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June 1, 2020

Stroock Special Bulletin

By: Michelle M. Jewett, Richard G. Madris, Jeffrey W. Meyers, Daniel Martinez, Lauren W. Shandler

On May 27, 2020, the Internal Revenue Service (the “IRS”) published Notice 2020-41, which provides welcome relief to developers and sponsors of renewable energy projects that are experiencing construction delays due to the COVID-19 pandemic.  Notice 2020-41 modifies prior IRS guidance concerning the “beginning of construction” requirement for both the production tax credit (the “PTC”) and the investment tax credit (the “ITC”) by extending (i) the dates by which projects that were started in 2016 and 2017 must be placed in service and (ii) certain 2020 deadlines for certain solar projects experiencing delays to qualify as commencing construction in 2019. Without this guidance, there was a risk that many renewable energy projects would not be eligible for these valuable tax credits.

Background

The PTC and the ITC are the two important federal income tax incentives currently available for renewable energy projects.  The PTC provides a tax credit per kilowatt-hour of electricity produced for ten years, and the ITC provides a credit equal to a specified percentage (30% for projects started before 2020) of the investment costs of the project.  The qualification for, and amounts of, the PTC and ITC credits depend on when the construction of a project begins and when the project becomes operational.[1]

The IRS has published several Notices that outline two methods that establish the year in which construction of a project begins: (i) the “Physical Work Test” and (ii) the “Five Percent Safe Harbor.”[2]  The Physical Work Test requires that physical work of a significant nature occurs in such year and is determined by the relevant facts and circumstances.  The Five Percent Safe Harbor requires that a taxpayer pays or incurs five percent or more of the total cost of the facility in a specific year.  The Notices provide that, for property that is constructed for the taxpayer by another person under a binding written contract with the taxpayer, costs incurred by the other person are deemed incurred by the taxpayer when the costs are incurred by the other person.  Both methods contain a “Continuity Requirement” pursuant to which a taxpayer must make continuous progress towards completion of the qualified facility or energy property once construction has begun in order to be treated as having commenced construction in a specific year.  The determination of whether the Continuity Requirement has been satisfied is based on all of the relevant facts and circumstances.

Both methods also contain a “Continuity Safe Harbor” that permits a qualified facility or energy property to be deemed to have satisfied the Continuity Requirement if the facility or property is placed in service by a certain deadline.  Prior to Notice 2020-41, the deadline was by the end of the calendar year that was no more than four calendar years after the calendar year during which construction began.  If a qualified facility or energy property was not placed in service by that deadline, then the Continuity Requirement was based on facts and circumstances.  Given the inherent uncertainty with respect to the application of a facts and circumstances test, particularly in light of delays resulting from the COVID-19 pandemic, sponsors and developers of renewable energy projects have been concerned about satisfying the Continuity Requirement if the Continuity Safe Harbor is not available.

For purposes of the Five Percent Safe Harbor, for a cost related to the purchase of property to be considered “incurred” by an accrual method taxpayer in a particular year (and therefore taken into account for purposes of applying the Five Percent Safe Harbor), the property generally must be provided to the taxpayer by the end of the year.  However, an accrual method taxpayer may treat the date of payment as the date a cost is incurred if the taxpayer reasonably expects to take title to or receive delivery of the property within 3½ months after the date of payment (the so-called “3½ Month Rule”).  Since the ITC is scheduled to phase down for projects commencing construction in 2020, failing to satisfy the Five Percent Safe Harbor for 2019 would result in a reduction in the ITC that can be claimed.  A number of developers and sponsors relied on this rule for purposes of satisfying the Five Percent Safe Harbor for solar and other projects in 2019 but found that as a result of supply chain interruptions the property could not be delivered within the required 3½ month period.

Notice 2020-41

Notice 2020-41, recognizing that many renewable energy projects were delayed due to the COVID-19 pandemic, expands the Continuity Safe Harbor and makes it easier for taxpayers to meet the Five Percent Safe Harbor by expanding the 3½ Month Rule.

Notice 2020-41 provides that for any qualified facility or energy property that began construction under the Physical Work Test or the Five Percent Safe Harbor in calendar year 2016 or 2017, the Continuity Safe Harbor is satisfied if a taxpayer places the qualified facility or energy property in service by the end of a calendar year that is no more than five calendar years after the calendar year during which construction with respect to that qualified facility or energy property began.  This allows an extra year to complete the project.  As a result, projects that began construction in 2016 have until the end of 2021 to be placed in service, and projects that began construction in 2017 have until the end of 2022.  This approach is welcome because it does not require taxpayers to demonstrate that they have experienced construction delays as a result of the pandemic.

Furthermore, Notice 2020-41 modifies the 3½ Month Rule, which allows a taxpayer to treat services or property as provided to the taxpayer (and thus counting towards the Five Percent Safe Harbor) when the taxpayer pays for the services or property, provided that the taxpayer can reasonably expect the person to provide the services or property within 3½ months after the date of payment.  The IRS notes that the 3½ Month Rule will be satisfied if the taxpayer's reasonable expectation at the time of the payment was that the person would provide the ordered services or property within 3½ months, regardless of any subsequent events that prevent that reasonable expectation from actually occurring.  Nevertheless, to provide certainty, Notice 2020-41 provides that for services or property paid by the taxpayer on or after September 16, 2019, the taxpayer will be deemed to have had a reasonable expectation that the services or property would be received within 3½ months in the case they are actually received by October 15, 2020.  This safe harbor provides needed relief to many renewable energy developers that otherwise may not have been able to satisfy the existing 3½ Month Rule with the level of certainty needed to complete their projects and qualify for the ITC or PTC.  Developers and sponsors of renewable energy projects may begin to rely on Notice 2020-41 immediately.

Of course, developers and sponsors should review their project documents and financing agreements to determine whether those agreements contemplate the extensions provided in Notice 2020-41 or whether amendment of any of those agreements is required in order to take advantage of the extensions without creating a breach or default, or incurring some other penalty under the project contracts.

For further information on the application of Notice 2020-41 to ongoing renewable energy projects please contact us.

 

______________________________

For More Information

Michelle M. Jewett

Richard G. Madris

Jeffrey W. Meyers

Daniel Martinez

Lauren W. Shandler

[1] The full PTC amount is 2.5 cents per kWh (adjusted annually for inflation).  The amount of the PTC is reduced for projects where construction started after 2016 as follows:  by 20% for projects started in 2017, by 40% for projects started in 2018, by 60% for projects started in 2019, and by 40% for projects started in 2020.  Thus, the PTC amount for projects started in 2020 is 1.5 cents per kWh produced for 10 years (adjusted annually for inflation), and projects starting in 2021 will not receive any PTC under the current law.

The percentage of the ITC is 30% for projects started through 2019, reduced to 26% for projects started in 2020, to 22% for projects started in 2021, and to 10% for commercial and utility projects started after 2021.

[2] See Notice 2013-29, Notice 2013-60, Notice 2014-46, Notice 2015-25, Notice 2016-31, Notice 2017-04, Notice 2018-59, and Notice 2019-43.

This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.