Investment Tax Credit for Domestic Semiconductor Manufacturing Signed into Law
On August 9, 2022, Congress enacted a 25 percent tax credit for investment in semiconductor manufacturing to incentivize domestic semiconductor production. The Advanced Manufacturing Investment Tax Credit (ITC) was enacted as part of the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act (the Act) in response to supply chain disruptions that have resulted in a shortage of semiconductors for products such as cars, smartphones, and medical devices. The Act contains several items that aim to reduce U.S. reliance on imported semiconductors.
Framework of the ITC
The ITC, codified in new section 48D of the Internal Revenue Code, allows a credit for investments in semiconductor manufacturing facilities and equipment. The credit is available to eligible taxpayers that have made a "qualified investment with respect to an advanced manufacturing facility" in the taxable year. Generally, a "qualified investment with respect to an advanced manufacturing facility" means the taxpayer's "basis of any qualified property placed in service during the taxable year by the taxpayer during such taxable year which is part of an advanced manufacturing facility." Taxpayers may make "qualified investments" with respect to any "qualified property" placed in service after December 31, 2022. Taxpayers may claim the ITC with respect to "qualified property" on which construction is already in progress, but it is limited to only its basis in the property that is attributable to work done after the date on which the Act was enacted, which was August 9, 2022. Any preexisting basis in the property will not be a "qualified investment" for purposes of the ITC. The ITC terminates with respect to property for which construction begins in 2027 or later.
An "advanced manufacturing facility" is "a facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment."
"Qualified property" means tangible property:
- For which deprecation (or amortization in lieu of depreciation) is allowed;
- That is either constructed, reconstructed or erected by the taxpayer, or acquired by the taxpayer, provided that "the original use of such property commences with the taxpayer"; and
- Which is integral to the operation of the advanced manufacturing facility
"Qualified property" includes buildings or structural components, but no credit is allowed to the extent a building or structural component is not used in connection with manufacturing semiconductors. For example, "a building or portion of a building used for offices, administrative services, or other functions unrelated to manufacturing" will not be considered "qualified property." Pursuant to section 50(c), a taxpayer's basis in "qualified property" with respect to which it claims the ITC is decreased by the amount of the credit.
Any taxpayer is eligible for the ITC, subject to two exceptions focused on national security concerns. First, an entity classified as a "foreign entity of concern" under the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (Pub. L. 116-283, at § 9901(6)) (the 2021 NDAA) is not eligible for the credit. A "foreign entity of concern" means any foreign terrorist organization, any entity or individual sanctioned by the Department of the Treasury (Treasury), certain foreign state-run companies, any individual convicted of crimes related to espionage or arms trafficking, and other entities otherwise determined to be detrimental to national security or U.S. foreign policy. Second, a taxpayer that has been allowed an ITC in a prior year that that has made an "applicable transaction" under the new section 50(a)(3) during the taxable year is not eligible for the ITC. An "applicable transaction" means "any significant transaction (as determined by the Secretary [of the Treasury], in coordination with the Secretary of Commerce and the Secretary of Defense), involving the material expansion of semiconductor manufacturing capacity" in China, or a "foreign country of concern."
Direct Pay Election
Taxpayers may elect to treat the ITC as a direct payment against tax. In the event an electing taxpayer claims a credit that is greater than its tax liability, the excess credit will be treated as an overpayment of tax. The election, which is irrevocable, must be made at least 270 days after the enactment of the ITC, but before the due date (including extensions) for the tax return for the taxable year for which the taxpayer makes the election.
Partnerships and S corporations that hold qualified property may also elect to treat the credit as a payment of tax. In the case of an electing partnership or S corporation, Treasury will make a payment to the partnership or S corporation in an amount equal to the amount of the ITC determined for the entity for that taxable year. The payment to the entity is treated as tax-exempt income for purposes of determining the partners' outside bases and shareholders' tax liability. The amount of credit otherwise due to an electing partnership or S corporation is reduced to zero to preclude any double benefit before their distributive shares or pro rata share are determined. The election to must be made at the entity level. Accordingly, no partner or shareholder in an electing partnership or S corporation may make an election to treat any credit as a payment of tax.
Electing taxpayers are subject to an anti-abuse rule that mimics the effect of the accuracy-related penalties in section 6662 or the erroneous refund penalty of section 6676 (neither penalty is applicable). In the event a taxpayer elects to treat an amount in excess of their credit as a payment of tax, that taxpayer is subject to an additional tax equal to 100 percent of the amount of the excessive payment, plus an amount equal to 20 percent of the excessive payment. Taxpayers that make excessive payments will not be subject to the 20 percent additional tax if they can show that they made the excessive payment due to reasonable cause. In addition, similar to the rules involving electing partnerships and S corporations, electing taxpayers are prohibited from obtaining a double benefit: an electing taxpayer's credit is reduced to zero and, for all other purposes, is treated as having been allowed to the taxpayer for that taxable year.
Direct payments of tax under the Act are treated the same as refundable credits for purposes of sequestration. Like refundable credits, amounts treated as direct payments of tax by electing taxpayers are exempt from reduction in the event that sequestration takes effect.
Taxpayers that invest in the expansion of its foreign semiconductor manufacturing capacity may be required to pay back any amount of ITC they claimed in previous years. The Act adds a new recapture rule to section 50(a) under which taxpayers that engage in an "applicable transaction," within 10 years from the date on which the taxpayer placed in service property for which it was eligible for an ITC must add to their taxes for that taxable year the amount of all ITC previously allowed to that taxpayer. As noted above, the Act defines an "applicable transaction" as "any significant transaction (as determined by the Secretary [of the Treasury], in coordination with the Secretary of Commerce and the Secretary of Defense), involving the material expansion of semiconductor manufacturing capacity" in China, or a "foreign country of concern." In the event the IRS determines that a taxpayer has engaged in an applicable transaction, the taxpayer may avoid application of the recapture rule if it ceases or abandons the applicable transaction within 45 days of the IRS's determination.
The recapture rule mirrors a similar limitation imposed with respect to grants from the CHIPS for America Fund under the Act, under which semiconductor manufacturing incentives will be clawed back if the grantee significantly expands its manufacturing capacity in China or another foreign country of concern. Additionally, grants from the CHIPS for America Fund may not be used to pay dividends or for stock buybacks.
Coordination with Other Credits
The Act provides coordination rules that limit taxpayers' eligibility for certain other investment credits alongside the ITC. Specifically, an eligible taxpayers may not receive any credit under new section 48 to the extent its basis in any property is attributable to expenditures eligible for the rehabilitation credit under section 47.
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