Editor’s note: This article is an excerpt from law firm and consultants Chadbourne Parke‘s Project Finance NewsWire. It discusses new renewable energy developments in light of the recent five-year tax credit extension. The full article is available here.
The decision by Congress to extend expiring tax credits for renewable energy through 2019 for wind and 2021 for solar ―with phase outs ― could reduce the volume of new wind and solar construction in 2016, but bring lots of additional investment ultimately into the sector.
Congress may revisit whether to allow more time for fuel cell and combined heat and power projects.
Many renewable energy companies may turn to raising new capital to dive back into project development. Development pipelines had thinned as it looked like the tax credits were running out.
The key to qualifying for tax credits is to start construction of new projects by the new deadline and then be able to show continuous work on the projects after the construction-start deadline.
The IRS has not been making developers who finish projects within two years after the deadline prove continuous work. It hopes to issue a notice in March to explain how it will apply this policy now that a larger range of projects qualify potentially for tax credits if they are under construction by future deadlines and the amount of tax credits for which a project qualifies varies depending on when construction starts.
Many useful lessons can be drawn from the experience of wind companies with construction-start deadlines in 2013
Tax credit extensions
Tax credits for renewable energy projects were extended in December as follows.
Wind developers will have through December 2016 to start construction of new wind farms to qualify for 10 years of production tax credits at the full level. Production tax credits were $23 a megawatt-hour for wind electricity in 2015. The credits are adjusted each year for inflation. The 2016 figure will not be announced until April. The tax credits run for 10 years after a project is first put in service.
Projects that start construction in 2017, 2018, or 2019 will qualify for 10 years of tax credits at reduced levels. The levels are 80% for projects starting construction in 2017, 60% in 2018, and 40% in 2019.
Developers will have the option to claim a 30% investment tax credit instead of PTCs during the same period and with the same phase down. For example, a developer who starts construction of a wind farm in 2018 could claim an 18% investment tax credit (30% x 60%).
Congress extended a 50% “depreciation bonus” that expired at the end of 2014 retroactively to the start of 2015. Companies that put new equipment in service in 2015, 2016, or 2017 can deduct 50% of the tax basis in the equipment immediately and the other 50% using the normal depreciation table. New equipment put in service in 2018 will qualify for a 40% bonus. Equipment put in service in 2019 will qualify for a 30% bonus.
The depreciation bonus is an acceleration of depreciation that would otherwise be claimed on a project. Wind farms in the U.S., for instance, are largely depreciated over five years. With a bonus, 50% of the project cost is taken as a depreciation deduction in year one, and the remaining 50% of project cost is depreciated over five years, including partly in year one.
Projects on Indian reservations can be depreciated more rapidly than projects in other parts of the United States. For example, a wind farm or solar project on an Indian reservation can be depreciated over three years rather than five years. This will remain true of any such projects that are completed by December 2016. The provision had expired at the end of 2014. The tax extenders bill extended it retroactively.
Developers of wind, geothermal, biomass, and other projects that qualify for production tax credits have had to live with the IRS construction-start rules since 2013.
There are two ways to start construction. One is by “incurring” at least 5% of the final project cost. Costs are not incurred merely by spending money. The developer must either take delivery of equipment before the construction-start deadline or else pay before the deadline and take delivery within 3-1/2 months after payment. Delivery can be at the factory.
The IRS modified the 5% threshold in August 2014 to say that a developer who incurs at least 3% of the final project cost can claim tax credits on a fraction of the electricity output or project cost. At 3%, the project would qualify for 60% of the normal tax credits. At 4%, it would qualify for 80%.
The other way to start construction is to commence “physical work of a significant nature” at the project site or at a factory on equipment for the project. The IRS has interpreted the physical work test in a liberal manner so that not much must be done before the deadline. However, many tax equity investors have not been as keen to finance projects that rely on physical work.
It is not enough merely to have started construction in time to qualify for tax credits. There must also be continuous work on the project after the construction-start deadline. The IRS has not been making developers prove that there was continuous work on any project that is completed within two years after the deadline.
IRS and Treasury officials are talking about issuing a new notice explaining how they will apply this presumption now that the tax credits step down in amount over time. They are debating whether to spare companies from having to prove continuous work if a project is put in service within two years after the last construction-start deadline for any credit or to have separate two-year periods for each step down in the credits.
Some counsel have suggested that, under this “vintaging” approach, a developer would also have to prove that construction of the project did not start too soon. It is unclear why this would be the case. The government hopes to issue a new notice on the two-year presumption in March.
Another issue under discussion is whether to have separate presumptions of varying lengths for different types of projects. For example, geothermal and offshore wind projects take more time to build than onshore wind farms. However, the IRS may decide this is more trouble than it is worth.
The tax credit extensions are expected to take the pressure off developers and the tax equity market to close as many financings in 2016.
Larger wind developers who can afford it are expected to negotiate more contracts this year to buy “PTC components” on which they need to take delivery this year or in the first three and a half months of 2017. Developers had been stockpiling nacelles, blades and tower segments for use after the construction-start deadline in future projects.
Smaller developers who do not have the money to pay for equipment orders this year will end up late in the year trying to mobilize excavation or road contractors to dig turbine foundations or put in roads on project sites before year end. Weather could be a factor at some sites.
The extension may put developers who relied on the physical work test to start construction of projects before 2014 in a stronger position to persuade tax equity investors and lenders that the physical work is significant if more work was done on the project in 2015 or can be done before year end 2016.
The entire Project Finance NewsWire is available here.