On May 12, 2023, the Internal Revenue Service (IRS) released long-awaited guidance on the domestic content bonus credit under the Inflation Reduction Act of 2022 (IRA). Specifically, the IRS released Notice 2023-38 regarding the domestic content bonus credit that is applicable to Sections 45, 45Y, 48, and 48E of the Internal Revenue Code of 1986, as amended (the Code). (This notice follows an earlier notice (Notice 2022-51) released in October 2022 soliciting comments on bonus tax credit requirements, which Wilson Sonsini covered in a previous alert.) The domestic content bonus credit provides a 10 percent increased production tax credit (PTC) amount for a qualified facility or a 10 percentage point (or 2 percentage point if prevailing wage and apprenticeship requirements are not satisfied) increased investment tax credit (ITC) amount for an energy project, qualified facility or energy storage technology, if the applicable project satisfies the “domestic content requirement,” and the taxpayer timely submits a certification statement to the IRS. The notice describes the rules regarding the domestic content requirement and related recordkeeping and certification requirements, as well as a safe harbor that classifies certain components in representative types of applicable projects as being either steel or iron components or manufactured products. The notice states that Treasury and the IRS intend to issue proposed regulations that provide further guidance in line with the notice.

Rules Regarding the Domestic Content Requirement

The notice provides that in general, an applicable project satisfies the domestic content requirement if both the “Steel or Iron Requirement” and the “Manufactured Products Requirement” are satisfied. One hundred percent of iron and steel, and at least 40 percent (increasing to 55 percent over time) of the cost of manufactured products must be produced in the United States, except for offshore wind facilities, for which at least 20 percent (increasing to 55 percent over time) must be produced in the United States. As expected, all project materials will be categorized as either construction materials that are structural in function (to which the Steel or Iron Requirement applies) or manufactured products (to which the Manufactured Products Requirement applies).

The notice provides a nonexhaustive categorization of applicable project components for both categories for utility-scale solar, land-based wind, offshore wind, and battery storage technology. Notably, the guidance does not provide any categorizations for assets used in distributed generation projects. The categorizations provided in the notice are as follows:

• Utility-scale photovoltaic system
  • Steel or Iron Requirement: steel module racking, pile or ground screw, and rebar in foundation (e.g., concrete pad)
  • Manufactured Products Requirement: Photovoltaic trackers, modules (which includes other Manufactured Product Components, if applicable, including a photovoltaic cell, mounting frame or backrail, glass, encapsulant, backsheet, junction box (including pigtails and connectors), edge seals, pottants, adhesives, bus ribbons, and bypass diodes), and inverters
• Land-Based Wind
  • Steel or Iron Requirement: Tower, steel or iron rebar in foundation (e.g., spread footing)
  • Manufactured Products Requirement: Wind turbine (which includes the following Manufactured Components, if applicable: nacelle, blades, rotor hub, and power converter), wind tower flanges
• Offshore Wind
  • Steel or Iron Requirement: Tower, jacket foundation
  • Manufactured Products Requirement: Wind tower flanges, wind turbine (which includes the following Manufactured Product Components, if applicable: nacelle, blades, rotor hub, and power converter), transition piece, monopile, inter-array cable, offshore substation, export cable
• Battery Storage Technology
  • Steel or Iron Requirement: Steel or iron rebar in foundation (e.g., concrete pad)
  • Manufactured Products Requirement: Battery pack (which includes the following Manufactured Components, if applicable: cells, packaging, thermal management system, and battery management system), battery container/housing, inverter

Steel or Iron Requirement

The Steel or Iron Requirement applies to applicable project components that are construction materials made primarily of steel or iron and are structural in function. The Steel or Iron Requirement does not apply to steel or iron used in manufactured product components or subcomponents of manufactured product components (e.g., nuts, bolts, screws, washers, and other small subcomponents that are made primarily of steel or iron but are not structural in function). The steel or iron requirement is met if all manufacturing processes with respect to any steel or iron items that are applicable project components take place in the United States, except metallurgical processes involving refinement of steel additives.

Manufactured Products Requirement

The Manufactured Products Requirement is met if all manufactured products that are components of an applicable project are produced or deemed to be produced in the United States, inclusive of U.S. possessions. A Manufactured Product means an item that is produced as a result of a manufacturing process, and treated as produced in the United States if all the manufacturing processes for the Manufactured Product take place in the United States and all of the components of the Manufactured Product are of U.S. origin (a “U.S. manufactured product”). A Manufactured Product Component means any article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into an applicable project component that is itself a Manufactured Product, and considered to be of U.S. origin if it is manufactured in the United States, regardless of the origin of its subcomponents (a “U.S. Manufactured Product Component”). To be clear, this means that there can be “Manufactured Product Components” that are themselves not manufactured, but that are incorporated into a project component that is considered a “Manufactured Product.”

All manufactured products that are components of an applicable project are deemed to be produced in the United States if the “domestic cost percentage,” which is the percentage produced by dividing the costs incurred to manufacture Manufactured Products in the United States and to mine, produce, or manufacture components of non-U.S. Manufactured Products in the United States by the total costs incurred to produce each Manufactured Product, equals or exceeds the “adjusted percentage” that applies to the applicable project.

The adjusted percentages of domestic content for manufactured products are as follows:

• 40 percent for projects that begin construction prior to 1/1/25;
• 45 percent for projects that begin construction after 12/31/24, but before 1/1/26;
• 50 percent for projects that begin construction after 12/31/25, but before 1/1/27; and
• 55 percent for projects that begin construction after 12/31/26

Offshore wind projects have their own adjusted percentage requirements:

• 20 percent for projects that begin construction prior to 1/1/25;
• 27.5 percent for projects that begin construction after 12/31/24, but before 1/1/26;
• 35 percent for projects that begin construction after 12/31/25, but before 1/1/27;
• 45 percent for projects that begin construction after 12/31/26, but before 1/1/28; and
• 55 percent for projects that begin construction after 12/31/27

The cost of a Manufactured Product includes only direct costs (as defined in Treasury Regulations Section 1.263A-1(e)(2)(i), i.e., direct material and direct labor costs) that are paid or incurred (within the meaning of Section 461 of the Code) by the manufacturer of the Manufactured Product to produce the Manufactured Product. The cost of a U.S. Manufactured Product Component of a non-U.S. Manufactured Product includes only direct costs (as defined in Treasury Regulations Section 1.263A-1(e)(2)(i), i.e., direct material and direct labor costs) that are paid or incurred (within the meaning of Section 461 of the Code) by the manufacturer of the non-U.S. Manufactured Product to produce or acquire the U.S. Manufactured Product Component. Direct costs (including direct labor costs) of incorporating the applicable project components into the applicable project are not counted.

Retrofitted Facilities

The notice further provides rules regarding the domestic content requirement in respect of retrofitted projects. A retrofitted project is eligible for the domestic content bonus credit if i) it is placed in service after December 31, 2022, ii) the fair market value of the used property is not more than 20 percent of the project’s total value calculated by adding the cost of the new property to the value of the used property, and iii) the new property meets the domestic content requirement and the taxpayer complies with the certification and recordkeeping requirements discussed below.

Safe Harbor for Classification of Certain Applicable Project Components

The notice identifies certain project components commonly found in utility-scale photovoltaic systems, land-based wind facilities, offshore wind facilities and battery energy storage technologies, and categorizes such applicable project components as subject to either the Steel or Iron Requirement or the Manufactured Products Requirement. The notice clarifies that the identified items may not be an exhaustive set of applicable project components for those types of applicable projects and that these identified applicable projects and applicable project components must meet the statutory requirements to be eligible for the relevant PTC and ITC and the domestic content bonus credit.

Certification Requirements

The notice provides that a taxpayer must submit to the IRS a statement certifying for each applicable project for which a taxpayer is reporting a domestic content bonus credit amount. The taxpayer must certify that the applicable project meets the domestic content requirement as of the date the applicable project is placed in service (i.e., the date on which such property is placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business or in the production of income).

In particular, the statement must include the following information: i) whether the applicable project is a qualified facility, energy project, or energy storage technology; ii) the specific type of applicable project; iii) the geographic coordinates and the address (if applicable) of the applicable project; iv) the date the applicable project was placed in service; v) the total domestic content bonus credit amount with respect to the applicable project in the first taxable year in which the taxpayer reports a domestic content bonus credit amount for such applicable project, and vi) any additional information with respect to the applicable project that is required by the applicable forms and instructions for reporting domestic content bonus credit amounts. The statement must be signed by a person with legal authority to bind the taxpayer and contain the following statement: “Under penalties of perjury I declare that I have examined the information contained in this Domestic Content Certification Statement and to the best of my knowledge and belief, it is true, correct, and complete.”

The taxpayer must attach the statement to Form 8835 (Renewable Electricity Product Credit), Form 3468 (Investment Credit), or other applicable form for the first taxable year in which the taxpayer reports a domestic content bonus credit amount for such applicable project. If the taxpayer reports a domestic content bonus credit amount for a PTC project, the taxpayer must in each subsequent taxable year attach to its annual return a copy of the statement filed in the first taxable year.

Recordkeeping Requirements

The notice provides that a taxpayer claiming a domestic content bonus credit amount must meet the general recordkeeping requirements under Section 6001 of the Code to substantiate that the domestic content requirement has been met. Under Section 6001 of the Code and Treasury Regulations promulgated thereunder, the taxpayer must keep permanent books of account or records that are sufficient to establish the domestic content bonus credit amount and retain such books and records so long as the project is potentially subject to a tax assessment.

Example

A project sponsor is developing a solar photovoltaic system. The sponsor will hire an engineer to build the project, construction on which will begin in late 2023. The project materials consist of inverters, trackers, modules, steel beams, and a transformer. The steel beams are considered to be construction materials that are subject to the Steel or Iron Requirement, meaning that 100 percent of the steel beams must be manufactured in the United States. The other components are Manufactured Products subject to the Manufactured Products Requirement. Assume that the project sponsor purchases the modules and inverters directly from the manufacturers and provides them to the contractor. The modules and inverters are both manufactured outside the United States. Thus, the direct manufacturing costs would go into the denominator of the Manufactured Products Requirement fraction. The trackers and transformer are made entirely in the United States. Some of the components of the trackers are imported, but otherwise all components of the trackers and transformer are made in the United States. The direct manufacturing costs to make the trackers and transformer would go into the denominator of the fraction. All of the direct manufacturing costs for the transformer would also go into the numerator of the fraction, and the direct manufacturing costs for the U.S.-made components of the trackers would go into the numerator. Labor costs incurred at the project development site would not be included in the fraction. Provided the fraction yields at least 40 percent U.S.-made components, the Manufactured Products Requirement would be met.

Effective Date

Proposed regulations will apply to taxable years ending after May 12, 2023. The notice states that taxpayers may rely on the rules described in the notice for any project the construction of which begins before the date that is 90 days after the date of publication of the forthcoming proposed regulations in the Federal Register.

Key Takeaways

The formula provided in the notice to calculate qualifying domestic manufacturing costs for solar modules, inverters, and other manufactured components is based on the manufacturer’s costs to produce such components (rather than the amount paid to purchase the completed component), which will potentially make it difficult for project sponsors to comply with all of the rules in the notice.

The manufactured products fraction will compel project developers to request detailed cost segregation information from manufacturers with respect to products delivered to a project site for incorporation into a project. To determine the amount of domestic manufactured products and components costs, developers will need to obtain direct cost information (i.e., direct materials and direct labor costs that are paid or incurred by the manufacturer). This information includes both U.S. and non-U.S. source labor costs, with both costs being included in the denominator and the U.S.-source costs being included in the numerator of the manufactured products fraction. However, indirect costs, such as rent, overhead, and utilities are not to be included in the calculation. An example in the notice discusses this distinction between direct and indirect costs.

The notice may compel manufacturers to ask for premiums on materials for which the manufacturer can certify would qualify for the domestic content bonus and provide supporting documentation.

Project sponsors who begin construction on projects in the next few months can choose between applying the methodology set forth in the notice for purposes of determining whether such project meets the Steel or Iron Requirement and the Manufactured Products Requirement, or alternatively using whatever methodology is ultimately adopted in the proposed regulations. For projects that begin construction more than 90 days after publication of the forthcoming proposed regulations in the Federal Register, the sponsor cannot rely on the methodology in the notice and instead must follow the methodology provided in the forthcoming regulations.