United States: Treasury And IRS Issue Guidance On Domestic Content Bonus Credit For Renewable Energy Projects

On May 12, 2023, the IRS and the Department of the Treasury issued highly anticipated guidance regarding the requirements to satisfy the domestic content bonus tax credit provisions for investment tax credits under Sections 48(a)(12) and 48E(a)(3)(B) of the Code (the "ITC") and production tax credits under Sections 45(b)(9) and 45Y(g)(11) of the Code (the "PTC") (the "Domestic Content Bonus Requirements") in Notice 2023-38 (the "Notice"), which may be found here.

As summarized in our initial blog post regarding the key provisions with respect to the ITC and PTC under the Inflation Reduction Act, which may be found here, the ITC percentage and the PTC rate may be increased by the following amounts if the Domestic Content Bonus Requirements are satisfied (the "Domestic Content Bonus Credit Amount").

For the ITC, the Domestic Content Bonus Credit Amount depends on whether one of the following requirements is satisfied: (i) the energy project has a maximum net output of less than 1 MW (AC), (ii) construction of the energy project began before January 29, 2023, or (iii) the energy project satisfies the prevailing wage and apprenticeship requirements in Section 48(a)(10)(A) of the Code (the "5x Increase Options"). With respect to the PTC, because the credit amount is not determined by multiplying the applicable rate by eligible project costs (as with the ITC), there is no need for a separate Domestic Content Bonus Credit Amount based on whether a 5x Increase Option is satisfied. Instead, the 10% increase in the credit amount for meeting the Domestic Content Bonus Requirements applies to the credit amount itself.

At a high level, under the Inflation Reduction Act the Domestic Content Bonus Requirements are satisfied if (i) 100% of any steel or iron that is a component of the facility was produced in the United States (the "Steel or Iron Requirement"), (ii) 40% of manufactured products that are components of the facility were produced in the United States (the "Manufactured Products Requirement"), and (iii) the taxpayer certifies to (i) and (ii) in the manner required by the Notice (the "Certification Requirement"). The Notice provides more detail on these requirements, but the rules are complicated. Following a step-by-step approach describing how to apply the provisions in the Notice.

Step 1 – Identify and Sort Applicable Project Components

In analyzing whether the Steel or Iron Requirement and the Manufactured Products Requirement are satisfied, the first step for any taxpayer is to determine which project components it must test under the Notice's formulation, and which prong of the test each components must meet. In this first step, taxpayers must evaluate any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into the relevant facility (each, an "Applicable Project Component"). Any Applicable Project Component may qualify as steel, iron, or a "Manufactured Product" produced as a result of a manufacturing process. A manufacturing process, for this purpose, is the application of processes to alter the form or function of materials or of elements of a product in a manner that adds value and that transforms such materials or elements to represent a new item functionally different from that which would result from the assembly of such elements or materials.

Once the Applicable Project Components are identified, they then must be tested under either the Steel or Iron Requirement or the Manufactured Products Requirement, each described below. To assist taxpayers in determining whether the Steel or Iron Requirement, or the Manufactured Product Requirement, applies to a particular Applicable Project Component, the Notice categorizes several Applicable Project Components that may be found in utility-scale photovoltaic systems, land-based wind facilities, offshore wind facilities, and battery energy storage technologies as subject to either the Steel or Iron Requirement or the Manufactured Product Requirement. While the Notice cautions that the list below may not be an exhaustive set of all Applicable Project Components for such facilities, Applicable Project Components sorted as set forth below will be accepted by the IRS (pending further changes to this guidance, if any) for those Applicable Project Components and Manufactured Product Components.

Step 2 – Test Steel and Iron Applicable Project Components Under the Steel and Iron Requirement

The Steel or Iron Requirement is met if all manufacturing processes (except metallurgical processes involving refinement of steel additives) with respect to all steel or iron Applicable Project Components take place in the United States. This requirement applies to Applicable Project Components that are construction materials (i) made "primarily of" steel or iron, and (ii) that are structural in function. Although this formulation leaves some uncertainty, the Notice's table set forth above provides helpful guidance for taxpayers to identify which Applicable Project Components must be tested under the Steel or Iron Requirement.

The Steel or Iron Requirement does not apply to steel or iron used in Manufactured Product Components or subcomponents thereof. For example, nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges and similar items not structural in function are not subject to the Steel or Iron Requirement.

Step 3 – Test Manufactured Products Applicable Project Components Under the Manufactured Products Requirement

The Manufactured Products Requirement is satisfied if not less than the adjusted percentage (the "Adjusted Percentage") of the total costs of all Manufactured Products of a facility are attributable to Manufactured Products (including components) which are mined, produced, or manufactured in the United States.

The Adjusted Percentage is 40% for projects on which construction begins before January 1, 2025. The Adjusted Percentage is subject to the following increases based on the year in which construction begins:

The Adjusted Percentage is slightly different for offshore wind facilities—starting at 20% and eventually capping at 55% for offshore wind facilities that begin construction in 2028 or later.

The Manufactured Products Requirement itself requires a multi-part analysis. For purposes of determining the Adjusted Percentage numerator, Manufactured Products must be divided into two baskets, Manufactured Products produced in the United States and non-U.S. Manufactured Products.

a. Manufactured Products Produced in the United States

A Manufactured Product is considered to be produced in the United States (a "U.S. Manufactured Product") if (i) all of the manufacturing processes for the Manufactured Product take place in the United States, and (ii) any article, material, or supply, whether manufactured or unmanufactured, directly incorporated into an Manufactured Product (a "Manufactured Product Component") is manufactured in the United States, regardless of the origin of any subcomponents.

For purposes of this rule (and the Notice generally) United States means the several states, the District of Columbia, Puerto Rico, Guam, American Samoa, the U.S. Virgin Islands, and the Commonwealth of the Northern Mariana Islands.

If a Manufactured Produce is considered to be a U.S. Manufactured Product, then all direct materials and labor costs incurred by the manufacturer in manufacturing the product would be included in the numerator for purposes of the Adjusted Percentage analysis.

b. Manufactured Product Components of Non-U.S. Manufactured Products

For any Manufactured Product that is not a U.S. Manufactured Product (i.e., either the final manufacturing process did not occur in the United States or one or more of the Manufactured Product Components included in the Manufactured Product was not manufactured in the United States), the cost of any Manufactured Product Component is included in the numerator. Again, all direct materials and labor costs incurred by the manufacturer in connection with manufacture of the applicable Manufactured Product Component would be included in the numerator for purposes of the Adjusted Percentage analysis.

For purposes of the Adjusted Percentage analysis, the denominator is the sum of the costs of each Applicable Project Component that is a Manufactured Product.

For example, assume a project includes two Manufactured Products, A and B. Manufactured Product A includes two components, both of which were manufactured in the United States, and final manufacturing of Manufactured Product A occurred in the United States. All of the manufacturer's direct material and labor costs of $100 would be included in the numerator. Manufactured Product B includes three Manufactured Product Components, X ($30), Y ($50), and Z ($100), and the manufacturer's total cost of Manufactured Product B was $200. Final manufacturing occurred in the United States. X and Y were both manufactured in the United States, but Z was not. In this case, the $30 for X and the $50 for Y would be included in the numerator. However, neither the $100 for Z nor the manufacturer's additional $20 of manufacturing costs would be. Accordingly, in this case the Adjusted Percentage would be 60%, as follows: $180 [$100 Manufactured Product A + $30 Manufactured Product Component X + $50 Manufactured Product Component Y] divided by $300 [$100 Manufactured Product A + $200 Manufactured Product B].

Step 4 –The Certification Requirement

To satisfy the Certification Requirement, any taxpayer claiming a Domestic Content Bonus Credit Amount must submit a statement to the IRS certifying that the requirements described above have been satisfied (the "Domestic Content Certification Statement"). The Domestic Content Certificate Statement must include the following information for each Applicable Project:

c. Whether the Applicable Project is a qualified facility, energy project, or energy storage technology;

d. The specific type of Applicable Project (for example, Utility-Scale Photovoltaic System or Battery Energy Storage Technology);

e. The geographic coordinates of an Applicable Project and the address of the Applicable Project, if applicable;

f. The date the Applicable Project was placed in service;

g. The total domestic content bonus credit amount determined under §§ 45(b)(9), 45Y(g)(11), 48(a)(12), or 48E(a)(3)(B) with respect to the Applicable Project in the first taxable year in which the taxpayer reports a domestic content bonus credit amount for such Applicable Project; and

h. Any additional information with respect to the Applicable Project that is required by the applicable forms and instructions for reporting domestic content bonus credit amounts determined under §§ 45, 45Y, 48, or 48E.

The Domestic Content Certification Statement must be signed by a person with legal authority to bind the taxpayer and contain the following statement: "Under penalties of perjury I declare that I have examined the information contained in this Domestic Content Certification Statement and to the best of my knowledge and belief, it is true, correct, and complete."

The Domestic Content Certification Statement must be attached to Form 8832 (Renewable Energy Product Credit), Form 3468 (Investment Credit) or other applicable form filed with the tax return submitted for the first taxable year in which a Domestic Content Bonus Credit Amount is claimed. For Domestic Content Bonus Credit Amounts claimed under Sections 45 or 45Y, the Domestic Content Certificate Statement must be attached to each tax return submitted for subsequent taxable years.

In addition, taxpayers claiming the Domestic Content Bonus Credit Amount must comply with general record-keeping requirements.

The Notice also includes guidance for retrofits. If the relevant facility contains some used property, provided the fair market value of the used property is not more than 20% of the facility's total value, the facility is eligible for the Domestic Content Bonus Credit Amount if the new property included in the facility meets the Domestic Content Bonus Requirements. The Steel or Iron Requirement and the Manufactured Products Requirement must be satisfied as of the date the facility is placed in service for federal income tax purposes.

The IRS is planning to issue proposed regulations on the domestic content requirement. As such, the guidance provided by this Notice may only be relied on for facilities that begin construction before the date that is 90 days after such proposed regulations are published, which date is unknown at this time.

Foley will continue to monitor developments related to the domestic content tax credit adders as they unfold.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.