Biden admin bows slightly to European pressure in trade clash

The Biden administration on Thursday signaled some flexibility in how it would implement a revised tax credit for electric vehicles in the new Inflation Reduction Act that has rankled the European Union and other trading partners.

The Treasury Department, in a new "white paper" published Thursday, indicated it would adopt an expansive definition of which countries have a “free trade agreement” with the United States. That could help some overseas automakers qualify for at least a portion of the credit that favors U.S. manufactured vehicles.

However, the new guidance clearly states that to qualify for the full tax credit, the final assembly of an electric vehicle must take place in the United States, Canada or Mexico. That could still make the vast majority of imported automobiles ineligible for the full $7,500 tax credit consumers can get on the purchase of a new electric vehicle. Treasury will propose a more detailed rule on the tax credit in March.

The law and its new electric vehicle tax credit provision have heightened trade tensions between the United States and other leading auto-producing countries such as France, Germany, South Korea and Japan. European leaders, in particular, have publicly raised concerns with President Joe Biden that the tax credit and other IRA provisions that subsidize U.S. clean energy could be the death knell for European industry as investment is siphoned away to the United States. Congressional lawmakers have been unapologetic, saying they crafted the law to boost U.S. jobs and production of electric vehicles.

Treasury released a preliminary list of which vehicles qualify for the credit on Thursday, and expects it to grow in coming days as they hear from more manufacturers. That still could be shorter than the list of cars the Energy Department has previously said are eligible for the credit.

However, Congress also created a separate tax credit for clean commercial vehicles which isn’t as stringent as the one for new consumer car sales and that could provide some opportunities for overseas manufacturers. Treasury also published answers to a list of "Frequently Asked Questions" about the new tax credit to help manufacturers and consumers sort through the complexities.

Why countries are concerned: The Inflation Reduction Act, which Biden signed into law on Aug 16, immediately required electric vehicles to be assembled in North America to qualify for the $7,500 consumer tax credit.

Previously, EVs assembled outside North America could qualify for the credit, although each automaker was limited to a cap of 200,000 vehicles before they maxed out.

The new North American assembly requirement eliminated many electric vehicles made overseas that previously qualified, angering the EU, Japan and South Korea and raising the prospect of a legal challenge at the World Trade Organization.

The EU, which is home to big automakers like Volkswagen, BMW and Mercedes-Benz, has been concerned the EV tax credit will siphon investment away from Europe in favor of the United States. However, South Korea has an opposite concern.

Its biggest car company, Hyundai, has already announced plans to build a $5.5 billion electric vehicle facility in Georgia that won’t become operational until 2025.

South Korea has asked Treasury for a grace period so it can continue importing cars that qualify for the credit until the Georgia facility starts production. However, Treasury’s white paper does not address that issue, potentially leaving the automaker out in the cold.

Important battery provisions: The guidance released Thursday provides more hope for foreign producers of electric vehicle batteries. The IRA introduced separate requirements effective on Jan. 1 for critical minerals and other battery components that Congress intended to spur more production in the United States. Additional provision that take effect in 2024 also would would prevent cars containing material and parts from China from being eligible for the tax credit.

To qualify for a portion of the tax credit, 40 percent of the value of the critical minerals in the battery must be extracted or processed in the United States or in any country with which the United States has a free trade agreement. That level increases to 80 percent by 2027. The critical minerals could also be recycled in North America to qualify.

The U.S. currently has formal free trade agreements with 20 countries, including Canada, Mexico, South Korea and other countries in Asia, Latin America, Africa and the Middle East.

Treasury noted that the term “free trade agreement” is not defined in the IRA or any other statute, enabling the department to come up with its own definition. This could potentially broaden the group of countries eligible for the tax credit, including the European Union which does not have a formal trade deal with the U.S.

Treasury said it would identify a list of criteria for what qualifies as a free trade agreement with the United States in a notice of proposed rulemaking it plans to issue in March.

Treasury and the IRS “also 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.”

To qualify for the another portion of the tax credit, at least 50 percent of the vehicle's battery components have to be manufactured or assembled in North America, starting in 2023. That requirement increases to 100 percent by 2029.

IRA did not provide any leeway for components manufactured or assembled in free trade agreement countries, like it did for the critical minerals content requirement.

Commercial vehicle tax credits: Taxpayers that buy electric or other clean vehicles for their business operations can also apply for a separate tax credit that has less stringent criteria than the ones for the cars sold directly to consumers.

That potentially could provide a sizable market for overseas manufacturers who lease electric vehicles in the United States. However, they have to take care that the lease does not contain terms that would prompt the IRS to recharacterize it as a sale, Treasury said.