The Treasury and the IRS On October 24 issued the final rules for the advanced manufacturing production credit under Internal Revenue Code Section 45X, which offers eligible taxpayers a monetizable tax credit for the domestic production and sale of specific eligible components that support clean energy technologies.
The government had previously released proposed regulations, for which it received 193 written comments and held a public hearing on February 22, 2024. In response to stakeholder feedback, the final rules clarify several issues while largely maintaining the approach of the proposed regulations. For prior coverage, see Proposed Regulations for the Advanced Manufacturing Credit.
Production Activity
Consistent with the proposed regulations, the final regulations clarify that secondary production, which involves using recycled materials to produce an eligible component, satisfies the production requirement of Section 45X. Additionally, the final rules clarify that Treasury and the IRS do not intend to adhere strictly to Section 263A when defining production under Section 45X. Several stakeholders had suggested aligning Section 45X’s definition of production with Section 263A. However, because Section 45X does not define the term “production,” the concept of substantial transformation was adopted in the proposed rules to be better applied broadly across the technologies that comprise eligible components. This definition distinguishes qualifying production for Section 45X from partial transformation, mere assembly, and superficial modification.
The government emphasized the difference between Section 45X and Section 263A, noting that Section 263A focuses on capturing costs for producing inventory for capitalization and was not intended to govern Section 45X production. They concluded that the substantial transformation definition fits better with the intent of Section 45X and declined to follow Section 263A in defining production, as there is no statutory basis for doing so.
Further, the term "mere assembly" found in the proposed rules has been replaced with "minor assembly" throughout the final rules. This change addresses technologies such as solar modules, battery modules, and nacelles, which are primarily produced through assembly processes. As long as the substantial transformation requirement is met, the final regulations clarify that assembly alone is not disqualifying. However, minor assembly or superficial modification is nonetheless excluded from the production definition if substantial transformation is not achieved.
Costs Incurred by the Taxpayer
For the production of electrode active materials and critical minerals, the Section 45X credit is calculated as 10% of the costs incurred to produce the eligible components. A significant area of feedback from commenters concerned the proposed rules excluding costs related to the extraction or acquisition of raw materials, as well as direct and indirect material costs as defined under Section 263A. Although Treasury and the IRS declined to follow Section 263A for defining production, Section 263A and its regulations govern the identification of includable costs incurred by the taxpayer.
Treasury and the IRS initially expressed concern about the administrability of allowing credits through a production chain, potentially allowing claims by multiple taxpayers, and whether the costs were essential to production or too far removed from the production activity of an eligible component. In the final rules, the government reconsidered its stance on these costs and revised its position from the proposed rules.
Extraction costs are permitted in certain circumstances for taxpayers extracting raw materials domestically and for those taxpayers that acquire extracted raw materials, regardless of where they are sourced, to produce eligible components. For domestic extraction costs to be included, the costs must be incurred by the taxpayer that meets the requirements to claim a Section 45X credit with respect to the applicable critical mineral or electrode active material. If a taxpayer acquires extracted raw material as a direct or indirect material costs, the costs may also be included as production costs consistent with the rules under Section 263A, regardless of where the materials are sourced.
The final rules provide examples of arrangements whereby multiple taxpayers enter into contract manufacturing agreements, offering flexibility in determining which party claims the credit. However, no party can claim the credit without a designation agreement.
The final rules also adjust substantiation requirements for taxpayers claiming the credit for electrode active materials or critical minerals. The proposed rules initially required taxpayers to provide a certificate of analysis (COA) to verify that their product met the qualification criteria for the applicable critical mineral. After reviewing comments from stakeholders, the substantiation requirements were revised for critical minerals and rules were added for electrode active materials.
Generally, to include direct or indirect material costs as production costs for Section 45X, taxpayers must attach certifications from their suppliers confirming that the supplier did not previously claim the credit or is aware of any prior credit claims in the production chain. Taxpayers must also maintain as part of its books and records an analysis document confirming that the constituent materials included in production costs did not qualify as eligible components at acquisition, a list of all direct and indirect material costs included in the total production cost, and documentation of production activities showing that the materials were used in the production of the eligible component. The documentation must be provided with the tax return or be available upon request; otherwise, it will be deemed a failure to substantiate the claim.
While this revised approach is favorable for taxpayers with eligible costs to include in calculating their Section 45X credit, they should be mindful of the additional compliance requirements to substantiate the costs included.
Other Highlights in Final Regulations
The government reaffirmed that the domestic requirement applies only to the production activity, and that the statutory language of Section 45X does not impose the same domestic requirement to the constituent elements, materials, and subcomponents used in producing eligible components.
The final rules provide various technical clarifications on specific eligible components concerning both production requirements and eligibility. Taxpayers should consult with their advisors to determine if they are producing eligible components.
The definition of aluminum has been reserved in the final rules as the government considers additional factors. Further guidance regarding aluminum is anticipated.
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