The Inflation Reduction Act (IRA) was signed into law by President Biden on August 16, 2022. The IRA made major changes to United States rules for electric vehicle (EV) tax credits. The IRA and its implications for foreign-made EVs raises serious concerns under various sources of international trade and investment agreements, potentially including the rules of the World Trade Organization, Free Trade Agreements (FTAs), and Investment Treaties.
EV Tax Credits Were In Place Before the IRA
Before enactment of the IRA, under IRS Code Section 30D buyers of EVs, including plug-in hybrid EVs (PHEVs), received up to $7,500 in tax credits upon the purchase of a new EV or PHEV. These credits were available without an expiration date, although a per-automotive manufacturer (OEM) cap was imposed such that credits for vehicles made by a single OEM would expire (after a phase-down period) once credits had been claimed for 200,000 vehicles made by such OEM. This tax credit applied to nearly all EVs purchased in the U.S. until the manufacturer hit the cap, irrespective of the source of vehicle’s assembly and source of parts. The pre-IRA enactment 30D credit also imposed no limitation on credit eligibility related to the MSRP of the vehicle or the income of the buyer.
The New IRA Rules for Tax Credits Reduces the Eligibility for Most EVs
The IRA has completely revised the prior law and imposed new rules for qualifying for the tax credit. Under the IRA, to qualify for the full $7,500 credit, final assembly of the vehicle must be in North America and (beginning when the Department of the Treasury issues guidance later this year) a certain proportion of the value of the components and minerals in the battery must be manufactured or assembled in North America (components) or a Free Trade Agreement country (minerals). The credits with these new requirements will be reduced or eliminated for most EVs currently on the U.S. market, and the credit is certainly zeroed-out for all EVs that don’t have final assembly in North America.
The Treasury Department and IRS have already started issuing guidance on this new law, and will be issuing further guidance. This will present an important opportunity for impacted companies to address ambiguities in the IRA.
The New IRA Rules May Breach WTO and FTA Provisions
The new IRA rules on EV tax credits requires final assembly of the EV to occur in the United States, Canada, and/or Mexico to be eligible for the tax credit. It also requires certain amounts of North American (battery components) and U.S. or Free Trade Agreement country (battery minerals) content. These new restrictions on tax treatment for EVs treat imported EVs and U.S.-assembled EVs that do not contain sufficient North American / U.S. or Free Trade Agreement country content less favorably than U.S., Canadian, and Mexican made EVs. These restrictions on EV tax credits raise serious concerns under the WTO agreements, including the General Agreement on Tariffs and Trade (GATT) and the Agreement on Trade and Investment Measures (TRIMs), as well as certain U.S. FTAs that certain EVs are receiving discriminatory treatment on the basis of origin and content, in violation of those agreements. This could trigger a WTO dispute. Moreover, if the IRA succeeds in building a strong and globally competitive U.S. EV industry, as the Act seeks, the restrictions could backfire if U.S. trading partners respond in kind by putting restrictions on the importation or sale of U.S. EVs in their own markets while the United States maintains discriminatory restrictions on its own EVs in apparent violation of WTO rules.
The New IRA Rules May Breach Investment Treaty Rights of Foreign Investors in the United States
Investment treaties (including bilateral investment treaties, multilateral investment treaties, and FTAs that contain investment chapters) provide substantive and procedural protections to foreign investors in the United States. For example, qualifying investors and investments in the United States must be accorded a minimum standard of treatment including fair and equitable treatment, and must not be discriminated against when compared against other domestic or third country investors’ investments that are in like circumstances.
Investment treaties specify what is required for a foreign investor and its investment to have rights under the treaty. A qualifying “investor” is usually defined broadly to encompass a variety of types of legal entities including direct and indirect ownership of the investment. U.S. investment treaties also typically define “investment,” to broadly include a wide variety of assets such enterprises, shares, stock, licenses, authorizations, permits, intellectual property, etc. U.S. investment treaties often protect investors’ rights even prior to establishment of the investment. Many foreign-origin automotive manufacturers that have existing investments or are making investments in the United States could avail themselves of rights under one of several U.S. investment treaties, depending on the nationality and ownership structure of their U.S. investments.
As stated by one international investment tribunal, “customary international law imposes two limitations on the power to tax. Taxes may not be discriminatory and they may not be confiscatory." 1 A similar reasoning may apply to tax credits. The new rules under the IRA remove prior tax credits that were available to all U.S. (and foreign) manufacturers of EVs and replace them with tax credits that are circumscribed to benefit only certain EVs with final assembly in North America and a certain proportion of the value of the components and minerals in the battery must be manufactured or assembled in North America (components) or a trade agreement country (minerals).
One investment treaty tribunal recently found that when a state grants subsidies “and if it becomes necessary to modify them, this should be done in a manner which is not disproportionate to the aim of the legislative amendment, and should have due regard to the reasonable reliance interests of recipients who may have committed substantial resources on the basis of the earlier regime."2 The new rules for tax credits for EVs might be viewed as discriminatory, unfair, and/or inequitable to certain foreign-owned U.S. manufacturers of EVs that do not meet the new standards for U.S., North American and trade agreement country content in those U.S.-made vehicles.
Depending on the factual circumstances, an investor may also assert that the previous regulatory framework under IRS Code Section 30D and any additional specific commitments by the U.S. government underpinning the investor’s U.S. investment created legitimate expectations that were violated by the change in law and revocation of tax benefits.