U.S. Government’s Proposed Interpretive Guidance on FEOC Restrictions
Background
On December 1, 2023, the U.S. Department of the Treasury and the Internal Revenue Service issued specific items of guidance for section 30D of the Internal Revenue Code (the “IRC”). On the same day, The U.S. Department of Energy (the “DOE”) also released proposed interpretive guidance on the statutory definition of “foreign entity of concern” (“FOEC”) in the Infrastructure Investment and Jobs Act (the “IIJA”).
Section 30D of the IRC was amended on March 31, 2023, in conjunction with the U.S. Inflation Reduction Act (the “IRA”) to provide tax credit subsidies to purchasers of new clean vehicles manufactured in the U.S. However, section 30D(d)(7) of the IRC lists the entities excluded from the IRA tax credits like the following: (i) any vehicle 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 an FOEC; and (ii) any vehicle 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 an FOEC.
Section 30D of the IRC defines an FEOC to be pursuant to the statutory definition of the FEOC prescribed in the IIJA, which provides that an FEOC is “a foreign entity owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation,” but delegates the defining of each specific term, such as “foreign country that is a covered nation," “foreign entity," etc., to the executive branch. However, the executive branch’s delay in announcing interpretive guidance for these terms has caused some uncertainty in the relevant industry, which is why the DOE’s notification of the proposed interpretive rule “Interpretation of Foreign Entity of Concern” on December 1, 2023, was received with keen interest from EV companies worldwide.
Overview of Proposed Interpretive Guidance on FEOC Restrictions
The DOE’s proposed guidance of an FEOC, announced on December 1, 2023, provides the following specific terminology interpretation of the IIJA’s definition of an FEOC, where an entity is an FEOC if it is “owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation.”
A “government of a foreign country that is a covered nation” can be (i) a national or subnational government; (ii) an agency, department, or instrumentality of a national or subnational government; (iii) a dominant or ruling political party; or (iv) a current or former senior foreign political figure and their immediate family of countries like the People's Republic of China, the Russian Federation, the Democratic People's Republic of North Korea, and the Islamic Republic of Iran.
A “foreign entity” is defined as (i) a government of a foreign country; (ii) a natural person who is not a lawful permanent resident of the United States, citizen of the United States or any other protected individual; (iii) a partnership, association, corporation, organization or other combination of persons organized under the laws of or having its principal place of business in a foreign country; or (iv) an entity organized under the laws of the United States that is owned by, controlled by or subject to the direction of an entity that qualifies as a foreign entity under paragraphs (i) through (iii).
“Subject to the jurisdiction” means (i) the foreign entity is incorporated or domiciled in, or has its principal place of business in, a covered nation; or (ii) with respect to the critical minerals, components or materials of a given battery, the foreign entity engages in the extraction, processing or recycling of such critical minerals, the manufacturing or assembly of such components, or the processing of such materials, in a covered nation.
An entity can be considered to be "owned by, controlled by or subject to the direction of" another entity when (i) 25% or more of the entity's board seats, voting rights or equity interest are cumulatively held by that other entity, whether directly or indirectly, via one or more intermediate entities; or (ii) with respect to the critical minerals, battery components or battery materials of a given battery, the entity has entered into a licensing arrangement or other contract with another entity (a contractor) that entitles that other entity to exercise effective control over the collective production of the critical minerals, battery components or battery materials that would be attributed to the entity.
Therefore, the following entities may be considered an FEOC.
① An entity incorporated or domiciled in, or has its principal place of business in the People's Republic of China.
② With respect to the critical minerals, components or materials of a given battery, the entity engages in the extraction, processing or recycling of critical minerals, the manufacturing or assembly of such components, or the processing of such materials, in the People's Republic of China.
③ An entity with more than 25% of its board seats, voting rights, equity interest cumulatively held directly or indirectly by the Chinese government.
④ An entity that has entered into a licensing arrangement, etc., that entitles another entity of a foreign country of concern to effectively control the collective production of its critical minerals, battery components, or battery materials.
Additionally, the DOE’s interpretation also prescribes a joint venture as an FEOC if the government of a foreign country that is a covered nation controls, either directly or indirectly, 25% or more of the joint venture.
Significance and Implications of FEOC Guidance
The IRA FEOC guidance was finalized and implemented after its public comment period ended on January 3, 2024, resolving much of the uncertainty in corporate governance and investment that had increased due to the absence of interpretive guidance.
However, this new rule now requires Korean battery companies to acquire additional stakes if they have a joint venture with a Chinese partner that is an FEOC. Korean battery companies have high reliance on Chinese critical minerals and battery components, which has led to the establishment of many Korean-Chinese joint ventures for the stable supply of materials. However, the ownership stakes of the Chinese partner in most of these joint ventures, including the ones that have yet to be established, exceed 25%, making them highly likely to be considered an FEOC.
For example, out of the seven joint ventures established by the Korean battery cell manufacturer SK On, the equity stakes of the Chinese company exceed 25% in all but one that has yet to finalize its equity distribution. Similarly, among the six joint ventures of Korea’s bipolar electrode manufacturer, LG Chem, other than the three ventures with undecided equity distribution, China’s Huayou Cobalt holds 50% of the ownership stakes for the other three ventures. In the case of POSCO Holdings, with the exception of two joint ventures with undecided equity distribution, China-based companies Huayou Cobalt and CNGR Advanced Material have 35% to 80% ownership of the rest of its seven joint ventures related to bipolar electrodes. Therefore, Korean battery companies may require an exorbitant amount of funds to secure at least 75% ownership of the joint ventures. Moreover, it is uncertain as to whether their Chinese partners, who seek to exercise effective control over the joint ventures, would readily transfer company ownership. Ultimately, Korean battery companies should consult legal experts to review how much influence the Chinese government has on their Chinese partners and determine whether their Chinese partner is an FEOC to prepare for additional expenses.
Moreover, this proposed guidance is anticipated to cause a great shift in the entire EV battery supply chain. For example, starting 2024, Tesla, which currently holds the highest market share in the U.S. EV market, will likely redesign its supply chain from using battery cells produced in China by CATL and LG Energy Solution to one that is oriented towards using battery cells produced in U.S. factories to receive maximum tax credits. Therefore, it is essential for Korean battery cell manufacturers targeting the U.S. export market to build new supply chains for critical minerals and battery materials that rely highly on China.
DR & AJU’s Comments
In accordance with the proposed guidance for IRA FEOC, it would be wise for Korean battery companies who procure materials from China or wish to start a joint venture with Chinese companies to consult legal experts on whether their business partner is considered an FEOC. Companies should also make equity adjustments to avoid incurring extra expenses.
DR & AJU’s Global Compliance Group, Washington, D.C. Liaison Office and D&A Advisory, Inc. deliver accurate and crucial information to help domestic companies effectively and promptly respond to changes in the U.S. and China’s trade policies and establish effective strategies to ensure compliance with applicable laws by providing comprehensive advisory on internal control strategies.
DR & AJU will continue to closely monitor developments in international trade policies to respond expeditiously through close cooperation with businesses when necessary.
References: US Department of Energy(https://www.energy.gov/articles/department-energy-releases-proposed-interpretive-guidance-foreign-entity-concern-public), KOTRA, KITA, HI INVESTMENT & SECURITIES CO., LTD.
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