FEOC Restrictions: A Capital Structure Rule Wearing a Supply Chain Costume

FEOC is discussed as a supply chain rule, and half of it is. The other half has nothing to do with where components come from. It asks who owns the entity claiming the credit, who lent it money, who can appoint its officers, and whether anyone has contractual authority over what it produces.

A project with an entirely domestic supply chain can be disqualified because 15% of its debt sits with the wrong holder. That threshold is low, debt is rarely screened the way equity is, and the consequence is not a reduced credit — it is no credit.

This is the seventh post in the policy and regulation series and the first of two on FEOC. You will get what a prohibited foreign entity is, the four separate triggers that make an ordinary company foreign-influenced, what "effective control" reaches including licensing and data access, the difference between taxpayer-level and project-level restrictions, and when each applies.

ℹ️ Note: This describes how these rules work in practice. It is not tax or legal advice, and significant definitional questions remain open — Treasury guidance is still being issued.

What Are the FEOC Rules For?

To stop entities subject to foreign adversary ownership, control or influence — primarily connected to China, Russia, Iran or North Korea — from benefiting from US clean energy tax credits, and to stop credits flowing to projects that depend on those entities for critical inputs.

That produces two entirely different restrictions, and conflating them is the most common analytical error.

	Taxpayer-level	Project-level
The question	Who are you?	What did you buy?
Applies to	§48E, §45Y, §45X, §45U, §45Z, §45Q	§48E, §45Y, §45X
Test	Is the claimant a prohibited foreign entity?	Did the project receive "material assistance" from one?
Also restricts	Transfer of the credit to a PFE	—
Covered in	This post	The next post

A project can pass one and fail the other. A US sponsor with clean ownership can buy disqualifying components; a project with an impeccable bill of materials can be owned or financed in a way that disqualifies it entirely.

What Is a Prohibited Foreign Entity?

A prohibited foreign entity is either a specified foreign entity or a foreign-influenced entity. The two are reached by completely different routes.

A specified foreign entity is, broadly, an entity that is itself on the wrong side of the line. Bracewell lists the categories:

• any designated terrorist organisation, or a specially designated national or blocked person under OFAC
• Chinese military companies, and entities subject to the Uyghur Forced Labor Prevention Act
• the governments of China, Russia, Iran or North Korea, and their instrumentalities
• non-publicly traded entities "more than 50 percent owned (by vote or value... by beneficial interest)" by such governments or entities

Most sponsors read that list, conclude it does not describe them, and stop. That is the error. The SFE definition is not where ordinary companies get caught — the foreign-influenced entity definition is.

What Makes an Ordinary Company Foreign-Influenced?

Four triggers, any one of which is sufficient. Bracewell sets them out, and the thresholds are lower than most capital structures are screened against.

Trigger	Threshold
Officer appointment	An SFE has "the direct authority to appoint a covered officer"
Single ownership	A single SFE owns at least 25%
Aggregate ownership	Multiple SFEs own 40%
Debt	At least 15% of the entity's debt is issued to one or more SFEs
Effective control	Payments made under arrangements giving an SFE effective control

The debt trigger deserves particular attention, because it is the one that surprises people.

Fifteen percent is a low threshold. On a project with $150m of senior debt, $22.5m held by a single qualifying entity is enough. Debt participations move in the secondary market, syndicates change composition, and a sponsor that diligenced its lender group at financial close may have a materially different group two years later. Equity ownership is monitored because it is governed by a shareholders' agreement; debt holdings frequently are not monitored at all.

The officer appointment trigger is similarly structural rather than proportional. It does not require any ownership at all — a contractual right to appoint a covered officer is sufficient on its own, which reaches investor protections and board arrangements that were negotiated for entirely unrelated reasons.

ℹ️ Note: Screen the debt stack on the same cadence as the cap table, and put a transfer restriction in the credit agreement if the structure will not tolerate a change. Discovering a 15% holding after the fact is a problem with no cure.

What Does "Effective Control" Actually Reach?

Contractual authority, not just corporate power. This is the trigger that catches commercial arrangements nobody thought of as ownership.

Bracewell describes effective control as including contractual authority to:

• "determine quantity or timing of component production or electricity output"
• "direct sales or usage of output"
• "restrict access to any critical data, site of production"
• licensing arrangements under which royalties are received "beyond 10 years"

Read those against a normal project and the exposure becomes visible. An offtake arrangement that lets a counterparty direct dispatch. A technology licence with a long royalty tail. A supply agreement conditioning access to performance data or to the manufacturing site. A service arrangement giving a vendor control over when equipment runs.

None of those is an ownership interest. All of them can constitute effective control.

The licensing limb is the most commercially awkward, because long-dated licence and royalty arrangements are ordinary in technology-heavy equipment — batteries in particular. A licence structured to pay royalties for the life of an asset is a routine commercial term that, if the licensor is a specified foreign entity, is a FEOC problem.

McGuireWoods notes that the initial guidance did not finalise "key definitional tests (including the definition of a 'licensing agreement')" for determining effective control. So the boundary of the most commercially significant trigger is still open — which is itself something to model rather than assume away.

When Do the Restrictions Apply?

Different dates for different provisions, and the gaps matter for planning.

Bracewell sets out the schedule. For sections 45X, 45Y, 48E and 45Q, the prohibitions apply to "taxable years beginning after July 4, 2025" — which for a calendar-year taxpayer means from 1 January 2026. For section 45U, the specified foreign entity prohibition runs from July 2025, while the foreign-influenced entity prohibition applies only to "taxable years beginning after July 4, 2027."

The project-level material assistance requirement, covered in the next post, has its own date: projects beginning construction before 1 January 2026 are generally exempt from it, while those beginning on or after that date are subject to all three tests.

That creates a further consequence for the beginning-of-construction date, which has by now accumulated five. It fixes credit eligibility. It starts the continuity clock. It sets the domestic content threshold. It locks energy community status. And it determines whether the material assistance rules apply at all.

What Happens If You Fail?

The credit is denied — and for disqualifying payments the exposure extends for a decade.

At the taxpayer level, a prohibited foreign entity cannot claim the credit, and the credit cannot be transferred to one. That is binary: not a reduction, not a haircut.

The effective control limb carries a longer tail. Where a taxpayer makes payments under disqualifying arrangements at any time in the following ten years, the full credit amount must be repaid. So a contract signed after closing, or a royalty stream continuing under an arrangement that turns out to confer effective control, can reach back and unwind a credit claimed years earlier.

That ten-year tail is the structural reason FEOC belongs in contract review rather than only in a closing checklist. A one-time diligence exercise establishes the position at closing. It does nothing about a licence amendment in year four.

How Deep Does Ownership Diligence Have to Go?

Further than most sponsors would like, and the exact depth is unresolved.

The ownership tests are expressed as percentages held by specified foreign entities. Applying them to a real structure immediately raises the question of whether you look only at direct holders, or trace beneficial ownership up through every intermediate vehicle until you reach individuals and governments.

McGuireWoods notes the guidance has not settled this: there is continued uncertainty over whether Treasury will adopt a simplified "no-look-through" approach comparable to the section 897 regulations. The difference between the two answers is enormous in practice. A no-look-through rule makes screening a manageable exercise against a register of direct holders. A full look-through obligation requires tracing chains of holding companies across jurisdictions that may not disclose beneficial ownership at all.

Until that is resolved, the defensible position is to diligence to beneficial ownership where it is obtainable, document the limits of what could be obtained, and record the basis on which the conclusion was reached. That is not a satisfying answer, and it is the one that survives a later tightening of the standard — because a file showing a reasoned, documented effort can be re-tested, whereas a bare conclusion cannot.

McGuireWoods describes the resulting position bluntly as creating "significant diligence burdens and continued uncertainty." That is the operating environment, and pricing it into transaction timelines is more useful than waiting for it to clear.

What Remains Unresolved?

Enough to matter. McGuireWoods records several open questions in the initial guidance.

Definitional gaps persist "concerning how PFE and specified foreign entity (SFE) status will be ultimately determined," which they note creates "significant diligence burdens and continued uncertainty." There is no settled answer on whether Treasury will adopt a simplified "no-look-through" approach to ownership analysis, which would materially change how deep a diligence exercise has to go through chains of holding companies.

On the project-level side, Treasury must publish PFE-specific safe harbour tables by 31 December 2026, which will require reassessment of positions taken before they exist.

The practical consequence is that a FEOC position taken today is provisional. Documenting the basis for the position — which entities were screened, against which lists, on what date, using which interpretation — is what allows it to be revisited when the rules firm up, rather than reconstructed.

How Does This Affect Tax Equity and Credit Transfers?

It makes the counterparty's identity a condition of the deal, in both directions.

The taxpayer-level restriction has two limbs. An entity claiming the credit may not be a prohibited foreign entity — and the credit may not be transferred to one. That second limb turns every credit sale into a screening exercise on the buyer, and every credit purchase into a screening exercise on the seller.

For a transfer transaction the practical consequences are immediate.

The buyer must be screened. A seller transferring credits to a purchaser that turns out to be a foreign-influenced entity has a problem with the transfer itself, not merely a commercial one. Buyer representations and covenants on PFE status are now a standard feature of transfer documentation for that reason.

The seller must be screened. A buyer is acquiring credits generated by a project whose own eligibility depends on the seller not being a PFE and on the project passing the material assistance test. Neither is something the buyer can verify from the outside, which is why the diligence and indemnity package in a credit sale has grown.

Tax equity partnerships need the same analysis at the partner level. A fund structure with foreign limited partners is exactly the kind of arrangement the ownership thresholds were drafted to reach, and a 25% single holder or 40% aggregate can arise through a fund's own investor base rather than through anything the project did.

As covered in the earlier diligence post, insurance exists for tax positions generally — but the entity-level FEOC question is one where the underwriting depends almost entirely on the quality of the screening record. An insurer is being asked to price a factual question about ownership, and it will want to see who was checked, against what, and when.

Why Does This Hit Storage Hardest?

Because the supply chain and the standard are both worse. Morgan Lewis identifies the double exposure directly:

"The battery energy storage industry is especially sensitive to the material assistance limitation given the China-dominated legacy supply chain for battery energy storage equipment. This challenge is magnified under the OBBBA by singling out the energy storage industry with more stringent material assistance standards than those applied for other technologies."

Two problems compounding. Storage starts from a supply chain concentrated in exactly the jurisdiction the rules target, and it is then held to a tougher threshold than solar or wind.

The entity-level exposure is also higher for storage, because the technology arrangements are more entangled. Battery systems commonly involve technology licences, long-dated service agreements and remote monitoring — all categories that can grant "specific authority over key aspects of the applicable person, project, or product," which is the shape of the effective control test. A solar project buying modules has a procurement relationship. A storage project frequently has a continuing technical relationship with its cell supplier, and continuing relationships are where effective control lives.

The market response Morgan Lewis describes is instructive. Battery manufacturers are now certifying "their non-PFE status to provide customers with comfort," and parties are "working with third-party accounting and legal advisors to document their FEOC-compliant status." Their assessment of how that is going is candid: contractual negotiation "around the allocation of risk and certification... has been challenging."

For a sponsor the practical reading is that supplier certification is available but not free, and that the negotiation over who stands behind it is now a material commercial term in storage procurement rather than a legal formality.

How Do You Screen for FEOC in Excel?

As a capital structure test with binary flags, run on a schedule rather than once. The arithmetic is trivial; the discipline is not.

The inputs

Assumptions, labelled as such:

Total equity                          $100,000,000
Total debt                            $150,000,000
Largest single SFE-linked holder      ownership and debt positions
Officer appointment rights            contractual review
Contracts conferring effective control  contractual review

The four entity tests

Test_1_Officer   = Any SFE holds a right to appoint a covered officer?      TRUE/FALSE
Test_2_Single    = MAX(single SFE ownership %)         ≥ 25%  ?             TRUE/FALSE
Test_3_Aggregate = SUM(all SFE ownership %)            ≥ 40%  ?             TRUE/FALSE
Test_4_Debt      = SFE-held debt / Total debt          ≥ 15%  ?             TRUE/FALSE

FIE_Status       = OR(Test_1, Test_2, Test_3, Test_4, Effective_Control)

The debt test in dollars

Threshold_Debt   = 150,000,000 × 15%                                = $22,500,000

That is the number to circulate. A single participation of $22.5m in a $150m facility is sufficient, which is a smaller position than many syndicate members hold and well inside normal secondary trading volumes.

The value at risk

Credit_At_Risk   = Full ITC or PTC value                            = $75,000,000
Nature_Of_Loss   = Total denial, not reduction
Tail_Exposure    = Disqualifying payments within 10 years → full repayment

The monitoring schedule

Cap table screen        quarterly
Debt holder screen      quarterly, and on any transfer
Contract review         on execution of any new licence, offtake or service agreement
Re-screen against       updated SFE/PFE lists whenever published

Model FEOC as a covenant rather than a condition precedent. A condition precedent is satisfied once; this exposure is continuous for ten years, and the model should carry it as an ongoing compliance obligation with a monitoring cost attached.

ℹ️ Note: The right output is not a percentage but a dated attestation: which entities were screened, against which list, on what date, and by whom. When the definitions firm up, that record is what allows the position to be re-tested rather than rebuilt.

To run the full version — the four entity tests applied to your own cap table and debt register, contract review flags for effective control triggers, and the ten-year payment tail tracked as a covenant — prompt Dezzmond with your capital structure and material contracts.

What Do Lenders and Tax Equity Actually Check?

• Has the cap table been screened to beneficial ownership? Including through holding structures, pending clarity on look-through.
• Has the debt stack been screened, and is it restricted from transfer? 15% is the threshold and participations move.
• Does anyone hold a right to appoint a covered officer? Independent of ownership percentage.
• Have material contracts been reviewed for effective control? Offtake, licensing, service and data access arrangements.
• Are there royalty arrangements running beyond ten years? Specifically flagged in the effective control test.
• Is there a monitoring process, or a one-time screen? The ten-year payment tail makes this a covenant.
• What is the position if the definitions tighten? Documented reasoning, not a conclusion.

Frequently Asked Questions

What is a prohibited foreign entity?

Either a specified foreign entity — including OFAC-designated persons, Chinese military companies, entities under the Uyghur Forced Labor Prevention Act, and the governments of China, Russia, Iran and North Korea with their instrumentalities — or a foreign-influenced entity.

What makes a company foreign-influenced?

Any of: a specified foreign entity holding the right to appoint a covered officer; a single SFE owning at least 25%; multiple SFEs owning 40%; at least 15% of the entity's debt issued to SFEs; or payments under arrangements conferring effective control.

Can a licensing agreement disqualify a project?

Potentially. Effective control includes licensing arrangements under which royalties are received beyond ten years, alongside contractual authority over production quantity or timing, direction of sales or usage, and restriction of access to critical data or the site of production.

When did the rules take effect?

For sections 45X, 45Y, 48E and 45Q, taxable years beginning after 4 July 2025. The foreign-influenced entity prohibition for section 45U applies to taxable years beginning after 4 July 2027.

What happens if a disqualifying payment is made after closing?

Where payments are made under disqualifying arrangements at any time in the following ten years, the full credit amount must be repaid — which is why FEOC is a continuing covenant rather than a closing condition.

Closing: Diligence the Balance Sheet, Not Just the Bill of Materials

The instinct with FEOC is to send the procurement team to check where the modules were made. That work is necessary and it is the subject of the next post. It is also only half the exercise, and it is the half most projects are already doing.

The other half asks questions that no supply chain review will reach. Who owns 25% of the sponsor. Whether several holders together reach 40%. Who bought into the debt last quarter. Whether a technology licence pays royalties for eleven years. Whether anyone, anywhere, holds a contractual right to say when the plant runs.

Those are capital structure and contract questions, they sit with different teams, and the thresholds — 25%, 40%, 15% of debt, one officer — are low enough that ordinary commercial arrangements reach them. The ten-year payment tail then makes the whole thing a covenant rather than a condition, which is the part most likely to be missed once a deal has closed and everyone has moved on.

The next post takes the other half: material assistance, the cost ratio, and how the calculation is actually run.

Sources: Bracewell — FEOC and Material Assistance Rules for Clean Energy Tax Credits · McGuireWoods — IRS Releases Initial FEOC Guidance · Baker Tilly — Understanding Foreign Entity of Concern (FEOC) Provisions in the OBBBA · Morgan Lewis — How FEOC Rules Are Reshaping Energy Storage Tax Credit Eligibility