The United States Should Fix the FEOC Guidance

According to the Australian Financial Review, one of the United States’ strongest allies would like to better understand the U.S. administration's interpretation of the “foreign entity of concern” language. Australia is not alone, and South Korea has made similar inquiries. It is critical that the United States answers this question directly and clearly by closing loopholes and avoiding frictions with key partners.

The Inflation Reduction Act (IRA) provides U.S. taxpayer-funded tax credits to companies that use a certain percentage of critical minerals mined, processed, or refined in the United States or countries with which the United States has a free trade agreement (FTA). The IRA recognizes that it will take time for the United States to produce a majority U.S.-made battery and tiers the tax credit qualification accordingly—this year, it will provide up to $3,750 in tax credits per electric vehicle if 40 percent of the value of the critical minerals contained in the vehicle are from the United States or a U.S. FTA country, and $3,750 credit if 50 percent of the value of the battery components were manufactured in North America. That qualifying percentage for critical minerals increases to 80 percent by 2027 and to 100 percent for battery components after 2028.

Although FTA countries meet the sourcing requirements, the IRA explicitly prohibits “foreign entities of concern”—defined as China, Iran, North Korea, and Russia, from receiving taxpayer subsidies. Although the IRA was passed on politically partisan lines, the drafters recognized that the law’s success would hinge on effective implementation and eventual broad-based public acceptability over time. It seems obvious then that elected members of Congress would prohibit the United States’ greatest adversaries from receiving their constituents’ tax dollars.

The United States’ allies are confused not by the law, but by the Biden administration’s guidance intended to interpret it. That guidance allows for a company to receive U.S. taxpayer funds even if a foreign entity of concern (China) owns up to 25 percent. The administration concluded that, given China’s expansive control and investments across the critical minerals value chain, too few projects would qualify under the IRA, as written. They reasoned that a mere 25 percent stake would represent a passive, non-controlling investment, and therefore should qualify for subsidies so long as not directly managed by the Chinese Communist Party (CCP). The administration’s interpretation may be appropriate with a country that shared the United States’ values.

The U.S. Federal Bureau of Investigation concluded that “the Chinese government is seeking to become the world’s greatest superpower through predatory lending and business practices, systematic theft of intellectual property, and brazen cyber intrusions.” The administration’s supply chain report found that overreliance on China for critical minerals and materials posed national and economic security threats.

The administration’s guidance takes pains to distinguish and qualify 25 percent ownership by China’s private sector companies from disqualified “state-owned entities.” For example, the guidance provides, “DOE's assessment of the battery supply chain strongly suggests that minority control can attenuate with multiple tiers of separation between the state and the firm performing the covered activity.” However, this is likely an academic distinction without a practical distinction. The FBI notes that, “using a whole-of-society approach to achieve these goals, China takes advantage of every opportunity—from joint ventures to economic espionage—to develop and maintain a strategic economic advantage.” Similarly, Stanford’s Center on China’s Economy & Institutions concluded that a large share of China’s economy operates in a grey zone of mixed or blended ownership between the state and private sector:

“The number of private owners with direct equity ties with the state almost tripled between 2000 and 2019, and those with indirect equity ties rose 50-fold. The analysis suggests that equity ties to the state may have aided, not constrained, the growth of China’s private sector.”

Taken together, there seems little distinction between the CCP and China’s private sector today. Australia concedes this point. According to press reporting on Canberra’s submission, “determining control by the government of a covered nation, may still be difficult in some circumstances . . . Australia notes that even with clear criteria, it may be burdensome in some cases for private companies to demonstrate their compliance.”

Beijing’s companies are taking actions to make it even more difficult to distinguish between the CCP, relative control, and private companies. Chinese battery behemoth, CATL is restructuring the shareholdings of two top executives with direct connection to the CCP. Robin Zeng Yuqun, the founder, chairman and general manager of CATL, and Li Peng, the company’s vice chairman, will reduce their 27.9 percent of the company to meet the 25 percent IRA guidance loophole. Rebuffing congressional protests, Ford intends to partner with CATL to build a battery factory in Michigan. Ford believes that it should be entitled to U.S. taxpayer subsidies because they will hire local employees to assemble CATL’s licensed technologies.

While implementing the IRA as written would be clear, doing so would limit the administration’s goal of broadening EV adoption. Yet the current guidance opened a loophole that the CCP intends to take advantage of. A reasonable person would conclude that CATL is exploiting the system, and such action should be prohibited.

Anticipating and writing rules that might capture every possible situation would be impracticable, and the government and business cannot disqualify 25 percent content according to a “I know it when I see it” test. Instead, the administration should modify the existing guidance to properly incentivize the creation of an U.S. supply chain over time. The current guidance falls short and could institutionalize the acceptability of otherwise prohibited FEOC content while lacking credible penalties for abuse.

If the objective of the IRA is to spur the creation of a U.S. supply chain, then the FEOC guidance should align with that objective. As the law requires an increasing amount of domestic and FTA-content over time, so too should it require a proportional reduction of FEOC content. For example, the guidance should reduce the permissible 25 percent now to something closer to 10 percent in 2028. This would better align the guidance with congressional intent while retaining the administration’s goals. Importantly, it would send a clear signal to the private sector to invest and enter appropriate partnership structures rather than encourage evasion.

The administration should also anticipate cheating and build mechanisms for enforcement and establish clear penalties. To encourage broad EV adoption, the administration should prioritize efficiency over time-consuming bureaucracy. Rather than have the government establish a policing function, it should instead empower the industry to police itself. In revising the FEOC guidance, the administration should allow a company who has been or likely will be injured by a FEOC cheating party to petition a federal court or the Department of Commerce to seek redress. The Department of Commerce already has the authority and duty to investigate cases where an injured party alleges that foreign companies dumped product into the U.S. market or to determine the effect of imports on national security.

The revised guidance should trigger mandatory stiff and immediate penalties on violators. U.S. business and capital need the confidence to invest and knowing that Uncle Sam has their back will go a long way. U.S. business will be reluctant to deploy capital and compete if Chinese firms can exploit U.S. taxpayer subsidies without penalty. The Chinese solar case is instructive in what not to do. In that instance, the Commerce Department concluded that Chinese companies violated U.S. trade rules, but fearful of slowing solar adoption, President Biden deferred the justified tariffs.

The Biden administration and Congress view China’s dominance of the critical mineral supply chain and clean energy manufacturing as existential threats. The IRA provided hundreds of billions of U.S. taxpayer-funded subsidies to develop a domestic clean energy supply chain. The law prohibits China from benefiting from U.S. taxpayer subsidies. Yet the administration’s “foreign entity of concern” guidance created a loophole that Chinese firms are exploiting. To achieve congressional intent and preserve political support while broadening EV adoption, the administration should close the loophole and empower the U.S. private sector.

Frank Fannon is a senior adviser (non-resident) for the Office of the President at the Center for Strategic and International Studies in Washington, D.C., and managing director of Fannon Global Advisors, a strategic advisory focused on geopolitics, energy transition, and market transformation. Fannon served as the inaugural U.S. Assistant Secretary of State for the Bureau of Energy Resources.

Frank Fannon
Senior Advisor (Non-resident), Office of the President