1603 Grant Program: Treasury Department Releases New Guidance Concerning the Beginning of Construction Requirement

Background

Last week the U.S. Treasury Department (Treasury) released additional guidance – in the form of frequently asked questions and answers (FAQs) – relating to the "beginning of construction" requirement for specified energy property of facilities intended to qualify for the federal grant (the grant) under section 1603 of the American Recovery and Reinvestment Act (Recovery Act).

The FAQs follow the revised program guidance released in March 2010 (the revised guidance), that substantially modified Treasury's original July 2009 guidance (the "original guidance" and, together with the FAQs and the revised guidance, the guidance) as to the beginning of construction requirement. Against the backdrop of Treasury's earlier guidance and the slow movement by Congress on current legislative proposals to extend the 1603 grant program, the FAQs provide much needed and timely guidance for developers and investors who are planning to construct grant eligible projects.

Beginning of Construction Requirement

Under section 1603(a) of the Recovery Act, in order for specified energy property of facilities not placed in service in 2009 or 2010 to qualify for the grant, the taxpayer must begin construction of such facilities before January 1, 2011. The FAQs echo the original and revised guidance that the beginning of construction requirement can be satisfied in one of two ways:

By performing sufficient physical work on the specified energy property based on the facts and circumstances (the "physical work of a significant nature test"); or By satisfying a 5% cost safe harbor (the "safe harbor test"). For either test, the FAQs affirm the revised guidance that work performed, or costs paid or incurred (as the case may be), by the applicant and by other persons pursuant to a binding written contract are taken into account (to be binding, a contract must be enforceable under state law and cannot limit damage in the event of a breach to less than 5% of the total contract price). Moreover, in the case of work performed for an applicant under a binding written contract, the FAQs confirm the earlier guidance that for either test – only work undertaken after the contract is entered into is counted.

Physical Work of a Significant Nature Test

Scope of Physical Work. In determining whether the physical work of a significant nature test has been satisfied, the FAQs affirm that only physical work on the specified energy property is counted. Thus, physical work on non-qualifying property, such as buildings or employee parking lots, does not qualify.

As to the amount of physical work necessary with respect to such specified energy property, the FAQs provide generally that "any physical work on the specified energy property will be treated as the beginning of construction even if such work relates to only a small part of the facility." This is a helpful clarification and should provide taxpayers some level of comfort when the time comes to commence physical work on the project. In addition, the FAQs reiterate that physical work of a significant nature does not include preliminary activities – identified in the earlier guidance as planning or designing, securing financing, exploring, researching, clearing a site, test drilling of a geothermal deposit, test drilling to determine soil condition, or excavation to change the contour of the land (as distinguished from excavation for footings and foundations).

If a contractor is manufacturing property for a number of customers, the FAQs additionally provide that the contractor must "reasonably demonstrate that physical work has started" on the property that will become specified energy property of the applicant. The FAQs specify that the determination of whether a method is reasonable will depend on the relevant facts and circumstances. For this reason, applicants that enter into any binding written contracts with manufacturers or other vendors for specified energy property should include appropriate contractual provisions to require such third parties to maintain and provide to the applicant the records necessary for the applicant to demonstrate that sufficient physical work has been expended on the applicant's specified energy property prior to 2011.

Examples of Work that Qualifies. Against this backdrop, the FAQs indicate that the following work should constitute physical work of a significant nature:

Physical work on a transformer that increases the voltage of electricity produced at the facility to the voltage needed for transmission (because power conditioning equipment is specified energy property); Laying the foundation for one wind turbine that is part of a larger wind farm; Starting construction on onsite roads that are used for moving materials to be processed (e.g., biomass) and roads for equipment to operate and maintain the qualified facility; Construction of a structure that is essentially an item of machinery or equipment or a structure that houses property used as an integral part of a qualified activity if the use of...

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