On May 12, 2023, the U.S. Internal Revenue Service (IRS) and the Department of the Treasury (Treasury) released Notice 2023-38 (the Notice), which provides highly anticipated guidance regarding the “bonus” tax credits provided by the Inflation Reduction Act of 2022 (IRA) to renewable energy projects satisfying the so-called “domestic content” requirement.
The Notice provides helpful framework to determine the cost counted toward the required threshold of U.S. manufactured products and includes a safe harbor provision and examples. Certain aspects of the guidance, however, might trigger commercial challenges that may affect the financing of such projects and create difficulties for developers and manufacturers in their efforts to meet these requirements.
Treasury intends to include this guidance in forthcoming proposed regulations, which will apply to taxable years ending after May 12, 2023. Taxpayers may rely on the guidance included in the Notice with respect to any eligible project the construction of which begins before the date that is 90 days after the date the proposed regulations are published.
Background
As discussed more fully here, the IRA provides incremental tax credits, or “adders,” for certain renewable projects that are placed in service after 2022, including an adder for projects that meet certain “domestic content” requirements. Projects qualifying for production tax credits (PTCs) under Section 45 and new Section 45Y and investment tax credits (ITCs) under Section 48 and new Section 48E could qualify for an increased credit if they satisfy the domestic content requirement.1
Generally, to qualify for this adder, taxpayers must meet two requirements. First, 100% of any relevant steel or iron that is a component of the completed facility must be produced in the United States2 (the Steel or Iron Requirement). Second, “manufactured products” that are components of the completed facility must be produced in the United States (the Manufactured Products Requirement).
As such, for a project to be eligible for the Domestic Content adder, the taxpayer must first identify each “Applicable Project Component” (i.e., any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into an eligible project). Second, the taxpayer must determine whether a particular Applicable Project Component is subject to the Steel or Iron Requirement or the Manufactured Products Requirement. Third, it must be determined that the relevant Applicable Project Component satisfies the applicable requirement. If the identified steel and iron components, for example, are not 100% produced in the United States, then the project will not qualify for the domestic content adder. Finally, the taxpayer needs to timely submit a certification to the IRS and comply with certain recordkeeping requirements. Each of these requirements is described more fully below.
Determining Which Requirement Applies
Key to applying these rules is determining whether a particular Applicable Project Component is subject to the Steel or Iron Requirement or the Manufactured Products Requirement. Anticipating the uncertainty that is likely to arise in making that determination, the Notice provides a table identifying various Applicable Project Components that may be found (the Safe Harbor Table) in certain eligible projects and indicating whether those components should be tested under the Steel or Iron Requirement or the Manufactured Products Requirement. The Safe Harbor Table is shown below.
Table 2 – Categorization of Applicable Project Components
Applicable Project
Applicable Project Component
Categorization
Utility-scale photovoltaic system
Steel photovoltaic module racking
Steel/Iron
Pile or ground screw
Steel/Iron
Steel or iron rebar in foundation (e.g., concrete pad)
Steel/Iron
Photovoltaic tracker
Manufactured Product
Photovoltaic module (which includes the following Manufactured Product Components, if applicable: photovoltaic cells, mounting frame or backrail, glass, encapsulant, backsheet, junction box (including pigtails and connectors), edge seals, pottants, adhesives, bus ribbons, and bypass diodes)
Manufactured Product
Inverter
Manufactured Product
Land-based wind facility
Tower
Steel/Iron
Steel or iron rebar in foundation (e.g., spread footing)
Steel/Iron
Wind turbine (which includes the following Manufactured Product Components, if applicable: the nacelle, blades, rotor hub, and power converter)
Manufactured Product
Wind tower flanges
Manufactured Product
Offshore wind facility
Tower
Steel/Iron
Jacket foundation
Steel/Iron
Wind tower flanges
Manufactured Product
Wind turbine (which includes the following Manufactured Product Components, if applicable: the nacelle, blades, rotor hub, and power converter)
Manufactured Product
Transition piece
Manufactured Product
Monopile
Manufactured Product
Inter-array cable
Manufactured Product
Offshore substation
Manufactured Product
Export cable
Manufactured Product
If it is determined that a particular project includes Applicable Project Components that are not listed in the Safe Harbor Table, a factual determination will need to be made as to whether those Applicable Project Components are subject to the more restrictive Steel or Iron Requirement.
SIDLEY INSIGHT: The Notice’s inclusion of the Safe Harbor Table is extremely helpful insofar as it (i) defines a number of common project components as single Applicable Project Components, thereby eliminating the need to determine whether such components are one or more Applicable Project Components and (ii) eliminates any uncertainty in determining whether a particular Applicable Project Component is subject to the Steel or Iron Requirement or the Manufactured Products Requirement.
We note, however, that the Safe Harbor Table identifies and classifies only Applicable Project Components associated with wind and solar projects; it does not do the same for projects involving other eligible renewable technologies, such as biogas and fuel cell. Expanding this table in the proposed regulations to include Applicable Project Components associated with other technologies would be helpful.
In cases where the Safe Harbor Table does not address the classification of a particular component, there are several issues for which additional guidance would be welcome. First, it would be helpful if the proposed regulations included some examples illustrating how a determination is made that a particular component is an Applicable Project Component (as opposed to a subcomponent of a larger Applicable Project Component). Second, in determining whether an Applicable Project Component is subject to the Steel or Iron Requirement, it is unclear what it means to say that a component is (i) “made primarily of steel or iron” or (ii) is “structural in function.” It would be helpful if the proposed regulations included a percentage-based or some other formulaic standard and examples for determining whether something is made primarily of steel or iron. Similarly, additional guidance would be welcome on what it means to be “structural in function,” although the Safe Harbor Table does provide some insight into what Treasury considers to be “structural” components.
Steel or Iron Requirement
The Steel or Iron Requirement applies to any Applicable Project Components that (i) are construction materials, (ii) are made primarily of steel or iron, and (iii) perform a structural function. This requirement is satisfied if all manufacturing processes (other than metallurgical processes involving refinement of steel additives) take place in the United States. The Steel or Iron Requirement does not apply to steel or iron used in Manufactured Product Components or their subcomponents, as described more fully below, or to steel or iron that does not perform any structural function. Thus, the Notice specifically provides that “items such as nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges and similar items that are made primarily of steel or iron but are not structural in function are not subject to the Steel or Iron Requirement.”
SIDLEY INSIGHT: Consistent with the Buy America Requirements in 49 CFR §661.5, metallurgical processes are excluded as such processes occur after the initial refinement of steel and do not directly contribute to the production of steel.
Although it was previously assumed that a single nut, bolt, or screw that is not of U.S. origin should not prevent a project from qualifying for this adder, the Notice’s determination that such items are generally not subject to the Steel or Iron Requirement is helpful.
It is also important to note that for purposes of the Steel or Iron Requirement, the origin of the raw materials used to produce the iron or steel is not relevant. So foreign raw material would still meet this requirement if the manufacturing processes occurs in the United States.
SIDLEY INSIGHT: As suggested by the IRA’s inclusion of the Adjusted Percentage Rule, satisfaction of the Manufactured Products Requirement other than by application of that rule seems unlikely due to the fact that absent its application, all Manufactured Products would need to be produced in the United States. In this regard, the inclusion of the cost of U.S. components of a non-U.S. Manufactured Product in the numerator of the Adjusted Percentage Rule is a taxpayer-friendly rule, allowing taxpayers to partially benefit from the relevant manufactured products, even when not all components are manufactured in the United States.
However, the determination and calculation of the relevant costs of the Manufactured Products and their components, as required by the Notice, is likely to create significant challenges for developers and manufacturers and lead to uncertainty regarding projects’ eligibility for the domestic content adder, which may affect their financing.
First, likely the most significant challenge for manufacturers and developers is the way the Adjusted Percentage Rule is calculated (i.e., based on the manufacturer’s costs to manufacture the relevant components). As such, manufacturers will be required to provide taxpayers and investors information about their own direct costs. Manufacturers may be reluctant to provide details about their actual costs, as this is information they often deem to be proprietary and confidential.<
Second, even if a manufacturer may be willing to provide such information (and presumably, market forces will encourage manufacturers to do so), it may not currently have the relevant systems, procedures, and accounting processes in place to properly trace its direct labor and material costs to each specific component, which may limit their ability to provide such needed information without incurring significant incremental costs.
Third, from the perspectives of the developers and investors, the inclusion of only direct costs paid by the manufacturer, although generally consistent with the Buy American Requirements, requires a different approach than the approach taken in determining costs that are taken into account for other purposes, including the 5% safe harbor test for purposes of the “beginning of construction” requirement.
Finally, investors, developers and their advisers may face commercial and practical challenges in their due diligence efforts relating to the qualification of the project for the domestic content tax credit adder. Other than relying on the information, representations, and possibly certifications provided by the manufacturer, query how one can verify such information and perform its own due diligence on this issue. Even if a manufacturer agrees to provide the relevant required information, it may be reluctant to provide access to its internal documentation, books, and records that may be required to verify such information. Absent the ability to review the specific material and documentation substantiating such costs, the market may need to develop other approaches to determine compliance with these rules. With that in mind, IRS and Treasury should consider including in the proposed regulations certain safe harbors that would allow taxpayers to rely on certifications from its suppliers and manufacturers with respect to the domestic content adder. Until that time, and likely thereafter, certain tax insurance products may need to be developed and considered.
Retrofitted Projects
Retrofitted projects may qualify as originally placed in service if the fair market value of the used property is not more than 20% of the project’s total value calculated by adding the cost of the new property to the value of the used property (the 80/20 Rule).4 The Notice provides that projects placed in service after December 31, 2022, that meet the 80/20 Rule are eligible for the domestic content adder if the new property meets the domestic content requirements (i.e., the old property is not tested).
SIDLEY INSIGHT: This is a favorable result for retrofitted projects. Treasury could have taken other steps, such as limiting the adder to a percentage of the adder equal to the percentage of the project that is new property, or providing no exception for retrofitted projects, which may have old property made of foreign iron or steel or would not otherwise meet the recordkeeping requirements to establish that such old property meets the domestic content requirements.
The calculation of the applicable costs for purposes of the domestic content adder, as described above, is different and narrower than the calculation of the applicable costs for purposes of the 80/20 Rule (which is based on the acquisition cost and also takes into account indirect cost). Accordingly, taxpayers will need to develop different documentation, reporting, and analysis processes for each requirement.
Certification Procedures and Recordkeeping
When claiming a domestic content adder, a taxpayer must provide a Domestic Content Certification Statement certifying that as of the project’s placed-in-service date, any steel or iron items subject to the Steel or Iron Requirement or Manufactured Product subject to the Manufactured Product Requirement are properly treated as produced in the United States. The Domestic Content Certification Statement must be attached to Form 8835 – Renewable Electricity Product Credit, Form 3468 – Investment Credit, or other applicable form for reporting the domestic content adder for each year in the credit period.
In addition to the foregoing, the Domestic Content Certification Requirement must include the following information: (1) whether the project is a qualified facility, energy project, or energy storage technology, (2) the specific type of project (e.g. Utility-Scale Photovoltaic System or Battery Energy Storage Technology), (3) the geographic coordinates of an Applicable Project and the address of the Applicable Project, if applicable, (4) the date the project was placed in service, (5) the total domestic content adder amount determined under §§ 45(b)(9), 45Y(g)(11), 48(a)(12), or 48E(a)(3)(B) with respect to the project in the first taxable year in which the taxpayer reports a domestic content adder amount for such project, and (6) any additional information with respect to the project that is required by the applicable forms and instructions for reporting domestic content adder amounts determined under §§ 45, 45Y, 48, or 48E. The Domestic Content Certification Statement must be signed, under penalties of perjury, by a person with legal authority to bind the taxpayer.
In addition, a taxpayer claiming a domestic content adder must meet the general recordkeeping requirements under § 6001 of the Code and maintain records sufficient to substantiate any claimed domestic content bonus credit amount.
Conclusion
The domestic content adder could provide significant boost to renewable energy projects’ economics. The clarifications and processes provided in the Notice are critical and helpful guidance relating to the rules required to be met in order to be eligible for this adder.
However, some aspects of the Notice, especially the use of the manufacturer’s costs as the basis for the Adjusted Percentage Rule, may create significant challenges for taxpayers and manufacturers.
To allow taxpayers and projects to benefit from the domestic content adder in the manner intended by Congress, IRS and Treasury should consider including additional clarification and examples in the proposed regulations. Additional safe harbors should be added to address some of the unanswered questions and, more important, to allow developers, investors, and manufacturers to mitigate concerns and challenges they may face in determining the applicable costs of the relevant Manufactured Products and their components for purposes of the Adjusted Percentage Rule.
1 In the case of PTC-eligible projects, projects satisfying the domestic content requirement are entitled to additional credits equal to 10% of the credits otherwise available (i.e., 110% of the PTC amount). In the case of ITC-eligible projects, the percentage of eligible basis used in determining the ITC amount is increased by 10 percentage points (i.e., from 30% to 40%). The above assumes that the projects satisfy (or are exempt from) the prevailing wage and apprenticeship requirements. Projects that do not satisfy such labor-related requirements will be eligible only for an additional two percentage points in the case of ITC-eligible projects (i.e., from 6% to 8%) or 10% of the reduced PTC amount otherwise available (which equates to 2% of the full PTC amount) in the case of PTC-eligible projects. A project is exempt from the prevailing wage and apprenticeship requirements if (1) the project has a maximum net output of less than 1 megawatt of electrical (as measured in alternating current) or thermal energy or (2) construction of the project began before January 29, 2023 (discussed more fully here).
2 For the purpose of the Notice, United States includes the several States, the District of Columbia, the Commonwealth of Puerto Rico, Guam, American Samoa, the U.S. Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
3 Sections 45Y and 48E apply to projects placed in service after December 31, 2024, while Section 45 and 48 apply to projects that begin construction prior to January 1, 2025.
4 See Rev. Rul. 94-31, 1994-1 C.B. 16; Notice 2008-60, 2008-2 C.B. 178.
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