The U.S. Treasury Department has clarified when construction begins in order to qualify for 1603 cash grants in lieu of tax credits.
Earlier this week, the U.S. Treasury Department released new guidance related to the cash grant program under Section 1603 of the American Recovery and Reinvestment Act of 2009. This guidance comes in the form of a set of FAQs regarding the “beginning of construction” as it relates to the grants.
Section 1603 provides a cash grant for placing in service certain renewable energy property. One of the requirements under the program is that the property be placed in service during 2009 or 2010, or placed in service after 2010 (and before that property’s credit termination date) only if the construction of such property began during 2009 or 2010.
On March 15, 2010, the Treasury revised its original 1603 grant guidance to clarify the meaning of when construction has begun. The FAQs are meant to further clarify the revised guidance; significant points are summarized below.
Overview of the Section 1603 Grant Program
The 1603 grant program was enacted as part of the Recovery Act in response to the downturn in the economy and the lack of potential investors for renewable energy projects. The grants aim to stimulate new investments into renewable energy projects by offering direct cash payments instead of tax credits. 1603 grants for renewable energy projects generally equal 30 percent of the project’s cost basis.
Beginning of Construction
In order for property placed in service after 2010 to qualify for the 1603 grant, construction of the property must have begun during 2009 or 2010. There are two ways to show that construction has begun: actual physical work of a significant nature and satisfaction of the safe harbor by paying or incurring more than 5 percent of the total cost of the property. Work performed by the applicant and by other persons under a binding written contract is taken into account in determining whether construction has begun.
Physical Work of a Significant Nature
The FAQs reinforce the revised guidance’s definition of “physical work of a significant nature” by making clear that the property worked on must be “specified energy property,” as defined in related Treasury regulations, which is limited to tangible personal property and other tangible property used as an integral part of the qualifying project and located at the site of the project. Although property used for electrical transmission is generally not specified energy property, the FAQs note that work on a transformer that steps up the voltage of the electricity produced by the facility to the voltage needed for transmission is work related to specified energy property because power conditioning equipment is part of a qualified facility.
Pursuant to the revised guidelines, FAQs and the Treasury regulations relating to the investment tax credit, construction of a building generally will not qualify as physical work of a significant nature because buildings are not specified energy property. However, the FAQs make clear that two types of structures will be treated as specified energy property: a structure that is essentially an item of machinery or equipment, or a structure that houses property used as an integral part of a qualified activity if the use of the structure is so closely related to the use of the housed property that the structure clearly can be expected to be replaced when the property it initially houses is replaced. Thus, the construction of some buildings may qualify as the beginning of construction. Clearing land, obtaining permits and erecting a fence on the other hand would not constitute the beginning of construction as such activities are considered “preliminary work” under the FAQs.
Significantly, the FAQs clarify that work on only a small part of the facility may constitute physical work of a significant nature. The FAQs do not clarify what constitutes a “small part of the facility,” but imply that work on a single wind turbine might suffice. However, the FAQs caution that the Treasury will closely scrutinize any activity that does not involve a continuous program of construction, or a contractual obligation to undertake and complete within a reasonable time a continuous program of construction. This implies that a delay in construction could be fatal to a project’s grant eligibility, though events beyond the applicant’s control (e.g., weather disruptions) will be taken into account by the Treasury in determining whether construction has been pursuant to a continuous program. Query whether delays related to regulatory approvals and obtaining financing would be problematic.
For work pursuant to a binding written contact, the FAQs explain that work performed under the contract includes only work that takes places after the binding written contract is entered into. Additionally, work associated with components or parts that are in existing inventory, or that are normally held in inventory by the contractor, will not constitute the beginning of construction. Work under the contract will be treated as physical work of a significant nature only if it is work on property that will become specified energy property of the applicant. For example, if a contractor is manufacturing solar panels specifically for the applicant under a binding written contract, any physical work on those panels is physical work of a significant nature on specified energy property of the applicant. If an applicant has a binding written contract with a contractor who is manufacturing solar panels for a number of customers, physical work on the panels would only be considered work performed under the applicant’s binding written contract if the contractor can reasonably demonstrate that physical work has started on panels that will become specified energy property of the applicant.
Finally, the FAQs make clear that if the specific site of the project has not been identified at the time of the initial application this will not impact whether or not construction has begun on the project. Changes in the site of the project after the initial application will similarly not impact whether or not construction has begun.
5 Percent Safe Harbor
Under the 2009 guidance, an applicant may satisfy the safe harbor when the applicant incurs (in the case of an accrual basis applicant) or pays (in the case of a cash basis applicant) more than 5 percent of the total cost of the property. Although the references to Code Section 461(h) were removed from the revised guidance, the FAQs make clear that the economic performance rules under that Code Section continue to apply in determining whether costs have been incurred.
There is one exception to the general principles that are used to determine when amounts are incurred. Under the general rules for property manufactured, constructed or produced for the applicant by another person under a binding written contract that is entered into prior to the manufacture, construction or production of the property, for accrual basis taxpayers the cost of such property is “incurred” when the property is provided to the applicant. The exception is that for periods before the property is provided to the applicant, costs incurred by the other person with respect to the property are treated as costs of the property that are incurred by the applicant at the time the costs are incurred by the other person. When calculating the costs incurred by the other person, the applicant may rely on a statement by the other person as to the costs incurred. The exception does not apply to costs incurred by subcontractors of the other party, meaning that contractor costs are only deemed incurred upon delivery of the components produced by a subcontractor.
Notably, the FAQs specifically provide that if the applicant (or contractor in the case of dealing with a subcontractor) reasonably expects to be provided with the property within 3 and a half months of the date of payment, the property will be deemed provided on the payment date. Under the revised guidance and 2009 guidance, it was unclear that this rule applied. The express inclusion of it implies that the rest of the economic performance rules under the Treasury regulations will also apply.
In addition, the FAQs make clear that to satisfy the 5 percent safe harbor, an applicant must demonstrate that costs paid or incurred before the end of 2010 are equal to or greater than 5 percent of the actual total costs of the specified energy property. Reasonable expected costs are not sufficient for this calculation. If an applicant is uncertain of its total costs, an applicant may elect to apply for a grant based on some, but not all, units of property if its project includes multiple units.
The FAQs also indicate that the creation of a special-purpose vehicle that will own the property and apply for the grant will not affect the applicability of these rules even if the developer has entered into binding written contracts with contractors and then assigned the rights under those contracts to the special-purpose vehicle.
The clarification provided by the FAQs related to the safe harbor summarized above may make meeting the safe harbor more palatable than relying on the physical work standard and perhaps worth the additional upfront expenses needed to reach the 5 percent threshold.
Process of Applying for the Grant
Lastly, the FAQs address when an applicant must submit an application demonstrating that construction has begun. For property that is placed in service after December 31, 2010, but before October 1, 2011, an applicant need only submit a single application demonstrating both that construction began on the property in 2009 or 2010 and that the property has been placed in service. For property that is placed in service on or after October 1, 2011, applicants must submit a preliminary application by October 1, 2011, demonstrating that construction on the property began in 2009 or 2010. Such applications must then be supplemented at the time the property is placed in service.
For projects relying on “physical work of a significant nature,” applicants must document the physical work with a written report. For projects with an anticipated cost basis of $1 million or more, the report must be from an independent engineer. To demonstrate that physical work of a significant nature has commenced under a binding written contract, applicants should submit a copy of the binding written contract and a statement from the contractor describing the work that has commenced.
For projects relying on the 5 percent safe harbor, applicants must submit a statement from an authorized representative of the applicant, signed under penalty of perjury, or for projects with an estimated eligible cost basis of $1 million or more, from an independent accountant, attesting to the method of accounting used by the applicant for federal tax purposes (cash or accrual). For applicants that use the cash method of accounting, the statement should state the amount that has been paid before the end of 2010; give a detailed description of the costs that have been paid and provide an estimate of the total cost of the specified energy property, and must include evidence of payment, such as invoices or other financial records. For applicants that use the accrual method of accounting, the statement should note the amount that has been incurred before the end of 2010; provide a detailed description of the costs incurred and an estimate of the total cost of the specified energy property, and must include evidence of the costs incurred, such as invoices or other financial records. If an applicant is relying on costs paid or incurred by a contractor, a copy of the binding written contract and a statement from the contractor, signed under penalty of perjury, of costs paid or incurred and allocated to the applicant’s project must be included.
The FAQs state that the Treasury will notify an applicant whether or not the work performed is physical work of a significant nature, or whether or not the safe harbor has been satisfied, after it has received and reviewed the applicant’s application demonstrating that construction has begun.
Hayes Holderness, summer associate, also contributed to this newsletter.