- Favorable Updated Guidance on Beginning of Construction
- September 25, 2013 | Authors: Amit Kalra; Craig M. Kline; David B. Weisblat
- Law Firms: Troutman Sanders LLP - Chicago Office ; Troutman Sanders LLP - New York Office ; Troutman Sanders LLP - Washington Office
On September 20, the Internal Revenue Service issued Notice 2013-60, clarifying Notice 2013-29, 2013-20 I.R.B. 1085. Notice 2013-29 provided guidance on beginning of construction of a qualified facility for purposes of section 45 of the Internal Revenue Code. See our previous client alert regarding Notice 2013-29.
As described below, Notice 2013-60 clarifies the requirements to be satisfied for a wind farm currently under development to be eligible for production tax credits even if it is placed in service after December 31, 2013. The revised requirements are very helpful and should be well received by sponsors and tax equity investors looking for greater certainty that a to be constructed wind farm will not lose access to the renewable energy production tax credit (‘PTC”) or the renewable energy investment tax credit (“ITC”).
Notice 2013-29 provides guidance on when construction of a qualified facility will have begun for purposes of the PTC under section 45 of the Internal Revenue Code (the “Code”) or the ITC under section 48 of the Code in lieu of the PTC. Notice 2013-29 provides two methods by which a taxpayer can satisfy the beginning of construction requirement: (1) starting physical work of a continuous nature (the “Physical Work Test”) or (2) incurring 5% or more of the costs of the facility (the “Safe Harbor Test”). Both of these methods require that the taxpayer make continuous progress towards completion once construction has begun (the “Continuous Construction Test” (for Physical Work) and the “Continuous Efforts Test” (for the Safe Harbor)). Notice 2013-29 also provides that a taxpayer may enter into a master contract for purposes of satisfying the Physical Work Test. It does not address the effect of a transfer of a facility after construction has begun.
Continuous Construction / Continuous Efforts Tests
Under Notice 2013-29, both the Continuous Construction Test and the Continuous Efforts Test are dependent on all facts and circumstances and neither provides an entirely clear standard for satisfaction. For projects under development that were seeking financing, much energy had been devoted to how satisfaction of the Continuous Construction Test would be evidenced and to what extent the Continuous Efforts Test provided an easier standard.
Notice 2013-60 provides a method that will allow taxpayers to be deemed to satisfy both the Continuous Construction and Continuous Efforts Tests. Under Notice 2013-60, if a facility is placed in service before January 1, 2016, the facility will be deemed to have satisfied the Continuous Construction Test and the Continuous Efforts Test. If a facility is not placed in service before January 1, 2016, whether the facility satisfies the Continuous Construction or Continuous Efforts Tests will be determined by the relevant facts and circumstances, as described in section 4.06 and section 5.02 of Notice 2013-29. This bright line standard greatly increases the confidence of financing parties that facilities under development will be eligible to claim PTCs or the ITC and should make it easier to develop more projects in the short term.
Master Supply Contracts
Notice 2013-29 also provides that if a taxpayer enters into a binding written contract for a specific number of components to be manufactured, constructed, or produced for the taxpayer by another person under a binding written contract (a “master contract”), and then through a new binding written contract (a “project contract”) the taxpayer assigns its rights to certain components to an affiliated special purpose vehicle that will own the facility for which the property is to be used, 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 for purposes of the Physical Construction Test. Notice 2013-60 clarifies that this provision also applies for purposes of the Safe Harbor.
The use of master contracts that then can be assigned to affiliated project companies should give developers much needed flexibility to acquire property before the close of 2013 and later assign that property to grandfathered projects once the developer has more clarity on the ability to complete development.
Transfer of a Facility
Finally, with respect to the transfer of a facility after construction has begun under either the Physical Work Test or the Safe Harbor, Notice 2013-60 clarifies that the statutory language requires only that construction of a facility begin before January 1, 2014. It does not require the construction to be begun by the taxpayer claiming the credit. If a qualified facility satisfies either the Physical Work Test or the Safe Harbor, a taxpayer that owns the facility during the 10-year period beginning on the date the facility was originally placed in service may claim the PTC with respect to that facility even if the taxpayer did not own the facility at the time construction began. Alternatively, a taxpayer that owns the facility on the date it is originally placed in service may elect to claim the ITC in lieu of the PTC with respect to that facility even if the taxpayer did not own the facility at the time construction began. Any ITC claimed on a facility will be limited to the taxpayer’s basis in qualified property (as defined in section 48(a)(5)(D)).
The Notice provides the following example: In August 2013, Developer acquires a parcel of land on which it intends to build and operate a wind farm (“Facility”). Developer contributes the land to its wholly-owned limited liability company (“LLC”), which is disregarded as an entity separate from its owner for federal tax purposes, to hold and develop Facility. In November 2013, Developer incurs 5 percent of the cost of Facility and thereafter maintains continuous efforts to advance towards the completion of Facility. In April 2014, to finance the development of the project, Developer sells 95 percent of the interests in LLC to a group of investors (“Investors”) who are not related to Developer, and Developer does not contribute sales proceeds to LLC. Under Rev. Rul. 99-5, 1999-1 C.B. 434, Developer is treated as selling 95 percent of each of the assets of LLC to Investors, and immediately thereafter Developer and Investors are treated as contributing their respective 5 percent and 95 percent interests in those assets to LLC, which is now a partnership and the owner of Facility for federal tax purposes. In October 2015, LLC places Facility in service. Because Facility satisfies the Safe Harbor and assuming Facility is otherwise a qualified facility under section 45(d), LLC is eligible to claim the PTC with respect to electricity generated by Facility and sold to an unrelated party. Alternatively, LLC may elect to claim the ITC in lieu of the PTC.
This clarification that the Physical Work Test and the Safe Harbor apply at the project level, rather than at the level of the taxpayer, is entirely consistent with the statute and relieves an unnecessary bottleneck to the financing of projects under development.
Overall, Notice 2013-60 provides the elements necessary to grandfather many more projects for PTC and ITC eligibility. It raises the possibility that solutions like those successfully used to grandfather solar facilities for cash grant purposes are now available for wind farms. Some of those cash grant grandfathered solar facilities still have not been placed in service, notwithstanding expiration of the cash grant nearly two years ago. The guidance provides significant support for an industry facing the loss of a valuable incentive and should be well received by both project developers and their investors.