The rapidly growing offshore wind sector received a significant boost at the end of 2020, thanks to the creation of a new investment tax credit (“ITC”) for offshore wind projects and the issuance of an IRS notice extending the safe harbor period for finishing construction to ten years. These changes are a welcome relief to offshore wind developers and investors, who have lobbied for years for specific rules that take into account the longer development time and more cost-intensive nature of offshore wind projects.
Taxpayers are allowed to claim an ITC for a renewable energy project equal to 30% of the basis of eligible energy property placed in service in a particular year. The ITC is subject to phase-out based on the year in which construction begins on a project. While the Internal Revenue Code does not explain what it means to “begin construction,” the IRS has issued a series of notices that provide safe harbors for establishing when construction begins on a project. Given the importance to tax equity investors of clearly establishing the availability of ITCs, it has become an industry standard practice for renewable energy developers to maintain records in accordance with the guidance in the notices showing that each project meets the requirements of the safe harbors to be treated as having begun construction as of a certain date.
In general, the notices provide two methods to establish the beginning of construction for a qualified facility: the physical work test and the 5% safe harbor. Each method requires the taxpayer to make continuous progress towards completion once construction of the project has begun. The notices provide that a taxpayer may demonstrate that it has met this continuity requirement if a project is placed in service within four calendar years after its construction begins (the “Continuity Safe Harbor”). In response to development delays caused by COVID-19, the IRS issued Notice 2020-41, which extends the Continuity Safe Harbor to five years for projects that began construction in either 2016 or 2017. If a taxpayer does not meet the Continuity Safe Harbor, it may demonstrate it has met the continuity requirement by meeting a facts-and-circumstances test. As a practical matter, reliance on the Continuity Safe Harbor is the preferred approach in the industry because of the stakes involved and investors’ unwillingness to rely on the vagueness of a facts-and-circumstances test.
The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (the “Stimulus Bill”) was signed into law on December 27, 2020 as part of a broader legislative package providing COVID-19 related relief. The new legislation extended existing tax credits and added offshore wind projects to the list of energy property that can qualify for the ITC. Under the new ITC, offshore wind projects that begin construction on or prior to December 31, 2025 may now qualify for an ITC equal to 30% of the taxpayer’s basis in qualifying offshore wind energy property in the year the project is placed in service. Offshore wind projects will be subject to all other rules and requirements applicable to eligibility for claiming the ITC. The Stimulus Bill did not alter the applicability of the production tax credit (“PTC”) to offshore wind projects, so offshore wind projects that wish to claim the PTC rather than the ITC must begin construction on or before December 31, 2021, and will be subject to existing PTC phase-outs.
On December 31, 2020, only a few days after the Stimulus Bill was signed into law, the IRS issued Notice 2021-5 based on comments from Congress and project stakeholders. The new notice extends the four-year Continuity Safe Harbor period for offshore wind projects to ten years.
Prior to the issuance of the new notice, offshore wind projects would have been subject to the regular four-year Continuity Safe Harbor period applicable to other renewable energy projects. However, because offshore wind projects are ordinarily subject to greater delays than similar projects not constructed offshore, they are at a significantly higher risk of failing to meet the requirements of the four-year Continuity Safe Harbor. The notice is especially valuable to developers because just being at risk of failing to meet the requirements of the Continuity Safe Harbor, and therefore being ineligible for the full ITC, could jeopardize a project’s ability to obtain funding.
The IRS observed that these delays ordinarily result from various complicating factors, including stringent permitting requirements applicable to offshore projects, the difficulty of installing equipment offshore, heightened environmental regulation, and the need to construct new transmission lines to connect offshore projects to the electrical grid. The IRS noted that these delays are ordinarily outside the control of project developers and can double project completion times. And while these disruptions would generally be covered by the list of excusable disruptions under previous notices, the excusable disruption rules do not apply to the Continuity Safe Harbor and therefore do not provide investors with enough certainty.
The new notice is intended to provide investors with the certainty they need in light of the potential delays inherent in offshore wind projects. Specifically, the new notice allows the Continuity Safe Harbor to be satisfied for offshore wind projects if they are placed into service no more than ten years after the year during which construction began.