Thought Leadership

Proposed Regulations Issued Regarding Section 45X Advanced Manufacturing Production Tax Credit

Client Updates

On December 14, 2023, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) published proposed regulations (linked here) in a Notice of Proposed Rulemaking (the “NPRM”) regarding the Advanced Manufacturing Production Credit under section 45X (the “45X Credit”) of the Internal Revenue Code.

The 45X Credit, enacted by the Inflation Reduction Act of 2022 (the “IRA”), is considered to be one of the most powerful incentives of the IRA, designed to strengthen U.S. energy security by incentivizing the onshoring of production of key clean energy components and critical minerals.

The proposed regulations represent the first guidance that has been issued with respect to eligibility, qualifying and accounting for production of clean energy components and critical minerals. Comments on the proposed regulations are due by February 13, 2024, and a public hearing on the proposed regulations is scheduled for February 22, 2024.

Background
The 45X Credit is a production credit generally based on the amount of the components produced during the tax year. The calculation of the credit varies with the specific components produced and the production method utilized. Calculation methods include: a dollar value per component by size or weight, a dollar value per electric capacity of the component (measured in watts), and a dollar value as a percentage of the cost to produce the component or critical minerals. The 45X Credit is particularly advantageous for vertically integrated producers, since they can take a credit for each eligible component included in a product, such as, for example, the battery module, the battery cells inside the module and the electrode active materials in the battery cells.

A taxpayer generally becomes eligible to claim the 45X Credit by producing and selling eligible components. However, the eligible components must be produced by the taxpayer in the United States and sold to an unrelated party.

The 45X Credit is effective for components produced and sold after December 2022 but, for components other than critical minerals, will phase out starting in 2030 and terminates completely by 2033.

Eligible components for the 45X Credit are generally organized into the following five categories: solar energy components, wind energy components, inverters, battery components and critical minerals. Battery components are subdivided into three categories: electrode active materials, battery cells and battery modules.

Effective Date
The regulations are proposed to apply to eligible components for which production is completed and sales occur after December 31, 2022, and during taxable years ending on or after the date of publication of the final regulations in the Federal Register.

Proposed regulations overview
The proposed regulations are organized into four sections, proposed sections 1.45X-1 through 1.45X-4.

  • Proposed section 1.45X-1 provides general rules applicable to the section 45X credit, including the definition of the term “produced by the taxpayer.”
  • Proposed section 1.45X-2 provides operating rules to make a related person election.
  • Proposed section 1.45X-3 provides definitions and credit amounts for certain eligible components (i.e., solar energy components, wind energy components, inverters, and qualifying battery components) as well as the phase-out rules.
  • Proposed section 1.45X-4 provides definitions for applicable critical minerals and rules regarding the determination of the credit amount for such minerals.

Proposed Section 1.45X-1: Definition of Production
To be eligible for the 45X Credit, a taxpayer must produce the eligible component in the United States. The proposed regulations provide, however, that constituent elements, materials and subcomponents used in the production of eligible components are not subject to the domestic production requirement. Critics of the proposed regulations assert that these rules do not go far enough in restricting use of foreign-produced subcomponents and are expected to press for stricter regulations.

Proposed section 1.45X-1(c)(1) defines the term “produced by the taxpayer” to mean “a process conducted by the taxpayer that substantially transforms constituent elements, materials, or subcomponents into a complete and distinct eligible component that is functionally different from that which would result from mere assembly or superficial modification of the elements, materials, or subcomponents.” Explicitly excluded from this definition are partial transformation, mere assembly, and superficial modification. Processes that do not “substantially transform” materials into a “complete and distinct eligible component,” as described above, are not considered produced by the taxpayer for purposes of the 45X Credit.

Six illustrative examples are included in the proposed guidance. The following actions are provided as examples of minor assembly that would not qualify for the credit: (i) taxpayer puts the external casing on a battery module that already had cells, battery management systems, and other components integrated into it (Example 3); (ii) taxpayer purchases two halves of a wind turbine nacelle and combines them into a single nacelle (Example 4); and (iii) taxpayer purchases a prefabricated wind turbine blade and applies paint and finishes (Example 6).

A special rule is proposed for solar grade polysilicon, electrode active materials, and applicable critical minerals for which the term “produced by the taxpayer” means “processing, conversion, refinement, or purification of source materials, such as brines, ores, or waste streams.”

The 45X Credit is extended to production that integrates, incorporates, or assembles certain eligible components. The term integrated, incorporated, or assembled means those production activities by which an eligible component that is a constituent element, material, or subcomponent is substantially transformed into another complete and distinct eligible component. The same special rule for solar grade polysilicon, electrode active materials, and applicable critical minerals described above is also relevant for production activities that integrate, incorporate, or assemble such materials.

The proposed regulations make clear that, except where otherwise allowed (discussed below), the eligible taxpayer for purposes of the 45X Credit must be the party that “directly performs the production activities.”

The proposed guidance also answers the question of who is allowed to claim the credit when multiple parties are involved with the production process. For example, in contract manufacturing arrangements, the eligible taxpayer for the credit must be the party that performs the actual production activities, although the parties may agree which of them is to claim the credit and such agreement will be respected upon filing of certain certifications.

The proposed rules also indicate that a routine order for off-the-shelf property is not properly treated as a contract manufacturing arrangement. If the contractor makes no more than de minimis modifications to the property to meet the customer’s specific needs or if, at the time the agreement is entered into, the contractor knows that the order can be filled out of existing stocks or normal production of finished goods, than an order would be considered routine.

The proposed regulations also include an anti-abuse rule pursuant to which the 45X Credit is disallowed if the primary purpose of the production of an eligible component is to obtain the credit in a manner that is “wasteful, such as discarding, disposing of, or destroying the eligible component without putting it to a productive use.”

Proposed Section 1.45X-2: Sales to Unrelated Persons
The 45X Credit requires the sale of eligible components to an unrelated person. The proposed regulations define related persons as those who would be treated as a single employer under section 52(b) of the Code. However, section 1.45X-2(d) provides time and manner operating rules for an exception to this requirement by election (the “Related Party Election”), pursuant to which a taxpayer may treat a sale to a related person, such as an affiliate, as a sale to an unrelated person in the year of the sale to the affiliate, rather than have to wait for the affiliate to on-sell the component to an unrelated person in order to claim the credit.

Proposed Section 1.45X-3
Proposed section 1.45X-3 provides definitions related to eligible components, the calculation of the 45X Credit amount for each category and substantiation rules.

Section 45X defines solar energy components as “a solar module, photovoltaic cell, photovoltaic wafer, solar grade polysilicon, torque tube, structural fastener, or polymeric backsheet.” Section 45X also defines each of these items and specifies the credit amount for each; those definitions and credit amounts are repeated in the proposed regulations. The proposed regulations provide additional guidance regarding the substantiation the taxpayer must offer to document the component’s capacity and use in solar energy property.

Section 45X defines wind energy components as “blades, nacelles, towers, offshore wind foundations and related offshore wind vessels.” Section 45X also defines each of these items and specifies the credit amount for each; those definitions and credit amounts are repeated in the proposed regulations. The proposed regulations provide additional guidance regarding the substantiation the taxpayer must offer to document the component’s capacity and use in wind energy property.

Section 45X defines qualifying battery components as “electrode active materials, battery cells and battery modules.” Section 45X also defines each of these items and specifies the credit amount for each of these items; those definitions and credit amounts are repeated in the proposed regulations and, as to certain items, additional detail regarding the definition is provided.

For electrode active materials, the credit amount is equal to 10% of the costs incurred by the taxpayer with respect to production of such materials. The proposed regulations provide that such costs include all costs as defined under Code section 263A that are paid or incurred within the meaning of section 461 of the Code for the production of electrode active materials, except direct and indirect material costs and any costs related to the extraction of raw materials.

Although the definition of a battery module in the statute refers to both modules using battery cells and modules with no battery cells, in the proposed regulations, modules with no cells are further defined as “a product . . . that contains an energy storage medium that remains in the module (for example, it is not consumed through combustion) and that is not a custom-built electricity generation or storage facility . . . neither standalone fuel storage tanks nor fuel tanks connected to engines or generation systems qualify as modules with no battery cells.” This definition appears to exclude fuel cells, such as those that operate on hydrogen, from the definition of battery components for purposes of the 45X Credit.

Proposed Section 1.45X-4: Applicable Critical Minerals
Proposed section 1.45X-4 provides definitions of applicable critical minerals which generally track the statutory definitions. In the case of critical minerals, the credit amount is 10% of the costs incurred in production, which is defined as conversion (a chemical transformation) or purification but excludes costs related to the extraction of raw materials. Note that there is no phaseout of the credit for critical minerals.

Baker Botts continues to monitor IRA guidance and will provide further updates as guidance is released. We would be pleased to assist you in your analysis of the IRA and clean energy tax incentives, as well as in preparation of any comments you might wish to submit in response to the proposed regulations.

ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm whose lawyers practice throughout a network of offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy, technology and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.

Related Professionals