To qualify for a grant in lieu of tax credits for specified energy property under section 1603 of Division B of the American Recovery and Reinvestment Act of 2009 ("section 1603"), qualifying property must be placed in service in 2009, 2010, or 2011, or, if it is not placed in service during that period, construction must begin in 2009, 2010, or 2011 and the property must be placed in service before the applicable "credit termination date."
The U.S. Treasury Department has provided in guidance that there are two ways for an applicant to begin construction. The first is to begin "physical work of a significant nature." The second is to meet the requirements of a "safe harbor," which provides, in general, that an applicant that "pays or incurs" more than 5% of the total cost of the project's specified energy property in 2011 will be considered to have begun construction in that year.
For federal income tax accounting purposes, a taxpayer using the accrual method of accounting is deemed to have "incurred" a cost when, among other things, "economic performance" occurs with respect to that cost. Pursuant to long-standing income tax regulations, economic performance with respect to a cost that relates to the provision of property to the taxpayer generally is considered to occur when the property is "provided" to the taxpayer. As an alternative, however, the regulations provide that a taxpayer may treat economic performance as occurring on the date of payment if the taxpayer reasonably expects the property to be provided within 3 1/2 months after the date of payment (the "3 1/2 month rule").
We have become aware of an issue that has serious ramifications for developers wishing to take advantage of the 5% safe harbor. Last week the Treasury Department indicated that it believes that, for purposes of the section 1603 grant, the use or non-use of the 3 1/2 month rule is a "method of accounting" that cannot be changed without the IRS's consent. Thus, if a taxpayer has previously treated economic performance as occurring in the year the property was provided but the 3 1/2 month rule could have applied to treat economic performance as having occurred in the prior year, the taxpayer is considered to have adopted a method of accounting for that particular item that does not take advantage of the 3 1/2 month rule. As a result, the taxpayer could not change that method of accounting for that kind of item without obtaining advance consent from the IRS. Although it appears that the IRS believes the 3 1/2 month rule is an accounting method, many advisors previously thought this position would not apply for purposes of the grant because the Treasury Department had adopted the 3 1/2 month rule for a different purpose. After some initial confusion, officials of the Treasury Department recently indicated that it would follow the IRS view. If the Treasury Department maintains this view, then a grant applicant that has ever had an opportunity to rely on the 3 1/2 month rule for general income tax accounting purposes but did not, may not be able to rely on the 3 1/2 month rule with respect to certain costs for purposes of meeting the 5% safe harbor.
These issues are in a constant state of flux. We and others have emphasized to the Treasury Department that this and other issues related to the "begin construction" requirement are extremely important and time sensitive. We are in regular contact with the Treasury Department and are encouraging it to take steps to clarify this issue in a manner that would allow all applicants to rely on the 3 1/2 month rule. In the meantime, many grant applicants may be able to avoid this issue with proper planning, although the time for implementing alternative strategies is limited. It is also very important that potential grant applicants consult with their accountants and other advisors because of the requirement that accountants certify that the safe harbor requirements have been met.
Please contact a key contributor if you would like to discuss this or any other issue relating to the section 1603 grant generally or the "begin construction" requirement specifically.