Summary

On December 15, 2023, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued a notice of proposed rulemaking (the Proposed Regulations) regarding the advanced manufacturing production credit under Section 45X of the Internal Revenue Code of 1986, as amended (the Code) pursuant to changes authorized by the Inflation Reduction Act of 2022 (IRA). These Proposed Regulations provide updated rules regarding the production and sales of eligible components and applicable critical minerals to unrelated persons, including new substantiation requirements for credit eligibility.

Section 45X provides a production tax credit for the domestic manufacturing of certain components for solar, wind, and energy storage projects, and applicable critical minerals. Except with respect to applicable critical minerals, the Section 45X credit phases down beginning in 2030 and fully phases out by 2032. The amount of the Section 45X credit varies depending on the component produced and sold.

Key Takeaways

The Proposed Regulations:

• clarify the general rules for claiming Section 45X credits, including contract manufacturing agreements, production and sale requirements, and specific exclusions to credit eligibility;
• provide rules regarding sales to related persons and clarify the establishment and requirements for the “related person election” with respect to eligible components;
• provide definitions for eligible components, including solar components, wind components, inverters, and battery components;
• introduce anti-abuse rules meant to prevent taxpayers from improperly claiming credits for sales of eligible components not for productive use; and
• provide new substantiation requirements for eligible components and applicable critical minerals.

A hearing on the Proposed Regulations is scheduled for February 22, 2024, with a deadline for public comments of February 13, 2024.

General Rules and Definitions

Overview. Proposed Regulation § 1.45X-1(a) would provide general rules regarding eligibility for the Section 45X credit. Generally, a taxpayer must produce and sell an “eligible component” to an unrelated party to qualify for the credit. Proposed Regulation § 1.45X-1(c) would provide a definition for the term “produced by the taxpayer” for primary and secondary production and clarify which taxpayer may claim the Section 45X credit with respect to contract manufacturing arrangements (CMA).

Exclusions. The Proposed Regulations clarify that partial transformation that does not result in a substantial transformation of inputs into a complete and distinct eligible component is not included in the definition of “produced by the taxpayer.” Minor assembly of inputs and superficial modifications of a final eligible component are also excluded from eligibility for Section 45X credits.

Contract manufacturing. Proposed Regulation § 1.45X-1(c)(3) would provide that if the production of an eligible component is performed, in whole or part, under a CMA, then the party to such contract that may claim the Section 45X credit is the party that performs the actual production activities that bring about a “substantial transformation resulting in the eligible component.” Proposed Regulation § 1.45X-1(c)(3)(ii)(B) would define “contract manufacturing arrangement” to mean any agreement providing for the production of an eligible component if the agreement is entered into before the production is completed. This definition would exclude routine purchase orders for off-the-shelf property, where a contractor is required to make no more than de minimis modifications to the property. Further the Proposed Regulations provide a special rule to allow parties to a CMA to determine which party will claim the Section 45X credit, the certification requirements for this special rule, and examples to elaborate on how to apply the special rule.

Production in the United States. Proposed Regulation § 1.45X-1(d)(1) would provide that sales are eligible for Section 45X credits only for eligible components produced within the United States under Section 638(1), or a possession of the United States as defined under Section 638(2). Proposed Regulation § 1.45X-1(d)(2) would clarify that constituent elements, materials, and subcomponents used in the production of eligible components are not subject to the domestic production rule.

Production and sale in a trade or business. Proposed Regulation § 1.45X-1(e) would provide that an eligible component must be produced and sold in a “trade or business” of the taxpayer, as defined under Section 162 of the Code.

Integrated, incorporated, or assembled. Proposed Regulation § 1.45X-1(f) would provide that a taxpayer is deemed to have produced and sold an eligible component to an unrelated person if such a component is integrated, incorporated, or assembled into another eligible component that is then sold to an unrelated person. “Integrated, incorporated, or assembled” is defined to mean production activities by which components are substantially transformed into a complete and distinct eligible component, functionally different from a mere assembly or superficial modification.

Interaction between Section 48C and Section 45X. Proposed Regulation § 1.45X-1(g)(1) would provide that an eligible component must be produced at a Section 45X facility and cannot include property that is included in a Section 48C facility. Proposed Regulation § 1.45X-1(g)(2)(i) would define a Section 45X facility to include all tangible property that comprises an independently functioning production unit that produces one or more eligible components.

Anti-abuse rule. Proposed Regulation § 1.45X-1(i)(1) would provide an anti-abuse rule that would make the Section 45X credit unavailable in “extraordinary circumstances” in which, based on a facts and circumstances inquiry, the primary purpose of the production and sale of an eligible component is to obtain the benefit in a manner that is wasteful (e.g., discarding, disposing of, or destroying the eligible component without putting it to productive use).

Sales to an Unrelated Person

Overview. Proposed Regulation § 1.45X-2(b) would provide definitions of the terms “person,” “related person,” and “unrelated person.”

Special rule for a sale to a related person. Proposed Regulation § 1.45X-2(c) would provide, pursuant to Section 45X(a)(3)(A), a special rule and example for a taxpayer to treat a sale of an eligible component to a related person as if they had sold such component to an unrelated person.

• The related person election. Section 45X(a)(3)(B)(i) provides that, at the election of the taxpayer, a sale of components by such taxpayer to a related person is treated as if made by the taxpayer to an unrelated person. Proposed Regulation § 1.45X-2(d)(2) would provide that a taxpayer must make an affirmative election annually (in the form and manner prescribed in guidance, which is currently Form 7207 (Advanced Manufacturing Production Credit)) with a timely filed original U.S. federal income tax return, including extensions (the “Related Person Election”). The full scope and effect of the Related Person Election would be clarified by Proposed Regulation § 1.45X-2(d)(3), which would apply to all sales to related persons, including between members of the same consolidated group and to partnerships. With respect to consolidated groups, Proposed Regulation §§ 1.45X-2(d)(2) and -(3)(i) provide that the Related Person Election is made by an agent for the group and would be filed with the group’s consolidated return. A separate election would be required for each member claiming the credit and must include the name and employer identification number of the agent of the group and the member on whose behalf the form is filed. The election would be irrevocable for that taxable year and would apply solely for purposes of the Section 45X credit.
• Anti-abuse rule for the related person election. Proposed Regulation § 1.45X-2(d)(4) would provide an anti-abuse rule that would prohibit the Related Person Election in extraordinary cases where a taxpayer seeks to improperly exploit the Section 45X regime. Here, Treasury and the IRS are concerned that the Related Person Election may be abused by enabling related parties to sell “defective” eligible components. Proposed Regulation § 1.45X-2(d)(4)(iii) would address these concerns by eliminating credit availability for components that are not capable of being used for their intended purposes within the meaning of Section 45X.
• Related person sale of integrated components. Proposed Regulation § 1.45X-2(e)(1) would provide that a person is treated as having sold an eligible component to an unrelated person if such component is integrated, incorporated, or assembled into another eligible component that is subsequently sold to an unrelated person. The credit would arise upon such subsequent sale.

Eligible Components

Overview. Proposed Regulation § 1.45X-3 would provide definitions for components, rules for determining credit amounts, documentation requirements, and phase out provisions. Proposed Regulation § 1.45X-4 would provide information for applicable critical minerals.

In general, the Proposed Regulations provide rules for five categories of components and their various forms:

• Inverters. A project component that is used to convert direct current electricity from one or more solar modules or certified distributed wind energy systems into alternating current electricity. The Proposed Regulations provide guidance with respect to each of the following types of inverters: central inverters, commercial inverters, distributed wind inverters, microinverters, residential inverters, and utility inverters.
• Solar energy components. As provided in Section 45X, eligible solar energy components include the following: solar modules, photovoltaic cells, photovoltaic wafers, solar grade polysilicon, torque tubes, structural fasteners, and polymeric backsheets.
• Wind energy components. As provided in Section 45X, eligible wind energy components include the following: blades, nacelles, towers, offshore wind foundations, and related offshore wind vessels. 
• Battery components. Both Section 45X and the Proposed Regulations provide specific rules with respect to each of electrode active materials, battery cells, and battery modules.
• Applicable critical minerals. As specified in Section 45X, applicable critical minerals includes a list of 50 minerals, such as lithium and zinc.

Inverters. Proposed Regulation § 1.45X-3(d) would define the term “inverter” as an end product that is suitable to convert DC electricity from one or more solar modules or certified distributed wind energy systems into AC electricity. An “end product” is suitable to convert DC electricity from one or more solar modules or certified distributed wind energy systems into AC electricity if it is able to connect with such modules or systems and convert DC electricity to AC electricity from such connected source. Proposed Regulation § 1.45X-3(d) would define an “inverter” as including each of “central inverter,” “commercial inverter,” “distributed wind inverter,” “microinverter,” and “residential inverter.”

• Microinverters. Proposed Regulation § 1.45X-3(d)(2)(i) would clarify that an inverter is suitable for large utility-scale systems if it is capable of serving as a component in a large utility-scale system and meets the core engineering specifications for such application. Proposed Regulation § 1.45X-3(d)(5) would clarify that a direct current optimized inverter system (DC optimized inverter system) may qualify as a microinverter. Proposed Regulation § 1.45X-3(d)(5)(i) would define a microinverter as an inverter that is suitable to connect with one solar module, has a rated output of 120- or 240-volt single-phase power, or 208- or 480-volt three-phase power, and has a capacity, expressed on an AC watt basis, that is not greater than 650 watts. In general, the credit amount for each type of inverter would be equal to the product of the inverter’s total rated capacity and the amount prescribed in Section 45X(b)(2)(B) for a given inverter. Proposed Regulation § 1.45X-3(d)(5)(iv)(B) would clarify how to determine the credit amount of a DC optimized inverter system that qualifies as a microinverter. For DC optimized inverter systems, the credit amount is the lesser of 1) the sum of the AC capacity of each DC optimizer that is paired with an inverter in a combined DC optimized inverter system or 2) the AC capacity of the inverter itself in the combined system. Taxpayers must produce and sell the inverter and the DC optimizers in the DC optimized inverter system together as a single end product to qualify for the Section 45X credit. Proposed Regulation § 1.45X-3(d)(5)(iii)(C) would clarify that, similar to a DC optimized inverter system, a “multi-module inverter” may also qualify as a microinverter. A “multi-module inverter” means an inverter that is comprised of an inverter with independent connections and DC optimizing components for two or more modules. Proposed Regulation § 1.45X-3(d)(5)(iv)(C) would provide that the credit amount for a multi-module inverter that qualifies as a microinverter is equal to the product of 11 cents multiplied by the total AC capacity of the DC optimizers in the multi-module inverter when paired with the inverter in the multi-module inverter. Proposed Regulation § 1.45X-3(d) would generally require taxpayers to document whether an inverter is suitable to or suitable for a statutorily required use or application, the inverter’s rated output, and the inverter’s capacity, as applicable, in a specification sheet, bill of sale, or other similar documentation.

Solar energy component. Proposed Regulation § 1.45X-3(b) would define solar energy component as a solar module, photovoltaic cell, photovoltaic wafer, solar grade polysilicon, torque tube, structural fastener, or polymeric backsheet. The Proposed Regulations would also clarify the calculation of the credit amount for each type of solar energy component. Proposed Regulation §§ 1.45X-3(b)(1)(ii) and -(b)(5)(ii) would require the capacity of a solar module or photovoltaic cell to be determined by the nameplate capacity in direct current (DC) watts using Standard Test Conditions, as defined by the International Electrotechnical Commission. Documentation requirements with respect to solar energy components are also enumerated under Proposed Regulation § 1.45X-3(b), e.g., a structural fastener that meets certain requirements must be described in a bill of sale or other similar documentation.

Wind energy component. Proposed Regulation § 1.45X-3(c) would define the term “wind energy component” as a blade, nacelle, tower, offshore wind foundation, or related offshore wind vessel. Proposed Regulation § 1.45X-3(c)(4)(i) would clarify that a “vessel” within the context of an “offshore wind vessel,” is purpose-built for development, transport, installation, operation, or maintenance of offshore wind energy components if it is built to be capable of performing such functions and is of a type that is commonly used in the offshore wind industry. In addition, a “vessel” is retrofitted for development, transport, installation, operation, or maintenance of offshore wind energy components if such vessel was incapable of performing such functions prior to being retrofitted, the retrofit causes the vessel to be capable of performing such functions, and the retrofitted vessel is of a type that is commonly used in the offshore wind industry. Proposed Regulation § 1.45X-3(c) would clarify the calculation amounts for different components, based on the total rated capacity of the completed wind turbine for which such component is designed. For a related offshore wind vessel, the credit amount is equal to 10 percent of the sales price of the vessel, not including services or maintenance fees associated with such sale. In the event a Related Person Election has been made with respect to an offshore wind vessel, the election does not treat the sale price as an arm’s length price pursuant to Section 482 of the Code. Proposed Regulation § 1.45X-3(c)(7) would require taxpayers to document the turbine model for which such component is designed and the total rated capacity of the completed wind turbine in technical documentation associated with the sale of such component.

Battery components. Proposed Regulation § 1.45X-3(e)(1) would define the term “qualifying battery component” as electrode active materials, battery cells, or battery modules. Proposed Regulation § 1.45X-3(e)(2)(i)(A) would define the term “electrode active materials” to include cathode electrode materials, anode electrode materials, and electrochemically active materials that contribute to the electrochemical processes necessary for energy storage. Proposed Regulation § 1.45X-3(e)(2)(v) would clarify that a taxpayer may claim only one Section 45X credit with respect to a material that qualifies as both an electrode active material and an applicable critical mineral. Proposed Regulation § 1.45X-3(e)(2)(i)(A) would provide that the following materials in a battery or vehicle would not qualify as an electrode active material: battery management systems, terminal assemblies, cell containments, gas release valves, module containments, module connectors, compression plates, straps, pack terminals, bus bars, thermal management systems, and pack jackets.

• Production costs incurred. Proposed Regulation § 1.45X-3(e)(2)(ii) would provide that for an electrode active material the credit amount is equal to 10 percent of the costs incurred by the taxpayer with respect to production of such materials. Proposed Regulation § 1.45X-3(e)(2)(iv) would clarify that the costs incurred for purposes of determining the credit amount includes costs as defined in Regulation § 1.263A-1(e) that are paid or incurred within the meaning of Section 461 of the Code by the taxpayer for the production of an electrode active material only. Therefore, production costs for purposes of Section 45X would not include any costs incurred after the production of the electrode active material. Further, direct material costs, as defined in Regulation § 1.263A-1(e)(2)(i)(A), or indirect material costs, as defined in Regulation § 1.263A-1(e)(3)(ii)(E), and any costs related to the extraction or acquisition of raw materials would not be taken into account as production costs.
• Includible production costs. A wide range of costs that are attributable to the production of an electrode active material would be taken into account as a cost incurred in producing the electrode active material, including, but not limited to, labor, electricity used in the production of the electrode active material, storage costs, depreciation or amortization, recycling, and overhead.
• Excluded production costs. The cost of acquiring the raw material used to produce the electrode active material, the cost of materials used for conversion, purification, or recycling of the raw material, and other material costs related to the production of the electrode active material would not be taken into account.

Battery cells and modules. Proposed Regulation § 1.45X-3(e)(3) and (4) would provide definitions, rules for measuring capacity, and documentation requirements for battery cells and battery modules. Proposed Regulation § 1.45X-3(e)(4)(i) would define a “battery module” as a module, in the case of a module using battery cells, with two or more battery cells that are configured electrically, in series or parallel, to create voltage or current to a specified end use, or a module with no battery cells, and, in each case, with an aggregate capacity of not less than 7 kilowatt-hours. Proposed Regulation § 1.45X-3(e) would clarify how capacity must be determined for battery cells and battery modules.

• Battery cell standards. Proposed Regulation § 1.45X-3(e)(3)(ii) would provide that taxpayers must measure the capacity of a battery cell in accordance with a national or international standard, such as IEC 60086-1 (Primary Batteries), or an equivalent standard. Proposed Regulation § 1.45X-3(e)(4)(ii)(A) would provide that, for modules using battery cells, taxpayers must measure the capacity of a module using battery cells with a testing procedure that complies with a national or international standard published by a recognized standard setting organization. Proposed Regulation § 1.45X-3(e)(4)(ii)(B) would provide that, for modules with no battery cells, taxpayers must measure the capacity using a testing procedure that complies with a national or international standard published by a recognized standard setting organization.

Phase out. Proposed Regulation § 1.45X-3(f) would provide rules for the phase out of the Section 45X credit. Consistent with the statutory language, a Section 45X credit for any eligible component that is not an applicable critical mineral and that is sold after December 31, 2029, would be equal to the product of the eligible component amount multiplied by the relevant phase out percentage. The phase out percentage would be equal to 75 percent for eligible components sold during calendar year 2030; 50 percent for eligible components sold during calendar year 2031; 25 percent for eligible components sold during calendar year 2032, and zero percent for eligible components sold after calendar year 2032. This percentage is determined based on the year the component is sold rather than the year it is produced.

Applicable Critical Minerals

Overview. Proposed Regulation § 1.45X-4(b) adopts, with some clarifications, the definitions of applicable critical minerals provided in Section 45X(c)(6). In particular, Proposed Regulation § 1.45X-4(b)(14) would clarify that the term “99.9 percent graphitic carbon by mass” means graphite that is 99.9 percent carbon by mass.

Clarification of aluminum definitions. To clarify the role of the aluminum industry with respect to renewable energy and energy storage, Proposed Regulation § 1.45X-4(b)(1) would interpret Section 45X(c)(6)(A) to mean aluminum, including commodity-grade aluminum, described in Section 45X(c)(6)(A)(i) and (ii). Proposed Regulation § 1.45X-4(b)(1) would define “commodity-grade aluminum” as aluminum that has been produced directly from aluminum that is described in Proposed Regulation § 1.45X-4(b)(1)(i) or (ii) and is in a form that is sold on international commodity exchanges, which would include commercial grade aluminum that is 99.7 percent aluminum by mass. The term “commodity-grade aluminum” is limited to primary production of unwrought forms by specifying that commodity-grade aluminum must be “produced directly” from certain forms of aluminum.

Credit calculation. To determine the credit amount, Proposed Regulation § 1.45X-4(c)(1) would provide that for an applicable critical mineral, the credit amount is equal to 10 percent of the costs incurred by the taxpayer with respect to production of such materials. Proposed Regulation § 1.45X-4(c)(2) would provide definitions of production processes for applicable critical minerals.

Production costs incurred. Proposed Regulation § 1.45X-4(c)(3) would clarify that the costs incurred for purposes of determining the credit amount includes costs as defined under Regulation § 1.263A-1(e) that are paid or incurred within the meaning of Section 461 of the Code by the taxpayer for the production of an applicable critical mineral only. Direct or indirect materials costs as defined in Regulation § 1.263A-1(e)(2)(i)(A) and Regulation § 1.263A-1(e)(3)(ii)(E), respectively, and any costs related to the extraction or acquisition of raw materials would not be taken into account as production costs. However, includible costs incurred in producing the applicable critical mineral include labor, electricity used in the production of the applicable critical mineral, storage costs, depreciation or amortization, recycling, and overhead. The cost of acquiring the raw material used to produce the applicable critical mineral, the cost of materials used for conversion, purification, or recycling of the raw material, and other material costs related to the production of the applicable critical mineral would not be included.

Substantiation Requirements

With respect to applicable critical minerals, Proposed Regulation § 1.45X-4(c)(4) would require taxpayers to document that their product meets the criteria for an applicable critical mineral as described in Section 45X(c)(6) with a certificate of analysis (COA) provided by the taxpayer to the person to whom the taxpayer sells the applicable critical mineral.

With respect to eligible components, the Proposed Regulations require taxpayers to maintain specific documentation based on the type of component, which requirements are part of the general recordkeeping requirements under Section 6001.

Effective Date

The Proposed Regulations are intended to apply to any eligible components for which production is completed and sales occur after December 31, 2022, and during any taxable years ending on or after the date of publication of the final regulations in the Federal Register.

Request for Public Comments

Treasury and the IRS request comments on all aspects of the Proposed Regulations, in particular the following:

• whether the definition of the term “routine purchase order” in Proposed Regulation § 1.45X-1(c)(3)(ii)(B), which is based on the definition in Regulation § 1.263A-2(a)(1)(ii)(B)(2)(ii), should be further clarified or modified;
• rules addressing the application of the Section 45X credit to pass-through estates and trusts under reserved Proposed Regulation § 1.45X-1(h);
• whether further clarification is needed as to the scope of the definition of “improper use” in Proposed Regulation § 1.45X-2(d)(4)(ii);
• whether the definition of “defective components” with respect to eligible components provided in Proposed Regulation § 1.45X-2(d)(4)(iii) requires further clarification;
• determining the costs incurred with respect to the production of electrode active materials in battery components under Proposed Regulation § 1.45X-3(e)(2), including the magnitude of such extraction costs and other direct and indirect material costs relative to the overall incurred production costs, and how “extraction” should be defined for this purpose;
• whether further clarification or modifications are needed with respect to the rules in Proposed Regulation § 1.45X-3(e)(2) regarding CMAs;
• for battery cells and modules, whether further clarification is required for the phrase “to a specified end use” in Section 45X(c)(5)(B)(iii)(I)(aa);
• whether additional considerations are required, and whether further guidance is required, with respect to what recognized national or international standards are currently available for measuring capacity of modules with no battery cells, under Proposed Regulation § 1.45X-3(e)(4)(ii)(B); and
• whether additional guidance is required under Proposed Regulation § 1.45X-4(c)(4) with respect to substantiation requirements for COAs, including whether a similar requirement should be applied to electrode active materials.

A hearing on the Proposed Regulations is scheduled for February 22, 2024, with a deadline for public comments of February 13, 2024.

Our team would be pleased to assist you in your strategic planning. For more information on issues pertaining to tax and energy and climate solutions, please contact Wilson Sonsini attorneys Elina Coss, Nicole Gambino, Hershel Wein, Brandon King, or Jaron Goddard.

Beau Brawner contributed to the preparation of this Alert.