Treasury Issues Proposed Regulations on 45X Advanced Manufacturing Production Credit
On December 14, 2023, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued proposed regulations (the “Proposed Regulations”)1 providing additional guidance to taxpayers on the advanced manufacturing production credit (the “AMP Credit”) available under section 45X of the Internal Revenue Code of 1986, as amended (the “Code”).2 These proposed regulations will undoubtedly be subject to some change before being finalized.3
The Proposed Regulations, among other items, address certain key issues regarding the AMP Credit:
- What “produced by the taxpayer” means;
- Circumstances in which sales to related parties qualify for the Credit;
- Arrangements in which taxpayer can contract for the manufacture of eligible components with another taxpayer and which taxpayer would be entitled to the Credit;
- What costs are considered when determining the credit for the production of “electrode active materials” and “critical minerals”;
- Clarifying certain definitions and technical requirements for eligible components;4
- Specifying documentation and substation requirements; and
- Providing anti-abuse rules.
As background, the Inflation Reduction Act of 2022 (the “IRA”)5 added section 45X of the Code, which generally provides that taxpayers are eligible to receive the AMP Credit for any “eligible components” that are produced in the United States by such taxpayer and sold to an unrelated taxpayer.
“Eligible components” include close to two dozen different types of components and range from solar grade polysilicon to solar modules, electrolytes to battery modules, micro- to utility- scale inverters, offshore and onshore wind turbine components, and approximately fifty critical minerals. The total amount of AMP Credit per eligible component varies based on the component type, but may be based on (i) a dollar per kilogram amount (e.g., the AMP Credit amount for a torque tube is $2.28 per kilogram), (ii) a dollar per unit of capacity of the eligible component (e.g., the AMP Credit amount for a solar module is equal to $0.07 per direct current watt of capacity of such module), or (iii) ten percent of the costs incurred by the taxpayer to produce certain eligible components (i.e., electrode active materials and critical minerals).
The AMP Credit is available for components produced and sold after December 31, 20226 and will begin phasing out for eligible components sold in 2030 and will fully phase out in 2032. This phase out, however, does not apply to the AMP Credit for the production of critical minerals.
A summary of some of the more notable provisions in the Proposed Regulations follows.
“Production” Requires “Substantial Transformation”
The Proposed Regulations define “produced by the taxpayer” as a process 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.” The Proposed Regulations emphasize that “production” does not include minor assembly, superficial modification, or “partial transformations” that do not result in the substantial transformation of constituent elements, materials, or subcomponents into a complete and distinct eligible component.
The Proposed Regulations provide several examples of processes that would not be considered “production” for purposes of the AMP Credit:
- Producing one of three sections of a wind tower, where the remaining sections of the wind tower are produced by other taxpayers;
- Placing the casing on a battery module that already has cells, battery management systems, and other components integrated;
- Purchasing two finished halves of a wind turbine nacelle and combining them into a single nacelle;
- Purchasing dry cell batteries and filling the electrolyte; and
- Purchasing prefabricated wind turbine blades and applying paint and finishes.7
The Proposed Regulations also provide a useful confirmation that constituent elements, materials, and subcomponents of an eligible component do not need to be domestic.
Obviously, the determination of what constitutes a “production” will require a detailed and thoughtful analysis of a taxpayer’s activity at a facility. While not cited in the Proposed Regulations, caselaw and other authority under section 954 (which also turns on whether activities are considered a “transformation”) and under sections 199 and 263A (which use analogous definitions of “produced”) may provide useful points of reference in making the production determination.
Certain Sales to Related Persons Can Generate AMP Credits
The AMP Credit is only available for eligible components that are sold in a taxable year, and, generally, only for eligible components that are sold to an unrelated person. For purposes of section 45X, persons are treated as related to each other if they would be treated as single employer under section 52(b). In general, partnerships, trusts, estates, corporations, and sole proprietorships under common control are treated as related. However, there are several paths available for sales to related parties to still qualify for the AMP Credit.
For example, a sale to a related person will be treated as a sale to an unrelated person if the related person subsequently sells the eligible component to an unrelated person. In an example provided by the Proposed Regulations, X and Y are related persons, and Z is an unrelated person. X produces and sells battery cells — an eligible component — to Y in 2024. Y sells the battery cells to Z in 2025. X may claim the AMP Credit for battery cells in 2025, the taxable year in which the cells are sold by Y to an unrelated person.
The sale of incorporated eligible components to an unrelated person may also qualify for the AMP Credit under the Proposed Regulations. If, in the example above, Y incorporates the battery cells into battery modules — themselves eligible components — and sells the battery modules to Z in 2025, X and Y may each claim the AMP Credit in 2025 for the battery cells and battery modules, respectively (assuming both X and Y engaged in domestic “production” of the relevant eligible components). Similarly, if W is a related person to X and Y, W produces and sells electrode active material to X in 2023, and the electrode active material is incorporated into the battery cells, W, X, and Y would each be able to claim the AMP Credit in 2025, the year in which the sale to an unrelated person occurs, for electrode active material, battery cells, and battery modules respectively.
Taxpayers may also make a “Related Person Election” to treat the sale of an eligible component to a related person as a sale to an unrelated person such that a subsequent sale to an unrelated person is not necessary. If, in the above examples, X made a Related Person Election for 2024, X would be eligible to claim the AMP Credit in 2024 when it sold the battery cells to Y, rather than 2025 when Y sold the battery modules to an unrelated person Z. Similarly, if W made a Related Person Election for 2023, it would be eligible to claim the AMP Credit for electrode active materials in 2023, rather than 2025 when the battery module incorporating such electrode active material was ultimately sold to an unrelated person Z.
Use of Contract Manufacturing Agreements Permitted
Under the Proposed Regulations, the AMP Credit may be available for eligible components produced pursuant to a “Contract Manufacturing Agreement.”8 By default, the person who actually produces and sells the eligible component is entitled to the AMP Credit, but the parties to a Contract Manufacturing Agreement may determine by agreement which of the parties may claim the AMP Credit. In other words, the taxpayer that contracted for the manufacture of an eligible component pursuant to a Contract Manufacturing Agreement may claim the AMP Credit, even if that taxpayer did not actually produce the eligible component, if the parties so agree and satisfy certification requirements set forth in the Proposed Regulations.9
Definition of Cost Incurred for Critical Minerals and Electrode Active Materials May Include Certain Capital Expenditures
Under section 45X, the AMP Credit for critical minerals and electrode active materials equals 10% of costs incurred by the taxpayer in the production of such critical mineral or electrode active material. Until the Proposed Regulations, there was substantial uncertainty regarding what costs could be considered in determining the AMP Credit amount. The Proposed Regulations clarify that costs incurred includes “all costs as defined in §1.263A-1(e) that are paid or incurred within the meaning of section 461 of the Code by the taxpayer for the production of an applicable critical mineral only, except direct or indirect materials costs . . ., and any costs related to the extraction of raw materials.” In other words, costs incurred may include labor, electricity used in the production of the electrode active material or critical mineral, storage costs, depreciation or amortization, recycling, and overhead.
The “costs incurred by the taxpayer in the production” does not include the cost of acquiring raw materials, the cost of materials used for conversion, purification, or recycling of the raw material, and other costs in the nature of materials related to the production of critical minerals. For many taxpayers, “materials used for conversion, purification, or recycling” comprise a substantial portion of operational expenses relating to the production of critical minerals and electrode active materials.
Treasury expressed great concern over the potential for double counting if extraction or raw material costs were includable in the AMP Credit calculation and pointed out that double counting may occur if raw material costs were includable in some scenarios: e.g., if A produces a critical mineral and sells it to B, and B produces an electrode active material from such critical mineral, the critical material may be credited twice, once as the critical material eligible for the AMP Credit and then as an includable raw material cost for the electrode active material. However, Treasury appears very receptive to comments on the appropriate treatment of raw material and extraction costs in the AMP Credit, welcoming an “assessment of the magnitude of extraction costs and other direct and indirect material costs relative to the overall costs incurred in the production” of critical minerals and electrode active materials.
Overall, the clarification with respect to which costs are counted for purposes of the AMP Credit for critical minerals and electrode active materials is extremely useful for taxpayers, but we expect further refinement and clarification in the final regulations published by Treasury. While the apparent inclusion of certain capital expenditures in the AMP Credit calculation is a boon for taxpayers, it may be outweighed for some by the exclusion of major items of operational expenses.
Availability of AMP Credit Is Subject to Anti-Abuse Principles
Interestingly, the Proposed Regulations explicitly describe a purpose of the AMP Credit and provide a broad anti-abuse rule:
“[a] purpose of section 45X and the section 45X regulations (and the regulations in this chapter under sections 6417 and 6418 related to the section 45X credit) is to provide taxpayers an incentive to produce eligible components in a manner that contributes to the development of secure and resilient supply chains. Accordingly, the section 45X credit is not allowable if the primary purpose of the production and sale of an eligible component is to obtain the benefit of the section 45X credit in a manner that is wasteful, such as discarding, disposing of, or destroying the eligible component without putting it to a productive use.”
Whether an AMP Credit might be denied on anti-abuse principles is determined based on all facts and circumstances, but an example set forth in the Proposed Regulations describes a scenario in which a taxpayer produces an AMP Credit with a cost which is less than the amount of the AMP Credit and, under the facts set forth in that example, IRS would apply the anti-abuse rule and deny the AMP Credit to the taxpayer.
Similarly, in order to prevent abuse of the Related Person Election, the Proposed Regulations include an anti-abuse rule which denies the availability of the election if the components are improperly used or defective.
Lastly, throughout the Proposed Regulations, there are various rules regarding record keeping and substantiation requirements — including as to whether an eligible component meets the technical definition set forth in section 45X and the Proposed Regulations — meant to ensure that there is no abuse of the availability of the AMP Credit.
1 Proposed Regulation REG107423-23 (available here).
2 The Proposed Regulations were published in the Federal Register on December 15, 2023.
3 Treasury and IRS have requested comments on the Proposed Regulations and will accept comments received within 60 days after the date of publication to the Federal Register (i.e., February 13, 2024). A public hearing will be held on February 22, 2024.
4 For example, the Proposed Regulations explicitly state that that flow batteries and thermal batteries may be eligible for the AMP Credit as “battery modules without cells,” resolving substantial uncertainties for manufacturers of novel and emerging energy storage technologies.
Many of the definitions of the different eligible components have several requirements for eligibility, such as capacity ranges, required voltages, and, for some critical minerals, purity levels. This Alert does not list all of the relevant requirements and conditions for eligibility for the AMP Credit.
5 For our prior coverage of the IRA, see here.
6 The Proposed Regulations clarify that production of an eligible component may occur before January 1, 2023, so long as the sale occurs after December 31, 2022.
7 On the other hand, the Proposed Regulations appear to bless the use of recycled materials in a production process.
8 A Contract Manufacturing Agreement is defined broadly as an agreement or agreements for the production of an eligible component that is entered into before the production of the eligible component to be delivered under the contract is completed. They do not include routine purchase orders for off-the-shelf property, or agreements that can be satisfied out of existing stock or normal production of finished goods.
9 It is unclear from the Proposed Regulations how the allocation of AMP Credits by agreement between parties to a Contract Manufacturing Agreement will interact with transfer provisions under section 6418 and direct pay elections under section 6417. But, it would seem that whichever party is entitled to the AMP Credit under a Contract Manufacturing Agreement should be treated as the taxpayer for all purposes and be entitled to transfer the credit under section 6418 or elect direct pay under section 6417.
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.