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The “commence construction” concept in solar dates back to the 1603 Treasury Grant program

No one can predict the future of the solar industry after 2016 – but don’t let that stop you from trying. If a full extension or gradual step-down of the thirty percent investment tax credit (ITC) is out of reach, the next best compromise may be an extension for those projects that are under construction when the 2016 step-down to a ten percent ITC occurs. At the Novogradac Financing Renewable Energy Conference in Las Vegas this past April, Keith Martin of Chadbourne & Parke predicted a “better than 50/50” chance that a form of “commence construction” language is passed, while Michael Novogradac went on record as being “cautiously optimistic” that we will see commence construction language as part of an extensions package. Why the optimism, and how might this work for the solar industry?

The “commence construction” concept in solar dates back to the 1603 Treasury Grant program, which allowed investors to take the thirty percent ITC as an upfront cash grant instead of applying it towards their tax bill (particularly convenient in a recession). Created in 2009 as part of the American Recovery and Reinvestment Act (ARRA), the 1603 Treasury Grant program expired on December 31, 2011, but with one key exception – projects that started construction before the end of the program could qualify for the cash grant until the expiration of the thirty percent ITC in 2016.

Commence construction language for 1603 grants sounds simple – and for projects that were unequivocally under construction, it was. But for projects in development rushing to qualify for the extension, the guidelines became quite technical. If a similar provision is passed for the thirty percent ITC, we should expect an equally meticulous process determining which projects do – and don’t – qualify before ‘the cliff’.

What can we expect if commence construction language is applied to the thirty percent ITC? With the 1603 program, we saw specific guidance surrounding 1) how a project qualifies as under construction, 2) the sale of “safe-harbored” projects, and 3) the final deadline for interconnection.

      1. How can a project qualify as “under construction”? Under the 1603 program, a project could use one of two methods. The owner could either incur five percent of construction costs before the end-of-year deadline, or begin “physical work of a significant nature” on site – with no interruptions of work between beginning and completing construction. The first method proved most popular, since it did not require the permits or approvals otherwise necessary for commencing construction on a site, and did not bring up potentially vague questions of “significance”. (“Physical work of a significant nature” is generally interpreted as pouring concrete pads for inverters or beginning installation of racking; site clearing, grading, and geotechnical work do not qualify; anyone who’s seen a site undergoing site clearing as opposed to the infrastructure for a pad pour might disagree, but the line has to be drawn somewhere.)Incurring five percent of costs, by comparison, is a relatively easy matter. Land acquisition costs and legal fees do not qualify, but most system equipment does. If equipment is ordered, it must be delivered within three and a half months of payment, providing that the accounting method of the solar company incurring the cost books the expenditure upon payment and not delivery. Just one more wrinkle: the five percent cost calculation must be on the final, eligible cost of the system used as basis for the tax credit – not the cost as estimated when the equipment is purchased. In other words, if cost overruns are likely, a company would be wise to overestimate their five percent safe harbor by a comfortable margin.
      2. Can projects be sold once they have commenced construction? In short, yes – though a tax attorney specializing in solar tax credits should sign off on any transfer of the project assets to avoid losing the safeharbor qualification.  Sales to a related entity (with greater than twenty percent common ownership) are easier than sales to unrelated parties. Similarly, sales of project companies are easier than assignment of individual assets (like the PPA and the safe harbored equipment) so long as the project company is a “real” project company, and not a shell LLC company created specifically for warehousing safe harbored equipment without any additional project assets (like a PPA, permitting, or an interconnection agreement). But be wary – with the 1603 program, the longer the wait between the expiration of the credit and the placed in service date of the project, the greater the likelihood that the full expected value of the credit is jeopardized due to haircuts applied by the IRS.
      3. How long of a runway will projects have before they are required to be placed in service? The 1603 program allowed safe harbored projects until the end of 2016 to reach completion, in line with the thirty percent ITC step-down. A five-year term is more than sufficient to benefit fully from commence construction language. Of course, an extension term for safe harbored thirty percent ITC projects is very much up in the air, since the impending step-down is a permanent change – with no additional milestone or change on the books that might serve as a de facto final deadline.

If we do see commence construction language similar to the 1603 program, we can expect to see equipment orders from project owners seeking to safeharbor their deals flood an already tight supply situation. Considering the veritable juggernaut of projects rushing for completion by 2016, delivery schedules will likely feel the crunch. One question everyone should be asking is – it’s June of 2015, do you know where your equipment supplier relationships are?

The primary benefit of the commence construction language would be to reduce the frightening risk that a project misses a December 31, 2016 deadline and loses the key to its value proposition. The importance to investors of this safety net cannot be overstated. However, it would also introduce a layer of complexity to deals that would increase transaction costs and risk for projects hoping to qualify for the thirty percent ITC well after 2016. Our takeaway if a commence construction clause is passed? Build in a little something extra for legal fees – our blog won’t serve as a definitive authority if you get audited.

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Sol Systems is a solar energy finance and investment firm. The company has facilitated financing for over 200MW of distributed generation solar projects on behalf of Fortune 100 corporations, insurance companies, utilities, banks, family offices, and individuals. Sol Systems provides secure, sustainable investment opportunities to investor clients, and sophisticated project financing solutions to developers. The company’s tailored financial services range from tax structured investments and project acquisition, to debt financing and SREC portfolio management. For more information, please visit www.solsystems.com.