Semiconductor Industry Receives Long-Awaited Tax Credit Guidance From Treasury

OVERVIEW

US Congress enacted the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act) on August 9, 2022.[4] The CHIPS Act provides a framework for transformative investments to restore and advance US leadership in the research, development, and manufacturing of semiconductors. Congress added Section 48D to the Code as part of the CHIPS Act. Under Section 48D, a taxpayer may be able to claim an amount equal to 25% of its qualified investment for a tax year with respect to an advanced manufacturing facility.[5]

The Final Section 48D Regulations finalize the March 2023 Proposed Regulations. Together with separately issued regulations addressing direct pay elections for Section 48D credits (e.g., Treas, Reg. § 1.48D-6), these regulations establish the Section 48D guidance base for taxpayers.

Below, we briefly address changes made to the March 2023 Proposed Regulations by the Final Section 48D Regulations with respect to the definition of “semiconductor manufacturing,” the continuity requirement-related rules, and the parameters of a “significant transaction” as relevant to the applicable transaction rules.

CHANGES TO DEFINITION OF “SEMICONDUCTOR MANUFACTURING” BROADENS WHICH TAXPAYERS CAN AVAIL THEMSELVES OF SECTION 48D CREDITS

A taxpayer can only claim Section 48D credits with respect to qualified investment attributable to an advanced manufacturing facility. For this purpose, the term “advanced manufacturing facility” means a facility for which the primary purpose is manufacturing semiconductors or manufacturing semiconductor manufacturing equipment.[6]

The March 2023 Proposed Regulations defined the term “semiconductor manufacturing” by reference to “semiconductor fabrication” or “semiconductor packaging.”[7] The definitions of the foregoing terms in the March 2023 Proposed Regulations failed to capture the full spectrum of semiconductor activities that a semiconductor manufacturer undertakes. More specifically, semiconductor manufacturing can involve front-end manufacturing, where wafers are fabricated and probed, but also back-end manufacturing, where chips are ultimately assembled, tested, and packaged. The March 2023 Proposed Regulations did not reference “assembly” and “test” activities as in-scope “semiconductor manufacturing” activities.

In a welcome response to comments, the Final Section 48D Regulations explicitly provide that assembly and test activities qualify as in-scope “semiconductor manufacturing” activities.[8] The Final Section 48D Regulations also clarify that “wafer production” activities (e.g., activities undertaken by manufacturers of solar wafers) are now in-scope “semiconductor manufacturing” activities.[9]

Together, the above changes serve to broaden the base of taxpayers who can avail themselves of Section 48D credits.

TAXPAYERS NOW HAVE MORE CERTAINTY WITH RESPECT TO THE BEGINNING OF CONSTRUCTION, CONTINUITY REQUIREMENTS

A taxpayer must begin construction of credit-eligible property prior to the date that Section 48D sunsets, which is December 31, 2026. A taxpayer may establish that construction of an item of property begins under either a physical work test or a 5% safe harbor.[10] For this purpose, multiple items of qualified property or advanced manufacturing facilities that are operated as part of a “single advanced manufacturing facility project” (Single Project) are treated as a single item of property.[11] Regardless of whether a taxpayer relies on the physical work test or 5% safe harbor to establish the beginning of construction, it must also satisfy a continuity requirement.[12] A taxpayer can satisfy the continuity requirement either by maintaining “continuous construction” or “continuous efforts.” Satisfaction of the continuity requirement is determined based on the relevant facts and circumstances.

The Final Section 48D Regulations make certain favorable changes to the beginning of construction and continuity requirement-related rules in the March 2023 Proposed Regulations.

First, the Final Section 48D Regulations incorporate a list of on- and off-site work activities for purposes of the physical work test, which should give taxpayers greater certainty with respect to which activities help satisfy the test as compared to the March 2023 Proposed Regulations (which identified no such examples).[13]

Second, for purposes of the continuous efforts test, the Treasury and the IRS clarified that a taxpayer has met the factor of paying or incurring additional amounts included in the total cost of the property for a tax year in which it pays or incurs 5% or more of the total cost of the property each calendar year after the calendar year during which construction of the property began.[14] The “paying or incurring additional amounts” factor is one of four nonexclusive factors that a taxpayer can use to establish continuous efforts but arguably can now be viewed as a “super factor” for taxpayers that surpass the 5% spend threshold.

Third, unlike the March 2023 Proposed Regulations, which provided a list of factors for Single Project treatment but no indication as to how those factors should be weighted, the Final Section 48D Regulations affirmatively provide that a taxpayer can satisfy the Single Project definition with respect to multiple properties if, at any point during construction of the multiple properties or facilities, they are owned by a single taxpayer, and any two or more of the seven factors listed in Treas. Reg. § 1.48D-5(a)(3)(i) are met (e.g., the properties or facilities are constructed on contiguous pieces of land). For this purpose, related taxpayers (e.g., trades or businesses under common control within the meaning of Treas. Reg. § 1.52-1(b)) are treated as one taxpayer in determining whether multiple facilities or properties are treated as a Single Project.[15]

The revised Single Project test should provide much greater certainty for taxpayers that a particular project constitutes a Single Project. This is particularly important for taxpayers constructing long-lived projects given the Section 48D credit sunset date. More specifically, if a taxpayer continues to construct a part of a Single Project, the construction of which began before the Section 48D credit sunsets, it can now more easily tie back property that it places in service in a post-2026 year attributable to the Single Project itself and, in turn, rely on the Single Project’s beginning of construction date to claim credits for the post-2026 placed in service property (assuming satisfaction of other applicable rules).

Together, the above changes provide additional certainty to taxpayers, which is especially important considering the IRS will not issue private letter rulings for the beginning of construction requirement and is similarly not expected to issue private letter rulings with respect to the continuity requirement.

THE REVISED SCOPE OF A “SIGNIFICANT TRANSACTION” PROVIDES GREATER CERTAINTY FOR WHAT TRIGGERS THE APPLICABLE TRANSACTIONS RULES

If an applicable taxpayer engages in an applicable transaction before the close of the applicable period in the tax year that the applicable transaction occurs, then the applicable taxpayer must recapture Section 48D credits that it claimed in prior tax years.[16] Further, any applicable taxpayer that engages in an applicable transaction during a certain tax year cannot meet the eligible taxpayer definition and, in turn, cannot claim Section 48D credits for that tax year.[17] The term “applicable transaction” means, with respect to any applicable taxpayer, any significant transaction involving the material expansion of semiconductor manufacturing capacity of such applicable taxpayer in any foreign country of concern.[18] In the March 2023 Proposed Regulations, the Treasury provided a laundry list of events that constituted a “significant transaction,” which included, in part, any investment – whether proposed, pending, or completed – that is valued at $100,000 or more, including (i) a merger, acquisition, or takeover and (ii) any other investment, including any capital expenditures or the formation of a subsidiary.[19] Importantly, the definition of a “significant transaction” differed in certain respects from the definition of the same term for purposes of the US Department of Commerce (Commerce) rules (e.g., 15 CFR part 231).

In response to comments, the Final Section 48D Regulations materially amend the scope of a “significant transaction.” In particular, the significant transaction rules for a CHIPS Act funds recipient now leverage the taxpayer’s agreement with Commerce: if a taxpayer enters into a “required agreement” with Commerce (e.g., an agreement for CHIPS Act funds), then the term “significant transaction” has the same meaning as provided in the required agreement.[20] This uniformity provides taxpayers negotiating for CHIPS Act funds an opportunity to weigh in on the scope of a “significant transaction” as applicable to their facts. Taxpayers who will not receive CHIPS Act funds still benefit from the updated rules, which streamline the definition of a “significant transaction” and, importantly, largely allow taxpayers to sidestep applicable transaction treatment for ordinary course of business transactions (e.g., funding payroll).

CONCLUSION

Overall, the Final Section 48D Regulations provide welcome guidance to taxpayers and reflect an open-eared Treasury that clearly listened to taxpayer feedback to make certain changes to the March 2023 Proposed Regulations. The combination of the above changes, as well as others not mentioned herein, provides greater certainty to taxpayers who intend to make the types of transformative investments in the research, development, and manufacturing of semiconductors that Congress desired when it promulgated Section 48D.