The IRS recently issued proposed regulations that provide taxpayers with guidance regarding the implementation of the Internal Revenue Code (IRC) Section 48D advanced manufacturing investment credit. This federal income tax credit was established by the Creating Helpful Incentives to Produce Semiconductors Act of 2022 (commonly referred to as the CHIPS Act).
The focus of this article is the credit’s eligibility requirements, including the types of taxpayers that may claim the credit and the types of property that may qualify for the credit. Read on as we highlight key points from the proposed regulations.
The Section 48D credit provides an incentive to eligible taxpayers that manufacture semiconductors and semiconductor manufacturing equipment within the United States. The proposed regulations, released March 21, 2023, affect taxpayers that claim the credit or instead make an elective payment election.
The proposed regulations address:
1. The credit’s eligibility requirements;
2. An election for eligible taxpayers to receive cash in lieu of the credit and be treated as making a payment or overpayment of tax, or for an eligible partnership or S corporation to receive such an elective payment, instead of the credit; and
3. A special 10-year credit recapture rule that applies if there is a significant transaction involving the material expansion of semiconductor manufacturing capacity in a “foreign country of concern.”
Overview of current law
Per the CHIPS Act, to be eligible for the advanced manufacturing investment credit, a taxpayer must:
- Not be a “foreign entity of concern,” which includes certain sanctioned entities or entities owned by, controlled by, or subject to the jurisdiction or direction of the government of a “foreign country of concern” such as the Democratic People’s Republic of North Korea, the People’s Republic of China, the Russian Federation, or the Islamic Republic of Iran; and
- Not have made an “applicable transaction” during the tax year, defined as, “with respect to any applicable taxpayer, any significant transaction … involving the material expansion of semiconductor manufacturing capacity of such applicable taxpayer in the People’s Republic of China or a foreign country of concern.” However, an applicable transaction does not include a transaction that primarily involves the expansion of manufacturing capacity for “legacy semiconductors,” defined as digital or analog logic semiconductors of the 28 nanometer generation or older.
- A significant transaction is defined in the proposed regulations as certain investments that are valued at $100,000 or more, including (i) a merger, acquisition, or takeover, or (ii) certain other investment, including any capital expenditures or the formation of a subsidiary, that meets certain requirements.
- A material expansion is defined in the proposed regulations as “the addition of physical space or equipment that has the purpose or effect of increasing semiconductor manufacturing capacity of a facility by more than 5%; or a series of such expansions which, in the aggregate at any time during the applicable period, increasing the semiconductor manufacturing capacity of a facility by more than 5%.”
The proposed regulations provide for a number of key definitions:
The amount of the credit allowable to a taxpayer for any taxable year is generally an amount equal to 25% of the taxpayer’s qualified investment for the tax year in an advanced manufacturing facility, as defined below.
- An advanced manufacturing facility is a facility for which the primary purpose is the manufacturing of (i) finished semiconductors or (ii) finished semiconductor manufacturing equipment.
- A qualified investment for a tax year is the basis of any qualified property placed in service by the taxpayer during the tax year that is part of an advanced manufacturing facility.
- Basis is generally the amount of the taxpayer’s capital investment in property for tax purposes. In most situations, the basis of an asset is its cost to the taxpayer.
- Qualified property is tangible depreciable property that is integral to the operation of the advanced manufacturing facility that is either (i) constructed, reconstructed, or erected by the taxpayer, or (ii) acquired by the taxpayer, if the original use of such property begins with the taxpayer. Per the CHIPS Act, such property may include buildings or a building’s structural components, but it does not include portions of a building used for offices, administrative services, or any other functions unrelated to manufacturing.
Unlike for most other investment tax credits under Section 46, certain buildings or a building’s structural components may be eligible for the advanced manufacturing investment credit under Section 48D.
The credit is generally available for (i) qualified property that a taxpayer places in service after Dec. 31, 2022, and (ii) qualified property that is under construction prior to Jan. 1, 2023, but only to the extent of the basis of that property that’s attributable to the construction occurring after Aug. 9, 2022.
The proposed regulations clarify certain eligibility requirements related to the definitions of “qualified property” and “advanced manufacturing facility.” Read on for an overview.
Qualified property under the proposed regulations
IRC Section 48D provides that qualified property does not include “a building or portion of a building used for offices, administrative services, or other functions unrelated to manufacturing.” These proposed regulations expand upon the definition of qualified property, explaining that qualifying property does not include a building and its structural components, or a portion thereof, used for:
- Administrative services such as human resources or personnel services, payroll services, legal and accounting services, and procurement services;
- Sales or distribution functions;
- Security services (not including cybersecurity operations); or
- Any other functions unrelated to manufacturing of semiconductors or semiconductor manufacturing equipment.
Qualified property includes property acquired by the taxpayer if the original use of such property commences with the taxpayer. The proposed regulations define the term “original use” generally as:
“…The first use to which the property is put by any taxpayer in connection with a trade or business or for the production of income. Additional capital expenditures paid or incurred by a taxpayer to recondition or rebuild property acquired or owned by the taxpayer satisfy the original use requirement to the extent of the amount of the expenditures paid or incurred by a taxpayer. However, a taxpayer’s cost to acquire property reconditioned or rebuilt by another taxpayer does not satisfy the original use requirement. Whether property is reconditioned or rebuilt property will be determined based on the facts and circumstances.”
The proposed regulations also address the treatment of inventory by providing taxpayers with guidance on how to determine the “original use” of property held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business. They explain that “original use” in the context of inventory means:
- where a taxpayer initially acquires new property and holds it primarily for sale to customers in the ordinary course of the taxpayer’s trade or business and subsequently withdraws the property from inventory, and uses the property primarily in the taxpayer’s trade or business or primarily for the taxpayer’s production of income, or
- where a person initially acquires new property and holds it for sale to customers in the ordinary course of the person’s business and a taxpayer subsequently acquires the property from the person for use in the taxpayer’s trade or business or for the production of income.
The original use begins on the date on which the taxpayer first uses the property in the taxpayer’s trade or business or for the production of income, the proposed regulations state.
Section 48D also provides that qualified property must be “integral to the operation of the advanced manufacturing facility.”
The proposed regulations specify:
“Property is integral to the operation of manufacturing semiconductors or semiconductor manufacturing equipment if such property is used directly in the manufacturing operation, is essential to the completeness of the manufacturing operation, and is not transformed in any material way as a result of the manufacturing operation. Materials, supplies, and other inventoriable items of property that are transformed into a finished semiconductor or into a finished unit of semiconductor manufacturing equipment are not considered property integral to the operation of manufacturing semiconductors or semiconductor manufacturing equipment. In addition, property such as pavements, parking areas, inherently permanent advertising displays, or inherently permanent outdoor lighting facilities, although used in the operation of a business, ordinarily are not integral to the operation of manufacturing semiconductors or semiconductor manufacturing equipment.”
Regarding research or storage facilities, the proposed regulations further specify:
“If property, including a building and its structural components, constitutes a research or storage facility and is used in connection with the manufacturing of semiconductors or semiconductor manufacturing equipment, the property may qualify as integral to the operation of the advanced manufacturing facility … Specific examples of research facilities include research facilities that manufacture semiconductors in connection with research, such as pre-pilot production lines and prototypes, including semiconductor packaging. Specific examples of storage facilities are mineral, chemical, and gas storage tanks, including high pressure cylinders or specially designed tanks and drums.”
However, a research facility that does not manufacture any type of semiconductors or semiconductor manufacturing equipment does not qualify, the proposed regulations state.
Advanced manufacturing facility under the proposed regulations
IRC Section 48D provides that an advanced manufacturing facility means “a facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment.” The proposed regulations provide that the determination of the “primary purpose” of a facility is based on an analysis of all the facts and circumstances surrounding the construction, reconstruction, or erection of the advanced manufacturing facility. They state, “Facts that may indicate a facility has a primary purpose of manufacturing finished semiconductors or manufacturing finished semiconductor manufacturing equipment include:
- “Designs or other documents for the facility that demonstrate that the facility is designed to make finished semiconductors or finished products consisting of specialized equipment that can only be used for semiconductor manufacturing;
- “The possession of permits or licenses needed to manufacture finished semiconductors or finished semiconductor manufacturing equipment; and
- “Executed contracts to supply finished semiconductor manufacturing equipment to a finished semiconductor manufacturer in place either before or within six months after the facility is placed in service.”
The proposed regulations also provide that a facility that manufactures, produces, grows, or extracts materials or chemicals that are supplied to an advanced manufacturing facility does not meet the primary purpose requirement. “Thus, for example, facilities that grow wafers or produce gases, or that manufacture components or parts, to supply an advanced manufacturing facility that manufactures semiconductors or semiconductor manufacturing equipment are not facilities for which the primary purpose is the manufacturing of semiconductors or the manufacturing of semiconductor manufacturing equipment,” the proposed regulations state.
What does CohnReznick think?
In the proposed regulations, the Treasury Department and IRS have requested comments on certain questions that were left open. One such topic is the scope of the definition of the term “semiconductor,” specifically whether this term should include “semiconductor substances – materials with electronic properties controllable by the addition of, typically small, quantities of specific elements or dopants – on which an electronic device or system is manufactured, such as, but not limited to polysilicon and compound semiconductor wafers.”
The Treasury Department and IRS also requested comments on other matters not discussed in this article, including:
- a basis allocation of a pass-through entity’s basis in qualified property;
- a taxpayer’s ability to claim a Section 48D credit for qualified progress expenditures;
- the elective payment election; and
- recapture in the case of certain expansions.
We expect the final regulations to address and clarify these matters.
Additionally, manufacturers should consider whether they meet the rules for the advanced manufacturing investment credit, and if they do not, they may consider ways in which they may pivot their business to potentially qualify for the credit.
For additional details, see the proposed regulations. If you have a project in the works related to semiconductor or semiconductor equipment manufacturing, or are considering starting one, contact your advisors to discuss your possible eligibility.
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