Can EVs unplug from China? 3 things to watch from Treasury.

By David Iaconangelo | 03/24/2023 06:37 AM EDT

Upcoming guidance from the Treasury Department could reshape the electric vehicle industry and help define which models are eligible for U.S. tax credits.

An electric car charges at a mall parking lot.

An electric vehicle charges at a mall parking lot. Justin Sullivan/Getty Images

The Treasury Department plans to issue guidance next week that could have lasting implications for U.S.-China collaborations on electric vehicles — as well as the Biden administration’s goals on climate and human rights.

At issue: the Inflation Reduction Act, which allows buyers of new EVs to claim up to $7,500 in tax credits.

Those credits will become unavailable in the coming years whenever an electric car’s battery parts are supplied by companies considered a “foreign entity of concern.”


But which companies would that entangle?

The answer is a legal gray area, according to legal analysts, clean car advocates, automakers and human rights advocates. The foreign entity exclusion is likely to have special relevance for China, the source of three-fourths of the world’s lithium-ion batteries. Analysts say Chinese companies could be disqualified from helping build federally subsidized EVs.

It remains unclear how strictly the law might be interpreted and how far it might go.

For instance, Ford Motor Co. announced plans in February to build a $3.5 billion battery factory in Michigan while licensing technology from China-based Contemporary Amperex Technology Co. Ltd. (CATL).

Treasury’s guidance could conceivably endorse — or throw into question — partnerships of that kind, involving a Chinese-headquartered company, analysts say. Some environmental groups have told Treasury that disconnecting EVs from Chinese battery behemoths could slow the U.S. transition to electric cars.

Conservatives and hawkish Democrats are calling for scrutiny of deals like the Ford-CATL partnership, arguing that Chinese companies should be strictly excluded from any business arrangement that would benefit from federal subsidies.

Human rights researchers are also split on what the foreign entity exclusion could mean for addressing allegations of forced labor in the auto supply chain.

For some auto companies, implementation of the foreign entity provision is “probably the most important outstanding question to be answered by Treasury” about the law’s electric vehicle tax credits, said Corey Cantor, an electric vehicle analyst at BloombergNEF.

It’s unclear if Treasury’s upcoming guidance will address the foreign entity provision. During a call with reporters this week, Treasury officials did not say directly whether it would, while saying the department was focused on making sure foreign investments made in the United States will not compromise national security.

The guidance will give further clarity on other anxiously awaited North American battery-sourcing requirements for the EV tax credit, the officials confirmed.

But for China’s battery sector, the foreign entity provision may carry the highest stakes. Here are three things to know about the provision and its influence over the future of EVs.

1. What does the law say about foreign entities? 

The Inflation Reduction Act does not itself define a “foreign entity of concern,” instead citing a definition contained in the 2021 bipartisan infrastructure law.

Any entity “owned by, controlled by, or subject to the jurisdiction or direction” of governments in China and other covered nations, like Russia and Iran, would fall into the foreign entity of concern category, according to the infrastructure law’s definition.

That language is unique because it could refer to the national origin of the companies involved in battery production. That is different from just the physical location of factories or mines, which is the focus of North American sourcing mandates in the Inflation Reduction Act.

The provision might be interpreted as excluding a wide range of corporations with a Chinese footprint, according to Andy Howlett, a tax lawyer and member at Miller & Chevalier.

But he added that Treasury may want to pursue a far narrower definition — for instance, applying it only to companies that are directly owned by the Chinese state.

That might seem to the department like the best way of ensuring that EV carmakers in the U.S. and other allied countries can actually access the tax credits, particularly in the next few years, Howlett said.

Treasury could conclude that Congress created the EV tax credits “to incentivize the use of electric vehicles,” he said. “If they want to run with that, they could just say, ‘We’re going to interpret every provision in a manner that gets as many electric vehicles on the road as possible.’

“The question is, what kind of interpretation are they going to make?” he said of the Treasury Department.

The foreign entity exclusion will go into effect in phases.

Starting in 2024, an electric car will be ineligible for tax credits if its battery components are manufactured or assembled by a foreign entity of concern. In 2025, the same will apply to EVs that use critical minerals extracted, processed or recycled by those entities, according to the Inflation Reduction Act’s text.

The law also has significant North American sourcing requirements for batteries, which will be a subject of Treasury’s guidance next week.

For instance, 40 percent of an EV’s battery minerals must be extracted and processed in North America or a free-trade partner of the United States in order for car buyers to claim a $3,750 tax credit. In 2027, that percentage rises to 80 percent.

At least half of the battery’s components would also have to be manufactured in North America to get an additional $3,750 in credits. In 2029, the same would apply for 100 percent of the battery’s components.

2. What does the auto industry want?

Some EV advocates have expressed worries about whether the Inflation Reduction Act’s sourcing requirements — including the foreign entity exemption — might derail progress toward adoption of clean cars.

Automakers are unlikely to be able to comply with most of the new requirements in time to claim the law’s tax credits, and Treasury officials have few systems in place to track sourcing of EV components, the Natural Resources Defense Council argued in public comments to Treasury.

When the foreign entity exemptions kick in next year, “very few (if any) automakers [will be] eligible for the credit,” the NRDC wrote.

In an outpouring of letters to Treasury, car companies and battery producers have asked the department to issue guidance that would clarify how it interprets the foreign entity provision.

The Alliance for Automotive Innovation, a trade group that represents most major automakers, said Treasury should deliver guidance on “the exact scope of ownership or control that is necessary to trigger the [foreign entity of concern] exclusion,” in public comments to Treasury in November.

A few automakers and clean car advocates have urged Treasury to take a flexible approach.

Joint ventures that include subsidiaries of Chinese companies should be allowed to claim the tax credits as long as the Chinese company is legally organized outside of that country, wrote representatives of Ford in their own November comments to Treasury.

RMI, a clean energy think tank, said in its comments that Treasury should let companies headquartered in China or other rival countries participate in battery extraction, processing or assembly as long as that takes place in a factory located in the United States or on the soil of a free-trade partner, the group wrote.

But some members of Congress disagree.

After Ford and CATL announced their battery plant in Michigan, Republicans in the Senate and House denounced it as a giveaway to a foreign rival.

Sen. Marco Rubio (R-Fla.) sent a letter to the Biden administration saying he was “alarmed” at the deal and demanding that no Inflation Reduction Act subsidies “go to enrich [People’s Republic of China] national champion CATL, or any other Beijing-supported company, directly or indirectly” (Greenwire, Feb. 14).

Sen. Joe Manchin, a Democrat, joined the parade of criticism, saying he had “grave concerns” about the deal and adding that Ford had “serious questions to answer” about it.

Ford said it remains to be seen whether cars containing the batteries would be eligible for the Inflation Reduction Act’s consumer tax credits. But the company has expressed confidence that the factory’s batteries could be eligible for a separate credit for production of clean equipment (Greenwire, Feb. 13).

Ford has repeatedly defended its plans by saying that federal subsidies would not flow to CATL.

Melissa Miller, a Ford spokesperson, said in an emailed statement that the Michigan plant did not involve any foreign investment and that the site would be built, owned and operated by a wholly owned Ford subsidiary.

She added that “no other entity” except Ford “will receive any government benefit for this project,” calling the planned production of batteries in the United States “a win for Ford, our customers, and our country.”

Still, the blowback from Ford’s announcement may underscore the political sensitivities surrounding Chinese companies and the Biden administration’s implementation of the EV tax credits, according to Cantor at BNEF.

“There’s definitely been a political conversation,” he said.

3. What could this mean for forced labor?

The foreign entity provision may carry importance that goes beyond the question of which EV drivers can save money on their new cars.

International human rights researchers have documented systems that detain Uyghur minorities and press them into jobs at factories producing a huge range of goods for export.

In 2021, Congress banned imports made wholly or in part in Xinjiang, which researchers say is the regional hub of those forced-labor systems.

The auto industry’s supply chains are also entangled with human rights abuses, according to reports.

Late last year, researchers at the U.K.’s Sheffield Hallam University led an investigation concluding that “practically every major traditional automotive and electric vehicle manufacturer has significant exposure to forced labor in the Uyghur Region.”

The report led Senate Finance Chair Ron Wyden (D-Ore.) to question eight major automakers on how their operations might be tied up with Uyghur forced labor.

Kendyl Salcito, executive director of human rights nonprofit NomoGaia and a participant in the Sheffield Hallam investigation, said she thought the Inflation Reduction Act’s foreign entity provision might help delink the production of EVs from forced labor.

“It’s my position that the global market should aggressively pressure Chinese EV battery manufacturers not to pursue operations in the Uyghur Region,” she wrote in an email. “This seems like one of the rare opportunities for the global community to prevent a new harm from occurring, rather than retroactively respond to it.”

Other forced-labor researchers say that the foreign entity provision could serve as either a weapon against forced labor or a smokescreen for the auto industry.

Nathan Picarsic, a co-founder of geopolitical research firm Horizon Advisory, said that “on its face” the Inflation Reduction Act might seem to discourage electric carmakers from doing business with Chinese battery suppliers linked to forced labor.

But it might also give carmakers a way to skirt enforcement of the 2021 Uyghur Forced Labor Prevention Act — the law banning Xinjiang-linked imports, he added.

Chinese companies that use forced labor in their operations might be able to “launder” their battery minerals or materials by selling them to a company from outside the U.S., which could in turn incorporate those materials in their electric vehicles, Picarsic said.

Customs and Border Protection officials have begun forcing companies from a variety of business sectors to provide extensive documentation before their imports can enter the United States. To date, CBP has impounded $961 million worth of shipments, according to recently released data from the customs agency.

But customs officials might be discouraged from such aggressive enforcement actions if Treasury makes it clear that Chinese companies’ foreign subsidiaries can act as suppliers for EV batteries, argued Picarsic.

“It’s a potential end-around for the Uyghur Forced Labor Act,” he said.

CBP spokesperson Jeffrey Quiñones said in a statement that the agency identified forced-labor products by using “a dynamic risk-based approach,” adding that foreign entity exclusion “is under the responsibility of Treasury and we defer to them” on how it would be enforced.

Forced-labor allegations have bedeviled other low-carbon energy industries in the past, most notably solar. Trade groups in that industry say impoundments of huge solar panel shipments contributed to a decline in solar deployment last year (Energywire, March 9).

Some clean car advocates say that a similar setback in the country’s progress toward clean cars is worth risking.

“I would never try to buy a product or want to build my economy on the backs of forced labor or child labor,” said Robbie Diamond, the chief executive of Securing America’s Future Energy, a nonprofit that advocates for improving U.S. clean energy security. “Anyone who actually would, I would say, has a moral question to ask themselves.

“I want to get [to EV goals] as fast as humanly possible, but we need to do it the right way,” he added. “Even if it means we have to walk before we run.”