On Tuesday, March 21, 2023, the Department of Commerce issued a notice of proposed rulemaking on the guardrail provisions included in the CHIPS Incentives Program under the CHIPS and Science Act, intended to ensure that any funded semiconductor technology and innovation is not used by adversary countries against the United States or its allies and partners.  As part of the proposed rule, Commerce defined  both “foreign entity of concern” and “owned by, controlled by, or subject to the jurisdiction or direction of” a country of concern. These terms are critical limitations included with respect to CHIPS Act and IIJA funding, as well as the Inflation Reduction Act’s consumer clean vehicle tax credit under Section 30D. Written comments are due no later than May 22, 2023.

Foreign Entity of Concern Overview 

The term “foreign entity of concern” appears in a number of recently enacted laws but, until this week, there was not much clarity on how the Administration intended to interpret it.  The IRA definition of FEOC cites to the definition of FEOC contained in the Bipartisan Infrastructure Investment and Jobs Act (IIJA) (42 USC 18741(a)(5)).  That definition includes entities that are “owned by, controlled by, or subject to the jurisdiction of [North Korea, China, Russia, and Iran].”  The most natural read of the “owned by” and “controlled by” clauses would encompass any Chinese, North Korean, Russian or Iranian governments or their state-owned entities.  The “subject to the jurisdiction” clause, however, is less clear and could be interpreted narrowly to mean any company incorporated in one of the four nations or, more broadly, to include any company (including U.S. companies) with any business at all in the four nations of concern.

In addition to the IIJA and IRA, the CHIPS and Science Act included this same definition for FEOC and directed the Secretary of Commerce to promulgate regulations, which Commerce did this week.    

Implication of an FEOC Designation Under the Inflation Reduction Act

Under the Inflation Reduction Act, vehicles that use batteries that contain (i) any “applicable critical minerals” that were extracted, processed or recycled by an FEOC or (ii) any component manufactured or assembled by an FEOC would be ineligible for the $7,500 Section 30D consumer tax credit (Sec. 13401(e)(7)) starting after 2023.  These prohibitions will take effect in 2024 for any EV components and in 2025 for “applicable critical minerals.”  If an entity is designated as an FEOC because it is subject to the jurisdiction of China, it does not appear that the designation would trigger any other national security implications or repercussions outside of making any vehicle that uses the battery ineligible for the tax credit—at least not by anything in the statute itself. 

Many in the automotive industry have been expecting that Treasury would use existing definitions of control that look at issues like percentage of ownership and voting rights.  Specifically, Treasury could use definitions of an entity under common control under Internal Revenue Code section 52, and conclude that minority owners (less than 50 percent) are generally excluded from this definition.

In a recent speech, John Podesta, who is leading the IRA implementation for the White House, acknowledged that Chinese companies will be able to participate in the IRA.  He explained that given the Chinese head start in the EV and EV battery industry, the U.S. will likely have to rely on their “know-how” to some extent as domestic capabilities grow.  These comments drew sharp criticism from Senator Joe Manchin (D-WV), who authored many of the IRA provisions; he’s been critical of the Administration for what he views as weakening domestic sourcing and manufacturing requirements in the IRA.  What Podesta did not make clear, however, was the extent to which Chinese companies could benefit from the consumer tax credit piece of the IRA, as opposed to the manufacturing tax credit under 45X, which does not contain the same prohibition on foreign entities of concern.     

Commerce’s Proposed Rule

Under Commerce’s proposed definition, any entity for which a Chinese person (or company) directly or indirectly holds at least a 25 percent voting interest would be deemed a foreign entity of concern. 

Specifically, Commerce’s proposed rule defines foreign entity of concern and owned by, controlled by, or subject to the jurisdiction or direction of as the following:

§ 231.106 Foreign entity of concern.

Foreign entity of concern means any foreign entity that is—

(a) Designated as a foreign terrorist organization by the Secretary of State under 8 U.S.C. 1189;

(b) Included on the Department of Treasury’s list of Specially Designated Nationals and Blocked Persons (SDN List), or for which one or more individuals or entities included on the SDN list, individually or in the aggregate, directly or indirectly, hold at least 50 percent of the outstanding voting interest;

(c) Owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation (as defined in 10 U.S.C. 4872(d));

(d) Alleged by the Attorney General to have been involved in activities for which a conviction was obtained under—

(1) The Espionage Act, 18 U.S.C. 792 et seq.;

(2) 18 U.S.C. 951;

(3) The Economic Espionage Act of 1996, 18 U.S.C. 1831 et seq.;

(4) The Arms Export Control Act, 22 U.S.C. 2751 et seq.;

(5) The Atomic Energy Act, 42 U.S.C. 2274, 2275, 2276, 2277, or 2284;

(6) The Export Control Reform Act of 2018, 50 U.S.C. 4801 et seq.;

(7) The International Economic Emergency Powers Act, 50 U.S.C. 1701 et seq.; or

(8) 18 U.S.C. 1030.

(b) Included on the Bureau of Industry and Security’s Entity List (15 CFR part 744, supplement no. 4);

(c) Included on the Department of the Treasury’s list of Non-SDN Chinese Military Industrial Complex Companies (NS-CMIC List), or for which one or more individuals or entities included on the NS-CMIC list, individually or in the aggregate, directly or indirectly, hold at least 50 percent of the outstanding voting interest;

(d) Identified in the Federal Communications Commission’s list of Equipment and Services Covered By section 2(a) of the Secure and Trusted Communications Networks Act of 2019 as providing covered equipment or services; or

(e) Determined by the Secretary, in consultation with the Secretary of Defense and the Director of National Intelligence, to be engaged in unauthorized conduct that is detrimental to the national security or foreign policy of the United States under this chapter.

§ 231.112 Owned by, controlled by, or subject to the jurisdiction or direction of

(a) A person is owned by, controlled by, or subject to the jurisdiction or direction of an entity where at least 25 percent of the person’s outstanding voting interest is held directly or indirectly by that entity.

(b) A person is owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country or of a foreign political party where:

• The person is a citizen, national, or resident of the foreign country located in the foreign country;

• The person is organized under the laws of or has its principal place of business in the foreign country; or

• At least 25 percent of the person’s outstanding voting interest is held directly or indirectly by the government of a foreign country or a foreign political party.

If this definition is adopted by Treasury for IRA purposes, it would mean that virtually any Chinese person, resident or entity located in China is a FEOC, since this would cover entities owned by a Chinese person, as well as any company that is headquartered or incorporated in China, which presumably would be the case.  Since it is framed in the alternative (“or”), this means that virtually any Chinese company, including the Chinese subsidiary of a U.S. or other foreign company (e.g. European or Japanese), would be a FEOC, since it would be subject to Chinese jurisdiction and likely incorporated there. Moreover, in the context of joint ownership or a joint venture, any entity wherever located, including the U.S., with a Chinese partner, where at least 25 percent of the voting rights are held (either directly or indirectly) by a Chinese company, the Chinese government or Communist Party, is a FEOC.  This would cover U.S. joint ventures with a number of prominent Chinese state-owned enterprises or where Beijing owns so-called “golden shares” that give it 25% voting rights. 

If adopted, this definition would not only prohibit companies from purchasing or sourcing directly from Chinese companies but would also impact their ability to source from U.S. and third-country suppliers where any form of Chinese ownership is involved.  For CHIPS Act purposes, the provision is alleviated to a degree by the additional requirement that any joint research and development of IPR licensing must relate to “a technology or product that raises national security concerns as determined by the Secretary of Commerce,” which limits its scope, but no similar limitation appears in the IRA.

While it’s not clear that Treasury will issue identical guidance with respect to “foreign entity of concern” for purposes of the IRA, it would be strange for the two agencies to issue conflicting definitions, given that both statutes reference the identical IIJA definition.  According to Commerce’s website regarding the guardrails proposed rule: “[t]he Department of Commerce and the Department of the Treasury have been coordinating closely on CHIPS funding and the Investment Tax Credit to ensure these incentives are complementary and advance the Biden Administration’s economic and national security goals.”  For this reason, we believe there is a good chance that Treasury will follow Commerce’s CHIPS Rule FEOC definitions and suggest companies consider how these definitions might impact their own supply chains in assessing compliance with the IRA EV credit requirements.

Next steps

Hogan Lovells will continue to monitor further guidance issued across the Administration and will keep you apprised of any significant updates.  Should you have any questions or concerns about the potential implications of this proposed rule for your business and whether or not your EV battery would qualify for the consumer tax credit under 30D, please do not hesitate to contact any one of us.   

Authored by Kelly Ann Shaw, Jamie Wickett, Warren Maruyama, Tim Bergreen, Ches Garrison, and Josh LaFianza.