Highly Anticipated Domestic Content Bonus Guidance Released

Aug 15, 2023

V&E Renewable Energy Update

V&E Renewable Energy Update

On May 12, 2023, the Department of the Treasury (the "Treasury") and Internal Revenue Service (the "IRS") issued Notice 2023-38 (the "Notice"), providing guidance on the rules taxpayers must satisfy to qualify for the domestic content bonus credit (the "Domestic Content Bonus") available under sections 45 and 48 of the Internal Revenue Code of 1986, as amended (the "Code"), for "qualified facilities" or "energy projects" placed in service after December 31, 2022, and under Code sections 45Y and 48E for "qualified facilities" or "energy storage projects" placed in service after December 31, 2024 (collectively, the "DC Projects").

As background, the Inflation Reduction Act of 2022 (the "IRA"), effective January 1, 2023, provided a 10% Domestic Content Bonus for the production tax credits under Code sections 45 and 45Y ("PTC") and investment tax credits under Code sections 48 and 48E ("ITC").1 Our prior coverage of the IRA can be found here and here and further coverage and details can be found here.

Generally, the Code provides that in order to be eligible for the Domestic Content Bonus, (i) 100% of all steel or iron which is a component of the DC Project must be produced in the U.S. (the "Steel and Iron Requirement") and (ii) not less than the adjusted percentage2 of the total costs of all manufactured products of the DC Project must be attributable to manufactured products (including components) which are mined, produced, or manufactured in the U.S. (the "Manufactured Product Requirement"). In applying these rules, the Code cross references, and heavily relies on the rules set forth in, section 661 of title 49 of the Code of Federal Regulations, commonly referred to as the "Buy America Requirements" of the Federal Transit Administration.

The Notice clarifies that the term "produced" as used in the Domestic Content Bonus provisions has the same meaning as "manufactured" as described in the Notice – i.e., "produced as a result of the manufacturing process."

"Manufacturing process," in turn, is defined consistently with Buy America Requirements, as "the application of processes to alter the form or function of materials or of elements of a product in a manner adding value and transforming those materials or elements so that they represent a new item functionally different from that which would result from mere assembly of the elements or materials." (emphasis added). While it would have been helpful for Treasury to point to other areas of the Code where "manufacture" and "production" are relevant (e.g., section 954), these definitions at least confirm that Buy America Requirements principles will apply and that mere assembly in the U.S. will not be sufficient. Unfortunately, there is no guidance as to what "mere assembly" might include, so taxpayers will need to analyze it in light of Buy America Requirements and, potentially, analogous provisions of the Code.

The Notice also provides some clarification as to the term "Manufactured Product." Namely, it provides that, consistent with Buy America Requirements, a "Manufactured Product" is an item produced as a result of a manufactured process. The Notice also goes on to provide that a "Manufactured Product Component" is any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into a Manufactured Product.3 This is significant because, as described below, a U.S. Manufactured Product Component that is incorporated into a non-U.S. Manufactured Product will not lose its character as U.S.

One of the most useful pieces of the Notice is the examples of Manufactured Products and Manufactured Product Components for utility scale solar, onshore and offshore wind, and battery energy storage, reproduced here:4

It appears that, if the classifications in the above chart are used by a taxpayer with respect to a DC Project, they will not be challenged. However, it seems a taxpayer could take an alternative position depending on the underlying facts of the project.

In addition, the classifications above are obviously limited in application — it is not clear how these principles might apply to other project types, such as rooftop solar, geothermal, biomass, and others.

With respect to steel and iron, the Code points to section 661.5 of Buy America Requirements, which requires that all steel and iron manufacturing processes must take place in the U.S.,5 except metallurgical processes involving refinement of steel additives. Section 661.5 of Buy America Requirements further provides that the Steel and Iron Requirement applies to all construction materials made primarily of steel or iron, but does not apply to steel or iron used as components or subcomponents of Manufactured Products.

The Notice confirms that the Buy America Requirements described above apply, but also provides that it applies to "construction materials made primarily of steel or iron and are structural in function." (emphasis added). The clarification that it only applies to structural steel and iron is important and provides a useful ground rule that might limit the application of the Steel and Iron Requirement. Unfortunately, the Notice did not specify what "primarily" means nor did it provide a threshold percentage.

Additionally, the Notice provides that the Steel and Iron Requirement does not apply to steel or iron used in Manufactured Product Components or subcomponents of Manufactured Product Components, e.g., items such as nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges, and similar items are treated as components or subcomponents of Manufactured Products and are not subject to the Steel and Iron Requirement.

Similar to the Steel and Iron Requirement, the Notice adopts a consistent approach to the Manufactured Product Requirement in Buy America Requirements. Specifically, the Manufactured Product Requirement is met if (i) all manufacturing processes for the Manufactured Product take place in the U.S. and (ii) all of the Manufactured Product Components of the Manufactured Product are of U.S. origin. For this purpose, U.S. origin means it is manufactured in the U.S., regardless of subcomponent origin.6

In other words, not only must a taxpayer show that the Manufactured Product is manufactured in the U.S., but in order for the Manufactured Product to count as U.S. manufactured for purposes of the Domestic Content Bonus, all of the Manufactured Product Components of the Manufactured Product must also be U.S. manufactured.

While this is undoubtedly a high bar to reach (and may result in many projects not qualifying for the Domestic Content Bonus), the Notice sensibly provides that any Manufactured Product Components that are U.S. manufactured may count as U.S. manufactured for purposes of calculating the Manufactured Product applicable percentage even if the Manufactured Product that they are a component of does not qualify. In other words, in determining whether a DC Project has satisfied the Manufactured Product Requirement, the cost of (i) U.S. Manufactured Products and (ii) Manufactured Product Components that are of U.S. origin comprising non-U.S. Manufactured Products, will be considered.

Also helpful is the description of costs which are taken into account for purposes of calculating the Manufactured Product applicable percentage: under the Notice, only direct materials and direct labor costs that are paid or incurred within Code section 461 are counted. Direct costs relating to incorporation of Manufactured Products into a project are not counted.

The Notice clarifies that a repowered project that meets the "80/20 Rule" may qualify for the Domestic Content Bonus if it otherwise satisfies the Domestic Content Bonus rules with respect to the new property. Depending on the repowering strategy used, this could result in a windfall for repowered projects.

To be eligible for the Domestic Content Bonus, taxpayers must submit a statement with its U.S. federal income tax return certifying, under penalty of perjury, that the project satisfies the Steel and Iron Requirement and the Manufactured Product Requirement (for PTCs, this is an annual requirement).

Finally, although light on details as to what is required, the Notice provides that taxpayers must keep sufficient records in accordance with Code section 6001 to substantiate eligibility for the Domestic Content Bonus.

The Notice states that the rules set forth therein are intended to be included in forthcoming proposed regulations with a proposed effective date of May 12, 2023. However, taxpayers may rely on the Notice to determine whether a project is eligible for the Domestic Content Bonus provided the project begins construction by the date that is 90 days after the date of publication of the proposed regulations.

1 For the PTC, the Domestic Content Bonus is an increase of 10% of the otherwise available credit.For the ITC, the Domestic Content Bonus is an additional ten percentage points of credit, reduced to two percentage points if the prevailing wage and apprenticeship requirements are not satisfied. See our prior coverage on the prevailing wage and apprenticeship requirements here.

2 The "adjusted percentage" is 40% for projects beginning construction before 2025, 45% in 2025, 50% in 2026 and 55% thereafter (and for offshore wind facilities: 20% for projects beginning construction before 2025, 27.5% in 2025, 35% in 2026, 45% in 2027 and 55% thereafter).

3 The Notice includes a helpful example illustrating this rule and the calculation of the applicable percentage for the Manufactured Product Requirement. See Notice 2023-38, Section 3.03(2)(d).

4 Chart is copied from Notice 2023-38, Section 3.04, Table 2.

5 Pursuant to the Notice, the "U.S." includes all 50 states, District of Columbia, Puerto Rico, Guam, American Samoa, the U.S. Virgin Islands, and the Northern Mariana Islands.

6 Note, if not manufactured in the U.S., a component may be treated as produced in the U.S. if it is mined domestically.

V&E Renewable Energy Update

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.