On December 1, 2023, the Department of the Treasury and the Internal Revenue Service (IRS) issued proposed regulations (REG-118492-23) with additional guidance on the excluded entities provision in the section 30D clean vehicle tax credit. The provision disqualifies vehicles from being eligible for the credit starting in 2024 if the vehicle's battery contains battery components that were manufactured or assembled by a foreign entity of concern (FEOC). Then, starting in 2025, a vehicle is disqualified if the vehicle's battery contains any applicable critical minerals extracted, processed or recycled by a FEOC. The proposed regulations also clarify which clean vehicles (including plug-in electric vehicles (EVs) and certain fuel cell vehicles) are eligible for the credit (in part by defining terms including "assembly," "constituent materials," "extraction" and "manufacturing," among others). The credit, which essentially reduces the cost of a vehicle to the ultimate vehicle purchaser or lessee by as much as $7,500 (assuming the taxpayer and the vehicle satisfy certain other criteria), is only available for vehicles placed in service through 2032. Concurrently the Department of Energy (DOE) issued a proposed interpretive rule (RIN 1901-ZA02)—which is where the bulk of the substantive FEOC rules are found—to provide additional clarification of terms used in the definition of FEOC.1 Comments on RIN 1901-ZA02 are due by January 3, 2024, and comments on REG-118492-23 are due by January 18, 2024.
Overview of Section 30D
The section 30D tax credit, a key subsidy for EVs in the United States, was amended by the Inflation Reduction Act of 2022 (IRA, P.L. 117-169). At a high level, the IRA changes were designed to disallow the section 30D credit if a FEOC played a part in the sourcing of critical minerals or other components that went into the EV battery. FEOC is defined in 42 U.S.C. 18741(a)(5), and most relevant for purposes of the auto industry, a FEOC includes entities that are owned by, controlled by or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation—that is, China, Russia, Iran and North Korea. The credit is claimed by a new (not used) vehicle purchaser or lessee. Both individuals and businesses can claim the credit, although certain high-income taxpayers are not eligible to receive the credit. Note, however, that the credit can be transferred to EV dealers starting in 2024.
The amount of the tax credit goes up to $7,500 per vehicle if both the critical minerals and battery components requirements are satisfied. Those requirements generally look to whether a certain percentage of the value of the applicable critical minerals/components in the battery were either extracted or processed in the U.S. or in any country with which the U.S. has a free trade agreement in effect (for purposes of the critical minerals requirement) or were substantially manufactured or assembled in North America (for purposes of the battery components requirement). In all cases, final assembly of the vehicle must have occurred within North America and the vehicle must be powered by an electric battery that has a capacity of at least seven kilowatt hours. Vehicles that weigh 14,000 pounds or more are not eligible for the credit, and vans, sport utility vehicles and pickup trucks with a manufacturer's suggested retail price (MSRP) in excess of $80,000, and all other vehicles with an MSRP in excess of $55,000, also are not eligible for the credit. To check if a specific type of vehicle meets the requirements, click here.
Initial proposed regulations addressing other aspects of section 30D were released on October 10, 2023 (REG-113064-23) and on April 17, 2023 (REG-120080-22). The Treasury/IRS also issued Rev. Proc. 2023-33 on October 6, 2023; Notice 2022-46 on October 5, 2022; and Rev. Proc. 2022-42 on December 12, 2022, with additional guidance on section 30D.
Determining FEOC Compliance
Lawmakers, including in particular Sen. Joe Manchin (D-WV), have been outspoken in their calls for the Treasury to issue FEOC guidance that would ensure China will not benefit from section 30D. In a letter to the Treasury, Manchin wrote: "I am incredibly concerned by recent reports that suggest Chinese battery companies are actively pursuing business opportunities and arrangements, including joint ventures and investments, in South Korea and Morocco to take advantage of the IRA."
In a Treasury press release issued with the guidance, John Podesta, Senior Advisor to the President for Clean Energy Innovation and Implementation, indicated the rules will help "to reverse the decades-long trend of letting jobs and factories go overseas to China" and "ensure that the electric vehicle future will be made in America."
For FEOC compliance, one critical open issue the proposed regulations from Treasury and DOE guidance seek to address is determining when an entity2 is either deemed to be owned/controlled by a covered nation government or deemed to be subject to the jurisdiction or direction of a covered nation government, such that it is a FEOC.3 Prior to release of this guidance, Treasury had reserved on this question and thus the auto industry has been speculating and lobbying on the potential outcome for more than a year.
The proposed regulations break the test into four key definitions: (1) "foreign entity," (2) "government of a foreign country," (3) "subject to the jurisdiction" and (4) "owned by, controlled by, or subject to the direction."
We provide the first three key definitions almost verbatim below, as these are fairly straightforward to review without commentary:
"Foreign entities" are defined as (i) a government of a foreign country, (ii) a natural person who is not a lawful permanent resident of the United States, citizen of the United States or any other protected individual (as such term is defined in 8 U.S.C. 1324b(a)(3)), (iii) a partnership, association, corporation, organization or other combination of persons organized under the laws of or having its principal place of business in a foreign country or (iv) an entity organized under the laws of the United States that is owned by, controlled by or subject to the direction (as interpreted in Section IV) of an entity that qualifies as a foreign entity in paragraphs (i)–(iii).
Government of a foreign country is broadly defined to include (i) a national or subnational government of a foreign country, (ii) an agency or instrumentality of a national or subnational government of a foreign country, (iii) a dominant or ruling political party (e.g., Chinese Community Party) of a foreign country or (iv) a current or former senior political figure and their immediate family members.
A foreign entity is "subject to the jurisdiction" of a covered nation if (i) the foreign entity is incorporated or domiciled in, or has its principal place of business in, a covered nation, or (ii) with respect to the critical minerals, components or materials of a given battery, the foreign entity engages in the extraction, processing or recycling of such critical minerals, the manufacturing or assembly of such components, or the processing of such materials, in a covered nation.
The following sections elaborate on the fourth definition: "owned by, controlled by, or subject to the direction." The DOE guidance covers both ownership criteria and licensing criteria.
The proposed regulations look to both direct ownership and indirect ownership:
- If 25% or more of an entity's board seats, voting rights or equity interests are cumulatively held (either directly or indirectly) by the government of a covered nation, the entity will be classified as a FEOC (even if with such a minority stake, the entity will be deemed to be controlled by such government because such government could still have "meaningful influence over corporate decision-making"). This 25% threshold also applies to joint ventures, such that if a covered nation government controls, either directly or indirectly, 25% or more of a joint venture, then the joint venture is a FEOC.
- Finally, if 50% or more of one entity's board seats, voting rights or equity interests are directly held by a second (parent) entity (including a covered nation government), then the first entity (subsidiary) and the second entity (parent) are treated as the same entity and any holdings of the subsidiary are fully attributed to the parent.
To understand in practice how the rules above will be applied, we have a few examples to walk through (these examples are in the DOE guidance):
Example #1: China owns 25% of Corp A's stock, therefore China is deemed to control Corp A and Corp A is a FEOC. Corp A owns 40% of Corp B's stock, therefore Corp A is deemed to control Corp B. However, China's indirect control of Corp B is calculated proportionately (25% x 40% = 10%), which means that China is deemed to only own a 10% interest in Corp B and therefore Corp B is not a FEOC.
Example #2: China owns 50% of Corp A's stock, therefore not only is China deemed to control Corp A (such that Corp A is a FEOC), but all of the holdings of Corp A are fully attributed to China (essentially China and Corp A are treated as the same entity). Corp A owns 25% of Corp B's stock, therefore China (which is treated as the same as Corp A such that it is deemed to own 25% of Corp B's stock) is deemed to control Corp B and Corp B is also a FEOC.
In an effort to address concerns raised by several members of Congress, the DOE proposed regulations provide that if a covered nation government "enters into a formal arrangement to act in concert with another entity or entities that have an interest in the same third-party entity, [then] the cumulative board seats, voting rights, or equity interests of all such entities are combined for the purpose of determining the level of control attributable to each of those entities." To understand this rule, we have another example (this example is not in the DOE guidance):
Example #3: China owns 10% of Corp A's stock, but China has an arrangement with Partnership C (which owns 15% of Corp A's stock) providing that China and Partnership C will coordinate with respect to their ownership interests to have greater influence over matters impacting Corp A. The arrangement causes China to be deemed to constructively own 25% of Corp A's stock, therefore China is deemed to control Corp A such that Corp A is a FEOC.
We draw extra attention to the fact that subsidiaries of a FEOC, even those owned more than 25% by a FEOC, may not become a FEOC. The DOE guidance states "a FEOC that is controlled by a covered nation government may hold an interest in a subsidiary, even an interest above 25%, and that subsidiary may still not be a FEOC if the covered nation's level of control of the subsidiary falls below 25%." This can be seen from the above Example #1.
Further, due to the focus on governments of covered nations, the analysis of whether a subsidiary of a FEOC itself is a FEOC changes depending on whether the cause of the FEOC status of the parent is triggered by government ownership or control as opposed to jurisdiction. The DOE guidance states "when an entity is a FEOC due to it being 'subject to the jurisdiction' of a covered nation, subsidiaries of the FEOC are not automatically considered to also be FEOCs solely based on their parent being a covered nation jurisdictional entity."
The examples above are focused on demonstrating ownership/control by a government of a foreign nation. The following example demonstrates how the jurisdictional prong of the FEOC analysis interacts with the ownership/control prong such that a subsidiary would not automatically be deemed to be a FEOC (this example is not in the DOE guidance):
Example #4: Corp A was formed under the laws of China. Even though China does not own any of Corp A's stock, Corp A is deemed to be subject to the jurisdiction of China and is therefore a FEOC. Corp A owns a 100% interest in Corp B, and Corp B is incorporated in the United States. As Corp A is not "subject to the ownership, control or direction of China" as a result of not having 25% or more of its board seats, voting interest or equity interest held by the government of China, Corp B is not automatically considered to also be a FEOC solely as a result of the ownership by Corp A. Note that Corp B could still become a FEOC through other pathways (e.g., conducting activities in China that rise to the level of its principal place of business or China owning 25% of Corp A).
Licensing and Contractual Relationships
The DOE guidance also makes clear that licensing agreements or other contractual agreements can also create a control relationship for this purpose and has proposed a safe harbor for evaluating "effective control." Therefore, an entity will be deemed to be owned/controlled by another entity (including a covered nation government) if "[w]ith respect to the critical minerals, battery components, or battery materials of a given battery, the entity has entered into a licensing arrangement or other contract with another entity (a contractor) that entitles that other entity to exercise effective control over the extraction, processing, recycling, manufacturing, or assembly (collectively, 'production') of the critical minerals, battery components, or battery materials that would be attributed to the entity."
"Effective control" is defined as "the right of the contractor in the contractual relationship to determine the quantity or timing of production, to determine which entities may purchase or use the output of production, or to restrict access to the site of production to the contractor's own personnel; or the exclusive right to maintain, repair, or operate equipment that is critical to production."
The DOE guidance indicates that a contractual relationship will be deemed not to confer effective control if the following rights are expressly reserved to non-FEOC entities:
- To determine the quantity of critical mineral, component or material produced (subject to any overall maximum or minimum quantities agreed to by the parties prior to execution of the contract).
- To determine, within the overall contract term, the timing of production, including when and whether to cease production.
- To use the critical mineral, component or material for its own purposes or, if the agreement contemplates sales, to sell the critical mineral, component or material to entities of its choosing.
- To access all areas of the production site continuously and observe all stages of the production process.
- At its election, to independently operate, maintain and repair all equipment critical to production and to access and use any intellectual property, information and data critical to production, notwithstanding any export control or other limit on the use of intellectual property imposed by a covered nation subsequent to execution.
Because DOE acknowledged that "it may be particularly difficult to definitively evaluate the contractual relationships of upstream suppliers," DOE is also considering whether to offer a pre-review process where entities could voluntarily request a review of contracts and licensing arrangements by DOE to help with the determination of whether effective control by a FEOC is present.
Compliant Battery Ledger and Up-Front Review System
Qualified manufacturers will be required to provide to the IRS with an estimate of the number of FEOC-compliant batteries they expect to procure each year so that the agency can maintain a compliant-battery ledger. This is separate from the periodic written reports identifying which vehicle identification numbers (VINs) are tied to vehicles eligible for the credit under section 30D. This estimate will reflect the number of batteries that such manufacturer knows are (or reasonably anticipates will be) FEOC-compliant. This ledger becomes important for corrective actions that the IRS may take upon discovering errors and inaccuracies in the materials submitted by vehicle manufacturers. If errors and inaccuracies are discovered, the impacts are generally relegated only to vehicles that have not yet been placed into service. If the errors and inaccuracies are found to be inadvertent, the ledger of a vehicle manufacturer's FEOC-compliant batteries may be reduced prospectively, including below zero, to make up for the vehicles that were sold and placed into service that were not actually FEOC-compliant as a result of the errors and inaccuracies.
Note that the Treasury is proposing that it has the authority to terminate an automaker's ability to qualify all unsold or future vehicles for the credit if there is a finding of fraud, intentional disregard or gross negligence of the rules. Further, failure to provide periodic written reports for a vehicle (or providing incorrect information on the report or failing to update the report if there's been a material change) could cause a vehicle to be disqualified as a new clean vehicle eligible for the credit. The Treasury and IRS would like comments on, among other topics, whether it would be "feasible and helpful" if manufacturers encoded section 30D eligibility into the VIN for each vehicle.
The proposed regulations also contemplate implementing an up-front review of conformance with the critical minerals and battery component requirements starting in 2025. Under the up-front review system, the IRS and DOE would review certain attestations, certifications and documentation provided by the qualified manufacturer (including the number of compliant batteries) demonstrating compliance with section 30D to provide additional oversight and certainty. Following such review, the IRS will either approve (in whole or in part) or reject the reported number of FEOC-compliant batteries. If the manufacturer discovers that there has been an increase or decrease in the number, it must notify the IRS within 30 days and the ledger will be adjusted. If an automaker's compliant battery ledger reaches zero, the automaker's vehicles will no longer be credit eligible.
The proposed regulations contemplate a due diligence transition rule that would apply to any new clean vehicles identified on a periodic written report provided to the IRS before the date that is 30 days after the date these regulations are finalized. For this purpose, FEOC compliance can be determined without the physical tracking requirement.
Low-Value (Non-Traceable) Battery Materials Transition Rule
The proposed regulations contain a placeholder for a list of non-traceable battery materials deemed to be low-value (compared to the total value of the battery) battery materials for which origin/source is hard to trace because they "are often commingled during refining, processing, or other production processes by suppliers."
The preamble states that the Treasury and IRS are considering whether the applicable critical minerals contained in electrolyte salts, electrode binders and electrolyte additives may be designated as identified non-traceable battery materials.
Rather than implement a de minimis exception, the proposed regulations contain another transition rule that would temporarily (through 2026) allow qualified manufacturers to exclude certain identified non-traceable battery materials and associated constituent materials from the FEOC compliance rules and other due diligence requirements (i.e., periodic written reports) imposed by section 30D. In order to take advantage of the transition rule, the qualified manufacturer will need to submit a report as part of the up-front review process described above "demonstrating how the qualified manufacturer will comply with the excluded entity restrictions once the transition rule is no longer in effect and all materials must be fully traced through the entire electric vehicle battery supply chain."
Importantly, while the proposed regulations place the burden on the qualified manufacturer for determining whether all battery components, applicable critical minerals and associated constituent materials are FEOC compliant (and require the qualified manufacturer to provide certain attestations and certifications), Prop. Treas. Reg. §1.30D-6(b)(1) provides that "reasonable reliance on a supplier attestation or certification will be considered due diligence if the qualified manufacturer does not know or have reason to know after due diligence that such supplier attestation or certification is incorrect."
When and What to Test for FEOC
As a reminder, there are technically two separate FEOC/excluded entity rules. The first (the FEOC Battery Component Rule found in section 30D(d)(7)(A)), which comes into play in 2025, provides that if a vehicle's battery contains any applicable critical minerals extracted, processed or recycled by a FEOC, then the vehicle is not eligible for the credit.
The second (the FEOC Critical Mineral Rule found in section 30D(d)(7)(B)), which comes into play in 2024, provides that if the vehicle's battery contains critical minerals or battery components that were manufactured or assembled by a FEOC, then the vehicle is not eligible for the credit.
The Treasury and IRS have determined that "a serial number or other identification system must be used to physically track FEOC-compliant batteries to specific new clean vehicles."
When and what to test to ensure satisfaction of each of these FEOC rules varies. For the FEOC Battery Component Rule, testing is done at the time of manufacturing or assembly. For the FEOC Critical Mineral Rule, testing is done at the time of extraction, processing or recycling, which may involve multiple testing points for the entire supply chain. For example, if an applicable critical mineral is extracted by a non-FEOC but is later processed or recycled by a FEOC, such mineral is not FEOC-compliant as a result of the second testing point at processing or recycling.
For the FEOC Critical Mineral Rule, FEOC compliance matters "through the step in which such mineral is processed or recycled into a constituent material, even if the mineral is not in a form listed in section 45X(c)(6)." The proposed regulations provide as an example of this with nickel sulphate used in the production of a nickel-manganese-cobalt cathode active powder. Note, however, that applicable critical minerals that are fully consumed in the production of a constituent material or battery component and no longer remains in any form in the battery (such as certain solvents used in electrode production) can be disregarded for this purpose (Prop. Treas. Reg. §1.30D-6(c)(4)).
For the FEOC Battery Component Rule, there are three general steps to determine if a battery is compliant:
- The qualified manufacturer determines if the battery components, applicable critical minerals and associated constituent materials are FEOC-compliant. A battery component other than a battery cell is FEOC-compliant if it is not manufactured or assembled by a FEOC.
- The FEOC-compliant battery components, applicable critical minerals and associated constituent materials are physically tracked to specific battery cells to determine if such cells are FEOC-compliant. However, the proposed regulations provide a temporary allocation method at Prop. Treas. Reg. §1.30D-6(c)(3)(ii)(A) that can be used for applicable critical minerals and associated constituent materials if physical tracking is too difficult—but this transition rule becomes unavailable in 2027. The Treasury and IRS have asked for comments about whether it would be appropriate to make this transition rule permanent (see Prop. Treas. Reg. §1.30D-6(c)(3)(ii)(C) for an example illustrating the temporary allocation-based determination rule).
- The battery components, including the battery cells, are physically tracked to specific batteries to determine if such batteries are FEOC-compliant (so a battery is FEOC-compliant "if it contains only FEOC-compliant battery components (other than battery cells) and FEOC-compliant battery cells").
This means that you must test for FEOC compliance at multiple levels: the battery level, the battery component level, the battery cell level and the applicable critical mineral/associated constituent material level.
The Treasury justifies the different treatment of battery cells as resulting from the fact that battery cells contain critical minerals that are subject to additional requirements. As a result, FEOC compliance of a battery cell becomes harder to satisfy in 2025, as critical minerals must also be considered. If the associated vehicle is placed in service in 2024, then the battery cell "is FEOC compliant if it is not manufactured or assembled by a FEOC and it contains only FEOC-compliant battery components." For battery cells of vehicles placed in service in 2025 and beyond, FEOC-compliance requires that "it is not manufactured or assembled by a FEOC and it contains only FEOC-compliant battery components and applicable critical minerals" (emphasis added).
Examples of these rules can be found in Prop. Treas. Sec. §1.30D-6(c)(4)(iv).
The proposed regulations also clarify that if multiple manufacturers are involved in the production of a vehicle, the section 30D(d)(3) requirements must be met by the manufacturer who satisfies the reporting requirements of the greenhouse gas emissions standards set by EPA under the Clean Air Act (42 U.S.C. 7521 et seq.) for the subject vehicle.
These proposed regulations and guidance indicate an awareness and appreciation by the Treasury and DOE for the practical reality of today's clean vehicle supply chain while at the same time providing a path towards ensuring the full intent of the statutory provisions are realized in relatively short order. Perhaps most importantly, DOE has created a fairly objective and bright-line framework for determining when an entity is a FEOC and indicates an openness to creating an up-front approval system for licensing arrangements, which may become the primary means of collaboration with Chinese entities given the relatively low 25% threshold for equity ownership in joint ventures. The various transition rules, concepts such as the battery ledger to allow for correction of inadvertent errors and inaccuracies and concepts such as non-traceable battery materials evidence the Treasury's and DOE's attempt to provide a framework that will allow the FEOC rules to be practically implemented.
These rules are generally proposed to apply to new clean vehicles placed in service on or after January 1, 2024, for taxable years ending after December 31, 2023. Additional guidance (in the form of proposed regulations) regarding the definition of applicable critical minerals under Section 45X will be forthcoming. Comments on REG-118492-23 are due by January 18, 2024.
1. DOE also will use this interpretive rule to prioritize projects to receive grants under its Battery Materials Processing and Battery Manufacturing and Recycling Grant Programs.
2. Note that an entity for this purpose isn't limited to a corporation, but could be (among other things) a government, a natural person or a partnership.
3. Note that "government of a foreign country" is proposed to be defined to include subnational governments and certain current or former senior foreign political figures.
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.