No Costs Were “Incurred”
No costs were “incurred” under a construction contract for a large power plant until the plant reached substantial completion, the Internal Revenue Service ruled.
The ruling has implications for renewable energy companies rushing to start construction of new US projects this year to qualify for tax credits.
A utility signed a lump-sum turnkey construction contract with a contractor before 2008 to build a power plant that burns petroleum coke in a circulating fluidized-bed boiler to generate electricity. The utility qualified potentially for a 50% “depreciation bonus” on the project, or the ability to deduct 50% of the cost immediately, but only if it could show that the project was not under construction before 2008.
It was a bad fact that the utility had a binding construction contract in place before 2008. The IRS said the fact that the contract price increased as a consequence of a settlement agreement settling conflicting claims that the contractor and utility had against each other, and that other changes were made to reduce the guaranteed output and make small changes in equipment design due to changes in the expected characteristics of the petroleum coke, did not prevent the contract from being considered binding back to the date it was originally signed.
It was also a bad fact that physical work on the project started before 2008.
However, the depreciation bonus rules let one ignore these factors if no more than 10% of the total project cost was “incurred” before 2008.
The utility said that under its method of accounting, it does not treat costs as incurred until a project is accepted. The construction contractor retained control over the project and risk of loss until substantial completion. Therefore, the IRS said, no costs were incurred under the construction contract until acceptance of the project by the utility after substantial completion. The utility had significant construction period interest that was considered incurred before 2008, but it and other pre-2008 costs did not exceed 10% of the total project cost.
The utility failed to claim a depreciation bonus on any of its assets in the year the project went into service. The IRS does not ordinarily rule in cases where a tax return has already been filed, absent special circumstances. The utility appears to have produced a letter from its regulators “requiring” it to claim the bonus. The utility could not just file an amended tax return because the decision to change course on depreciation is considered a change in “method of accounting” requiring IRS permission.
The ruling is Private Letter Ruling 201313012. The IRS made it public in late March.