Executive summary: The CHIPS Act
The CHIPS Act of 2022 offers billions of dollars in grants and a new income tax credit to jump-start domestic semiconductor manufacturing. President Joe Biden signed it into law on Aug. 9, 2022, after it passed with bipartisan support in Congress.
Incentivizing semiconductor manufacturing
Division A of the act creates an income tax credit, four new federal grant programs, and other incentives to promote domestic semiconductor manufacturing.
The new advanced manufacturing investment credit is a component of the existing investment tax credit. Under the new section 48D, qualified investments will be eligible for a credit of 25% of the basis of property placed in service during the taxable year. Qualified investments are generally tangible property that are integral to the operation of an “advanced fabrication facility.” This term is defined as a facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment.
The property placed in service may be equipment, buildings, or structural components of a building used for manufacturing semiconductors or equipment that will be used to manufacture semiconductors. Generally, the construction, reconstruction or erection of the property must begin after Dec. 31, 2022, and before Jan. 1, 2027. For construction that commences before Jan. 1, 2023, the credit is only available for property the basis of which is attributable to construction occurring after the enactment of the CHIPS Act. The credit is ultimately claimed in the year the qualified investment is placed in service.
The credit offers an election for direct payment of tax. In lieu of claiming the credit as a reduction of tax liability on a tax return, taxpayers may elect to treat the full value of the credit as a payment of tax for the taxable year with respect to which the credit was determined. The additional payment of tax may be refunded, creating the same effect as if the credit were refundable. S corporations and partnerships may also be eligible for such an election. However, the election for eligible pass-through entities would result in a payment being made directly to that entity.
In addition to the new section 48D credit, the CHIPS Act contains over $50 billion of incentives in the form of four new grants. These grants will serve to fund workforce development, the security of the domestic supply chain for semiconductors, and other programs dedicated to bringing semiconductor technologies from lab prototypes to fabrication through university collaboration and research and development.
Washington National Tax observations
The new advanced manufacturing investment tax credit is expected to facilitate the domestic production of semiconductors for computer chips. While there are relatively few companies that fabricate the semiconductors, of particular importance to the middle market is that the credit may also be applicable to manufacturers of the tooling and equipment used in the semiconductor manufacturing process. The cost to construct and operate a semiconductor fabrication plant could easily be prohibitive for middle market firms. That said, middle market manufacturers are more likely to produce equipment later used by semiconductor manufacturers in their specialized fabrication plants. The ability to claim the credit for manufacturing such equipment could create substantial benefits for middle market manufacturers and jumpstart growth in this industry.
The direct pay mechanism may bring about a significant benefit to semiconductor manufacturers as many developers of substantial projects lack the taxable income to fully benefit from nonrefundable tax credits. Separately, developers will receive the benefit of cash to help fund construction or reconstruction of semiconductor fabrication plants. This, of course, is attractive for developers who may otherwise have to wait for unused tax credits to be utilized in a tax year when they have a tax liability to be offset by carried forward credits. Finally, the use of tax equity structures is a common technique used to produce a benefit like that of a refundable credit where developers generate nonrefundable credits. Therefore, the direct pay mechanism could create an attractive alternative to tax equity structures. Additional Treasury guidance will be critical for understanding and determining the ultimate benefit of this new election.
There are several questions that likely require guidance from the Treasury Department. This includes parameters for the definition of “advanced manufacturing facility” and what is meant by primary purpose with respect to semiconductor manufacturing equipment. A safe harbor for the “beginning of construction” rules and guidance on the implementation of the direct pay provision would also be helpful.
It should be noted that the CHIPS Act explicitly provides for exemption of refund payments of the section 48D credit from sequestration, a deficit control device enacted by Congress. Accordingly, the section 48D credit is not subject to a haircut.