On Friday, the U.S. Treasury Department and U.S. Internal Revenue Service (“IRS”) released amended proposed regulations pertaining to the clean vehicle tax credit under section 30D of the Internal Revenue Code (the “Section 30D credit”). The amendments, which modify a regulatory package issued in April of this year, provide helpful additional guidance regarding the application of requirements relating to “foreign entities of concern” (“FEOC”), which are designed to encourage American manufacturing of electric vehicle (EV) components by precluding availability of the Section 30D credit in cases where battery components or critical minerals of electric vehicles are sourced to certain foreign jurisdictions – specifically, China, Russia, North Korea and Iran.
As amended, these proposed regulations provide a framework for taxpayers to perform necessary due diligence designed to ensure compliance with the FEOC requirements. The framework creates a methodology for both establishing and enforcing such compliance through (i) the determination of when applicable critical minerals (and associated constituent materials), battery components, battery cells, and batteries are compliant with the FEOC rules, and (ii) establishment of penalties in the case of intentional disregard, fraud or inadvertent errors that go uncured.
The Treasury and Department and IRS also released new Revenue Procedure 2023-38, providing procedural rules governing compliance with applicable reporting, certification, and attestation requirements associated with the diligence procedures mentioned above. Review of such compliance will involve assistance by the Department of Energy.
Statutory Background
Section 30D of the Code, as revised by the Inflation Reduction Act of 2022 (the “IRA”), permits a credit against U.S. federal income tax liability with respect to each qualified plug-in electric drive motor vehicle (“EV”) placed in service by the taxpayer during the taxable year.1 The Section 30D credit equals either $3,750 (if one of two key requirements is met) or $7,500 (if both requirements are met). First, if an applicable percentage of the “applicable critical minerals” (as defined by reference to Section 45X(e)(6)) in the EV’s battery is either (1) extracted or processed (i) in the United States or (ii) in any country with which the United States has a free trade agreement in effect, or (2) recycled in North America, the taxpayer is eligible (subject to other requirements, including the final assembly of the EV in North America) for a credit of $3,750 (the “Critical Minerals Requirement”).2 For purposes of the Critical Minerals Requirement, the applicable percentage begins at 40% for certain vehicles placed in service prior to January 1, 2024, and increases yearly, reaching 80% for vehicles placed in service in 2027 onwards. Secondly, if an applicable percentage of the value of the components of the EV’s battery is manufactured or assembled in North America, the taxpayer is eligible (subject to other requirements) for another credit of $3,750 (the “Battery Components Requirement”).3 For purposes of the Battery Components Requirement, the applicable percentage begins at 50% for certain vehicles placed in service prior to January 1, 2024, and increases yearly, reaching 100% for vehicles placed in service in 2029 onwards.
The Section 30D credit is not available for any EV placed in service in 2025 onwards whose battery contains any applicable critical minerals that were “extracted, processed, or recycled by a foreign entity of concern” (as defined in section 40207(a)(5) of the Infrastructure Investment and Jobs Act (42 U.S.C. 18741(a)(5))) (the “FEC Critical Minerals Exclusion”). Similarly, the Section 30D credit is not available for any EV placed in service in 2024 onwards whose battery contains any components that were “manufactured or assembled by a foreign entity of concern” (the “FEC Battery Components Exclusion”). The term “foreign entity of concern” includes, inter alia, any foreign entity that is owned by, controlled by, or subject to the jurisdiction or direction of a government of North Korea, China, Russia, or Iran (each, a “Covered Nation”).4
Substantive Changes
1. Clarity regarding meaning of FEOC
The proposed regulations as amended provide some much-needed clarity on the definition of “FEOC” by referencing proposed guidance issued by the U.S. Department of Energy.
As alluded to above, the IRA, through Section 30D of the Code, defines FEOC by referencing the corresponding definition of the same phrase in Section 40207(a)(5) of the Infrastructure Investment and Jobs Act (the “IIJA”). For these purposes, an FEOC means (1) terrorist organizations identified as such by the Secretary of State, (2) certain designated nationals and blocked persons for purposes of the Office of Foreign Assets Control of the United States Treasury Department (OFAC), and (3) any foreign entity “owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a Covered Nation (as defined in section 2533c(d) of Title 10), which currently includes China, Russia, North Korea, and Iran.”
Under the second clause of the “FEOC” definition above, an entity incorporated in, headquartered in or performing the relevant activities in a Covered Nation would be classified as a foreign entity of concern.5 Moreover, for purposes of the third clause, an entity would be “owned by, controlled by, or subject to the direction” of another entity if 25% or more of the entity’s board seats, voting rights or equity interest are cumulatively held by such other entity.6 For purposes of these rules, licensing agreements or other contractual agreements may also support a finding of control. Additionally, a “government of a foreign country” would be broadly defined to include subnational governments and certain current or former senior foreign political figures.7
Comment
There had been considerable speculation and concern in the industry regarding to what extent the “FEOC” definition for purposes of Section 30D of the Code would track existing guidance under the CHIPS Act and Section 48D of the Code, a tax credit designed to incentivize the manufacturing of semiconductors and semiconductor manufacturing equipment. While the Section 30D regulations do not completely track that guidance, they do adopt the expansive 25% “direct or indirect control” standard, and in certain cases appear to go even further by implicating license agreements and other contractual arrangements involving FEOCs. However, importantly, in establishing whether the 25% threshold for direct or indirect control is met, the Section 30D regulations do not appear to treat upper-tier FEOCs differently than other entities. The industry had been on the lookout for a rule whereby a subsidiary of an upper-tier FEOC could itself automatically be deemed to be an FEOC by virtue of “imputed” FEOC status in tiered structures.
2. Stringent Due Diligence Requirements
Perhaps even more impactful to taxpayers than the definitional clarity regarding FEOC will be new guidance regarding due diligence that must be performed in order to ensure FEOC compliance. The amendments to the proposed regulations provide that a qualified manufacturer (“QM”)8 must conduct due diligence with respect to all battery components and applicable critical minerals (and associated constituent materials) that are relevant to determining whether such components or minerals are FEOC-compliant.
The due diligence process specifies that taxpayers must first complete the following:
- Step 1. First, the QM determines whether battery components and applicable critical minerals (and associated constituent materials) are FEOC-compliant.9
- Step 2. Next, the FEOC-compliant battery components and FEOC-compliant applicable critical minerals (and associated constituent materials) are physically tracked to specific battery cells. Alternatively, FEOC-compliant applicable critical minerals and associated constituent materials (but not battery components) may be allocated to battery cells, without physical tracking under certain specific rules. In the case of certain pre-identified non-traceable battery materials, special transition rules exist in order to meet this requirement through 2026.10
- Step 3. Finally, the battery components, including battery cells, are physically tracked to specific batteries.11
These physical tracking rules are complex, but the proposed regulations provide helpful specificity and incorporate certain rules designed to prevent abuse, such as a requirement that allocations of critical minerals to certain battery cells must be made within the type of associated constituent materials (such as powders of cathode active materials, powders of anode active materials, or foils) in which such minerals are contained, rather than permitting a mixing and matching process that could obtain a more favorable result.12
The final result of such due diligence will be the preparation of a “compliant-battery ledger” which must be submitted to the IRS for review and approval.13 In connection with the foregoing, IRS determinations will be made with assistance from the Department of Energy. Specifically, this will involve the following:
- Determining the number of batteries with respect to new clean vehicles for which the QM anticipates providing a periodic written report during the calendar year and that it knows or reasonably anticipates will be FEOC-compliant.14
- Attesting to the number of FEOC-compliant batteries and providing the basis for the determination, including attestations, certifications and documentation demonstrating compliance, with specifics regarding timing and methodology to be provided under the Internal Revenue Bulletin.15
- Once the IRS determines that the QM provided the required attestations, certifications, and documentation, approval or rejection (in whole or in part) of the determined number of FEOC-compliant batteries.16
- Adjustment based on decreases or increases in the number of FEOC-compliant batteries within 30 days of discovering the need for such adjustment.17
One compliant-battery ledger may be established for all vehicles for a calendar year, or there may be separate ledgers for specific models or classes of vehicles.18
3. Timing of ledger
Section 5 of Revenue Procedure 2023-38 includes some key timing considerations taxpayers will want to consider. Specifically, if a QM submits the information to the DOE by July 1 of the year prior to the calendar year for which the compliant-battery ledger is being established, the DOE will review the submission and provide its analysis, and the IRS, in consultation with the DOE, will determine the projected number of FEOC-compliant batteries for the QM prior to the beginning of the calendar year. The DOE will then have 45 days to review the information submitted by the QM unless a longer period is agreed to. A QM must also generally respond to a request for additional information by the DEO within 21 days of such request. The DOE will notify the QM and the IRS of its analysis either agreeing with the projected number of FEOC-compliant batteries determined and attested to by the QM, disagreeing with such number, or agreeing with such number in part, no later than October 1 of the calendar year prior to the calendar year for which the QM is seeking determination regarding the projected number of FEOC-compliant batteries. The IRS will then make a final determination concerning the projected number of FEOC-compliant batteries no later than October 31.
Observation
The new due diligence procedures provide welcome and detailed guidance, but taxpayers may find that on an organizational basis, they currently lack the internal mechanisms and procedures necessary to establish compliance, particularly when it comes to the physical tracking procedures designed to link critical minerals and components with specific battery cells.
Comments
The proposed regulations state that taxpayers may rely on the proposed regulations for vehicles placed in service prior to the date final regulations are published in the Federal Register, provided the taxpayer follows the proposed regulations in their entirety, and in a consistent manner.
Comments on the proposed regulations and requests for a public hearing are due by the date that is 45 days after the proposed regulations are published in the Federal Register, which is scheduled to be December 4, 2023.
For further information, please contact:
Michael Rodgers, Partner, Linklaters
michael.rodgers@linklaters.com
1 IRC § 30D(a).
2 IRC § 30D(e)(1).
3 IRC § 30D(e)(2).
4 42 U.S.C. § 18741(a)(5)(C) (incorporating by reference 10 U.S.C. § 2533c(d)(2)).
5 The preamble to the Proposed Regulations as amended references newly proposed Department of Energy guidance interpreting section 40207(a)(5)(C) of the IIJA.
6 Id.
7 Id.
8 For these purposes, a “QM” is generally any manufacturer which enters into a written agreement with the Secretary under which such manufacturer agrees to make periodic written reports to the Secretary providing vehicle identification numbers and such other required vehicle information.
9 Prop. Reg. § 1.30D-6(c)(1)(i).
10 Prop. Reg. § 1.30D-6(c)(1)(ii).
11 Prop. Reg. § 1.30D-6(c)(1)(iii).
12 Prop. Reg. § 1.30D-6(c)(3).
13 Prop. Reg. § 1.30D-6(d).
14 Prop. Reg. § 1.30D-6(d)(2)(i).
15 Prop. Reg. § 1.30D-6(d)(2)(ii).
17 Prop. Reg. § 1.30D-6(d)(2)(iii).
18 Rev. Proc. 2023-38 Section 5.01.
