Tax Legislation Sets Up Race to “Begin Construction” of Renewables Facilities by Year-EndBy Richard H. Allan
When Congress sent the “fiscal cliff bill” – officially known as the American Taxpayer Relief Act of 2012 (ATRA) – to the President for signature in early January, it also provided a lifeline to renewable energy development by extending – in modified form — eligibility for tax credits. Tax credits have allowed the industry to remain competitive with fossil fuels. Eligibility for those credits was set to expire at the end of 2012 for wind projects and at the end of 2013 for other renewable energy sources. As part of the “fiscal cliff” tax deal, however, Congress extended eligibility for tax credits for renewable energy projects through the end of 2013, provided developers “begin construction” before the end of the year. Unfortunately, the Act gives developers little direction as to what the phrase “begin construction” means.” That is the subject of this article.
Background on the Tax Credits
The production tax credit (PTC) was enacted as part of the Energy Policy Act of 1992, and has been extended several times. The PTC is an income tax credit based on production of electricity from certain renewable energy sources. Eligible taxpayers receive a credit at an inflation-adjusted rate per kilowatt-hour of electricity generated from qualified resources and sold to unrelated persons. The credit is available for 10 years, beginning when the facility is placed in service.
For calendar year 2012, the Internal Revenue Service calculated the credit for the sale of electricity produced from wind, closed-loop biomass, geothermal energy, and solar energy at 2.2 cents per kilowatt hour and the credit for the sale of electricity produced from open-loop biomass facilities, small irrigation power facilities, landfill gas facilities, trash combustion facilities, qualified hydropower facilities, marine and hydrokinetic energy facilities at 1.1 cents per kilowatt hour.
Section 1102 of the American Recovery and Reinvestment Act of 2009 (ARRA) provided taxpayers with the right to elect to claim a 30 percent investment tax credit (ITC) in lieu of the PTC for wind, closed-loop biomass, open-loop biomass, geothermal, municipal solid waste , hydropower and marine and hydrokinetic energy facilities. Unlike the PTC, which is claimed over the 10 years after the facility is placed in service, the ITC is claimed in the year the facility is placed in service. Under the ARRA, the ITC and PTC were made available for wind energy projects placed in service before January 1, 2013, and other projects placed in service before January 1, 2014.
Extensions and Modifications in ATRA
Although the focus in news media was on the “middle class tax cuts” issue in congressional and Administration efforts to avoid the “fiscal cliff,” the Act is far more expansive. With respect to renewable energy and alternative fuels, the Act extends and modifies several important benefits, including:
- The credit for cellulosic biofuel production and bonus depreciation for cellulosic biofuel plant property were both extended through 2013 and expanded to include algae; 
- The expired credits and payments for biodiesel and renewable diesel were resurrected, with expiration dates extended two years, to the end of 2013, as was the credit for property used to refuel alternative fuel vehicles;
- The credit for plug-in electric vehicles, which previously was restricted to vehicles with “at least 4 wheels,” was expanded to include plug-in electric vehicles with 2 or 3 wheels.
Section 407 of the Act extends the PTC and ITC to qualified facilities “the construction of which begins before January 1, 2014.” In other words, the ATRA not only extends the PTC and ITC expiration for wind facilities beyond the December 31, 2012 expiration, it changes the threshold for vesting of the right to claim the PTC or ITC. The former threshold – the date the facility was “placed in service” – has been replaced by the date construction of the facility begins. That new threshold applies to wind facilities, biomass, geothermal, landfill gas, municipal solid waste, hydropower, and marine and hydrokinetic facilities.
In addition to effectively extending the time for completing eligible projects, the change provides another benefit: project developers can know at the outset of construction whether the facility will qualify for tax credits, rather than incurring all the costs of construction with the hope of beating an end-of-year deadline for placing the facility in service.
When Does Construction Begin?
The Act, however, does not define what it means to “begin construction” of a qualified facility. Although the meaning of the term might seem self-evident, precedents from the Internal Revenue Code and IRS rules provide several possibilities, with different implications for project development. Given the uncertainties about the future of the PTC and ITC – there are no guarantees beyond the end of 2013 – project developers will need answers, from Congress, the Internal Revenue Service or the Treasury Department, about several key questions:
- Will the beginning of construction be determined based on accomplishing particular construction tasks (such as pouring foundations), on achieving a certain threshold of expenditures, or some other metric? Although some states define “construction” for purposes of regulating the siting and development of energy facilities, those definitions are unlikely to carry weight with the IRS.
- If the project permits include associated facilities such as access roads, transmission lines or maintenance buildings, does construction of those project elements count as – or at least count toward – the beginning of construction? Guidance from the Treasury Department for implementation of the Section 1603 “grant in lieu of tax credit” program under the ARRA indicates that the answer likely is “no”: the “qualified facility” includes “property integral to the production of electricity” but specifically excludes “property used for electrical transmission.”
- Once construction begins, must the developer diligently continue construction to completion, or may the developer suspend construction without losing the right to claim tax credits when the facility eventually is placed in service? The taxpayer still cannot claim the PTC or ITC until the facility is placed in service. But does the fact that Congress has eliminated the “placed in service” deadline mean that once started, the developer can complete the project whenever it wishes?
Wind energy projects, which consist of arrays of separate turbines, may face an additional issue. In 1994, the IRS ruled that a wind farm is not a “facility” for purposes of the PTC; rather, the term “facility” means “each wind turbine together with its tower and supporting pad owned by a taxpayer that is originally placed in service” before the statutory deadline. If applied to the new “beginning of construction” threshold, that interpretation could mean that for a hypothetical 50-turbine wind farm, construction must begin before January 1, 2014 on each of the 50 separate “facilities” – not just some elements of the overall project — in order for all 50 turbines to be eligible for the PTC. Put another way, barring a further extension by Congress beyond 2013, only those turbines for which construction “begins” before the end of 2013 would qualify for the tax credit.
Preparing to Meet the Deadline — the Worst Case
Until developers receive federal guidance on the definition of “beginning construction,” they may want to plan for the worst while hoping for the best. The “worst case,” in this context, would be a definition of construction that requires significant physical construction on the facility site. Developers would need to carefully review their permitting efforts to avoid pitfalls that can delay the start of construction beyond the end of 2013. Of particular concern are pre-construction requirements, limitations on when construction activities may occur, and the possibility of appeals or injunctions.
Projects may face a variety of requirements that must be met before construction may begin. For example, areas to be disturbed by project development may need to be surveyed for sensitive plant or animal species. Where species are only seasonally present or evident, or where the surveys must be conducted during a defined part of a species’ lifecycle (for example, nesting), a missed season can delay construction for a year.
Among the most common restrictions on construction activities are prohibitions on certain construction-related activities during certain periods of the year, for the benefit of threatened or endangered species. These can include restrictions on construction noise during nesting periods, restrictions on in-water work during spawning or migration seasons of protected fish species, and restrictions on ground disturbance or traffic to protect seasonally-present ground-dwelling species.
Finally, not the least of concerns for project developers is the potential for appeals or other legal challenges. Even if an appeal does not have the legal effect of suspending the permittee’s ability to develop the project, few developers are likely to be in a financial position to risk capital by proceeding with development before appeals are resolved. Opponents, moreover, could be expected to understand the leverage they gain by filing appeals or seeking temporary restraining orders or injunctions as the critical deadline for “beginning construction” – and securing the right to valuable tax credits — approaches.
Preparing to Meet the Deadline — the Best Case
The Section 1603 program provides a preferable and far more likely template for what will be required to “begin construction.” Treasury Department guidance states that “construction begins when physical work of a significant nature begins.” “Physical work of a significant nature” is not limited to work at the facility site. Rather, it includes work performed under a written binding contract for the manufacture, construction or production of facility components by another person. Using the example of a wind facility, Treasury explains: “If the facility’s wind turbines and tower units are to be assembled on site from components manufactured off site and delivered to the site, physical work of a significant nature begins when the manufacture of the components begins at the off-site location.” The Treasury Department’s Section 1603 guidance also provides for a “safe harbor”: “An applicant may treat physical work of a significant nature as beginning when more than 5 percent of the total cost of the property has been paid or incurred ….”
By adopting for the PTC and ITC the definition of “beginning of construction” used in the Section 1603 program, two important goals would be accomplished. First, a developer seeking the tax credit would not be captive to permit conditions or legal challenges that delay or halt development on the facility site – provided, of course, that the developer is willing make the commitments necessary to proceed with offsite work such as the manufacture of facility components. Second, developers and their counsel would be able to use the experience from the Section 1603 program to successfully structure contractual relationships to qualify for beginning construction.
This article is not a substitute for legal advice. Please consult with your legal counsel for specific advice and/or information. Read our complete legal disclaimer.