Bonus energy credit domestic content requirements: Preliminary IRS guidance

The IRS recently issued Notice 2023-38 (Notice), providing initial domestic content bonus credit guidance on how taxpayers can satisfy the domestic content requirements and qualify for one of the bonus energy credit structures under the Inflation Reduction Act (IRA). The Notice additionally announces forthcoming proposed regulations (Regulations) the Treasury Department will release to expand on this guidance.

Key takeaways

• Up to an additional 10% “bonus” investment or production tax credit amount is available to taxpayers who certify that any steel, iron or manufactured product that is a component of their qualifying clean energy project was produced in the United States.
• The Notice provides guidance on what parts or materials in the supply chain must be analyzed in order to determine if a project satisfies the domestic content requirement.
• Steel or iron is defined as construction materials made primarily of steel or iron that are structural in function.
• The cost of manufactured products and components is defined to include only direct materials and direct labor costs.
• The United States is defined as the several States, the District of Columbia and territories. There is no “foreign equivalent” as is found in the Buy American Act.
• The Notice provides several definitions, rules and related recordkeeping and certification requirements in advance of the Regulations’ release.
• The IRS and Treasury anticipate the Regulations will apply to taxable years ending after May 12, 2023. Taxpayers can rely on the Notice in the interim.

Background

An annual per kilowatt hour production tax credit (PTC) under current section 45 and new section 45Y is available for electricity a taxpayer produces from renewable resources. Current section 48 and new section 48E provide an upfront investment tax credit (ITC) for the “energy percentage” of the basis of energy property a taxpayer places in service during a taxable year. The PTC and ITC amounts are determined using baseline figures that can be increased if taxpayers satisfy certain additional requirements, including the project paying prevailing wages, employing apprentices, using domestically produced content and being located within an energy community. Find out how your organization can leverage IRA tax credits to save as much as 50% or more on qualifying project costs.

The PTC’s baseline amount of 0.3 cents per kilowatt hour is increased by 10% if the taxpayer certifies that any steel, iron or manufactured product that is a component of the qualifying facility at which the electricity is produced was made in the U.S. The ITC’s baseline percentage of 6% is increased by 2% if the taxpayer makes the same certification with respect to any steel, iron or manufactured product that is a component of the qualifying energy property (10% if the aforementioned prevailing wage and apprenticeship requirements, or a specified alternate requirement is met).

Manufactured Products, defined below, are deemed to have been produced in the U.S. if a percentage of the products’ total costs is attributable to manufactured products that are mined, produced or manufactured in the U.S. For projects which begin construction prior to 2025, this percentage threshold is 40% (20% in the case of an offshore wind facility). The percentage increases by 5% annually up to 55% in the case of projects which begin construction after 2026 (offshore wind facilities are covered by a separate interval increase). For purposes of testing whether this requirement has been met (a detailed discussion of the Manufactured Products Requirement follows), this percentage threshold is referred to as the Adjusted Percentage.     

The Notice

Qualifying for the domestic content bonus

The Notice provides guidance on how to qualify for the domestic content bonus credit and how to certify compliance with the requirements. The Domestic Content Requirement applies to: “(1) a qualified facility under sections 45 and 45Y; (2) an energy project under section 48; or (3) a qualified investment with respect to a qualified facility or energy storage technology under section 48E (Applicable Project). To satisfy the Domestic Content Requirement, a taxpayer must certify to the Secretary of the Treasury for each Applicable Project that any steel, iron or Manufactured Product which is a component of the Applicable Project was produced in the United States.”

To claim a domestic content bonus credit amount, a taxpayer must satisfy the Domestic Content Requirement for each Applicable Project and must timely submit certification to the IRS.  There are two overall requirements to satisfying the Domestic Content Requirement; the Steel or Iron Requirement and the Manufactured Products Requirement. Both the Steel or Iron Requirement and the Manufactured Products Requirement are defined below.

Components

Compliance with the domestic content bonus credit rules is determined by analyzing components of an Applicable Project. The relevant components include the project’s parts and its subparts. The analysis begins with the identification of the Applicable Project, defined above. The first subpart of the Applicable Project is the Applicable Project Component, defined as any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project. An Applicable Project Component is what may qualify as steel, iron, or a Manufactured Product. The next subpart of an Applicable Project Component is a Manufactured Product Component, defined as any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project Component that is a Manufactured Product.

Critically, the above instructs the taxpayer how far down the supply chain an analysis must be done. For example, if a contractor is constructing an Applicable Project, an analysis must be done of the products the contractor incorporates into the Applicable Project; these products are the Applicable Project Components. A further analysis must be done into the products acquired by the contractor from a supplier. The parts a supplier uses to construct a product sold to the contractor are the Manufactured Product Components.

Applicable Project Components and Manufactured Product Components must be divided into one of two categories: (1) steel or iron or (2) Manufactured Products. The steel or iron group includes Applicable Project Components that are construction materials made primarily of steel or iron and are structural in function. The steel or iron group does not include steel or iron used in Manufactured Product Components or subcomponents of Manufactured Product Components. For example, items such as nuts and bolts are primarily made of steel or iron but are not structural in function, so they are not put into the steel or iron category.

A Manufactured Product is defined as an item produced as a result of the manufacturing process. Manufacturing Process is defined as the application of processes to alter the form or function of materials or of elements of a product in a manner adding value and transforming those materials or elements so that they represent a new item functionally different from that which would result from mere assembly of the elements or materials.

Definitions

The Notice introduces several definitions, including those to cover the components of a project, the various stages of the production process, mining, and provides that the U.S. includes the several states, the District of Columbia, the Commonwealth of Puerto Rico, Guam, American Samoa, the U.S. Virgin Islands, and the Commonwealth of the Northern Mariana Islands.

Steel/iron requirement

All steel or iron must be manufactured in the U.S. in order to satisfy the Steel or Iron Requirement. Steel or iron components of a qualifying project will be considered manufactured in the U.S. if all manufacturing processes regarding the Applicable Project Components take place within the U.S., with the exception of metallurgical processes involving the refinement of steel additives.

Manufactured Products Requirement

The Manufactured Products Requirement is met if all Applicable Project Components that are Manufactured Products are produced in the U.S. or are deemed to be produced in the U.S. All Applicable Project Components that are Manufactured Products are deemed to be produced in the U.S. if the Adjusted Percentage Rule is satisfied.

A Manufactured Product is considered produced in the U.S. if: (1) all of the manufacturing processes for the Manufactured Product take place in the U.S. and (2) 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 United States, regardless of the origin of its subcomponents. This is key because it limits how far down the supply chain an analysis must be made.

The Adjusted Percentage Rule compares a project’s Domestic Cost Percentage (defined below) to its Adjusted Percentage. If the Domestic Cost Percentage for an Applicable Project equals or exceeds the Adjusted Percentage that applies to qualify for the domestic content bonus credit, then the applicable project satisfies the Adjusted Percentage Rule. The Domestic Cost Percentage is a project’s Domestic Manufactured Products and Components Cost divided by its total Manufactured Products Cost.

The Domestic Manufactured Products and Components Cost is the sum of:

(1) U.S. Manufactured Products that are Applicable Project Components, and

(2) Manufactured Product Components of non-U.S. Manufactured Products that are manufactured, mined or produced in the United States.

A Manufactured Product Component that is manufactured is a U.S. Component if it is manufactured or produced in the United States, regardless of the origin of its subcomponents. A Manufactured Product Component that is not manufactured is a U.S. Component if it is mined in the United States.

For determining the Domestic Manufactured Products and Components Cost, the cost of a U.S. Manufactured Product or U.S. Component includes only direct costs as defined in the Treasury Regulations covering uniform cost capitalization (specifically, section 1.263A-1(e)(2)(i)). This includes direct materials and direct labor costs. Direct costs, including direct labor costs, of incorporating the Applicable Project Components into the Applicable Project are not counted in the Domestic Manufactured Products and Components Cost.

The Total Manufactured Products Cost for an Applicable Project is the sum of the costs of each Applicable Project Component that is a Manufactured Product. The same cost rules as for Domestic Manufactured Products and Components apply, only direct costs.

Classification safe harbor

The Notice provides a non-exhaustive list of common components that may be found in utility-scale photovoltaic system, land-based wind facility, offshore wind facility and battery storage technology projects and classifies them as needing to meet the Steel//iron or Manufactured Products Requirement to provide taxpayers with helpful clarity.

Retrofitted projects

Leveraging previous IRS guidance, the Notice provides that retrofitted projects can qualify as having been originally placed in service despite utilizing used property, so long as the fair market value of the used property does not exceed 20% of the project’s total value (80/20 Rule). A project can in turn qualify for the domestic content bonus credit if it is placed in service after Dec. 31, 2022, meets the 80/20 Rule and the other requirements the Notice sets forth.

Certification requirement

A taxpayer will certify its qualifying project meets the Domestic Content Requirement by attaching a statement (signed by a person with legal authority to bind the taxpayer under penalty of perjury) to its tax return for the first year in which a domestic content bonus credit is claimed, and a copy of the statement must be attached to each subsequent year’s return on which the credit is claimed. The statement must include several additional items of information, including but not limited to:

• Whether the project is a qualified facility, energy project or energy storage technology
• The specific type of project
• The geographic coordinates and address of the project

Substantiation requirement

Taxpayers claiming the bonus credit amounts must follow the recordkeeping requirements under section 6001, by maintaining documentation necessary to substantiate that their project has met the domestic content requirements. 

For more information on this topic, or to learn how a Baker Tilly specialist can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.