Tightening American clean vehicle tax credit may create advantage for Canadian firms

May 2024 was a significant month for the clean vehicle market in the United States, with wide-ranging implications for other jurisdictions.

On May 6, 2024, the US Department of Treasury published final regulations ("Final Rules") for the clean vehicle tax credits provided under the Inflation Reduction Act of 2022 ("IRA").[1] Concurrently, the US Department of Energy ("DOE") released its final interpretative guidance on the statutory definition of "foreign entity of concern" ("FEOC").[2]

On May 14, 2024, the Biden administration announced expanded tariffs on imports from China, which include higher tariffs on critical minerals vital to the clean vehicle supply chain.[3] The net result of this eventful month for clean vehicle technologies in the United States is, we submit, potentially good news for Canadian automotive suppliers.

Background

In an article earlier this year, Benefit from the US Inflation Reduction Act[4], we updated readers regarding the amendments made under Section 30D of the Internal Revenue Code ("IRC").  These changes provided purchasers of a "new clean vehicle" with a tax credit of up to US$7,500 at the time of purchase. This credit is divided equally into two parts:

1. US$3,750 for a clean vehicle which met certain critical mineral requirements.
2. US$3,750 for a clean vehicle which met certain battery component requirements.[5]

In the proposed regulations published in April 2023, the Treasury mandated that the critical mineral requirements were determined according to the "Value Added Test."

This test required that, beginning in 2024, at least 50 per cent of the value of the critical minerals contained in a battery must have been extracted or processed in the US, in a country with which the US has a free trade agreement, or recycled in North America. This percentage was to increase by 10 per cent each year, reaching 80 per cent in 2027.

Where a manufacturer achieves the minimum applicable percentages, then the entire value of the critical mineral could be treated as being either extracted or processed in the United States, or in a country with which the United States has a free trade agreement.

These applicable percentages remain in place in the Final Rules. What changes is how the manufacturer must certify its compliance with these rules.

Compliance is now achieved through a new, stricter, three-step process termed the "Traced-Qualifying Value Test" (the "TQVT"). By enforcing stricter requirements on tracing each procurement chain for critical minerals, Canada based businesses involved in the clean vehicle supply chain stand to benefit from these shifting market dynamics.

Traced-Qualifying Value Test

Consistent with the proposed regulations, the new TQVT requires manufacturers to first determine each procurement chain. Second, the manufacturer must determine the "traced qualifying value" of all applicable critical minerals and the "total traced qualifying value."

The "traced qualifying value"[6] is defined with respect to critical minerals extracted or processed in the US or in a country which the US has a free trade agreement as follows:

The value of the applicable critical mineral multiplied by the greater of:

1. The value added to the applicable critical mineral by extraction that occurred in the United States or in any country with which the United States has a free trade agreement in effect, divided by the total value added by extraction of the applicable critical mineral; or
2. The value added to the applicable critical mineral by processing that occurred in the United States or in any country with which the United States has a free trade agreement in effect, divided by the total value added by processing of the applicable critical mineral.

For critical minerals recycled in North America, "traced qualifying value" means, with respect to an applicable critical mineral that is recycled into a constituent material: the value of the applicable critical mineral multiplied by the percentage obtained by dividing the value added to the applicable critical mineral by recycling that occurred in North America by the total value added by recycling of the applicable critical mineral.[7]

Notably, the Final Rules require manufacturers to determine, separately for each procurement chain, the traced qualifying value of an applicable critical mineral, including the percentages necessary to calculate the traced qualifying value. "Total traced qualifying value" means the sum of the traced qualifying values of all applicable critical minerals contained in a clean vehicle battery.[8]

Once a manufacturer makes these assessments, the qualifying critical mineral content must be determined, which is achieved by dividing the total traced qualifying value by the total value of the critical minerals.

Overall, the TQVT mandates detailed tracing to enhance transparency and ensure that only the actual value added, quantified as a specific percentage, qualifies towards meeting the critical minerals requirements. In contrast, the Value Added Test could have recognized the full value of a critical mineral once the applicable threshold was achieved.

By our reading, the goal of the changes is to reward manufacturers for each incremental increase in value-added activities in the US (and within trusted trading partner nations …like Canada). The TQVT is intended to align more closely with the legislative goals of strengthening US and allied-country supply chain self-sufficiency.

The Final Rules grant manufacturers a transition period until 2026 prior to complying with the new TQVT. Until then, manufacturers can continue to use the Value Added Test for the purposes of satisfying the critical mineral requirements.

Foreign entities of concern

The two-step process for assessing whether a foreign entity is an FEOC has remained consistent from the proposed regulations. A manufacturer sourcing critical minerals must determine whether the supplier is a foreign entity, then whether that foreign entity is a FEOC. A FEOC is an entity that is "owned, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation."[9] A covered nation refers to China, Iran, North Korea, and Russia.

Pursuant to the final interpretive guidance published by the DOE, an entity is considered a FEOC if it is headquartered, incorporated or performing relevant activities in a covered nation, if 25 per cent or more of its voting rights, board seats, or equity interest are held by the government of a covered nation, or if the entity is effectively controlled by a FEOC through a license or contract with that FEOC.[10]   

Under the Final Rules on the clean vehicle tax credits published by the Treasury, an electric vehicle containing battery components manufactured or assembled by a FEOC will be ineligible to receive the tax credit starting in 2024. Similarly, an electric vehicle with a battery containing critical minerals extracted, processed, or recycled by a FEOC will be ineligible to receive the new clean vehicle tax credit starting in 2025.[11]

Manufacturers with specific "impracticable-to-trace battery materials" are excluded from complying with the FEOC regulations until the end of 2026. These materials include graphite in anode materials and applicable critical minerals contained in electrolyte salts, electrode binders, and electrolyte additives. To obtain this transitionary exemption, a manufacturer is required to submit detailed reports to the Treasury describing how they plan to comply beginning in 2027.

Determining whether an entity is a FEOC requires careful analysis of its legal nature, ownership, and business structure. Under certain circumstances, a foreign entity may be deemed an FEOC only in relation to its activities within a covered nation. In other cases, entities which may appear to potentially fall into the FEOC category at first instance, may not. 

New critical mineral tariffs

As noted above, the Biden administration has instructed the Office of the US Trade Representative to implement tariffs on US$18 billion worth of imports from China. This includes an increase in the tariff rate for certain critical minerals and battery components, which increase from 7.5 per cent to 25 per cent effective 2024.

These measures are part of a broader strategy to strengthen local supply chains for key technological sectors within the US and among trusted trading partners.[12]

What these changes mean for Canadian businesses

From the stricter supply chain tracing requirements to the tightened restrictions on doing business with FEOCs, the Final Rules and guidance uniquely position Canadian businesses to expand their presence in the US clean vehicle market.

Canadian businesses involved in the clean vehicle supply chain, from extracting and sourcing critical minerals to recycling and manufacturing battery components, are strategically positioned by geography and the Canada-Mexico-United States trade agreement to capitalize on these significant changes to the legal framework governing the US clean vehicle market. These changes present exciting new opportunities for Canada-based entities, including, notably, foreign-owned companies located in Canada.

The Transportation & Mobility Team at Gowling WLG will continue to monitor the development of the IRA, changes to existing US clean vehicle tariffs, and their implications for Canada-based businesses. We thank readers who have reached out and look forward to answering additional questions.