In the second of a two-episode series, Tim Jacobs of Hunton Andrews Kurth continues his discussion of the energy credits enacted in the Inflation Reduction Act and the proposed regulations.
This transcript has been edited for length and clarity.
David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: energy boost, part 2.
We’re continuing our deep dive from last week into the energy credits enacted under the Inflation Reduction Act. The first part, which you should definitely listen to before this one, lays the groundwork for the credits and what’s to come in this episode. Tax Notes contributing editor Marie Sapirie will be back again in just a minute to tell us more about this.
Later in the episode, we’ll hear from Tax Notes State author Michael Semes about his article series on an Arizona Court of Appeals holding in ADP LLC v. Arizona Department of Revenue.
But first, Marie, welcome back to the podcast.
Marie Sapirie: Thanks for having me.
David D. Stewart: Could you give us a quick recap of who you talked to and what was discussed in the first episode of the series?
Marie Sapirie: I spoke with Tim Jacobs from Hunton Andrews Kurth. In the first episode, we talked about the history of the Inflation Reduction Act’s energy tax credit changes and the implementation process to date.
David D. Stewart: And what can we look forward to in part 2?
Marie Sapirie: In this part, we’ll hear Tim’s insights on the domestic content rules and the prevailing wage and apprenticeship requirements. We conclude with a look at what guidance is expected next.
David D. Stewart: All right, let’s go to that interview.
Marie Sapirie: Tim, welcome back to the podcast.
Timothy L. Jacobs: Marie, great to be here.
Marie Sapirie: In sections 45, 45Y, 48, and 48E, there’s a bonus for the use of domestic content in applicable energy projects. And as mentioned earlier, the IRS and Treasury put out Notice 2023-38 in June explaining the rules they intend to include in proposed regulations. Would you tell us about the bonus credit, what the notice added, and what we should look for in the proposed regulations?
Timothy L. Jacobs: So the Notice 2023-38 came out on May 12. The initial guidance came out in the form of an IRS notice, and the domestic content provisions themselves that Congress enacted, which is section 45(b)(9), is the primary provision but also applies, as you said, under section 48, referenced the Buy America Act regulations, which are 49 CFR 661. They were incorporated, those rules were incorporated into the domestic content provisions.
And what the bonus credit does is I like to think of it in terms of the investment tax credit. It is essentially a 10 percent bonus credit on top of the base 30 percent credit that’s normally available for investment tax credit. But you go over to the production tax credit and it’s essentially a 10 percent bonus credit on top of the normal credit rate that applies under that provision for production tax credits.
But essentially, there are three components that are involved. The notice calls them “applicable project components,” but it’s steel or iron and then it’s manufactured products. Those are the three items that the statute focuses on. There are also, of course, unmanufactured items, which would be items that come to the site or that are at the site, such as concrete and so forth, that are not necessarily covered by the statute itself or incentivized by domestic content.
But the way that the rules work is you have to have 100 percent U.S. manufactured steel, which is steel or iron, and that is consistent with the rules under the Buy America Act, which 49 CFR 661.5 actually has specific rules regarding steel or iron. The notice, Notice 2023-38, correctly concludes that when we’re talking about steel or iron and that 100 percent requirement, it is structural steel or iron. It is not items that are component parts of manufactured products that may be steel or iron. And that is an important distinction.
Manufactured products, the way the statute is worded and the way that the Buy America Act is applied, is at the component level. Buy America and the regulations were promulgated by the Federal Transit Administration, and the Federal Transit Administration generally has three levels of categorization. One is the end product, then it’s the components, and then it’s the subcomponents, and generally the subcomponents are disregarded, and you look to the component level to measure out the appropriate percentage for purposes of the statute.
Here it is 40 percent. Do you have domestic content at 40 percent at the component level? Notice 2023-38, however, basically divides up the statutory provisions into interpretation that is at the applicable project component level and then what they call manufactured product components.
Manufactured product components resemble very closely subcomponents because they are items that are directly incorporated into the manufactured product. And so there’s a question mark, which has, say, enveloped the industry, which is why Treasury and IRS adopted what is essentially a subcomponent analysis when that particular analysis is not used in the Buy America Act.
Typically, subcomponents are disregarded in the equation or in the calculation of domestic content. Since May and the issuance of the guidance, there have been a number of commentary; I think actually you wrote an article that was called “the Domestic Content Quandary,” which actually describes some of the issues with financing projects with actually capitalizing on the domestic content bonus credit.
And some of the issues that you see that have been caused by the notice I think are really twofold. One is that focus on subcomponents, which are the manufactured product components, and then also the requirement that manufacturer’s costs are what are used in the calculation of the so-called domestic manufactured products and components cost, the adjusted percentage rule calculation, as I would say.
It’s the domestic cost percentage. That that calculation uses the manufacturer’s direct cost. It does not use the taxpayer’s cost. Taxpayer’s cost would be the cost that is paid for the manufactured product that is delivered to the site. And so what we see in this notice is manufacturers are not willing to disclose their cost because of competitive advantage and issues of profit margins and revelation of profit margins. And so you’re left with a program under domestic content that, it’s still in the works, let’s say.
Lots of stakeholders have tried to discuss the issue with Treasury, with Department of Energy, with the White House to come up with a way to move past manufacturer’s cost. And it’s not just manufacturer’s cost, it’s direct cost, the manufacturer’s direct cost, which currently do not exist and are not tracked in the same manner that the notice itself requires. So you see manufacturers having to move at this point to a new system of accounting to actually come up with those costs.
You have a hesitation by manufacturers to actually disclose those costs, and then you also have investors and the tax equity market and transferees dealing with that issue to understand how to capture domestic content bonus credit when manufacturers may or may not be willing to disclose their books and records that reveal those costs.
Then you also have what is in this notice a safe harbor — or it’s described as a safe harbor — which is a table that includes solar battery energy storage systems, both onshore wind and offshore wind. There is a listing which is of some of the applicable project components and a listing of some of the manufactured product components, and then also certain items that are categorized as steel or iron.
But what’s not in the tables that the IRS notice has is it does not include some of what you would understand are under the definitions were maybe perhaps the unlisted components — the unlisted applicable project components and the unlisted manufactured product components.
And there’s a question mark: What do you do if an item that you know is part of a solar project or part of a wind project is not listed in the table? Do you have to take that into account because of the definition of applicable project component, manufactured product component? Or is that excluded because it’s not listed in the table because Treasury, Department of Energy and FTA
And the question mark is, what is Treasury going to do here? Is Treasury going to issue an IRS notice, which they can do right now? Treasury and IRS could issue or update the notice to provide additional information to clarify certain issues that have been troubling the industry. They could issue an IRS notice in short form to adjustments to the original notice or to essentially provide a separate safe harbor.
They could do that immediately. There’s also discussion whether they will move to a notice of proposed rulemaking, which would be the next logical step given that Notice 2023-38 was a notice of intent to propose regulations.
The timing of that is critical because right now everyone is in discussions and negotiations about doing transactions, building projects. And so timing is critical. It does take time to issue proposed regulations, but right now there is not clarity on what Treasury will actually do, whether they issue a notice before the end of this year or in the very near future, or whether they will actually move directly to proposed regulations and are working on those, or I do understand they are working on proposed regulations.
But whether they can issue those proposed regulations in the near term to be very helpful to the industry, I do hope the answer is they will be moving quickly in the next short period.
Marie Sapirie: Under the IRA, taxpayers who satisfy prevailing wage and apprenticeship requirements can claim increased credit amounts under a number of code sections and an increased deduction under section 179D. Would you give us an overview of the new requirements, as well as what the proposed regulations added to the understanding of the prevailing wage and apprenticeship rules?
Timothy L. Jacobs: Yeah, so it’s important to understand that the prevailing wage and apprenticeship rules are — they’re almost in every single tax credit of relevance at least to large taxpayers and investors. The only provisions that do not have prevailing wage and apprenticeship that we’ve talked about would be 45X, the advanced manufacturing credit. But pretty much every credit that is relevant or that I’ve discussed here actually does have these labor requirements. And they originate by congressional reference in the IRA to the Davis-Bacon Act.
The Davis-Bacon Act goes back, I believe, to the 1930s roughly, 1931. It has been in the federal system for almost 100 years now. Regulations have been in existence for some time, but there was more recently a rewrite of those regulations and a finalization of the regulations. But Davis-Bacon Act applies to public buildings and public works, and the set of rules that apply there require prevailing wages to be paid to laborers and mechanics. And that is an offshoot of the fact that the federal government is paying for those public buildings and works. And as a result of that, insisting on prevailing wages.
The IRA incorporates those Davis-Bacon Act rules by reference with respect to wage determinations, and what the proposed regulations do that were issued in August is one of the first things they do is actually tell you that they are not following the Davis-Bacon Act in its entirety, but that the Davis-Bacon Act rules and regulations and authorities would apply with respect to the determination of wage, determinations by the Department of Labor, and at certain definitions, key definitions such as laborers and mechanics, what are laborers and mechanics, what is considered to be a site of the work, those types of definitions.
Some of the key definitions that come out of the regulations under Davis-Bacon, that those would also apply to the prevailing wage and apprenticeship rules for tax purposes. The Treasury was guarded in saying that they would not wholesale bring in Davis-Bacon Act, but only where it was appropriate for administrative purposes. And I think that’s key.
Although when you review the actual language that’s embodied in these proposed regulations, you come away with the pretty clear impression that the proposed regulations were heavily influenced by the Davis-Bacon Act regulations and by the Department of Labor rules.
And I say that for one reason because the Davis-Bacon Act regulations, after an extended period of time, they were outstanding for almost a year and a half, but they were finalized I believe it was August 23 when they ended up on the federal register, August 23, 2023, and then the prevailing wage and apprenticeship rules come out on August 30, 2023.
So seemed pretty clear to me that the prevailing wage and apprenticeship rules or regulations were certainly not mirror image, but they were following closely the Davis-Bacon Act.
Marie Sapirie: Are there any outstanding issues on the prevailing wage and apprenticeship rules that we should look for in future guidance?
Timothy L. Jacobs: Comments are due on October 30. I’m working on a set of comments for various clients myself, but I think that some of the key issues relate to the apprenticeship requirement. The apprenticeship requirement I would say is you have to have qualified apprentices. There are basically three requirements. There’s really two requirements and one tripwire, I’d say. There’s a labor hours requirement, then there’s a participation requirement, and then there is a journey-worker-to-apprentice ratio requirement, which is the tripwire.
But the apprenticeship requirement is the item that I think has generated the most attention and the most issues because it is not as grounded in the Davis-Bacon Act. And I believe you actually wrote an article most recently entitled “Apprentices and Emergency Repairs.” It talks about some of the items that we expected that would’ve been addressed in the proposed regulations but which are creating problems. The statute for apprenticeship requirement uses the term with respect to the construction of the qualified facility.
The other language that’s in there is construction, alteration, or repair. And when you go to 45(b)(7), which is the prevailing wage requirement, that provision actually breaks down construction from alteration or repair. Construction is before the placed-in-service date. Alteration or repair is described as after the placed-in-service date. And that is with respect to the 10-year credit period for PTC purposes, the production tax credit purposes. But one of the key issues is this language that’s in the apprenticeship requirement, which is under 45(b)(8). It does not have that same breakdown, but it uses the words with respect to construction.
Now, Congress, when it enacted the statute, obviously used those words with intent, and I think the correct reading is that the apprenticeship requirement applies before the placed-in-service date during the construction period and does not apply to the operational period during the 10-year credit period for the reasons that you actually stated in the article regarding emergency repairs.
Going out and requesting an apprentice and bringing an apprentice in during the operational period is very different. It’s a different paradigm than it is during the construction period when you can anticipate the need, you can go to the qualified program and make the request and such and so forth.
One of the other issues is what I’ll call preliminary activities. Those activities that for tax purposes are not considered construction per se. They do not count towards beginning of construction, things like site grading, demolition, clearing of the land, those types of items.
Those actually may be covered by the Davis-Bacon Act, but they do not count as beginning of construction. And so they are considered to be preliminary activities. They don’t count. When you move to excavation and firm land grading, then that’s different. You start actually pouring concrete, that’s beginning of construction. Lots of notices under that, starting with [Notice] 2013-29, etc.
The issue that was not raised or not addressed necessarily in the proposed regs, but what I understand actually was addressed in the ABA tax section, the video conference with Treasury, is what do you do with those preliminary activities if they started before the January 29, 2023, date? January 29, 2023, date is the date that 60 days after the original notice was issued for prevailing wage.
And the clarity that came out is that those preliminary activities that might’ve occurred before January 29, that would not allow you to grandfather in or allow you to move in under 45(b)(6) to say you have begun construction and therefore don’t have to apply prevailing wage and apprenticeship, that those preliminary activities that they began before January 29, 2023, they’re not covered by prevailing wage apprenticeship. It’s actually going forward. I think that’s the correct answer in that respect.
But there’s another question, which is, if those preliminary activities are not construction for tax purposes, then those preliminary activities really should not track prevailing wage apprenticeship rules in the first place. So I think that’s an easier answer.
There are a number of other issues that I think were addressed in the proposed regs. We now have, the curative payment rules are laid out, how you cure a failure to pay prevailing wage, how you cure a failure to request apprentices, what the process is, the involvement of Department of Labor. There are wage determination rules. There’s the general wage determination, and there’s the supplemental wage determination rules. All of that is laid out in what are fairly detailed regulations.
I would say that there are still many areas that remain open, but some of the key issues do revolve around the apprenticeship rules and then also with respect to good faith, effort exception, and these curative payment provisions.
Marie Sapirie: So to conclude, what’s the next major piece of the implementation that we should expect?
Timothy L. Jacobs: So I think they’ve signaled that they’re — I think it’s called phase 2. So the assistant secretary, I believe, on September 8, 2023, said that they’re moving towards the manufacturing credits, and that’s 45X and 48C. And I’d also throw in there the clean hydrogen credit. Those are the three items that I’m looking for. It’s 45X, 48C, and 45B. 48C, the guidance is already out, but the process of allocation is ongoing right now. 45X I think we’re going to see proposed regulations very soon.
And in 45B, I believe we will see clean hydrogen; we will see guidance towards the end of this year. I think the other major question is, as I said before, is Treasury going to act on domestic content quickly? And as I said, I think it is actually imperative that Treasury move quickly to either issue an updated notice of intent, in particular with respect to technologies that are not listed in the tables that they included in Notice 2023-38, or they don’t actually issue the proposed rule or regulations. We would hope that they do that very quickly on domestic content.
Marie Sapirie: Well, thank you for joining the podcast today.
Timothy L. Jacobs: All right, thank you.