Final regulations on the advanced manufacturing production credit offer insights and clarifications on inclusion of extraction costs, use of recycled materials, and assembly costs. Here’s a closer look at some of the changes in the 45X guidance.
The U.S. Department of Treasury (Treasury) and IRS have released final regulations to guide taxpayers who claim the Advanced Manufacturing Production Credit under Internal Revenue Code (IRC) Section 45X. The most recent 45X guidance includes modifications to previous proposed regulations but also notes some instances where suggestions from commenters were intentionally not addressed.
As discussed previously, the Inflation Reduction Act (IRA) 45X tax credit provides an incentive to manufacturers who:
Produce eligible components.
In the United States.
For sale to unrelated parties.
As part of their trade or business.
Those components must be produced and sold after Dec. 31, 2022, to qualify for the 45X tax credit, and the credit will begin to phase out for components sold after Dec. 31, 2029.
The latest 45X guidance takes additional steps to provide clarity on some of the key terms that a business will rely on to determine what costs related to eligible components can qualify for the credit. The proposed regulations specified that a component will be considered “produced by the taxpayer” when it conducts a process “that substantially transforms constituent elements, materials, or subcomponents into a complete and distinct eligible component … ” The final regulations include several sections that focus on specific types of elements, materials, and subcomponents that will qualify for the credit.
Direct and indirect material costs and extraction costs for critical minerals
The proposed rules wouldn’t have allowed direct or indirect material costs, or any costs related to the extraction or acquisition of raw materials, to be taken into account as production costs. The final 45X guidance clarifies that both direct and indirect material costs, as well as extraction costs can qualify, provided that the purchased material itself isn’t an eligible component.
The final 45X guidance clarifies that both direct and indirect material costs, as well as extraction costs can qualify, provided that the purchased material itself isn’t an eligible component.
As noted in the preamble, “The final regulations adopt a rule allowing taxpayers that produce applicable critical minerals and electrode active materials as specified in the statute to include direct and indirect materials costs … in production costs if certain conditions are met.” Similarly, “For both electrode active materials and applicable critical minerals, the final regulations … allow taxpayers to include extraction costs related to the extraction of raw materials in the United States or a United States territory … ” Extraction costs can only be claimed “if they are paid or incurred by the taxpayer that claims the section 45X credit with respect to the relevant electrode active material or applicable critical mineral.”
Secondary production/recycled materials can meet “produced by the taxpayer” requirement
Treasury responded to several commenters who requested that the final regulations specifically permit recycled materials to be used in a process that would still qualify as substantial transformation for purposes of claiming the credit. There was concern after the release of the proposed regulations that the preamble included both primary and secondary production in the definition of “produced by the taxpayer” but the text of the regulations didn’t mention secondary production. The latest guidance includes an amendment to the text of the final regulations to specifically include “secondary production.”
Does assembly qualify for the advanced manufacturing production credit?
The proposed regulations specified that a component would be considered produced by the taxpayer when it conducts a process “that substantially transforms constituent elements, materials, or subcomponents into a complete and distinct eligible component … ” They went on to note that, among other activities, “mere assembly” wouldn’t be considered substantial transformation.
Commenters raised concerns with the modifier “mere” as it related to assembly. The use seemed to suggest that assembly in and of itself could be insufficient to qualify as a form of transformation. Treasury modified the final regulations to replace the term “mere assembly” with “minor assembly” everywhere it appeared.
Treasury modified the final regulations to replace the term “mere assembly” with “minor assembly” everywhere it appeared.
The term “minor assembly” still introduces some ambiguity, but it does provide that assembly can be included in this evaluation if it rises to a sufficiently substantial level. Unfortunately, the guidance didn’t offer any examples to help taxpayers distinguish what levels of assembly would be sufficient. However, taxpayers do have clarity that there are levels to assembly activity, which can serve as the basis for a position to include assembly in the analysis.
Treasury and IRS did acknowledge that assembly is a primary production activity for businesses that are producing and selling solar modules and battery modules with cells. While the guidance doesn’t offer specific examples on what assembly rises above the threshold of “minor,” the fact that they include “with cells” as a key requirement for assembly to qualify as substantial transformation in this instance does provide some insight.
Exemption from domestic production requirement for component elements
Many of the provisions of the IRA included domestic production requirements. While the advanced manufacturing production credit includes a requirement that the “substantial transformation” operations be performed in the United States, it was silent on whether all of the parts, materials, and subcomponents that went into the production of a eligible component needed to be sourced in the United States.
The final 45X guidance states, “An eligible component that is a ‘constituent element, material or subcomponent’ of another eligible component is not subject to the domestic production rule, and thus, an eligible component may incorporate another eligible component that is also a foreign-sourced ‘constituent element, material or subcomponent’ and still be eligible for a section 45X credit. In addition, raw materials and intermediate products generally qualify as constituent elements, materials, or subcomponents.”
Final 45X guidance stresses that determinations will be fact-specific
The proposed rules provided examples of certain situations and activities that wouldn’t qualify as substantial transformation. The final regs offer some rules on certain assembly activities related to a few types of modules that will qualify as substantial transformation. But the regulations make very clear that each credit claim will be based on the specific facts and circumstances related to each taxpayer’s production of each potentially eligible component.
Because the determination of whether a production activity or process results in “substantial transformation” for any specific eligible component will be highly fact dependent, taxpayers considering a claim for the 45X advanced manufacturing production credit should consult with their tax advisors to perform a thorough item-by-item, component-by-component evaluation of their 45X eligibility.
