John W. Kellogg and Rebecca B. DeCook, Partners, Moye White LLP
Once again the race is on to get new renewable energy projects under construction by year end. While the American Taxpayer Relief Act of 2012 (“ATRA”) provided the long sought extension of the Production Tax Credit (“PTC”) and Investment Tax Credit (“ITC”) for certain renewable resources through 2013 (wind, biomass, geothermal, landfill gas, trash, hydropower and marine and hydrokinetic facilities), the extension comes with terms that present new challenges for developers.
Significantly, to qualify for the PTC or ITC, new renewable projects must “begin construction” prior to January 1, 2014. Under prior law, to qualify for the PTC, the facility had to be “placed in service” by the applicable deadline, which essentially required the commencement of commercial operation. The change in terminology under ATRA increases the availability of the PTC/ITC to a broader array of long lead-time projects, provided they can meet the new “begin construction” deadline by the end of this year. For projects that meet this deadline, the PTC/ITC is effectively extended by more than one year.
Unfortunately, ATRA does not provide any guidance regarding what activities will meet the “begin construction” requirement. However, the same “begin construction” concept was used in the former Section 1603 grant program – a program that was not extended by ATRA. While the ultimate interpretation of the “begin construction” requirement under ATRA is uncertain until the IRS issues guidance, at this point, using the Section 1603 guidance as the model, a new project will satisfy the “begin construction” requirement if, by December 31, 2013, it: (i) initiates physical work of a significant nature; or (ii) incurs more than 5 percent of the total project costs.
Physical Work
Following Section 1603 guidance, the “begin construction” requirement is satisfied if “physical work of a significant nature” has started on the renewable project prior to January 1, 2014. This includes both on-site physical work at the facility, as well as off-site physical work under a binding written contract with another party, such as an equipment supplier. To be “binding,” the contract: (i) must be more than an option; (ii) clearly identify the amount and design specifications of the property to be purchased; (iii) specify damages if the developer terminates the contract of no less than 5 percent of the contract value; and (iv) result in the issuance of a notice to proceed with work before the end of 2013.
For Section 1603 purposes, the IRS clarified that “physical work of a significant nature” does not include preliminary activities such as planning or designing, securing financing, exploring, researching, clearing a site, obtaining permits, test drilling a geothermal deposit, test drilling to determine soil condition, 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. However, the beginning of excavation of foundations, installation of transformers, setting anchor bolts, pouring foundations, or the construction of a road to be used to transport equipment to the site, would meet the requirement. Similarly, physical assembly of major components off site at a factory, so long as the developer has a binding contract in place for such work, will satisfy the requirement.
While ATRA does not provide an “end” date for eligibility, there is no requirement that the facility be placed in service by a certain date. Arguably, this could allow for indefinite construction periods to maintain eligibility for the PTC/ITC. However, if ATRA is patterned upon Section 1603 guidance, to qualify, once physical work has commenced, there must be a continuous program of construction to completion, subject to certain allowable delays.
Cost Method – Five Percent of Total Project Cost
The alternative to demonstrating actual physical work on the project is to pay or incur 5 percent or more of the total project cost prior to the end of 2013 (the “Cost Method”). While IRS guidance issued under ATRA may or may not change this percentage for the PTC/ITC, the administrative requirements to determine the eligible costs and when payment or incurring such costs are deemed to have occurred should be consistent. For cash method taxpayers, evidence that the amount has been paid is generally sufficient (i.e., a wire confirmation). For accrual method taxpayers, a cost is generally considered incurred when: (i) the liability is fixed and determinable with reasonable accuracy; and (ii) the services or property has been delivered or such services or property must be provided within 3.5 months of payment. For equipment subject to a contract, but not yet manufactured (i.e., long lead-time items), amounts paid under a binding written contract prior to December 31, 2013 can be treated as costs incurred under the Cost Method.
To satisfy the Cost Method, keep in mind that the amount paid or incurred before the end of 2013 must equal 5 percent or more of the total cost of the facility. If the facility’s total costs increase, such that the amounts paid or incurred by the end of 2013 are less than 5 percent of the total, then the Cost Method requirements may not be met.
Parting Thoughts
The extension of the PTC/ITC is a significant victory for the renewable energy industry, however, because projects must “begin construction” by December 31, 2013, its availability may be limited to those projects that have already completed a significant amount of pre-construction activity. All of this assumes the IRS will follow the Section 1603 guidance in interpreting the ATRA requirements – an enormous assumption without any guidance from the IRS. We are monitoring the IRS in anticipation that it will issue guidance in the near future that will give more certainty to developers.
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.
