The IRS has released final regulations (T.D. 10010) on the advanced manufacturing credit under Section 45X that make favorable changes expanding the scope of the credit in important ways.
The advanced manufacturing credit was created by the Inflation Reduction Act, and offers credits for producing and selling specific solar energy components, wind energy components, inverters, battery components, and critical minerals. Most of components have set credit rates per-component or per-capacity, but the credits for electrode active materials and critical minerals are calculated as 10% of the costs of production.
The IRS previously released proposed regulations in 2023 (REG–107423–23) that excluded material costs from the costs of production eligible for the credit. Many taxpayers submitted comments in opposition to this rule, and the final regulations released on Oct. 24 are much more favorable. They generally allow material costs to be included unless the material is purchased from another taxpayer that can claim a separate credit for the material as a component itself. Certain domestic extraction costs can also be creditable.
The final regulations also provide important guidance that:
- Offers extensive definitions of eligible components
- Defines production in the U.S.
- Provides rules for determining who is eligible in contract manufacturing situations
- Creates potentially burdensome substantiation rules
The final regulations are applicable for tax years ending on or after the regulations are published in the Federal Register, but taxpayers can rely on them for earlier tax years as long as they follow them consistently and in their entirety.
Grant Thornton Insight
The final rules make several favorable changes and provide much-needed certainty. Taxpayers producing eligible components should ensure they are structuring sales transactions and supplier agreements to qualify for the credit, as complex issues can arise from various procurement and contracting scenarios. It will also be critical to collect any needed documentation suppliers and buyers. There may be opportunities to improve the credit calculation for electrode active material and critical minerals with methods to increase the cost of production under the favorable new rules.
General rules
Section 45X offers a credit for taxpayers producing specified components in the United States and selling the component to an unrelated person (with special rules allowing credits for certain sales to related parties). There are no restrictions on where the component can be sold or used as long as it is produced domestically.
The credit is only available for sales after Dec. 31, 2022, and production must also have been completed after Dec. 31, 2022. The preamble to the proposed regulations acknowledged that the credit is available for components that began production before 2023, but declined to offer any specific rules around how to define when a component is considered “completed.”
The credits are available at the following prescribed rates for specifically defined components:
Solar components:
- Thin film or crystalline photovoltaic cells: $0.04 multiplied by the capacity in direct current watts
- Photovoltaic wafer: $12 per square meter
- Solar grade polysilicon: $3 per kilogram
- Polymeric backsheet: 40 cents per square meter
- Solar module: 7 cents multiplied by the capacity in direct current watts basis
- Torque Tube: 87 cents per kilogram
- Structural fastener: $2.28 per kilogram
Wind energy components:
- Blades: 2 cents multiplied by the capacity in watts of the completed wind turbine
- Nacelles: 5 cents multiplied by the capacity in watts of the wind turbine
- Towers: 3 cents multiplied by the capacity in watts of the wind turbine
- Offshore wind foundations: 2 cents for fixed platform and 4 cents for floating platforms multiplied by the capacity in watts of the wind turbine
- Related offshore wind vessels: 10% of the sales price of such vessel
Inverters:
- Central inverter: 25 cents multiplied by the capacity in alternating current watts
- Utility inverter: 1.5 cents multiplied by the capacity in alternating current watts
- Commercial inverter: 2 cents multiplied by the capacity in alternating current watts
- Residential inverter: 6.5 cents multiplied by the capacity in alternating current watts
- Microinverter or distributed wind inverter: 11 cents multiplied by the capacity in alternating current watts
Other components:
- Battery cell: $35 multiplied by the capacity on a kilowatt-hour basis
- Battery module: $10 ($45 if no battery cells) multiplied by capacity on a kilowatt-hour basis
- Electrode active materials: 10% of the costs incurred by taxpayer with respect to production of such materials (which include cathode materials, anode materials, anode foils, and electrochemically active materials, including solvents, additives, and electrolyte salts)
- Applicable minerals: 10% of the costs incurred by the taxpayer with respect to production of such mineral (which includes aluminum, antimony, arsenic, barite, beryllium, bismuth, cerium, cesium, chromium, cobalt, dysprosium, erbium, europium, fluorspar, gadolinium, gallium, germanium, graphite, hafnium, holmium, indium, iridium, lanthanum, lithium, lutetium, magnesium, manganese, neodymium, nickel, niobium, palladium, platinum, praseodymium, rhodium, rubidium, ruthenium, samarium, scandium, tantalum, tellurium, terbium, thulium, tin, titanium, tungsten, vanadium, ytterbium, yttrium, zinc, and zirconium.)
Grant Thornton Insight
The final regulations hew very close to the statute in defining eligible components. The IRS rejected many calls to expand the scope of qualifying components, noting that the statutory language is fairly prescriptive and doesn’t grant the IRS any authority to add to the categories. The final regulations do provide helpful clarity in several areas, including the capacity measurements for purposes of many credit rates, definitions for various terms used to define specific components, and the scope of materials qualifying under the electrode active material and critical mineral definitions.
No Section 45X credit is allowed for a component produced in a production unit that includes any property included in a facility in which a Section 48C credit was claimed. The final regulations include extensive rules defining the scope of a Section 48C facility and the potential overlap of the credits.
Unlike many of the other IRA credits, there are no prevailing wage and apprenticeship requirements in order to access the full credit amounts under Section 45X. However, the credit rates for all components except critical minerals are scheduled to phase down beginning in 2030, with a credit haircut increasing by 25% each year until the credit disappears for 2034.
Taxpayers can elect to claim the credit as a refundable payment under Section 6417 for any consecutive five-year period while the credit is available. In years in which a refundable payment election is not in place, taxpayers can elect to sell and transfer the credit to an unrelated party under Section 6418. See our prior articles for more information on the refundable credit rules and credit transfer rules.
Grant Thornton Insight
Taxpayers can strategically plan their election to receive refundable credits to capture the five consecutive years in which the credits may be the largest due to increases in production. Taxpayers should also consider their ability to utilize credits, the potential reduction in the credit rates in 2030, and the evolving market for credit transfers.
Sales
Section 45X generally requires the sale of component to an unrelated party, though there are other mechanisms for eligibility. The IRS declined to provide any specific rules on when and whether a sale occurs, and the final regulations provide that the determination of whether a transaction is a sale in substance is made by applying general tax principles. Taxpayers can be considered to have sold a component to an unrelated person if the component is integrated, incorporated, or assembled into another product or eligible component which is sold to an unrelated person.
Taxpayers are treated as related if they would be treated as a single employer under Section 52(b). The rules allow taxpayers to treat a sale as to an unrelated party if a related party sells the component to an unrelated party. The statute also allows taxpayers to elect to treat a sale to a related party as a sale to an unrelated party under rules prescribed by the Treasury Secretary. The final regulations require substantial information in order to make this election.
An anti-abuse rule allows the IRS to deny a credit if the primary purpose of production is to obtain a credit in a manner that is wasteful, such as discarding or destroying and eligible component without putting it to productive use.
Production
The final regulations provide that a component will be treated as “produced by a taxpayer” if the taxpayer “substantially transforms 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 of the elements, materials, or subcomponents.” The final regulations provide that secondary production from producing eligible components from recycled material will be included in the definition of “produced by the taxpayer.”
Grant Thornton Insight
The IRS rejected many requests to expand this definition with more examples or specific production processes for each component, arguing that a broader rule is better at applying the rules to varying and evolving fact pattens. The preamble does, however, acknowledge that some eligible components like solar modules and battery modules are produced primarily by assembling other components. The final regulations changed the term “mere assembly” to “minor assembly” to more clearly indicate that this type of assembly can qualify. Taxpayers may still face challenges in applying this rule to their processes, which does not rely on any other familiar definitions of production from other code section such as Section 263A.
The components must be produced within the United States, with the “United States” defined broadly to include U.S. territories and the seabed and subsoil of territorial waters under Section 638. The final regulations clarify that a component’s constituent elements, materials, and subcomponents do not need to be produced in the United States.
The final regulations retain the rules for contract manufacturing in the proposed regulations, which provide that the credit is available for the taxpayer that performs the actual production activities that bring about a substantial transformation resulting in the eligible component. The final regulations also retain a rule allowing parties that are in “contract manufacturing arrangement” to agree on which party will claim the credit. A “contract manufacturing arrangement” means any agreement providing for the production of any eligible component entered into before the production is completed, but does not include routine purchase orders for off-the-shelf property. A certification statement signed under penalties of perjury is required.
Production costs
Unlike most of the components with set per-component or per-capacity credit rates, the credits for electrode active materials and critical minerals are based on the cost of production. The proposed regulations would have defined “cost of production” narrowly to exclude material costs, a decision that was heavily criticized. The IRS shifted its stance in the final regulations.
Under the final rules, production costs will include all costs as defined in Treas. Reg. Sec. 1.263A-1(e) that are paid or incurred within the meaning of Section 461 for the production of the critical mineral or electrode active material. This will include direct and indirect materials costs as defined in Treas. Reg. Secs. 1.263A- 1(e)(2)(i)(A) and §1.263A-1(e)(3)(ii)(E) unless the material costs come from the purchase of materials that themselves are eligible components for the seller. In addition, taxpayers can include the costs of domestic extraction of raw materials if the extraction costs are paid or incurred by the taxpayer claiming the credit.
Grant Thornton Insight
The expansion of the definition of production costs is an extremely favorable development that will significantly increase the allowable credit for many taxpayers. Importantly, the material for producing the electrode active materials and critical minerals does not need to be sourced domestically in order for the material costs to be included in the credit calculation. Only taxpayers seeking to include their own extraction costs will be limited to domestic activity. Taxpayers will be required to comply with burdensome documentation rules to establish that any material is not itself a creditable component for the supplier. Taxpayers can also consider assessing Section 263A to see if there are opportunities to increase the amount of production costs for purposes of the credit.
Substantiation and documentation
The final regulations include numerous substantiation and documentation rules that could prove burdensome for taxpayers, including:
- Obtaining an employer identification number and certification from suppliers under penalties of perjury that they are not claiming a credit for any constituent elements, materials, or subcomponents of an electrode active material or critical mineral
- Providing an analysis of why any constituent elements, materials, or subcomponents did not qualify for a credit for suppliers
- Listing all direct and indirect material costs
- Creating a document “ideally prepared by an independent third party” on production activity
- Documenting testing standards and methodologies used to establish the capacity of various components
- Documenting that components meet core engineering specifications and capacity requirements using a bill or sale or similar documentation
- Documenting that components like torque tubes and structural fasteners are used in the required manner with bill of sale or similar documentation
Next steps
Taxpayers can rely on the rules immediately for sales occurring in 2023 and 2024. It will be critical to immediately ensure processes are in place to meet the documentation requirements, which may involve information requests from supplies and buyers. Taxpayers should also consider the impact of the credit on any contract manufacturing relationships, including potential agreements on who claims the credit. There may be various opportunities to enhance the benefit of the credit, including filing amended returns for any 2023 credits that excluded the cost of production, structuring sales transactions and supply chains to ensure qualification, and evaluating opportunities to increase the cost of production.
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