Elective Safe Harbor Released for IRA Domestic Content Tax Credit ‘Adder’

The US Department of Treasury and the IRS on May 16 released Notice 2024-41, which provides a new elective safe harbor that taxpayers may use to qualify for the domestic content bonus credit amount under Sections 45, 45Y, 48, and 48E of the Internal Revenue Code. Released over one year following earlier guidance, the Notice is likely to provide more certainty for taxpayers seeking to qualify for the domestic content bonus credit amount with respect to certain solar and onshore wind projects. The Notice, however, is unlikely to provide similar results for standalone battery electric storage systems projects or other nonsolar or wind projects.

DC Adder Background

To qualify for the domestic content tax credit “adder” (DC Adder) enacted under the Inflation Reduction Act of 2022, a taxpayer must certify that all steel or iron used in an applicable energy project or facility is produced in the United States (Steel or Iron Requirement), and that the total cost of all manufactured products (including components) that are mined, produced, or manufactured in the United States is equal to a specified “adjusted percentage” (ranging from 40% to 55%, with lower percentages for offshore wind) (Manufactured Products Requirement).

The US Department of Treasury (Treasury) and the IRS released Notice 2023-38 on May 12, 2023, providing guidance on qualifying for the DC Adder. We discussed this guidance in detail in our May 18, 2023 LawFlash. Under this guidance, to determine whether the Steel or Iron Requirement and the Manufactured Products Requirement are met, a taxpayer must first determine whether each “applicable project component” qualifies as steel, iron, or a “manufactured product.” Notice 2023-38 provides a nonexclusive safe harbor that taxpayers may rely on for the classification of certain applicable project components as steel, iron, or a manufactured product.

Notice 2023-38 provides stringent rules for determining whether manufactured products incorporated into a project satisfy the Manufactured Products Requirement. To calculate whether manufactured products incorporated into a project equal the applicable adjusted percentage, Notice 2023-38 requires knowledge of whether the manufacturer’s own production activities are conducted in the United States, as well as knowledge of whether the “manufactured product components” incorporated into the manufactured products are US-sourced.

Notice 2023-38 also requires knowledge of manufacturers’ own internal cost structure. This is because the guidance requires that costs potentially included in the numerator, and costs always included in the denominator, of an adjusted percentage calculation are the direct materials and direct labor costs of the manufacturer of the manufactured product, including with respect to non-US manufacturers. In doing so, Notice 2023-38 effectively requires taxpayers to obtain cost data from their suppliers and manufacturers, including foreign manufacturers, which has presented significant challenges in the market for developer customers to obtain necessary substantiation and verification, let alone any contractual guaranty, from their equipment vendors in order to support DC Adder qualification.

In response to this commercial reality, Treasury and the IRS released the Notice.

The Notice

In General

Notice 2024-41 (Notice) provides a new elective safe harbor (New Elective Safe Harbor) that taxpayers may elect to use to classify applicable project components and to calculate the applicable adjusted percentage to qualify for the DC Adder without requiring certification or even knowledge of vendors’ costs. Importantly, the New Elective Safe Harbor is available only to solar, land-based wind, and battery electric storage systems (BESS) projects. The Notice mentions the IRS plans to expand the New Elective Safe Harbor to additional technologies and project types (including offshore wind) but has not provided timing on when it will do so.

Helpfully, the Notice provides that taxpayers may rely on the New Elective Safe Harbor for projects that “begin construction” before 90 days after future modification, update, or withdrawal of the New Elective Safe Harbor. Long-standing “begin construction” standards are expected to apply for purposes of such reliance.

In addition to the New Elective Safe Harbor, the Notice (1) expands the list of applicable projects in the “Safe Harbor List” released in Notice 2023-38 categorizing applicable project components to include Hydropower Facilities, (2) redesignates “utility scale photovoltaic system” applicable project as “ground-mount and rooftop photovoltaic system” (and further subdivides each category for purposes of the various domestic content safe harbors), and (3) includes certain additional manufactured product components with respect to applicable projects previously included in the Safe Harbor List.

The New Elective Safe Harbor

The New Elective Safe Harbor allows taxpayers to certify the Manufactured Product Requirements without needing to know vendors’ internal costs because, under the New Elective Safe Harbor, the actual internal production costs of vendors becomes irrelevant. Only the US versus non-US sourcing profile of each manufactured product component must be known to apply the New Elective Safe Harbor, which continues to be determined under the sourcing standards set forth in Notice 2023-28.

The New Elective Safe Harbor may be elected on a project-by-project basis. The New Elective Safe Harbor must be adopted completely or not at all for a particular project (no mixing and matching approaches between the New Elective Safe Harbor and prior guidance for a single project). The rules of Notice 2023-28 (including required knowledge of vendors’ internal costs) continue to apply if the New Elective Safe Harbor is not elected.

The Notice sets forth an “exclusive and exhaustive” list of applicable project components (including manufactured products) and “manufactured product components” for the currently enumerated sectors (solar, onshore wind, and BESS). The Notice then provides a fixed “assigned cost percentage” (Assigned Cost Percentage) for each applicable manufactured product component to be taken into account in determining whether the project satisfies the applicable adjusted percentage.

Generally, the US source-adjusted percentage is determined by aggregating the Assigned Cost Percentages of US-sourced manufactured product components. An additional Assigned Cost Percentage for “production” is added if all listed manufactured product components for a manufactured product are US-sourced. The percentage values for each applicable project category add up to 100% (i.e., the total of percentage values of all manufactured product components and “production” for the category).

As an example, the below sets forth the Assigned Cost Percentages for the components of an onshore wind energy system:

Any equipment of an applicable project that is not listed in the New Elective Safe Harbor table included in the Notice, or equipment included in the New Elective Safe Harbor table that is not incorporated into the project, is not taken into the safe harbor adjusted percentage rule calculation. The calculation therefore disregards equipment incorporated into a project that is not included on the Safe Harbor List.

For example, project substations and main power transformers are ignored by the New Elective Safe Harbor calculations in the currently enumerated project types. Conversely, any equipment included in the Safe Harbor List that is not included in the project effectively reduces the maximum adjusted percentage the project may obtain.

Two scenarios provide additional complication for these calculations: “Mixed Source Items” and co-located solar energy and BESS treated as a single energy project.

For taxpayers that source a type of manufactured product or manufactured product component both from US and non-US manufacturers (Mixed Source Items), the Assigned Cost Percentage is available for such Mixed Source Items only if (1) they have a nameplate capacity or (2) they are associated with and integrated into applicable project components separate from the applicable project components that the non-US sourced Mixed Source Items are integrated into.

In such cases, the Assigned Cost Percentage for such Mixed Source Items is multiplied by the US-sourced percentage of the total nameplate capacity for such Mixed Source Items (or their associated applicable project components). For example, the Assigned Cost Percentage for Ground-mount (fixed) PV Cells is 49.2%. If 50% of the PV Cells in an applicable Solar PV project are US-manufactured, the Assigned Cost Percentage credited to the taxpayer for purposes of the New Elective Safe Harbor would be 24.6%.

If a solar energy project and BESS are treated as a “single energy project” (see our November 28, 2023 LawFlash for discussion of when this can be the case), the Notice requires a single calculation across the entirety of the project to test for satisfaction of the Applicable Percentage Rule. This single calculation uses a weighted average formula that takes the aggregate Assigned Cost Percentages and nameplate capacities for both systems into account.

Takeaways

• The ability to forgo collection of manufacturer costs to qualify for the DC Adder is likely to provide more certainty to the market to finance energy projects on the basis of qualification for domestic content, similar to the effect generated by the release of applicable proposed and final regulations on tax credit sales under Section 6418.
• For many types of projects (e.g., renewable natural gas, biogas, geothermal), the Notice provides no additional guidance. Until the New Elective Safe Harbor is expanded, such projects may continue to face the same difficulties plaguing the domestic content analysis as had existed prior to the Notice.
• Because of the relevant Assigned Cost Percentages, BESS projects will have difficulty meeting the Applicable Percentage Rule if cells are not supplied by US manufacturers. Based on current supply chains, BESS projects may therefore have difficulty qualifying for the DC Adder unless successfully paired with a solar project under the special rule described above for “single energy projects.”
• Two different timelines are provided by the Notice for when taxpayers may rely on (1) the New Elective Safe Harbor and (2) the other aspects of the Notice and Notice 2023-38. This may suggest the IRS expects to update the New Elective Safe Harbor prior to the release of proposed regulations for domestic content.
• The IRS and Treasury asked for comments about other types of projects that it should add to the Applicable Cost Percentages table for the New Elective Safe Harbor by July 15, 2024. It also asked how often the table should be updated. Updates will be appropriate as relevant costs of components change over time and as technologies develop.