The difference between Prohibited Foreign Entity (PFE) compliance and domestic content compliance

This past May, developers and investors started steering clear of U.S. solar factories with ties to Chinese companies. The factories were making panels in the U.S., but new PFE restrictions raised questions about what could put a project’s tax credits at risk. The uncertainty extends beyond PV modules: a battery can contain U.S.-made components but raise questions about who’s involved in its production and supply chain. In general, a supplier’s assurance that its products are “domestic” no longer tells a developer everything they need to know.

Two different sets of tax rules are now shaping how developers think about the origin of clean-energy equipment: domestic content requirements and restrictions on prohibited foreign entities (PFEs). They sound like two sides of the same coin, but they look at different parts of the supply chain. Domestic content asks whether the project uses qualifying U.S.-produced equipment and materials. PFE rules ask whether the entities, contracts, and supply chains behind that equipment create a separate eligibility concern. The two rules also carry different stakes. Domestic content can increase the value of a project’s tax credit, while PFE restrictions can make a project ineligible for the credit altogether.

Developers are making equipment and supplier decisions months or years before a project reaches commercial operation, when a mistake can mean higher costs, a narrower procurement pool, or lost tax-credit value. As the rules become more consequential, treating “U.S.-made” as a catch-all for compliance can leave a costly blind spot. And the incentives extend upstream: manufacturers claiming the Section 45X production credit face similar PFE restrictions, giving suppliers their own reason to scrutinize who’s involved in their supply chains.

Where was it made vs. who’s involved

Domestic content can be thought of as a physical manufacturing location test. The question is whether enough of a project’s steel, iron, and manufactured products meet the applicable U.S. content requirements to qualify for the domestic content bonus. For a solar or storage project, that can turn equipment sourcing into a detailed accounting exercise: where were the relevant components manufactured, and how much of their cost can be attributed to qualifying domestic production?

PFE compliance looks at the supply chain from another angle. Instead of tracing the manufacturing location of components, it can require developers to examine the entities behind them—including whether certain foreign entities have ownership, control, or other prohibited involvement in the project or its supply chain. A component isn’t PFE-compliant just because it’s manufactured in the U.S.

The difference is easy to overlook when both questions hit the procurement desk as some version of “Will this equipment get us the maximum tax credit?” But they can produce different answers. A U.S.-manufactured inverter may help a project meet domestic-content requirements while still requiring scrutiny of the ownership and control of the entities involved in its supply chain. Conversely, equipment manufactured abroad may not automatically create a PFE issue, even though it might make the project harder to qualify for a domestic-content bonus.

For developers, the practical takeaway is straightforward: domestic content and PFE compliance are separate screens on the same supply chain. Passing one doesn’t eliminate the need to run the other.

Where the rules overlap, and where they don’t

The easiest way to see the difference is to imagine a few equipment-buying decisions.

Scenario one: A U.S.-made product with a foreign connection. A developer buys a component manufactured at a U.S. facility. From a domestic-content perspective, that may be exactly what the project needs. But if a prohibited foreign entity has a role in producing or supplying that component, the equipment may raise a separate PFE issue. The factory’s address alone doesn’t settle the question.

Scenario two: An imported product from a non-PFE supplier. Now flip the situation. A component is manufactured overseas by a company that doesn’t fall within the PFE restrictions. That doesn’t make the component domestic-content compliant; it may just mean the project doesn’t have a PFE problem with that particular equipment. The project could still miss out on the domestic-content bonus.

Scenario three: A component that clears both screens. The cleanest outcome is equipment that satisfies the applicable domestic-content requirements and doesn’t contain prohibited foreign involvement. But getting there may require developers to weigh supplier, cost, manufacturing, and documentation considerations simultaneously rather than treating U.S. manufacturing as a proxy for broader compliance. That conclusion also requires separate documentation because the two regimes use different tests and cost concepts.

This creates an important shift in procurement. Developers need to look beyond whether a supplier makes equipment in the U.S. to who owns or controls the supplier, who manufactures the relevant components, and who participates elsewhere in the supply chain. The result is a two-dimensional compliance problem: domestic content determines whether the project can claim a valuable bonus, while PFE restrictions can determine whether the underlying credit remains available at all.

What this means for procurement and project diligence

The biggest practical change is that a supplier’s word may no longer be enough. Developers need to build both compliance tests into procurement before equipment is ordered, not try to reconstruct the supply chain when it’s time to claim the credit.

For domestic content, that means collecting information on where relevant steel, iron, and manufactured products were produced and how their costs are treated under the applicable rules. PFE compliance requires a broader set of information about the supply chain, including which entities manufactured or supplied components and whether any are PFEs. Interim guidance from the IRS provides guidance and clarifications for how to determine the material assistance cost ratio including supplier certifications, cost information, and records that taxpayers need to retain to substantiate their calculations.

Developers may want representations and warranties covering compliance, rights to request supporting documentation, and remedies if a supplier’s status or sourcing changes. Those provisions can be especially important when equipment is sourced through multiple tiers of suppliers, where the developer may have limited visibility into upstream manufacturing. The IRS imposes penalties if anyone “knows or has reason to know” of inaccuracies, and suppliers must certify under penalties of perjury in their material assistance certifications to their customers.

Lower-priced equipment may look attractive until the cost of extra diligence, documentation, or compliance risk is factored in. Developers that establish these requirements early can make sourcing decisions with the project’s expected tax-credit value in mind.

Implications for project economics

Domestic content can add value to a project by increasing its tax credit, while PFE restrictions can put that underlying credit at risk. The distinction matters even more in a market where the window for claiming these credits for certain technologies is narrowing. For wind and solar projects, the OBBBA includes transition and termination rules tied to when construction begins and, in some cases, when the facility is placed in service. Other technologies may follow different timelines. Developers should therefore confirm the applicable credit, construction date, placed-in-service date, and any transition rule before relying on a project schedule. For developers trying to meet these deadlines, losing tax-credit value because of an avoidable sourcing or compliance issue could have a much bigger impact on project economics.

That creates a tradeoff for developers: the lowest-cost equipment is not necessarily the lowest-cost option after tax benefits are accounted for. Paying more for equipment that qualifies for the domestic-content bonus may improve project economics if the incremental tax benefit outweighs the higher procurement cost. Likewise, a cheaper component can become expensive if its sourcing creates enough PFE exposure to threaten credit eligibility.

The effects can extend past the price of individual components. If only a limited pool of suppliers can meet both sets of requirements, developers may face higher equipment prices, longer lead times, or fewer opportunities to negotiate. Those constraints can affect development schedules and financing assumptions, especially for projects competing for equipment in a tight market.

For investors and lenders, this makes tax-credit compliance part of the project's broader risk-adjusted return calculation. They need to consider how a project’s sourcing strategy affects the value and certainty of the tax benefits attached to its equipment. In a market where relatively small changes in capital costs or tax-credit value can move a project across an investment hurdle, the distinction between domestic content and PFE can have an outsized impact.

Developers should evaluate both frameworks before equipment is ordered and contracts become hard to unwind, as this will give them more opportunity to maximize their tax-credit value.

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