Earlier this month, the Internal Revenue Service (“IRS”) and Department of the Treasury released proposed regulations (the “Proposed Regulations”) relating to the advanced manufacturing tax credit under Section 45X of the Internal Revenue Code (“45X Credits”). The Proposed Regulations clarify various definitions for key terms under Section 45X of the Code, including the definition of the phrase “produced by the taxpayer” (Section 1.45X-1), supply additional detail regarding the rules relating to sales to unrelated persons, sales to related persons, and the related person election set forth in Section 45X(a)(3)(B) of the Code (Section 1.45X-2), and provide definitions with respect to all eligible components and critical minerals, as well as the credit amount for each and the required phase-out percentages (Sections 1.45X-3 and 1.45X-4).
Taxpayers may generally rely on the proposed regulations at least until final regulations are promulgated. Written or electronic comments to the Proposed Regulations must be received by February 13, 2024 in advance of a public hearing scheduled for the morning of February 22, 2024.
Section 45X of the Code provides a manufacturing production tax credit to taxpayers that produce and sell during the taxable year to an unrelated person, certain components for renewable energy and battery storage projects, including PV cells and other solar energy components, wind components, and storage components. The tax credit rate varies depending on the eligible component. The credit phases out beginning in 2030. 45X Credits may be claimed by the taxpayer that produces eligible components, or it may be sold to another taxpayer pursuant to Section 6418 of the Code. Further, pursuant to Section 6417 of the Code, the taxpayer may also claim direct payments in lieu of the tax credits, for a five-year period.
The Proposed Regulations should provide helpful guidance for taxpayers claiming 45X Credits and should help clarify applicable requirements for taxpayers interested in selling or claiming direct payment for the credit. Select specific provisions of the Proposed Regulations are described in more detail below.
Section 1.45X-1: General Rules
- As mentioned above, Section 1.45X-1 of the Proposed Regulations provides various definitions for terms used throughout Section 45X of the Code, including the following key terms:
- “Produced by the taxpayer” means a process conducted by the taxpayer that substantially transforms constituent elements, materials, or subcomponents into a complete and distinct eligible component that is functionally different from that which would result from mere assembly or superficial modification of the elements, materials or subcomponents. This does not include partial transformation that does not result in a substantial transformation, mere assembly of two or more constituent elements, materials, or subcomponents, or superficial modification of the final eligible component.
- “Eligible taxpayer” means the taxpayer directly performing the production activities that bring about a substantial transformation resulting in the eligible component, and must sell such eligible component to an unrelated person. There are special rules concerning contract manufacturing agreements allowing the parties to such agreement to determine the party that may claim the 45X Credit. However, the contract manufacturing agreement must be entered into before production of the eligible component is completed and must not be for off-the-shelf property.
- The Proposed Regulations clarify that production of an eligible component may begin before December 31, 2022, but must be completed, and the sale of such eligible component must occur after December 31, 2022, to be eligible for 45X Credits.
- While Section 45X(d)(2) of the Code established that eligible components must be produced in the United States or a possession of the United States to be eligible for 45X Credits, the Proposed Regulations clarify that this requirement does not apply to constituent elements, materials and subcomponents used in the production of eligible components.
- The Proposed Regulations explain that a taxpayer may claim 45X Credits for each eligible component produced and sold to an unrelated person, including any eligible component the same taxpayer produces that was used as a constituent element, material or subcomponent and integrated, incorporated or assembled into another complete and distinct eligible component.
- As an example, X produces electrode active materials (EAMs) that are incorporated into battery cells produced by X once complete. In the following taxable year, X incorporates such battery cells into battery modules that are then incorporated into electric vehicles. X then sells the electric vehicles to Z, an unrelated person, in 2024. X can claim the 45X Credits in 2024 for the EAMs, the battery cells, and the battery modules.
Section 1.45X-2: Sales to Unrelated and Related Persons
- Section 45X(a)(1)(B) of the Code establishes, to be eligible for 45X Credits, eligible components must be sold by the taxpayer to an unrelated person. The Proposed Regulations clarify that a taxpayer is treated as selling an eligible component to an unrelated person if such component is sold to an unrelated person by a person who is a related person with respect to the taxpayer.
- As an example, the Proposed Regulations outline a situation where X and Y are related, and X sells solar modules to Y. If Y then sells such solar modules to Z, X may claim the 45X Credit in the taxable year in which the solar modules were sold to Z.
- Section 45X(a)(3) of the Code provides an option for the taxpayer to elect to treat such a sale of components to a related person as a sale to an unrelated person. The Proposed Regulations provide rules for making the election and clarify that the election must be made annually for each trade or business. Further, in the event of such an election, the Proposed Regulations provide that the Secretary of Treasury may require such information or registration as deemed necessary to prevent duplication, fraud, improper or excessive credit amounts.
- The Proposed Regulations provide that if a taxpayer produces and then sells an eligible component to a related person who then integrations, incorporates or assembles such eligible component into another complete and distinct eligible component that is subsequently sold to an unrelated person, such taxpayer may claim the 45X Credit for the taxable year in which the related person’s sale to the unrelated person occurs.
- Using the same facts as the example above, assume X instead sells photovoltaic wafers to Y, who then incorporates the photovoltaic wafers into solar modules and sells such modules to Z. X may claim the 45X Credit for the sale of photovoltaic wafers in the taxable year in which the sale to an unrelated party, Z, is made.
Section 1.45X-3 and 4: Eligible Components and Applicable Critical Minerals
- The Proposed Regulations largely reiterate the information already contained in Section 45X with respect to eligible components and applicable critical minerals.
- However, the Proposed Regulations provide an answer as to how to calculate the eligible costs for purposes of calculating the 10% credit for critical minerals and electrode active materials. Generally, capitalized costs under Section 263A are included in the calculation, however, any costs related to the extraction or acquisition of raw materials would not be included. The IRS has invited comments regarding a workable solution to include the cost relating to the extraction or acquisition of raw materials in the calculation.
Foley & Lardner will continue to monitor these developments, including any changes between the Proposed Regulations and adopted final regulations.