As background, under the Inflation Reduction Act of 2022 (the “IRA”), effective January 1, 2023, section 30D of the Code was amended to provide a $7,500 EV Credit for a new electric vehicle (“EV”) the “final assembly” of which occurs within North America and which is “placed in service” before 2033.2 The amount of the EV Credit is reduced if (i) the “critical minerals” contained in the battery are not primarily extracted or processed in the U.S. or recycled in North America (the “Critical Minerals Sourcing Requirement”) or (ii) the battery is not primarily sourced from North America (the “Battery Components Sourcing Requirement”).3 EV manufacturers must certify to the Treasury and the IRS compliance with the Critical Minerals Sourcing Requirement with respect to each step in their supply chain. As such, EV manufacturers would need to determine the location where extraction, processing, and/or recycling occurs for each critical mineral included in an EV battery.4 Our prior coverage of the IRA can be found [here] and [here] and further coverage and details can be found [here].
The Proposed Regulations provide stricter sourcing requirements than the EV industry had hoped, significantly reducing the amount of EVs eligible to qualify for the EV Credit once the Proposed Regulations go into effect.5 However, Treasury officials noted that the sourcing requirements support the IRA policy objectives of spurring investment in and strengthening reliance on domestic manufacturing. The administration expects an increase in the amount of EVs eligible for the EV Credit in coming years as EV manufacturers continue to build out and increase their reliance on U.S. supply chains.
Under the Proposed Regulations, a critical mineral will satisfy the Critical Minerals Sourcing Requirement (a “qualifying critical mineral”) if (i) 50% or more of the value added to the critical mineral by extraction or processing is derived from extraction or processing that occurs in the U.S. (or in any country with which the U.S. has a free trade agreement in effect) or (ii) 50% or more of the value added to the critical mineral by recycling is derived from recycling that occurs in North America (the “Value Added Test”).6 The Value Added Test will be applied separately for each location in which extraction, processing, or recycling occurs.7
With respect to the Battery Components Sourcing Requirement, EV manufacturers must identify battery components8 for which substantially all manufacturing or assembly occurred in North America (“North American Battery Components”) and then determine the “incremental value” attributable to such manufacturing or assembly work.9 Importantly, the Battery Components Sourcing Requirement does not take into account the subcomponents comprising any battery component.
The percentage of qualifying critical minerals comprising a battery is compared to the relevant applicable critical minerals percentage in Code section 30D(a)(2) to determine whether an EV battery satisfies the Critical Minerals Sourcing Requirement. Similarly, the “incremental value” attributable to North American Battery Components comprising a battery is compared to the total “incremental value” of all battery components comprising such battery and the percentage is compared to the relevant applicable battery component percentage in Code section 30D(b)(2) to determine whether the EV satisfies the Battery Components Sourcing Requirement.10
1 The Proposed Regulations go into effect on April 18, 2023, leaving EV manufacturers just two weeks to evaluate and adjust their supply chains to comply with the new “sourcing requirements.”
The Proposed Regulations include a request for comments by the Treasury and the Internal Revenue Service (“IRS”) on (i) the impact the Proposed Regulations will have on small businesses; (ii) the implementation of the Critical Minerals Sourcing Requirement and Battery Components Sourcing Requirements and the distinction between processing of critical minerals and manufacturing/assembly of battery components; and (iii) whether the modified adjusted gross income limitation should be expanded to more business entities. Comments must be submitted within sixty (60) days after the Proposed Regulations become effective.
2 Under the Proposed Regulations, (i) “final assembly” is deemed to occur at the EV’s plant of manufacture (as reported on the vehicle identification number) or the final assembly point reported on the label affixed to the EV and (ii) a new EV is “placed in service” on the date the taxpayer takes possession of the EV.
3 The reduction percentage (i) for failure to comply with the Critical Minerals Sourcing Requirement is 40% for EVs placed in service in 2023 and increases by 10% annually until it reaches 80% in 2027 and (ii) for failure to comply with the Battery Components Sourcing Requirement is 50% for EVs placed in service in 2023, 60% for EVs placed in service in 2024 or 2025, and increases by 10% annually thereafter until it reaches 100% in 2029.
4 Given the complexity of battery supply chains and the detailed tracking that would be required for EV manufacturers to certify compliance with respect to each step in their supply chain, the EV industry views this requirement as overly burdensome.
5 The Proposed Regulations also clarified that (i) in the event an EV is held by a partnership (or other pass-through entity), the modified adjusted gross income limitation on the EV Credit applies at the partner level and the EV Credit will be allocated among the partners consistent with the general allocation of partnership items; (ii) the modified gross income limitation does not apply when an EV is held by a corporation; and (iii) in the event an EV is held by multiple owners, the EV Credit may be claimed by only one owner.
6 The Proposed Regulations note that the Value Added Test will apply to EVs placed in service in 2023 and 2024 and that the Treasury expects to issue a more stringent test for EVs placed in service thereafter.
Under the Proposed Regulations, (i) “extraction” includes activities performed to extract or harvest minerals or natural resources from the ground or a body of water and concludes when activities are performed to convert raw mined or harvested products to substances that can be readily transported or stored for direct use in critical mineral processing; (ii) “processing” begins when chemical or thermal processes are used on extracted minerals or natural resources or manmade minerals or resources to create a new product that will be processed into a final constituent material; and (iii) “recycling” includes activities during which recyclable materials containing applicable critical minerals are transformed into specification-grade commodities and consumed in lieu of virgin materials to create new constituent materials.
7 For purposes of the Value Added Test, “value added” is determined by the increase in the arm’s-length price that was or would be paid by an unrelated party attributable to the relevant activity.
8 “Battery components” include a battery cell and battery modules, as well as a cathode electrode, anode electrode, solid metal electrode, separator, liquid electrolyte and solid state electrolyte.
9 Under the Proposed Regulations, (i) “manufacturing” means the industrial and chemical steps taken to produce a battery component and (ii) “assembly” means the process of combining battery components into battery cells or battery modules.
10 Manufacturers are required to select a date after final processing or recycling (with respect to the Critical Minerals Sourcing Requirement) or manufacturing or assembly (with respect to the Battery Components Sourcing Requirement) for determining the values associated with critical minerals or battery components, as applicable. Such date would need to be uniformly applied for all applicable critical minerals or battery components contained in a battery. Manufacturers may calculate the applicable value based on a battery of a specific vehicle or may average the calculation over a limited period of time with respect to vehicles from the same model line, plant, class, or some combination of thereof.
