United States: IRS, Department Of Treasury Release Guidance On Domestic Content Rules For Energy Projects

TAKEAWAYS

• The Guidance sets out the requirements for using domestic steel, iron and manufactured products in order for a project to be eligible for the domestic content bonus credit amount.
• Projects that meet the domestic content requirement will be eligible to receive a 10 percent bonus under the production tax credit and up to a 10 percent bonus under the investment tax credit, provided that other requirements are also met.

On Friday (May 12, 2023), the Department of Treasury and the Internal Revenue Service (IRS) released Guidance for taxpayers seeking to take advantage of domestic content bonus credits associated with energy projects under the Inflation Reduction Act (IRA). Specifically, the Guidance sets out the requirements for using domestic steel, iron and manufactured products in order for a project to be eligible for the domestic content bonus credit amount. Projects that meet the domestic content requirement will be eligible to receive a 10 percent bonus under the production tax credit and up to a 10 percent bonus under the investment tax credit, provided that other requirements are also met.

Under the Guidance, an "Applicable Project" includes (i) a qualified facility, (ii) an energy project, or (iii) a qualified investment with respect to a qualified facility or energy storage technology under sections 45, 45Y, 48 and 48E of the Internal Revenue Code, respectively.

Domestic Content Requirements

An Applicable Project is eligible for a domestic content bonus credit amount if 1) the Applicable Project satisfies the Domestic Content Requirement and 2) the taxpayer timely submits to the IRS the certification. An Applicable Project satisfies the Domestic Content Requirement if the Steel or Iron Requirement and the Manufactured Products Requirement are satisfied.

The required domestic content is initially 40 percent for utility-scale photovoltaic systems, land-based wind facilities and battery energy storage technologies and 20 percent for offshore wind facilities. For the first category, the required percentage of domestic content will increase from 40 percent for facilities for which construction begins before 2025 to 55 percent facilities for which construction begins after 2026; for offshore wind projects, the requirement will increase from 20 percent for a facility for which construction begins before 2025 to 55 percent for a facility for which construction begins after 2027.

Under the Guidance, "Applicable Project Component" means any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project. An Applicable Project Component may be deemed steel, iron or a Manufactured Product.

A "Manufactured Product Component" means any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project Component that is a Manufactured Product.

Steel and Iron Requirements

The requirement for steel and iron to be considered domestic is that all manufacturing processes take place in the United States, except metallurgical processes involving refinement of steel additives. This requirement applies to content that is a construction material that is made primarily of steel or iron and is structural in function. It does not apply to steel or iron used in Manufactured Product Components or subcomponents of Manufactured Product Components. For example, items that are made primarily of steel or iron but are not structural in function—such as nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges, etc.—are not subject to the requirements for steel and iron.

Manufactured Product Requirement

A "U.S. Manufactured Product" means (1) all the manufacturing processes for the Manufactured Product take place in the United States; and (2) all the Manufactured Product Components of the Manufactured Product are of U.S. origin. A Manufactured Product Component is considered to be of U.S. origin if it is manufactured in the United States, regardless of the origin of its subcomponents.

The IRA directed Treasury to adapt the Buy America rules of the U.S. Department of Transportation's Federal Transit Administration (FTA), which imposes restrictions on the use of federal funding by states and municipalities for transit projects. Indeed, Treasury stated that it consulted with FTA on designing the Guidance.

The Guidance includes, in Table 2, a listing of certain key elements of the covered types of projects, categorizing each as either iron/steel or manufactured products. The Table 2 list helps clarify two issues. First, under the FTA rules, there are sometimes questions about whether products with metal content should be treated as iron/steel items or manufactured products. The Table 2 list clarifies this issue. For example, with respect to solar projects, steel photovoltaic module racking will be treated as a structural item subject to the iron/steel rules, and photovoltaic modules will be treated as manufactured products. Similarly, the tower components of wind facilities will be treated as subject to the iron/steel rules, while wind turbines are manufactured products.

Second, under the FTA rules, a key issue is determining what constitutes the manufactured product whose components must be made in the United States. Importantly, a transit project as a whole is not normally considered to be the manufactured product; rather, major subsystems (e.g., an escalator) are considered the manufactured products. A similar approach is incorporated into the Guidance. For example, the Table 2 list describes a photovoltaic module as a manufactured product and the following as its components: "photovoltaic cells, mounting frame or backrail, glass, encapsulant, backsheet, junction box (including pigtails and connectors), edge seals, pottants, adhesives, bus ribbons, and bypass diodes." This means that each of those components must be manufactured in the United States for the photovoltaic module to qualify as a U.S.-manufactured product. Subcomponents of components can be foreign-sourced but must undergo a manufacturing process in the United States that transforms them into the components.

Other issues will need to be clarified and likely will have to be resolved on a case-by-case basis. It will be particularly important to determine how extensive and complex the production process must be for a component to qualify as being manufactured in the United States.

Comparison to Other Domestic Content Requirements

Although similar to the "Buy American" requirements of other laws (particularly those issued by the Transportation Department), they are not exactly the same. For example, the domestic content requirements of the Build America Buy America Act, enacted as part of the Infrastructure Investment and Jobs Act, have the same requirements for iron and steel, but apply a 55 percent U.S. content requirement to manufactured goods. The IRA rules require that the manufactured goods be made in the United States with components that are also made in the United States, but they do not impose any requirements on subcomponents or impose a value requirement. The IRA does impose an overall domestic content value requirement on the project as a whole. This highlights that satisfaction of the requirements of one domestic content program does not necessarily mean that the requirements of other such programs are satisfied; each must be examined individually.

Effective Date

The Guidance will apply to taxable years after May 12, 2023, but taxpayers may rely on the rules for the domestic content bonus credit requirements for any qualified facility, energy project or energy storage technology for which construction begins 90 days before the date of the regulation's publication in the Federal Register.

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.