Domestic Content Bonus Credit
The Internal Revenue Service explained today how to determine whether wind, solar, storage and other renewable energy projects qualify for a bonus tax credit for using enough domestic content.
The guidelines are in Notice 2023-38.
They require a more complicated analysis to qualify than expected. They will make it harder for projects to qualify that use solar modules, nacelles or other components that contain any imported parts.
They will also require manufacturers to disclose their costs to make modules, nacelles, inverters and other manufactured components shipped to the project site and to break down the costs among the various parts and materials used to make them. This information will be difficult for project developers to get manufacturers to disclose.
Projects placed in service in 2023 or later qualify for an extra 10% investment tax credit if they use enough domestic content. However, the extra tax credit is only 2% unless the project complies with, or is exempted from, wage and apprentice requirements. Production tax credits on projects that qualify fully are multiplied by 1.1.
More detail about the wage and apprentice requirements can be found here.
To qualify, all iron and steel and at least 40% initially (increasing over time to 55%) of the cost of all manufactured products used to build the project must be produced in the United States. For offshore wind projects, the percentage starts at 20%.
Divide materials brought to the project site for incorporation into the project into two categories: construction materials and manufactured products.
Construction materials are materials that are made primarily of steel or iron and are structural in nature. If they are removed, things fall down. Examples are rebar, piles at solar projects and steel towers at onshore wind farms.
Construction materials must be entirely US made, meaning all of the manufacturing processes must take place in the United States, except for the mining of raw ore and metallurgical processes involving refinement of steel additives.
Put in the second category all other components brought to the site for incorporation in the project, but only "manufactured products." Manufactured products are things that were manufactured in a factory. Mere final assembly by welding together parts is not manufacturing. Manufacturing involves altering the form or function of parts and raw materials by "adding value and transforming" them into a new product "functionally different from that which would result from mere assembly."
The IRS released a table showing what parts of utility-scale solar projects, onshore and offshore wind projects and large battery projects are steel or iron construction materials versus manufactured products. The table can be found here.
The table does not mention step-up transformers, but says the offshore substation in an offshore wind farm is a manufactured product.
Set up a manufactured products fraction.
The fraction must be at least 40% for projects on which construction starts by the end of 2024, 45% for projects starting construction in 2025, 50% in 2026 and 55% thereafter. It starts at 20% for offshore wind projects, increasing to 55% for such projects that start construction in 2028 or later.
The numerator is the cost of the manufactured products made in US factories. The United States for this purpose means not only the 50 US states and District of Columbia, but also Puerto Rico, Guam, the US Virgin Islands, American Samoa and the Northern Mariana Islands.
The denominator is the cost of all the US and foreign manufactured products used to build the project.
Determining what can be put in the numerator is complicated.
It requires analyzing, for manufactured products made in US factories, the origin of parts and materials the factories used to make them. Any manufactured product using all US-made parts and materials is treated as entirely US made. The entire cost to the manufacturer to make the product goes into the numerator.
However, if any material used by the US factory came from outside the United States, then the focus shifts to the origin of the different materials and parts used by the factory. In that case, only the cost to the manufacturer of the materials and parts that are US made goes into the numerator of the fraction.
Developers will have a hard time getting manufacturers to reveal their costs.
Developers will want equipment manufacturers to certify the origin of the components used to make manufactured products delivered to the project site for incorporation in the project. They will also want them to certify their "direct" costs to make any such products broken down among the various parts and materials used to make them.
The manufacturer's "direct" costs are materials costs paid to suppliers and wages and payroll taxes on wages paid to workers at the US factory that makes the manufactured product. They do not include rent, depreciation, utilities, storage and handling, pension contributions, employee benefits, other overhead costs and similar items. A list of what is considered "indirect" and does not count can be found at 26 CFR § 1.263A-1(e)(2)(ii).
Developers will want manufacturers to pay damages if the IRS finds later on audit that an origin and cost certificate is inaccurate.
The following example shows how the calculation works.
A solar developer hires a construction contractor to build a solar project. Construction starts for tax purposes by the end of 2024. The main project elements are steel piles, trackers, modules, inverters and a step-up transformer.
The steel piles are construction materials and must be 100% US made. Failure to reach 100% on the piles rules out any domestic content bonus credit.
The remaining items are manufactured products and must be at least 40% US made.
The developer buys the modules and inverters directly from manufacturers and supplies them to the construction contractor as owner-supplied equipment. The inverters and step-up transformer are made outside the United States. The direct cost to the manufacturer to make them goes into the denominator of the manufactured products fraction.
The trackers and modules are made in US factories. The modules use imported cadmium but the other parts and materials used to make them are produced in the United States.
The trackers are made from all US parts and materials.
The direct cost to the manufacturer to make the modules and trackers goes in the denominator of the fraction. The entire direct cost to the manufacturer to make the trackers also goes in the numerator. The direct cost to the module manufacturer for all of its US-made parts and materials, but not also its labor, goes into the numerator.
Labor costs at the project site do not count. The aim of the manufactured products fraction is to identify how much of the equipment was made in US factories.
Project developers and domestic manufacturers who are unhappy with the complexity will have a chance to persuade the Treasury to change how the calculations work.
Notice 2023-38 explains what the Treasury plans currently to say in proposed regulations late this year or early next year.
Developers who start construction of projects for tax purposes by mid-August 2023 will have the option to apply the calculations in Notice 2023-38 or to use whatever approach is adopted in the proposed regulations. The proposed regulations are expected to apply retroactively to projects placed in service in tax years ending after May 12, 2023. Thus, companies that have calendar tax years would be able to use the approach in the proposed regulations for projects placed in service on or after January 1, 2023.
Bonus credits can only be claimed on projects put in service in 2023 or later.
Manufacturers who are able to offer products that help developers qualify for the domestic content bonus credit have been asking for premiums.
Developers have been asking such manufacturers not only to certify that their products were manufactured (as opposed to assembled) at US factories, but also to recertify to the domestic content after any IRS guidance is issued or else return any premium paid for the equipment.
The domestic content requirements have waiver provisions for cases where use of US-made components would increase the project cost by more than 25% or US-made components are not available in sufficient quantity or quality.
A project cannot waive into a bonus credit, according to the Congressional tax committee staffs. Their view is the waivers are relevant only for avoiding a domestic content penalty, meaning inability for tax-exempt and state and local government entities, the Tennessee Valley Authority, Indian tribes and rural electric cooperatives to receive full direct cash payments from the IRS for tax credits on projects on which construction starts after 2023. (More detail about the direct-pay option can be found here.)
Project owners will have to certify to the IRS that they are entitled to the bonus credit.
The certificate must be signed by a person with authority to bind the company. It must be attached to the annual tax return filed for the year the project is placed in service. A copy must be included with subsequent tax returns in cases where production tax credits are claimed on a project over time.
The certificate must identify the project and project type, location, when it was placed in service and total bonus credit calculated.
The bonus calculations are done as of the date the project is placed in service. Only costs that have been "incurred" by that date by manufacturers for US tax purposes count in the calculations.
Taxpayers will have to keep records to prove qualification for the bonus credit for as long as a project is exposed to a potential back tax assessment. The IRS usually has three years after the tax return is filed to audit, but taxpayers often consent to an extension where the IRS has come up against the deadline and is not yet ready to close the audit.