Treasury Department, IRS issue “directional” guidance on clean vehicle credit provisions of the Inflation Reduction Act
In the final days of 2022, the US Department of the Treasury (Treasury) and Internal Revenue Service (IRS) published preliminary guidance and notices related to clean vehicle tax credit provisions of the Inflation Reduction Act (IRA). Significantly, one IRS publication noted a possible approach that vehicle leasing companies might use to claim a monetarily equivalent clean vehicle tax credit while avoiding some of the most challenging sourcing and domestic manufacturing requirements of the IRA’s Clean Vehicle credits program. Treasury deferred until March 2023 the publication of binding guidance regarding critical minerals and battery component content requirements for the new Clean Vehicle credits, but provided “directional” indications of potential flexibility in its application of some of those eligibility requirements.
A range of manufacturers, suppliers and other stakeholders are vitally interested in how Treasury and other federal agencies will implement the clean vehicle credits created by the IRA, including their unprecedented eligibility requirements. As a policy matter, agencies’ interpretations and application of various new clean vehicle and clean energy credits and incentives will address two arguably competing aims of the ambitious IRA: (i) to impel and incentivize rapid transition to “cleaner,” low-carbon energy generation, transportation and industry and (ii) to achieve that transition through US domestic production and “onshoring” of manufacturing, and materials sourcing and processing that today are primarily conducted outside the US.
Following is a summary of significant emerging regulatory guidance in Treasury’s late-December publications. We highlight preliminary indications of the federal government’s policy direction and options with respect to important eligibility criteria, as well as significant questions that remain open even as the Clean Vehicle credit program has already taken effect.
New credits and some eligibility restrictions effective January 1, 2023
The new Clean Vehicle credit (Internal Revenue Code Section 30D) established by the IRA became available January 1, 2023, replacing the previous federal electric vehicle purchaser tax credit and eliminating the per-manufacturer credit cap on vehicles sold after December 31, 2022. The IRA also imposes several new restrictions on persons and vehicles eligible to claim clean vehicle tax credits. Restrictions limiting eligibility to purchasers with incomes below certain thresholds and vehicles with retail prices below specified caps took effect on January 1. Earlier, on December 12, Treasury released Revenue Procedure 2022-42, which provides guidance on a number of eligibility, procedural and reporting requirements for vehicle manufacturers seeking to qualify vehicles for the clean vehicle credit.
On December 29, 2022, two business days before the effective date of the Clean Vehicle credit, Treasury issued guidance on (in the form of a “Notice of intent to Propose Regulations,” Notice 2023-1) regarding the definitions of certain important terms governing credit eligibility, including adjusted gross income limits for purchasers qualified to claim the credit; “Manufacturer’s Suggested Retail Price” (for purposes of application of the maximum retail price for eligible vehicles); and “final assembly” (to qualify for the credit, “final assembly” of a vehicle must have been conducted in the US). Those definitions hewed closely to IRA statutory definitions, including a somewhat vague definition of final assembly. Some of the definitions may be subject to further development and adjustment in the final regulations. The specific contours of the final assembly definition could be important to the eligibility of electric vehicles that today are primarily manufactured outside the US.
Guidance provided in Revenue Procedure 2022-42, Notice 2023-1 and ancillary documents, along with the terms of the statute, provide the initial parameters and requirements for the Clean Vehicle credits, effective on January 1, 2023. As explained below, Treasury has not yet proposed guidance regarding at least two very consequential new eligibility requirements. Under the terms of the IRA, those requirements will not take effect until such guidance issues. Treasury now forecasts it will publish proposed guidance in March 2023.
Treasury provides “anticipated direction” of guidance regarding critical minerals and battery components, defers proposed guidance to March 2023
Two of the Clean Vehicle credits’ most significant new eligibility conditions are minimum content requirements for batteries used in battery-electric vehicles, covering critical minerals sourcing and processing, and North America battery component manufacturing.
The IRA critical minerals provision conditions eligibility for a $3,750 per vehicle credit on the vehicle’s batteries containing a percentage of specified “critical minerals” obtained from one of three sources, either (1) extracted or processed in the US; (2) extracted or processed in a country “with which the United States has a free trade agreement in effect;” or (3) recycled (e.g., from existing batteries) in North America. The percentage requirement for such critical minerals, measured by their proportionate value, begins at 40 percent in 2023 and increases in 10-percent annual increments to 80 percent in 2026.
In order to qualify for a second $3,750 credit, “the value of the components in the vehicle’s battery that were manufactured or assembled in North America [must be] equal to or greater than 50 percent.” The battery component requirement increases to 60 percent in 2024 and 2025, and thereafter in 10-percent annual increments until reaching 100 percent in 2029. This eligibility criterion will require manufacturers to conduct detailed review, tracking and reporting of their complex supply chains.
Need for definition of eligibility terms and concepts
Certain essential terms and conditions of the two new eligibility criteria, including what specifically constitutes mineral “extraction,” “processing,” a “free trade agreement” and battery component “manufacturing” or “assembly,” are not well defined. Similarly, the IRA does not specify a method for determining the percentage “value” of critical minerals or components manufactured or assembled in North America. The definition of these terms could have significant effects for clean vehicle manufacturers, suppliers and related businesses because much of the existing high-voltage battery supply chain and manufacturing capacity today are located outside of the US and North America. The IRA’s transition rules provide that the new critical minerals and battery component eligibility requirements take effect only after Treasury/IRS issues proposed guidance for implementing those requirements.
Treasury “directional” views on critical minerals and battery component requirements
Treasury announced on December 29, 2022 that it intended to defer publication of proposed guidance on the critical minerals and battery component requirements until March 2023. The same day, Treasury and IRS issued a White Paper outlining their “preliminary views” regarding the implementation of those consequential requirements. The agencies took pains to emphasize that their views were preliminary and non-binding, and did not constitute “proposed guidance” that would trigger application of the new eligibility requirements. This included the White Paper’s redundantly qualified title: “Anticipated Direction of Forthcoming Proposed Guidance on Critical Mineral and Battery Component Value Calculations for the New Clean Vehicle Credit.” The White Paper is nonetheless significant as it publicly signals the federal government’s current policy views and inclinations regarding the contours of those requirements, and hints at potential flexibility in their application. Some of the provisions of the White Paper include:
- Preliminary definitions of essential terms for critical minerals requirement, including “extraction,” “processing,” “recycling,” "constituent materials," and the calculation of “value” and “value added.”
- Three-step process for determining critical minerals compliance for a transitional period from 2023-24. Recognizing the complexity of critical minerals supply chains and detailed tracking needed to determine compliance, the White Paper suggests a three-step process to allow manufacturers to develop the capability to certify compliance, including: (i) identifying the procurement chain(s) for each critical mineral; (ii) evaluating each procurement chain to determine if critical minerals have been extracted or processed in the US or a country having a free trade agreement with the US, or recycled in North America, including allocation of critical minerals partially extracted or processed in one of those eligible jurisdictions; and (iii) calculating the percentage of the value of such “qualifying critical minerals” contained in a battery.
- Free Trade Agreement definition. Noting that the term “free trade agreement" is not defined in the IRA “or in any other statute,” Treasury states that it intends to seek comment on what criteria should be used to identify free trade agreements for purposes of the critical minerals requirement and suggests some possible general criteria. The White Paper hints at some flexibility in the designation of countries with a US free trade agreement, and indicates that it may encompass more countries than those having “comprehensive trade agreements” with the US.
- Preliminary definitions of terms necessary to apply the battery manufacture or assembly requirement, including “battery cell,” “battery component,” “manufacturing,” “assembly,” “value” and “incremental value.”
IRS suggests potential alternative credit availability for vehicle leasing companies
Also on December 29, IRS issued Fact Sheet 2022-42, providing answers to a number of frequently asked questions regarding IRA clean vehicle credits. Although not binding in any particular case and subject to change, the publication is intended to provide the Agency’s present view of certain general issues.
Significantly, the last section of the Fact Sheet could be read to provide a path for auto manufacturers whose vehicles may not qualify for the Clean Vehicle credit to use the IRA’s separate Commercial Clean Vehicle credit provision to generate a similar tax benefit, albeit indirectly. IRS indicated that, subject to certain conditions, battery electric vehicles purchased by companies for the purpose of leasing those vehicles to “customers” (presumably including individual consumers leasing passenger cars) may qualify for a tax credit of up to $7,500. The Agency stated that the separate Qualified Commercial Clean Vehicle credit provision of the IRA (IRC Section 45W) would allow the lessor who purchased and owns the vehicle to qualify for IRA tax credits. Importantly, the Qualified Commercial Clean Vehicle credit does not impose some of the stringent eligibility requirements of the Section 30D Clean Vehicle credit, such as the critical minerals, battery component manufacturing and vehicle final assembly requirements.
This interpretation allows a vehicle leasing company to purchase vehicles from a manufacturer and claim a credit of up to $7,500 per vehicle, so long as it retains ownership of the vehicle that meets other basic requirements. Theoretically, this could allow a manufacturer to sell passenger cars and light-duty trucks that qualify as commercial clean vehicles to an affiliated leasing company (on arms-length terms), which in turn could be entitled to claim a credit in the same amount as the Clean Vehicle credit for those subsequently leased vehicles – without meeting Section 30D’s critical minerals, manufacturing and assembly requirements. The automaker or affiliated leasing company could pass along some or all of the effective tax savings to vehicle lessees, thereby mitigating any competitive disadvantage the automaker might otherwise face due to its vehicles’ ineligibility for the Section 30D credit.
Such an interpretation may meet significant opposition as contrary to the intent of the clean vehicle credits provisions of the IRA and may also raise other business and legal questions and complications. And IRS could readily change a non-binding statement of its view set out in a general information fact sheet. At this point, however, IRS may have illuminated an alternative path for automakers and others to obtain the benefit of clean vehicle tax credits while avoiding some of the more challenging requirements of Section 30D.
The Fact Sheet also clarified IRS’s view on several other clean vehicle tax credit questions, including that the New Clean Vehicle and Used Clean Vehicle credits may not be carried forward and are not refundable.
To learn more about the IRA, its implementation and potential effects, or to discuss opportunities for input or outreach to relevant policymakers, please contact one of the authors or your usual DLA Piper attorney.