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It comes months after an earlier Treasury rule on domestic manufacturing locked out many vehicles from European, Japanese and South Korean automakers from receiving the tax credit. Around 22 electric and plug-in hybrid models currently qualify for the credit, less than one-fifth of the more than 100 models on the market.
It’s not clear how many of those cars will remain eligible when the new rules take effect come January. The stringent rules are a victory for China hawks seeking to cut U.S. reliance on the country, while automakers like Ford — which is planning to license Chinese battery technology for a plant in Michigan — will need to reassess whether they can sell their cars with the tax break attached.
Getting Americans behind the wheel of electric cars is a key pillar of President Joe Biden’s climate agenda, and the tax credit is his foremost lever to get them there. It can shave up to $7,500 off the price of an electric car, making them affordable for a new range of drivers.
But Democrats in Congress imposed a series of escalating domestic content restrictions in last year’s Inflation Reduction Act aimed at cutting China out of the U.S. EV supply chain.
While China still dominates that supply chain for key parts of the vehicles — notably the batteries used to power them — administration officials expressed confidence that automakers would be able to meet the new rules, highlighting the billions of dollars they are pouring into new U.S. manufacturing facilities.
“Automakers have already adjusted the supply chain to ensure buyers are eligible for these credits and are continuing to do so,” Deputy Treasury Secretary Wally Adeyemo told reporters. “These changes take time, but companies are making the investments and Americans are buying these cars.”
The rules also offer some flexibility that automakers had sought, including a two-year phase-in period for enforcing the rule on some difficult-to-trace battery powders that go into their EVs. And it drew quick praise from industry representatives.
“It’s a stringent rule that’s done thoughtfully and in a way that is workable for the industry,” said Albert Gore, executive director of the Zero Emission Transportation Association.
Gore said he expected the rule to reduce the number of models eligible for the federal credit — at least temporarily — but noted that “no possible interpretation” was likely to keep every model currently eligible on the list.
“Anytime you’re introducing requirements like this … you’re extremely likely to see some models drop off,” Gore said. “That is totally normal and expected given that you cannot just flip a switch when it comes to supply chains.”
Jennifer Safavian, president and CEO of Autos Drive America, a trade group for foreign automakers, said in a statement that the group appreciates the “flexibility” the guidance provides for carmakers to leverage the credit.
“While automakers in the U.S. are working to build up domestic supply chains and diversify their sourcing, this shift will take time,” Safavian said.
The new rules, part of which take effect in January, come at a critical moment for EV adoption in the United States. The three largest American manufacturers — Tesla, General Motors and Ford — have each walked back some EV production targets in recent months, citing high interest rates and softening consumer demand. And Republicans are stepping up their attacks on Biden’s EV push on the Hill and the presidential campaign trail.
Walking a tightrope
Under the Inflation Reduction Act, automakers may not source any battery parts or critical minerals for vehicles eligible for the tax credit from a “foreign entity of concern,” beginning in 2024 and 2025, respectively. The law stipulates that China, Russia, Iran and North Korea are covered by the provision.
But lawmakers left the administration with the tall task of defining which companies in those countries — as well as their joint ventures and American subsidiaries — would be subject to the ban.
U.S. automakers and the EV industry argued the guidance should offer flexibility, since even though they have poured billions of dollars into expanding in America to meet the domestic content requirements, they haven’t had enough time to fully extricate their supply chains from China.
Domestic industry groups and China hawks in both parties on the Hill pushed back, arguing for a strict approach to cut China out for good. Republicans and Democratic Sen. Joe Manchin (W.Va.) had warned the Treasury Department in recent weeks against providing any leeway to automakers to continue relying on Chinese suppliers.
“Treasury guidance should make clear in the most comprehensive way possible that taxpayer subsidies cannot flow to foreign entities of concern through any structuring mechanism conceivable,” House Ways and Means Chair Jason Smith (R-Mo.) wrote to the Treasury Department in September.
Ultimately, the administration sought to thread the needle by issuing a relatively strict definition of the companies that would be subject to the ban, but offering automakers some flexibility in how it enforces the ban on some battery powders whose origins are hard to trace.
The Treasury and Energy Departments issued separate but linked proposals to interpret the provision on Friday. While DOE’s rule sets a definition of “foreign entity of concern,” Treasury’s rule lays out how it applies to automakers seeking the EV tax credit.
The DOE rule also applies to a $6 billion grant program it is administering to boost domestic battery production. That program, established by the 2021 bipartisan infrastructure law, discourages applicants from sourcing battery materials from a “foreign entity of concern.”
As many EV industry watchers had expected, DOE largely aligned its definition of “foreign entity of concern” with the Commerce Department’s interpretation of similar language in last year’s CHIPS and Science Act. The rule bars suppliers from accessing federal incentives if as little as 25 percent of the company’s stock, voting shares or board seats are held by people or businesses based in a country like China.
That’s stricter than the 50-percent threshold contained in other parts of the Internal Revenue Code. And some aligned with the auto industry argued that the 25-percent definition alone would likely disqualify many EV models from the credit.
But DOE also went further than the CHIPS definition in determining that a company could be considered a foreign entity of concern if it agrees to license technology from a Chinese firm and that Chinese company exercises “effective control” over production.
Some Republican lawmakers, like Sen. Marco Rubio (R-Fla.), had pushed Treasury to include licensing agreements in its definition of the provision in a bid to target Ford’s agreement to license advanced battery tech from China’s largest battery manufacturer for a planned factory in Michigan.
Ford has insisted that its deal with Contemporary Amperex Technology Co. will send no taxpayer dollars back to Beijing, and argues the agreement is necessary to allow it to become the first automaker to manufacture next-gen lithium, iron and phosphate batteries in the United States, rather than buying them from China.
A senior administration official, speaking anonymously to brief reporters on the rule, said that DOE had “not evaluated any specific plan or [automaker] situation” for eligibility under the licensing rule. But Ford has said it will own and operate the Michigan facility, which could spare it from the “effective control” threshold in the interpretation.
Gore praised DOE’s approach to licensing agreements for distinguishing between “purely a payment of a licensing fee for using a technology for which another company has a patent” and an arrangement that amounts to a “joint venture by another name.”
“Licensing of IP [alone] does not make the licensee a foreign entity of concern,” Gore said. “It would be a mistake to place an arbitrary constraint on that that we wouldn’t place on any other industry.”
Some relief for automakers
The rule proposed by Treasury puts additional requirements on automakers to comply with the DOE restrictions. Carmakers will need to physically trace battery cells throughout their supply chain to ensure a foreign entity of concern isn’t involved, and face severe penalties if they try to get around the rules.
But Treasury’s rule also proposes some measures to help automakers comply with DOE’s definition in the short term, including an exception through 2026 for certain low-value battery minerals that are difficult to trace to their origins.
Such “de minimis” exceptions are a fairly common practice in trade policy, including in treaties like the North American Free Trade Agreement and its Trump-era successor, the United States-Mexico-Canada Agreement.
But the temporary reprieve could draw the ire of Manchin, who has already threatened to back a lawsuit over Treasury’s rules for the rest of the credit.
“Nowhere in the IRA is there a ‘value added test’ or ‘de minimis’ exception to create loopholes that would allow a Foreign Entity of Concern to participate in any portion of the mining, processing, or manufacturing of electric vehicles,” Manchin warned Treasury in November.
Friday’s rules are the most significant update to the EV tax credit since the department proposed guidance interpreting the rest of the credit in March. Those rules initially restricted eligibility to just 14 models, though that number has topped 20 in recent months, including popular models like the Tesla Model Y and Model 3 and the Chevy Bolt.
The administration is also hoping that another upcoming change in the rules will supercharge the credit. Beginning in January, EV buyers can choose to claim the credit as an instant rebate or cash when they buy the vehicle, rather than having to wait until filing taxes for the year.
But the IRA also stipulates that another domestic sourcing requirement for automakers will become more stringent starting in January. Automakers will need to produce even more of their battery components and critical minerals for eligible vehicles in the United States or its trade partners, potentially disqualifying additional vehicles from the credit.
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