Proposed Regulations on Section 45X Advanced Manufacturing Production Tax Credit
On December 14, 2023, the Department of Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) released proposed regulations to implement the Section 45X1 advanced manufacturing production credit established by the Inflation Reduction Act.2 Section 45X provides a tax credit for the domestic production and sale of certain eligible components, including solar and wind energy components, inverters, qualifying battery components and applicable critical minerals.
The proposed regulations provide guidance on:
- General rules applicable to the Section 45X credit, including the definition of the term “produced by the taxpayer;”
- Rules for sales to unrelated persons through a person related to the taxpayer, including the rules for a taxpayer to make an election to treat sales of eligible components to related persons as if made to unrelated persons;
- Definitions and credit amounts for certain eligible components, including solar energy components, wind energy components, inverters, and qualifying battery components, and phase-out rules; and
- Definitions and credit amounts for applicable critical minerals that are eligible components.
I. General Rules for Claiming Advanced Manufacturing Production Credit
The proposed regulations clarify the general rules for the Section 45X credit. Central to these regulations is the ‘produced by the taxpayer’ requirement, which emphasizes the importance of substantial transformation, over mere assembly or superficial modification. Taxpayers must produce the components in the United States or its territories to qualify for the Section 45X credit, but this requirement does not extend to constituent elements, materials, or subcomponents, offering flexibility to manufacturers in sourcing materials. Finally, the regulations introduce a rule allowing parties to decide who may claim the Section 45X credit through agreement and certification, offering flexibility in contract manufacturing arrangements.
A. Credit amount
The proposed regulations provide that the credit amount is equal to the sum of the credit amounts for each eligible component that is produced and sold by the taxpayer to an unrelated person.3 These amounts are determined in the manner described in Section 45X(b), which specifies applicable amounts for a list of eligible components.
B. Definition of “produced by the taxpayer”
The proposed regulations define the term “produced by the taxpayer” to mean a process conducted by the taxpayer 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.4
In drafting this definition, Treasury and the IRS appear to have leveraged the concept of “substantial transformation” from the manufacturing exception to the branch rules for foreign base company sales income. There have been decades of litigation over what constitutes “substantial transformation” versus “minor assembly” in this context. See e.g., Bausch & Lomb Inc. v. Commissioner, T.C. Memo. 1996-57 (assembling sunglasses in Ireland was found to be “substantial transformation,” not “minor assembly”). This history may provide further guidance on the concept of substantial transformation in the context of the Section 45X credit.
Additionally, the proposed regulations provide that the taxpayer seeking the Section 45X credit must be the person who performs the actual production activities which bring about a substantial transformation resulting in the eligible component, and who sells such eligible component to an unrelated person.5 Importantly, in contract manufacturing arrangements, the credit goes to the taxpayer that performs the actual production activities that bring about a substantial transformation resulting in the eligible component.6 However, a special rule allows the parties in a contract manufacturing arrangement to determine, by agreement, the party who may claim the credit.7 For example, a principal that conducts no manufacturing itself may claim the credit if the contract manufacturer agrees in writing. The parties must meet certain certification requirements,8 and the proposed regulations include examples to illustrate its application.9
C. Produced in the United States
Only eligible components produced in the United States qualify for the Section 45X credit, under the proposed rules.10 Importantly, the proposed regulations clarify that constituent elements, materials and subcomponents used in the production of eligible components are not subject to this domestic production rule.11
D. Sale of integrated components
A taxpayer may claim Section 45X credits, under the proposed rules, by producing and selling an eligible component to a related person, who then integrates, incorporates, or assembles the component into another complete and distinct eligible component, which is subsequently sold to an unrelated person.12 The key factor is the substantial transformation of the initial component into another complete, distinct eligible component, functionally different from that which would result from mere assembly or superficial modification.13 The taxpayer may claim Section 45X credits for sales of multiple integrated eligible components to related persons, if they are subsequently sold to an unrelated person.14
E. Anti-abuse rule
The proposed regulations provide a general anti-abuse rule that disqualify the Section 45X credit, in cases where the primary purpose of the production and sale of an eligible component is to obtain the benefit of the Section 45X credit in a wasteful manner that is wasteful, such as discarding, disposing of, or destroying the eligible component without putting it to a productive use.15
One of the potential abuses for this credit is relatively unique: manufacturing and selling a component solely for the credit and then destroying it. This type of abuse is possible because the credit amount is fixed while the production cost is not—and possibly less than the credit—thus creating an incentive to manufacture and sell unneeded components. The anti-abuse rule makes the credit unavailable in this situation.
II. Sale to an Unrelated Person
The proposed regulations clarify that sales of eligible components to related persons, which are then integrated, incorporated, or assembled into another eligible component, can qualify for the Section 45X credit. Importantly, this may allow vertically integrated manufacturers to stack Section 45X credits for each eligible component they produce.
A. Definitions
The proposed regulations define the terms “person,” “related person,” and “unrelated person” for purposes of the Section 45X credit.16 The term “person” is broadly defined, including individuals, trusts, estates, partnerships, associations, companies, and corporations, as defined in Section 7701(a)(1) of the Code.17 Notably, a disregarded entity (for example, under Treas. Reg. § 301.7701-3) is not a “person” for these purposes.18
The term “related person” is defined as a person who is related to another person, if such persons would be treated as a single employer under the regulations for Section 52(b) of the Code.19 The term “unrelated person” is simply defined as a person who is not a “related person” for these purposes.20 The proposed regulations provide that, for purposes of the Section 45X credit, a taxpayer is treated as selling components to an unrelated person if such component is sold to such person by a person related to the taxpayer.21 Even though the taxpayer’s direct sale is to a related person, the taxpayer is still eligible for the Section 45X credit.22
B. Sales of integrated components to related persons
Section 45X(d)(4) provides that a person is treated as having sold an eligible component to an unrelated person if such component is integrated, incorporated, or assembled into another eligible component that is sold to an unrelated person. The proposed regulations provide that, for such sales, the taxpayer may claim a Section 45X credit in the taxable year of the sale to the unrelated person.23 The proposed regulations provide several examples to illustrate the treatment of sales of multiple incorporated eligible components to related and unrelated persons.24
However, under Section 45X(a)(3)(B), if a taxpayer makes an election in the form and manner prescribed by the Secretary of the Treasury or a delegate, a sale of components by the taxpayer to a related person will be treated as if made to an unrelated person for purposes of Section 45X(a) (Related Person Election). The proposed regulations provide the form and manner for a taxpayer to make the Related Person Election.25
The proposed regulations provide that, if a taxpayer makes the Related Person Election and produces and sells an eligible component to a related person—who then integrates, incorporates, or assembles the taxpayer’s eligible component into another complete and distinct eligible component, which is subsequently sold to an unrelated person—the taxpayer’s sale of the eligible component to the related person would be treated as if made to an unrelated person in the taxable year in which the sale to the related person occurs.26
An illustrative example provided in the regulations is particularly instructive.27 It describes a scenario where three related companies—W, X, and Y—participate in a sequence of transactions involving the production and sale of electrode active materials (EAMs) and various battery components. In 2023, W produces EAMs and sells them to X and makes a Related Party Election. The following year, in 2024, X incorporates the EAMs into battery cells that it produces and sells to Y and makes a Related Party Election. Finally, in 2025, Y incorporates the battery cells into battery modules that it produces and sells to Z, an unrelated person. W may claim a Section 45X credit for the sale of the EAMs in 2023, X may claim a credit for the sale of the battery cells in 2024, and Y may claim credit for the sale of battery modules in 2025.
III. Eligible Components
The proposed regulations clarify definitions and introduce technical requirements for eligible components, including solar and wind energy components, inverters, and qualifying battery components. The regulations offer detailed guidance on the calculation of credit amounts for each component, emphasizing the importance of specific documentation for eligibility. They further specify the costs eligible for the Section 45X credit in the production of electrode-active materials, including labor and electricity, but excluding costs related to the extraction or acquisition of raw materials. Finally, the regulations introduce a phase-out schedule for certain eligible components.
IV. Applicable Critical Minerals
The proposed regulations offer guidance on the calculation of credit amounts for critical minerals, specifying that a taxpayer must provide a certificate of analysis (COA) when they sell a critical mineral to be eligible for the credit. The regulations further specify the costs eligible for the Section 45X credit in the production of critical minerals, including labor and electricity, but excluding costs related to the extraction or acquisition of raw materials.
A. Definitions
Section 45X(c)(6) defines applicable critical minerals that are eligible components for purposes of the Section 45X credit. The proposed regulations adopt, with some clarifications, the definitions of applicable critical minerals provided in Section 45X(c)(6).28
B. Credit amount
The proposed regulations provide that in the case of any applicable critical mineral, the credit amount is equal to 10 percent of the costs incurred by the taxpayer with respect to production of such mineral.29 Additionally, the proposed regulations provide definitions of production processes for applicable critical minerals.30
C. Production costs incurred
The proposed regulations mirror those for qualifying battery components. Specifically, the costs incurred for purposes of determining the credit amount include those as defined under 1.263A-1(e)31 that are paid or incurred within the meaning of Section 461 of the Code by the taxpayer for the production of an applicable critical mineral only.32 Importantly, the proposed regulations provide that the rules regarding ownership and property produced under a contract with a taxpayer that are used to determine whether a taxpayer is engaged in production or resale activities for purposes of Section 263A do not apply for purposes of determining the taxpayer that is engaged in production activities for purposes of the Section 45X credit.
Treasury and the IRS are considering including, in production costs, the costs of extraction and other similar value-added activities in the production of raw materials used in applicable critical minerals.
D. Substantiation
The proposed regulations require the taxpayer to document that their product meets the criteria for an applicable critical mineral.33 Specifically, taxpayers must provide a COA when they sell a critical mineral.34
1 Unless otherwise specified, all “section” or “§” references are to the Internal Revenue Code of 1986, as amended (Code) or the Income Tax Regulations (26 CFR part 1).
2 Notice of Proposed Rulemaking, 2023-27498.
3 Prop. Treas. Reg. § 1.45X-1(b).
4 Prop. Treas. Reg. § 1.45X-1(c)(1).
5 Prop. Treas. Reg. § 1.45X-1(c)(3)(i).
6 Prop. Treas. Reg. § 1.45X-1(c)(3)(ii)(A).
7 Prop. Treas. Reg. § 1.45X-1(c)(3)(iii).
8 Prop. Treas. Reg. § 1.45X-1(c)(3)(iv).
9 Prop. Treas. Reg. § 1.45X-1(c)(3)(v).
10 Prop. Treas. Reg. § 1.45X-1(d)(1).
11 Prop. Treas. Reg. § 1.45X-1(d)(2).
12 Prop. Treas. Reg. § 1.45X-1(f)(1).
13 Prop. Treas. Reg. § 1.45X-1(f)(1)(i).
14 Prop. Treas. Reg. § 1.45X-1(f)(2)(i).
15 Prop. Treas. Reg. § 1.45X-1(i)(1)
16 Prop. Treas. Reg. § 1.45X-2(b).
17 Prop. Treas. Reg. § 1.45X-2(b)(1).
19 Prop. Treas. Reg. § 1.45X-2(b)(2).
20 Prop. Treas. Reg. § 1.45X-2(b)(3).
21 Prop. Treas. Reg. § 1.45X-2(c)(1).
23 Prop. Treas. Reg. § 1.45X-2(e)(1).
24 Prop. Treas. Reg. § 1.45X-2(e)(2).
25 See Prop. Treas. Reg. § 1.45X-2(d).
26 Prop. Treas. Reg. § 1.45X-2(e)(3)(i).
27 Prop. Treas. Reg. § 1.45X-2(e)(3)(ii).
28 Prop. Treas. Reg. § 1.45X-4(b).
29 Prop. Treas. Reg. § 1.45X-4(c)(1).
30 Prop. Treas. Reg. § 1.45X-4(c)(2).
31 These proposed regulations apply Section 263A and the Section 263A regulations solely to identify the types of costs that are includible in production costs incurred for purposes of computing the credit amount, but do not apply Section 263A or the Section 263A regulations for any other purposes, such as to determine whether a taxpayer is engaged in production activities.
32 Prop. Treas. Reg. § 1.45X-4(c)(3).
