The Inflation Reduction Act combined two somewhat competing concepts in changes to the Clean Vehicle Credit. First, it wanted to provide a significant credit for the move to electric vehicles that were better for the environment. Second, it wanted to promote domestic development and manufacture of those vehicles and their components to help the U.S. economy.
As the Internal Revenue Service develops guidance to implement these statutory requirements, it is finding it necessary to make some compromises to keep the promotion of domestic production and development from preventing electric vehicles from qualifying for the credits designed to promote their sale.
Late in 2022, the IRS addressed the requirement that the clean vehicles be assembled in North America. Early in 2023, the IRS adopted guidance on the requirements that a slowly rising percentage of the battery components be manufactured or assembled in the U.S. That percentage was 50% for 2023.
The IRS also adopted guidance on the requirements that the critical minerals in the battery be either extracted or processed in the U.S. or any country with which the U.S. has a free trade agreement in effect, or that the critical minerals be recycled in North America. That percentage was 40% for 2023. The IRS delayed implementation of battery component and critical mineral requirements until April 16, 2023, reflecting in part its own delay in issuing the relevant guidance.
In late 2023, the agency addressed the final of these requirements for the Clean Vehicle Credit — complying with the foreign entity of concern requirement — through the issuance of proposed regulations from the Treasury and the Department of Energy and Revenue Procedure 2023-38.
Foreign entity of concern
Under the legislation, a vehicle will not qualify for the clean vehicle credit if the vehicle's battery does not comply with the "foreign entity of concern" requirements. This is effective for the battery components for any clean vehicle that is placed in service after Dec. 31, 2023, and effective for the critical minerals for any clean vehicle placed in service after Dec. 31, 2024.
The proposed definition of an FEOC is an entity either controlled by or subject to the jurisdiction of a covered national government, at present including China, Iran, North Korea and Russia. The entity is considered owned or controlled by a foreign entity of concern if 25% or more of the entity's board seats, voting rights, or equity interest are cumulatively held by a covered national government or another foreign entity of concern. It could also apply to subnational governments and certain political individuals. Control could also be established through licensing or other contractual agreements. The main foreign entities of concern for clean vehicles would likely revolve around China.
Other defined terms in the proposed regulations include "foreign entity," "subject to the jurisdiction," "owned by, controlled by or subject to the direction," and "government of a foreign country."
Due diligence requirements
Qualified manufacturers have the burden to show that the battery components and critical minerals are FEOC-compliant. This involves being able to trace those battery components and critical minerals back to their point or origin.
Due to the inability under current standards to trace certain low-value battery materials with precision, the proposed regulations allow qualified manufacturers to exclude certain identified nontraceable materials until 2027.
Due diligence generally requires the physical tracing of battery components and critical minerals to specific battery cells and the physical tracing of battery cells and battery components to specific batteries. Under a temporary rule, through December 2026, where physical tracing may not be possible, a battery cell may be deemed to be FEOC-compliant through allocating the available mass of applicable minerals and materials specific to battery cells assembled or manufactured at that facility.
Manufacturers seeking to take advantage of the clean vehicle credit will need to develop detailed verification and tracking procedures. Subcontractors must be contractually required to provide similar due diligence information to the manufacturer. Effective in 2025, qualified manufacturers must submit a compliant-battery ledger to the IRS listing the number of compliant batteries, and make updates through written reports.
Rev. Rul. 2023-38
Revenue Ruling 2023-38, issued at the same time as the proposed regulations, addresses the reporting, certification and attestation requirements for the clean vehicle credit. It similarly addresses those same issues for the previously-owned clean vehicle credit and the clean commercial vehicle credit.
Summary
The proposed regulations and revenue procedure provide much-needed guidance of the FEOC requirements, but also highlight the significant burden placed on qualified manufacturers to meet these requirements and to prepare to meet further requirements as they are phased in.
The IRS has identified a number of areas in which it has invited additional comments on the proposed regulations for possible modifications or further clarity in the final regulations. Qualified manufacturers may rely on the proposed regulations until the final regulations are issued.
The IRS anticipates beginning upfront review of the certification and documentation requirements for clean vehicles placed in service after Dec. 31, 2024.
