On May 12, 2023, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) published Notice 2023-38 Domestic Content Bonus Credit Guidance under Sections 45, 45Y, 48, and 48E (the “Notice”). The Notice provides guidance regarding the requirements that taxpayers must satisfy in order to qualify for the domestic content bonus credit for certain clean energy tax credits as established by the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”). The Notice also announces that the IRS and Treasury intend to issue proposed regulations on the domestic content bonus credit requirements and related recordkeeping and certification requirements, expected to be effective for tax years ending after May 12, 2023. In the meantime, taxpayers are entitled to rely upon the Notice for any qualified facility, energy project, or energy storage technology the construction of which begins before the date that is 90 days after the publication of the forthcoming proposed regulations in the Federal Register.
Although there may be overlapping concepts in the requirements, the domestic content requirements under the Inflation Reduction Act discussed in the Notice differ from the domestic content requirements for infrastructure projects receiving federal funds under the Build America, Buy America Act (enacted as part of the Infrastructure Investment and Jobs Act). At this time, the Office of Management and Budget is preparing final regulations to guide federal agencies in their implementation of the domestic content requirements of the Build America, Buy America Act.
In addition to the domestic content bonus credit discussed herein, the Treasury and IRS have previously issued other guidance under the Inflation Reduction Act, including with respect to the prevailing wage and apprenticeship requirements (discussed by us here), the low-income community bonus credit (discussed by us here), and the energy community bonus credit (discussed by us here).
The Inflation Reduction Act increases the amount of certain tax credits allowable to a taxpayer by a “bonus” amount if the domestic content requirement described below is satisfied. For the production tax credit under Section 45 and, after 2025, the clean electricity production credit under Section 45Y, a clean energy project that satisfies the domestic content requirement is entitled to up to a 10% increase in the base credit allowable. For the investment tax credit under Section 48 and, after 2025, the clean electricity investment credit under Section 48E, a clean energy project that satisfies the domestic content requirement is entitled to up to a 10-percentage point increase in credit (for example, a 40% credit rather than a 30% credit). Direct payments to eligible taxpayers under Section 6417 with respect to the above credits will generally be reduced or eliminated if the domestic content requirement is not satisfied.
The domestic content requirement is satisfied with respect to a clean energy project if the taxpayer certifies that any steel, iron, or manufactured product which is a component of the project upon completion of construction was produced in the United States, as determined under the Buy America Requirements administered by the Federal Transit Administration. For this purpose, the manufactured products which are components of a clean energy project upon completion of construction are deemed to have been produced in the United States if not less than the “adjusted percentage” of the total costs of all such manufactured products of such project are attributable to manufactured products (including components) which are mined, produced, or manufactured in the United States. The adjusted percentage is 40% for projects that begin construction before 2025 (or 20% in the case of offshore wind facilities) but after 2024 will increase annually with respect to the Section 45Y credit to reach a maximum of 55% for projects the construction of which begins after 2026 (or 2027 in the case of offshore wind projects).
Overview of the Notice
The notice provides guidance regarding:
- how to determine when a component is viewed as iron or steel, as opposed to a manufactured product;
- how to perform the “adjusted percentage” calculation with respect to manufactured products, including guidance as to which costs of which components are properly taken into account;
- safe harbors for the proper classification of certain common components of utility scale wind, solar and battery storage projects;
- the application of the domestic content requirement to retrofitted projects;
- the manner in which the taxpayer will be required to certify its compliance with the domestic content requirement to the IRS; and
- taxpayer recordkeeping requirements to substantiate compliance with the domestic content requirement.
The Notice provides that an Applicable Project is eligible for the domestic content bonus credit if it satisfies the “Domestic Content Requirement,” which consists of the “Steel or Iron Requirement” and the “Manufactured Products Requirement,” and timely submits the required certification to the IRS. For this purpose, an “Applicable Project” is a qualified facility under Sections 45 or 45Y; (ii) an energy project under Section 48; or (iii) a qualified investment with respect to a qualified facility or energy storage technology under Section 48E.
The Steel or Iron Requirement
The Notice provides that an Applicable Project meets the Steel or Iron Requirement if, consistent with 49 CFR Sections 661.5(b) and (c), all manufacturing processes with respect to any steel or iron items take place in the United States, except metallurgical processes involving refinement of steel additives. The Steel or Iron Requirement applies to construction materials that are primarily made from steel or iron and that “are structural in function.” The Steel or Iron Requirement does not apply to steel or iron in “Manufactured Product Components” (as defined in the Notice and below) or their subcomponents. The Notice does not shed much light on the Steel or Iron Requirement beyond the regulatory definition; however, the Notice does provide a list of example items that are made primarily of steel or iron but are not structural in function, and therefore not subject to the Steel or Iron Requirement, such as: nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, and door hinges.
The Manufactured Products Requirement
The Notice provides complex rules for the calculation of the percentage of domestic content used to determine whether an Applicable Project satisfies the Manufactured Products Requirement, which in most cases will require the taxpayer to obtain and use specified manufacturer/vendor cost information regarding not only each manufactured component directly incorporated into the Applicable Project, but also each of the direct components of those components.
Under those rules, all “Applicable Project Components” (defined by the Notice as any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project) that are “Manufactured Products” (defined in the Notice as an item produced as a result of a Manufacturing Process) must be produced in the United States or deemed to be produced in the United States. For an Applicable Project Component that is a Manufactured Product to be considered produced in the United States (a “U.S. Manufactured Product”) (i) all of the “Manufacturing Processes” (defined in the Notice as the application of processes to alter the form or function of materials or of elements in a manner adding value and transforming those materials or elements so that they represent a new item functionally different from that which would result from mere assembly of the elements or materials) with respect to such Applicable Project Component must take place in the United States, and (ii) all of the “Manufactured Product Components” (defined in the Notice as any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into the Applicable Project Component that is a Manufactured Product) of such Applicable Project Component must be of U.S. origin. The Notice provides that a Manufactured Product Component will be considered to be of U.S. origin if it is manufactured in the United States regardless of the origin of any subcomponents. For purposes of the Notice, the United States includes U.S. territories.
All Applicable Project Components of an Applicable Project that are Manufactured Products will be deemed produced in the United States if the relevant costs related to both (i) U.S. Manufactured Products that are Applicable Project Components and (ii) Manufactured Product Components of non-U.S. Manufactured Products that are Applicable Project Components if the Manufactured Product Components are mined, produced or manufactured in the United States (“U.S. Components”) are, as a percentage of total relevant costs for all Applicable Project Components that are Manufactured Products (the “Domestic Cost Percentage”) greater than or equal to the adjusted percentage (as defined above). The Domestic Cost Percentage calculation only includes “direct costs as defined in Section 1.263A-1(e)(2)(i)” (i.e., the direct materials and labor costs paid or incurred by the manufacturer of the U.S. Manufactured Product to produce the U.S Manufactured Product or by the manufacturer of the non-U.S. Manufactured Product to produce or acquire the U.S. Components). The Notice excludes from the numerator of the Domestic Cost Percentage direct costs, including direct labor costs, of incorporating the Applicable Project Components into the Applicable Project.
Example of the Domestic Cost Percentage Calculation with Respect to Manufactured Products
The Notice provides an example of the Domestic Cost Percentage calculation. In the example, the Taxpayer acquires an Applicable Project from an EPC Contractor. The Applicable Project consists of two Applicable Project Components.
The first Applicable Project Component is manufactured in the United States by the EPC Contractor and includes two Manufactured Product Components that are manufactured in the United States. The first Applicable Project Component is therefore a U.S. Manufactured Product. As a result, the EPC Contractor’s direct costs of manufacturing the first Applicable Project Component are included in the numerator and denominator of the Domestic Cost Percentage.
The EPC Contractor purchases the second Applicable Project Component from the Supplier, who manufactured the component in the United States. The second Applicable Project Component includes three Manufactured Product Components, two of which are manufactured in the United States (and are therefore U.S. Components) and one of which is manufactured outside the United States. The second Applicable Project Component is therefore a Non-U.S. Manufactured Product. As a result, the Supplier’s direct costs of producing or acquiring the U.S. Components of the second Applicable Project Component are included in the numerator of the Domestic Cost Percentage and Supplier’s direct costs of manufacturing the second Applicable Project Component are included in the denominator.
The example in the Notice does not use or reference specific items of clean energy property. However, based on the Notice’s safe harbor classification of wind turbines and wind tower flanges as Manufactured Products and the nacelle, blades, rotor hub, and power converter as Manufactured Product Components of a wind turbine, the example’s methodology could be applied to, for example, a land-based wind facility, substituting “wind tower flanges” for the first Applicable Product Component and “wind turbine” for the second Applicable Product Component. The result would then be that the wind tower flanges were U.S.-manufactured and the wind turbine was non-U.S. manufactured but that the costs of the U.S.- manufactured nacelle and blades of that wind turbine, when added to the cost of the wind tower flanges, are sufficient to cause both the wind turbine and the wind tower flanges to be deemed U.S. manufactured products.
The Notice provides a safe harbor for the classification of certain project components typically found in utility-scale photovoltaic systems, land-based wind facilities, offshore wind facilities, and battery energy storage technologies. The Notice provides guidance on the identification of Applicable Project Components, their status as steel or iron versus Manufactured Products, and the identification of Manufactured Product Components of Applicable Project Components that are Manufactured Products.
Pursuant to long-standing IRS guidance, an Applicable Project may qualify as newly placed in service even though it contains some used property, provided the fair market value of the used property is not more than 20 percent of the Applicable Project’s total value (the “80/20 Rule”). The 80/20 Rule is calculated by adding the cost of the new property together with the value of the used property. The cost of the new property includes all costs properly included in the depreciable basis of the new property. The Notice makes clear that, when the 80/20 Rule applies, the determination of whether the Domestic Content Requirement is satisfied is made solely with respect to the new property.
A taxpayer must submit to the IRS a “Domestic Content Certification Statement” attached to Form 8835, Renewable Electricity Product Credit; Form 3468, Investment Credit; or other applicable form for reporting the domestic content bonus credit, filed with the taxpayer’s annual return for the first year in which the taxpayer reports a domestic content bonus credit with respect to an Applicable Project. In the case of the production tax credit and the clean electricity production credit, in each subsequent year of reporting the domestic content bonus credit after the first, the taxpayer must attach a copy of the Domestic Content Certification Statement from the first year’s annual return that was submitted to the IRS. The Domestic Content Certification Statement must include the following information for each Applicable Project: (i) whether the Applicable Project is a qualified facility, energy project, or energy storage technology; (ii) the specific type of Applicable Project (for example, utility-scale PV system); (iii) the geographic coordinates and address of the Applicable Project; (iv) the date the Applicable Project was placed in service; (v) the total domestic content bonus credit amount for the first year; (vi) any additional information with respect to the Applicable Project as required by the applicable forms and instructions; and (vii) a signature under penalties of perjury by a person with legal authority to bind the taxpayer.
A taxpayer must substantiate that the Domestic Content Requirement was met for the Applicable Project by meeting the general recordkeeping requirements of Section 6001. Section 6001 generally requires that any taxpayer liable for any tax imposed by the Code, or for the collection thereof, must “keep such records as the Secretary may from time to time prescribe.” The regulations under Section 6001 give slightly more detail, describing that the requirement is to keep permanent books of account or records as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown.
We will continue to monitor the Inflation Reduction Act guidance initiatives from the IRS and Treasury and will provide further updates as guidance is released. In the meantime, Baker Botts would be pleased to assist you in your analysis of the Inflation Reduction Act and other clean energy tax incentive matters.
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