Four-year lookback pain
A four-year lookback rule is causing pain for some US renewable energy developers.
Production tax credits can be claimed for 10 years at full rates on the electricity output from wind, geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy projects that are under construction by December 2016. There must also be continuous work on the project after construction starts.
The IRS said in early May that it will not make a developer prove continuous work on any project that is completed within four years. However, the four years start at the end of the year construction started. Thus, for example, if a wind developer dug several turbine foundations on the site for a wind farm in 2013, then the four years would run out at the end of 2017.
Before May, a developer had two years to finish without proving continuous work. The two years ran from the current construction-start deadline: for example, from the end of 2016.
More importantly, there are two ways to start construction. One is by beginning physical work of a significant nature at the site or at a factory on equipment for the project. The other is by “incurring” at least 5% of the total project cost.
If the developer ends up having to prove continuous work to qualify for tax credits because a project takes more than four years to build, then it makes a difference how construction started. It should be possible to prove continuous work if construction started under the 5% test because the developer must prove “continuous efforts” on the project. This can include steady work on development-type tasks.
If construction started under the physical work test, then “continuous construction” must be proven. This may be impossible to do for a wind farm that normally takes only six to eight months to build once work begins in earnest on the site.
When the IRS announced a retrospective four-year window in early May, it also said that developers who started work in anticipation of earlier construction-start deadlines by doing physical work would not be able to upgrade to the 5% test based on incurred costs through the end of 2016.
This is causing pain for developers who did modest work ahead of earlier deadlines.
The development rights to their projects have become difficult to sell. The projects also have become difficult to finance in the tax equity market. Michael Storch, executive vice president and chief corporate development officer of Enel Green Power North America, asked at the Global Windpower 2016 convention in late May, “Are we going to end up with a double standard where we could not raise tax equity earlier because [of concerns about whether there was] enough physical work, and we cannot raise tax equity today because what the investors thought was too little now looks to them like too much.”
One group of developers asked the Treasury and Internal Revenue Service to address the problem by letting developers choose to live under the former two-year window for completing projects that runs from the end of 2016, regardless of when construction started. This option would be available for any developer whose project was under construction before 2017. It would mean a project on which construction started in 2016 or any earlier year would have until the end of 2018 to be completed to qualify for full tax credits. If the project takes longer, then the developer would have to prove continuous work.
Anyone choosing this two-year window would be allowed to prove continuous work based on the 5% test if at least 5% of the project cost is incurred by the end of 2016, even if physical work started in an earlier year. This would make it easier to prove continuous work if required to do so.
The American Wind Energy Association proposed a series of alternatives. AWEA wants the IRS to address when earlier physical work can be abandoned and, thus, free the project to establish a new construction-start date.
It also wants a four-year window from the end of 2016 for all projects that started construction any time before 2017. And it says a project should not be barred from upgrading to the 5% test. If work started under both the physical work test and the 5% test, then the developer should be able to choose which it prefers. At the very least, it says, inability to upgrade should be applied prospectively after the IRS changed the rules on May 5 this year.
Developers faced earlier deadlines at the end of 2011, 2013 and 2014 to start construction to qualify for Treasury cash grants or tax credits.
The IRS has issued five notices — two in 2013 and one each in 2014, 2015 and 2016 — explaining how the construction-start rules work for tax credits.
The agency has reserved on construction-start issues for solar projects, which have until the end of 2019 to start construction and qualify for a full 30% investment tax credit. Solar projects, unlike other projects, face an outside deadline of December 2023 to be put in service to qualify for a larger tax credit than the permanent 10% investment tax credit. The IRS must still decide what continuous work requirement, if any, to impose on solar in view of this outside deadline to finish.
The solar notice is expected this fall.
It could serve as a vehicle for relief on the retrospective four-year window for other renewable energy projects. However, if the solar notice slips to late in the year, then it would not leave enough time for developers who want to move to the 5% test to do so. The Treasury is aware of this problem. It is possible there could be a separate, shorter notice solely addressed to the lookback issue.