An In-Depth Look at Section 45X Proposed Regulations
- The U.S. Department of the Treasury and IRS announced Proposed Regulations to Section 45X of the Internal Revenue Code on Dec. 14, 2023.
- The statute provides a production tax credit for domestic manufacturing of certain "eligible components" for solar and wind energy, inverters, battery components and critical minerals.
- This Holland & Knight alert provides a closer look at rules and specific components called for in the Proposed Regulations.
The U.S. Department of the Treasury and IRS on Dec. 14, 2023, released Proposed Regulations regarding the Section 45X Advanced Manufacturing Production Credit of the Internal Revenue Code. (See Holland& Knight's previous alert, "Treasury, IRS Release Section 45X Advanced Manufacturing Production Credit Proposed Regulations," Dec. 14, 2023.)
Enacted by the Inflation Reduction Act, Section 45X provides a production tax credit for domestic manufacturing of certain "eligible components" for solar and wind energy, inverters, battery components and critical minerals. The tax credit is effective for sales after Dec. 31, 2022. The amount of the credit varies depending on the component produced and sold. With exception, the eligible component must be sold to an unrelated person. The Proposed Regulations provide clarity around many aspects of this entirely new tax credit.
Among other criteria, to be eligible to claim Section 45X tax credits, the statute requires that the eligible component be "produced by the taxpayer." The Proposed Regulations provide a more detailed definition of this criteria. Specifically, it requires that "produced" means that the taxpayer must substantially transform 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 such elements, materials or subcomponents. The definition explicitly excludes a partial transformation.
A special rule is provided for the definition of "produced by the taxpayer" in the case of solar-grade polysilicon, electrode active materials and applicable critical minerals. As it relates to these eligible components, the term means processing, conversion, refinement or purification of source materials, such as brines, ores or waste streams to derive a distinct eligible component.
As required under the statute, this production of the eligible component has to occur in the United States or a U.S. territory. The Proposed Regulations make clear, however, that the constituent elements, materials and subcomponents used in the production of eligible components are not required to be produced in the United States or a U.S. territory.
The Proposed Regulations also provide special rules for contract manufacturing arrangements, where the production of an eligible component is contracted under an agreement entered into before production of the eligible component to be delivered under the contract is completed.
Holland & Knight Insight: Taxpayers using contract manufacturing arrangements to produce eligible components should ensure that such agreements make clear the economic arrangement between the parties, including the party entitled to claim the Section 45X credit.
Further, consistent with the statute, the Proposed Regulations provide that a taxpayer may claim a Section 45X credit for each eligible component the taxpayer produces and sells to an unrelated person, including any eligible component the taxpayer produces that was used as a constituent element, material or subcomponent and integrated, incorporated or assembled into another complete and distinct eligible component or another complete and distinct product (that is not itself an eligible component) that the taxpayer also produces and sells to an unrelated person.
Holland & Knight Insight: The Proposed Regulations provide guidance regarding the "sale to an unrelated person" requirements, including rules applicable to sales between members of a consolidated group and sales of integrated components to related parties. Taxpayers making subcomponents (that are themselves eligible for Section 45X) for integration into other eligible components should analyze the rules as applied to their specific facts and circumstances carefully to ensure compliance.
Definitional Rules: Eligible Components
1. Solar Energy Components
Statutorily, solar energy components include solar modules, photovoltaic cells, photovoltaic wafers, solar-grade polysilicon, torque tubes or structural fasteners, or polymeric backsheets. The Proposed Regulations provide some additional color on the definitions provided in the statute. Notably, for calculating the credit value when based on capacity, the Proposed Regulations state that such capacity is to be determined in direct current watts using Standard Test Conditions, as defined by the International Electrotechnical Commission. The Internal Revenue Code generally requires the taxpayer to maintain documentation supporting the credit claim. The Proposed Regulations impose some specific documentation with respect to certain eligible components, specifically including certain solar components – for example, documentation must be maintained on how these components were used downstream.
2. Wind Energy Components
Statutorily, this includes blades, nacelles, towers, offshore wind foundations and related offshore wind vessels. The Proposed Regulations provide some additional color on the definitions in the statute. For example, under the statute an offshore wind vessel is one that is "purpose-built or retrofitted for purposes of the development, transport, installation, operation, or maintenance of offshore wind energy components." The Proposed Regulations clarify that "purpose-built" is met when the vessel is built to be capable of performing such functions and that it is of a type that is commonly used in the offshore wind industry.
3. Inverter Components
Statutorily, this includes central inverters, commercial inverters, distributed wind inverters, microinverters and residential inverters. The definitions require that to be considered an eligible component, the inverter must be suitable for its required end use and that taxpayers document its suitability, as well as its rated output and capacity.
4. Battery Components
Statutorily, this includes battery cells, battery modules and electrode active material. Under the statute, "electrode active materials" is defined as materials that contribute to the electrochemical processes necessary for energy storage. The term is further defined in the Proposed Regulations as 1) battery-grade materials (the processed materials found in a final battery cell or an analogous unit or the direct battery-grade precursors to those processed materials) that 2) enable the electrochemical storage within a commercial battery component. In addition to those materials specifically called out in the statute – cathode materials, anode materials, anode foils and electrochemically active materials, including solvents, additives and electrolyte salts – the Proposed Regulations state that such materials could include electrolytes, catholytes, anolytes, separators, and metal salts and oxides.
5. Critical Minerals
Statutorily, this includes a static list of 50 critical minerals that are defined with specificity. For example, to be an eligible component, lithium must be either 1) converted lithium carbonate or lithium hydroxide, or 2) purified to a minimum purity of 99.9 percent lithium by mass. The 50 critical minerals are as follows: aluminum, antimony, arsenic, barite, beryllium, bismuth, cerium, cesium, chromium, cobalt, dysprosium, erbium, europium, fluorspar, gadolinium, gallium, germanium, graphite, hafnium, holmium, indium, iridium, lanthanum, lithium, lutetium, magnesium, manganese, neodymium, nickel, niobium, palladium, platinum, praseodymium, rhodium, rubidium, ruthenium, samarium, scandium, tantalum, tellurium, terbium, thulium, tin, titanium, tungsten, vanadium, ytterbium, yttrium, zinc and zirconium.
The Proposed Regulations confirm that the credit does not phase out over time for critical minerals, but rather is evergreen. The Proposed Regulations provide some helpful clarifications on specific critical minerals – for example, confirming that graphite includes both synthetic and natural graphite that has a minimum purity level of 99.9 percent graphitic carbon by mass. Calculating the credit value for critical minerals is 10 percent of the cost of production, as discussed below. The Proposed Regulations further note that the cost of production excludes costs incurred after the production of the applicable critical mineral or incorporating the applicable critical mineral into another product.
10 Percent Cost of Production
The value of the Section 45X tax credit depends on which eligible component the taxpayer is producing and selling and the volume of such sales. Though generally a set value (e.g., battery cells generate a tax credit of $35 per capacity), under the statute, electrode active materials and critical minerals garnish a credit value of "10 percent of the costs incurred by the taxpayer" to produce such eligible components.
Holland & Knight Insight: A significant open issue that was created by the statute is how to calculate this value. The Proposed Regulations answer this question, but in a manner that limits the value of the credits the Proposed Regulations request comments on this topic. Taxpayers producing electrode active materials or critical minerals should consider commenting on the impact of this Proposed Regulations provision, particularly given the cost of raw materials.
Specifically, the definition provided excludes direct and indirect material costs, as well as costs related to the extraction or acquisition of raw materials. The preamble to the Proposed Regulations suggests that electricity costs, storage costs, depreciation or amortization, recycling and overhead would be includible costs and that the intent in limiting the includible costs was to "mitigate the risk of crediting the same costs multiple times."
The Proposed Regulations express some concern that Section 45X tax benefits could be manipulated and deny the benefit in the "extraordinary circumstance" in that the primary purpose of production and sale of eligible components is the tax benefits themselves. The Proposed Rules point out that in the case where the sale of an eligible component generates a tax benefit greater than the cost of producing such eligible component, the credit is unavailable.
Except for critical minerals, the credit phases down beginning in 2030 and fully phases out by 2032. The Proposed Regulations acknowledge that under the statute, there is no phase-out for critical minerals. Comments to the Proposed Regulations are requested by Feb. 13, 2024.
This alert provides a summary of the Proposed Regulations and is not meant to be exhaustive. Please contact the authors if you have any questions. To be sure you receive this forthcoming analysis, please subscribe to our alerts.
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