The CHIPS Act's semiconductor production credit.

• Date: 01 April 2023
• Author: Wallwork, Adam

U.S. companies have gone from leading global semiconductor chip production at the inception of the industry to comprising only approximately 12% of global production capacity today. According to the Semiconductor Industry Association (SIA), the United States is behind other countries when it comes to semiconductor chip production "mostly because other countries'governments have invested ambitiously in chip manufacturing incentives and the U.S. government has not. Meanwhile, federal investments in chip research have held flat as a share of GDP, while other countries have significantly ramped up research investments." (1)

The decline in U.S. domestic chip production capacity began garnering national attention during 2020 and 2021 as the COV1D-19 pandemic, difficulties in foreign trade and logistics, spiking demand for consumer electronics, and disasters at certain critical foreign manufacturing facilities led to a sudden and projected multiyear semiconductor shortage. The shortage has had an impact on multiple sectors of the economy including automobile manufacturers and has heightened scrutiny on the vulnerabilities associated with increasing reliance on a global semiconductor supply chain. In response, lawmakers on both sides of the aisle have come to view the expansion of semiconductor manufacturing in the United States as an important economic and national security issue.

Against this backdrop, the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (2021 NDAA) was enacted on Jan. 1, 2021. (2) Congress authorized activities related to semiconductor manufacturing and research and development (R&D) through various government agencies in Title XCIX of the 2021 NDAA (CHIPS for America programs) under multiple sections, including, but not limited to, Section 9902. Under Section 9902, the U.S. Department of Commerce is authorized to provide financial assistance to eligible applicants through a competitive selection process.

Although Commerce, as well as other government agencies, had the authority to establish the CHIPS for America programs, funding appropriations were lacking for nearly two years after the enactment of the 2021 NDAA. After much anticipation, Congress passed the bipartisan Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act of 2022, which President Joe Biden signed into law on Aug. 9,2022. (3) The Biden-Harris administration concurrently announced that the legislation "will boost American semiconductor research, development, and production, ensuring U.S. leadership in the technology that forms the foundation of everything from automobiles to household appliances to defense systems" and "strengthen American [semiconductor] manufacturing, supply chains, and national security, and invest in research and development, science and technology, and the workforce of the future to keep the United States the leader in the industries of tomorrow, including nanotechnology, clean energy, quantum computing, and artificial intelligence." (4)

Division A of the CHIPS and Science Act, designated as the CI UPS Act of 2022, enhanced the CHIPS for America programs and provides over $50 billion in associated appropriations. Of that amount, $39 billion is allocated under Section 103 of the CHIPS Act of 2022 to the semiconductor incentives program established under Section 9902 of the 2021 NDAA (over five fiscal years) "to incentivize investment in facilities and equipment in the United States for the fabrication, assembly, testing, or packaging of semiconductors at mature technology nodes" and production or research and development of semiconductors, materials used to manufacture semiconductors, or semiconductor manufacturing equipment through a competitive application process. (5)

Commerce announced its goal to begin soliciting applications for the fiscal year 2022 allocation ($19 billion of the $39 billion) by early February 2023, within six months of the enactment date.

In addition, Section 107 of the CHIPS Act of 2022 creates a new refundable 25% advanced manufacturing investment tax credit (ITC) under Sec. 48D for qualified investment related to facilities that primarily manufacture semiconductors and semiconductor manufacturing equipment. Importantly, this new ITC can supplement and be paired with other funding secured under the CHIPS for America programs. This article summarizes the key features of the new Sec. 48D credit and highlights key considerations for manufacturers of semiconductors and semiconductor manufacturing equipment, including current uncertainties surrounding the credit.

Advanced manufacturing ITC overview

The refundable Sec. 48D credit is equal to 25% of the qualified investment in new depreciable tangible property integral to the operation of a facility to manufacture semiconductors or semiconductor manufacturing equipment. The refundable nature of the credit stems from a taxpayer's ability to make an election to be treated as making a payment against tax equal to the credit amount otherwise determined in lieu of claiming the credit (direct-pay election) as a general business tax credit. (6) Through the direct-pay election, taxpayers are entitled to a payment from the federal government to the extent that they do not have a tax liability to offset or if the taxpayer is in a tax loss position.

The costs associated with building or expanding a semiconductor manufacturing facility can easily surpass $1 billion, meaning a 25% tax credit would be significant to the project's economic viability. With such a substantial incentive value tied to qualifying for the Sec. 48D credit, it is critical for potential credit claimants to assess eligibility in order to plan accordingly. Considerations include: (1) understanding the meaning of the terms "qualified investment," "qualified property,""advanced manufacturing facility," "eligible taxpayer," "foreign entity of concern," and "applicable transaction"; (2) identifying which costs will qualify and areas of uncertainty; (3) implementing a process to track qualified investments, including planning around timing, basis reduction, and recapture provisions; and (4) substantiating and monetizing the Sec. 48D credit.

Qualified investment and qualified property

An eligible taxpayer's qualified investment with respect to an advanced manufacturing facility is the tax basis (i.e., capitalized costs) of any qualified property originally placed in service by the taxpayer after 2022. (7) The construction of such property must begin before Jan. 1, 2027. (8) If the construction began before Jan. 1, 2023, only capitalized costs attributable to the construction, reconstruction, or erection of the property after Aug. 9, 2022 (i.e., the CHIPS Act of 2022 enactment date), are eligible for the Sec. 48D credit, provided that the property is placed in service after Dec. 31, 2022. It is necessary for taxpayers that have qualified investments incurred on or before Aug. 9, 2022, to separately track costs after that date to help substantiate and determine the credit-eligible portion of the tax basis of qualified property.

Historically, the IRS and Treasury have focused on eligible basis associated with federal ITC claims through exams as well as part of the Sec. 1603 grant-inlieu-of-ITC program. Having sufficient documentation is crucial to accurately calculating and substantiating Sec. 48D credit claims. Best practices may include commissioning a cost-segregation study. Note that the IRS may impose a 20% penalty on any excessive amounts treated as payments or amounts received as payments due to a lack of reasonable cause, which may include insufficient documentation to substantiate the credit amount. (9)

Furthermore, taxpayers that have planned projects with an expected placed-in-service date after Dec. 31, 2026, should consider contemporaneous documentation of a beginningof-construction strategy to support a determination that construction began before Jan. 1, 2027. The IRS provides two methods to establish the beginning of construction when determining eligibility for ITCs: (1) having paid or incurred at least 5% of the total cost of the depreciable basis of the qualified facility or property, excluding land and property not integral to the facility (5% safe harbor), and (2) starting physical work of a significant nature on-site or off-site related to a qualified facility or property (physical work test).

Moreover, once it has been determined that construction has...