Treasury Expects a Transition Period for EV Critical Minerals Requirement

The Treasury Department issued a white paper on how it will shape proposed guidance for electric vehicle batteries and critical minerals, with some specifics on how it will define the critical mineral/battery component dividing line but deferring the definition of a free trade agreement.

An FTA definition is important because to qualify for $3,750 of an up-to-$7,500 tax credit for a new electric passenger vehicle, a certain percentage of the critical minerals in the advanced battery has to be either mined, processed or recycled in either the U.S. or a country that has an FTA with the U.S.

In the white paper, published Dec. 29, Treasury said "the term 'free trade agreement' is not defined" in any statute, and it will seek comment on criteria to identify an FTA for the purpose of the critical minerals requirement. It said it expects criteria to include "whether an agreement reduces or eliminates trade barriers on a preferential basis, commits the parties to refrain from imposing new trade barriers, establishes high-standard disciplines in key areas affecting trade (such as core labor and environmental protections), and/or reduces or eliminates restrictions on exports or commits the parties to refrain from imposing such restrictions, including for the critical minerals contained in electric vehicle batteries." Officials added that existing comprehensive FTAs will definitely be covered.

It's unclear whether the Japan mini-deal, which is not a comprehensive FTA but does reduce barriers on a preferential basis and establishes high-standard disciplines in digital trade, would count. It's also not clear whether a commitment not to restrict exports of critical minerals would be enough to count if no other criterion is met.

"Treasury and the IRS expect to propose that the Secretary may identify additional free trade agreements for purposes of the critical minerals requirement going forward and will evaluate any newly negotiated agreements for proposed inclusion during the pendency of the rulemaking process or inclusion after finalization of the rulemaking," the white paper said.

Treasury had already said that the tax credit would be available, based on the North American assembly of the vehicle, price and income limits, before it issued its proposed rule on battery components and critical minerals. The white paper said the amount of the credit will be partly based on the vehicle's battery capacity, as it was under the previous EV tax credit. That will not limit any of the cars that meet the regional assembly requirement.

The Zero Emissions Transportation Association has been advising those who want to buy an EV to do so in January and February -- or any part of March before the rule is issued -- because the credit coverage will be more expansive than when the battery and critical minerals requirements come into effect.

The IRS specified the new owner must drive the car off the lot before the proposed rule on battery components and critical minerals is out.

A long wait for delivery of ordered vehicles affected many buyers who expected to get EV tax credits when they put down deposits, but the car no longer qualified after the Inflation Reduction Act was signed in August, because the Volkswagen, Hyundai, Kia or Subaru the purchaser had bought was not assembled in North America.

Leilani Gonzalez, ZETA policy director, told us "we’re not going to be able to make a clear distinction of where this is really going to impact the industry until the proposed rulemaking in March."

The proposed rulemaking will detail what counts as a battery component and where critical minerals can be sourced to qualify.

Treasury said it will continue to communicate with stakeholders about those requirements as it works on the proposed rule it expects to issue in March. But it published "preliminary views" in the white paper. "This does not constitute proposed guidance issued by the Secretary or her delegate, and this discussion is not intended to (and does not) create any right or benefit, substantive or procedural, enforceable at law or in equity by any party," the agency said.

It said it anticipates a transition rule for critical minerals for calendar years 2023 and 2024. "This transition rule would be intended to provide manufacturers time to develop the necessary capability to certify compliance to the critical mineral requirement throughout their supply chains."

Battery manufacturers would have to determine their procurement chains for each mineral, from extraction and processing, through creating "constituent materials," such as powders for cathode active materials, powders for anode active materials, foils, metals for solid electrodes, binders, electrolyte salts and electrolyte additives.

For the critical minerals to qualify, it said, "50 percent or more of the value added of the critical mineral extraction steps occurred in the United States or in any country with which the United States has a free trade agreement in effect; or 50 percent or more of the value added of the critical mineral processing steps occurred in the United States or in any country with which the United States has a free trade agreement in effect."

Value is determined by "the arm’s-length price that was paid or would be paid for the property by an unrelated purchaser determined in accordance with the principles of section 482 of the Internal Revenue Code."

The white paper is silent on the law's foreign entity of concern element, one of the aspects that most concerns ZETA. How well the U.S. auto industry will be able to friendshore its battery chain will be determined in part by how the government defines foreign entities of concern, Gonzalez said.

"If you have a joint venture with a company that does their extracting in North America or Australia, but processing in a non-covered nation," will that count, she asked rhetorically. What if both extraction and processing happen in an FTA partner, but the processing is done by a company that has a Chinese company as part owner? She asked: "Are they going to have a de minimis threshold for these foreign entities of concern?"

Gonzalez said government regulators have been asking battery makers how long it will take to friendshore and cut China out of supply chains.

"Our response back is it depends on how you determine the value of the supply chain," she said. If you don't allow any Chinese ownership, it's not doable in the medium term. If it's OK that you are sourcing and extracting in an allied nation, when 25% of the company doing the extraction is Chinese, that's a different timeline.

"It’s a different answer every time unless we have full clarity of the rule," she said.

In addition to the arm's-length regulation, the white paper says manufacturers will need to use one date after the final processing step for all critical minerals as the date to determine the cost. Still, to determine whether batteries in a given vehicle will qualify, the manufacturer can average across a year, quarter or a month the percentage of its critical minerals that are friendshored or of U.S. origin, and can determine that for all vehicles from a certain plant, of a certain class, or of a certain model.

Any battery component assembled in North America will be eligible. Treasury did not definitively say how deep into a battery it will look at components but said it may include "a cathode electrode, anode electrode, solid metal electrode, separator, liquid electrolyte, solid state electrolyte," all sub-components of a battery cell. Battery cells are assembled into a module, and then into a pack, which is ready to go into the car or truck. It will not require that all those components are assembled in North America, because the cell, too, would qualify as North American, regardless of where its components were made.

Value, however, will be measured by backing out the non-North American components. "Incremental value, with respect to a battery component, means the value determined by subtracting from the value of that battery component the value of the manufactured or assembled battery components, if any, that are contained in that battery component," the white paper said.

Constituent materials, as defined in the critical minerals section, will not be considered toward the value of the battery cell, only manufactured parts.

To qualify for the battery portion of the credit, manufacturers will add up the incremental value of each battery component assembled in North America, then divide that number by either all incremental values of components or by the value of the finished module.

ZETA -- and other commenters -- had said that the agency should not go past the cell level. "That is the clearest across the board," Gonzalez said, and said that the manufacturers' credit also starts at the cell level.

As with critical minerals, Treasury suggests manufacturers could average their calculations over time for cars and trucks assembled in North America. "If the resulting percentage is equal to or greater than 50 percent for vehicles placed in service in 2023 after the date on which Treasury and the IRS issue proposed guidance, then the vehicle would satisfy the battery component requirement," the white paper said.

This suggests that credits payable at the time of purchase will not be possible, at least not in the first year.

The white paper said Treasury will expressly identify when its proposed guidance is issued. "Treasury and the IRS often allow taxpayers to rely on proposed guidance during the period between its issuance and the issuance of final rules and anticipate addressing the extent of reliance in the proposed guidance," the agency said.

Many commenters had expressed concerns that too rigorous interpretations of the law would slow adoption of EVs, since fewer vehicles would qualify for the full credit, or perhaps any credit.

In the year-end guidance, Treasury said the $55,000 maximum price of cars that qualify will include not just the base price but also the retail delivered price suggested by the manufacturer for each accessory or option that is physically attached to the car.

Gonzalez said it's hard to know whether cars that are not assembled in North America or don't qualify for the tax credit for another reason, such as being too expensive or don't have the requisite percentage of batteries or minerals, will lose market share -- or if adoption will be slowed.

In 2022, Tesla and General Motors cars did not qualify for the tax credits under an old volume cap rule, but their vehicles accounted for about three-quarters of U.S. EV sales.

"I don’t think the tax credits are going to be the sole reason why there’s going to be a shift in the market," she said. There will be more moderate-price models coming out over the next few years, she noted, and buyers may also be influenced by seeing more chargers along their routes, or seeing a neighbor buy an EV.