On May 27, 2020, the Internal Revenue Service (“IRS”) issued Notice 2020-41 (“Notice”) providing COVID-19 relief for businesses seeking to qualify for the production tax credit for renewable energy facilities under Section 45 (“PTC”) of the Internal Revenue Code (the “Code”) and investment tax credit for energy property under Section 48 (“ITC”) of the Code. Pursuant to the Notice, the IRS extended Continuity Safe Harbor for qualified energy projects that began construction in calendar year 2016 or 2017 and provided for a Three-and-a-half Months Rule Safe Harbor with respect to services or property paid for by the taxpayer on or after September 16, 2019, and received by October 15, 2020.
Section 38 of the Code allows for certain business tax credits against income taxes, which include the ITC and the PTC. As a general rule, to qualify for the ITC or the PTC, a taxpayer must begin construction of a qualified facility by a certain date, as specified under the Code, based on the type of the facility, the type of credit and subject to certain phase-outs. A business can satisfy the beginning of construction requirements under one of two tests: the physical work test or the 5 percent safe harbor test. Under the physical work test, construction of a qualified facility begins when physical work of a significant nature begins, including on-site and off-site work performed by the taxpayer and by a third party pursuant to a binding contract. Under the 5 percent safe harbor test, construction of a qualified facility is considered to have begun if a taxpayer pays or incurs within the meaning of Treasury Regulation § 1.461-1(a)(1) and (2) 5 percent or more of the total cost of the qualified facility.
Once construction has begun, both the physical work test and the 5 percent safe harbor test require that the taxpayer make continuous efforts to advance towards completion of the facility. In Notice 2013-60, the IRS provided for a Continuity Safe Harbor test, which stated that a qualified facility will be deemed to have satisfied the continuity requirement if the facility is placed in service before January 1, 2016. Subsequently, the IRS issued multiple guidance extending the Continuity Safe Harbor. Pursuant to the latest changes prior to the Notice, the Continuity Safe Harbor was considered to be satisfied if a taxpayer placed a facility in services by the later of (i) a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began or (ii) December 31, 2018.
Due to the COVID-19 pandemic and resulting delays in the development of the facilities eligible for ITC and PTC, the IRS recognized that some taxpayers may not be able to satisfy Continuity Safe Harbor and therefore provided relief for any qualified facility or energy property that began construction under the physical work test or the 5 percent safe harbor test in calendar year 2016 or 2017. Pursuant to the Notice, Continuity Safe Harbor will be 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. Thus, for example, if construction of a qualified facility began in 2016, the Continuity Safe Harbor with respect to this facility will be satisfied if the facility is placed in service not by the end of 2020, but by the end of 2021. This guidance is especially significant for wind projects seeking 100 percent of PTC, not subject to a phase-out, pursuant to beginning of construction before January 1, 2017.
The Notice also provided for a Three-and-a-half Month Rule Safe Harbor applicable under the 5 percent safe harbor test. As discussed above, construction of a facility will be considered to have begun when a taxpayer pays or incurs 5 percent of the total qualified facility costs. The determination of whether a liability has been incurred is based on the all-events test under Section 461(h) of the Code. As a general rule, economic performance for the liability will occur once the services or property out of which such liability arises has been provided to the taxpayer. However, pursuant to Treasury Regulation § 1.461-4(d)(6)(ii), a taxpayer will be permitted to treat services or property as provided to the taxpayer when the taxpayer makes a payment to the person providing such services or property if the taxpayer can reasonably expect the provision of such services or property within three-and-a-half months after the date of payment. The Notice temporarily modifies the three-and-a-half-month rule by providing for the Three-and-a-half Month Rule Safe Harbor, which states that if a taxpayer paid for services or property 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 three-and-a-half months after the date of payment in the case of any services or property actually received by the taxpayer by October 15, 2020.
Based on the foregoing, as a general rule, if a taxpayer of a qualified facility makes a payment in December of 2019 for wind turbines based on a reasonable expectation of the delivery of such turbines within three-and-a-half months of the date of payment, then the taxpayer can meet the 5 percent safe harbor test and will be deemed to have begun construction of the qualified facility in 2019. However, as a result of the COVID-19 pandemic, many businesses experienced significant disruptions and delays in operation. Such delays caused grave concerns for taxpayers that relied on the three-and-a-half-month rule for purposes of meeting the beginning of construction test in 2019 as opposed to 2020, which significantly affected the phase-out and availability of PTC or ITC. This is particularly important for solar projects since 2019 was the last year which was not subject to the phase-out. Pursuant to the Notice, taxpayers may now rely on the Three-and-a-half Month Rule Safe Harbor, which gives taxpayers more time to satisfy the 5 percent safe harbor test with respect to projects that began construction in 2019.