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Business Tax

When Construction Begins Under Carbon Sequestration Credit

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

The IRS has issued a Notice that provides guidance on when construction begins on a qualified facility, or on carbon capture equipment, that may be eligible for the credit for carbon oxide sequestration.

Background.

Code Sec. 45Q(a) provide a credit for the sequestration of “qualified carbon oxide” captured by a taxpayer using carbon capture equipment at a “qualified facility.”

The term “qualified carbon oxide” generally means any carbon oxide that is captured by carbon capture equipment from an industrial source that would otherwise be released into the atmosphere. (Code Sec. 45Q(c)(1))

A “qualified facility” generally is any industrial or direct air capture facility the construction of which begins before January 1, 2024, and either the construction of carbon capture equipment also begins before such date or the original planning and design of the facility includes installation of carbon capture equipment. (Code Sec. 45Q(d)(1))

When construction begins on a qualified facility or carbon capture equipment.

Notice 2020-12 provides two methods for taxpayers to establish the beginning of construction:

  1. The Physical Work Test and
  2. The Five Percent Safe Harbor.

Both the Physical Work Test and the Five Percent Safe Harbor methods require a taxpayer to make continuous progress toward completion once construction begins (Continuity Requirement). (Notice 2020-12, 4.01)

Physical work test. Under the Physical Work Test, a taxpayer may establish the beginning of construction by starting physical work of a significant nature. Work of a significant nature includes work performed by the taxpayer and work performed for the taxpayer by other persons under a binding written contract that is entered into before the manufacture, construction, or production of components of a qualified facility or components of carbon capture equipment. (Notice 2020-12, Sec. 5.01)

Under the Physical Work Test, whether and when a taxpayer has begun construction of a qualified facility or carbon capture equipment depends on the relevant facts and circumstances. Both offsite and on-site work are relevant for purposes of demonstrating that physical work of a significant nature has begun. (Notice 2020-12, Sec. 5.02)

The Physical Work Test also contains a continuous construction test (Continuity Requirement) that requires the taxpayer to maintain a continuous program of construction once construction begins. A continuous program of construction generally involves continuing physical work of a significant nature on the construction of the qualified facility or carbon capture equipment. Whether a taxpayer maintains a continuous program of construction to satisfy the Continuity Requirement will be determined by the relevant facts and circumstances. (Notice 2020-12, Sec. 7.01)

Five percent safe harbor. Under the Five Percent Safe Harbor, a taxpayer may establish the beginning of construction by having paid or incurred 5% or more of the total cost of the qualified facility or carbon capture equipment. (Notice 2020-12, Sec. 6.01)

All costs properly included in the depreciable basis of a qualified facility or carbon capture equipment are taken into account to determine whether the Five Percent Safe Harbor has been met. (Notice 2020-12, Sec. 6.02)

In the case of cost overruns for a single project, the Five Percent Safe Harbor is satisfied as long as the total aggregate cost of the qualified facilities or units of carbon capture equipment that are eligible for the Section 45Q Credit is not more than 20 times greater than the amount the taxpayer paid or incurred. (Notice 2020-12, Sec. 6.03)

The Five Percent Safe Harbor also contains a continuous efforts test (Continuity Requirement). Whether a taxpayer makes continuous efforts to advance towards completion of a qualified facility or carbon capture equipment will be determined by the relevant facts and circumstances. (Notice 2020-12, Sec. 7.02)

Facts and circumstances indicating continuous efforts to advance towards completion of a qualified facility or carbon capture equipment include, but are not limited to:

  1. Paying or incurring additional amounts included in the total cost of the qualified facility or carbon capture equipment;
  2. Entering into binding written contracts for the manufacture, construction, or production of components of the qualified facility or components of the carbon capture equipment or for future work to construct the qualified facility or carbon capture equipment;
  3. Obtaining necessary permits; and
  4. Performing physical work of a significant nature. (Notice 2020-12, Sec. 7.02)

Generally, if a taxpayer places a qualified facility or carbon capture equipment in service by the end of a calendar year that is no more than six calendar years after the calendar year during which construction of the qualified facility or carbon capture equipment began (Continuity Safe Harbor Deadline), the qualified facility or carbon capture equipment will be considered to satisfy the Continuity Safe Harbor. (Notice 2020-12, Sec. 7.05)

For example, if construction begins on a qualified facility or carbon capture equipment on January 15, 2021, and the qualified facility or carbon capture equipment is placed in service by December 31, 2027, the qualified facility or carbon capture equipment will be considered to satisfy the Continuity Safe Harbor. (Notice 2020-12, Sec. 7.05)

Qualification under both the physical work test and the five percent safe harbor. The IRS will deem construction to have begun on the date the taxpayer first satisfies one of the two methods of establishing the beginning of construction. For example, if a taxpayer performs physical work of a significant nature on a qualified facility or carbon capture equipment in 2020, and then pays or incurs five percent or more of the total cost of the qualified facility or carbon capture equipment in 2021, construction will be deemed to have begun in 2020 because the Physical Work Test was satisfied in 2020. (Notice 2020-12, Sec. 4.02)

However, a taxpayer that fails to satisfy the Five Percent Safe harbor in year one due to cost overruns (see above) will not be prevented from using the Physical Work Test in a later year to establish the beginning of construction, provided that occurs before January 1, 2024. (Notice 2020-12, Sec. 4.02)

Reliance on Notice 2009-83. Notice 2009-83, 2009-44 IRB 588, as modified by Notice 2011-25, 2011-14 IRB 604, provides guidance on determining eligibility for the credit under Code Sec. 45Q for carbon dioxide sequestration, the amount of the credit for tax years prior to the BBA amendments to Code Sec. 45Q, and the rules regarding adequate security measures for secure geological storage of carbon dioxide. Taxpayers may rely on Notice 2009-83, as modified by Notice 2011-25, until additional guidance on those specific issues is provided by the IRS. (Notice 2020-12, Sec. 10)

Effective date.

The provisions of this Notice are effective on March 9, 2020. Taxpayers that began construction on a qualified facility or carbon capture equipment by satisfying either the Physical Work Test or the Five Percent Safe Harbor Test, or both, before the effective date of this Notice, may use the effective date of this Notice as the date that construction began on such qualified facility or carbon capture equipment. A taxpayer that began construction on a qualified facility or carbon capture equipment before the effective date of this Notice under both the Physical Work Test and the Five Percent Safe Harbor may choose either method (but not both) for the purpose of applying the beginning of construction rules of this Notice. (Notice 2020-12, Sec. 11)

To continue your research on the Code Sec. 45Q carbon dioxide sequestration credit, see FTC 2d/FIN ¶ L-18401 ; United States Tax Reporter ¶ 45Q4.

 

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