On April 4, 2023, the Department of Treasury (the “Treasury”) and the Internal Revenue Service (“IRS”) published Notice 2023-29, Energy Community Bonus Credit Amounts under the Inflation Reduction Act of 2022 (“the Notice”), the long-awaited draft guidance on the bonuses available under the Inflation Reduction Act of 2022 (“IRA”) for the production tax credit (“PTC”) and the investment tax credit (“ITC”) for qualifying facilities (“EC Projects”) located in “energy communities”. While the Notice purports to address many of the most significant questions regarding how the various eligibility criteria are to be measured and applied, it unfortunately uses ambiguous language that makes it very difficult to determine how to apply many of the principles set forth in the Notice, which will make it challenging in many instances for renewable energy developers and their investors to be confident that a given project will qualify.
Two Tests for Determining Where an EC Project is Located
The Notice states that a project is deemed “located in” or “placed in service within” an energy community (and hence constitutes an EC Project eligible to claim the bonus tax credit) if it meets either the “Nameplate Capacity Test” or, for non-electric generating or storage facilities (e.g., a fuel production facility such as a biogas facility), the “Footprint Test.”
Under the Nameplate Capacity Test, a project qualifies if, based on the location of energy-generating units, at least 50 percent of its nameplate capacity “is in an energy community area.” This is determined by dividing the nameplate capacity of the project’s energy-generating units (i.e., turbines or solar panels) that are “located in an energy community” by the total nameplate capacity of all the projects energy-generating units.
Under the Footprint Test, a project is considered located or placed in service within an energy community if at least 50 percent of the project’s square footage is situated in an energy community area.
The Notice states that a project that has a nameplate capacity (such as wind and solar projects) must apply the Nameplate Capacity Test, while a project that has no nameplate capacity (such as qualified biogas property) must apply the Footprint Test.
Energy Community Categories
The IRA defines three categories of “energy communities”, which the Notice labels and clarifies as follows:
Both the Nameplate Capacity Test and the Footprint Test apply to projects located in any of these three categories. A threshold question when determining whether a project is “within an energy community” for purposes of either of the tests is how one defines the boundaries of the “energy community area.” While those boundaries are clear for purposes of the Statistical Area Category, which relies upon designated MSAs and non-MSAs, and the Coal Closure Category, which relies upon defined census tracts, the Brownfields Category lacks such clarity. This makes it very difficult to determine whether a project that seeks to qualify under the Brownfields Category in fact meets the Nameplate Capacity Test or the Footprint Test, since the Notice provides no guidance on how the boundaries of the “energy community area” are to be drawn for purposes of those tests. This is an issue that begs to be addressed in the final rule, and ideally in a clarification issued prior to that. Similar questions plague interpretation of the safe harbors that the Notice establishes for the Brownfields Category, as discussed below.
Safe Harbors Under the Brownfield Category
A brownfield site, as defined in CERCLA, includes real property, the expansion, redevelopment, or reuse of which may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant (as defined under 42 U.S.C. § 9601) and certain mine-scarred land (as defined in 42 U.S.C § 9601(39)(D)(ii)(III)). Excluded from the definition of a brownfield are properties described in 42 U.S.C. § 9601(39)(B), which include sites subject to government orders, consent decrees, or certain other requirements under CERCLA and other federal environmental statutes.
To aid in determining eligibility of brownfield projects for the energy communities bonus credit, the Notice creates a “safe harbor” for the Brownfield Category under which eligible properties can automatically qualify as a brownfield site if one of the following three conditions is satisfied:
The first safe harbor condition is awkwardly phrased, and it is unclear what exactly it means for a site to have been “assessed … as meeting the definition of a brownfield site,” particularly in the case of non-federal brownfield sites. Most state brownfield programs (e.g., voluntary cleanup programs) do not formally designate a site as a “brownfield.” If a site requires cleanup or closure due to the presence of hazardous substance contamination, a person may enter the site into the state’s brownfield program and as long as the site meets the relevant eligibility criteria it will be accepted into the program. The Notice does not explain whether this safe harbor is meant to include any site that has been entered into any state program, whether it applies only to sites entered into state brownfield incentive programs, or whether a site must somehow be formally designated as a “brownfield” for the safe harbor to apply. For example, it is unclear if a site that is in a state’s standard corrective action program, as opposed to that state’s voluntary cleanup program, would qualify for this safe harbor.
The second safe harbor condition (regarding Phase II ESAs) raises two important, unanswered questions. The first question concerns the meaning of the phrase “with respect to the site”: How does the IRS propose to define the “site” for purposes of this safe harbor? A typical wind energy project may consist of dozens of leased parcels, which together are colloquially referred to as the “project site.” Hence, by definition, a “project site” always includes 100 percent of the nameplate capacity and footprint of a project. But whereas Phase I ESAs are generally performed for the entire project site and not for individual parcels, when a Phase II ESA is called for it typically focuses on specific areas within the project site. Depending on the nature and scope of the suspected impacts prompting the Phase II, the Phase II ESA may be confined to a single parcel or it may encompass several parcels. It would seem to be the case that whenever a Phase II ESA confirms the presence of contamination on any portion of the project site, no matter how limited, it would result in the project meeting the Nameplate Capacity Test or the Footprint Test, as applicable, because the Phase II was performed for a portion of the project site and, as noted above, the project site by definition includes all of the generating units. If, on the other hand, the IRS intends for “on the site” to mean only those areas actually affected by contamination for purposes of the Nameplate Capacity and Footprint Tests, then very few (if any) sites are likely to qualify other than mine-scarred lands, because projects are rarely built in areas with such extensive contamination. This is especially true for wind projects with footprints that cover tens of thousands of acres, but also for solar projects covering hundreds of acres instead of thousands.
The second question raised by the Phase II safe harbor condition concerns the Notice’s reliance on the ASTM E 1903 standard. While Phase I ESAs are almost always conducted in compliance with the ASTM E 1527 standard, in practice Phase II ESAs rarely reference or explicitly follow the ASTM E 1903 standard because Phase IIs are by nature bespoke assessments. So, if the presence of hazardous substance has been confirmed on a portion of a project site through Phase II sampling, is that not sufficient to qualify for the safe harbor if the Phase II does not fully conform to the ASTM standard? Or is the intent of this condition to put form over function and require that a Phase II ESA be performed in conformance with the process set forth in ASTM E 1903, even though that is by no means necessary to detect the presence of hazardous substance releases?
Finally, the third safe harbor condition, applicable to projects of 5 MW or less, simply requires that an ASTM-compliant Phase I “has been completed with respect to the site.” This once again raises the question of what constitutes a “site”. In addition, it is notable that the Notice’s plain language requires merely that a Phase I ESA has been completed, not that the Phase I has identified any Recognized Environmental Conditions (RECs) suggesting the presence or potential presence of a release of hazardous substances. In other words, as currently drafted, this safe harbor would enable every ≤ 5 MW project to qualify as an EC Project whether or not any contamination is present, because Phase Is are performed for virtually every project as a matter of course (and as a condition of financing). While that would certainly be beneficial to the industry, it is questionable whether such a result is consistent with the Congress’ intent in creating the energy communities provision in the IRA. While some have speculated that the finding of a REC is an implicit requirement of the Phase I safe harbor condition, there is no such indication in the Notice and no justification for the IRS to impose a condition that is not explicit in its own guidance.
The IRA promises to provide historic stimulus to renewable energy development in the U.S. The energy communities provision is one of the most significant tools for accomplishing that goal and one of the areas where guidance has been most sorely needed and eagerly anticipated. The Notice, while helpful in some regards, unfortunately fails to provide the level of clarity and certainty needed for taxpayers to determine whether their projects, particularly those relying on the Brownfields Category, constitute EC Projects that qualify for the bonus credit.
The IRS intends to issue formal, proposed regulations that, when finalized, will apply to taxable years after April 4, 2023. In the meantime, the IRS says taxpayers may rely on the guidance set forth in the Notice, and it is accepting comments on the Notice until May 4 to help inform the proposed regulations. Renewable energy developers, investors and lenders would be wise to submit comments seeking further clarification of these issues.For questions regarding the IRA or the Notice, or to discuss the energy communities issues further, please contact the authors or any member of Locke Lord’s renewable energy team.
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