Good news came for renewable energy developers on June 29, 2021, when the IRS issued Notice 2021-41. The notice gives developers more time to finish projects and makes it easier to prove that they began construction on a project in a particular year. The relaxed rules in the notice will help developers constructing wind, solar, and other renewable projects to qualify the projects for production tax credits (“PTCs”) and investment tax credit (“ITCs”). The notice provides significant relief to developers who have faced slowdowns, equipment shortages, and delays in construction caused by COVID-19.
Background on ITCs, PTCs, and Beginning Construction
Investors in renewable energy projects generally have a choice between claiming ITCs or PTCs. The ITC is equal to a percentage of the basis of eligible energy property placed in service in a particular year. The PTC varies based on the amount of electricity an eligible energy property produces for each of the first 10 years after the project is placed in service. Both the ITC and the PTC phase out depending on when a project begins construction. While the Internal Revenue Code does not explain what it means to “begin construction,” the IRS has issued a series of notices that provide guidance for establishing the year in which construction on a project began. Given the importance to tax equity investors of clearly establishing the amount and availability of ITCs and PTCs, it has become an industry standard practice for renewable energy developers to maintain records in accordance with the guidance in the notices. The notices provide two alternative paths to proving the beginning of construction for a qualified facility: the physical work test and the 5% safe harbor. Each method requires the taxpayer to make continuous progress towards completion once construction of the project has begun (the “continuity requirement”).
IRS Notice 2021-41 Extends the Continuity Safe Harbor
Previous notices provided that a taxpayer could demonstrate that it met the continuity requirement if a project was placed in service within four calendar years after its construction began (the “Continuity Safe Harbor”). In response to development delays caused by COVID-19, last year, the IRS issued a notice extending the Continuity Safe Harbor to five years for projects that began construction in either 2016 or 2017.
This year, to provide additional relief, the IRS issued Notice 2021-41, which further extends the Continuity Safe Harbor and provides that projects that began construction in 2016 through 2020 can meet the Continuity Safe Harbor if they complete construction and are placed in service no more than six calendar years after the calendar year in which construction began. This means that a developer who started construction on a project in 2016 has until the end of 2022 to place it in service to meet the Continuity Safe Harbor. This extra time will be valuable to developers who have struggled to complete construction on time because of the pandemic.
IRS Notice 2021-41 Relaxes the Facts and Circumstances Test
Under the notices, if a project completes construction outside of the Continuity Safe Harbor window, a taxpayer can still demonstrate it has met the continuity requirement by meeting a facts-and-circumstances test. The previous notices provided two different versions of the facts-and-circumstances test whose application depended on whether a project began under the physical work test or the 5% safe harbor. If a project began under the 5% safe harbor, it was subject to the “Continuous Efforts” facts-and-circumstances test, which requires a showing that the developer had made “continuous efforts” on activities such as incurring expenses, entering into contracts, obtaining permits, and performing physical work. On the other hand, a project that began under the physical work test was subject to the much stricter “Continuous Construction” facts-and-circumstances test, which mandated that the developer prove that it had performed ongoing physical work of a significant nature, such as manufacturing equipment, installing structures, and digging foundations. The Continuous Construction test is much harder to meet because developers typically do not continuously perform physical work on a project from the time construction begins to the time the project is placed in service. As a result, developers and tax equity investors typically have been more reluctant to rely on the physical work test in demonstrating the beginning of construction of a project.
IRS Notice 2021-41 allows developers the choice between the Continuous Construction standard and the more lenient Continuous Efforts standard to satisfy the facts-and-circumstances test for proving continuity, regardless of whether they began construction under the physical work test or the 5% safe harbor. This is a substantial benefit to developers who began construction under the physical work test, because if they fail to complete their projects during the six-year Continuity Safe Harbor window, they will still have the option to meet the relaxed standard of Continuous Efforts rather than proving that they have been performing continuous physical work of a significant nature throughout the project's development.
Notice 2021-41 delivers significant relief to developers who have faced longer construction times during the COVID-19 pandemic. It may increase the likelihood that developers begin construction under the physical work test because of availability of the more relaxed Continuous Efforts test, and may motivate tax equity investors to finance such projects.
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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