will not affect credit eligibility.
Notice 2014-46 clarifies the application of the Physical Work Test and the effect that certain transfers with respect to a facility after construction has begun will have on a taxpayer's ability to qualify for the PTC or the ITC. In addition, Notice 2014-46 modifies the application of the Safe Harbor for certain facilities for which a taxpayer paid or incurred less than 5 percent, but at least 3 percent, of the total cost of the facility before January 1, 2014.
Physical Work Test
The Physical Work Test requires that a taxpayer begin physical work of a significant nature prior to January 1, 2014. Notice 2014-46 clarifies that the test focuses on the nature of the work performed, not the amount of work performed or the cost of such work. The key appears to be that work begin on a significant task relating to the production of qualifying property, and that the taxpayer maintain a continuous program of construction. There is no fixed minimum amount of work or monetary or percentage threshold that is required to satisfy the test.
Examples of qualifying work include:
In the case of a wind farm, beginning excavation for the foundation, setting anchor bolts into the ground, or pouring the concrete pads of the foundation
Physical work on a custom-designed transformer that steps up the voltage of electricity produced at a facility to the voltage needed for transmission
Starting construction of roads that are integral to the facility, such as onsite roads that are used for moving materials to be processed (for example, biomass) or roads for equipment to operate and maintain the qualified facility. By contrast, constructing roads that provide access to a facility would not qualify because such roads would not be considered integral to the operation of the facility.
It is important to realize that these are examples and are for illustrative purposes only. Any work begun prior to January 1, 2014 on a significant task relating to the production of qualifying property is sufficient, so long as the Continuous Construction Test is satisfied.
Notice 2013-60 clarified that a fully or partially developed facility could be transferred without losing its qualification under the Physical Work Test or the Safe Harbor for purposes of the PTC or the ITC. Notice 2014-46 provides a new limitation on this rule. The limitation is targeted at developers that transfer tangible personal property (including contractual rights to such property under a binding written contract) to unrelated parties. In general, under this rule, in the case of a transfer consisting solely of tangible personal property, any work performed or any amount paid or incurred by the transferor cannot be taken into account by the transferee for purposes of the Physical Work Test or the Safe Harbor. Thus, for example, if a developer incurs a cost during 2013 in connection with the construction of tangible personal property, and transfers that tangible personal property to an unrelated party, the unrelated party could not take the developer’s cost into account for purposes of satisfying the Physical Work Test or the Safe Harbor.
Note that the limitation on transfers applies only if the transfer consists solely of tangible personal property, and the transferee and the transferor are unrelated. A partnership or limited liability company generally will not be considered unrelated to the developer so long as the developer retains a greater than 20 percent ownership interest in such partnership or limited liability company. Thus, a developer with PTC property can partner with another party so long as the developer retains a greater than 20 percent ownership interest in the project company.
Notice 2014-46 also clarifies that a taxpayer that began construction of a facility in 2013 with the intent to develop the facility at a certain site, can transfer equipment and other components to a different site, and take the work performed or the amount paid or incurred prior to January 1, 2014, into account for purposes of determining whether the facility at the new site satisfies the Physical Work Test or the Safe Harbor.
New 3 Percent Safe Harbor
If the amount a taxpayer paid or incurred before January 1, 2014, with respect to the total cost of a facility that is a single project comprised of multiple facilities is less than 5 percent – but at least 3 percent – of the total cost of the facility at the time the facility is placed in service, the Safe Harbor may be satisfied and the PTC or ITC may be claimed for some of the individual facilities comprising the project. Specifically, a taxpayer may claim the PTC or ITC on individual facilities with a total aggregate cost of up to 20 times the amount the taxpayer paid or incurred before January 1, 2014.
The rule is illustrated by two examples. In example 1, a developer incurs $30,000 in costs prior to January 1, 2014 to construct a five-turbine wind farm that will be operated as a single project. The total cost of the project is $800,000, with each turbine costing $160,000. In October 2015, the developer places the project in service, so the Continuous Efforts Test is satisfied. Because the developer did not pay or incur 5 percent of the total cost of the project before January 1, 2014, however, the developer does not satisfy the Safe Harbor with regard to the entire project. However, the project consists of five separate facilities, and the cost incurred by the developer before January 1, 2014 exceeded 3 percent of the total cost of the project. Accordingly, the developer will be treated as satisfying the Safe Harbor for three of the turbines, as their total aggregate cost of $480,000 is not greater than 20 times the $30,000 in costs incurred by the developer prior to January 1, 2014. Thus, the developer can claim the PTC on electricity produced from three of the turbines, or the ITC based on $480,000, the cost of three of the turbines of the project.
By contrast, in example 2, a developer incurs $25,000 in costs prior to January 1, 2014, to construct an open-loop biomass facility, partly comprised of one boiler and one turbine generator that are functionally interdependent. In October 2015, developer places the facility in service. The total cost of the facility is $600,000. Because the developer did not pay or incur 5 percent of the actual total cost of the facility before January 1, 2014, and because the boiler and turbine generator are integral parts of a single facility that is not a single project comprised of multiple facilities, the developer will not satisfy the Safe Harbor. However, if physical work of a significant nature began before January 1, 2014, the developer may be able to claim the PTC or the ITC with respect to the facility.