The Investment Tax Credit for Solar Power (the "ITC") is a tax credit offered to individuals and businesses based on the amount they invest in eligible solar energy conversion facilities. The benefits of the ITC have been extensive enough to warrant the extension of the program on multiple occasions. The latest expansion, adopted in 2015, is expected to spur as much as $140 billion in the economy and double U.S. solar power employment by 2020. Such expansion will assist states in meeting their ever-increasing renewable portfolio standards and replacing fossil fuel generation.

The deduction percentage that taxpayers receive through the ITC program depends on when they begin the construction of their energy projects. Commercial and utility projects that "commenced construction" through 2019 are eligible to receive a 30% ITC credit. The percentage then drops down to 26% for projects that begin construction in 2020, and, then, to 22% for projects that begin construction in 2021. The definition of "commencement of construction" has been a source of significant uncertainty for solar developers. To reduce this uncertainty, the IRS released new guidance in Notice 2018-59, available here. The IRS created two methods for taxpayers to establish the commencement of construction: (1) the "physical work" test and (2) the "five percent safe harbor" test. Taxpayers will be deemed to have "commenced construction" on the day that either of these tests is satisfied. Following the commencement of construction, taxpayers must continue to make progress on their project to meet the "continuity requirement."

Physical Work Test:

To meet the physical work test, a developer must have started physical work of a significant nature on a solar project. This test focuses on the nature of the work performed, rather than the amount or the cost. To satisfy this test, the IRS considers factors such as: (a) whether the developer has entered into written contracts for the manufacture, construction, or production of the energy property, (b) the amount of off-site work of a physical nature that has been completed (e.g., the manufacture of components to be used at the facility), and (c) on-site work of a physical nature (e.g., the installation of racks, collection, concentration, or tracking infrastructure). The inquiry will be based on the facts and circumstances of each case. However, certain preliminary planning activities will not satisfy the safe harbor, such as: (1) securing financing, (2) exploration, (3) research, (4) resource mapping or modeling, (5) permitting, site clearance, or (6) grading, or removal of existing structures. Physical work does not include purchasing components from existing inventory or that are normally held in inventory by a vendor.

Five Percent Safe Harbor test:

The five percent safe harbor test requires that a taxpayer pay or incur five percent or more of the total cost of the solar project to qualify. All costs that are included in the depreciable component of the energy property are taken into account to determine whether this test is met. This does not include the land or any property not integral to the energy property. This inquiry is also based on the facts and circumstances of each case.

Continuity Requirement:

Although taxpayers can qualify for the ITC by using either the physical work test or the five percent safe harbor test, both methods require that the taxpayer meet the "continuity requirement." Thus, the taxpayers must make continuous progress towards the completion of the solar project. Under the physical work test, this standard can be met by showing that the construction involves continuing physical work of a significant nature. Under the five percent safe harbor test, taxpayers show continuity by taking actions such as making additional payments, acquiring permits, or drafting contracts related to the construction. Again, the inquiry is fact-specific under both tests. The IRS also clarified that certain events outside the developer's control (e.g., delays due to natural disasters, regulatory approval processes, interconnection, work stoppages, supply shortages, the presence of endangered species, or financing delays) will not adversely affect the developer's ability to obtain the ITC if the developer otherwise satisfies the continuity requirement. In all events, under the "Continuity Safe Harbor," if the developer places a project in service by the end of a calendar year that is no more than four calendar years after the calendar year in which construction commenced, the developer will be deemed to have satisfied the continuity requirement.

Phased Projects

The IRS also issued a set of rules to determine whether a set of phased projects should properly be considered a single project for purposes of the ITC. The determination of whether multiple energy properties are operated as part of a single project for purposes of ITC qualification is made in the calendar year during which the last of the energy properties is placed in service. If appropriate, the energy properties may be disaggregated, such that earlier-completed phases of the project qualify for the ITC (or for a more generous version of it). Because project phasing can significantly impact the size and timing of ITC qualification—and therefore investor expectations and returns—developers should remain cognizant of the phasing regulations.

The IRS has clarified "commencement of construction" for the ITC, potentially spurring greater development of solar energy conversion facilities. This guidance should assist states in achieving their ever-increasing renewable portfolio standards and replacement of fossil fuel generation facilities to meet their climate change goals.

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