IRS Issues Additional Guidance on Construction Start Issues
The Internal Revenue Service released additional guidance August 8 on how far along wind and other renewable energy projects had to be by December 2013 to be considered under construction.
Such projects had to be under construction by December 2013 to qualify for federal tax credits.
The agency tried to address the uncertainty that has caused tax equity investors to back away from financing wind farms and other renewable energy projects that relied on the “physical work test” to start construction. Investors worried that minimal physical work like excavating a handful of turbine foundations or putting in a few hundred feet of string roads at a project site is not enough.
A group of wind generators and tax equity investors encouraged the IRS to provide several clear examples of what qualifies as significant physical work.
The IRS did not want to draw more bright lines like it has already done with the 5% test.
Instead, it said: “Assuming the work performed is of a significant nature, there is no fixed minimum amount of work or monetary or percentage threshold required to satisfy the Physical Work Test.”
The agency drew attention to several examples of significant physical work that were in earlier guidance.
Those suggested that significant physical work begins with “the beginning of the excavation for the foundation” or with “physical work on a customer-designed transformer that steps up the voltage” or with string roads at a project site.
Some tax equity investors read an example in earlier guidance to suggest that a wind developer relying on work on turbine foundations needed to have started on at least 20% of them in 2013. The IRS said it did not intend to suggest there is a 20% threshold or any fixed minimum amount of work required.
The agency has said all along that a developer had merely to start work on a significant task in 2013, but not to complete the task in 2013.
Will this be enough to reopen the tax equity market for developers who relied on the physical work test? Some may want to hear from IRS or Treasury officials what is intended before financing projects that involve something as minimal as just digging a hole at a site without doing anything more to build out the rest of the foundation, but the words suggest even that is okay.
The new guidance addresses two other issues.
Some larger wind companies stockpiled turbines or other equipment in 2013. They may have had a list of projects at which they might use the equipment. Companies have been asking whether they can change their minds -- for example, can a company decide in 2014 to use the equipment at a project it acquires from another developer who did not start construction in time on his project, use the stockpiled 2013 equipment, and treat the acquired project as under construction in time on grounds that at least 5% of the project cost was incurred in 2013.
The IRS said yes.
Projects that were under construction by the end of 2013 qualify potentially for federal tax credits. One way to start construction was by starting physical work of a significant nature at the project site or on equipment at a factory. The other way was by “incurring” at least 5% of the project cost.
Some developers incurred a lot of costs but not 5%. Some who fell short of 5% asked whether they can claim tax credits on a fraction of the project. The IRS said yes, as long as at least 3% of the total project cost was incurred by the end of 2013. For example, if 3% of the project cost was incurred in time, then tax credits can be claimed on 60% of the electricity output or project cost.
The additional guidance is in Notice 2014-46.
It is relevant not only to wind farms, but also to geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy projects.
The Senate tax-writing committee voted in April to extend the deadline to start construction to qualify for tax credits to December 2015. This provision is part of a broader package of tax extenders. The package has stalled in the Senate. However, the Senate majority leader, Harry Reid (D.-Nevada), has said he will try to bring it up again in a “lame-duck” session of Congress in late November or December.
By Keith Martin