United States: Green projects get needed guidance on domestic content bonus credit

Tax News and Developments May 2023

In brief

Released 12 May 2023, Notice 2023-38 ("Notice") provides interim guidance on the "domestic content" bonus tax credit amounts available for facilities that generate electricity from renewable resources (e.g., wind and solar facilities) and certain energy storage property. The "domestic content" bonus incentivizes owners of green energy projects to utilize domestically-manufactured materials and components (including steel, iron, and "manufactured products") by offering them an additional incentive in the form of an increased tax credit for doing so.

Legislative Background

The Inflation Reduction Act (IRA) amended sections 45 and 48 and added new sections 45Y and 48E. The IRA also provides for several "bonus credits" to encourage certain taxpayer investments, including a "domestic content bonus credit", which increases the amount of tax credits for which a qualifying facility is eligible if certain requirements are met for US-sourced components. 

Section 45 provides taxpayers with a production tax credit for electricity produced by a qualified renewable energy facility owned by the taxpayer and sold to an unrelated party. The IRA amended section 45 to increase the amount of the section 45 credit by 10% if the qualified facility can show that all steel, iron, and "manufactured products" which are components of such facility upon completion of construction were produced in the United States (the "domestic content requirement"). For purposes of the domestic content requirement, a manufactured product is deemed to be produced in the United States if not less than an "adjusted percentage" of the total costs of the manufactured products of the facility are attributable to manufactured products (including components) which are mined, produced, or manufactured in the United States.

Section 45Y provides for a production tax credit for clean electricity generated by qualified facilities placed into service after 31 December 2024. Under section 45Y, qualification of the tax credit is technology neutral, meaning that a facility qualifies based on the lack of greenhouse gas emissions associated with the electricity generation process, rather than the specific technology used to generate power. The section 45Y credit amount is, however, likewise increased by 10% for qualified facilities that meet the domestic content requirement.

Section 48 provides a taxpayer with an investment tax credit equal to a percentage of the basis of qualifying property placed into service by the taxpayer during the taxable year. The IRA amended section 48 to increase the percentage used to calculate the section 48 credit for energy projects which meet the domestic content requirement.

Section 48E provides for a technology-neutral investment tax credit for qualified clean energy production facilities or energy storage property placed into service after 31 December 2024. This amount is increased for qualifying property which meet the domestic content requirement.

General Definitions

The Notice provides interim guidance on whether a credit-eligible facility, referred to as an "applicable project," meets the domestic content requirement and thereby qualifies for the domestic content bonus credit. It clarifies how "applicable project components" which are articles, materials, or supplies, whether manufactured or unmanufactured, that are directly incorporated into an Applicable Project are taken into account for purposes of this determination. Applicable project components are categorized as either (i) steel or iron that serves a structural function, or "manufactured products" that comprise the project. Articles, materials, or supplies, whether manufactured or unmanufactured, that are directly incorporated into an applicable project component that is a "manufactured product" are referred to as "manufactured product components".

Steel or Iron Requirement

For an applicable project to meet the domestic content requirement, all steel or iron used therein must be domestically produced. This means that all manufacturing processes with respect to applicable project components that serve a structural function and that made of steel or iron must take place in the United States. The sole exception to this rule is for metallurgical processes involving the refinement of steel additives. The steel or iron requirement does not apply to steel or iron used in manufactured product components or subcomponents of manufactured product components, such as nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges, and similar items made primary of steel or iron but are not structural in function.  

Manufactured Products Requirement

In addition, in order for an applicable process to qualify for the domestic content bonus, manufactured products that are applicable project components must be produced in the United States or deemed to be produced in the United States. A manufactured product is deemed produced in the United States if all of the manufacturing processes for the manufactured product take places in the United States and all of the manufactured product components of the manufactured product are of US origins. A manufactured product component is considered to be of US origin if it is manufactured in the United States, regardless of the origin of its subcomponents.  

All applicable project components that are manufactured products are deemed to be produced in the United States if the “adjusted percentage rule” is satisfied. For purposes of the adjusted percentage rule, a percentage is calculated by dividing the “domestic manufactured products and components cost” by the “total manufactured products” cost. The domestic manufactured products and components cost is the sum of the costs of an applicable project’s (1) US manufactured products that are applicable project components and (2) manufactured product components of non-US manufactured products that are applicable project components if the manufactured product components themselves are mined, produced, or manufactured in the United States.

The total manufactured products cost is the sum of the costs of each applicable project component that is a manufactured product.  

If the percentage calculated as described above is equal to or greater than the “adjusted percentage,” the manufactured products which are applicable project components are deemed to be manufactured domestically for purposes of the bonus credit. The adjusted percentage is 40% for qualified facilities the construction of which begins before 1 January 2025, and incrementally increases to 55% over time. In the case of offshore wind facilities, the adjusted percentage is 20% for facilities the construction of which begins before 1 January 2025, incrementally increasing to 55%.   

Safe Harbor

The Notice also provides a list of applicable project components in utility-scale photovoltaic systems, land-based wind facilities, offshore wind facilities, and battery energy storage systems and classifies these applicable project components into steel/iron structural elements and manufactured products. These applicable project components must meet the applicable steel or iron test or manufactured products test in order to meet the domestic content requirement.  

Retrofitted Projects

The Notice provides guidance on how retrofitted projects can qualify for the new credits and the domestic content bonus credits even though they may contain used property. Generally, a retrofitted project qualifies as newly placed in service, and therefore as qualifying for tax credits in the same manner as a newly-constructed project, if the fair market value of the used property comprising the retrofitted project does not exceed 20% of the applicable project’s total value, calculated by adding the cost of new property to the value of the old property. A retrofitted project placed in service after 31 December 2022 that meets the foregoing test will also be eligible for the domestic content bonus credit amount if the new property used to retrofit that project meets the domestic content requirement.  

What's Next

Treasury and the IRS intend to issue proposed regulations consistent with the Notice that will apply to tax years ending after 12 May 2023. Taxpayers may rely on the interim guidance until 90 days after proposed regulations are published. While the IRS and Treasury have not established a formal consultation for this Notice, interested stakeholders should consider submitting comments on the contents of the Notice and the proposed regulations.

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