The Inflation Reduction Act of 2022 (IRA) created a 10% tax credit adder to encourage the use of “domestic content” in renewable projects that qualify for the production tax credit (PTC) and investment tax credit (ITC). Projects built using the required amounts of U.S.-produced steel, iron and manufactured products can receive a significant 10% increase to the credits. Taxpayers have been eagerly anticipating Treasury and IRS guidance on this credit adder since the IRA was signed into law in August 2022.
On May 12, 2023, the IRS released Notice 2023-38 establishing the initial guidance on this bonus program and the standards on which projects will be evaluated, a safe harbor regarding the classification of certain components, and the promise of more guidance to come in the form of proposed regulations.
Applicable Projects and the Domestic Content Bonus Opportunity
The domestic content bonus applies across three distinct categories tied to four tax credit statutes:
- PTC-eligible qualified facilities described in IRC Sections 45 or 45Y;
- ITC-eligible generation or storage energy properties under IRC Section 48 (applicable until 2025); and
- Technology-neutral ITCs for qualified investments in zero greenhouse gas generation facilities or energy storage technologies under IRC Section 48E (applicable after 2024).
Retrofits of existing projects in these applicable categories are eligible for the domestic content bonus, but they must meet the so-called 80/20 rule, which requires no more than 20% of the value of the project to come from existing equipment. The “new” property used in these retrofit projects will need to satisfy the domestic content requirements to qualify for the 10% tax credit bonus.
To meet the domestic content bonus criteria, taxpayers must construct a project with 100% U.S. content steel and iron and incorporate the appropriate “adjusted percentage” of domestically manufactured products.
The adjusted percentages of domestic content for manufactured products are as follows:
- 40% for projects that begin construction prior to Jan. 1, 2025;
- 45% for projects that begin construction after Dec. 31, 2024, but before Jan. 1, 2026;
- 50% for projects that begin construction after Dec. 31, 2025, but before Jan. 1, 2027; and
- 55% for projects that begin construction after Dec. 31, 2026.
Offshore wind projects have their own percentage schedule that follows similar timing, but sets the adjustable percentages for manufactured products as follows:
- 20% for projects that begin construction prior to Jan. 1, 2025;
- 5% for projects that begin construction after Dec. 31, 2024, but before Jan. 1, 2026;
- 35% for projects that begin construction after Dec. 31, 2025, but before Jan. 1, 2027;
- 45% for projects that begin construction after Dec. 31, 2026, but before Jan. 1, 2028; and
- 55% for projects that begin construction after Dec. 31, 2027.
Renewable energy projects that meet the necessary domestic content criteria will receive an increase in credit value, specifically a 10% greater PTC value (i.e., approx. $3/kWh currently, subject to inflation adjustment) and a 10 percentage points greater ITC (i.e., a 40% credit). These credit values are predicated on projects also meeting the prevailing wage and apprenticeship (PWA) prerequisites; otherwise, the credits get an 80% cut. (Read more about PWA guidance in McGuireWoods’ Nov. 30, 2022, alert.)
Description of Domestic Content Items
In general, the domestic content requirements apply to any steel, iron or “manufactured product” that is a component of an energy project. The IRS and Treasury are relying on precedential regulations in 49 CFR 661.1 through 661.21, known as the Buy America Requirements, to ascertain whether an item will be deemed to have been produced in the United States.
- Items “Produced” in the United States
Since the enactment of the IRA, there has been an open question about whether an item could be “produced” in the United States if the activity was limited to final construction or assembly. Notice 2023-38 conclusively establishes that final assembly is not enough through definitions of key terms. “Produced” and “Manufactured” have the same meaning. “Manufactured” means to be produced as a result of the manufacturing process. A “manufacturing process” requires an alteration or transformation of the form or function of materials or elements to create a functionally different new item than what would result from “mere assembly of the elements or materials.”
There was also a question about what geographies were covered by the reference to the “United States.” Notice 2023-38 definitively explains that this includes not only the 50 states, but also the District of Columbia and the five U.S. territories (Puerto Rico, Guam, American Samoa, the U.S. Virgin Islands and the Northern Mariana Islands).
- Steel and Iron
Notice 2023-38 clarifies that all manufacturing processes with respect to any steel or iron items that are components of an energy project must take place in the United States. However, metallurgical processes involving refinement of steel additives are not required to be performed in the United States. Moreover, only structural construction materials made primarily of steel or iron must meet the domestic content requirement, and not steel or iron parts of other components. There is no domestic content requirement for items that are made primarily of steel or iron but are not structural in function, such as nuts, bolts, screws, washers, cabinets, covers, shelves, clamps, fittings, sleeves, adapters, tie wire, spacers, door hinges and similar items.
- Manufactured Products and Components
Notice 2023-38 explains that a manufactured product is considered to be produced in the United States only if: (1) all the manufacturing processes for the product take place in the United States and (2) all the components of the product are of U.S. origin. A component is of U.S. origin if it is manufactured in the United States, regardless of the origin of its subcomponents. This means a taxpayer must look to the underlying component costs of a manufactured product when there are less than 100% U.S. components used in any otherwise U.S.-manufactured product.
To determine the project’s domestic content percentage, the costs for domestic manufactured products and domestic components are divided by the total costs for all manufactured products incorporated into the project. No indirect costs are included in this calculation (including the costs to incorporate any component into the project); only direct costs under Treas. Reg. §1.263A-1(e)(2)(i) of producing the manufactured product are included. This calculation can become complex when non-U.S. components are involved and require a “look through” to manufacturer’s costs, rather than project costs. This could become difficult to certify with any level of accuracy when relying on a third-party manufacturer’s determination of costs.
Component Safe Harbor
Notice 2023-38 provides a non-exhaustive safe harbor list of common project components for classification as either a “steel/iron” component or a “manufactured product.” The safe harbor project component list is categorized for (i) utility-scale photovoltaic systems, (ii) land-based wind facilities, (ii) offshore wind facilities and (iv) battery energy storage. Taxpayers may rely on these classifications and have certainty in claiming the domestic content bonus with respect to their renewable energy project.
Direct Pay for Tax-Exempt Entities
Under Section 6417 adopted through the IRA, tax-exempt entities, Indian tribes, state and local governments, the Tennessee Valley Authority and electric cooperatives can receive a refund of unapplied ITCs or PTCs, but starting in 2024, they will need to satisfy the domestic content requirements to get the full credit amount as a refund. If they fail to meet the domestic content requirements, credits are reduced by 10% for projects beginning construction in 2024, by 15% for projects beginning construction in 2025 and by 100% for projects beginning construction after 2025. There is an exception to the domestic content requirement to permit direct pay to these tax-exempt entities when using domestic materials or components is not available in the market or would increase the project costs by more than 25%. Notice 2023-38 does not address this requirement for Section 6417 direct pay, but this guidance and future regulations will be the governing standards unless the IRS issues special rules in the forthcoming direct-pay guidance that is expected in summer 2023.
Certification and Record-Keeping Requirements
The IRS has not prescribed a specific certification form for the domestic content bonus credit; however, Notice 2023-38 gives a comprehensive list of information that must be included with the certification. This list includes the specific type of project and the tax credit it is claiming, the geographic location, the total amount of bonus credit claimed, and a requirement that it be signed by an authorized person under penalties of perjury. The certification must be filed with a taxpayer’s annual return and included along with Form 3468 for ITCs and Form 8835 for PTCs (and in the latter case, the certification must be filed annually for each year of the PTC claim period). Taxpayers must maintain records to substantiate the credit claim, but this record-keeping requirement is consistent with general record-keeping for tax filings and is not a heightened standard.
The IRS and Treasury intend to expand on Notice 2023-38 and issue proposed regulations applicable to tax years that end after May 12, 2023, although that date could certainly be adjusted. In the meantime, taxpayers may rely on Notice 2023-38 as binding on the domestic content bonus credit rules for any qualified facility, energy project or energy storage technology that begins construction prior to 90 days after the publication of those proposed regulations in the Federal Register.