May 18, 2023 IRS issues guidance on domestic content bonus for clean energy project credits
In Notice 2023-38 (Notice), the IRS previewed the proposed regulations it intends to release on how taxpayers can qualify for the domestic content bonus for credits under IRC Sections 45, 45Y, 48 and 48E for qualified facilities, energy projects and energy storage technology. The Notice includes instructions on how to determine if the materials used in the projects meet the requirements, as well as recordkeeping and certification methods. To get the domestic content bonus, taxpayers must certify to the Treasury Secretary that (1) certain steel and iron components in their energy projects were manufactured in the United States and (2) at least 40% of the manufactured products (20% in the case of offshore wind facilities), including the components of those products, were produced in the United States (as determined by the Buy America Requirements). The IRS intends for the forthcoming proposed regulations to apply to tax years ending after May 12, 2023; taxpayers may rely on the Notice for any qualified facility, energy project or energy storage technology that begins construction no later than 90 days after the proposed regulations are published in the Federal Register. Qualifying projects The Inflation Reduction Act (IRA) added a domestic content bonus to certain energy credits that allows taxpayers to increase their tax credits by 10%, so long as they meet the requirements related to the applicable percentage of the total cost of components that are mined, produced or manufactured in the United States (see Tax Alert 2022-1236). The domestic content bonus applies to credits for:
Credit amount Qualifying projects under IRC Sections 48 and 48E get a 10% bonus (so, for example, a taxpayer that would get a 30% credit would get a 40% credit). If wage and apprenticeship requirements are not met, then the bonus would only be 2%. The increase to the IRC Sections 45 and 45Y credits are incremental, so the 10% increase would affect the amount per kWh. For example, if the taxpayer received a credit of 2.5 cents per kWh, the increased credit would result in 2.75 cents per kWh. Tax-exempt organizations and other direct pay-eligible entities must meet the requirements outlined in the Notice for projects that begin construction after December 31, 2023, or they could incur a 10% penalty under IRC Section 45(b)(10). The Notice does not address the "exceptions" to this rule that are outlined in IRC Section 45(b)(10)(D) or how those exceptions are expected to be implemented. Requirements for steel, iron and manufactured products For energy projects to comply with the new requirements, all of the steel and iron must be completely manufactured in the United States except for the "metallurgical processes involving refinement of steel additives." This requirement applies to construction materials made primarily of steel or iron that are "structural in function," but not to the steel and iron in manufactured product components or subcomponents (such as nuts, bolts, etc.). For manufactured products that are components of the energy project, 40% of the total cost of the product must comply with the new requirements (20% for offshore wind facilities). The percentage is gradually raised to 55% for projects that begin after 2026 (55% after 2027 for offshore wind facilities). A manufactured product is produced in the US if all of the manufacturing processes take place in the United States and all of the product components are of US origin. Components include any articles, materials or supplies that are incorporated into the manufactured product and may be of US origin if manufactured in the United States regardless of the origin of subcomponents. The percentage is determined by dividing the "domestic manufactured products and components cost" by the "total manufactured products cost," which results in the "domestic cost percentage." Only the direct material and labor costs, as defined in IRC Section 263A, are included in the "domestic manufactured products and components cost.". The Notice details how to make these calculations and provides an example calculation. Safe harbor The Notice establishes a safe harbor for certain components that may be found in energy projects. These components, which are automatically accepted as compliant for the domestic content bonus, may be found in (1) utility-scale photovoltaic (PV) systems, (2) land-based wind facilities, (3) offshore wind facilities and (4) battery energy storage technologies. The Notice has a table listing these components and whether they qualify as iron, steel or manufactured components. Retrofitted projects The Notice also allows qualifying projects that contain used property, which may not comply with the new requirements, to qualify for the domestic content bonus if the fair market value of the used property is not more than 20% the project's total value (80/20 Rule) and the new property meets the domestic content requirements. The cost of new property includes all costs properly included in the depreciable basis of the new property. Certification and substantiation requirements Taxpayers must submit to the IRS a Domestic Content Certification Statement for each project. The statement must include the information specified in the Notice, and taxpayers must attach it to Form 8835, Renewable Electricity Product Credit or Form 3468, Investment Credit (or any other applicable form) that is filed with the taxpayer's annual return for the first tax year in which the taxpayer reports a domestic content bonus credit amount. For subsequent years, taxpayers can attach a copy of the original certification statement. Taxpayers must meet general recordkeeping requirements under IRC Section 6001 to substantiate that the requirements have been met. Implications The Notice provides important preliminary guidance that will allow taxpayers investing in eligible types of renewable energy property to more confidently assess whether projects may be eligible for the domestic content bonus. While the guidance provides theoretical clarity on the domestic content requirements, the calculation is much more complicated than expected and will likely create some challenges in a real-world environment. For example, the guidance addresses how to categorize common solar, wind and energy storage components for purposes of the manufactured products requirements, but it is unclear how these requirements will apply to more complex renewable energy systems that typically include a significant number of components housed in iron and steel. Additionally, it may be difficult in practice to obtain the detailed cost information necessary to calculate the percentage of a project that is composed of domestic content. The development of a robust documentation package in support of the additional tax credit will likely change the information-sharing expectations between taxpayers, project developers and equipment vendors. While the safe harbor is helpful, it is likely not practical, and developers will have to think through the components for their manufactured products. For example, a solar PV project may have three steel/iron components, and two manufactured products, with one of those manufactured products (the PV module) potentially having many different components. Thus, the taxpayer would have to not only determine where the PV module was manufactured, but also where each of the components were made. Similarly, if an offshore wind developer secured the components for an export cable from multiple parties, the developer would have to check the products are compliant. Additionally, even if only one party supplied the cable, that party might have manufactured the components in different countries requiring the taxpayer to not only look at it at the product level but also by breaking it down into the individual components. In addition, the taxpayer would need to know the direct cost to the PV module maker of those components. One would assume that such information is normally highly confidential. Due to the complications, and the confidential nature of some of the information required to complete the calculation, it would make sense for developers to try to push the equipment sellers to provide them with all the necessary information and indemnify them for any issues resulting from that information. It remains to be seen whether equipment suppliers would be willing to take such actions. ———————————————
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor | ||||||||||||||||||||||||||
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