Treasury issues awaited guidance on Clean Vehicle tax credits eligibility
The US Department of the Treasury has issued anxiously awaited guidance clarifying the meaning and application of a number of eligibility requirements for the federal “Clean Vehicle” tax credit established by last year’s Inflation Reduction Act. Treasury’s guidance, issued in the form of an unpublished Notice of Proposed Rulemaking (NPRM) setting forth proposed regulations, is scheduled for official publication in the Federal Register on April 17, 2023.
The proposed new regulations, if adopted, will substantially affect the complex international supply chains for high-voltage batteries used to power electric vehicles sold in the United States, including the sourcing of battery minerals and materials, and electric vehicle and battery manufacturing activity conducted in the United States. Interested parties will have 60 days from the publication of the NPRM in the Federal Register to provide comments on the proposed regulations.
Background: Two-part credit for purchasers of qualified EVs, ambiguous eligibility criteria
In 2022, Congress passed and President Joe Biden signed into law the Inflation Reduction Act (IRA), designed in part to spur a rapid transition to electric-powered transportation and clean energy generation. The IRA also seeks to promote US energy security and the development and growth of US domestic manufacturing, power generation, and infrastructure to fuel that transition. To serve those aims, the law established numerous new tax credits and incentives for clean energy and transportation electrification projects. One provision (amended Internal Revenue Code § 30D), created a new tax credit for purchasers of qualified electric vehicles, known as the Clean Vehicle credit.
The Clean Vehicle credit for new battery electric-powered light-duty vehicles (mostly passenger cars and light trucks) is divided into two separate parts, each subject to US domestic content requirements. Eligibility for one part is contingent on the geographic location(s) of mining and processing of designated “critical minerals” contained in the vehicle’s battery. To qualify for the second part of the credit, a specified percentage of the value of a vehicle’s battery components must be manufactured or assembled in North America. Each of the two parts is worth $3,750, meaning purchasers of qualified new vehicles may claim a total tax credit of $7,500 per vehicle (subject to vehicle purchase price and buyer income limits).
Several key terms of the Clean Vehicle Credit eligibility provisions are not fully defined in the statute, resulting in ambiguity and uncertainty regarding how eligibility will be determined for EVs whose battery minerals and components are obtained or manufactured outside of the United States. Because availability of the credit will be important to EV price competitiveness in the US market, the interpretation and application of credit criteria is very important to suppliers and manufacturers of battery and EV materials and components.
The Inflation Reduction Act directed the Secretary of the Treasury to issue guidance on the application of new provisions of Section 30D by no later than December 31, 2022. Treasury did not meet that deadline. In late December, the Department instead issued preliminary documents indicating the “direction” of its thinking and analysis, including a notice of intent to propose regulations in the future, and a white paper stating Treasury’s preliminary views regarding application of critical minerals and battery component credit eligibility requirements. See Treasury Department and IRS issue “directional” guidance on clean vehicle credit provisions of the Inflation Reduction Act | DLA Piper. Treasury further stated last December that it intended to issue guidance on those eligibility requirements by March 2023. On the last day of March, Treasury issued its proposed regulations providing that guidance.
I. Critical minerals requirements
In order to qualify a new vehicle for the first half of the Clean Vehicle credit, 40% of the critical minerals contained in the battery from which the vehicle’s motor draws its power must be: (i) extracted or processed in the United States, or in any country with which the US has a free trade agreement; or (ii) recycled in North America. The IRA incrementally increases the minimum percentage subject to that requirement to 80 percent by 2027. The new proposed regulations seek to clarify the meaning of key terms and elements of those criteria.
In the NPRM, Treasury proposes a three-step process for manufacturers to determine critical minerals value percentages, including:
- Determine the procurement chains for each critical mineral. The proposed rules define procurement chains as a “common sequence of extraction, processing, or recycling activities that occur in a common set of locations, concluding in the production of constituent materials.” Some international supply chains can be difficult to fully identify or disaggregate, and the same critical mineral may have multiple different chains. As a result, this first step may be time-and-resource consuming for a number of battery and EV manufacturers.
- Identify qualifying critical minerals. The next step in applying the critical minerals requirement is to determine which of those minerals qualify as extracted or processed in the U.S. or an FTA jurisdiction. For 2023 and 2024, Treasury intends to use a “50% of value added test”: critical minerals having 50 percent or more of their value added by extraction or processing activity conducted in the US or in a country with which the US has a free trade agreement will qualify to be counted toward the required percentage. Treasury explains that this test will apply during a two-year transition period. After 2024, it intends to apply an (unspecified) “more stringent test.” Definitions and criteria to be used to identify qualifying critical minerals activities are discussed further below.
- Calculate qualifying critical mineral content. Once qualifying critical minerals are identified, the manufacturer can calculate the value of those qualifying critical minerals. Dividing the value of qualifying critical minerals in a battery by the total value of all critical minerals in that battery yields the percentage used to determine eligibility for the first part of the Clean Vehicle credit.
Criteria for classification of qualifying critical minerals and activities
The proposed regulations also define and clarify the application of key terms necessary to determine whether a critical mineral activity qualifies to be counted toward the Clean Vehicle credit’s minimum content requirements (i.e., critical minerals that are extracted or processed in the US or in a country with which the US has a free trade agreement, or are recycled in North America).
The meaning of “extracted or processed.” The proposed regulations define “extracted” as the “activities performed to extract or harvest minerals or natural resources from the ground or a body of water, including, but not limited to, operating equipment to extract minerals or natural resources from mines and wells, or to extract or harvest minerals or natural resources from the waste or residue of prior extraction.” Chemical or thermal processes involved in refining will not be considered “extraction.”
The proposed regulations define “processed” as the “non-physical processes involved in refining of non-recycled substances or materials, including the treating, baking, and coating processes used to convert such substances and materials into constituent materials.”
The definition of “free trade agreement.” Countries having a comprehensive free trade agreement (FTA) with the U.S. are clearly within the scope of the IRA term “country with which the United States has a free trade agreement.” This includes Australia, Bahrain, Canada, Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Israel, Jordan, South Korea, Mexico, Morocco, Nicaragua, Oman, Panama, Peru, and Singapore.
In addition, the proposed regulations define several additional criteria that will be used to identify countries having an FTA with the U.S. for purposes of the Clean Vehicle credit. Those broader criteria appear likely to include some countries that do not have a comprehensive free trade agreement with the US. Treasury indicates that it intends to propose to include additional countries meeting those criteria. However, the only such country expressly mentioned in the guidance is Japan, which on March 28 entered a Critical Minerals Agreement with the US, committing to free trade in critical minerals. The guidance does not specifically mention European Union countries or any other country under consideration for this status.
Definition of constituent materials. Treasury also defines what materials will be classified as “constituent materials,” which will be deemed to be critical minerals (and not battery components) for purposes of credit calculations. As a general matter, the proposed regulations define constituent materials as critical-mineral-containing final products of extraction or processing, which are subsequently used in the manufacturing or assembly of battery components. Significantly, the guidance establishes that constituent materials are “the final products relevant for calculating the value of applicable critical minerals in the battery.”
“Cathode active materials,” “anode active materials,” and certain other materials qualify as critical minerals. Cathode active materials and certain other processed materials containing critical minerals will be classified as constituent materials that may be counted as qualifying critical minerals for purposes of the credit analysis. This guidance is consistent with Treasury’s “anticipated direction” announced last December. Nonetheless, the classification of such materials continues to be the subject of substantial debate among Members of Congress, the Biden Administration, and potentially affected businesses.
II. Battery component requirements
Eligibility for the second part of the Clean Vehicle credit under the IRA requires 50 percent of the components of an EV battery (measured by value) to be manufactured or assembled in North America (the required North American percentage increases incrementally to 100 percent in 2029). The proposed regulations set forth Treasury’s intended application of key terms and eligibility criteria for the second half of the credit.
Four step process
The proposed regulations create a four-step process to identify battery components whose value may be counted toward the minimum percentage value requirement:
- Identify components that are manufactured or assembled in North America. Such components are designated as “North American battery components.”
- Determine the incremental value of each battery component and of North American battery components. The “incremental value” of a battery component “X” is essentially the total value of that component (X) less the value of any other manufactured or assembled battery components that are incorporated in battery component X.
- Determine the total incremental value of battery components. The “total incremental value of battery components” in an EV battery is defined as the “sum of the incremental values of each battery component contained in [that] battery.”
- Calculate the qualifying battery component content. The “qualifying battery component content” is the percentage of the value of all of a battery’s components attributed to North American components, which is used to determine credit eligibility. The proposed regulations more precisely define the term as the “percentage that results from dividing the total incremental value of North American battery components  by the total incremental value of battery components.” That qualifying battery component content must meet the applicable minimum (50 percent in 2023) to make a vehicle eligible for the second part of the 30D Clean Vehicle tax credit.
To guide the application of the four steps, the regulations would also define certain key terms, including “battery” and “battery component.” Notably, those two terms do not include thermal management systems, battery cell cases, cans or pouches. Constituent materials are not considered “battery components” for purposes of credit eligibility. The guidance further defines manufacturing as the steps used to produce a battery component from constituent materials and other battery components, and assembly as the “process of combining battery components into battery cells and modules.”
“Foreign entities of concern” criteria deferred to future
Starting in 2024, the IRA excludes from Section 30D credit eligibility vehicles containing battery components that were manufactured or assembled by a “foreign entity of concern.” The statute extends that exclusion in 2025, to vehicles containing critical minerals that were extracted or processed by such an entity. The statute describes a foreign entity of concern as an entity “owned by,” “controlled by” or “subject to the jurisdiction or direction of” a government of Russia, Iran, China, or North Korea, but provides no further relevant definition. See 42 U.S.C. 18741(a)(5)(C). The scope and application of the indefinite term “foreign entity of concern” has significant implications for the US high voltage battery and EV markets, as Chinese companies today dominate the extraction and processing of battery critical minerals, and the world’s largest battery manufacturers are also Chinese companies.
The new proposed regulations, however, decline to explain or clarify how Treasury intends to interpret and apply the consequential provision that will begin to apply to electric vehicles in less than nine months. Instead, Treasury briefly states that it intends to issue guidance on that subject “at a later date.”
Interpretation and application of several Clean Vehicle credit criteria involves balancing of two IRA policy objectives that are presently in tension. The Act seeks to impel a rapid transition to electric-powered vehicles in order to reduce carbon emissions and mitigate climate change. At the same time, it seeks to enhance future US energy security and foster the development of a US-based battery and EV manufacturing and supply industry and related domestic supply chains. The tension arises because domestic manufacturing of batteries and “critical minerals”-related activities in the US today are relatively minimal -- development of domestic supply and production capabilities to levels necessary to meet targeted US demand is likely to take several years.
Treasury’s proposed regulations, if adopted, would substantially clarify how the federal government intends to apply ambiguous and controversial provisions of the IRA pertaining to tax credits for battery electric vehicles. Given the continuing tension between major policy objectives, and the considerable stakes for affected parties with divergent interests, Treasury’s guidance (to be published officially in mid-April for public comment) may be subject to further congressional or administrative action and judicial challenges.
DLA Piper will continue to monitor and report on the practical impacts of these and related regulations and policies as they develop. Our lawyers and policy professionals provide robust cross-disciplinary energy, transportation, climate policy and tax services focused on this dynamic sector. For more information, please contact any of the authors or your usual DLA Piper contact.
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