Two months after the passage of the One Big Beautiful Bill Act, the clean energy industry is still working to interpret the impact of the new Foreign Entity of Concern (FEOC) rules in the bill on tax credits, and is looking forward to upcoming Treasury guidance for more certainty. The Act shortened the duration of most clean energy tax credits under the Inflation Reduction Act.

"I discuss this almost every day," said Jenny Speck, tax partner at Vinson & Elkins. "Developing clear, manageable rules is the first step, because the current regulations themselves are ambiguous. We've heard this is priority guidance—it should be at the top of their agenda."

The FEOC provisions in OBBBA build on the original rules under the Inflation Reduction Act. The original rules restricted entities associated with China, Russia, North Korea, or Iran—known as foreign entities of concern—from claiming clean vehicle tax credits. The new FEOC rules apply to the Section 45X Advanced Manufacturing Production Credit, the Section 45Y Clean Electricity Production Credit, and the Section 48E Clean Electricity Investment Credit.

"We believe wind, solar, and 45X will be the three areas with the most rigorous due diligence," Speck said.

Associations with foreign entities of concern "could include a single Chinese shareholder holding 25% or more, or two or more such shareholders collectively holding 40%, or a Chinese lender holding at least 15% of initial issue debt. Additionally, licensing agreements with Chinese interests could also make a supplier a prohibited foreign entity... It is currently unclear how U.S. developers will identify such arrangements," Norton Rose Fulbright wrote in a July article.

Advait Arun, senior associate for energy finance at the Center for Public Enterprise, believes the industry has some understanding of "the approximate cost share of prohibited content," but as for "what kind of licensing or service agreements might violate FEOC rules, or which prohibited foreign entities are actually already present in these construction processes—I think we don't yet have that clarity."

"Developing clear, manageable rules is the first step, because the current regulations themselves are ambiguous. We've heard this is priority guidance—it should be at the top of their agenda."

—Jenny Speck, tax partner at Vinson & Elkins

The U.S. Treasury and IRS issued OBBBA guidance on August 15, clarifying how project developers can demonstrate they began construction before the deadline to qualify for the 45Y and 48E tax credits. A footnote in the guidance states they are "currently drafting additional guidance on the FEOC rules, as deemed necessary and appropriate."

"The FEOC rules are extremely burdensome," said Lauren Collins, tax partner at Vinson & Elkins. "They are extremely complex and contain multiple traps for the unwary. If you don't invest significant time in understanding these rules and conducting due diligence on equity and debt structures, you will inevitably run into problems."

Collins said that as her firm delves deeper into these rules, they "discover new issues almost daily, especially when applying them to real-world scenarios."

"My basic conclusion is that when the rules are actually applied, taxpayers will rarely truly trigger these restrictions and become prohibited foreign entities," she said. "The problem is that these rules are difficult to apply and conduct due diligence on; the administrative burden of proving compliance is the real challenge. It's not a substantive issue—will we trigger the restrictions? Rather, it's how do we prove compliance with any certainty?"

Industry Shift

Bryen Alperin, partner and managing director at Foss & Company, also called some of the new FEOC restrictions "burdensome" and said meeting these new requirements "will be one of the biggest challenges facing the industry... It could significantly increase costs related to legal compliance and other areas."

Alperin said investors have begun to favor the 45Y production tax credit over the 48E investment tax credit because the latter carries potential recapture risk under the FEOC rules.

"In an investment tax credit transaction, you receive the full tax credit in the first year, but then there's a ten-year compliance period during which the credit can be recaptured," Alperin said. "Suppose you build a solar facility in 2028 and claim the tax credit. Our investors receive the credit, but eight years later—when the project may have new owners and we're no longer involved—someone unexpectedly hires a Chinese company for maintenance."

In such a scenario, the tax credit from eight years earlier could be recaptured, Alperin said.

"I think the biggest concern is—regardless of what the final rules look like, once the government issues them, you have to bear a fairly heavy compliance burden. There's also greater legal risk—the IRS's statute of limitations for recapture is now longer, which holds you liable for a longer period."

—Advait Arun, senior associate for energy finance at the Center for Public Enterprise

"This makes many of our investors nervous," Alperin said. "Many investors who previously only did solar are now considering wind deals because wind generates production tax credits. Going forward, we may see more solar projects choosing production tax credits over investment tax credits, because investment tax credits will carry a risk premium that makes investors uneasy."

Arun said the FEOC rules are also inherently disadvantageous to smaller developers because they lack sufficient resources to ensure supply chain compliance.

"I think the biggest concern is—regardless of what the final rules look like, once the government issues them, you have to bear a fairly heavy compliance burden on your own," he said. "There's also greater legal risk—the IRS's statute of limitations for recapture is now longer, which holds you liable for a longer period."

Developers are also adjusting their strategies in response to the Treasury's August guidance. That guidance states that construction for most wind and solar projects is deemed to begin "when physical work of a significant nature begins," rather than when 5% or more of the project's total costs have been paid. Solar facilities with a net output below 1.5 megawatts can still use the 5% test.

"[The physical work test] is indeed more subjective," Arun said. "For the 5% test, if you have contracts and proof of payment, it's relatively easy to demonstrate and verify to the IRS. But the other thing they changed is that the wording of the physical work test now distinguishes between 'physical efforts' and 'construction plans,' and payments and contracts no longer count in the facts-and-circumstances analysis the IRS may conduct."

Arun said the IRS now has "discretion," which adds "ambiguity" to the process.

Alperin noted that the Trump administration is generally moving toward more subjective discretion, which puts pressure on solar and wind projects, "not only regarding the IRA, but also permits that may not be obtainable—permits that used to be routine standard approvals the government would grant."

Overall, Alperin said the industry is still digesting the physical work test guidance, "but as far as I can tell, its impact is not as significant as some feared." He said the start-of-construction guidance "is not retroactive and does not dramatically change the competitive landscape," which is "a relief."

Collins said she and her colleagues find the latest guidance "very workable."

"We see many clients and developers already acting on it, beginning various forms of physical work of a significant nature to protect the safe harbor eligibility of their wind and solar projects," she said. "The physical work test has been in use for over a decade. We have clear application rules, and those rules haven't changed, and it's less costly than the 5% safe harbor method."

However, Collins noted that the 5% test "is not subjective. It is—you pay that amount, you get safe harbor protection, and that certainty is what the industry likes. But the physical work of a significant nature method has gained broad acceptance over the years and is fairly well-established."

Similar to the lack of clarity in the FEOC rules, Arun said abandoning the 5% test could disadvantage developers that are too large to qualify for the 1.5-megawatt solar exemption but too small to be considered "big fish" rather than "sharks."

"Obviously, I think everyone is right that this is not the worst-case scenario for the industry," he said. "But I think conclusively demonstrating to the IRS that you've begun construction and are conducting construction activities relies on having sufficient market share and market relationships to build a large project pipeline."

Under the safe harbor provisions, wind and solar projects that begin construction before July 4 next year can still be placed in service by December 31, 2030; projects that begin construction after that date must be placed in service by the end of 2027 to qualify.

Additionally, OBBBA includes a provision that projects beginning construction before the end of 2025 are exempt from some of the new FEOC restrictions. To that end, developers are working to push projects forward as quickly as possible, Alperin said.

"Developers were already pushing to start as many projects as possible," he said. "But I think between now and the end of the year, they'll redouble their efforts to start as many projects as they can."