The US Department of Treasury issued its long-awaited proposed guidance on March 31, 2023 to implement the critical mineral and battery component watershed requirements of the Inflation Reduction Act (IRA), which significantly revised the tax credit incentive mechanism of the Internal Revenue Code (Code) that relates to electric vehicles (EVs). Since the IRA’s enactment, the critical mineral and battery component requirements have generated tremendous interest and comment from virtually all segments of the automotive, mining, and component manufacturing industries.
The IRA overhauled Section 30D of the Code for qualified plug-in electric drive motor vehicles, including adding fuel cell vehicles to the Section 30D tax credit, removing a previously existing sales cap, and basing credit eligibility on MSRP recommendations, purchaser income thresholds, final assembly locations, and critical mineral and battery component sourcing and manufacturing. The IRA also added a new credit for previously owned “clean vehicles” under Section 25E of the Code and a new credit for qualified commercial clean vehicles under Section 45W of the Code.
On December 29, the Internal Revenue Service (IRS) and Treasury released a white paper on the critical mineral and battery component sourcing mandates, providing a look into the anticipated direction of the forthcoming guidance and the process for determining whether vehicles qualify under those requirements. Although the white paper itself did not amount to proposed guidance or otherwise carry legally binding authority, it was a first look into how the IRS and Treasury were thinking of applying some of the provisions that have created concern among many stakeholders. Its release brought forth more questions from lawmakers and industry participants with respect to whether, or the extent to which, the proposed guidance would stray from congressional intent in the IRA.
On March 31, we received our answer.
Critical Minerals
The proposed guidance specifies that the application of the critical mineral requirement is consistent with the framework that Treasury previously released in its December 2022 white paper. The guidance sets forth a proposed three-step process for determining the percentage of the value of the applicable critical minerals in a battery.
First, manufacturers must determine the procurement chain or chains for each applicable critical mineral included in the battery. The guidance specifies that a procurement chain is “a common sequence of extraction, processing, or recycling activities that occur in a common set of locations, concluding in the production of constituent materials.”
Second, each procurement chain must be separately evaluated to determine whether critical minerals procured from that chain have been (1) extracted or processed either in the United States or in any country with which the US has a free trade agreement in effect, or (2) recycled in North America. Critical minerals that meet this requirement are deemed qualifying critical minerals. However, the proposed guidance further states that it is applying (for a limited transition period), a 50% value-added test to determine whether the qualifying critical mineral definition is satisfied:
[A]n applicable critical mineral would be treated as extracted or processed in the United States, or in any country with which the United States has a free trade agreement in effect, if: (1) 50 percent or more of the value added to the applicable critical mineral by extraction is derived from extraction that occurred in the United States or in any country with which the United States has a free trade agreement in effect; or (2) 50 percent or more of the value added to the applicable critical mineral by processing is derived from processing that occurred in the United States or in any country with which the United States has a free trade agreement in effect.
Third, the manufacturer must calculate the percentage of the value of qualifying critical minerals contained in a battery.
Constituent Materials
Importantly, the proposed guidance retains the white paper’s proposal that “constituent materials” fall within the critical mineral requirement.
In the months after the white paper’s issuance, this classification was the subject of significant debate among industry participants. Some industry participants argue that it amounts to a loophole in the IRA that would allow anode and cathode materials to be sourced from foreign countries rather than in the United States—thereby driving foreign competition for US manufacturers.
Free Trade Agreements
Of equal importance, the proposed guidance offers a four-part criteria for determining whether the United States has a “free trade agreement” in effect with another nation (a term that is otherwise undefined in the IRA or the Code):
[A]n agreement between the United States and another country, as to the critical minerals contained in electric vehicle batteries or more generally, and in the context of the overall commercial and economic relationship between that country and the United States: (A) reduces or eliminates trade barriers on a preferential basis, (B) commits the parties to refrain from imposing new trade barriers, (C) establishes high-standard disciplines in key areas affecting trade (such as core labor and environmental protections), and/or (D) reduces or eliminates restrictions on exports or commits the parties to refrain from imposing such restrictions on exports.
The proposed guidance specifically identifies the following nations as currently meeting this criteria: Australia, Bahrain, Canada, Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Israel, Jordan, Korea, Mexico, Morocco, Nicaragua, Oman, Panama, Peru, and Singapore—and possibly Japan.
Battery Components
Consistent with the framework that Treasury previously released in the white paper, the proposed guidance sets forth a four-step process for determining the percentage of the value of the applicable battery components in a battery.
First, manufacturers must determine whether each battery component in a battery was manufactured or assembled in North America. Under the proposed regulations, this means a “battery component for which substantially all of the manufacturing or assembly of which occurs in North America, without regard to the location of the manufacturing or assembly activities of the components that make up the particular battery component.”
Second, manufacturers must determine the incremental value for each battery component.
Third, manufacturers must total the incremental value of battery components.
Fourth, manufacturers must determine the “qualifying battery component content”—the percentage of the value of the battery components contained in the battery from which the electric motor of a new clean vehicle draws electricity that were manufactured or assembled in North America.
Effectiveness
Importantly, the IRA’s critical mineral and battery component requirements take effect when the proposed guidance is published in the Federal Register. From a practical perspective, this means that vehicles placed in service after April 17, 2023 must comply with the requirements if the purchaser-taxpayer intends to claim any portion of the clean vehicle tax credit permitted under the IRA’s revision to the Code.