Tag: clean energy tax credit

Treasury Proposes Clean Electricity Tax Guidance

On May 29, 2024, the Internal Revenue Service (IRS) and the Treasury Department released the pre-publication version of proposed guidance to implement “technology-neutral” clean electricity tax credits, including deeming certain technologies as per se zero-emitting and outlining potential methodologies for determining how other technologies—namely those involving combustion or gasification—could qualify as zero-emitting based on a lifecycle emissions analysis (LCA). The Clean Electricity Production Credit (45Y) and Clean Electricity Investment Credit (48E) were enacted in the Inflation Reduction Act (IRA) of 2022 and replace the current production and investment tax credits that are explicitly tied to certain types of renewable energy technologies.

Stakeholders have cited the 45Y and 48E credits as the most important driver of greenhouse gas (GHG) emission cuts possible from the IRA over the next decade. One study by the Rhodium Group found that the credits could reduce the power sector’s GHG emissions by up to 73 percent by 2035. The tax credits aim to give qualifying facilities the ability to develop technologies over time as they reduce emissions and offer longer-term certainty for investors and developers of clean energy projects. This proposed rule, when finalized, will be a critical driver for developers and companies allocating resources among different projects and investments.

The proposed guidance is scheduled to be published June 3, 2024 in the Federal Register, launching a 60-day comment period. A public hearing will be held August 12-13, 2024.

Proposed Guidance Details

Starting in Fiscal Year (FY) 2025 for projects placed into service after Dec. 31, 2024, 45Y provides taxpayers with a base credit of 0.3 cents (1.5 cents, if the project meets prevailing wage and apprenticeship requirements) per kilowatt of electricity produced and sold or stored at facilities with zero or negative GHG emissions. (These per kilowatt credit values are adjusted for inflation using 1990 as the base year.) Under 48E, taxpayers would receive a 6 percent base credit (30 percent, if the project meets prevailing wage and apprenticeship requirements) on qualified investment in a qualified facility for the year the project is placed in service. Both credits include bonus amounts for projects located in historical energy communities, low-income communities, or on tribal land; for meeting certain domestic manufacturing requirements; or for being part of a low-income residential building or economic benefit project. Direct pay and transferability are options for both credits. Both credits are in effect until 2032, when they become subject to a three-year phaseout.

Technologies recognized as per se zero-emissions in the guidance are wind, solar, hydropower, marine and hydrokinetic, nuclear fission and fusion, geothermal, and certain types of waste energy recovery property (WERP). The guidance also outlines how energy storage can qualify, including by proposing definitions of electricity, thermal, and hydrogen storage property.

A principal debate in the proposal is how to determine, using an LCA, whether certain combustion and gasification (C&G) technologies can qualify as zero-emitting.

The guidance includes a set of definitions and interpretations critical to implementation of the tax credits. For example, the proposed C&G definition includes a hydrogen fuel cell if it “produced electricity using hydrogen that was produced by an electrolyzer powered, in whole or in part, by electricity from the grid because some of the electricity from the grid was produced through combustion or gasification.” The proposed C&G definition would also include both biogas- and biomass-based power, but eligibility depends on the LCA results; for biomass, the guidance seeks comment on what spatial and temporal scales should apply and how land use impacts the LCA.

The guidance states that the IRS intends to establish rules for qualifying facilities that generate electricity from biogas, renewable natural gas, and fugitive sources of methane. The guidance says that Treasury and the IRS “anticipate” requiring that, for such facilities, the gas must originate from the “first productive use of the relevant methane.”

The proposed C&G definition allows for carbon capture and storage (CCS) that meets LCA requirements. However, the IRA does not allow credits to go toward facilities already using certain other credits, including the relatively more generous section 45Q credits for CCS.

Specifically, there are seven other credits that cannot be used in combination with a 45Y or 48E credit: 45 (existing clean electricity production credit); 45J (advanced nuclear electricity credit); 45Q (CCS); 45U (zero-emission nuclear credit); 48 (existing clean electricity investment credit); for 45Y, 48E (new clean electricity production credit); and for 48E, 45Y (new clean electricity investment credit).

The guidance proposes beginning and ending boundaries for LCAs, stating “the starting boundaries would include the processes necessary to produce and collect or extract the raw materials used to produce electricity from combustion or gasification technologies, including those used as energy inputs to electricity production. This includes the emissions effects of relevant land management activities or changes related to or associated with feedstock production.” Another topic in the guidance is the use of carbon offsets to reach net-zero qualification status, with the proposal seeking comment on boundaries: “offsets and offsetting activities that are unrelated to the production of electricity by a C&G Facility, including the production and distribution of any input fuel, may not be taken into account” by an LCA. The guidance also includes rules on qualified interconnection costs in the basis of a low-output associated qualified facility, the expansion of a facility and incremental production, and the retrofitting of an existing facility.

The guidance describes the role of the Department of Energy (DOE) in implementing the tax credits. Any future changes to technologies designated as zero-emitting or to the LCA models must be completed with analyses prepared by DOE’s national labs along with other technical experts. Facilities seeking eligibility may also request a “provisional emissions rate,” which DOE would administer with the national labs and experts “as appropriate.”

Next Steps

As noted above, the proposed guidance is scheduled to be published June 3, 2024 in the Federal Register, launching a 60-day comment period for interested parties to make arguments and provide evidence for changes they would like to see before the rule becomes final. A public hearing will be held August 12-13, 2024. The Treasury Department in consultation with interagency experts plans to carefully review comments and continue to evaluate how other types of clean energy technologies, including C&G technologies, may qualify for the clean electricity credits.

© 2024 Van Ness Feldman LLP
For more news on Clean Energy Tax Credits, visit the NLR Environmental, Energy & Resources section.

The Domestic Content Bonus Credit’s Promising New Safe Harbor

On May 16, 2024, the Internal Revenue Service (IRS) published Notice 2024-41 (Notice), which modifies Notice 2023-38 (Prior Notice) by providing a new elective safe harbor (Safe Harbor) that will allow taxpayers to use assumed domestic cost percentages in lieu of percentages derived from manufacturers’ direct cost information to determine eligibility for the domestic content bonus credit (Domestic Content Bonus). The Notice grants a promising reprieve to the Prior Notice’s relatively inflexible (and arguably impracticable) standard on seeking direct cost information from manufacturers, raising novel structuring considerations for energy producers, developers, investors and buyers.

The Notice also expands the list of technologies covered by the Prior Notice (Applicable Projects).

In this article, we share key takeaways from the Notice as they apply to energy producers, developers and investors and provide a brief overview of the Domestic Content Bonus as well as a high-level summary of the Notice’s substantive content.

IN DEPTH

KEY TAKEAWAYS FROM THE NOTICE

The Notice provides a key step forward in eliminating qualification challenges for the Domestic Content Bonus by providing an alternative to the Prior Notice’s stringent requirement of seeking direct cost information from manufacturers. In short, a taxpayer can aggregate the assumed percentages in the Notice that correspond with the US-made manufactured products in its project. If the assumed percentages total is greater than the manufactured product percentage applicable to such project (currently 40%), then the taxpayer is treated as satisfying the manufactured product requirement. Although the Notice promises forthcoming proposed regulations that could amend or override the Notice, this gives taxpayers time to appropriately interpret the latest rules and respond accordingly.

The new guidance’s impact will likely require restructuring to the existing development of energy projects as it relates to the Domestic Content Bonus. Below, we outline some key considerations for energy producers, developers, investors and buyers alike:

  • The Safe Harbor is expected to dramatically increase the availability of the Domestic Content Bonus. The Prior Notice’s challenging cost substantiation requirements left most industry participants on the sidelines. Initial feedback from developers, investors and credit buyers was extremely positive, and we have already seen fulsome renegotiation and speedy agreement between counterparties over domestic content contractual provisions in project documents.
  • While the Safe Harbor eliminates the requirement to seek direct cost information from manufacturers for certain Applicable Projects, a taxpayer’s obligations with respect to substantiation requirements for manufacturers’ US activities is not clear in the Notice. Given the standing federal income tax principles on recordkeeping and substantiation, taxpayers should carefully reconsider positions on diligence and review existing relationships with manufacturers.
  • Although the Notice expressly provides that the Safe Harbor is elective with respect to a specific Applicable Project, it’s unclear whether the Safe Harbor is extended by default to any and all of a taxpayer’s Applicable Projects upon election effect or whether an elective position is required with respect to each Applicable Project. Taxpayers, especially those with multiple Applicable Projects, should consider the various implications resulting from an elective position prior to reliance on the Safe Harbor.
  • For Safe Harbor purposes, the Notice provides a formula for computing a single domestic cost percentage for solar energy property and battery energy storage technologies that are treated as a single energy project (PV+BESS Project), but ambiguity exists as to whether such technologies should be aggregated for other purposes under the investment tax credit.
  • It’s unclear how the calculations would operate for repowered facilities given the assumed domestic cost percentage approach.
  • The Notice limits the Safe Harbor to solar photovoltaic, onshore wind and battery energy storage systems, leaving taxpayers with other types of Applicable Projects stranded with the Prior Notice. For example, the Notice does not cover renewable natural gas or fuel cell. The IRS seeks comments on whether the Safe Harbor should account for other technologies, the criteria and how often the list of technologies should be updated. Affected taxpayers should fully consider the requested comments and provide feedback as necessary.
  • The IRS seeks comments on various issues with respect to taxpayers who have a mix of foreign and domestic manufactured product components (mixed source items). Taxpayers with mixed source items that the Notice attributes as disregarded and entirely foreign sourced (notwithstanding the domestic portion) should take cautionary note and provide feedback as necessary.

BACKGROUND: THE DOMESTIC CONTENT BONUS CREDIT

The Inflation Reduction Act of 2022 spurred the creation of “adder” or “bonus” incentive tax credits. In pertinent part, Applicable Projects could further qualify for an increased credit (i.e., the Domestic Content Bonus) upon satisfaction of the domestic content requirement.

To qualify for the Domestic Content Bonus, taxpayers must meet two requirements. First, steel or iron components of the Applicable Project that are “structural” in nature must be 100% US manufactured (Steel or Iron Requirement). Second, costs associated with “manufactured components” of the Applicable Project must meet the “adjusted percentage” set forth in the Internal Revenue Code (Manufactured Products Requirement). For projects beginning construction before 2025, the adjusted percentage is 40%.

The Prior Notice provided guidance for meeting these requirements. Taxpayers should begin by identifying each “Applicable Project Component” (i.e., any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project). Subsequently, taxpayers must determine whether the Applicable Project Component is subject to the Steel or Iron Requirement or the Manufactured Products Requirement.

If the Applicable Project Component is steel or iron, it must be 100% US manufactured with no exception. If the Applicable Project Component is a manufactured product, such component and its “manufactured product components” must be tested as to whether they are US manufactured. If the manufactured product and all its manufactured product components are US manufactured, then the manufacturer’s cost of the manufactured product is included for purposes of satisfying the adjusted percentage. If any of the manufactured product or its manufactured product components are not US manufactured, only the cost to the manufacturer of any US manufactured product components are included.

The core tension lies in sourcing the total costs from the manufacturer of the manufactured product or its manufactured product components. There’s a substantiation requirement on the taxpayer imposed by the Prior Notice, but there’s also a shrine of secrecy from the corresponding manufacturer.

Apparently acknowledging the need for reconciliation, the Notice aims to pave a promising path for covered technologies (i.e., solar, onshore wind and battery storage).

THE MODIFICATIONS: A PROMISING PATH FOR THE DOMESTIC CONTENT BONUS CREDIT

NEW ELECTIVE SAFE HARBOR

Generally

The Safe Harbor allows a taxpayer to elect to assume the domestic percentage costs (assumed cost percentages) for manufactured products. Importantly, the election eliminates the requirement for a taxpayer to source a manufacturer’s direct costs with respect to the taxpayer’s Applicable Project and instead allows for the reliance on the assumed cost percentages. The Notice prohibits any partial Safe Harbor reliance, meaning taxpayers who elect to use the Safe Harbor must apply it in its entirety to the Applicable Project for which the taxpayer makes such election.

The Safe Harbor only applies to the Applicable Projects of solar photovoltaic facilities (solar PV), onshore wind facilities and battery energy storage systems (BESS). Taxpayers with other technologies must continue to comply with the Prior Notice. Notably, the Notice expands Solar PV into four subcategories: Ground-Mount (Tracking), Ground-Mount (Fixed), Rooftop (MLPE) and Rooftop (String), each having differing assumed cost percentages for the respective manufactured product component. Similarly, BESS is expanded into Grid-Scale BESS and Distributed BESS, each with differing assumed cost percentages for the respective manufactured product component.

For solar PV, onshore wind facilities and BESS, the Safe Harbor provides a list via Table 1[1] (Safe Harbor list) that denotes each relevant manufactured product component with its corresponding assumed cost percentage. Each manufactured product component (and steel or iron component) are classified under a relevant Applicable Project Component.

Of note are the disproportionately higher assumed cost percentages of certain listed components within the Safe Harbor list. For solar PV, cells under the PV module carry an assumed cost percentage of 36.9% (Ground-Mount (Tracking)), 49.2% (Ground-Mount (Fixed)), 21.5% (Rooftop (MLPE)) or 30.8% (Rooftop (String)).

For onshore wind facilities, blades and nacelles under wind turbine carry an assumed cost percentage of 31.2% and 47.5%, respectively.

For BESS, under battery pack, Grid-scale BESS cells and Distributed BESS packaging carry an assumed cost percentage of 38.0% and 30.15%, respectively. Accordingly, projects incorporating US manufactured equipment in these categories are likely to meet the Manufactured Products Requirement with little additional spend. Conversely, projects without these components are unlikely to satisfy the threshold.

Mechanics of the Safe Harbor

Reliance on the Safe Harbor is a simple exercise of component selection and subsequent assumed cost percentage addition. Put more specifically, a taxpayer identifies the Applicable Project on the Safe Harbor list and assumes the list of components within (without regard to any components in the taxpayer’s project that are not listed). Then, the taxpayer (i) identifies which of the components within the Safe Harbor list are in their project, (ii) confirms that any steel or iron components on the Safe Harbor list fulfill the Steel or Iron Requirement, and (iii) sums the assumed cost percentages of all identified listed components that are 100% US manufactured to determine whether their Applicable Project meets the relevant adjusted percentage threshold.

The Notice addresses nuances in situations involving mixed 100% US manufactured and 100% foreign manufactured components that are of like-kind, component production costs and treatment for PV+BESS Projects.

The Notice also provides that a taxpayer adjusts for a mix of US manufactured and foreign manufactured components by applying a weighted formula to account for the foreign components.

Consistent with the Prior Notice, the Notice provides that the assumed cost percentage of “production” costs may be summed and included in the domestic cost percentage only if all the manufactured product components of a manufactured product are 100% US manufactured.

Lastly, in accordance with the view that a PV+BESS Project is treated as a single project, the Notice provides that a taxpayer may use a weighted formula to determine a single domestic content percentage for the project.

The numerator is the sum of the (i) aggregated assumed cost percentages of the manufactured product components that constitute the solar PV multiplied by the solar PV nameplate capacity and (ii) aggregated assumed cost percentages of the manufactured product components that constitute BESS multiplied by the BESS nameplate capacity and the “BESS multiplier.” The BESS multiplier converts the BESS nameplate capacity into proportional equivalency (i.e., equivalent units) to the solar PV nameplate capacity. The denominator is the sum of the solar PV nameplate capacity and the BESS nameplate capacity. Divided accordingly, the final fraction constitutes the single domestic content percentage that the taxpayer uses to determine whether its PV+BESS Project meets the relevant manufactured product adjusted percentage threshold.

Additionally, the Notice confirms that taxpayers can ignore any components not included in the Safe Harbor list. Compared with the Prior Notice, this can be a benefit for taxpayers with non-US manufactured products that are not on the Safe Harbor list. Conversely, for taxpayers with US manufactured products that are not on the Safe Harbor list, they lose the benefit of including such costs in the Manufactured Products Requirement. However, this is mostly a benefit because it eliminates any ambiguity surrounding the treatment of components not listed in the Prior Notice.

EXPANSION OF COVERED TECHNOLOGIES

The Notice adds “hydropower facility or pumped hydropower storage facility” to the list of Applicable Projects as a modification to Table 2 in the Prior Notice. The modification is complete with a list of a hydropower facility or pumped hydropower storage facility’s Applicable Project Components that are delineated as either steel or iron components or manufactured products, though no assumed cost percentages are provided. Further, the Prior Notice’s “utility-scale photovoltaic system” is redesignated as “ground-mount and rooftop photovoltaic system.”

CERTIFICATION

To elect to rely on the Safe Harbor, in its domestic content certification statement, a taxpayer must provide a statement that says they are relying on the Safe Harbor. This is submitted with the taxpayer’s tax return.

RELIANCE AND COMMENT PERIOD

Taxpayers may rely on the rules set forth in the Notice and the Prior Notice (as modified by the Notice) for Applicable Projects, the construction of which begins within 90 days after the publication of intended forthcoming proposed regulations.

Comments should be received by July 15, 2024.

CONCLUSION

While this article provides a high-level summary of the substantive content in the Notice, the many potential implications resulting from these developments merit additional attention. We will continue to follow the development of the guidance and provide relevant updates as necessary.

© 2024 McDermott Will & Emery
For more news on IRS Taxpayer Safe Harbor, visit the NLR Tax section.

US Issues Final Regulations on FEOC Exclusions from Clean Vehicle Credit

On May 6, 2024, the U.S. Department of the Treasury (Treasury) and Internal Revenue Service (IRS) published final regulations (Final Regulations) regarding clean vehicle tax credits under Internal Revenue Code sections 25E and 30D established by the Inflation Reduction Act of 2022 (IRA). Among other important guidance, the Treasury regulations finalized its rules on Foreign Entity of Concern (FEOC) restrictions regarding the section 30D tax credit. On the same day, in conjunction with the Treasury final regulations, the U.S. Department of Energy (DOE) published a final interpretive rule (Notification of Final Interpretive Rule) finalizing its guidance for interpreting the statutory definition of FEOC under Section 40207 of the Infrastructure Investment and Jobs Act (IIJA). The Treasury final regulations and the DOE final interpretive rule largely adopted the proposed regulations and interpretive rule on FEOC published by the Treasury and the DOE on December 4, 2023, with some important changes and clarifications.

DOE Final Interpretative Rule on FEOC

The DOE’s final interpretive rule confirms the major elements of the December 2023 proposed interpretive rule and clarifies the definition of “foreign entity of concern” by providing interpretations of the following key terms: “government of a foreign country,” “foreign entity,” “subject to the jurisdiction,” and “owned by, controlled by, or subject to the direction.”

The final rule does not make any changes to its interpretations of “foreign entity” and “subject to the jurisdiction,” but makes clarifying changes to its interpretations of “government of a foreign country” and “owned by, controlled by, or subject to the direction.”

Government of a Foreign Country

The DOE’s final interpretive rule does not change the framework of the definition of “government of a foreign country,” which includes, among other elements, current or former senior political figures of a foreign country and their immediate family members. However, in the specific context of the PRC, DOE makes substantial changes and clarifies that the definition of “senior foreign political figure” now also includes current and former members of the National People’s Congress and Provincial Party Congresses, and current but not former members of local or provincial Chinese People’s Political Consultative Conferences.

Moreover, the final rule further clarifies and broadens when an official will be considered “senior” as follows: “an official should be or have been in a position of substantial authority over policy, operations, or the use of government-owned resources” (emphasis added).

Owned by, Controlled by, or Subject to the Direction

The DOE’s final interpretive rule is largely consistent with the proposed interpretive rule for the interpretations of “owned by, controlled by, or subject to the direction,” but makes some clarifying edits in response to public comments.

  • Control by 25% Interest

The DOE’s final interpretive rule finalizes the 25% control test provided in the proposed interpretive rule and makes further clarifications to the method for calculating the control percentage. The 25% threshold is to apply to each metric (board seats, voting rights, and equity interests) independently, not in combination, and the highest metric is used for the FEOC analysis. For example, if an entity has 20% of its voting rights, 10% of its equity interests, and 15% of its board seats held by the government of a covered nation, the entity would be treated as being 20% controlled by the covered nation government (not combined 45% control).

  • Effective Control by Licensing and Contracting

The DOE’s final interpretive rule finalizes that licensing agreements or other contracts can create a control relationship for FEOC test purposes and has proposed a safe harbor for evaluation of “effective control.” The final interpretive rule provides a list of rights covering five categories that need to be expressly reserved under the safe harbor rule. One requirement is that a non-FEOC needs to retain access to and use of any intellectual property, information, and data critical to production. In response to public comments, the final interpretive rule makes compromise regarding this requirement and provides that the non-FEOC entities need to retain such access and use no longer than “the duration of the contractual relationship.”

Moreover, in the final interpretive rule, the DOE declines to expand the definition of “control” to include foreign entities that receive significant government subsidies, grants, or debt financing from the government of a covered nation.

Treasury Final Regulations on FEOC Restrictions

The Treasury’s final regulations cross-reference the DOE’s FEOC interpretive guidance regarding FEOC definitions. Similar to the DOE’s final interpretive rule, the Treasury’s final regulations generally follow the December 2023 proposed regulations regarding FEOC restrictions and compliance regulations relating to the section 30D clean vehicle tax credit, but have also made certain important modifications and clarifications outlined below:

Allocation-based Accounting Rules

For the FEOC restrictions, the Treasury final regulations make permanent the allocation-based accounting rules for applicable critical minerals contained in battery cells and associated constituent materials.

Due Diligence

The final regulations confirm that to satisfy the due diligence requirement for FEOC compliance, and in addition to the due diligence conducted by the manufacturers meeting the qualification requirements of the regulations (qualified manufacturers) themselves, the qualified manufacturers can also reasonably rely on due diligence and attestations and certifications from suppliers if the qualified manufacturers do not know or have reason to know that such attestations or certifications are incorrect.

Impracticable-to-trace Battery Materials

The final regulations finalize a transition rule, which provides that the FEOC restrictions will not apply to qualified manufacturers as to “impracticable-to-trace battery materials” before 2027. The term “impracticable-to-trace battery materials” replaces the proposed regulations’ reference to “non-traceable battery materials.” Impracticable-to-trace battery materials are defined in the final regulations as specifically identified low-value battery materials that originate from multiple sources and are commingled by suppliers during production processes to a degree that the qualified manufacturers cannot determine the origin of such materials. The final regulations also identify certain battery materials as constituting impracticable-to-trace battery materials. Qualified manufacturers may temporarily exclude impracticable-to-trace battery materials from the required FEOC due diligence and FEOC compliance determinations until January 1, 2027. To take advantage of this transition rule, qualified manufacturers must submit a report during the upfront review process as set forth in the final regulations, demonstrating how they will comply with the FEOC restrictions once the transition rule is no longer in effect.

Traced Qualifying Value Test

The final regulations provide a new test, the “traced qualifying value test,” for OEMs to trace the sourcing of critical minerals and determine the actual value-added percentage for each applicable qualifying critical mineral for each procurement chain.

Exemption for New Qualified Fuel Cell Motor Vehicles

The final regulations also confirm that the FEOC restrictions generally do not apply to new qualified fuel cell motor vehicles (with certain exception) as they do not contain clean vehicle batteries.

Conclusion

Under the final regulations and final interpretive rule, to take advantage of the section 30D tax credit, qualified manufacturers shall conduct FEOC and supply chain analysis and satisfy the due diligence, certification and other requirements. Moreover, for the qualified manufacturers that seek to rely on their battery suppliers’ due diligence and relevant attestations or certifications, they should consider incorporating terms in their contracts with such suppliers that require reporting and tracing assurances regarding battery materials and critical minerals.

The DOE’s final interpretive rule became effective on May 6, 2024. The Treasury’s final regulations will be effective on July 5, 2024.

© 2024 Miller, Canfield, Paddock and Stone PLC
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