Proposed regulations to demystify the lucrative IRC section 45X credit

A version of this article was published Dec. 22, 2023, on Bloomberg Tax.

Businesses that make and sell energy components received a long-awaited rule proposal from the U.S. Department of Treasury Department on Dec. 14, 2023, regarding the advanced manufacturing production tax credit under Internal Revenue Code (IRC) Section 45X.

The proposed regulations provide much needed recommendations on this highly technical and lucrative credit. In addition to providing granular technical guidance on specific eligible components, companies across the energy sector — battery technology, solar, wind, and inverters — should consider the following takeaways.

Taxpayer production requirement

Eligible components must be produced by the taxpayer to qualify under Section 45X(a)(1). The proposal states that qualified production requires a substantial transformation of inputs into a complete and distinct eligible component, excluding companies performing final stage minor assembly from eligibility.

This effectively means that the eligible component undergoes an advanced manufacturing process, starting with the raw materials and subcomponents that results in a final ready-to-use product.

Companies and their accountants consequently must document the specific manufacturing process at a granular technical level and explain the substantial transformation. The manufacturing process is likely to be an audit focus, as it appears prone to abuse from taxpayers performing only final assembly in the United States.

Contract manufacturing

Certain companies that used outsourced manufacturing submitted comments urging the Treasury to credit the contracted payor, not the contract manufacturer, pointing as an example to rules once applicable to the domestic production activities deduction.

The proposed rules in Section 45X reject this, stating the party that may claim the credit is the taxpayer, generally, the contract manufacturer, that performs the actual production activities that results in the eligible component.

The Treasury laid out an option allowing the credit to be assigned over to the contractee if both parties agree. This was a big win for companies that design and sell eligible components but outsource production to contract manufacturers. It will allow them to negotiate terms that enable them to benefit from the credit, whether through assignment of the credit or favorable pricing terms.