Treasury Department, IRS Issue Final Rules Under Clean Vehicle Tax Credits

The Federal Register on May 6, 2024, published final regulations issued by the U.S. Department of the Treasury and IRS under the clean vehicle tax credits found at Sections 25E (previously owned clean vehicles) and 30D (clean vehicle credit) of the Internal Revenue Code.

The final regulations address a variety of topics related to these two credits, including providing guidance on relevant statutory definitions, dealer registration, the rules related to the transfer of the Section 30D credit and, importantly, the Critical Minerals Requirement and Battery Components Requirement, as well as the foreign entities of concern (FEOC) restriction under Section 30D. Simultaneous to the release of the final regulations, the U.S. Department of Energy (DOE) issued final guidance on how to determine if an entity is a FEOC.

This Holland & Knight alert addresses important highlights from the final regulations as they relate to the Critical Minerals Requirement and Battery Components Requirement, as well as the FEOC Restriction, including the DOE final guidance.

Background on the Clean Vehicle Tax Credit at Section 30D

The Inflation Reduction Act (IRA) greatly modified the existing Section 30D credit for consumers purchasing clean energy vehicles. The credit is equal to the sum of $3,750 if the Critical Minerals Requirement is satisfied, plus $3,750 if the Battery Components Requirement is satisfied, equaling a potential total credit of $7,500.

• Under the Critical Minerals Requirement, a certain "applicable percentage" of the battery must comprise critical minerals that were 1) extracted or processed in the U.S. or in any country with which the U.S. has a free trade agreement or 2) recycled in North America.
  • The applicable percentage climbs over time: 40 percent if the vehicle is placed in service after April 18, 2023, and before 2024; 50 percent if the vehicle is placed in service in 2024; 60 percent if the vehicle is placed in service in 2025; 70 percent if the vehicle is placed in service in 2026; and 80 percent if the vehicle is placed in service after 2026.
• Under the Battery Components Requirement, a certain "applicable percentage" of the battery components must have been manufactured or assembled in North America.
  • The applicable percentage climbs from 50 percent if the vehicle is placed in service after April 18, 2023, and before 2024; 60 percent if the vehicle is placed in service in 2024 or 2025; 70 percent if the vehicle is placed in service in 2026; 80 percent if the vehicle is placed in service in 2027; 90 percent if the vehicle is placed in service during 2028; and 100 percent if the vehicle is placed in service after 2028.

In addition to these requirements – both of which are focused on ensuring critical minerals and battery components are sourced in the U.S. or with trusted trading partners – a vehicle will not qualify for the Section 30D credit if a FEOC was involved in the sourcing of the critical minerals or battery components. Specifically, the credit is not available for vehicles:

• placed in service after Dec. 31, 2024, with respect to which any of the applicable critical minerals contained in the batteries of such vehicles were extracted, processed or recycled by a FEOC or
• placed in service after Dec. 31, 2023, with respect to which any of the components contained in the batteries of such vehicles were manufactured or assembled by a FEOC

The statute states that a FEOC includes an entity "owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation."¹ Although the statute identifies which countries are considered "covered nations,"² it does not otherwise describe what it means to be owned by, controlled by or subject to the jurisdiction or direction of a covered nation's government.

In addition to the Critical Minerals Requirement, Battery Components Requirement and FEOC Restriction, there are several other requirements that must be met for Section 30D credit eligibility. (See Holland & Knight's previous alert, "Treasury Department, IRS Release Clean Vehicle Tax Guidance," April 12, 2023.)

Final Treasury Department and IRS Guidance on the Critical Minerals Requirement and Battery Components Requirements

The final regulations confirmed that minerals other than those specified in Section 45X(c)(6) are not considered for purposes of the Critical Minerals Requirements and FEOC Restriction. However, if identified under Section 45X(c)(6), each step of extraction, processing or recycling through the step in which such applicable mineral is processed or recycled into an associated constituent material (materials employed directly in the manufacturing of battery components) must be taken into account, even if such applicable mineral is not in the form described in Section 45X(c)(6) at every stage.

As an adjustment to the 50% Value Added Test, the final regulations adopt a Traced Qualifying Value Test for purposes of determining if the Critical Minerals Requirement is met. (See Holland & Knight's previous alert, "Treasury Department, IRS Release Clean Vehicle Tax Guidance," April 12, 2023.) This test, which is more precise and more stringent, requires the tracing of any value added by extraction or processing in the U.S. or a country with which the U.S. has a free trade agreement in effect (FTA country) or recycling in North America. Under the Traced Qualifying Value Test, the value added throughout the supply chain through extraction, processing and recycling (and the location of such activity) must be evaluated to determine whether the applicable percentage is met. The manufacturer may treat as qualifying (the numerator for purposes of the applicable percentage) only the value added by extraction or processing in the United States or a FTA country or recycling in North America. By contrast, under the 50% Value Added Test, the manufacturer may treat the full value of the applicable critical mineral as qualifying (the numerator for purposes of the applicable percentage) if any of the following conditions were met:

• 50 percent or more of the value added to the applicable critical mineral by extraction is derived from extraction that occurred in the U.S. or a FTA country
• 50 percent or more of the value added to the applicable critical mineral by processing is derived from processing that occurred in the U.S. or a FTA country
• 50 percent or more of the value added to the applicable critical mineral by recycling is derived from recycling that occurred in North America

The final regulations allow the continued application of the 50% Value Added Test for a transition period.

Importantly, and as foreshadowed in the proposed regulations, the final regulations create a path for "impracticable-to-trace battery materials." These materials are specifically identified as graphite contained in anode materials (both synthetic and natural) and applicable critical minerals contained in electrolyte salts, electrode binders and electrolyte additives. Impracticable-to-trace battery materials need not be tested for the Critical Mineral Requirement or FEOC Restriction. The rules regarding impracticable-to-trace materials are temporary. The temporary relief is available only for clean vehicles for which the qualified manufacturer provides a periodic written report to the IRS before Jan. 1, 2027, and only if a qualified manufacturer demonstrates how it will comply once the transition rule is no longer in effect.

Though there were changes to the Critical Minerals Requirement in the final regulations, the final regulations adopted the Battery Components Requirements proposed regulations without change. The final regulations slightly modify the definition of "battery components" and create a new category of materials named "battery materials." Battery materials – that by definition do not include battery components and that do not contain critical minerals specified in Section 45X(c)(6) – are not considered for the Critical Minerals Requirement, Battery Components Requirement or the FEOC Restriction.

FEOC Restriction

The final regulations issued by the Treasury Department and IRS confirmed that an upfront review would be conducted of compliant-battery ledgers for vehicles placed in service after Dec. 31, 2024. The final regulations otherwise adopt the FEOC Restriction as proposed with no major modifications.

In conjunction with the final regulations issued by the Treasury Department and IRS, the DOE issued final interpretative guidance on how to determine whether an entity is a FEOC. The final guidance largely adopts the initial guidance issued in December 2023 and provides additional clarify on various aspects of the proposed guidance as emphasized below.

The final guidance confirms that the FEOC analysis is a two-step analysis that requires 1) determination whether an entity is a "foreign entity" and 2) determination it is "owned by, controlled by, or subject to the jurisdiction or direction of" the government of any covered nation (i.e., China, Russia, Iran and North Korea). (See Holland & Knight's previous alert, "A Look at Foreign Entities of Concern and the Section 30D Clean Vehicle Tax Credit," Dec. 5, 2023.)

The final guidance does not make any changes to the agency's proposed interpretation of the term "foreign entity." Specifically, the DOE notes that the definition of foreign entity encompasses situations where a U.S. entity is considered to be "foreign" as a result of control.

A foreign entity will be classified as a FEOC if it meets either of the following criteria:

1. The foreign entity is subject to the jurisdiction of a covered nation. This occurs when the foreign entity either:
   
   a. is incorporated or domiciled in, or has its principal place of business in, a covered      nation or
   
   b. engages in the extraction, processing or recycling of critical minerals, battery
       components or battery materials in a covered nation
   
   
2. The foreign entity is owned by, controlled by or subject to the direction of a government of a foreign country that is a covered nation. This occurs when either:
   
   a. 25 percent or more of the foreign entity's board seats, voting rights or equity
       interest, with each metric evaluated independently, whether directly or indirectly
       via one or more intermediate entities or
   
   b. with respect to the critical minerals, battery components or battery materials of a
       given battery, the foreign entity has entered into a licensing arrangement or
       other contract with a contractor that is a FEOC that entitles the FEOC contractor
       to exercise effective control over the extraction, processing, recycling,
       manufacturing or assembly of such items

For "equity interests," the DOE intends to refer to percent value of the ownership interest to include capital or profit interests and contingent equity interest that can be reasonably determined. Further, in response to requests from the industry, the DOE clarified in the final guidance that the 25 percent threshold applies to each metric independently – not in combination. Therefore, an entity that has 20 percent of its voting rights, 10 percent of its equity interests and 15 percent of its board seats each held by the government of a covered nation is generally not at risk of being classified as a FEOC. 

With respect to the reach of a "senior foreign political figure" who is considered part of the government of a foreign country, despite acknowledging the challenges/burden associated with identifying the interest of such individuals or an immediate family member of such persons (i.e., spouse, parent, sibling, child or a spouse's parent and sibling), the DOE has declined to provide a definitive list of such individuals. Therefore, it remains the responsibility of companies to individually analyze their specific upstream suppliers and make any necessary evaluations. 

With respect to the People's Republic of China (PRC), the final guidance clarifies that the "senior foreign political figure" identified in the proposed guidance does not constitute all senior foreign political figures in the PRC. Instead, the DOE considers ''senior foreign political figure'' to include 1) individuals currently or formerly in senior roles within the PRC government at the central and local levels, 2) individuals currently or formerly in senior roles within the Chinese Communist Party (CCP) and bodies and commissions under the CCP Central Committee, 3) current and former members of the CCP Central Committee, Politburo Standing Committee, Politburo, National People's Congress³ and Provincial Party Congresses, and national Chinese People's Political Consultative Conference (CPPCC), and 4) current but not former members of local or provincial CPPCCs. The clarifications to this definition are the most notable clarifications made in the final guidance.

Finally, although the DOE touted the possibility of establishing a voluntary pre-review process that would enable manufacturers to get a read on the potential contracts or licenses with FEOCs, the DOE has made it clear in the final guidance that it declines to establish such a process at this time. Instead, the DOE is expected to play a pivotal role in reviewing all of the documentation provided to the IRS for the purpose of determining eligibility for the Section 30D tax credit, and the DOE's review of licenses and contracts for effective control will take place through that process.

Conclusion

The Treasury Department and IRS final regulations provide clarity on a number of issues related to Sections 25E and 30D and, importantly, on the Critical Minerals Requirement, Battery Components Requirement and FEOC Restriction. Clearly, the Treasury Department and IRS were trying to strike the balance between providing clear rules consistent with the statute while also providing a glide path to ensuring clean vehicles qualifying under Section 30D were available. Unfortunately, these rules – like the proposed rules – require significant changes for manufacturers to track procurement chains in order to confirm whether a vehicle meets the requirements. The DOE rules on FEOC also continue to present challenges, particularly insofar as it requires knowing detailed information about suppliers, including the identify and background of individuals (and their family members) in order to determine if they are a senior foreign political figure sufficient to trigger the FEOC Restriction. 

Notes

¹ The IRA references the Infrastructure Investment and Jobs Act (42 U.S.C. 18741(a)(5)) for the definition of foreign entity of concern.

² "Covered nation" includes the Democratic People's Republic of North Korea, People's Republic of China, Russian Federation and Islamic Republic of Iran.

³ The DOE's initial FEOC guidance included the National Party Congress, but final guidance identifies the National People's Congress without also identifying the National Party Congress. It is unclear whether the failure to identify the National Party Congress was an error, as including this body seems to be consistent with the general definition of senior foreign political official.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.