June 2013 The Rush To Start Construction by Keith Martin and John Marciano, in Washington A lot of talk at recent renewable energy conferences in the United States is about how much of a rush there will be to start construction of new projects by year end. Wind, geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy proj- ects must be under construction by December 2013 to qualify for federal tax credits. The credits are worth at least 30% of the capital cost of such projects. Large wind company CEOs attending the Global Windpower 2013 convention in Chicago in May all said they hope to have at least one or two new wind farms under construction by year end. Equipment manufacturers have been focusing on what they can do to help devel- opers satisfy tests in the US tax rules for what it means to be under construction. However, unlike past years, few developers seemed to be using the wind convention to close turbine deals. Any new turbine orders seem unlikely to be placed until the fall. The Internal Revenue Service explained in April what a developer must do to be IN THIS ISSUE considered to have started construction of a project this year. The IRS guidance is in Notice 1 The Rush To Start Construction 2013-29. 6 How REITs Are Already There are two ways to start construction. Investing In Renewables One is by starting “physical work of a significant nature” at the site or at a factory that is 14 Accelerating The making equipment for the project. However, any work done by a contractor at the site or the (Commercial) PACE factory counts only if done under a binding contract that is in place before the work starts. 18 Sunny Days Ahead For Solar In Turkey The other way is by showing that the developer “incurred” at least / continued page 2 21 Oman: Future Power and Water Needs 24 US Public-Private Partnerships: A Few Steps Forward And THE TAX EQUITY MARKET is awaiting new guidelines that could affect One Possible Step Back how some deals are structured. 28 The CHP Revival The Internal Revenue Service is working on a revenue procedure that 34 Power Contracts With will explain what it wants to see in tax equity transactions involving tax The US Military credits for renovating historic buildings. The tax credits work like the 39 Shale Gas In China: How Far investment tax credit in renewable energy projects. They are claimed in From Dream To Reality? the year a project is completed. They are 20% of the amount spent on 43 More US Gas Exports Approved: What Next? renovations. Developers form partnerships with tax equity investors and allocate the credits disproportionately to the tax equity investors. 45 Commercial Microgrids: The Next Big Thing? The IRS feels that some such partnership transactions have become IN OTHER NEWS / continued page 3 50 Environmental Update too aggressive. This publication may constitute attorney advertising in some jurisdictions. Starting Construction The 5% test requires “continuous efforts,” but contemplates continued from page 1 that a project may still be merely under development, as long as the developer works diligently after 2013 on rounding up 5% of the total project cost by year end. Costs are not usually permits, negotiating contracts and moving the project along. It “incurred” merely by spending money. The developer must ordi- would be a good idea to keep a log. narily take delivery or title to services or equipment, but there There is no deadline to complete construction. are exceptions. Some in the IRS view the continuous work requirement as a Projects that are under construction by December 2013 will soft deadline. However, the IRS guidance itself suggests that it qualify for 10 years of production tax credits on the electricity is more a tool the IRS can invoke to prevent abuse. The IRS said output or an investment tax credit upon project completion for it “will closely scrutinize a facility, and may determine that 30% of the project cost. construction has not begun . if a taxpayer does not maintain a continuous program of con- struction.” (Emphasis added.) Developers have been asking a number of hard questions. Several types of renewable energy projects must be One question is whether a proj- ect on which physical work under construction by December to qualify for federal starts in 2013 and that normally takes X months to build can tax credits. qualify for tax credits if it takes three times that long to con- struct. The answer is yes if the delays are due to factors beyond the Continuous control of the developer. The IRS published a list of examples of Once construction starts, it must be continuous. This creates permitted delays. They are merely examples. There could be hindsight risk that a project that appeared under construction at others. They include severe weather, natural disasters, licensing the end of 2013 may not have been under construction after all. and permitting delays, inability to obtain specialized equipment Developers would do better to start under the 5% test rather than due to limited availability and similar supply shortages and rely on physical work, although anyone who can should do both. financing delays of less than six months. The problem with relying solely on physical work is that it What if there were no delays and the developer worked con- will require proving later that there was “continuous construc- tinuously, but at a much slower pace than normal? There is no tion.” The US Treasury Department used the same two tests to clear answer. administer a cash grant program for renewable energy projects What if there is a significant time lag between the start of that required projects to be under construction by 2011 to qual- work in 2013 and its later resumption that could have been ify. The Treasury came, over time, to feel that a project was not avoided by not waiting as long to negotiate a key contract. For truly under construction based solely on a limited amount of example, a developer relying on physical work in 2013 to start physical work until it had all the permits and contracts in place construction does not sign an interconnection agreement for to begin construction in earnest. Thus, for example, a developer the project until 2014 and there is an extended wait until the who started work on roads or a foundation at the site, but who utility can have the intertie in place to allow electricity to reach had no interconnection agreement, power contract, turbine the grid. The site work on the project is delayed to work back- supply agreement or balance-of-plant construction contract wards from when the intertie will be available. Such a project was not under construction even though another project with may have trouble qualifying under the physical work test, but all the contracts that did the same road work would be viewed seems to fit the pattern of a project still under development for as underway. There is a risk that IRS agents auditing projects in which the 5% test is better suited. the future will take the same position. The IRS had hoped not to publish any more guidance. 2 PROJECT FINANCE NEWSWIRE JUNE 2013 However, there is talk internally of possibly publishing examples A US appeals court struck down one such to give the market a clearer indication of how the agency ana- transaction in August 2012. The case, called lyzes several common fact patterns. The talk is still at an early Historic Boardwalk LLC v. Commissioner, involved stage. Any such guidance would probably not be issued until renovation of a sports arena and exhibition hall the fall. in Atlantic City that was originally built in the 1920s and was the site of the Miss America Physical Work pageant starting in 1933. The state of New Jersey, Physical work can be at the site or at a factory. It must be which did the renovation and had no use for the significant. federal tax credits on the project, entered into a The IRS said examples of significant physical work at the site complicated transaction to transfer the tax are “the beginning of the excavation for the foundation, the credits to Pitney Bowes. The transaction had a setting of anchor bolts in to the ground, or the pouring of the number of features that apparently are common concrete pads of the foundation.” in the historic and affordable housing tax equity Preliminary activities like engineering, securing financing, markets, but that would be viewed as aggressive doing environmental studies, negotiating contracts and obtain- in the renewable energy market. (See earlier ing permits are not physical work. Test drilling to determine soil coverage in the September 2012 NewsWire start- conditions, “excavation to change the contour of the land (as ing on page 7.) distinguished from excavation for footings and foundations)” An IRS associate area counsel in Detroit said and tearing down existing turbines and towers are not yet sig- in an internal memo made public in March 2013 nificant physical work on the new facility. They precede the that another transaction was nothing more than start of such work. a “circular flow of contracts” with no real partner- Test drilling at a geothermal field is not yet significant. Drilling ship formed. (See the April 2013 NewsWire start- is significant when it starts on production or reinjection wells. ing on page 27.) An example in the IRS guidance deals with a wind farm that The court decision and IRS memo have will have 50 turbines. Work starts in 2013 on 10 of the turbines.