Following last year's extension of the investment tax credit for qualifying projects for which construction begins prior to January 1, 2020, and of the production tax credit (PTC) with respect to certain facilities the construction of which begins before January 1, 2017, and for wind facilities the construction of which begins before January 1, 2020, the IRS has provided additional guidance in Notice 2016-31, which extends and modifies Notice 2013-29, as clarified by Notice 2013-60 and Notice 2014-46, and updated by Notice 2015-25 (the "Begun Construction Guidance"). 1
For purposes of establishing when construction begins, the Begun Construction Guidance provides two alternative methods: (1) the "physical work test" (i.e., physical work of a significant nature has begun and the taxpayer maintained a continuous program of construction); or (2) the "five percent safe harbor" (i.e., at least five percent of the total cost of the eligible property has been paid or incurred and the taxpayer maintained continuous efforts to advance towards completion of the facility).
After the extension of the PTC, the IRS issued Notice 2016-31 to provide additional guidance with respect to the PTC that extends and modifies the continuity safe harbor, and provides additional guidance regarding the application of the continuity safe harbor and the physical work test.
Continuity Safe Harbor
Under Notice 2016-31, a taxpayer will be deemed to meet the requirement of continuous progress towards completion of a facility once construction has begun under the physical work test and five percent safe harbor, as required by the Begun Construction Guidance, if the facility is placed in service within four calendar years following the calendar year in which construction began. The continuity safe harbor deadline will be determined by the earliest date that the facility meets the physical work test or five percent safe harbor. Notice 2016-31 also provides a non-exclusive list of disruptions that will not prevent a taxpayer from being deemed to meet the requirement of continuous progress towards completion of a facility once construction has begun under the physical work test and five percent safe harbor. These disruptions include severe weather conditions, natural disasters, certain delays in obtaining permits or licenses from federal, state, local, or Indian tribal governments, and interconnection-related delays, among others.
Physical Work Test
Notice 2016-31, which reiterates Notice 2014-46, provides that the physical work test is met if physical work of a significant nature has begun, with the focus of the analysis on the nature of the work performed, not the amount or the cost. Notice 2016-31 also provides a list of preliminary activities that will not be counted towards establishing that the physical work test is met. These preliminary activities, which include planning and designing, securing financing, clearing a site, conducting surveys, excavating to change the contour of the land and removing existing facilities, are excluded from physical work of a significant nature.
Notice 2016-31 also clarifies that, for the purpose of determining whether construction of a facility has begun, the facility may be disaggregated, and the projects can be separated into multiple facilities for purposes of determining whether a specific facility satisfies the continuity safe harbor described above. Any disaggregated facilities that are placed in service before the continuity safe harbor deadline will be eligible for the continuity safe harbor. The remaining disaggregated facilities may satisfy the continuity requirement under a facts and circumstances determination. This clarification ensures that specific projects that are a part of a larger facility will meet the continuity safe harbor and qualify for the PTC, even if other projects that were to be a part of the facility are delayed.
Application of the Five Percent Safe Harbor to Retrofitted Facilities
As a general matter, a facility may qualify as originally placed in service and qualify for PTCs if not more than 20 percent of the facility's total value relates to used property (the "80/20 Rule"). Pursuant to Notice 2016-31, in the case of a facility compromised of multiple facilities, the application of the 80/20 Rule is applied on a facility-by-facility basis. For retrofitted facilities, the five percent safe harbor only applies with respect to the cost of new property used to retrofit the existing facility.
The IRS is expected to issue separate guidance addressing the extension of the investment tax credit under Section 48 of the Internal Revenue Code for solar energy facilities.
