INFLATION REDUCTION ACT: NEW GUIDANCE ON DOMESTIC CONTENT BONUS CREDITS

On May 12, 2023, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) released Notice 2023-38 (the “Notice”) to provide guidance on the domestic content requirements under IRC sections 45, 45Y, 48 and 48E. The Notice was developed in partnership with the Department of Energy and Department of Transportation to provide initial guidance on rules that taxpayers must satisfy to qualify for domestic content bonus credit amounts prior to the issuance of forthcoming Treasury Regulations. The Notice is significant, because it defines the conditions under which clean energy investors and producers can get additional subsidies if their supply chains are “Made in America.”

The Notice requires a sophisticated analysis to determine qualification, including compliance with sourcing regulations, and a minimum percentage of domestic content for steel, iron and manufactured products. Renewable energy and battery storage projects that satisfy the domestic content requirements can be eligible for bonus tax credits under the applicable IRC provisions. The domestic content bonus is either 2% or 10% depending on whether the renewable energy project also satisfies certain wage and apprenticeship requirements. The domestic content requirements are also important to the direct pay provision of IRC section 6417 available to certain tax exempt or government entities. The Department of Energy estimates that having this bonus credit could drive an additional 50 gigawatts of clean energy deployment by 2030.

Determining What Constitutes Domestic Content

The Notice generally requires a taxpayer to certify that any steel, iron or manufactured product that is a component of the renewable energy project upon completion of construction was produced in the United States. Manufactured products are deemed to have been produced in the United States if all of the primary components are manufactured in the United States. Alternatively, if the project contains certain manufactured products that do not meet the requirement, then all of the manufactured products would still be deemed to have been produced in the U.S. if 40–55% of the total combined costs of all manufactured products (depending on the year construction begins) are attributed to components mined, produced or manufactured in the United States.

Construction materials that are made primarily of steel or iron and are structural in nature must be entirely U.S. made, meaning all of the manufacturing processes must take place in the United States, except for the mining of raw ore and metallurgical processes involving refinement of steel additives. The requirement does not apply to steel or iron used in components or subcomponents of manufactured products. For example, items such as nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges and similar items that are made primarily of steel or iron but are not structural in function are not subject to the steel or iron requirement.

Manufactured products are generally things that were manufactured in a factory. A manufactured product is considered to be produced in the United States if: (1) all of the manufacturing processes for the manufactured product take place in the United States; and (2) all of the manufactured product components of the manufactured product are of U.S. origin. A manufactured product component is of U.S. origin if it is manufactured in the United States, regardless of the origin of its subcomponents. Mere final assembly by welding together parts is not manufacturing. Manufacturing involves altering the form or function of parts and raw materials by “adding value and transforming” them into a new product “functionally different from that which would result from mere assembly.”

The IRS released a table within the Notice showing what parts of utility-scale solar projects, onshore and offshore wind projects and large battery projects are considered steel or iron construction materials versus manufactured products.

Since few of the projects attempting to qualify for bonus credits or direct payment are likely to have all of its manufactured products with 100% of their primary components qualifying as domestic content, most projects will have to comply with the overall minimum percentage test. To qualify, the minimum percentage of domestic content must be 40% for projects on which construction starts by the end of 2024, 45% for projects starting construction in 2025, 50% in 2026 and 55% thereafter.^[1]

Complying with the minimum percentage test will require developers to cooperate with manufacturers. The taxpayer must divide the cost of the manufactured products or components made in the United States^[2] by the entire cost of all the U.S. and foreign manufactured products used to build the project. The rules require analyzing the origin of parts and materials that the U.S. manufacturer used to make the product. If any components came from outside the United States, then the focus moves to the origin of the components. In that case, only the cost to the manufacturer of the components that are U.S. made is considered domestic content.

The example included in the Notice regarding how to conduct the calculation is instructive. In the example, a taxpayer acquires and places in service a project that contains two manufactured products. Manufactured Product 1 is manufactured in the United States and has two manufactured product components that are manufactured in the United States. Because the product and both of its components are produced in the United States, it is considered to be domestic content. Manufactured Product 2 is manufactured in the United States and has three manufactured product components.

Two of the three manufactured product components are manufactured in the United States, but the third product, component is manufactured outside of the United States. Accordingly, Manufactured Product 2 is considered a non-U.S. manufactured product because one component is manufactured outside of the United States. Thus, because a single product component included in one manufactured product is non-U.S. made, the entire project must engage in the more detailed calculation.

The example assumes the following costs:

For purposes of the example, the project’s domestic manufactured products and components cost consists of the cost of Manufactured Product 1 ($100), Component 2A ($30) and Component 2B ($50) for a total of $180. The project’s total manufactured products cost consists of the cost of Manufactured Product 1 ($100) and Manufactured Product 2 ($200) for a total of $300. Accordingly, the domestic cost percentage for the example project is 60% ($180 divided by $300). Since the overall percentage of 60% is above the minimum percentage threshold, both Manufactured Products 1 and 2 are deemed to have been produced in the United States.

The Notice requires a certification statement pursuant to which a taxpayer must submit to the IRS a statement certifying, for each applicable project that any steel or iron items subject to the steel or iron requirement or manufactured product that is a component of the applicable was produced in the United States.^[3]

Discussion

The Notice helps to clarify certain key questions and open issues surrounding the Domestic Content Bonus Credit. In practice, however, compliance with the Notice will likely be complicated.

While both developers and manufacturers are generally incentivized to support claims for a bonus tax credit, the Notice requirements will likely generate the need to negotiate certain details in the supply agreement. For example, since manufacturing and component costs will be required to comply with the Notice requirements, developers will need to get detailed cost information from manufacturers. The receipt of that information will have to be negotiated, since manufacturers may be unwilling to reveal sensitive cost information. Additionally, developers will likely want manufacturers to certify the origin of components and the direct costs to make the manufactured product.^[4] To the extent developers are paying a premium for products that qualify as domestic content, they will also likely want manufacturers to pay damages if the information is later determined to be inaccurate.

Additionally, an interesting takeaway from the example in the Notice is that even if only one component of a manufactured product is made outside of the United States, the portion of U.S. manufacturing costs attributable to the overall manufacturing of the product is only included in the denominator of the fraction and is cut against eligibility. This can be seen in Manufactured Product 2 in the example above, which has total component costs of $180 with an overall cost of $200 (showing $20 in additional cost attributable to the U.S. manufacturer’s direct activities). The numerator only includes the eligible costs of Components 1 and 2 of $80, while the denominator includes not only the ineligible components costs of $100 but also the U.S.-based manufacturing costs of the product manufacturer of $20 for a total of $200. That could be particularly problematic for solar panels, where the Notice lists 11 product components as part of a solar module (i.e., photovoltaic cells, mounting frame or backrail, glass, encapsulant, backsheet, junction box (including pigtails and connectors), edge seals, pottants, adhesives, bus ribbons and bypass diodes). If even a single one of those components is made outside of the United States, it appears that the U.S. panel manufacturer’s own U.S.-based costs would count as ineligible costs for purposes of the formula, and count against eligibility of the overall project, which does not seem consistent with the underlying intent.

Conclusion

Domestic content is an area where the renewable energy industry has needed additional guidance to help developers and product manufacturers determine eligibility. While the rules outlined in the Notice contain complexity and meeting the requirements may be a bit more challenging than originally hoped, the Notice provides much needed clarity to allow developers and manufacturers to move forward. It would not be surprising, however, to see taxpayers lobby Treasury to simplify the rules somewhat in the proposed regulations expected late this year.