On May 12, 2023, the Department of Treasury issued long-awaited guidance addressing the so-called domestic content “bonus credit” available under the Inflation Reduction Act of 2022 (“IRA”). As we have discussed elsewhere in detail, the IRA incorporates extensions of the existing clean energy tax credits under IRC section 45 and section 48 and establishes new “technology neutral” versions of these credits (pursuant to sections 45Y and 48E) that will become available starting in 2025. At the same time, the IRA also establishes a new 10% domestic content bonus credit that may be claimed in combination with these tax credits provided that the taxpayer: (1) uses U.S.-made iron and steel during construction of the energy-generation facility; and (2) ensures that the cost of any domestic manufactured products that are components of the facility meets a specified domestic content threshold.
The IRA statutory provision left open several key questions regarding how these domestic content requirements would work in practice (including, for example, how the threshold percentage would be calculated). Last Friday, Treasury issued long-awaited guidance (Notice 2023-38 or the “Notice”) that, among other things, addresses: (1) the contours of the “iron and steel” requirement; and (2) the method by which the adjusted percentage is to be calculated. While the guidance is consistent with traditional Buy America principles in certain respects, it also introduces both new concepts and new terminology — particularly with regards to the domestic content percentage calculation — which we discuss in detail below.
Under the Notice, any relevant qualified facility (under sections 45 or 45Y), energy project (under section 48), or qualified investment (under section 48E) is now considered an “Applicable Project.” Any article, material, or supply directly incorporated into the Applicable Project is called an “Applicable Project Component” (“APC”). Consistent with the multi-pronged requirement of the IRA, the APCs can be steel, iron, or manufactured products. Id.
If the APC is a manufactured product (an “APC-MP”), each component that makes up that product is a “Manufactured Product Component” (“MPC”).
Iron & Steel Construction Materials
The IRA provides that iron and steel domestic content rules must be “consistent” with the pre-existing Federal Transit Administration (“FTA”) Buy America regulations. Consistent with these FTA rules, the Notice provides that all of the manufacturing processes for the iron and steel APCs must take place in the United States (except for metallurgical processes involving the refinement of steel additives).
Importantly, however, the Notice also provides that this “100% domestic” requirement for iron and steel only applies to APCs that are “construction materials made primarily of steel or iron and [that] are structural in function.” The requirement for domestic iron and steel expressly does not apply at the steel or iron elements of a APC-MP. Thus, these requirement do not apply to the various iron and steel subcomponents that may be incorporated into APC-MPs (i.e., they do not apply to nuts, bolts, screws, washers, etc.).
The Notice instructs that an APC-MP is produced in the United States if 1) all the manufacturing processes for the APC-MP itself take place in the United States, and 2) all of the MPCs — that is, the components of the APC-MP — are of U.S. origin (meaning that it is manufactured in the United States).
If a APC-MP meets both of these prongs, then it is considered a “U.S. Manufactured Product” and the entire cost of the APC-MP counts as “domestic” for purposes of the domestic content percentage calculation.
But if the APC-MP does not meet either or both of these prongs, then it is considered a “Non-U.S. Manufactured Product.” However, in this latter scenario, the cost of any individual domestic MPCs that may be incorporated into the Non-U.S. Manufactured Product still can be counted as domestic for purposes of the calculation.
The “Adjusted Percentage Rule” states that the “Domestic Cost Percentage” must meet the adjusted percentage that applies to the project (which is currently 40%, or 20% in the case of offshore wind facilities). The Domestic Cost Percentage is calculated by dividing the “Domestic Manufactured Products and Components Cost” (i.e., total cost of domestic APC-MPs plus cost of domestic MPCs of non-domestic APC-MPs) by the “Total Manufactured Products Cost” (i.e., total cost of all APC-MPs).
If the resulting ratio is greater than 40% (or 20%, in the case of offshore wind), the project can qualify for the domestic content bonus credit, provided that requirements for the domestic iron and steel construction materials are also met. (To be clear, the cost of any iron and steel construction materials are not included in the adjusted percentage calculation). It also bears emphasis that the Notice directs taxpayers to conduct this calculation using only direct materials and direct labor costs as identified pursuant to the IRS rules
In any event, a key part of this rule is that the taxpayer does not get to include the cost of manufacturing the APC-MP from its respective MPCs in numerator unless every single component of the APC-MP is domestic (even if that APC-MP is itself manufactured in the United States). In all other circumstances, the taxpayer may only claim the direct costs of any domestic MPCs that are included in the large APC-MP (but not the cost of manufacturing the APC-MP).
Safe Harbor Examples
The guidance also includes a “Safe Harbor for Classifications of Certain Applicable Project Components,” which consists of a table that classifies certain components in certain types of clean energy technologies. This table allows taxpayers to readily identify what constitutes an iron or steel APC, an APC-MP, or an MPC, for these types of projects.
For example, we have excerpted Treasury’s breakdown of a utility-scale photovoltaic system, which, among other things, identifies the photovoltaic module as an APC-MP and its various constituent parts (including solar cells) as MPCs. The Notice includes similar breakdowns applicable to land-based wind facilities, offshore wind facilities, and battery energy storage technologies.
The Notice provides a framework for taxpayers to determine whether their projects qualify for clean energy tax credits, but it is not the end of the rule-making process.
The Notice makes clear that Treasury and the IRS intend to publish additional, proposed regulations in a Notice of Proposed Rulemaking (“NPRM”) in the Federal Register. This NPRM has the potential to be more detailed and comprehensive than the Notice. We also expect the NPRM to attract a significant number of comments from interested parties.
In the interim, however, the Notice expressly provides that taxpayers may “rely” on the rules set forth therein for any project the construction of which begins before 90 days after the proposed regulations are published in the NPRM.
We will continue to monitor developments in this area and will report on those developments here.