On September 22, the Commerce Department published a final rule implementing the national security-related restrictions and obligations on recipients of incentive funds under the CHIPS and Science Act of 2022 (the “CHIPS Act”). The final rule clarifies in some respects, and substantially expands in other respects, the definition of “foreign entity of concern” that appeared in Commerce’s proposed rule, issued in March.
When Commerce issued its proposed rule, the Treasury Department cross-referenced Commerce’s definition of “foreign entity of concern” in Treasury’s concurrently proposed regulations for the CHIPS Act’s tax credit under section 48D of the Internal Revenue Code. We commented at the time that if Treasury were to adopt that same definition for the section 30D electric vehicle (EV) credit under the Inflation Reduction Act (the “IRA”), there could be a significant reduction in the number of vehicles eligible for such credits relative to market expectations. Treasury issued proposed regulations for other aspects of the 30D credit one week after the CHIPS Act guidance, but did not include an interpretation of the term “foreign entity of concern,” and to date has yet to do so (though it has signaled an intent to do so later this year).
Given the scope of Commerce’s definition of the term “foreign entity of concern” in its final rule, the stakes are even greater. If Treasury adopts Commerce’s definition for purposes of section 30D, automakers would be barred from sourcing battery components or applicable critical minerals for vehicles they wish to be eligible for the credits from companies—located anywhere in the world—with 25% or more Chinese-economic ownership. This likely would result in an even more dramatic drop-off in vehicles eligible for the section 30D credits than we previously suggested, and thus would undermine the IRA’s policy goal of accelerating the electrification of the U.S. vehicle fleet. In addition, if Treasury adopts Commerce’s definition for purposes of 30D, it would work at cross-purposes to the IRA’s policy goal of onshoring and “friend-shoring” the EV battery supply chain, by undercutting the incentive for Chinese mineral and component companies to establish new facilities in the United States or other “friendly” countries in order to satisfy section 30D’s other content requirements.
With just under three months before the first excluded vehicle provision in section 30D kicks in (and well into the automakers’ purchasing cycles for batteries), the automotive industry and consumers eagerly await Treasury providing clarity regarding this issue.
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.
Such section defines “foreign entity of concern” by reference to section 40207(a)(5) of the Infrastructure Investment and Jobs Act (42 U.S.C. 18741(a)(5)), which mirrors the relevant definition in the CHIPS Act interpreted by the Commerce Department in its final rule. The statutory definition lists several categories of “foreign entities of concern.” We are focused here on activities undertaken by entities formed inside and outside of China, and thus focus on subsection (C), which refers to “a foreign entity owned by, controlled by, or subject to the jurisdiction or direction of a government of a covered nation [namely, China, Russia, Iran, or North Korea].”
The Commerce Department’s proposed rule defined “owned by, controlled by, or subject to the jurisdiction or direction of” separately from “foreign entity of concern.” See 15 CFR §§ 231.106, 231.112 of the proposed rule. The final rule integrates the two. See 15 CFR § 231.106 of the final rule. The following is a redline comparison of the final rule against the proposed rule, where the two components of the proposed rule are likewise integrated, with new language shown in bold-faced underlined text and deletions shown in strike-through text:
Foreign entity of concern means any foreign entity* that is—…
(c) Owned 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));
(1) A person is owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country listed in 10 U.S.C. 4872(d) where:
(i) The person is:
(A) a citizen, national, or resident of a foreign country listed in 10 U.S.C. 4872(d); and
(B) located in
the foreign country a foreign country listed in 10 U.S.C. 4872(d);
(ii) The person is organized under the laws of or has its principal place of business in a foreign country listed in 10 U.S.C. 4872(d);
At least 25 percent or more of the person’s outstanding voting interest, board seats, or equity interest is held directly or indirectly by the government of a foreign country listed in 10 U.S.C. 4872(d); or
(iv) 25 percent or more of the person’s outstanding voting interest, board seats, or equity interest is held directly or indirectly by any combination of the persons who fall within subsections (i)-(iii);
*“Foreign entity” is itself defined by 15 CFR § 231.103 of the final rule (which is unchanged from the proposed rule) and seems intended to encompass a range of U.S. entities, among other things, based on their foreign ownership or their being subject to foreign control.
In its final rule, Commerce clarifies in some respects, and broadens in other respects, the definition of “foreign entity of concern” by taking an expansive view of what circumstances would constitute an entity being “owned by, controlled by, or subject to the jurisdiction of” the government of a covered nation—most notably, China. Again, in adopting rules for purposes of section 30D, there is good reason for Treasury to consider the different statutory purposes of the CHIPS Act and the IRA’s EV credits, as described in our prior blog post.
Ownership by natural persons located in any country of concern
- Commerce’s final rule clarifies “foreign entity of concern” for individuals, by revising subsection (c)(1)(i)to cover citizens, nationals, or residents of a country of concern who are located in any country of concern. The supplemental information section of the final rule explains that “the term would include an Iranian national working in Russia, but would not include a Chinese national lawfully working in the United States or the Republic of Korea.”
- In the context of the CHIPS Act, the reference to an individual’s location has some logic. The CHIPS Act prohibits fund recipients, during the term of their award, from engaging in “joint research or technology licensing with a foreign entity of concern that relates to a technology or product that raises national security concerns.” 15 CFR 231.203(a). Subclause (c)(1)(i) seems to acknowledge that conducting research with a Chinese national in the United States does not pose the same level of risk as conducting research with a Chinese national residing in China.
- Commerce’s language would present administrative and other difficulties in the context of section 30D, given the other changes to the definition. Per subsection (c)(1)(iv) (discussed below), an entity formed outside of a country of concern but owned by an individual described in subsection (c)(1)(i) would itself be a foreign entity of concern. But that entity would cease to be a foreign entity of concern upon such individual ceasing to be “located in” a country of concern. Were Treasury to adopt such language for section 30D without further clarification, a vehicle’s eligibility for credits would depend on the physical location of the direct and indirect equity holders of the vehicle’s battery component and critical minerals suppliers—seemingly at the moment that such eligibility would be assessed. This could create both substantial administrative difficulties for Treasury and substantial diligence challenges for parties in the EV battery supply chain.
Ownership or control can be manifested by more than “voting interests”
- Commerce’s changes to subsection (c)(1)(iii) broaden “foreign entity of concern” by adding entities in which a government of a country of concern directly or indirectly holds 25% or more of the board seats or a 25% or greater equity interest (in addition to only those in which such a government holds a 25% or greater voting interest). The supplemental information does not explain such change, but it does note that one commenter argued that “the 25 percent voting interest threshold inadequately addresses the methods of influence—beyond mere voting—that are employed by and available to foreign countries of concern….”
- Commerce’s intent in adding a reference to “board seats” subsection (c)(1)(iii) is unclear, as it is unclear how a government can “[hold]” a board seat. We assume the language is intended to refer to a government directly or indirectly holding the right to designate directors, which is common for significant shareholders in closely-held companies. But Commerce’s decision not to expressly refer to designation raises the question of whether something else is intended.
- Commerce’s reference to “equity interest[s]” is likewise subject to interpretation. “Equity interest” is undefined by Commerce’s final rule. The supplemental information suggests that it is intended to encompass non-voting interests, though what those non-voting interests comprise (e.g., nonvoting preferred stock, limited partnership interests, convertible securities, or derivatives) is not specified.
Entities whose voting interest, board seats, or equity interest are held directly or indirectly by any combination of the persons who fall within subsection (i)-(iii)
- Commerce’s new subsection (c)(1)(iv) has the greatest potential impact. The new language specifically adds to the category of “foreign entities of concern” entities that have no “direct or indirect” ownership by a government of a country of concern. For convenience, we consider China as the only relevant such country. Under subsection (c)(1)(iv) of the final rule, an entity with the threshold ownership by Chinese persons, who themselves constitute foreign entities of concern under subsection (c)(1)(i), (ii), or (iii), constitutes a foreign entity of concern. That is, ownership by (i) Chinese citizens, nationals, and residents located in China [subsection (c)(1)(i)], (ii) entities organized in or having their principal place of business in China [subsection (c)(1)(ii)], or (iii) entities in which the Chinese government directly or indirectly holds a 25 percent or greater voting interest, share of the board seats, or equity interest [subsection (c)(1)(iii)] has the same impact under subsection (c)(1)(iv) as ownership by the Chinese government has under subsection (c)(1)(iii). In our view, under a straightforward reading of Commerce’s proposed rule, entities formed outside of China were “foreign entities of concern” only if the Chinese government held a 25% or greater voting interest, directly or indirectly.
If adopted as the definition of “foreign entity of concern” for purposes of section 30D, Commerce’s definition would substantially curtail the near-term availability of battery components and applicable critical minerals that could be used in credit-eligible vehicles. In so doing, it would likely limit the availability of credit-eligible vehicles and undermine section 30D’s policy goal of incentivizing EV adoption. In addition, if adopted by Treasury, Commerce’s definition would undermine section 30D’s policy goal of onshoring/“friend-shoring” the EV battery supply chain. Section 30D’s principal content requirements incentivize automakers to procure applicable critical minerals from the United States or other “free trade agreement” countries and battery components from North America. Privately-owned Chinese companies have responded to these incentives by siting new facilities in the United States and other such jurisdictions. The definition in Commerce’s final rule would treat U.S.-based facilities owned by private Chinese companies in the same manner that it treats such companies’ China-based facilities: in neither case could such facilities produce battery components or applicable critical minerals that could be used in credit-eligible vehicles. If Chinese companies slow their construction of U.S. facilities and U.S. automakers source battery components and applicable critical minerals from facilities in China for their non-credit-eligible vehicles, this could have the perverse effect of making those automakers more dependent on China than they would have been had such battery components and applicable critical minerals been available from Chinese-owned facilities in the United States, at least in the near term.
- Commerce’s addition of subsection (c)(1)(iv) in the final rule is not fully explained. The supplemental information to the final rule suggests that Commerce added subsection (c)(1)(iv) to prevent entities that would otherwise have been foreign entities of concern from avoiding such classification by “establishing entities for which multiple foreign entities of concern each have ownership below the 25 percent threshold.” New subsection (c)(1)(iv) certainly does that, as it applies where there is “any combination” of targeted foreign owners whose total ownership crosses the 25 percent threshold. However, the supplemental information does not touch on the fact that the proposed rule did not specifically define foreign entities of concern as including entities in which the requisite voting interest were held directly or indirectly by another foreign entity of concern. To the extent Commerce thought such an interpretation was implicit in the proposed rule, affected parties may thus seek to argue that the proposed rule did not provide them with adequate notice of that interpretation.
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It remains to be seen whether Treasury will depart from this CHIPS Act definition of “foreign entity of concern” when it adopts additional guidance for Section 30D. We will continue to monitor these developments closely.