Treasury Issues Preliminary Guidance on Domestic Content Bonus Credit Qualification

The U.S. Department of the Treasury earlier today released Notice 2023-38, Domestic Content Bonus Credit Guidance under Sections 45, 45Y, 48, and 48E (the Notice). The Notice indicates that the Treasury Department and the IRS intend to issue proposed regulations related to the domestic content bonus credit requirements and provides preliminary guidance that can be relied upon prior to the issuance of those regulations.

The Inflation Reduction Act of 2022 (the IRA) added a bonus credit for purposes of calculating the production tax credit (PTC) and investment tax credit (ITC) for an energy project that incorporates sufficient U.S.-sourced components. The domestic content bonus credit will also apply to a project that qualifies for the clean electricity production credit and the clean electricity investment credit that were added by the IRA and that will take effect with respect to qualified projects placed in service after December 31, 2024. The domestic content bonus credit increases the PTC by 10% or the ITC energy percentage by 10-percentage points, assuming a project satisfies or is not subject to the newly added prevailing wage and apprenticeship requirements (as discussed in our prior alert available here).

Domestic Content Bonus Credit Qualification Generally

A project qualifies for the domestic content bonus credit if the owner certifies to the Secretary of the Treasury that any steel, iron, or manufactured product which is a component of the project was produced in the U.S. Manufactured products that are components of a project are deemed to have been produced in the U.S. for this purpose if at least 40% (20% in the case of offshore wind projects) of the total costs of all manufactured products included in the project are attributable to manufactured products and components that are mined, produced, or manufactured in the U.S. The applicable percentages increase for certain projects which begin construction after 2025.

Steel and Iron

To qualify for the domestic content bonus credit, all steel and iron items included in a project must be produced in the U.S. This generally requires that all manufacturing processes with respect to any steel or iron items take place in the U.S., except metallurgical processes involving refinement of steel additives. The Notice clarifies that the steel and iron requirement does not apply to components or subcomponents of manufactured products. This includes, for example, nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adaptors, tie wire, spacers, door hinges, and similar items. The Notice distinguishes steel and iron items from manufactured products (or components or subcomponents thereof) based on whether the project component is “structural in function.” Components that are structural in function are treated as steel or iron and those that are not structural in function may constitute a component or subcomponent of a manufactured product.

This distinction between steel and iron items on one hand, and manufactured products on the other hand, has been a source of significant uncertainty in the market. Although the language of the Notice provides some additional clarity regarding this distinction, it likely will not resolve all questions that arise with respect to specific components of a project.

Manufactured Products

The Notice provides clarification on a number of issues related to manufactured products that are components of a project. Generally, a manufactured product is considered to be produced in the U.S. if (i) all manufacturing processes for the manufactured product take place in the U.S., and (ii) all of the manufactured product components of the manufactured product are of U.S. origin. A manufactured product component is considered to be of U.S. origin if it is manufactured in the U.S., regardless of the origin of its subcomponents.

The Notice applies an “Adjusted Percentage Rule” under which all manufactured products included in a project are deemed to be produced in the U.S. if the “Domestic Cost Percentage” of a project equals or exceeds the applicable domestic content adjusted percentage (generally 40% or 20% in the case of offshore wind projects). The Domestic Cost Percentage for a project for this purpose is equal to the quotient of:

(A) the sum of the costs of (i) all manufactured products for which all manufacturing processes take placed in the U.S. and all components of such manufactured products are produced in the U.S. (a U.S. Manufactured Product), and (ii) components of non-U.S. Manufactured Products that are mined, produced, or manufactured in the U.S. (a U.S. Component), divided by

(B) the total cost of all manufactured products included in the project (not including direct costs, such as direct labor costs, of incorporating a manufactured product into a project).

The Notice includes an example of the application of the Adjusted Percentage Rule. In the example, a project includes two manufactured products, one of which is a U.S. Manufactured Product and the other is a non-U.S. Manufactured Product. Two of three of the components of the non-U.S. Manufactured Product are U.S. Components. The total cost of the U.S. Manufactured Product is $100 and the total cost of the non-U.S. Manufactured Product is $200, of which the cost of the two U.S. Components is $80. The example concludes that the Domestic Cost Percentage of the project is 60% ($100 for U.S. Manufactured Product plus $80 for the U.S. Components of the non-U.S. Manufactured Product, divided by $300 total cost of manufactured products included in the project) and, therefore, the project satisfies the Adjusted Percentage Rule. As a result, both the U.S. Manufactured Product and the non-U.S. Manufactured Product included in the project are deemed to have been produced in the U.S. for purposes of the domestic content bonus credit requirements.

Whether property included in a manufactured product is a component or subcomponent may significantly affect whether the manufactured product qualifies as a U.S. Manufactured Product. For a manufactured product to qualify as a U.S. Manufactured Product, all components of such manufactured product must be of U.S. origin. Subcomponents of a U.S. Manufactured Product, on the other hand, are not required to be of U.S. origin. The Notice provides that a manufactured component means any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into a manufactured product. The Notice does not clearly distinguish, however, the difference between a manufactured product component and subcomponent for this purpose.

Project Component Treatment Safe Harbor

The Notice provides a helpful safe harbor for categorizing certain common project components as either “steel or iron” or a “manufactured product.” The safe harbor describes common project components included in utility-scale solar projects, land-based and offshore wind projects, and battery energy storage projects and designates whether they are treated as steel or iron or manufactured products:

Application of Domestic Content Bonus Credit Rules to Project Repowering

The Notice confirms that a project that includes some used parts, such as an existing project that will be repowered, may qualify for the domestic content bonus credit. To qualify as newly placed in service for purposes of the PTC or ITC, a repowered project must satisfy the “80-20 rule,” which requires that the fair market value of the used property constitutes not more than 20% of the total value of the project (based on the costs of new property plus the value of the used property). The Notice provides that a repowered project that otherwise satisfies the 80-20 test qualifies for the domestic content bonus credit if the new property incorporated into the project satisfies the domestic content requirements.

Domestic Content Certification and Recordkeeping

To claim the domestic content bonus credit with respect to a project, a taxpayer must certify to the IRS that, as of the date the project is placed in service, any steel, iron, or manufactured product that is a component of the project was produced in the U.S. The Notice provides that such a certification statement must be attached to the applicable form (e.g., Form 8835, Renewable Electricity Product Credit, or Form 3468, Investment Credit) filed with the taxpayer’s income tax return and must include the following information related to the project: (A) whether the project is a qualified facility, energy project, or energy storage technology, (B) the type of project (such as utility-scale photovoltaic system or battery energy storage technology), (C) the geographic coordinates and address, if applicable, of the project, (D) the date the project was placed in service, (E) the total domestic content bonus credit amount determined with respect to the project, and (F) any other information required by applicable forms and instructions for reporting domestic content bonus credit amounts.

The Notice also provides that a taxpayer must satisfy the general recordkeeping requirements in order to substantiate that a project qualifies for the domestic content bonus credit. The Notice does not provide specific guidance regarding what types of information and documentation may be necessary to substantiate qualification for the bonus credit.

Overall, the Notice provides welcome guidance related to the domestic content bonus credit and, in particular, the applicable rules for manufactured products included in a project. While some issues are not fully resolved by the Notice, such as the distinction between a component and subcomponent of a manufactured product, the Notice provides a significantly more substantive framework for analyzing whether a project may qualify for the domestic content bonus credit. The Treasury Department indicated that regulations related to the domestic content bonus credit will be promulgated. It is possible such future regulations may expand on or modify the rules in the Notice, but a taxpayer is allowed to rely on the Notice with respect to any project that begins construction before the date that is 90 days after the publication of the proposed regulations in the Federal Register.