An Unending Production Tax Credit? (IRS pushes Obama energy policy)

By Lisa Linowes -- August 11, 2014

Last month, GE’s Chief Financial Officer, Jeff Bornstein,  complained that IRS rules defining ‘begin construction’ were still too vague and holding up delivery of 400 to 500 turbines. “We expect that clarification to come from the Treasury in the next week or two,” he said. “We’ve seen that clarification and we think it is helpful.”

And sure enough, GE got exactly what it wanted. Last week, the IRS delivered its third guidance document–and it’s troubling.

Despite eking out a one-year extension of the wind production tax credit (PTC) last year, only 836 MW of new wind was installed in the first six months of this year, the second lowest since 2008 (in 2013, a single two megawatt turbine was erected in Q1/Q2).

Yet surprisingly, with the PTC nominally expired not unlike in  2013, the industry is advertising 14,600+ MW of new wind under development, including 2,000 MWs added to the pipeline this year, after the PTC expired!

Why the slump? But more importantly, why is there new wind growth without the PTC? Enter the Treasury Department, another arm of Obama energy policy.

IRS Interpretation

In the final hours of the 112th Congress, amid fears of fiscal calamity, House Republicans were pressed to accept, without debate or amendment, Senate language that extended the wind PTC for 1-year. [1] The extension included a significant change that relaxed project eligibility requirements. Under the new law, renewable projects need only ‘begin construction’ by January 1, 2014, instead of being ‘placed-in-service’ by that date.

The Senate wording was silent on what it meant to ‘begin construction’, shifting responsibility to the Internal Revenue Service (IRS) to issue guidance on Congress’s intent.

For the most part, the IRS relied on rules developed by the Treasury to administer Section 1603 cash grants which also used the ‘begin construction’ phrase. [2]  In both cases,  applicants were required to  begin ‘physical work of a significant nature’  or incur at least 5% of the project’s capital cost (the safe harbor rule) by a specific date. Since the PTC extension did not include a hard deadline for placing projects in service, the IRS stated it would strictly scrutinize whether projects maintained a continuous construction program, particularly for projects placed in service after January 1, 2016. [3]

Section 1603 grants fueled a wind bubble that more than doubled U.S. capacity in the period from 2009–2012. [4] By contrast, big wind appears stalled in 2013–14 adding just 1920 MW in the 18 months ending June 2014.

Predictable Slow-down

It’s no surprise that wind development slowed to a crawl after 2012. Developers, racing to meet 1603 deadlines, flushed the industry’s project pipeline. Most of 2013 was spent building the pipeline to an estimated 14,600 MW.

But important differences between the grant program and the production tax credit contributed to the slow-down.

Under the grant program, developers could submit applications to the Treasury detailing initial work completed and receive confirmation on whether they met the physical work test, or, for applicants relying on the 5% safe harbor, whether qualifying costs had been paid or incurred. After that, the Treasury had little discretion provided the completed facility pumped some energy on the wires by the statutory in-service date. Grants were usually paid out within 60-days of a project going online.

Tax credits, on the other hand, are granted only after an annual tax return is filed for the year in which the project is completed,  which means a project must be operational and producing electricity before a final determination of PTC-eligibility can be made. An IRS audit to validate eligibility may not happen until years after that. Banks and tax investors who only invest in wind for the credit were unwilling to take the risk on projects that might be denied the PTC. 

Going Too Far

The IRS issued two notices (here and here) in 2013 explaining how it intended to evaluate PTC eligibility which appeared to satisfy the industry. [5] But last month, GE’s Chief Financial Officer, Jeff Bornstein,  complained that IRS rules defining ‘begin construction’ were still too vague and holding up delivery of 400 to 500 turbines.

“We expect that clarification to come from the Treasury in the next week or two,” he said. “We’ve seen that clarification and we think it is helpful.”

And sure enough, GE got exactly what it wanted.

Last week, the IRS delivered its third guidance document–and it’s troubling.

For example, for projects hoping to satisfy the physical work test, there is no threshold or minimum amount (or cost) of work required to satisfy the test. Work need only begin before January 1, 2014. Apparently, a single worker equipped with a hand shovel digging in the vicinity of a proposed wind turbine foundation is enough to pass the test. And if that one worker keeps at it for one year or ten, the IRS may find the project satisfies the continuous construction requirement.

Developers who begin construction of a facility in 2013, can choose to transfer equipment and other components to an entirely different site, complete construction and claim the PTC for the new site. Work performed or expenses paid/incurred prior to January 1, 2014 will be taken into account by the IRS in determining whether the new project meets the physical work or 5% safe harbor tests. Under this interpretation, large wind developers can acquire turbines for use nationwide prior to 2014 and allocate them by project in later years.

Finally, according to the guidance, if a developer incurs less than five percent of the total cost of a project  at the time it is placed in service, as long as he pays or incurs at least three percent of the total cost before January 1, 2014, the safe harbor rule may be met and the PTC can be claimed for a portion of the project.

Conclusion

In reading the IRS’ latest guidance, AWEA’s claim of 14,600 MW of wind under development with 2000 MW of new wind added to the pipeline after the PTC expired is not far-fetched. The fact the GE reported on the IRS’ latest guidance before it was released suggests it had a hand in crafting it which raises other concerns.

The Senate’s $85 billion tax extender package that adds one more year to the PTC is deadlocked over Harry Reid’s refusal to allow amendments. Things might change in the lame duck, but animosity against the wind PTC runs high among House and some Senate Republicans. Given this latest tactic to drag out the PTC indefinitely, we hope Congress will take notice. Twenty-two years is long enough for the temporary PTC. It’s time for it to end, once and for all.

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[1]  American Taxpayer Relief Act of 2013 (ATRA 2013) also known as the Fiscal Cliff.

[2]  The cash grant program required that eligible renewable energy projects begin construction in 2009, 2010, or 2011 and be placed in service by January 1, 2013.

[3]  The IRS may determine that construction has not begun on a facility before January 1, 2014 if a project cannot demonstrate a continuous program of construction.

[4]  Ninety-percent, or more, of the record 13,000+ MW  installed in 2012, can be attributed to Section 1603, not the PTC.

[5] At a hearing before the House Subcommittee on Energy Policy, Health Care and Entitlements, industry representatives  testified that investors were now ready to move.