ML Strategies: Energy & Clean Technology Article
March 27, 2013
Congress Extends Renewable Energy Production Tax Credit; IRS Guidance on "Begin Construction" Requirements Expected Soon
Renewable energy advocates began 2013 breathing a sigh of relief as Congress extended a key tax incentive for renewable energy production. Capping weeks of intense negotiations between the Obama Administration and Congressional leaders to avert the fiscal cliff, the House of Representatives late on the night of January 1 passed H.R. 8, the American Taxpayer Relief Act (P.L. 112-240), on a vote of 257-167. The Act was passed by the Senate, 89-8, in a similar late-night vote on December 31.
The Act contains some significant short-term wins on tax policy for the renewable energy industry. A tweak to the Section 45 production tax credit (PTC) will allow projects that begin construction before January 1, 2014 to take advantage of the credit.
Under previous law, taxpayers could claim either a 1.1 or 2.2 cent-per-kilowatt-hour tax credit for electricity produced for a ten-year period from eligible facilities placed in service by the end of 2012 (wind) or 2013 (closed-loop biomass, open-loop biomass, geothermal, marine and hydrokinetic, qualified hydroelectric, landfill gas, or municipal solid waste facilities). Congress modified section 45 to allow eligible renewable energy facilities that begin construction — rather than those that are placed in service — before the end of 2013 to claim the ten-year credit. Thus, if a wind project begins construction in 2013 but is not completed until 2016, the project theoretically would be eligible for 10 years of PTCs starting in 2016.
The Act also allows facilities qualifying for the section 45 PTC to elect to take a 30% investment tax credit (ITC) in lieu of the PTC for facilities that begin construction by the end of 2013. (Solar projects already can utilize a 30% ITC under Sec. 48 through 2016.) The ITC election is particularly attractive to offshore and community wind developers. Efforts to extend a cash grant program that monetizes the 30% ITC — the Section 1603 Program — were unsuccessful.
However, in extending the PTC and ITC, Congress used the same “begin construction” language it did when creating the 1603 Program as part of the American Recovery and Reinvestment Act (P.L. 111-5) in 2009. A key distinction is that to qualify for Section 1603 grants, projects not only had to begin construction by a certain date but they also had to be placed in service by firm deadlines tied to existing sunsets in the tax code. In H.R. 8, Congress imposed no such deadline for completion of construction. So long as construction commences before January 1, 2014, projects are eligible for the credits upon being placed in service. Congress recognized that extending the placed-in service requirement for one year would not incentivize many new projects because most take well over a year to complete. A typical one-year extension would have been an extension in name only, with the credit expiring before most eligible projects could be generating electricity. At the same time, many in Congress opposed extending the tax credit at all, let alone for one year. So the one-year extension with the new “begin construction” language kept the cost of the provision low but allowed enough flexibility for developers to be confident in moving forward with construction.
As a result, the Internal Revenue Service must issue implementing regulations clarifying for the industry what actions constitute the beginning of construction for the PTC and ITC. Treasury has done much of this analysis already. In July 2010, the Treasury Department issued guidance (available here) on the “begin construction” language after the establishment of the Section 1603 cash-grant program, which Treasury administered. The 1603 guidance is illustrative of Treasury’s thinking but not binding for Section 45 PTC purposes. The renewable energy industry would like the IRS to adopt the same guidance for the PTC and ITC quickly, as that guidance contains a fairly generous definition of “beginning construction.”
According to Treasury’s Section 1603 guidance on “begin construction,” construction begins either when “physical work of a significant nature” begins, or, under a safe harbor, when a taxpayer incurs five % of the total costs of the facility.
Under the 1603 guidance, “any physical work on the specified energy property will be treated as the beginning of construction even if such work relates to only a small part of the facility.” This represented a new, more expansive approach, because traditionally the IRS has treated each turbine as a separate “facility” for tax purposes. Thus, the IRS must determine whether starting construction on a few turbines constitutes starting construction on the entire wind farm.
In its 1603 guidance, Treasury stated that it will “closely scrutinize any construction activity that does not involve a continuous program of construction or a contractual obligation to undertake and complete within a reasonable time, a continuous program of construction.” This suggests that if physical work of a significant nature begins on a small portion of a project, work must proceed continuously, or taxpayers will risk losing eligibility for the credits. Offshore wind developers who are faced with construction restrictions during whale migrations, as well as logistical delays due to the scarcity of appropriate offshore installation vessels, want the IRS to recognize these unique circumstances as potential impediments to continuous construction that nevertheless should not jeopardize eligibility.
The IRS must also determine whether to keep the five percent safe harbor or to impose a higher threshold for costs. In order to tighten eligibility requirements, the IRS could look to limit the safe harbor to identifiable and advanced projects. This could be based on an evaluation of such factors as completion of engineering studies, filing of applications for occupancy/lease rights, executed power purchase agreements, and executed contracts for procurement of equipment (as opposed to development of site assessment costs), along with some minimum percentage of non-refundable payment. On the other hand, in the absence of any legislative history, it would not be unreasonable to think that Congress, in adopting the same “begin construction” language, intended for Treasury’s 1603 guidelines (with the five percent safe harbor) to apply.
The IRS has been flooded with inquiries and is expected to issue its guidance in the next few months. This guidance may or may not be an interim matter, as the ultimate fate of the PTC and ITC — and all related clean energy and energy efficiency tax provisions — is tied to the tax reform debate expected later in this session of Congress. The renewable energy industry may have won a brief respite with this most recent extension, but the fight over extending clean energy incentives certainly will continue.