United States: IRS Issues Additional Guidance On When Construction Begins For Purposes Of Production Tax Credit, Investment Tax Credit

The Internal Revenue Service (IRS) has issued additional guidance relating to when construction begins with respect to wind and other qualified facilities for purposes of the production tax credit and investment tax credit.  This guidance focuses on the continuous construction and continuous efforts tests and the effects of ownership transfers of a facility after construction has begun.

The Internal Revenue Service (IRS) issued Notice 2013-60 (Notice) on September 20, 2013, to provide further guidance on meeting the beginning of construction requirements for wind and other qualified facilities (biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic facilities).  The Notice addresses the requirements of continuous construction and continuous efforts to complete a project, transfers of a facility after construction has begun, and the "master contract" provisions, discussed below.   

Background

Section 407 of the American Taxpayer Relief Act of 2012 extended until January 1, 2014, the production tax credit (PTC) and the investment tax credit (ITC) for electricity produced from qualified facilities.  Congress also liberalized the timing requirement for a qualified facility so that a taxpayer may meet the January 1, 2014, deadline by "beginning construction" on the facility by such date.  Previously, a taxpayer could only meet the deadline by placing the facility in service.

In April 2013, the IRS issued Notice 2013-29 to provide taxpayers with guidance with respect to when construction will be considered to have begun for purposes of the PTC and ITC (Prior Guidance).  For more information, see McDermott's  summary of the Prior Guidance.  The Prior Guidance relied upon, but also varied from, similar guidance issued with respect to the grant in lieu of investment tax credits pursuant to Section 1603 of the American Recovery and Reinvestment Tax Act of 2009, as amended (Grant Construction Guidance).  The Grant Construction Guidance was discussed  here here and  here.

Under the Prior Guidance, a taxpayer may establish that construction has begun on a qualified facility by demonstrating that "physical work of a significant nature" has begun (Physical Work Method) or by satisfying a 5 percent safe harbor (Safe Harbor).  The Physical Work Method only applies to physical work of a significant nature that is completed with respect to tangible property that is "integral to the facility."  The IRS will closely scrutinize a facility if a taxpayer does not maintain a "continuous program of construction," as defined in the Prior Guidance (Continuous Construction Test).  Under the Safe Harbor, construction of a qualified facility is considered as having begun before January 1, 2014, if a taxpayer pays or incurs (within the meaning of Treas. Reg. § 1.461-1(a)(1) and (2)) 5 percent or more of the total cost of the facility before such date and, thereafter, the taxpayer makes continuous efforts to advance toward completion of the facility (Continuous Efforts Test).

The Prior Guidance also provides that, with respect to the Physical Work Method, a taxpayer is permitted to enter into a binding written contract for specific components of the qualified facility to be manufactured, constructed or produced for the taxpayer by another person (a Master Contract).  The taxpayer is also permitted, pursuant to a second new contract, to assign the rights to the components constructed or produced under a Master Contract to an affiliated special purpose vehicle that will own the facility.  The work performed with respect to the Master Contract may be taken into account in determining when physical work of a significant nature begins with respect to the facility.

The Notice

Continuous Efforts

Under the Prior Guidance, with respect to both the Physical Work Method and the Safe Harbor, a taxpayer is required to make "continuous" efforts to construct or complete the facility pursuant to the Continuous Construction Test and Continuous Efforts Test.  The Prior Guidance provides lists of exceptions or disruptions to these efforts that are not considered to indicate that a taxpayer has failed to maintain a continuous program of construction or continuous efforts.  Practitioners and industry participants had a significant number of questions and concerns about the satisfaction of the "continuous" requirements. 

To alleviate these concerns, the Notice provides that, if a facility is placed in service before January 1, 2016, the facility will be considered to satisfy the Continuous Construction Test and the Continuous Efforts Test.  However, if a facility is not placed in service before January 1, 2016, the facility is not automatically deemed to have failed these tests; whether the tests are met will be determined by the relevant facts and circumstances described in the Prior Guidance. 

Master Contracts

The Notice clarified that the Master Contract provisions of the Prior Guidance also apply for purposes of the Safe Harbor.

Transfer of a Facility

The Prior Guidance was silent as to the effect of a transfer of a facility after construction has begun but prior to the facility being placed in service.  The Notice permits a taxpayer to claim the PTC or ITC even if the taxpayer was not the owner of the facility on the date construction began.  The Notice clarifies that the statute does not require construction to be begun by the taxpayer claiming the PTC or the ITC.

The Notice notes that any ITC claimed on a facility is limited to the taxpayer's basis in the qualified property as defined in Section 48(a)(5)(D) of the Internal Revenue Code.  As defined in that section, "qualified property" means property (1) that is tangible personal property or other tangible property (not including a building or its structural components), if such property is used as an integral part of the qualified investment credit facility; (2) with respect to which depreciation (or amortization in lieu of depreciation) is allowable; (3) which is constructed, reconstructed, erected or acquired by the taxpayer; and (4) the original use of which commences with the taxpayer

As an example of a transfer meeting the above requirements, the Notice discusses a developer that has contributed land to a single-member LLC that will own the facility.  The developer incurred the appropriate Safe Harbor costs in November 2013 with respect to the facility.  It is assumed that the developer maintains continuous efforts to advance towards completion of the facility.  In April 2014, the developer sells 95 percent of the interests in the LLC to unrelated investors to finance development of the project.  The developer keeps the proceeds of the sale of interests.  Under Revenue Ruling 99-5, the developer is treated as selling 95 percent of the assets of the LLC to the investors.  Immediately thereafter, both the developer and the investors are deemed to contribute their respective 5 and 95 percent of the assets to the LLC.  The LLC becomes a partnership for federal income tax purposes upon the contribution.  In October 2015, the LLC places the facility in service.  The Notice concludes that, because the facility satisfied the Safe Harbor (and assuming the facility is otherwise qualified under Section 45(d), which defines "qualified facilities" in the context of various energy technologies), the LLC is eligible to claim the PTC, or may elect to claim the ITC in lieu of the PTC. 

Conclusion

The Notice provides helpful guidance, particularly with respect to the Continuous Construction and Continuous Efforts Test, and is in many ways more liberal than the Grant Construction Guidance.  The Notice seems to confirm that developers or potential investors in qualified projects are not required to identify a specific project prior to the end of 2013.  Investors and developers should query whether a developer that begins construction on a project in 2014 can acquire Safe Harbor eligible equipment from a third party and thereby qualify its project as having begun construction prior to January 1, 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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