Background
PTCs are available for production of energy from qualified energy resources, which generally include wind, closed-loop biomass, open-loop biomass, geothermal energy, small irrigation power, municipal solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy.
ITCs are available for solar energy property, solar illumination property, geothermal energy property, qualified fuel cell property, qualified microturbine property, combined heat and power system property, qualified small wind energy property, and qualified geothermal heat pump property. In addition, a taxpayer may elect to treat certain renewable energy facilities that otherwise qualify for PTCs to claim ITCs in lieu of PTCs.
PTCs for any taxable year are calculated by multiplying an inflation-adjusted credit rate by kilowatt hours of electricity produced and sold by the taxpayer to an unrelated person. ITCs are calculated as a percentage of the basis of energy property placed in service during the taxable year.
Beginning construction
In many cases, eligibility for credits, and the amount of credits available, depends on when construction of a facility begins.
A taxpayer may establish the beginning of construction by starting physical work of a significant nature (the Physical Work Test). Alternatively, under a safe harbor, construction of energy property will be considered as having begun when a taxpayer pays (in the case of a taxpayer on the cash method of accounting) or incurs (in the case of an accrual method taxpayer) 5 percent of the cost of the energy property (the 5-Percent Test).
For purposes of satisfying the 5-Percent Test, an accrual method taxpayer is treated as incurring an expense when all events have occurred which determine the fact of liability, the amount of such liability can be determined with reasonable accuracy, and economic performance has occurred. In general, in the case of a liability incurred in connection with the acquisition of property, economic performance is considered to occur when the property is provided to the taxpayer. Depending on the taxpayer’s method of accounting, a taxpayer is permitted to treat property as having been provided when the property is delivered or accepted, or when title passes. Under an exception to this rule, a taxpayer is permitted to treat property as having been provided when it pays for the property if the taxpayer reasonably expected the seller to provide the property within 3 ½ months of the payment (3 ½ Month Rule).
Both the Physical Work Test and the 5-Percent Test require that a taxpayer make continuous progress toward completion of a project once construction has begun (Continuity Requirement). Under a safe harbor, a taxpayer will be deemed to satisfy the Continuity Requirement if the taxpayer places the energy property in service by the end of a calendar year that is no more than four calendar years after the calendar year during which construction of the energy property began (the Continuity Safe Harbor).
Notice 2020-41
COVID-19 has created supply line issues and construction delays that have created uncertainty in the renewable energy industry. Although the 3 ½ Month Rule requires only that an accrual method taxpayer reasonably expected to receive property within a 3 ½ month period in order to be treated as incurring an expense on the date of payment, and not actual receipt of the property, tax equity investors are often reluctant to fund projects, and developers are often reluctant to complete projects, if the project is relying on the 3 ½ Month Rule for credit eligibility and the property is not actually received within 3 ½ months of payment.
Similarly, COVID-19-related construction delays have called into question whether projects can be completed by the end of the fourth calendar year after the calendar year during which construction of the project began, raising concerns about whether the Continuity Safe Harbor can be satisfied.
Notice 2020-41 extends by one year the Continuity Safe Harbor for projects for which construction began in 2016 or 2017. Thus, for any qualified facility or energy property that began construction under the Physical Work Test or the 5-Percent Test in either 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.
Similarly, to provide certainty and assurance, Notice 2020-41 further provides that for property paid for by a taxpayer on or after Sept. 16, 2019, the taxpayer will be deemed to have had a reasonable expectation that the property would be received within 3½ months after the date of payment in the case of any property actually received by a taxpayer by Oct. 15, 2020. Although this new 3½ month safe harbor will not apply to any property received by a taxpayer after Oct. 15, 2020, the 3½ Month Rule may still be satisfied, as described above, based on reasonable expectations at the time of payment.
Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.
For more information on the legal and business implications of COVID-19, visit the Reed Smith Coronavirus (COVID-19) Resource Center or contact us at COVID-19@reedsmith.com
Client Alert 2020-361
