Proposed Rulemaking Issued on the CHIPS Act Advanced Manufacturing Investment Credit under IRC Section 48D

On March 23rd, the Treasury Department and the IRS published a notice of proposed rulemaking for the Section 48D Advanced Manufacturing Investment Credit (“Section 48D credit”) established by the CHIPS Act of 2022. Over the last few years, the market for semiconductors has been volatile, causing supply chain shortages. The Section 48D credit aims to incentivize investments in facilities that manufacture semiconductors or semiconductor manufacturing equipment in the United States, with the goal of creating American jobs and strengthening the U.S. economy and national security.

The Section 48D credit is equal to 25 percent of an eligible taxpayer’s qualified investment for the taxable year in a qualified advanced manufacturing facility. The credit is available for qualified property beginning construction after August 9, 2022 and placed in service after December 31, 2022.

The proposed regulations provide guidance and additional clarity on the eligibility requirements, direct payment procedures that make the credit effectively refundable, and special rules for the recapture of the credit that may result from transactions involving foreign entities of concern. Taxpayers may rely on these proposed regulations for property placed in service after December 31, 2022.

I. Credit Eligibility

To qualify for the Section 48D credit, the manufacturing facility’s primary purpose must be the manufacturing of semiconductors or semiconductor manufacturing equipment, and only property integral to the operation of an advanced manufacturing facility qualifies for the credit. The proposed regulations clarify that “integral” property, is property that is (1) used directly in the manufacturing operation, (2) essential to the completeness of the manufacturing operation, and (3) not transformed in any way as a result of the manufacturing operation. Under the proposed regulations, integral property may include certain research and storage facilities used in connection with the manufacturing of semiconductors or semiconductor manufacturing equipment; however, materials, supplies, and other inventoriable items that are transformed into a finished product would not be considered integral. The proposed regulations set forth several examples of property which would normally be integral to the operation of an advanced manufacturing facility, including inspection and metrology equipment and electrical power facilities, cooling facilities, chemical supply systems, and wastewater systems.

The proposed regulations also provide guidance regarding how to determine if a manufacturing facility’s primary purpose is manufacturing semiconductors or semiconductor manufacturing equipment. Whether a manufacturing facility meets the primary purpose test will be based on all facts and circumstances surrounding the construction, reconstruction, or erection of the advance manufacturing facility. The proposed regulations include some factors that the IRS may consider, including reviewing designs of the facility and supply contracts.

The proposed regulations also include an example where the primary purpose test is satisfied because 75 percent of the property placed in service is dedicated to the manufacture of semiconductors. While the 75 percent threshold is included for illustrative purposes, it may indicate that the IRS will use a 75 percent threshold to determine whether a facility meets the primary purpose test. The proposed regulations do not address whether a lower threshold would still meet the primary purpose test.

The proposed regulations make clear that a facility that manufactures, produces, grows or extracts materials that are supplied to another advanced manufacturing facility are not facilities that meet the primary purpose test. Taxpayers who do not manufacture semiconductors from start to finish, but who only perform one of the intermediate steps in the manufacturing process, may benefit from the credit. That means companies that fabricate chips or package semiconductors may be eligible for the tax credit.

The Treasury Department and the IRS request comments on the definition of the term “semiconductor.” They specifically want to know whether semiconductive substances should be included in the definition, and if so, what principles, standard, or parameters should be incorporated into the definition.

II. Direct Payment

Taxpayers may elect for “direct pay” under Section 48D. Under the proposed regulations, an election will be treated as made on the later of the due date of the claimant’s income tax return or the date on which the return is filed. This may lengthen the time the claimant receives the benefit of the credit, depending on the claimant’s facts, as costs for qualified investments potentially could be incurred more than one year before the elective payment is deemed made.

The proposed regulations also indicate that taxpayers will need to follow specific registration procedures before claiming direct pay. Treasury and the IRS have requested comments on the registration requirements and other procedures for electing direct pay with respect to Section 48D credits, so we expect to see forthcoming guidance on this issue.

III. Recapture

The statute requires a clawback of the full value of the credit claimed in all prior years if within 10 years of claiming the credit, a taxpayer or affiliate engages in a significant transaction that materially expands the semiconductor manufacturing capacity of the taxpayer in a foreign country of concern. The proposed regulations define the term “foreign country of concern” to mean a country that is a covered nation under existing law and any country that the Secretary of Commerce, in consultation with the Secretary of Defense, the Secretary of State, and the Director of National Intelligence, determines to be engaged in conduct that is detrimental to the national security or foreign policy of the United States.  The proposed regulations also state the Treasury Department and the IRS are considering reporting requirements that would require notifying the IRS regarding any planned significant transactions of the applicable taxpayer involving the material expansion of semiconductor manufacturing in a foreign country of concern. The Treasury Department and the IRS are seeking comments on the ability of applicable taxpayers to comply with reporting requirements and what specific procedures should be considered to ensure that the IRS has sufficient information to determine whether the transaction requires recapture of the credit.

The Department of Commerce also issued on March 21st proposed regulations on the national security safeguards for its CHIPS for America funding. To learn more, click here.