Final regulations under Section 45X address eligible components

In detail

Statutory background

Effective beginning in 2023, Section 45X provides a tax credit for (1) eligible components, (2) produced by a taxpayer, (3) in the United States or a US possession, (4) in the course of a trade or business, and (5) sold by the taxpayer to unrelated persons during the tax year.

Eligible components include solar energy components, wind energy components, inverters, qualifying battery components, and applicable critical minerals. The credit amount generally is cents or dollars per eligible component, but is 10% of production costs for electrode active materials and applicable critical minerals, and 10% of the sales price for qualified wind vessel property. 

Property that would otherwise qualify as an eligible component is an eligible component only if the property is produced at a Section 45X facility and no part of the Section 45X facility is also a Section 48C facility. 

A taxpayer is treated as selling a component to an unrelated person if (1) the related person sells the component to an unrelated person or (2) the component is integrated, incorporated, or assembled into another eligible component sold to an unrelated person. A taxpayer also may elect to treat a sale to a related person as made to an unrelated person (related party election).

Production activities

The proposed and final regulations define “produced by the taxpayer” as a process conducted by the taxpayer that substantially transforms constituent elements, materials, or subcomponents (inputs) into a complete and distinct eligible component. The proposed regulations provided that mere assembly or superficial modification of elements, materials, or subcomponents did not qualify as production. The final regulations replace the term “mere assembly” with the term “minor assembly.” The preamble to the final regulations explains the change as an acknowledgement that production of an eligible component may consist solely of assembling other eligible components into a final product.

The final regulations add that the production process for solar grade polysilicon, electrode active materials, and applicable critical minerals includes both primary production (using nonrecycled materials) and secondary production (using recycled materials). 

Under the proposed and final regulations, a taxpayer may perform production under a contract manufacturing arrangement, defined as an agreement entered into before production of the component is completed, and the taxpayer and contractor may choose which party claims the credit. The final regulations clarify that a routine purchase order for off-the-shelf property (that requires the contractor to make only de minimis modifications to the property or allows the contractor to satisfy the agreement out of existing stocks or normal production of finished goods) is not a contract manufacturing arrangement.

Production costs

The proposed regulations provided that production costs (the basis of the credit for electrode active materials and applicable critical minerals) include all costs described in Reg. 1.263A-1(e), except direct or indirect costs for materials and costs related to extracting raw materials. The final regulations modify this rule to include in production costs (1) extraction costs incurred by the taxpayer that produces and sells the component and (2) direct and indirect material costs, except costs that relate to the purchase of material that is an eligible component when acquired. 

The final regulations define “extraction” and specify that a taxpayer may not count the costs attributable to a completed eligible component that is incorporated into another eligible component as production costs of the second component. The final regulations require detailed substantiation and reporting of direct and indirect material costs included in production costs, for example a supplier certification and a list of materials, to document that a materials supplier is not claiming a Section 45X credit for the material costs and that the material was not itself an eligible component. 

Sales to related persons  

The final regulations clarify that a taxpayer that sells an eligible component to a related person that integrates or assembles the component into another eligible component is treated only as selling the component to an unrelated person. 

Observation: The preamble to the final regulations explains that the deemed treatment of selling to an unrelated person does not except the taxpayer from the requirement to produce the component.

Observation: The proposed and final regulations include an anti-abuse rule that invalidates a related person election if the taxpayer fails to provide required information to the IRS, or if the related person does not put a component to productive use or the component is defective because it does not meet the Section 45X requirements. The preamble to the final regulations states that the final regulations clarify that this rule does not apply to component defects that arise after the deemed sale, however, the language of the rule is unchanged from the proposed regulations. The preamble to the final regulations also states that the replacement of a defective component with a new component is not a new sale.