IRS Issues Notice Clarifying Earlier Guidance on "Beginning of Construction" Requirement for PTC and ITC Purposes
September 24, 2013
On September 20, 2013, the IRS released Notice 2013-60, which clarified Notice 2013-29. Each Notice 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
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.
The notice provided 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.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.
Once commencing construction, a taxpayer must engage in "a continuous program of construction" in order to satisfy the physical work requirement. Notice 2013-29 provided 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:
- severe weather conditions
- natural disasters
- licensing and permitting delays
- delays at the written request of a state or federal agency regarding matters of safety, security, or similar concerns
- labor stoppages
- inability to obtain specialized equipment of limited availability
- the presence of endangered species
- financing delays of less than six months
- 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. 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.
Like the "physical work test," Notice 2013-29 also required the taxpayer to engage in a continuous program of construction until such time that the project is placed in to service.
Notice 2013-60 contains a safe harbor for determining whether a program of construction will be treated as continuous. If a project that otherwise meets the 5 percent safe harbor or physical work test is placed into service before January 1, 2016, construction of such project will be deemed to be continuous without regard to the specific facts. Taxpayers who place projects into service after December 31, 2015 will have to demonstrate continuous program of construction based on all of the facts and circumstances, including the factors listed above.
Notice 2013-29 did not contain any guidance on whether a transfer of a project during construction had an impact on eligibility to claim the ITC or PTC. Silence on this point generated a lot of questions from taxpayers, because the guidance issued under the 1603 cash grant program limited the circumstances under which a project could be transferred while under construction and still be eligible for the cash grant. Notice 2013-60 makes clear that a taxpayer may claim the ITC or PTC for a project it places into service even if a different taxpayer owned the project when construction began. That is, the requirement that construction must begin before January 1, 2014 applies to the project rather than the taxpayer who eventually places the project into service.
Please contact Greg Broome (firstname.lastname@example.org; 415-947-2139), Andrew Bryant (email@example.com; 206-883-2512), or Adam O'Brien (firstname.lastname@example.org; 650-849-3347) in Wilson Sonsini Goodrich & Rosati's tax practice, or Scott Zimmermann (email@example.com; 415-947-2167), Peter Mostow (firstname.lastname@example.org; 206-883-2541), or Todd Glass (email@example.com; 415-947-2071) in the firm's energy and clean technology practice with any questions.
1 Please visit http://www.irs.gov/pub/irs-drop/n-13-29.pdf and http://www.irs.gov/pub/irs-drop/n-13-60.pdf to access the notices.
2 To view a previous WSGR Alert discussing guidance on the "beginning of construction requirement" 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 a contractual provision that limits damages to an amount equal to at least five percent of the total contract price will not be treated as limiting damages to a specified amount for this purpose.