Tax Strategy: Proposed regs for the Clean Vehicle Credit

The Inflation Reduction Act created a new Clean Vehicle Credit that included several new requirements to qualify for the credit, including North American final assembly, manufacturer's suggested retail price limits, purchaser modified adjusted gross income limits, and critical minerals and battery component requirements for the vehicle battery. 

In order to qualify for the $7,500 maximum credit, $3,750 of the credit must meet the critical minerals requirements, and $3,750 must meet the battery component requirements. Under the act, starting in 2023, in order to qualify for the critical minerals requirement, 40% of the critical minerals contained in the battery must be extracted or processed in the U.S. or any country with which the U.S. has a free trade agreement, or be recycled in North America. The percentage increases gradually to 80% by 2027. The $3,750 portion of the credit with respect to battery components requires that 50% of the components be manufactured or assembled in North America, with the percentage increasing over time to 100% in 2029. 

The act had directed the IRS to issue guidance on the CVC requirements by Dec. 31, 2022. The IRS was not able to issue proposed regulations on the crucial minerals and battery component requirements until March 31, 2023, and postponed application of those requirements until after their publication in the Federal Register on April 17, 2023. 

Critical minerals requirement

The proposed regulations provide a three-step process for determining the percentage of the critical minerals component of the battery:

1.  Determine the procurement chain for each critical mineral. This could be a complicated process as those chains may have many components, and there may be efforts to conceal the true source of some of those critical minerals.
2. Identify qualifying critical minerals. For 2023 and 2024, the proposed regulations consider a critical mineral to meet the test if at least 50% of the value added by extracting, processing or recycling the mineral occurs in a qualifying country. The proposed regulations indicate that a stricter requirement will apply after 2024.
3. Calculate the percentage value of the qualifying critical minerals content.

The proposed regulations define a number of terms with respect to the critical minerals requirements:

1. Extraction: This refers to physical processes.
2. Processing: This refers to non-physical processes, such as chemical and thermal processes.
3. Constituent materials: This refers to the final processing.
4. Recycling.
5. Value: This is defined as an arms-length price.
6. Value added.
7. Free trade agreement: The proposed regulations identify 20 countries with which the U.S. has a free trade agreement. The list does not include the European Union. However, the regulations also propose criteria for adding additional countries in line with the recent critical minerals agreement between the U.S. and Japan. Senator Joe Manchin, D-West Virginia, has expressed concern about too liberal an interpretation of this requirement watering down the effort to develop U.S. sources of critical minerals, which he says was the intent of the act.
8. Qualifying critical mineral content: This definition discusses selecting a uniformly applied date to determine value or an average value over a limited period of time.

Alex Kraus/Photographer: Alex Kraus/Bloombe

Battery component requirement

The proposed regulations set forth a four-step process for determining the qualifying battery components:

1.  Identify components manufactured or assembled in North America. This includes definitions of "battery," "battery cell," "battery component," "manufacturing," and "assembly."
2. Determine the incremental value of each battery component and North American battery component. This includes definitions of "incremental value" and "total incremental value of North American battery components."
3. Determine the total incremental value of battery components.
4. Calculate the percentage of qualifying battery component content.

Foreign entities of concern

Another important limit in the act involves "foreign entities of concern." This includes Russia, Iran, China, and North Korea. The act states that the Clean Vehicle Credit does not apply to vehicles containing battery components manufactured or assembled by a foreign entity of concern starting in 2024 and vehicles containing critical minerals extracted or processed by a foreign entity of concern starting in 2025. This applies without any percentage limits. China currently plays a dominant role in the extraction and processing of critical minerals. 

The proposed regulations indicate that the Treasury will address the foreign entities of concern issue at a later date.

Qualifying vehicles

The site fueleconomy.gov provides a list of the specific makes and models of clean vehicles that meet the critical mineral and/or battery component requirements. For vehicles placed in service on or after April 18, 2023, models of vehicles listed as possibly qualifying for the credit include the Cadillac Lyriq, the Chevrolet Bolt and Bolt EUV, the Ford E-Transit, F-150 Lightning (standard range and extended range batteries), the Mustang Mach-E (standard and extended range batteries), and the Tesla Model 3 Performance and Standard Range Rear Wheel Drive and Model Y All-Wheel Drive, Long Range All-Wheel Drive, and Performance. Some of these vehicles only potentially qualify for half of the credit, $3,750.  There are currently no foreign vehicles on this list.

Summary

There is clearly going to be a balancing act between making the Clean Vehicle Credit widely available as soon as possible to promote the use of clean vehicles, and promoting the development of the U.S. as a location for increased critical mineral and battery component sourcing, as well as final assembly. 

As of April 18, 2023, we should have available a list of vehicles that qualify under the critical minerals and battery component requirements of the CVC, as well as the other requirements of the credit, including the final assembly in North America requirement. Many electric vehicles are not expected to initially qualify for the credit, and it may take several years for manufacturers to be able to meet the requirements. The proposed regulations also address how the CVC coordinates with other credits. 

Comments on the proposed regulations in several specified areas are requested by June 16, 2023, including the definitions around critical minerals and battery components; the 50% value-added test for 2023 and 2024 and what should be done for later years; the countries that should be allowed free-trade agreement status and under what terms; and whether the rules that apply to partnerships and S corporations being able to pass the credit to their partners or members and shareholders should apply to trusts and similar entities. 

The proposed regulations generally apply to new clean vehicles placed in service after April 17, 2023, the date that the proposed regulations were scheduled to be published in the Federal Register.