U.S.-China EV Race Heats Up with Forthcoming Guidance on 'Foreign Entity of Concern' Rules
Building out the domestic supply chain for electric vehicle (EV) batteries is a pillar of the Biden administration's green industrial strategy, which seeks to firmly link U.S. re-industrialization and decarbonization efforts. While the Inflation Reduction Act (IRA) has begun mobilizing significant investment interests in EV manufacturing capacities in the United States, there is a major holdup in the implementation of its amendments to Section 30D of the New Clean Vehicle Credit (30D). The forthcoming guidance from the Treasury Department on what constitutes a “Foreign Entity of Concern” (FEOC) has significant implications for U.S. EV supply-chain development, EV deployment, and the U.S. auto industry’s ties with China. For example, the Ford Motor Company’s recent suspension of its planned EV battery manufacturing plant in Michigan, which entailed a battery licensing arrangement with the Chinese company Contemporary Ampler Technology Limited (CATL), exemplifies this challenge.
The term “Foreign Entity of Concern” (FEOC) has become well-known to many stakeholders involved in energy and high-tech supply chain policy matters, who are both inside and outside the U.S. federal government. It appeared in several recent laws, including the Infrastructure Investment and Jobs Act, the IRA, and the CHIPS and Science Act.
Under U.S. law, FEOC refers to entities that fall under one of the five categories, including foreign terrorist organizations as designated by the Office of the Secretary of State, Treasury Department-designated banned nationals, and those convicted for espionage or arms export control violation. The category most relevant to the IRA 30D discussion concerns 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.” Covered nations are made explicit in the 10 U.S. Code 2533c(d) as the Democratic People's Republic of North Korea, the People's Republic of China, the Russian Federation, and the Islamic Republic of Iran. For an entity that is not a government itself or a state-owned entity from one of these four countries, determination of ownership or control may be set by quantitative limitations, such as voting rights percentage. Meanwhile, what amounts to “subject to the jurisdiction or direction” is much harder to discern. Some legal experts have noted that its narrow interpretation could mean a company that is incorporated in one of the four nations, while its broad interpretation could mean a U.S. company with any business in these four nations.
The FEOC limitation under the IRA 30D seeks to “strengthen [EV] supply chains with trusted trading partners.” It is designed to serve as a key national security guardrail against the flow of federal incentives to those outside a group of trusted trading partners. The provision sets various requirements, including the sourcing requirements for minerals that are used in EV batteries and EV battery component manufacturing from the United States and countries it has a free trade agreement with, and the final assembly in North America. EVs that satisfy these conditions are eligible for a maximum of $7,500 in tax credits. The IRA disqualifies EVs that use battery components manufactured or assembled by a FEOC after 2023, and EVs that use batteries containing critical minerals that were extracted, processed, or recycled by a FEOC after 2024.
In the context of EV consumer tax credit, the most relevant of four “covered nations” is China, which is now the largest car exporter in the world, and accounts for 35 percent of global EV exports. Additionally, China accounts for about 80 percent of global manufacturing in lithium-ion batteries, as well as 60 to 90 percent in the global capacity to process key battery minerals, such as lithium, nickel, and rare earths. Thus, the Treasury’s interpretation of the FEOC definition poses significant uncertainty to whether planned EV battery manufacturing projects may proceed. One possible Treasury guidance would emulate the strict guidance proposed by the U.S. Department of Commerce for the implementation of the CHIPS and Science Act. The proposed guidance, which is scheduled to enter in force in late November, deems any entity a FEOC if a Chinese person or company directly or indirectly holds at least a 25 percent voting interest (15 CFR 231.112). Another possible Treasury interpretation may deem any entity with less than 50 percent voting interest from any country of concern, or any combination of countries of concern to be free of FEOC limitation. Yet another possibility is that each EV battery manufacturing project be subject to a case-by-case review for national security effects the way certain transactions currently are subject to review by the Committee on Foreign Investment in the United States.
The IRA passage spurred significant investment in onshoring. Since August of 2022, 72 new projects and $60 billion of new investment have been announced. While a significant share of this investment comes from U.S.-based companies, Korean, Japanese, German, and Chinese firms are also investing billions of dollars into U.S. EV supply chain projects. Some significant projects are battery factories, such as the planned $5 billion Hyundai-SK battery plant in Bartow Country, Georgia, and the $3.5 billion LG Energy Solution-Honda manufacturing facility in Jeffersonville, Ohio, which is currently under construction.
The Treasury Department’s decision could affect current EV projects and influence future investments. The suspension of Ford Motor Company’s EV battery project with CATL demonstrates the challenges involved with onshoring EV supply chains. Chinese battery companies are attractive partners for many EV manufacturers due to their proprietary technologies, such as CATL’s lithium ferrous phosphate batteries, and cost advantage. Today, Chinese batteries have a 30 percent cost advantage over U.S. and European equivalents. While U.S., Korean, and Japanese-owned projects in the United States could benefit from the full IRA EV incentives by complying with FEOC requirements, they will need to forego competitive Chinese battery technologies and avoid sourcing critical minerals from China. In some cases, EV manufacturing firms may determine that the cost advantage of Chinese technologies are worth more than IRA tax incentives. However, the increasing uncertainty around the FEOC definition and IRA may lead auto manufacturers to prioritize tax incentives rather than the cheaper batteries.
Another major implication from Treasury guidance is the pace of EV deployment in the United States. As part of its decarbonization goals, the Biden administration has committed to the target of electric vehicles accounting for half of all new vehicle sales by 2030. In the first half of 2023, the share of EVs surpassed 7 percent of domestic new car sales for the first time. Bloomberg NEF projects annual EV sales in the U.S. to grow from less than a million in 2022, to 4 million in 2026, while S&P Global forecasts 4.6 million EV sales by 2030. While the FEOC provision could temper EV ownership, continued expansion is possible due to an IRA provision concerning leasing. The so-called leasing loophole allows lessees to benefit from IRA tax credits for otherwise ineligible vehicles. In 2022, leased EVs accounted for less than 10 percent of all EV sales. This share increased to 35 percent as of spring 2023 likely due to the loophole. Additionally, federal fuel economy and greenhouse gas emissions regulations are other factors that will likely affect the extent to which the Biden administration meets its goal.
There may be some secondary implications from the forthcoming Treasury guidance. A strict interpretation could elicit a retaliatory response that can strain U.S. autos’ access to Chinese EV batteries, or other operations in China. China is not only a robust market, but also a manufacturing base for some of the foreign automakers for exporting to other regions. Moreover, Chinese EV makers could choose to entice U.S. consumers by lowering the price to a level that negates the high tariff rate which is currently imposed on Chinese auto imports. In 2018, President Donald Trump imposed a 25 percent tariff on Chinese vehicles on top of the 2.5 percent tariff on all vehicle imports. President Biden has not signaled any interest in reducing these trade barriers. After all, nothing in the IRA or other U.S. laws prevents U.S. consumers from purchasing Chinese vehicles. The clock is ticking for the Treasury to release its FEOC guidance, as the IRA 30D sourcing requirements for EV battery components will go into effect as early as January 1, 2024. The 30D tax credit is a key piece of the U.S. green industrial strategy, which seeks to balance decarbonization, domestic economic interests, and national security. As these key objectives are clearly in tension, the FEOC question presents the first big test to U.S. green industrial strategy.
Jane Nakano is the senior fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Quill Robinson is a senior program manager and associate fellow with the Energy Security and Climate Change Program at CSIS.