On May 27, 2020, the US Internal Revenue Service (the “IRS”) released Notice 2020-41 (the “Notice”), updating the IRS guidance on the start-of-construction rules for the production tax credit (“PTC”) and energy investment tax credit (“ITC”) by extending the continuity safe harbor for projects that began construction in either calendar year 2016 or 2017.1 Additionally, the Notice provides relief under the so-called 3 ½ month rule where payments were made on or after September 16, 2019, but the services or property were not expected to be provided until 2020, as long as they are actually received by October 15, 2020.
Previously, on May 7, 2020, Treasury announced its intention to modify these rules following requests for relief from a bipartisan group of US senators. This guidance was eagerly anticipated by the renewables industry, given that the COVID-19 pandemic has jeopardized developers’ ability to meet the prior deadlines for the continuity safe harbor.
Continuity Safe Harbor
Under IRS guidance, a taxpayer is able to demonstrate the start of construction of a project through satisfaction of either the “physical work test” or the “five percent safe harbor” and, thereafter, meeting a continuity requirement. The “physical work test” generally requires that the taxpayer maintain a continuous program of physical work of a significant nature, while the “five percent safe harbor” requires that the taxpayer maintain continuous efforts to advance toward completion of the facility. This can be shown by facts and circumstances demonstrating that the taxpayer has made such efforts. Under this facts-and-circumstances approach, delays beyond a taxpayer’s control generally do not cause a taxpayer to be treated as not meeting the continuity requirement. Delays resulting from COVID-19 might very well be treated as outside the control of the taxpayer for purposes of the facts and circumstances test, but developers and financers have been wary of relying on the facts and circumstances test to satisfy the continuity requirement due to its subjectivity.
In response to taxpayers’ requests for more certainty, the IRS provided a continuity safe harbor for each of these tests, allowing a project to be deemed to satisfy the continuity requirement of either test so long as it is placed into service by the end of the fourth year after the year in which construction starts. However, unlike the facts and circumstances test, delays beyond a taxpayer’s control are not excused under the continuity safe harbor.
Accordingly, prior to issuance of the Notice, a facility whose construction began in 2016 would have needed to be placed into service by the end of 2020, and a facility whose construction began in 2017 would have needed to be placed into service by the end of 2021. As a result of COVID-19 and related construction delays, this placed-in-service deadline had become particularly problematic for wind projects, as 2016 was the last year that a wind facility could begin construction and still receive the full amount of PTCs.
The Notice provides critical relief for the wind industry by extending the continuity safe harbor period from four years to five years for projects whose construction began in 2016 or 2017. For the renewables industry more generally, the extra year to satisfy the continuity safe harbor may be a crucial lifeline for projects that were in danger of failing to meet the deadline. With that cloud of uncertainty removed, those projects will have an easier time obtaining the financing needed to complete construction. However, this is narrowly tailored relief that does not address projects that started construction in 2018 or 2019 and that may nonetheless find their timelines adversely affected by COVID-19.
3 ½ Month Rule
Additionally, the Notice provides relief with respect to the five percent safe harbor and the 3 ½ month rule. Prior to issuance of the Notice, in order to be treated as incurring costs for purposes of the five percent safe harbor, a taxpayer was able to pay for equipment at the end of a year and receive the equipment in the following year but only if the taxpayer had a reasonable expectation that the equipment would be provided within 3 ½ months of payment. As a result of COVID-19 and related construction delays, this timeline had become problematic, especially for the solar industry because 2019 was the last year that a solar project could begin construction and still receive the full amount of ITCs, and many solar developers had made payments for safe harbor equipment in 2019 under the 3 ½ month rule.
The Notice provides relief by deeming satisfaction of the 3 ½ month deadline for services or property paid for by a taxpayer after September 16, 2019, provided that the services or property are actually received by October 15, 2020.
The Notice provides critical relief to the renewables industry and demonstrates the ability of the industry and the IRS to work quickly and collaboratively to address unexpected circumstances.
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1 The full text of IRS Notice 2020-41 is available here: https://www.irs.gov/pub/irs-drop/n-20-41.pdf.