April 30, 2013
U.S.

PTC clarity to ease renewable energy additions, questions remain

By Conway Irwin | Published: April 30, 2013 | energy.aol.comBy Conway Irwin | Published: April 30, 2013 | energy.aol.com

New guidance on eligibility requirements for the production tax credit (PTC) should encourage stepped-up development of renewable energy projects, but lingering questions remain, and could prove stumbling blocks to new construction.

The Internal Revenue Service (IRS) released new guidance for renewable energy projects that aim to meet eligibility requirements for the PTC – Notice 2013-29 – on 15 April, and released amended guidance on 25 April. The information included in these notices could help to encourage development of renewable energy projects by clarifying eligibility requirements for the PTC. “Before the notice, it wasn’t clear how to meet the new PTC eligibility requirement of starting construction in 2013,” said David Burton, a partner with law firm Akin, Gump, Strauss, Hauer & Feld.

PTCs are indispensable for the development of projects that generate electricity from several renewable sources, such wind, biomass and geothermal projects. “It is still substantially more expensive to build renewable energy projects than it is to build a natural gas-fired power plant just on the numbers,” Burton said. “Just on the numbers – which is how people generally make decisions – you’re going to opt for natural gas.”

“It will remain indispensable for the next three to five years unless there’s some tremendous technology development that reduces cost and increases efficiency,” he said.

In addition to wind, biomass, geothermal, facilities that can meet new PTC eligibility requirements include landfill gas, trash, hydropower and marine and hydrokinetic facilities, according to accounting firm KPMG.

To qualify for the PTC, renewable energy projects can officially begin construction in 2013 in one of two ways: by spending 5% of anticipated project costs prior to year-end 2013 – known as the Safe Harbor Rule – or by undertaking “physical work of a significant nature”.

Satisfying the Safe Harbor Rule often involves expenditures such as equipment purchases under binding, written contract. Equipment must be delivered either by 31 December, 2013, or 3 and a half months after completing the purchase, whichever is later.

“Significant” physical work, can refer to the work itself or a contract for the work, and it applies to all components of the facility that are functionally interdependent – “if the placing in service of each of the components is dependent upon the placing in service of each of the other components in order to generate electricity”, said KMPG.

Physical work could include beginning excavation to lay foundation for the facility, rebuilding roadways required to move materials to be processed, such as biomass, and some work that happens off-site, such as turbine construction. It excludes planning, designing, securing financing, conducting surveys and engineering studies, and removing outdated facilities, or construction that is not essential to the functioning of the facility, such as building fencing or roads for employee and visitors.

PTC eligibility for 2013 also requires that project developers demonstrate that projects be under “continuous construction” from 1 January 2014 until completion. This marks a change from the cash grant system – which gave renewable energy project developers the option to receive 30% of project costs up front in lieu of a tax credit – for which projects were eligible using the Safe Harbor Rule or by being under continuous construction.

Ways of satisfying continuous construction requirements include making additional payments towards construction, securing contracts for additional work, obtaining permits and performing physical work, and may be paused for a number of reasons, such as natural disasters or delays related to permitting, financing or availability of equipment and supplies, according to Akin,Gump.

“The difference between the cash grant and the PTC eligibility is that with the PTC, even if you spend 5% this year, you still have to be in continuous construction in 2014,” Burton said. “That did not apply to the cash grant.” Akin Gump has suggested that the IRS’ aim in requiring continuous construction for all projects was to prevent companies from qualifying for the PTC by using the Safe Harbor Rule, then depositing equipment purchased in a warehouse and using them as needed to build new PTC-eligible projects over an extended period.

Under the cash grant system, most projects opted for the Safe Harbor Rule, according to Akin Gump. “Developers prefer to opt for the five percent safe harbor as it is relatively objective,” the firm said in its alert. “The developer’s tax equity investors and their law firms are able to be relatively certain that the safe harbor was met.”

“In almost every instance, it motivated project developers to meet the 5% safe harbor,” Burton said.

With the cash grant system off the table, and continuous construction a requirement for all qualifying projects, the IRS’ new guidelines should help to encourage new projects by giving developers the information they need, Burton said.

Akin Gump noted in a 16 April project finance alert that the IRS had yet to clarify some critical points. These included the ability to transfer ownership of entities holding eligible projects, as well as the projects themselves.

“Let’s say I’m a developer, I develop a project and get it built, and then I want to do a tax equity transaction,” said Burton.

If a developer needs to transfer a substantial portion of the project to a tax equity investor, such as JP Morgan or Bank of America, it is unclear whether the project retains its PTC eligibility. “We know from conversations now with the IRS that they debated internally how to address that, but were unable to reach agreement,” Burton said. This lack of clarity could complicate execution of tax equity investment deals going forward.

Another open question is the use of “master agreements”, or a parent company’s purchase orders for equipment that will be doled out over time to the special purpose entities that develop actual projects, Burton said.

A company developing several renewable energy projects holds each of those projects in a special purpose entity (SPE), but may not yet have created those SPE’s at the time it signs a contract with a supplier for 500 wind turbines, Burton said. The question that the IRS has failed to address in new guidelines is whether each of those SPE’s can rely on the parent company contract with the supplier to qualify for the PTC.

“The cash grant guidance lets you do that, but the PTC guidance is vague,” Burton said. “It’s not clear if they don’t want you to use the master agreement to meet the 5% spending requirement for Safe Harbor.”