April 14, 2023
Proposed regs address advanced manufacturing investment credit established by the CHIPS Act of 2022
In proposed regulations (REG-120653-22), the IRS would clarify key terminology and the practical operation of the advanced manufacturing investment credit (AMIC) under IRC Section 48D, which was enacted under the CHIPS Act of 2022, to incentivize businesses to manufacture semiconductors and semiconductor manufacturing equipment in the United States. The proposed regulations define a semiconductor as "an integrated electronic device or system most commonly manufactured using materials such as, but not limited to, silicon, silicon carbide, or III-V compounds, and processes such as, but not limited to, lithography, deposition, and etching."
The proposed regulations address, among other items:
Taxpayers may rely on the proposed regulations for property placed in service after December 31, 2022, as long as they consistently apply the regulations in their entirety.
IRC Section 48D allows taxpayers to claim the AMIC, which equals 25% of the basis of any qualified property that is part of the taxpayer's advanced manufacturing facility if the property is placed in service after December 31, 2022. IRC Section 48D(b)(3) defines an advanced manufacturing facility as "a facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment."
IRC Section 48D, however, does not apply to property constructed after December 31, 2026. Also, for qualified property placed in service after December 31, 2022, whose construction began before January 1, 2023, the AMIC is available only to the extent the property's construction, reconstruction or erection occurred after August 9, 2022.
Under IRC Section 48D(d)(1), a taxpayer may elect to treat the AMIC as a payment of federal income tax equal to the amount of the AMIC, instead of as a credit against the federal income tax liability for that tax year (elective payment election). IRC Section 48D(d)(2) has special rules for an elective payment election, which allows a partnership or S corporation to receive a payment instead of a tax credit for property held directly by a partnership or an S corporation.
IRC Section 50(a)(1) generally requires a taxpayer's tax liability to be increased by the recapture percentage of the aggregate decrease in the credits allowed under IRC Section 38 from all prior tax years. The recapture rule applies if, during any tax year, the taxpayer disposes of investment credit property, or the property ceases to be investment credit property before the close of the recapture period. The aggregate decrease results from "reducing to zero any credit determined under [IRC Section 50(a)(1)] with respect to such property."
New IRC Section 50(a)(3)(A), also enacted under the CHIPS Act, includes a recapture rule requiring the taxpayer's federal income tax liability for the tax year in which an applicable transaction occurs to be increased by 100% of the aggregate decrease in the credits allowed under IRC Section 38 for all prior tax years. The recapture rule applies if the applicable transaction occurs before the close of the 10-year period beginning on the date the taxpayer placed the property eligible for the AMIC in service. The aggregate decrease results "from reducing to zero any investment credit determined under [IRC S]ection 46 that is attributable to the [IRC S]ection 48D credit with respect to such property."
The applicable transaction recapture rule will not apply if the taxpayer demonstrates that the transaction has ceased or was abandoned within 45 days of a determination and notice by the Secretary. An applicable transaction is "any significant transaction (as determined by the Secretary, in coordination with the Secretary of Commerce and the Secretary of Defense) involving the material expansion of [the] semiconductor manufacturing capacity of such applicable taxpayer in a foreign country of concern."
IRC Section 48D(b)(2)(A) defines qualified property as:
Qualified property does not include buildings or portions of buildings that are not used for manufacturing, such office buildings, or buildings used for administrative services. The regulations also provide a list of factors to determine if multiple items of qualified property will be treated as one manufacturing facility (see Prop. Reg. Section 1.48D-5(a)(3)(i)).
The proposed regulations define "original use" 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." The proposed regulations also define "original use" for inventory that is ultimately utilized within a trade or business.
Regarding the requirement for qualified property to be "integral to the operation of the advanced manufacturing facility," the proposed regulations would consider property integral to the manufacturing of semiconductors or semiconductor manufacturing equipment if it is directly used in the manufacturing operation and "is essential to the completeness of the manufacturing operation." In addition, the proposed regulations would clarify that a research or storage facility may qualify as integral to the operation of an advanced manufacturing facility if the property is used in connection with manufacturing semiconductors or semiconductor manufacturing equipment.
Advanced manufacturing facility
Regarding the requirement for an advanced manufacturing facility's primary purpose to be the manufacturing of semiconductors or semiconductor manufacturing equipment, the proposed regulations would clarify that facts and circumstances determine whether a facility is manufacturing finished semiconductors or manufacturing finished semiconductor manufacturing equipment. The proposed regulations would list the facts and circumstances that would be relevant to this analysis. A facility that manufactures, grows, produces or extracts materials or chemicals that are supplied to the advanced manufacturing facility would not meet the primary purpose test. Additionally, the proposed regulations define "semiconductor manufacturing," "manufacturing of semiconductors," "semiconductor manufacturing equipment" and "manufacturing of semiconductor manufacturing equipment."
The proposed regulations would allow a taxpayer to establish that construction has begun by satisfying the physical work test or the 5% safe harbor. Under the physical work test, construction would begin "when physical work of a significant nature begins, provided that the taxpayer maintains continuous construction or continuous efforts." The test's focus would be on the work performed, not the costs. The 5% safe harbor would treat construction as having begun when (1) the taxpayer pays or incurs 5% or more of the total cost of the property; and (2) the taxpayer maintains continuous construction or continuous efforts. To determine whether continuous construction or continuous efforts have occurred, all the relevant facts and circumstance would be taken into account.
The proposed regulations include an extended safe harbor for satisfying the continuity requirement. Under the safe harbor, a taxpayer would be deemed to satisfy the continuity requirement if the property were placed in service no more than 10 calendar years after the physical work test or the 5% safe harbor were satisfied for the property (or single advanced manufacturing facility project of which the property is a part).
The proposed regulations would follow proposed Reg. Section 231.202 of the Commerce Proposed Rule to define "significant transaction" to include certain transactions in which an applicable taxpayer or its affiliates engaged. An applicable taxpayer would include:
If the taxpayer entered into an applicable transaction before the end of the 10-year period beginning on the date the AMIC-eligible property was placed in service, the taxpayer would be subject to a tax increase for the tax year in which the transaction occurs. The proposed regulations define an applicable transaction by referencing IRC Section 50(a)(6) and Treas. Reg. Section 1.50-2, which generally equate an applicable transaction to "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 (as defined in section 9901(7) of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021)." Section 9901(a)(7) of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, as amended by section 103 of the CHIPS Act, defines "foreign country of concern" as a country that is a covered nation 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 define "foreign country of concern" in accordance with Section 9901(a)(7). Certain transactions involving the expansion of manufacturing capacity for legacy semiconductors would not equate to an applicable transaction. The proposed regulations would generally determine the recapture amounts under IRC Section 50 and its regulations.
Determination of AMIC
The proposed regulations would clarify that a partner's share of basis in the partnership's qualified property is determined under Treas. Reg. Section 1.46-3(f), which contains rules for determining a partner's share of the qualified basis of a partnership under the former investment tax credit provisions of former IRC Section 46(a) and (c). Under those regulations, the partner was treated as the taxpayer for its share of the basis of the partnership's qualified property for purposes of calculating the partner's qualified investment.
The proposed regulations would require an S corporation to apportion the basis of qualified property pro rata among its shareholders. In addition, the proposed regulations would require an estate or trust to apportion the basis of the estate or trust's qualified property among the estate or trust and the beneficiaries based on the income of the estate or trust allocable to each for the tax year.
The proposed regulations would be consistent with the rules for allocating basis for electing small business corporations and estates and trusts under Treas. Reg. Sections 1.48-5 and 1.48-6, which contain rules for allocating basis under former IRC Sections 48(e) and (f).
In addition, the proposed regulations would address a taxpayer's ability to make a qualified progress expenditure election to increase its qualified investment by any qualified progress expenditures made after December 31, 2022.
The proposed regulations also would clarify that a taxpayer's qualified investment does not include capital expenditures that are qualified rehabilitation expenditures.
The proposed regulations would apply to tax years ending on or after the date the final regulations are published in the Federal Register. Until the proposed regulations are adopted as final, taxpayers may rely on the proposed regulations for property placed in service after December 31, 2022, provided they consistently follow the proposed regulations in their entirety.
The IRS has requested comments on topics that include the following:
Comments on the proposed regulations may be submitted electronically via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-120653-22). Comments may also be submitted on paper and sent to: CC:PA:LPD:PR (REG-120653-22), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Comments are due by May 22, 2023.
The proposed regulations would clarify key terminology and the practical operation of the credit, which includes computational and direct payment procedures. For example, the regulations address the allocation of basis in a partnership and S corporation context and thereby provide much-needed clarity that was not available based solely on the IRC Section 48D statute. As such, the newly proposed rules provide a valuable roadmap for claiming the credit. As noted, the IRS has identified a broad range of topics upon which comments are desired, providing an important opportunity for taxpayers and practitioners to provide input prior to finalization of these rules. In this regard, EY has closely monitored questions, identified important themes and provided thought leadership to many industry taxpayers prior to issuance of the regulations.
Published by NTD’s Tax Technical Knowledge Services group; Jennifer A Brittenham, legal editor