Highlights of Final Regulations Under Section 45X Advanced Manufacturing Tax Credit

The U.S. Department of the Treasury and IRS on Oct. 28, 2024, published final regulations regarding the Section 45X Advanced Manufacturing Production Credit of the Internal Revenue Code (Final Regulations).

Section 45X, which was enacted in 2022 as part of the Inflation Reduction Act (IRA), provides a production tax credit for domestic manufacturing of components for solar and wind energy, inverters, battery components and critical minerals. Generally, the credit phases down beginning in 2030 and fully phases out by 2032, with an exception for critical minerals. The amount of the credit varies depending on the component produced and sold.

Generally, the Final Regulations conform to the Proposed Regulations. (See Holland & Knight's previous alert, "An In-Depth Look at Section 45X Proposed Regulations," Dec. 18, 2023.) The Final Regulations clarify several aspects of Section 45X, as highlighted below.

Topic 1: General Rules

What Does "Produced by the Taxpayer" Mean?

The Final Regulations continue to define "produced by the taxpayer" as a "substantial transformation" of "constituent elements, materials, or subcomponents into a complete and distinct eligible component that is functionally different from that which would result from minor assembly or superficial modification." Primary production involves producing an eligible component using nonrecycled materials, while secondary production involves producing an eligible component using recycled materials. Both terms can constitute production for Section 45X.

The preamble makes clear that for certain eligible components, such as solar modules and battery modules using battery cells, that are produced primarily by assembling other components, the Final Regulations clarify that the substantial transformation requirement is met by the taxpayer that assembles the constituent components to produce the solar module or battery module using battery cells.

By contrast, certain eligible components, such as nacelles, may be produced and sold to a third party in a manner in which only minor assembly is required. The third party completes the eligible component by performing minor assembly, but such minor assembly is insufficient to entitle the third party to the credit under Section 45X. Instead, the nacelle manufacturer remains entitled to the credit.

Are Eligible Components Used for Replacements Eligible for Section 45X?

The preamble to the Final Regulations clarifies that if an eligible component is produced and sold to an unrelated person in the normal course of a trade or business and the eligible component is then replaced with a new eligible component produced by the same taxpayer, there is no new sale to an unrelated person for the replacement eligible component, and the replacement eligible component relates back to the original sales transaction.

Are Defective Components Eligible for Section 45X?

If an eligible component is not defective at the time of sale, the component is eligible for Section 45X (assuming all other requirements have been met). Any defects arising after the point of sale may occur in the ordinary course of a business and do not generally implicate anti-abuse concerns.

Can Taxpayers Sell Integrated Components and Remain Eligible Under Section 45X?

Section 45X allows a taxpayer to sell an eligible component that is integrated into another eligible component and sold to an unrelated party to be eligible to claim Section 45X with respect to both eligible components. The "integrated component" is deemed sold to the unrelated party. The Final Regulations clarify that a taxpayer must produce (rather than merely purchase or acquire) the eligible component that is integrated, incorporated or assembled into another eligible component that is then sold to an unrelated person in order for the deemed sale rule to apply.

Are Sales to a Related Party Eligible Under Section 45X?

Generally, Section 45X permits a sale of an eligible component to a related party to be treated as sold to an unrelated party provided certain conditions are met. The Final Regulations clarify that for related party sale, the purchaser may either use the eligible component in its trade or business or sell it to a subsequent purchaser for use in the subsequent purchaser's trade or business. Further, the purchaser or subsequent purchaser may use the eligible component in the U.S. or outside of the U.S. For taxpayers with an integrated supply chain, the related party sale election can provide a streamlined method of claiming Section 45X.

What If a Taxpayer Uses a Contract Manufacturer to Produce Eligible Components?

The Final Regulations preserve the contract manufacturing rules as proposed, which allows taxpayers who enter into an agreement for the production of eligible components to elect which taxpayer gets to receive the Section 45X credit. The Final Regulations also provide clarification on contract manufacturing for tolling agreements. For example, where Taxpayer A extracts critical materials that do not meet the purification requirements of Section 45X (e.g., to be eligible, cesium must be 99 percent pure) but enters into a tolling agreement with Taxpayer B to purify such critical materials to an "applicable critical material" (as defined under Section 45X) before such materials are returned to Taxpayer A, then Taxpayer A may be eligible to claim the Section 45X credit with respect to the purified applicable critical materials.

What Should Taxpayers Claiming Section 45X Know About Potential OECD Pillar II Interaction?

Cross-border businesses should carefully monitor their Organization for Economic Cooperation and Development (OECD) Pillar Two U.S. effective tax rate as they increase U.S. operations. Pillar Two requires an effective tax rate (ETR) of at least 15 percent based on modified financial statement income. The ETR is equal to covered taxes divided by net revenue. Qualified refundable tax credits such as Section 45X are treated as an increase in revenue, thereby reducing the ETR. It is possible the Pillar Two ETR could dip below 15 percent for businesses with significant U.S. operations claiming direct pay of Section 45X, resulting in top-up taxes paid to a foreign jurisdiction for the U.S. operations. For foreign-headquartered businesses, this is an issue potentially as early as 2024. For U.S.-headquartered groups, this could become an issue as early as 2026.

How Do the Final Regulations Distinguish Between Facilities That Claim Section 48C and Section 45X?

The Final Regulations generally retain the position that property that would otherwise qualify as an eligible component under Section 45X is only eligible if no part of that Section 45X facility is also included in the qualified investment of a Section 48C facility. A Section 45X facility only comprises the independently functioning tangible property used by the taxpayer that is necessary to produce eligible components. Therefore, a taxpayer can have multiple independent manufacturing facilities where some components from facilities will qualify for the Section 45X credit and other components from facilities will not qualify for the Section 45X credit because the facilities are included in the qualified investment of a Section 48C facility.

Topic 2: Definitions of Eligible Components

Did the Final Regulations Clarify the Eligibility of Solar Energy Components?

Generally, the Final Regulations retain the definitions of solar components found in the Proposed Regulations. However, the Final Regulations make clarifications regarding, among other items, the proper capacity to use in a tandem module, eligibility of direct wafer technologies, the definition of polymeric backsheets and purity standard of solar grade polysilicon.

Did the Final Regulations Clarify the Eligibility of Wind Energy Components?

The Final Regulations generally conform to the Proposed Regulations but clarify the circumstances in which a nacelle repowering may constitute production of an eligible component. The Final Regulations also clarify the certification standards for wind turbines and confirm the credit amount for related offshore wind vessels.

How Are Inverters Clarified By the Final Regulations?

The Final Regulations adopt the Proposed Regulations' definitions of central and utility inverters. The Final Regulations clarify that commercial inverters may be used with optimizers and that, for microinverters, the inverter and the DC optimizer do not need to be physically packaged together at sale, and the inverter and DC optimizer do not need to be fully interconnected and assembled at the time of sale.

Do the Final Regulations Provide Changes to the Definition of Qualifying Battery Components?

The Final Regulations generally conform to the Proposed Regulations with respect to qualifying battery components but clarify that, in the case of a battery cell, "energy density" refers to volumetric energy density. The Final Regulations also clarify that battery modules that contain battery cells configured to a specified end use and particular capacity are eligible regardless of whether the items are typically called "battery modules" or "battery packs" in industry practice. Accordingly, a battery module using battery cells becomes an eligible component upon first meeting the requirements, notwithstanding when this transformation may occur in a manufacturing production chain.

Finally, the Final Regulations clarify that with regard to modules with no battery cell, no specific storage medium is required, and clarify rules for "production" of battery modules with no battery cells, including where substantial transformation occurs onsite or are specially manufactured for a single customer.

Topic 3: Changes to Costs of Production for Electrode Active Materials and Critical Minerals

What Is Included in Costs of Production for Electrode Active Materials and Critical Minerals?

For both electrode active materials and critical minerals, the Final Regulations allow taxpayers to include extraction costs related to the extraction of raw materials in the U.S. or a U.S. territory, but only if those costs are paid or incurred by the taxpayer that claims the Section 45X credit with respect to the relevant electrode active material or appliable critical mineral. This clarification is significant and reflects the Treasury Department's and IRS' determination that inclusion of extraction costs incurred by the taxpayer most accurately captures the meaning of ''the costs incurred by the taxpayer with respect to the production of'' applicable to critical minerals and electrode active materials under Section 45X.

If, however, a taxpayer acquired extracted raw material as a direct (or indirect) material cost, the material costs may be included as production costs consistent with the rules provided under Section 263A regardless of whether the extracted material is domestically or foreign-sourced. However, there is an important carveout as noted below.

The Final Regulations also allow taxpayers that produce electrode active materials and critical minerals to include direct and indirect materials costs in production costs if certain conditions are met but, importantly, only if those direct or indirect material costs do not relate to the purchase of materials that are an eligible component at the time of acquisition. The Final Regulations also note that for this exception the treatment as an "eligible component" is not dependent on whether a Section 45X credit was claimed, and so a foreign applicable critical mineral or electrode active material is an eligible component subject to this carveout and is not included in production costs.

In providing these rules, the Treasury Department and IRS emphasized that the inclusion of material costs must be balanced against the risk of multiple crediting of the same costs and the creation of incentives that are contrary to the purposes of Section 45X. Therefore, carving out costs of acquiring materials that are eligible components as a direct or indirect material cost with respect to the production of another applicable critical mineral or electrode active material appropriately implements Section 45X.

What Is Required as Substantiate Requirements for a Taxpayer Who Is Claiming a Section 45X Credit with Respect to an Applicable Critical Mineral or Electrode Active Material?

In order to include direct or indirect materials costs as production costs when calculating a Section 45X credit for the production and sale of an applicable critical mineral or electrode active material, a taxpayer must include – as an attachment to the tax return on which the Section 45X credit is claimed – certifications from any supplier, including the supplier's employer identification number, that is signed under penalties of perjury, from which the taxpayer purchased any constituent elements, materials or subcomponents of the taxpayer's eligible component, stating that the supplier is not claiming the Section 45X credit with respect to any of the material acquired by the taxpayer, nor is the supplier aware that any prior supplier in the chain of production of that material claimed a Section 45X credit for the material.

A taxpayer must also prepare and maintain certain information in the taxpayer's books and records and provide any other information related to the direct or indirect materials specified in guidance and comply with the directions for providing such information as specified in guidance.

Further Information

The Holland & Knight Energy Tax Team is available for questions regarding the Section 45X Final Regulations. To receive additional analysis from the team, please subscribe to our alerts and access the Holland & Knight Inflation Reduction Act Tax Resource Library.

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.