On May 27, 2020, the IRS issued Notice 2020-41, which provides much-anticipated relief for delays caused by the COVID-19 pandemic with respect to the “beginning of construction” requirements for renewable energy projects eligible for the production tax credit (“PTC”) or investment tax credit (“ITC”).
Notice 2020-41 modifies the guidance provided in Notices 2013-29, 2013-60, 2014-46, 2015-25, 2016-31, 2017-04, 2018-59, and 2019-43 (the “Prior Notices”) by (i) extending the Continuity Safe Harbor from four to five years for projects on which construction began in 2016 or 2017 and (ii) providing a safe harbor delivery date for property, the costs of which were intended to qualify for the so-called 3½ Month Rule.
Continuity Safe Harbor
The Prior Notices provide two methods by which a taxpayer can satisfy the applicable beginning of construction requirement: (i) starting physical work of a significant nature (the “Physical Work Test”) or (ii) incurring 5% or more of the costs of the project (the “5% Safe Harbor”). Both methods require that a taxpayer make continuous progress toward completion once construction has begun (the “Continuity Requirement”). The Prior Notices also provide a safe harbor (the “Continuity Safe Harbor”) pursuant to which the Continuity Requirement is deemed to be satisfied if a taxpayer places the project in service by the end of a calendar year that is no more than four calendar years after the calendar year during which construction began. For prior coverage on the Continuity Safe Harbor, please see our prior analysis of Notice 2017-04.
Notice 2020-41 modifies the Continuity Safe Harbor for any project that began construction in either 2016 or 2017 by providing that the Continuity Safe Harbor will be satisfied if the project is placed in service by the end of a calendar year that is no more than five calendar years after the calendar year in which construction began.
Accordingly, wind projects the construction of which begin in 2016 (the last year a project could begin construction and qualify for the full PTC) or 2017, which otherwise would have had placed-in-service deadlines of 2020 or 2021, respectively, to satisfy the Continuity Safe Harbor, now have an additional year to complete development and construction. The panoply of structuring issues raised by the possibility that the placed-in-service date could slip into the next year (tax opinions on the facts-and-circumstances test in the Continuity Requirement, tax insurance to cover off the risk, etc.) may become largely irrelevant.
3½ Month Safe Harbor
For purposes of the 5% Safe Harbor, the Prior Notices and applicable regulations provide that a liability is incurred for federal income tax purposes in the taxable year in which all events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. Applicable regulations further provide that a taxpayer may treat services or property as provided to the taxpayer (and, therefore, economic performance as having occurred) as the taxpayer makes payment to the person providing property or services, if the taxpayer reasonably expects the services or property to be provided within 3½ months after the date of payment (the so-called “3½ Month Rule”).
Notice 2020-41 clarifies that if the taxpayer’s reasonable expectation at the time of payment was that the services or property would be provided in 3½ months, the 3½ Month Rule will be satisfied regardless of whether subsequent events delay the provision of the services or property. However, to provide certainty and assurance, Notice 2020-41 provides that for services or property paid for by a taxpayer 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 3½ months after payment if the services or property are actually received by October 15, 2020 (the “3½ Month Safe Harbor”). The 3½ Month Safe Harbor applies only for purposes of the “beginning of construction requirements” for the PTC and the ITC.
Many sponsors, relying on the 3½ Month Rule, paid in full for equipment at the end of 2019 (the last year a solar project could begin construction and qualify for the 30% ITC) and expected delivery within 3½ months. The timing of the COVID-19 pandemic created supply chain delays that meant that many sponsors did not in fact take delivery within 3½ months of the date of payment, raising the question as to whether their expectations as to delivery were reasonable in the first place. The 3½ Month Safe Harbor should eliminate the need for an analysis of the reasonableness of the expectations in most cases.
We note that the 3½ Month Safe Harbor requires that the property be “received” by October 15, 2020. The key concepts in the applicable regulations are title transfer, delivery, and acceptance; the concept of receipt does not exist. However, because the October 15 date is so generous, we do not expect the imprecise drafting in Notice 2020-41 to be relevant in most circumstances.
The extension of the Continuity Safe Harbor is an extremely important development for the wind industry. Industry reports had suggested that a significant portion of wind projects scheduled to be placed in service in 2020 were at risk of slipping into 2021, with potentially disastrous consequences for the projects. The one-year extension provides crucial relief.
The 3½ Month Safe Harbor also provides welcome relief for both the solar and wind industries. As a practical matter, it should help most sponsors avoid awkward questions as to whether their expectations of delivery were reasonable and therefore should promote the stated goals of providing certainty and assurance as to the year in which the relevant costs were incurred.