The IRS recently issued Notice 2016-31, providing further guidance regarding the “beginning of construction” requirement for the production tax credit (PTC) under Section 45 of the Internal Revenue Code and the investment tax credit (ITC) under Section 48 of the Internal Revenue Code. As noted in our previous update, the Protecting American from Tax Hikes Act of 2015 (PATH Act) enacted amendments to the PTC and the ITC for certain renewable energy facilities.

The PATH Act extended the PTC for two years with respect to certain facilities, which are described below, the construction of which begins before January 1, 2017. It further extended the PTC for wind facilities, the construction of which begins before January 1, 2020. The PTC is subject to phase out over the four year period. The PATH Act also extended the ITC for solar energy facilities, the construction of which begins before January 1, 2022.

Extension and Modification of the Continuity Safe Harbor

Prior IRS guidance provided that a taxpayer may “begin construction” by either (1) beginning physical work of a significant nature (Physical Work Test) or (2) paying or incurring five percent or more of the total cost of the facility (5% Safe Harbor). Both methods require a taxpayer to make continuous progress towards completion once construction has begun (Continuity Requirement). The following are extensions and modifications of these rules:

• Notice 2013-60, issued on October 28, 2013. Provided a safe harbor for satisfying the Continuity Requirement (Continuity Safe Harbor) if a facility was placed in service before January 1, 2016.
• Notice 2015-25, issued on March 30, 2015. Extended the Continuity Safe Harbor by one year, thereby allowing a taxpayer to satisfy the Continuity Requirement if a taxpayer began construction on a facility prior to January 1, 2015 and places the facility in service before January 1, 2017.
• Notice 2016-31, issued on May 5, 2016. Extended the Continuity Safe Harbor and provides that a taxpayer may satisfy the Continuity Requirement by placing a facility in service during a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began. For example, if construction begins on a facility on June 1, 2016, and the facility is placed in service by December 31, 2020, the facility will be considered to satisfy the Continuity Safe Harbor.

A taxpayer may not rely upon the Physical Work Test and the 5% Safe Harbor in alternating calendar years to satisfy the beginning of construction requirement or the Continuity Requirement. For example, if a taxpayer performs physical work of a significant nature on a facility in 2015, and then pays or incurs five percent or more of the total cost of the facility in 2016, the Continuity Safe Harbor will be applied beginning in 2015, not in 2016.

Excusable Construction Disruptions

Notice 2016-31 provides the following non-exclusive list of excusable construction disruptions that will not be considered in determining whether a taxpayer has satisfied the Continuity Requirement:

• Severe weather conditions
• Natural disasters
• Delays in obtaining permits or licenses from federal, state, local or Indian tribal governments
• Delays at the written request of a federal, state, local or Indian tribal governments regarding matters of public safety, security or similar concerns
• Interconnection-related delays, such as those relating to the completion of construction on a new transmission line or necessary transmission upgrades to resolve grid congestion issues that may be associated with a project’s planned interconnection
• Delays in the manufacture of custom components
• Labor stoppages
• Inability to obtain specialized equipment of limited availability
• Presence of endangered species
• Financing delays
• Supply shortages

Activities that Satisfy the Physical Work Test

Also provided in Notice 2016-31 is the following non-exclusive list of activities that will satisfy the Physical Work Test (i.e., physical work of a significant nature) for different types of renewable energy facilities:

• Wind facilities. On-site physical work of a significant nature may include the excavation for the foundation, the setting of anchor bolts into the ground or the pouring of the concrete pads of the foundation.
• Hydropower facilities. On-site physical work of a significant nature may include the excavation for or construction of a penstock, power house or retaining wall structure.
• Biomass and trash facilities. On-site physical work of a significant nature may include the performance of site improvements, as opposed to site clearing, such as filling or compacting soil or installing stack piling.
• Geothermal facilities. On-site physical work of a significant nature may include physical activities that are undertaken at a project site after a valid discovery.

Preliminary activities, such as planning and designing, securing financing, exploring, researching and obtaining permits and licenses, will not satisfy the Physical Work Test.

Retrofitted Facilities and the 5% Safe Harbor

A facility may qualify as originally placed in service even though it contains some used property if the fair market value of the used property is not more than 20% of the facility’s total value (i.e., the cost of the new property plus the value of the used property), which is known as the 80/20 Rule. Notice 2016-31 clarifies that the 5% Safe Harbor will be applied only with respect to the cost of new property used to retrofit an existing facility.

Importance of Notice 2016-31

Notice 2016-31 provides important guidance for wind and other qualified facilities regarding the applicability of the “beginning of construction” requirements in light of the passage of the PATH Act. Taxpayers seeking eligibility of the production tax credit and the investment tax credit for their facilities should take care to structure development activities to meet the guidance provided by Notice 2016-31 because the IRS will not issue private letter rulings on the application of the notice or the application of the “beginning of construction” requirement.

It is important to note that Notice 2016-31 states that the U.S. Department of the Treasury and IRS anticipate issuing separate guidance addressing the extension of the ITC for solar energy facilities.

© 2016 Perkins Coie LLP