As noted in our prior article, New Twist to the Renewable PTC Extension: Defining "Under Construction," published March 12, 2013, the American Taxpayer Relief Act of 2012 ("ATRA") extends the Production Tax Credit ("PTC") and Investment Tax Credit ("ITC") for certain renewable facilities if construction of the facility begins prior to January 1, 2014, but did not define the "begin construction" requirement.
On April 15, 2013, the IRS provided guidance on this requirement; as expected, it is patterned after the previously issued Section 1603 guidance, with some additional and significant clarifications. Consistent with prior guidance, the “begin construction” requirement is met if by January 1, 2014: (i) physical work of a significant nature has commenced; or (ii) more than five percent (5%) of the total project cost of the facility are incurred prior to January 1, 2014. However, the IRS guidance clarifies that, thereafter, a “continuous program of construction” or “continuous efforts” must also be maintained in the manner described below.
The “begin construction” requirement is satisfied if “physical work of a significant nature” on tangible personal property integral to the facility has commenced prior to January 1, 2014. This work may include on-site physical work, or off-site physical work under a binding written contract with another party, such as an equipment supplier. Once commenced, there must be a continuous program of construction that involves physical work of a significant nature, subject to specific permissible construction disruptions identified by the IRS.
The term facility includes all components of property that are functionally dependent. For a wind farm, the electricity-generating wind turbine, the tower, and its supporting pad comprise a single facility. Under the new guidance, multiple facilities that meet certain specified criteria will be treated as a single facility for purposes of determining when construction has begun.
Tangible personal property “integral to the facility” includes property used to produce electricity, but does not include property used for electrical transmission. For example, physical work on a transmission tower would not qualify, but physical work on a custom-designed transformer that steps up the voltage of electricity produced at the facility to the voltage needed for transmission would qualify. Roads used to move materials or equipment to operate and maintain the facility would qualify, but access roads or roads used for employees or visitors would not qualify. Buildings are not considered an integral part of a facility, unless: 1) the structure is essentially an item of machinery or equipment, or 2) the structure houses property integral to the facility and the use of the structure is so closely related to the use of the housed property that the structure would be expected to be replaced when the property it houses is replaced.
“Physical work of a significant nature” continues to include excavation of foundations, setting anchor bolts, or the pouring of foundations. Similarly, physical assembly of major components off site at a factory will satisfy this requirement, so long as the developer has a binding contract in place for such work and the components are not held in the manufacturer’s inventory.
“Physical work of a significant nature” does not include preliminary activities even if the costs of those activities are properly included in the depreciable basis of the facility. Preliminary activities include planning or designing, securing financing, exploring, researching, clearing a site, obtaining permits, test drilling a geothermal deposit, test drilling to determine soil condition, or excavation to change the contour of the land, or the construction of access roads that are not an integral part of the operation of the facility.
To be “binding,” a contract must: (i) be entered into prior to work taking place; (ii) be enforceable under local law against the taxpayer or a predecessor; and (iii) not contain a liquidated damages provision. Work performed under a master contract and then assigned to a new affiliated special purpose vehicle under a new binding written contract may be considered in determining when physical work of a significant nature has begun with respect to a facility.
5 Percent Cost Safe Harbor and “Continuous Efforts”
Alternatively to physical work, construction of a facility will be considered to have commenced if five percent (5%) or more of the total project cost is paid or incurred prior to the January 1, 2014, and, thereafter, “continuous efforts” are made to advance towards completion of the facility. The total cost of the facility does not include the cost of land or any property that is not integral to the facility.
The “continuous efforts” requirement is new and does not require physical construction. Determination of “continuous efforts” is fact-specific, and includes, but is not limited to, the following: (i) paying or incurring additional amounts included in the total cost of the facility; (ii) entering into binding written contracts for components or future work on construction of the facility; (iii) obtaining necessary permits; and (iv) performing physical work of a significant nature.
The “continuous efforts” requirement is also subject to the same permitted disruptions and delays as the “continuous program of construction” requirement.
If the facility incurs cost overruns that cause the amounts paid or incurred by the end of 2013 to be less than 5% of the total, the IRS states that the Safe Harbor will not be satisfied, but the PTC/ITC may be claimed with respect to some, but not all, of the individual facilities comprising a single project, so long as the total aggregate cost of those individual facilities is not more than twenty times greater than the amount paid or incurred before January 1, 2014.
This new guidance by the IRS provides much needed clarification for PTC qualification. With the flexibility provided under the Safe Harbor, diligent developers should be able to plan and commence implementation of projects prior to January 1, 2014, even if actual physical construction of the project starts after that date.
Becky DeCook provides experienced and detailed counsel on telecommunications and energy matters. For more than 20 years she has represented clients in arbitrations, mediations, state and federal court proceedings, and proceedings before state utility commissions throughout the Central and Rocky Mountain regions of the United States, as well as before the Federal Energy Commission and the Federal Communications Commission.
Lead image: Helping hand via Shutterstock