IRA and the EU's Green Deal Industrial Plan - an opportunity also for German companies

published on 17 May 2023 | reading time approx. 5 minutes

The German automaker, Volkswagen, intends to invest more in the U.S. market in the future. One reason for this is the Inflation Reduction Act of 2022 (IRA) signed by U.S. President Joe Biden - a law that provides substantial subsidies for green energy. The European Union (EU) now fears that companies with strong financial standing will migrate to the USA. Therefore, one did not have to wait long for the EU’s response. On 1 February 2023, the European Commission presented “Green Deal Industrial Plan for the Net-Zero-Age”. In addition, the EU is planning to conclude a “light” free trade agreement with the USA so that European companies are also covered by the IRA. If the EU implements its plans quickly, the IRA and the Green Deal Industrial Plan could constitute two support packages offering significant opportunities for European companies to invest in green energy

In August last year, the US Congress passed the Inflation Reduction Act of 2022 (IRA). Besides the obvious goal of fighting inflation, the law is primarily intended to reduce the US budget deficit and promote climate protection in the USA. Around 737 billion US dollars are to be injected into the US budget through prescription drug pricing reforms, increased tax enforcement, and higher tax revenues. The tax reform includes two main tax increases:

(a) Book Minimum Tax: The IRA introduced a minimum corporate income tax of 15% for large corporations for tax years beginning after 31 December 2022. At first glance, the Book Minimum Tax resembles the Global Minimum Tax (Pillar 2) under the OECD's BEPS 2.0. A closer look, however, reveals significant differences (among others with regard to the scope of ap-plication, calculation of the tax base, and the level of the minimum tax). It is, therefore, unlikely that the Book Minimum Tax will be recognised as a qualifying regime for Global Minimum Tax purposes, but it will of course apply regardless.
(b) Excise Tax on Repurchase of Corporate Stock: Effective 1 January 2023, the USA has imposed a 1% tax on corporate stock repurchased by corporations traded on the U.S. securities market.

For more information on the tax increases in the USA click here:

Inflation Reduction Act – Impact on Small to Medium-Sized Foreign Businesses | Rödl & Partner (roedl.us)

At the same time, by enacting the IRA, the U.S. government launched a comprehensive programme to promote climate investment. Over ten years, about 369 billion US dollars will be up for grabs for investments in climate protection, mainly in the form of tax credits. The IRA promotes the expansion of renewable energies through support at both the corporation and the budget level. In this process, the IRA partly modified existing programmes, e.g., increased Production Tax Credit of the IRC Sec. 45 to US$0.005/kWh (base rate) and to US$0.025/kWh (bonus rate), and partly created new programmes: for example, IRC Sec. 45X's Advanced Manufacturing Production Credit provides a tax credit for manufacturers of certain eligible components based on number of produced units, wattage capacity, sales price, or production cost. Eligible components include components for solar, wind and battery projects (e.g., photovoltaic cells, blades) and particularly critical minerals (e.g., lithium, nickel). It is also possible to combine tax credits, if certain requirements are met, so that manufacturers can significantly reduce the costs of renewable energy investments. A tax credit can usually be deducted from the assessed income tax. In the case of certain subsidies or taxpayers (including tax-exempt organisations), the IRA also authorizes direct cash payments as subsidies.

The IRA pursues objectives arising from climate policy, but also from industrial policy, such as ensuring the long-term supremacy of the USA as the largest energy producer, and reducing dependence on China and Russia, especially with regard to the supply of raw materials. For this purpose, the IRA has been added “local content” provisions, which are now the focus of the debate in Germany and the European Union (EU). In order to enjoy the full tax benefits (see the bonus rate above), a certain proportion of the product must have been manufactured in the USA or come from countries with which the USA has concluded a free trade agreement. The local content requirements will become stricter over time.

It is precisely this aspect of the IRA that is causing Germany and the EU a headache. This is because there is no active free trade agreement between the EU and the USA. Many German companies have already announced their intention to increase investment in the USA. Volkswagen is one of them and about to receive subsidies and loans to the tune of 8.5 to 9.5 billion euros for a battery cell factory in the USA. The car maker has put on hold its plans to build a battery cell factory in Europe. In response to the IRA, the EU announced the Green Deal Industrial Plan in early February. The plan is intended to complement EU programmes already in place and, on the one hand, increase the EU's competitiveness and, on the other, support the rapid transition towards net-zero. The Green Deal Industrial Plan is based on four pillars:

1. A predictable and simplified regulatory environment

The first pillar is also a response to the call for cutting red tape. To this end, the European Commission already presented a draft of the “Net-Zero Industry Act” in mid-March. The Act aims to ensure simplified and faster granting of authorisations through, for example, shorter authorisation periods and “one-stop shops”. In addition, the Act is intended to promote strategic cleantech technologies (e.g., photovoltaics, CO2 storage and geothermal energy). The European Commission has also published a European Critical Raw Materials Act to ensure access to rare earths. The package of measures is complemented by the European Commission's proposals for reforming the electricity market. Consumers should be protected from price fluctuations and be able to benefit from the low renewable energy production costs.

2. Faster access to funding

The second pillar of the Green Deal Industrial Plan focuses on investment and financing for clean technology production in Europe. The EU is hoping to see a serious increase in private investment, which is necessary for the green transition. In order to achieve it, public financing will be increased, on the one hand, and further progress will be pursued on the European Capital Markets Union, on the other. The European Commission is considering the creation of a European Sovereignty Fund to finance investments in green technology at EU level. The granting of aid to net-zero industries should be made more flexible.

Specifically, the European Commission:

adopted a new temporary framework for crisis and change management (extension and prolongation of the previous crisis framework); and
amended the General Block Exemption Regulation: aid falling under this framework does not have to be notified to and approved by the European Commission in advance, but can be granted directly by Member States and notified to the European Commission afterwards.

3. Enhancing employee skills

As there is a great shortage of skilled labour, potential employees should be able to participate in up-skilling and re-skilling programmes in strategic industries. In addition, third-country nationals should have the opportunity to gain easier access to EU labour markets in sectors that are in particularly high demand.

4. Open trade for resilient supply chains

Trade should also contribute to the green transition. This should be achieved under the principles of fair competition and open trade. Thus, on the one hand, the EU will continue to develop its network of free trade agreements and other forms of similar cooperation with other associations or states, and, on the other hand, it will explore the creation of a critical raw materials club and industrial partnerships for clean technologies.

The proposed regulations will now undergo the usual path: they must be discussed and approved by the European Parliament and the Council of the European Union. The Green Deal Industrial Plan does mention the granting of tax benefits. However, the design of tax benefits is the responsibility of the respective Member States. This is because the EU does not have comprehensive legislative competence in the area of direct taxation. It is therefore still unclear what tax benefits might look like. The EU can only set the framework conditions by relaxing European state aid law.

In the meantime, the subsidy race between the USA and the EU has slightly eased. During a meeting at the White House on 10 March 2023 between U.S. President Joe Biden and EU Commission President Ursula von der Leyen, the USA and the EU took a significant step towards mutual collaboration: both parties want to negotiate an agreement for minerals and car batteries. For example, electric vehicles manufactured in Europe should also be eligible for the tax credits in the USA.

The above-mentioned frameworks offer great opportunities for European companies. On the one hand, EU companies could also benefit from US subsidies granted under the IRA. On the other hand, a growth-promoting investment climate in Germany and Europe will be created. The first steps have already been taken by adopting the Green Deal Industrial Plan. This framework still needs to be given a more specific shape. It remains to be seen when and in what form the EU will turn words into action.