The Treasury Department and the Internal Revenue Service (IRS) released IRS Notice 2023-38 (Notice) on May 12, 2023, providing interim guidance on domestic-content requirements under the Inflation Reduction Act (IRA). The Notice applies to the new bonus credit available for energy facilities, projects, and energy-storage technologies otherwise qualifying for the current or tech-neutral production tax credits (PTCs – sections 45 or 45Y) or the current or tech-neutral investment tax credits (ITCs – section 48 or 48E).1 While not specifically addressed, the Notice presumably also applies to the phase out of the direct-pay election for qualifying tax-exempt entities intending to monetize the applicable credits.
The Notice includes definitions and rules for determining whether an energy facility or project meets: (1) the 100% domestic-sourcing mandate for steel and iron and (2) the manufactured-products requirement, both of which must be satisfied to qualify for the bonus credit. The Notice bases the domestic-content rules on the Buy America Requirements administered by the Federal Transit Administration (FTA), which have long applied to federally funded transportation and mass-transit projects.2 While welcome news to energy-project developers, the interim guidance will require significant analysis of the myriad components and manufactured products comprising energy projects to ensure they meet the domestic-sourcing rules set out in the Notice to qualify for the bonus credit.
The Treasury Department and the IRS intend to reflect the interim guidance in proposed regulations on the domestic-content requirements, which are intended to apply to taxable years ending after May 12, 2023. In the interim, the Notice permits taxpayers to rely on the guidance with respect to energy facilities, projects or energy-storage technology that commence construction before the date that is 90 days after the proposed regulations are published in the Federal Register.
Unlike the other interim guidance that the Treasury Department and the IRS have released on IRA provisions, the Notice does not invite public comment nor offer areas where specific feedback is requested. Nevertheless, the Treasury Department and the IRS continue to engage with industries seeking to access tax credits under the IRA, and taxpayers should consider providing feedback on the Notice to take advantage of the continuing opportunity to influence the proposed and final regulations.
An energy facility, project, or energy-storage technology (referred to as an “Applicable Project”) satisfies the domestic-content requirement if it meets the Steel or Iron Requirement and the Manufactured Products Requirement, and the taxpayer satisfies the Certification Requirement, each of which is discussed below.
Steel or Iron Requirement – An Applicable Project satisfies the Steel or Iron Requirement if “all manufacturing processes with respect to any steel or iron items that are Applicable Project Components take place in the United States, except metallurgical processes involving refinement of steel additives.”3 An Applicable Project Component is “any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project.”4
The Notice indicates that the Steel or Iron Requirement applies to construction materials made primarily of steel or iron that are structural in function.5 However, the requirement does not apply to “steel or iron used in Manufactured Product Components or subcomponents of Manufactured Product Components.”6 Examples of steel or iron components that fall outside of the requirement include: “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. . . .”7
Based on this distinction, which is consistent with the FTA Buy America rules, the question for many taxpayers will be whether the steel or iron used in the Applicable Project is fundamentally structural – e.g., steel girders used in a building structure or iron rebar used in the foundation – or whether the steel or iron is really part of a manufactured product that is integrated into the Applicable Project.
Manufactured-Products Requirement – The Notice breaks the Manufactured Products Requirement into several component parts, which are critical to the determination of the adjusted percentage necessary for a manufactured product to meet the requirement.
- U.S. Manufactured Product: A manufactured product is considered to be produced in the United States if “all of the manufacturing processes for the Manufactured Product take place in the United States; and . . . all of the Manufactured Product Components of the Manufactured Product are of U.S. origin.”8 The Notice defines manufacturing process to mean “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.”9
- U.S. Component: Importantly, the Notice provides that a Manufactured Product Component is considered to be U.S. sourced if it is “manufactured in the United States, regardless of the origin of its subcomponents.”10 A component that is not manufactured is treated as a U.S. Component if it is mined in the United States.11
- Non-U.S. Manufactured Product: The Notice treats any manufactured product that fails to meet the first test – a product that includes a non-U.S. sourced component – as “non-U.S. manufactured product.
It is important to note that the Notice appears to adopt a broad view of manufacturing. Based on the definitions and the single example provided, an engineering or construction contractor in certain circumstances may be treated as the manufacturer of the product where the contractor is adding value and transforming material and/or other manufactured products into a new item that is functionally different from mere assembly of the component parts. The Notice, however, is far from clear with respect to the threshold for adding value and transforming materials – is the addition of significant labor and technical know-how sufficient?
Satisfying the Manufactured-Product Requirement – To meet the Manufactured Product Requirement, the product must meet one of two tests: (1) all of the project components are produced in the United States (which includes U.S. territories) or (2) the adjusted percentage of project components that are manufactured products are produced in the United States. For purposes of the current section 45 PTC and section 48 ITC, the adjusted percentage is 40% (20% for offshore-wind projects).12
To meet the first test, all of the project’s manufactured products must be U.S. Manufactured Products. They must be manufactured in the United States and consist of only U.S. sourced components (note that subcomponents are permitted to be foreign sourced).
To satisfy the second test, the cost of the project’s manufactured products, as a percentage of all the manufactured products in the project, must equal or exceed the 40% adjusted percentage (20% for offshore wind), determined as follows:
Cost of U.S. Manufactured Products plus
Cost of U.S. Components of Non-U.S. Manufactured Products
Cost of Total Manufactured Products
(U.S. and Non-U.S. Manufactured Products)
For purposes of determining the domestic-cost percentage, only the direct cost of manufactured products and components are included. Indirect costs, such as overhead and other costs ordinarily capitalized for tax purposes, are not taken into account.13
Safe Harbor for Classification of Components
Recognizing that there are gray areas between the Steel or Iron Requirement and the Manufactured Product Requirement, the Notice provides a safe-harbor for certain components that are typically found in utility-scale photovoltaic systems, land-based wind facilities, offshore wind facilities, and battery energy storage technologies.14 For example, the tower in a land-based wind facility is classified as steel/iron while the wind turbine and its components are manufactured products.
The Notice recognizes that the domestic-content bonus credit can apply to certain retrofitted projects otherwise qualifying under the PTC or ITC.15 In such case, the domestic-content requirement is satisfied if the fair market value of the used property is not more than 20% of the total cost, and the new property meets the domestic-content rules.
Taxpayers claiming the domestic-content bonus credit must include a statement certifying that the project satisfies the Steel or Iron Requirement and the Manufactured Product Requirement as of the date that the project is placed in service.16 The Notice provides specific high-level information that must be included in the domestic-content certification.17 Importantly, for purposes of the timing for the certification, the Notice provides that “an Applicable Project is considered placed in service for purposes of this notice is the date on which such property is placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business or in the production of income.”18
THIS DOCUMENT IS INTENDED TO PROVIDE YOU WITH GENERAL INFORMATION REGARDING IRS AND TREASURY GUIDANCE ON DOMESTIC PRODCUTION PASSAGES OF THE IRA. THE CONTENTS OF THIS DOCUMENT ARE NOT INTENDED TO PROVIDE SPECIFIC LEGAL ADVICE. IF YOU HAVE ANY QUESTIONS ABOUT THE CONTENTS OF THIS DOCUMENT OR IF YOU NEED LEGAL ADVICE AS TO AN ISSUE, PLEASE CONTACT THE ATTORNEYS LISTED OR YOUR REGULAR BROWNSTEIN HYATT FARBER SCHRECK, LLP ATTORNEY. THIS COMMUNICATION MAY BE CONSIDERED ADVERTISING IN SOME JURISDICTIONS.
1 Unless otherwise specified, all “section” references are to sections of the Internal Revenue Code of 1986, as amended.
2 See 49 C.F.R. §§ 661.1 through 661.21.
12 The same adjusted percentages apply to the tech-neutral ITC under section 48E. Note, however, that the tech-neutral PTC under section 45Y includes an escalating percentage that caps out at 55% for qualified facilities that begin construction after 2026 (and for qualified offshore-wind facilities that begin construction after 2027). See Notice § 2.02.
13 Id. at §§ 3.03(2)(b) and (c).