The Internal Revenue Service has had a flood of calls about a suggestion that turbine supply agreements and other construction or equipment contracts should not have liquidated damages provisions.

The suggestion was in guidance the IRS issued this week about what renewable energy developers must do by year end to be considered to have started construction of new projects. Wind, geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy projects that are under construction by year end qualify for production tax credits for 10 years on the electricity output or an investment tax credit upon completion for 30% of the project cost.

There are two ways to prove that construction started this year.

One is by showing that physical work of a significant nature started at the site or at a factory that is making equipment for the project. However, any work done by a contractor at the site or the factory counts only if done under a binding contract that is in place before the work starts. The other way to start construction is by incurring at least 5% of the total project cost this year.

The IRS guidance this week on starting construction said, “A contract is binding only if it . . . does not limit damages to a specified amount (for example, by use of a liquidated damages provision).”

IRS officials said they did not mean to depart from past practice on what contracts are considered binding. In the past, a contract has been binding as long as no effort is made in the contract to limit damages to which the parties are exposed after a breach or, if there is a limit, the limit is not less than 5% of the total contract price.

The agency is working on a correction.

In other developments

The IRS examination division — the part of the IRS that does audits — wants it clear that companies cannot cite the Treasury cash grant guidance as authority for positions taken about when construction started to qualify for tax credits. The Treasury issued more extensive guidance about what it means to start construction for grant purposes than the IRS did this week. IRS sources said they tried to get out what they could quickly without repeating everything in the Treasury cash grant guidance.

According to IRS sources, the intention was to follow the Treasury cash grant rules with three main exceptions.

First, the IRS added to the 5% test a further requirement that the developer must show “continuous efforts” on the project after this year. This was a way to impose a soft limit on when a project must be completed. There is no deadline otherwise for a project to be finished to qualify for tax credits.

Second, the IRS tried to clarify when construction work is considered continuous. It understood that few people relied on the physical work test under the Treasury grant program to start construction because a developer who relied on physical work had then to show that the construction work was continuous, while there was no similar requirement for anyone satisfying the 5% test. The guidance has a list of nine items that are not a problem if they hold up construction. Notwithstanding the list, the agency does not expect developers to work at a site in Alaska or Minnesota, for example, during the coldest winter months where normal practice is to cease outside work, IRS sources said.

Third, the IRS tried to help developers who flunk the 5% test because a project ends up costing more than expected. Wind developers can draw a circle around a smaller number of turbines whose cost is not more than 20 times the amount the developer incurred by December 2013 and claim tax credits just on that part of the project.

The IRS guidance this week did not address when grandfather rights to tax credits will carry over in cases where a project is sold before the project is completed. Early drafts of the guidance had rules similar to the Treasury cash grant program. However, they had to be dropped after they caused the draft to bog down in the internal approval process. It is possible additional guidance will be issued later this year on the issue, but no decision has been made.

by Keith Martin, in Washington