On Friday, March 31, 2023, the IRS issued proposed regulations on Section 30D (the “Proposed Regulations”). Following on the heels of Rev. Proc. 2022-42, Fact Sheet 2022-42, and a Treasury white paper from December, the Proposed Regulations provide long-awaited guidance on the requirements that EVs must meet in order to qualify for the tax credit for EV owners, in particular those relating to the sourcing of critical minerals and battery components within EVs. Such rules are crucially important not only to EV and battery manufacturers, but also to U.S. and non-U.S. manufacturers and miners of chemicals, metals and other components that are integrated into EV batteries.
Statutory Background
Section 30D, 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 $3750 (if one of two key requirements is met) or $7500 (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 $3750 (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 $3750 (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.4
Free Trade Agreements
The Proposed Regulations provide three criteria that the IRS uses to determine whether a country is considered to have a free trade agreement with the United States (a “U.S. FTA Country”) for purposes of the Critical Minerals Requirement: whether the agreement (1) reduces or eliminates trade barriers on a preferential basis, (2) commits the parties to refrain from imposing new trade barriers, (3) establishes high-standard disciplines in key areas affecting trade (e.g., core labor and environmental protections), and/or (4) reduces or eliminates restrictions on exports or commits the parties to refrain from imposing such restrictions. The current list of U.S. FTA Countries is: Australia, Bahrain, Canada, Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Israel, Japan, Jordan, South Korea, Mexico, Morocco, Nicaragua, Oman, Panama, Peru, and Singapore.5 As the preamble notes, the list includes countries with which the United States may not have a comprehensive free trade agreement, such as Japan, with which the United States recently concluded a Critical Minerals Agreement.
The Proposed Regulations also confirm that, for purposes of the Critical Minerals Requirement and the Battery Components Requirement, “North America” includes the territory of the United States (including Puerto Rico), Canada, and Mexico.6
Observations
- The preamble contemplates that the list of U.S. FTA Countries will evolve as new agreements meeting the stated criteria enter into force. Manufacturers and miners of EVs, critical minerals and battery components are advised to monitor this list closely even after the Proposed Regulations are finalized.
Critical Minerals Requirement
Whereas the statutory language simply states that a critical mineral can qualify under the Critical Minerals Requirement through either extraction or processing in the United States or a U.S. FTA Country (or recycling in North America), the Proposed Regulations impose a “50% of value added test,” under which at least 50% of the value added to the applicable critical mineral by extraction or processing must be derived from extraction or processing, as applicable, that occurred in the United States or in a U.S. FTA Country.7 Similarly, an applicable critical mineral is recycled in North America if at least 50% of the value added to the applicable critical mineral by recycling is derived from recycling that occurred in North America.8 Ominously, the preamble states that the “50% of value added test” is only expected to be a transition rule for vehicles placed in service in 2023 and 2024; a more stringent test is expected for later years, possibly involving a phase-up of the 50% threshold and requiring more detailed tracking through EV manufacturers’ supply chains. The preamble also suggests that such detailed tracking may be necessary to certify compliance with the FEC Critical Minerals Exclusion.
For purposes of the Critical Minerals Requirement, “extraction” means “activities performed to extract or harvest minerals or natural resources from the ground or a body of water” and includes operating equipment to extract or harvest minerals or natural resources from mines and wells or from the waste or residue of prior extraction, as well as the physical (but not chemical or thermal) processes involved in refining.9 Conversely, “processing” means the non-physical (including chemical or thermal) processes involved in the refining of non-recycled substances or materials, including the treating, baking, and coating processes used to convert such substances and materials into constituent materials (i.e., materials containing high-purity applicable critical minerals that are employed directly in the manufacturing of battery components, including anode/cathode active materials, foils, metals for solid electrodes, binders, and electrolyte salts/additives).10 Finally, “recycling” means the series of activities during which recyclable materials containing critical minerals are transformed into specification-grade commodities and consumed in lieu of virgin materials to create new constituent materials.11 As the preamble explains, processing ends when no further chemical, physical, or thermal processes are needed to create the final product that is used in manufacturing the battery component, i.e., the constituent material; similarly, recycling ends when no further transformations are needed to create the constituent material.
The calculation of whether an EV battery meets the required percentage of qualifying critical minerals is based on the value of the battery’s critical minerals at a date (selected by the EV manufacturer) after the final processing or recycling step has been completed.12 The portion of an applicable critical mineral that qualifies under the Critical Minerals Requirement is determined separately for each procurement chain—i.e., a common sequence of extraction, processing, or recycling activities in a common set of locations—with respect to an applicable critical mineral.13
Observations
- The “50% of value added test” may come as an unpleasant surprise to many manufacturers and miners who assumed that any reasonably substantial amount of extraction or processing would cause a critical mineral to meet the Critical Minerals Requirement. On the other hand, such an approach would be a happier development for those manufacturers who have minor aspects of their critical minerals supply chains located in China. Only time (and additional IRS guidance) will tell whether the IRS will follow a similar test in applying the FEC Critical Minerals Exclusion.
- The contemplated phase-ups of the “50% of value added test” may put added pressure on when an EV is considered to be placed in service. The Proposed Regulations state that an EV is placed in service on the date when the taxpayer takes possession of the vehicle.14 Interestingly, Fact Sheet 2022-42, Q&A #5, previously stated that a vehicle is placed in service when the taxpayer takes “delivery” of the vehicle.
- Notwithstanding that the Critical Minerals Requirement and the FEC Critical Minerals Exclusion literally refer to “applicable critical minerals” as defined in Section 45X(e)(6) (i.e., high-purity critical minerals that presumably require little additional refining), the Proposed Regulations, consistent with the Treasury white paper, make clear that both rules apply also to low-purity critical minerals at the time of mining and early-stage refining and processing.
Battery Components
For purposes of the Battery Components Requirement, the Proposed Regulations define a battery component as a component forming part of a battery that is manufactured or assembled from one or more components or constituent materials that are combined through industrial, chemical, and physical assembly steps, including a cathode electrode, anode electrode, solid metal electrode, separator, liquid electrolyte, solid state electrolyte, battery cell, and battery module.15 The definition of “battery” is restricted to one or more battery modules, each with at least two electrically configured battery cells to create voltage or current; it excludes any parts of the battery cell or module that do not contribute to the electrochemical storage of energy within the battery, such as thermal management systems and battery cells cases, cans, or pouches.16
For purposes of the Battery Components Requirement, “assembly” means the process of combining battery components into battery cells and battery modules, while “manufacturing” means the industrial and chemical steps taken to produce a battery component.
The calculation of whether an EV battery meets the required percentage of qualifying battery components will be based on the incremental value of each battery component after the last manufacturing or assembly step with respect to such battery component has been completed.17 For purposes of such calculation, constituent materials, though they may be manufactured or assembled into battery components, are not themselves battery components, and not all battery components will contain constituent materials.18 “Incremental value” refers to the excess of the battery component value over the value of the manufactured or assembled battery components within that battery component.19
Observations
- The concept of “incremental value” appears to require detailed valuation studies to determine the value of each battery component without taking into account the value of its constituent materials and other inputs. Complicating this exercise is the possibility that certain components of the battery, which are dependent on commodities prices, may fluctuate in value due to market pressures. Without an IRS safe harbor, manufacturers may need to monitor their calculations under the Battery Components Requirement to ensure that commodities prices do not cause previously compliant battery components to become suddenly noncompliant.
- The statutory language may very reasonably be read to mean that the Battery Components Requirement can be met through the assembly of subcomponents of a battery component into a battery component. The definition of “battery component” also suggests that this reading is correct. However, the Proposed Regulations appear to define assembly as the assembly of the battery component itself into battery cells and modules. Apart from ignoring the assembly of a battery component’s subcomponents into a battery component, this approach creates some complexities in assessing incremental value, as it would require manufacturers to assess the value of a battery component after its integration into a battery cell or module. Additional IRS clarification would be very helpful.
Foreign Entities of Concern
Possibly the most conspicuous gap in the Proposed Regulations is the lack of guidance on the FEC Critical Minerals Exclusion and the FEC Battery Components Exclusion. The preamble states without further elaboration that the Treasury Department and the IRS intend to issue guidance on these exclusions “at a later date.”
- Many questions remain regarding the definition of what constitutes a “foreign entity of concern” for purposes of Section 30D. Pending much-needed guidance, counsels of entities with Chinese or Russian ownership are well advised to examine their governance procedures to identify potential risks of such entities being viewed as subject to Chinese or Russian governmental control.
In addition to the above guidance on EV supply chains, the Proposed Regulations also provide guidance on other provisions in Section 30D, including documenting the place of an EV’s final assembly, establishing the manufacturer’s suggested retail price (which cannot exceed $80,000 for vans, SUVs and pickup trucks and $55,000 for other vehicles), and applying the modified adjusted gross income limitation for individuals (beyond which the credit phases out).
The EV owner credit under Section 30D creates a complicated regime under which certain supply chains friendly to the United States are favored over other supply chains—some of which may cause the credit to be completely unavailable. The impact of this regime on U.S. and non-U.S. manufacturers of EVs, batteries, batteries components, and critical minerals, as well as miners of critical minerals, will be significant. Advance planning to achieve optimal supply chains can mitigate the most serious effects of this post-IRA regime. More IRS guidance on “foreign entities of concern” is eagerly awaited.
For further information, please contact:
Judy Kwok, Partner, Linklaters
judy.kwok@linklaters.com
1. I.R.C. § 30D(a).
2. I.R.C. § 30D(e)(1).
3. I.R.C. § 30D(e)(2).
4. 42 U.S.C. § 18741(a)(5)(C) (incorporating by reference 10 U.S.C. § 2533c(d)(2)).
5. Prop. Reg. § 1.30D-3(c)(7).
6. Prop. Reg. § 1.30D-3(c)(11).
7. Prop. Reg. § 1.30D-3(c)(17).
8. Id.
9. Prop. Reg. § 1.30D-3(c)(8).
10. Prop. Reg. § 1.30D-3(c)(6), (13).
11. Prop. Reg. § 1.30D-3(c)(19).
12. Prop. Reg. § 1.30D-3(a)(3).
13. Prop. Reg. § 1.30D-3(a)(14).
14. Prop. Reg. § 1.30D-2(e).
15. Prop. Reg. § 1.30D-3(b)(5).
16. Prop. Reg. § 1.30D-3(b)(3).
17. Prop. Reg. § 1.30D-3(b)(3).
18. Prop. Reg. § 1.30D-3(b)(5).
19. Prop. Reg. § 1.30D-3(b)(9).
