IRS Notice 2014-46 clarifies guidance for Production Tax Credits and Investment Tax Credits

by Ballard Spahr LLP

Solar RoofThe American Taxpayer Relief Act of 2012 modified the definition of certain “qualified facilities” under Section 45(d) of the Internal Revenue Code to require that the construction of such facilities must begin prior to January 1, 2014 (i.e. on or before December 31, 2013). Accordingly, taxpayers may only receive renewable electricity Production Tax Credits under Section 45 of the Code or energy Investment Tax Credits (which a taxpayer may elect to receive in lieu of Production Tax Credits for certain qualified facilities) under Section 48 of the Code with respect to a facility if the construction of such facility began in 2013.

IRS notices published in 2013 established a framework in which a taxpayer may use either of two methods to establish that the construction of a “qualified facility” has begun. The first method is a subjective “Physical Work Test,” in which a taxpayer must establish that, under all the relevant facts and circumstances, “physical work of a significant nature” has begun. The alternative method is a more mechanical “Safe Harbor Test,” in which the construction of a facility will be deemed to have begun before January 1, 2014 if (i) the taxpayer incurs 5% or more of the total cost of facility (in accordance with its method of accounting) prior to January 1, 2014, and (ii) thereafter, the taxpayer makes continuous efforts to advance towards completion of the facility. Both methods require that the taxpayer make continuous progress towards completion, which requirement is deemed to be satisfied if the facility is placed in service before January 1, 2016.

The IRS released Notice 2014-46 on August 8, 2014 (the “2014 Guidance”), which provides additional guidance on the application of the Physical Work Test and the Safe Harbor Test. The guidance makes the following clarifications:

  • The Physical Work Test focuses on the nature of the work performed, not the amount or the cost (i.e. there is no 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).
  • A fully or partially developed facility may be transferred without losing its qualification under the the Physical Work Test or the Safe Harbor Test.
  • For purposes of the Safe Harbor Test, if a taxpayer pays or incurs less than 5% of the total cost of a facility that is a single project comprised of multiple facilities, but at least 3% of the total cost of such facility before January 1, 2014, the safe harbor may be satisfied and the credits may be claimed with respect to some of the individual facilities as long as the total aggregate cost of those individual facilities at the time the project is placed in service is not greater than 20 times the amount the taxpayer paid or incurred before January 1, 2014.

A copy of the 2014 Guidance can be found here.

Rather than re-writing the rules, the 2014 Guidance appears aimed at providing certainty and alleviating concerns raised by a conservative reading of the prior IRS guidance. Even though the sunset date of the Production Tax Credit has yet to be extended by Congress, these clarifying changes will hopefully at least give confidence to developers of projects that will have to rely solely on the Physical Work Test, or are worried about hitting the 5% threshold for the Safe Harbor Test.

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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