A&M Tax Minute / Expertise
The Treasury Department and the Internal Revenue Service issued proposed regulations on the Section 45X Advanced Manufacturing Production Credit on December 14, 2023. Section 45X was enacted under H.R. 5376 (commonly referred to as the Inflation Reduction Act) in 2022.
The proposed regulations generally confirm the statutory regime. Highlights include proposed rules relating to (i) the method by which the proper credit claimant is determined in contract manufacturing scenarios; (ii) the sale of a final product incorporating eligible components; (iii) the interrelation between Section 45X and Section 48C, the Qualifying Advanced Energy Project Credit; and (iv) the exclusion of material acquisition costs in computing the 10 percent credit for electrode active materials and applicable critical minerals.
The proposed regulations are applicable for eligible components for which production is completed and sales occur after December 31, 2022, and during a taxable year ending on or after the date the regulations are finalized.
Written or electric comments must be received by February 13, 2024. A hearing on the proposed regulations is scheduled for February 22, 2024, in Washington, D.C.
In brief, Section 45X provides a tax credit for the production and sale of “eligible components.” Eligible components include:
Eligible components must be produced and sold in a trade or business of the taxpayer to be eligible for the Section 45X credit. Eligible components generally must be sold to an unrelated person for the credit to apply, though taxpayers may make an election to receive the credit on a sale to a related person. The credit rates (except for applicable critical minerals) begin to phase out for eligible components sold after 2029 and are completely phased out for eligible components sold after 2032.
The Section 45X credit is one of three credits for which “direct pay” under Section 6417 is available to all taxpayers. Taxpayers must make an election for direct pay, but such election is only valid for five years. This direct pay election is made on a facility-by-facility basis. The Section 45X credit is also eligible to be transferred to an unrelated person for cash under Section 6418.
A&M can assist taxpayers in identifying and implementing optimal strategies for using and/or monetizing the Section 45X credit given the multiple options available under Sections 6417 and 6418.
Proposed Treas. Reg. § 1.45X-1
This section provides an overview of the general rules regarding the Section 45X credit, including a definition of the term “produced by the taxpayer.” It also provides rules for determining the proper credit claimant in contract manufacturing scenarios.
For a component to be produced by the taxpayer, the taxpayer must engage in a process that “substantially transforms constituent elements, materials, or subcomponents into a complete and distinct eligible component that is functionally different from that which would result from mere assembly or superficial modification of the elements, materials, or subcomponents.” Production by the taxpayer does not include partial transformation or mere assembly or superficial modification.
For contract manufacturing arrangements, generally the contractor is the credit-eligible taxpayer. However, the parties may determine by agreement that the customer may claim the Section 45X credit instead of the contractor.
The ability to choose which party takes the credit in a contract manufacturing arrangement will become a key negotiating point for such arrangements.
Eligible components for which construction began on or before December 31, 2022, are eligible for the Section 45X credit so long as the sale takes place in 2023 or later.
While eligible components must be produced in the United States or a U.S. territory, constituent elements, materials, and subcomponents used in the production of eligible components are not subject to this domestic production requirement.
A taxpayer may receive a Section 45X credit for both input components and final components where eligible components produced by the taxpayer are incorporated into another eligible component that is then sold to an unrelated person. Of note, a similar rule is provided where a taxpayer produces eligible components and integrates them into a final product that is then sold to an unrelated person. The example in the proposed regulations refers to the sale of an electric vehicle (a product, not a component) by a taxpayer that produced Section 45X components that were incorporated into the electric vehicle.
This rule providing for Section 45X credits even where there is only a sale of a final product that incorporates eligible components produced by a vertically integrated taxpayer is a welcome relief to taxpayers who may have been hesitant to restructure their operations to create interim eligible component sales within a controlled group.
The proposed regulations confirm the statute’s restriction on a taxpayer receiving a Section 45X credit for a component produced in a facility that receives a Section 48C credit. There is a series of examples illustrating the application of this rule for various production unit structures.
Taxpayers who claim a Section 48C credit on a portion of the facilities in their supply chain must be careful to delineate the separation between Section 48C facilities and other facilities to ensure maximum eligibility for the Section 45X credit.
The Section 48C credit is an application-based credit. Even if a taxpayer’s Section 48C application for a facility is approved, the taxpayer still ought to weigh the Section 48C credit against the Section 45X credit, as an approved application does not require a taxpayer to take the Section 48C credit.
Finally, this section of the proposed regulations contains an anti-abuse rule intended to prevent taxpayers from receiving a Section 45X credit from production and sale that is “wasteful.” The example given addresses a fact pattern where a taxpayer produces and sells an eligible component to a related or unrelated person with the knowledge that the purchaser will not resell the components or use them in its trade or business.
Proposed Treas. Reg. § 1.45X-2
This section provides proposed rules relating to the sale of eligible components to an unrelated person, or to a related person where the appropriate election is made.
When a taxpayer (X) sells an eligible component to a related person (Y) in 2023 and Y then sells the eligible component to an unrelated person (Z) in 2024, the timing of X’s Section 45X credit depends on whether X makes a related person sale election.
These rules extend taxpayers a fair amount of flexibility on the timing of the Section 45X credit for sales to related persons. These timing rules will be very important when the credit rates (except for applicable critical minerals) begin to phase out in 2030.
The application of these rules is illustrated by the following fact patterns:
These examples apply even where X and Y are members of the same consolidated group.
The proposed regulations detail the mechanics for making a related person election.
Proposed Treas. Reg. § 1.45X-3
This section echoes the Section 45X statute in providing the definitions of eligible components, excluding applicable critical minerals. The table in Appendix A, below, contains a summary of the eligible components as well as the applicable credit rate.
Notably, for the production of electrode active materials where the credit rate is a percentage of the production costs incurred, the credit-eligible costs include all costs as defined in Treas. Reg. § 1.263A-1(e) that are paid or incurred within the meaning of Section 461, except direct or indirect materials as defined in Treas. Reg. §§ 1.263A-1(e)(2)(i)(A) or 1.263A-1(e)(3)(ii)(E), respectively.
Proposed Treas. Reg. § 1.45X-4
This section echoes the Section 45X statute in providing the definitions of applicable critical minerals. The table in Appendix B, below, contains a summary of the applicable critical minerals. The credit rate is 10 percent of the production costs incurred by the taxpayer with respect to production of such critical mineral.
For purposes of the credit for the production of applicable critical minerals, the credit-eligible costs include all costs as defined in Treas. Reg. § 1.263A-1(e) that are paid or incurred within the meaning of Section 461, except direct or indirect materials as defined in Treas. Reg. §§ 1.263A-1(e)(2)(i)(A) or 1.263A-1(e)(3)(ii)(E), respectively.
The exclusion of direct or indirect material costs and extraction costs in computing the 10 percent credit for producing electrode active materials and applicable critical minerals could materially reduce the value of such credit for taxpayers. We note the preamble to the proposed regulations expressly states the Treasury Department and Internal Revenue Service are open to feedback on whether the exclusion of these costs is appropriate, specifically feedback on “the extent to which these costs…add value” to the electrode active material or the applicable critical minerals.