Later this week the Department of the Treasury is expected to release guidance on the Inflation Reduction Act (IRA)’s EV tax credit under section 30D of the Internal Revenue Code. Highly consequential for the guidance and practical availability of the credit will be how Treasury interprets the term “foreign entity of concern.” This is because Section 30D(d)(7) excludes from credit eligibility vehicles that are:
- placed in service after December 31, 2024, with respect to which any of the applicable critical minerals contained in the battery of such vehicle . . . were extracted, processed, or recycled by a foreign entity of concern; or
- placed in service after December 31, 2023, with respect to which any of the components contained in the battery of such vehicle . . . were manufactured or assembled by a foreign entity of concern.
Meanwhile, last week, Treasury and the Commerce Department released proposed regulations (here and here, respectively) that interpret “foreign entity of concern” for purposes of various incentive programs under the CHIPS & Science Act (CHIPS Act). Because the IRA’s definition of “foreign entity of concern” mirrors the CHIPS Act’s definition of “foreign entity of concern” interpreted by Commerce, and because Treasury cross-referenced Commerce’s interpretation of “foreign entity of concern” in Treasury’s CHIPS Act guidance, it is reasonable to wonder whether Treasury will adopt the same interpretation of “foreign entity of concern” for purposes of the EV credit exclusion in section 30D(d)(7).
If it does, there could be a dramatic diminution of vehicles eligible for the EV credits. Under Treasury’s proposed CHIPS Act regulations, a foreign entity of concern would include, inter alia, (i) any entity organized under the laws of China or having its principal place of business in China, and (ii) any entity organized outside of China 25% or more of whose voting interests are owned by the Chinese government (as in the case of foreign subsidiaries of Chinese state-owned entities (SOEs)). If that interpretation is used for purposes of section 30D, absent a nearly impossibly fast elimination of Chinese critical minerals and battery components from the EV supply chain, the number of vehicles eligible for the 30D EV credit will sharply decrease in 2024 and will be practically eliminated in 2025.
EV manufacturers and suppliers may wish to flag this concern to Treasury.
The IRA defines “foreign entity of concern” by reference to Section 40207(a)(5) of the Infrastructure Investment and Jobs Act. Most relevant is clause (C) of that definition, by which a foreign entity of concern includes any foreign entity that is “owned by, controlled by, or subject to the jurisdiction or direction of a government of a covered nation (as defined in section 2533c(d) of title 10)”—currently China, Russia, North Korea, and Iran. The phrase has been subject to speculation as to what level or nature of ownership would constitute “own[ership] by, [or] control by” a foreign government, and, most notably, what it would mean to be “subject to the jurisdiction or direction” of a foreign government.
The proposed CHIPS Act regulations adopt a broad interpretation of this phrase. In 15 CFR 231.106(c), the proposed regulations repeat the statutory language that foreign entities of concern include any foreign entity that is “[o]wned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation (as defined in 10 U.S.C. 4872(d)).” And, under 15 CFR 231.112, the proposed regulations interpret “[o]wned by, controlled by, or subject to the jurisdiction or direction of” as follows:
- A person is owned by, controlled by, or subject to the jurisdiction or direction of an entity where at least 25 percent of the person’s outstanding voting interest is held directly or indirectly by that entity.
- A person is owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country or of a foreign political party where:
- The person is a citizen, national, or resident of the foreign country located in the foreign country;
- The person is organized under the laws of or has its principal place of business in the foreign country; or
- At least 25 percent of the person’s outstanding voting interest is held directly or indirectly by the government of a foreign country or a foreign political party.
The proposed regulations thus take the position that direct or indirect ownership of 25% or more of voting securities is sufficient to confer “own[ership]” or “control.” More notably, the proposed regulations equate an entity being “organized under the laws of or [having] its principal place of business in [a covered nation]” to the entity being “subject to the jurisdiction… of a government of a covered nation” (emphasis added).
Narrower interpretations were available. For example, whether an entity is “controlled by” a government of a covered nation could have required a fact-based assessment as to that government’s ability to determine, directly or indirectly, the management or important decisions of the entity. This would be similar to the analysis undertaken by the Committee on Foreign Investment in the United States or the definition of “control” under the Securities Act of 1933. A 25 percent ownership stake could create a presumption of “ownership” or “control” but not necessarily be dispositive. Likewise, the proposed regulations could have interpreted being “subject to the jurisdiction [of a government]” as being subject to some affirmative government influence—akin to being “owned by, controlled by, or subject to the… direction of” such government.
As proposed for the CHIPS Act, foreign entities of concern would include:
- all entities formed in China regardless of ownership, including wholly-owned subsidiaries of non-Chinese companies;
- all entities formed outside of China where 25% or more of the voting interests are held directly or indirectly by Chinese state-owned entities, including such entities formed as joint ventures between Chinese and non-Chinese companies where a non-Chinese partner has majority or plurality control of the venture; and
- all entities formed outside of China that are deemed to have a “principal place of business” in China (for which no guidance has been provided), regardless of ownership.
The regulations would seem to exclude from the definition of “foreign entities of concern” (under 15 CFR 231.106(c)) U.S. or other non-Chinese subsidiaries of Chinese companies that are less than 25% owned, directly or indirectly, by the Chinese government (notwithstanding that the Chinese parent of such entities would themselves be considered foreign entities of concern). This reading is affirmed by the fact that Commerce could have clearly provided—but did not—that an entity would be deemed a foreign entity of concern by virtue of its voting securities being owned by another foreign entity of concern (as opposed to being owned by the government of a covered nation). We note, however, that other commentators have taken a different position on this point.
Applying the proposed CHIPS Act interpretation to the IRA could have a profound impact on the availability of the EV credits. If the interpretation is adopted by Treasury, a vehicle would be ineligible for the credit if even a small amount of the critical minerals in its battery is extracted, processed, or recycled in China or by an entity 25%-owned by Chinese SOEs (beginning in 2025), or if any of its components is manufactured or assembled in China or by an entity 25%-owned by Chinese SOEs (beginning in 2024). The current supply chain for both critical minerals and battery components is heavily dependent on such Chinese and Chinese state-owned companies. While it is conceivable that removing China from the battery components supply chain can be accelerated, removing China from the critical minerals supply chain will be effectively impossible in the short term.
Treasury has the flexibility to depart from the proposed CHIPS Act interpretation. While there is a good reason to adopt a single interpretation for the same term in nearly concurrently-enacted statutes, Treasury is not bound to apply the CHIPS Act interpretation of “foreign entity of concern” to the IRA. The term “foreign entity of concern” was first used in the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (NDAA). The language from the NDAA was mirrored in the Infrastructure Investment and Jobs Act of 2021 (IIJA), but without specifically cross-referencing the NDAA. The section 48D credit, which Treasury interpreted in its proposed CHIPS Act guidance, cross-references the definition in the NDAA. However, the section 30D EV credit in the IRA instead cross-references the definition in the IIJA. Treasury could thus take the position that other factors justify interpreting the term differently in the two contexts.
Indeed, there is a policy rationale for interpreting the term differently in the CHIPS Act and in the IRA. In the CHIPS Act, the section 48D credit uses the definition of “foreign entity of concern” to ensure that (1) tax credits for semiconductor manufacturing in the United States do not flow to unwanted foreign parties and (2) technologies or products that raise national security concerns are not transferred to unwanted foreign parties. In that context, a broad interpretation of “foreign entity of concern” generally does not threaten to undermine the effectiveness of the credit to achieve the core goals of the statute (such as promoting semiconductor manufacturing in the U.S.). In contrast, for the section 30D credit in the IRA, an overly broad interpretation of “foreign entity of concern” could effectively eliminate the availability of the EV credits, which would slow the electrification of the U.S. vehicle fleet and undermine IRA’s climate goals.
These countervailing concerns justify Treasury giving close consideration to whether to apply the same interpretation in a different context, or whether to adopt an alternative interpretation that may better vindicate the policy purposes of the statute it is interpreting.