Implications for Australia's critical minerals sector 10 min read
On 1 December 2023, the US Department of Energy published draft guidance on its proposed interpretation of the term 'foreign entity of concern' or 'FEOCs' (Draft Guidance), which directly relates to two major US green innovation reforms: the Infrastructure Investment and Jobs Act (Jobs Act) and the Inflation Reduction Act 2022 (IRA). The Jobs Act and the IRA respectively offer billions of dollars in incentives to downstream US participants in the battery metals value-chain who source their upstream material from non-FEOCs, and lucrative tax credits to eligible companies involved in new sources of zero-emission technologies.
These incentives have driven US battery technology companies and car-makers to scramble to source critical minerals such as lithium, nickel, graphite and cobalt from countries that are non-FEOCs, with many Australian miners lined up in anticipation of the downstream benefits.
However, the issue of the Draft Guidance, which proposes that the term FEOC ought to capture entities that are 25% or more owned by 'foreign governments' (defined broadly) from China, North Korea, Iran or Russia (each a 'covered nation') as well as those entities which otherwise process their battery metals in a covered nation irrespective of their controllers, may affect Australian miners whose ownership or other partners reflect the early-stage investment in Australia's critical mineral sector from FEOCs, potentially denying them the benefit of the US reforms.
In this Insight, we outline the key features of the Draft Guidance's proposed interpretation of the term 'foreign entities of concern' and its potential implications for Australia's critical minerals sector.
Key takeaways
- The term 'foreign entity of concern' (or FEOC) is relevant to the Jobs Act and IRA; two pieces of major US legislation impacting the global critical minerals sector and which offer billions of dollars in incentives to downstream US participants in the battery metals value-chain who source their upstream material from non-FEOCs.
- The Draft Guidance proposes that the term FEOC capture foreign entities (eg Australian companies) that are 25% controlled by a foreign government of a covered nation. The term 'foreign government' is defined broadly to include senior and former political figures; and is subject to tracing principles affecting downstream subsidiaries, which may capture subsidiaries participating in Australia's mining industry.
- Also proposed to be captured as FEOCs are foreign entities that engage in the extraction, processing, or recycling of battery critical minerals, the manufacturing or assembly of battery components, or the processing of battery materials within in a covered nation, or that are otherwise party to contracts with a FEOC which confers that FEOC 'effective control' over the production of its critical minerals, battery components or battery materials.
- Australian companies who wish to participate in the benefits of the US reforms will need to have regard to their source of capital, ownership structures and processing arrangements. Similarly, parties wishing to invest in or deal with a company will need to undertake due diligence with respect to the company's status as a non-FEOC or FEOC.
'Foreign entity of concern' status
Under the Jobs Act, the US Department of Energy is required to prioritise those eligible US companies that do not use battery material supplied by FEOCs when considering applications to access the billions of dollars worth of Jobs Act subsidies.
In a similar vein, the IRA disapplies tax credits potentially available for new clean vehicles, if any of the battery components were manufactured by a FEOC or any of the critical minerals contained in the battery of such vehicles were extracted processed or recycled by a FEOC (with this applying to new vehicles placed in service after 31 December 2023 and 31 December 2024 respectively) and proposed regulations released by the US Treasury Department and the IRS in tandem with the Draft Guidance foreshadow the implementation of a stringent due-diligence regime requiring applicants to identify the source of battery components and physically track them to specific battery cells for FEOC compliance (subject to temporary exceptions applying during a transitional period extending to 1 December 2026).
Relevantly, section 40207(a)(5) of the Jobs Act provides five grounds on which a 'foreign entity' (interpreted to be any natural person that is not a US citizen, permanent resident or other protected individual, any artificial person which is not organised in the US or has its principal place of business in a foreign country, a foreign government or any entity organised in the US which is owned by, controlled by or subject to the director of any of the foregoing categories), will constitute a FEOC.
While four of the grounds relate to entities designated as foreign terrorist organisations, included in the US Department of Treasury's Specially Designated Nationals and Blocked Persons List, alleged by the Attorney General to be involved in espionage and certain other illegal activities (for which a conviction is obtained) or otherwise determined by the Secretary of Energy to be engaged in unauthorised conduct adverse to US national security or foreign policy, a fifth ground covers those foreign entities which are 'owned by, controlled by, or subject to the jurisdiction of or direction of a government of a foreign country that is a covered nation'.
The Draft Guidance addresses the 'covered nation' category (being the most relevant category for the Australian critical minerals sector) and the Department of Energy's interpretation of 'owned by, controlled by, or subject to the jurisdiction of or direction of' tests.
Government of a foreign country
It is important to note that a 'foreign entity' (eg an Australian company) will not necessarily be a FEOC simply because it is 'owned by' or 'controlled by' persons from a 'covered nation'.
Rather, the FEOC designation requires that such 'ownership' or 'control' be that of a government of such covered nation. The Draft Guidance interprets 'government of a foreign country' (such as that of a covered nation) to include:
- a national or subnational government of that foreign country
- an agency or instrumentality of such national or subnational government
- a dominant or ruling party
- a current or former senior political figure (being a current or former senior official in the legislature, executive, judiciary or military with substantial authority over policy, operations or use of government resources) as well as their immediate family members.
Accordingly, a foreign entity that is owned by or controlled by a former 'senior political figure' of a covered nation will be considered to be an entity controlled by the government of that covered nation and designated a FEOC (if that control satisfies the 25% threshold discussed below).
Owned by, controlled by or subject to the direction?
In assessing whether an entity (the First Entity) is owned, controlled or subject to the direction of another entity (such as a government of a covered nation) (the Second Entity), the Draft Guidance proposes two tests:
- if 25% or more of the First Entity's board seats, voting rights or equity interest are cumulatively held by the Second Entity, whether directly or indirectly via intermediate entities; or
- the First Entity has entered into a licencing arrangement or other contract with the Second Entity, which entitles that Second Entity to exercise effective control over the extraction, processing, recycling, manufacturing or assembly of the critical minerals, battery components or battery materials (as applicable) that would be attributed to the First Entity.
The '25% interest' threshold proposed by the Draft Guidance is to be calculated on a cumulative basis by reference to the aggregate interests in the First Entity held by all foreign entities in the relevant class.
For example, to determine if the First Entity is owned, controlled or subject to the direction of a government of a covered nation, which would render the First Entity a FEOC, all interests in the First Entity specifically held by foreign government entities from that covered nation are to be aggregated when assessing if the 25% threshold has been met.
Relevantly, the interest held by entities that do not constitute foreign government entities of a covered nation will be added to the interest held by a foreign government entity of a covered nation for the purposes of assessing control, if such entities enter into a formal arrangement to act in concert.
To this end, the Draft Guidance expressly provides that the 25% interest test also applies to joint ventures, such that, if a government of a covered nation controls (either directly or indirectly) 25% of a joint venture, that joint venture will be deemed a FEOC. We expect that in the Australian context this is relevant to the predominant model for resources projects in Australia, namely unincorporated joint ventures.
The Draft Guidance also captures indirect control by a FEOC and describes the following illustrative scenarios to demonstrate the indirect control and tracing concepts:
Scenario 1:
Entity A holds a cumulative interest in 25% of Entity B's board seats, voting rights or equity or equity interest and Entity B holds a cumulative 50% of Entity C's board seats, voting rights or equity or equity interest.
In this scenario, given that Entity B holds 50% of Entity C, they would be treated as the same entity and all the interests held by Entity C will be imputed to Entity B (vice versa). Further, Entity A will be deemed to 'indirectly' control Entity C, with Entity A's 25% control of Entity B fully imputed over Entity C.
If Entity A is a government of a foreign country that is a covered nation, Entities B and C will be FEOCs in this scenario.
Scenario 2:
If scenario 2 is modified such that Entity B's holding in Entity C is 40% (ie sub 50%), Entity A will continue to directly control Entity B, however, the degree of Entity A's indirect control of Entity C will instead be calculated proportionately as 25% x 40% = 10% and therefore Entity A will only have a 10% interest in Entity C.
Accordingly, if Entity A is the government of a foreign country that is a covered nation, Entity B will be a FEOC, however, Entity C will not be a FEOC as Entity A's deemed 10% indirect control over Entity C is below the 25% threshold.
In addition to capturing more 'traditional' forms of interests in the First Entity for the purposes of determining control, the Draft Guidance also provides that a First Entity will be controlled by a Second Entity if it enters into a contract which confers that Second Entity 'effective control' over the production of the First Entity's critical minerals, battery components or battery materials.
Accordingly, if the First Entity enters into such a contract with a FEOC, the First Entity will be treated as a FEOC – however, it appears that this will only be to the extent of the critical minerals, battery components or battery materials referable to that contract. Therefore, the same First Entity may not be treated as a FEOC in respect of the material produced under other contracts.
A contract will confer 'effective control' to the counterparty if it confers the right to:
- determine the quantity or timing of production;
- determine which entities may purchase or use the output of production;
- restrict access to the site of production to the contractor’s own personnel; or
- exclusively maintain, repair, or operate equipment that is critical to production.
The Draft Guidance notes that this broader concept of 'effective control' through production is designed to prevent governments of covered nations evading the FEOC regime by, instead of controlling the primary entity, controlling a FEOC which contracts with the primary entity to be their producer of record, with a view to controlling production.
In an acknowledgement that not all production related contracts with FEOCs will confer effective control, a safe-harbour is provided such that a non-FEOC entity contracting with a FEOC will not be deemed to be a FEOC solely based on its contractual relationship if the non-FEOC has contractually reserved the following rights:
- to determine the quantity of critical mineral, component, or material produced (subject to any overall maximum or minimum quantities agreed to by the parties prior to execution of the contract);
- to determine, within the overall contract term, the timing of production, including when and whether to cease production;
- to use the critical mineral, component, or material for its own purposes or, if the agreement contemplates sales, to sell the critical mineral, component, or material to entities of its choosing;
- to access all areas of the production site continuously and observe all stages of the production process; and
- to, at its election, independently operate, maintain, and repair all equipment critical to production and to access and use any intellectual property, information, and data critical to production, notwithstanding any export control or other limit on the use of intellectual property imposed by a covered nation subsequent to execution.
Subject to the jurisdiction?
Notwithstanding the composite phrase 'owned by, controlled by, or subject to the jurisdiction of or direction of', the 'subject to the jurisdiction of' element exists as a separate test and as such, a foreign entity will constitute a FEOC if it is subject to the jurisdiction of a covered nation irrespective of the levels of control other FEOCs may have in that entity.
In this respect, the Draft Guidance provides that a foreign entity will be 'subject to the jurisdiction of' a covered nation if:
- the foreign entity is incorporated or domiciled in, or has its principal place of business in, a covered nation; or
- notably, the foreign entity engages in the extraction, processing, or recycling of battery critical minerals, the manufacturing or assembly of battery components, or the processing of battery materials (as applicable) in a covered nation.
The implications of this interpretation are significant, as while the 25% interest test is liable to capture de jure and de facto State Owned Enterprises (SOEs), the jurisdiction test would appear to be capable of rendering genuinely non-government related private enterprises as FEOCs by virtue of their location of incorporation or headquarters.
The Draft Guidance does however clarify that a subsidiary of a foreign parent entity which is deemed a FEOC on the basis of jurisdictional grounds (for example, due to the parent entity being incorporated in a covered nation as opposed to being due to a covered nation government's shareholding) will not necessarily be rendered a FEOC because of this and instead, each subsidiary will need to be independently assessed against the FEOC tests. Accordingly, the tracing principles only appear to be relevant in determining a subsidiary's FEOC status if any upstream entity is a FEOC as result of direct or indirect covered nation government control and not where such status is a result of other grounds.
The rationale for this expansive category of FEOCs provided by the US Department of Energy is that such a test reflects the reality of the legal reach and control enjoyed by covered nations over entities organised or otherwise operating within its boundaries.
Implications for Australian critical mineral miners and processors
Australian companies involved in mining, production and the processing of critical minerals may face off-takers of their product not having access to downstream subsidies if they have significant FEOC ownership or they process their minerals in covered nations. It is important to note that a 'foreign entity' (eg an Australian company) will not necessarily be a FEOC simply because it is 'owned by' or 'controlled by' persons from a 'covered nation'. Rather, the FEOC designation requires that such 'ownership' or 'control' to be by a government or government entity of such covered nation.
Critical mineral entities will not only need to be cognisant of their own share registers but may also need to be mindful of the upstream shareholding of their joint venture partners and the location of their processing facilities, and with whom they enter into offtake contracts. In particular, the proposed complex and broad approach to upstream association and ownership may have unintended consequences and it appears that it will be possible for some production of minerals to be treated differently under the Draft Guidance depending on the circumstances.
Next steps
The US Department of Energy is currently undertaking a consultation period regarding its proposed interpretation of 'foreign entity of concern'.
The Australian Government may wish to seek special concessions for Australian miners given that the Australian mining industry has a long term history of foreign investment. It is expected however that few changes will be accommodated.