On December 1, 2023, the Department of the Treasury ("Treasury"), and the Internal Revenue Service ("IRS") issued REG-118492-23, a series of proposed regulations heightening the standards required for an important electric vehicle tax credit. Additionally, on December 4, 2023, the Department of Energy ("DOE") published guidance, RIN 1901-ZA02, clarifying the application of Foreign Entity of Concern ("FEOC") credit eligibility exclusions in the proposed Treasury regulations. These proposed regulations would render vehicles containing certain content produced by "FEOC" entities – defined to include Chinese, Russian, North Korean and Iranian-owned or controlled companies – ineligible for U.S. tax credits.

The "30D Tax Credit" established by the Inflation Reduction Act ("IRA") has remained a prominent selling point for electric vehicles ("EV's") in the United States, providing up to a $7,500 credit per vehicle if the requirements surrounding critical minerals and battery components are met. Under the amendments implemented by the IRA, there were a series of controversial limits placed on eligibility of EV's for the credit if any part of the vehicle was sourced from an FEOC. Under the new proposed regulations, which better defined those FEOC compliance requirements, EV's with battery components that were manufactured by a FEOC will be disqualified from the tax credit starting in 2024. Further, in 2025 EV's will be disqualified from the credit if the vehicle's battery contains any applicable critical minerals extracted, processed, or recycled by a FEOC. The magnitude of these FEOC compliance regulations cannot be understated: even a single battery cell produced by an FEOC in a supply chain may render an entire vehicle ineligible for the credit.

Background of the 30D Tax Credit

A vehicle placed in service after December 31, 2023, will not be eligible for the credit if any of the components contained in the battery of such vehicle were manufactured or assembled by a FEOC. Further, a vehicle placed in service after December 31, 2024, will not be eligible for the credit if any of the applicable critical minerals contained in the battery of such vehicle were extracted, proceeded, or recycled by a FEOC. A FEOC is defined as an entity "owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation."

Impact of the Proposed Regulations and Guidance on FEOC-Compliance

The new substantive provisions of the proposed Treasury regulations, combined with the DOE guidance, clarify the previously incomplete definition of an FEOC and how it applies in the context of the 30D Tax Credit while imposing stringent tracing requirements to ensure compliance. Key provisions and definitions are provided below:

First, the DOE defines covered nations as "the People's Republic of China (PRC), the Russian Federation, the Democratic People's Republic of North Korea, and the Islamic Republic of Iran."

Next, the DOE proposed to interpret "foreign entity" to mean: "(i) A government of a foreign country; (ii) A natural person who is not a lawful permanent resident of the United States, citizen of the United States, or any other protected individual (as such term is defined in 8 U.S.C. 1324b(a)(3)); (iii) A partnership, association, corporation, organization, or other combination of persons organized under the laws of or having its principal place of business in a foreign country; or (iv) An entity organized under the laws of the United States that is owned by, controlled by, or subject to the direction (as interpreted in Section IV) of an entity that qualifies as a foreign entity in paragraphs (i)–(iii)."

Third, the DOE proposed to interpret "government of a foreign country" to mean: "(i) A national or subnational government of a foreign country; (ii) An agency or instrumentality of a national or subnational government of a foreign country; (iii) A dominant or ruling political party (e.g., Chinese Communist Party (CCP)) of a foreign country; or (iv) A current or former senior foreign political figure."1

Fourth, a foreign entity is "subject to the jurisdiction" of a covered nation if "(i) the foreign entity is incorporated or domiciled in, or has its principal place of business in, a covered nation, or (ii) with respect to the critical minerals, components or materials of a given battery, the foreign entity engages in the extraction, processing or recycling of such critical minerals, the manufacturing or assembly of such components, or the processing of such materials, in a covered nation."

Finally the DOE proposes that an entity is "owned by, controlled by, or subject to the direction" of another entity if: "(i) 25% or more of the entity's board seats, voting rights, or equity interest are cumulatively held by that other entity, whether directly or indirectly via one or more intermediate entities; or (ii) With respect to the critical minerals, battery components, or battery materials of a given battery, the entity has entered into a licensing arrangement or other contract with another entity (a contractor) that entitles that other entity to exercise effective control over the extraction, processing, recycling, manufacturing, or assembly (collectively, "production") of the critical minerals, battery components, or battery materials that would be attributed to the entity."2

To further explain this requirement, the DOE provided several examples as illustrated below:

  1. If Entity A cumulatively holds 25% of Entity B's board seats, voting rights, or equity interest, then Entity A directly controls Entity B. If Entity B cumulatively holds 50% of Entity C's board seats, voting rights, or equity interest, then Entities B and C are treated as the same entity, and Entity A also indirectly controls Entity C. If Entity A is the government of a foreign country that is a covered nation, Entities B and C are both FEOCs.
  2. If Entity A cumulatively holds 50% of Entity B's board seats, voting rights, or equity interest, then Entity A is the direct controlling "parent" of Entity B, and Entities A and B are treated as the same entity. If Entity B cumulatively holds 25% of Entity C's board seats, voting rights, or equity interest, then Entity C is understood to be directly controlled by Entity B and indirectly controlled by Entity A. If Entity A is the government of a foreign country that is a covered nation, Entities B and C are both FEOCs
  3. If Entity A cumulatively holds 25% of Entity B's board seats, voting rights, or equity interest, then Entity A directly controls Entity B. If Entity B cumulatively holds 40% of Entity C's board seats, voting rights, or equity interest, then Entity B directly controls Entity C. However, because Entity A does not hold 50% of the board seats, voting rights, or equity interest of Entity B, and Entity B does not hold 50% of the board seats, voting rights, or equity interest of Entity C, Entity A's indirect control of Entity C is calculated proportionately (25% x 40% = 10%). Based on that proportionate calculation, Entity A will be considered to hold only a 10% interest in Entity C, which is insufficient to meet the 25% threshold for control contemplated under this proposed guidance. If Entity A is the government of a foreign country that is a covered nation, Entity B is a FEOC. But Entity A holds only a 10% interest in Entity C, which is less than the 25% threshold requirement to deem Entity C controlled by Entity A. Therefore, Entity C is not a FEOC via the indirect control of Entity A.

Further, the new regulations will set new standards for qualified manufacturers to meet these new industry standards, expanding upon the previous IRA amendments mentioned above. Specifically, the Section 30D FEOC compliance requirements, which will take effect in 2024 and 2025 respectively, were clarified in the following ways:

First, regarding battery cells, the Treasury proposed regulations clarifying that battery cells are to be treated separately from battery components for compliance purposes as they contain both critical minerals and battery components. For EVs placed in service after December 31, 2023, a battery cell is FEOC-compliant if it is not manufactured or assembled by an FEOC and if it contains only FEOC-compliant battery components. Further, for vehicles in that time period, an EV battery will only be considered FEOC-compliant if it contains only FEOC compliant battery components and cells. For EVs placed in service after December 31, 2024, a battery cell is FEOC-compliant if it is not manufactured or assembled by an FEOC and if it contains only FEOC-compliant battery critical minerals and minerals.

To accomplish the relevant goals for FEOC compliance, in 2024 and 2025 respectively, the Treasury proposes a series of due diligence tracing requirements. The supply chain tracing requirements will impose a rigorous methodology of tracking each step of EV battery and vehicle production to ensure FEOC compliance. Manufacturers interested in maintaining the eligibility of 30D Tax Credits on their automobiles will need to pay close attention to tracking each entity involved in their supply chain to ensure FEOC-compliance all the way from minerals extraction and processing to battery production and subsequent vehicle manufacturing.

To lessen this burden, there are two proposed transition rules which provide flexibility for some manufacturers as they adjust to the new standards: (i) proven low value and difficult to trace battery materials and minerals will be excluded from tracing requirements until 2027 on an updated basis; (ii) temporary allocation-based determinations will be permissible for critical minerals that are sometimes commingled, allowing manufacturers to make general allocation of the sources of their critical minerals and materials during a transition period, tracing for FEOC compliance to the best of their ability.

Conclusions

The impact of these FEOC compliance requirements is significant, and every actor involved in the EV supply chain will be impacted. We anticipate contractual and commercial requirements will arise between companies and suppliers, requiring various entities in their respective EV supply chains to certify FEOC compliance in the future. As a result of the rigorous tracing requirements, we also foresee disputes arising over supply chain audit rights. Further, automobile companies across the board will generally demand greater accountability and internal auditing procedures from each actor within their supply chains to efficiently trace compliance. We recommend that business entities involved in EV sales, distribution or production begin to invest in FEOC compliance tracing as soon as possible, to ensure their respective EV's maintain 30D tax credit eligibility into the new year.

Footnotes

1. The guidance also defines senior foreign political figure in greater detail as "(a) a senior official, either in the executive, legislative, administrative, military, or judicial branches of a foreign government (whether elected or not), or of a dominant or ruling foreign political party, and (b) an immediate family member (spouse, parent, sibling, child, or a spouse's parent and sibling) of any individual described in (a). "Senior official" means an individual with substantial authority over policy, operations, or the use of government-owned resources."

2. For greater detail on the terms "owned by," "controlled by" and "subject to the direction" please see REG-118492-23 and RIN 1901-ZA02.

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