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In Notice 2016-31 the IRS updates guidance relating to the renewable electricity production tax credit under Section 45 (the PTC) and the energy investment tax credit under Section 48 (the ITC) to reflect the extension and modification of these credits by the Consolidated Appropriations Act, 2016 (the Act).

Background

Prior to the Act, the PTC and ITC for wind, closed-loop biomass, open-loop biomass, geothermal, landfill gas, trash, qualified hydropower, and marine/hydrokinetic renewable facilities was limited to facilities on which construction began before December 31, 2014. In addition, the ITC for solar property was scheduled to be reduced from 30% to the permanent rate of 10% for facilities placed in service after 2016. Division P of the Act extends and phases down the PTC and ITC for wind facilities. The extension permits wind facilities on which construction begins on or before December 31, 2019, to qualify for the credits. However, the otherwise allowable credit is reduced by 20%, 40%, and 60% for facilities on which construction begins in 2017, 2018, and 2019, respectively. Division P of the Act also extends the 30% ITC for solar property on which construction begins on or before December 31, 2021, if the property is placed in service on or before December 31, 2023. The solar ITC is phased down for facilities on which construction begins after 2019 to 26% for property on which construction begins in 2020 and 22% for property on which construction begins in 2021. Division Q of the Act (the Protecting Americans for Tax Hikes Act of 2015 (the PATH Act)) extends the PTC and ITC for other renewable energy facilities (closed-loop biomass, open-loop biomass, geothermal, landfill gas, trash, qualified hydropower, and marine/hydrokinetic) for two years to facilities on which construction begins on or before December 31, 2016. For additional detail regarding the statutory changes see Tax Alert 2015-2642.

The four IRS notices that preceded Notice 2016-31 provide background. Notice 2013-29 permits taxpayers to establish that construction on a facility has begun by either: (i) starting "physical work of a significant nature" (the Physical Work Test) or (ii) meeting a safe harbor by paying or incurring 5% or more of the total cost of the facility (the 5% Safe Harbor). Notice 2013-29 provides that a Section 45 facility generally includes all components that are functionally interdependent such that the placing in service or each of the components is dependent upon the placing in service of each of the other components in order to generate electricity. It states, however, that for purposes of determining whether construction has begun, multiple facilities that are operated as part of a single project are treated as a single facility.

Notice 2013-29 also establishes the Continuous Construction Test, stating that the IRS may determine that the Physical Work Test is not satisfied if the taxpayer fails to maintain a continuous program of construction. In addition, the 5% Safe Harbor is available only if the taxpayer maintains continuous efforts to advance completion of construction (the Continuous Efforts Test). Notice 2013-29 also provides a nonexclusive list of excusable disruptions to construction that will not cause a taxpayer to fail the Continuous Construction/Continuous Efforts Tests.¹

Notice 2013-60 provides that a facility placed in service before January 1, 2016, will be considered to satisfy the Continuous Construction Test and the Continuous Efforts Test (the Continuity Safe Harbor). Notice 2014-46 clarifies that there is no statutory requirement that the taxpayer placing a facility in service be the taxpayer that began construction, explaining that a partially or fully developed facility generally may be transferred to unrelated taxpayers without losing its qualification under the Physical Work Test or the 5% Safe Harbor. Notice 2015-25 described a one-year extension of the PTC and ITC to facilities on which construction began on or before December 31, 2014, and extended the Continuity Safe Harbor to facilities placed in service before January 1, 2017.

For additional details on these underlying notices, see: Tax Alert 2013-790 and Tax Alert 2013-852 (Notice 2013-29); Tax Alert 2013-1822 (Notice 2013-60); Tax Alert 2014-1453 (Notice 2014-46); Tax Alert 2015-552 (Notice 2015-25); and Tax Alert 2014-1790 (consolidated analysis of the first three notices).

Extension of Continuity Safe Harbor

Notice 2016-31 modifies the Continuity Safe Harbor. A facility will satisfy the Continuity Safe Harbor if it is placed 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. Thus, for example, if construction on a facility began in January 2016, the Continuity Safe Harbor is satisfied if the facility is placed in service on or before December 31, 2020. Notice 2016-31 also provides that a taxpayer may not rely on the Physical Work Test and the 5% Safe Harbor in alternating calendar years to satisfy the beginning of construction requirement or the continuity requirement. This means that construction begins for purposes of the Continuity Safe Harbor in the earlier of the year in which the Physical Work Test is satisfied or the year in which the 5% Safe Harbor is satisfied.

Additional clarifications

The Notice expands and clarifies the nonexclusive list of excusable construction disruptions provided in Notice 2013-29. The changes are:

— Clarification that licensing and permitting delays and delays at the written request of a state or federal agency includes delays attributable to a local or Indian tribal government;
— Interconnection-related delays,
— Delays in the manufacture of custom components; and
— Elimination of the six-month limitation on financing delays.

Notice 2016-31 also provides a nonexclusive list of examples illustrating physical work of a significant nature for different types of renewable energy facilities. The Notice provides new examples for hydropower facilities, biomass and trash facilities, and geothermal facilities, and a restatement of the example for wind facilities provided in Notice 2013-29. Repeating the limitation set out in Notice 2013-29, the current Notice provides that physical work of a significant nature does not include preliminary activities such as planning and designing, securing financing, or clearing a site.

The Notice also restates the Notice 2013-29 definition of a facility and its aggregation rule for purposes of determining when construction begins on facilities that are part of a single project. Notice 2016-31 adds that the aggregation rule is applied in the year that the last of the facilities are placed in service. In addition, Notice 2016-31 provides a disaggregation rule clarifying that facilities treated as parts of a single project for purposes of determining when construction begins may be disaggregated for purposes of determining whether the Continuity Safe Harbor is satisfied. Thus, facilities within a project that are placed in service within the safe harbor period will satisfy the Continuity Safe Harbor, while facilities placed in service thereafter must demonstrate based on the facts and circumstances that they satisfy the Continuous Construction/Continuous Efforts Test.

Additionally, Notice 2016-31 clarifies that when the 5% Safe Harbor is applied to an existing facility that is being retrofitted, only expenditures paid or incurred that relate to new construction should be taken into account. An example makes it clear that the value of used property is excluded from both the numerator and the denominator in applying the 5% Safe Harbor. The example also provides guidance on the application of the "80/20 rule," under which a facility is treated as a new property if the fair market value of the used property retained in the facility is not more than 20% of the facility's total value (the cost of the new property plus the value of the used property). The example clarifies that the 80/20 rule is applied separately to each individual facility comprising the single project.

Finally, the IRS stated that it will not issue private letter rulings to taxpayers on the application of the Notice or the application of the beginning-of-construction requirement under Sections 45(d) and 48(a)(5), and that it will issue separate guidance addressing the extension of the ITC for solar property.

Implications

Notice 2016-31 updates earlier guidance to conform to the Act's credit extensions. It extends and modifies the Continuity Safe Harbor and provides additional guidance regarding the application of the Continuity Safe Harbor and the Physical Work Test. Taxpayers should note that the extension of the Continuity Safe Harbor may benefit their projects even if they were not affected by the Act's beginning-of-construction extension. Facilities on which construction began in 2013 or 2014 would have previously satisfied the Continuity Safe Harbor only if they were placed in service before the end of 2016. Although the Notice does not specifically reference these facilities, they should satisfy the Continuity Safe Harbor if they are placed in service before the end of 2017 (facilities beginning construction in 2013) or 2018 (facilities beginning construction in 2014).

Taxpayers that have relied on the 5% Safe Harbor should be aware that the Notice gives added significance to the Physical Work Test by starting the running of the Continuity Safe Harbor in the first year in which either of those tests is satisfied. Thus, a taxpayer that began physical work in 2015 has only until December 31, 2019, to place property in service, even if the 5% Safe Harbor is not satisfied until 2016. This can be of particular concern in the case of a single project consisting of multiple facilities because the entire project is treated as a single facility for purposes of determining when construction begins. Thus, the Continuity Safe Harbor will begin to run when the Physical Work Test is satisfied for any of the multiple facilities within the project. The principal author of the Notice has stated the rule beginning the Continuity Safe Harbor with the first year in with either the Physical Work Test or the 5% Safe Harbor is satisfied may be reconsidered.

Notice 2016-31 also clarifies the application of the 5% Safe Harbor to retrofitted renewable energy facilities. This is especially beneficial to projects that have reached the end of the PTC period but want to upgrade their facilities with new technology. The Notice provides an example of the application of the 80/20 rule to a retrofitted wind facility. We have been informed by the IRS that there is a mathematical error in the calculation of the test that will be corrected when the Notice is officially published.

We will update this Alert should the facts require.

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ENDNOTES

¹ The listed disruptions are severe weather conditions, natural disasters, licensing and permitting delays, delays at the written request of a state or federal agency regarding matters of safety, security, or similar concerns, labor stoppages, inability to obtain specialized equipment of limited availability, the presence of endangered species, financing delays of less than six months, and supply shortages.