December 18, 2023
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On December 14, 2023, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) released proposed regulation [REG-107423-23] to provide guidance on the manufacturing tax credit requirements under Internal Revenue Code (IRC) section 45X (Proposed Regulations). The Proposed Regulations provide guidance on rules that taxpayers must satisfy to qualify for the Section 45X tax credit.
Section 45X was added to the IRC on August 16, 2022, by section 13502(a) of Public Law 117-169, 136 Stat. 1818, 1971, commonly referred to as the Inflation Reduction Act of 2022 (IRA). Section 45X provides a credit for the production (within the United States) and sale of certain eligible components including solar and wind energy components, inverters, qualifying battery components and applicable critical minerals.
The Proposed Regulation provide definitions of eligible components, rules related to calculating the credit, as well as specific recordkeeping and reporting requirements. The Proposed Regulations also provide rules for the production of eligible components and sale to unrelated persons, as well as special rules that apply to sales between related entities. Finally, the Proposed Regulations also include rules to make an election to treat sales to related persons as made to unrelated persons.
The Proposed Regulations are fairly comprehensive and provide detailed guidance specific to on a host of topics that are applicable to the various types of eligible property. A full summary of these Proposed Regulations is beyond the scope of this article, but some notable items include:
Section 45X requires that a taxpayer claiming the tax credit to be the producer of the eligible component, however, the statue did not provide details as to how that determination should be made. The Proposed Regulations provide that a taxpayer claiming a section 45X credit with respect to an eligible component must be the person that performs the actual production activities that bring about a substantial transformation resulting in the eligible component and that sells such eligible component. Neither a partial transformation, minor assembly of constituent inputs, nor a superficial modification of a final eligible component would qualify as being “produced by the taxpayer.” The Proposed Regulations contain various example of activities that would be considered partial transformation or mere assembly. For solar-grade polysilicon, electrode active materials and applicable critical minerals, “produced by the taxpayer” means processing, conversion, refinement or purification; any extraction activity is ineligible for a tax credit.
The Proposed Regulation provide that eligible components must be produced within the United States (as defined in section 638(1) of the Code, or a United States territory). The Proposed Regulation clarify that elements, materials and subcomponents used in the production of eligible components are not subject to the domestic production rule, and that it would also be permissible for elements, materials and subcomponents used in the production of eligible components to be recycled rather than newly created elements, materials and subcomponents.
While not necessarily surprising, it is interesting that Section 45X does not require any subcomponents to be domestically produced to qualify for the domestic manufacturing tax credit, while a taxpayer trying to claim a domestic content bonus tax credit under IRC Sections 45, 45Y, 48 and 48E must be concerned about a minimum amount of domestically made subcomponents in the manufactured products incorporated into a facility in order to qualify for a credit. Please see our discussion of the previously released domestic content bonus tax credit guidance. Practically speaking, it will mean some equipment will qualify for the Section 45X credit as domestically manufactured but will not necessarily be considered domestic for purposes domestic content bonus credits.
Unlike most of the tax credits available under section 45X, which are a fixed amount per unit of eligible property produced and sold by the taxpayer regardless of production cost, the available benefit for critical minerals and electrode active materials is equal to 10 percent of the costs incurred by the taxpayer with respect to production of such mineral or material. For taxpayers interested in pursuing this benefit, one significant open question has been how to determine which costs would ultimately be eligible for purposes of calculating the 10% credit. The Proposed Regulations answer this question initially but leave some room of potentially taxpayer friendly adjustments to be made in the final regulations.
The Proposed Regulations outline that generally capitalized costs under Section 263A are included in the calculation, however, any costs related to the extraction or acquisition of raw materials would not be taken into account as production costs. Thus, costs like labor, electricity used in the production, storage costs, depreciation or amortization, recycling and overhead should qualify, but the cost of acquiring the raw material used to produce the applicable critical mineral or active material, the cost of materials used for conversion, purification or recycling of such critical mineral or active material, and other material costs related to the production of the applicable critical mineral or active material would not be taken into account. So, while the credit is still accretive, the exclusion of the raw materials costs eliminates a signification portion of the production costs from the tax credit calculation. The preamble to the Proposed Regulations notes that the rules were drafted to exclude raw materials because Treasury and the IRS are concerned that “merely purchasing raw materials may enable a taxpayer to produce an applicable critical mineral but it is not by itself an activity that adds value,” and that “excluding material costs would also mitigate the risk of crediting the same costs multiple times.”
That said, Treasury and the IRS indicate in the preamble that they are open to including the cost of raw materials in the calculation of production costs if it can be proven to be workable. However, they would only be open to doing so if they determine that “the IRS could effectively administer such an approach and there are sufficient assurances that adopting such an approach would pose a limited risk of (i) crediting the same production costs multiple times and (ii) increasing other forms of fraud, waste, and abuse.” The Treasury Department and the IRS request comments on whether and to what extent including these costs might raise such risks. Comments to the Proposed Regulations are requested within 60 days of the date the rules are published in the Federal Register (February 13, 2024).
The Proposed Regulation provide some flexibility among parties in a contract manufacturing arrangement. Specifically, the Proposed Regulations contain a special rule allowing parties to a contract manufacturing arrangement to agree, in certain circumstances, on which party to the contract will claim the section 45X credit for eligible components produced subject to such contract.
The Proposed Regulations also contain detailed rules on the determination of related-party relationships, the timing of third-party sales and how to make a special election for related party transactions. It appears, however, that Treasury and the IRS are particularly concerned about potentially abused between related parties, and the rules contain various safeguards. For example, Proposed Regulation Section 1.45X-1(i)(1) provides a general anti-abuse rule that would make the Section 45X credit unavailable in extraordinary circumstances in which, based on a consideration of all the facts and circumstances, the primary purpose of the production and sale of an eligible component is to obtain the benefit of the section 45X credit in a manner that is wasteful, such as discarding, disposing of or destroying the eligible component without putting it to a productive use.
The Section 45X tax credit is an area where taxpayers has needed additional guidance to help product manufacturers determine eligibility, particularly considering the lead time required to build or expand a manufacturing facility. The rules outlined in the Proposed Regulations provide much needed clarity to allow manufacturers to move forward, while still leave some areas (such as the exclusion of raw materials costs for crucial minerals) somewhat unresolved. Interested parties should consider providing comments to the Proposed Regulations by February 13, 2024 deadline.
Practices
