On Wednesday, October 23, 2024, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued final regulations to implement the Advanced Manufacturing Investment credit under sections 48D and 50. Congress enacted the credit as part of the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act (the Act) to encourage domestic semiconductor manufacturing. The final regulations clarify certain key definitions for determining eligibility for the credit under section 48D, including certain activities involving semiconductor and semiconductor equipment manufacturing in China, which would result in the recapture of all prior credits claimed. 

While the final regulations under section 48D largely follow the structure and substance of the proposed regulations, they include significant clarifications. Most notably, the final regulations clarify the definition of "semiconductor manufacturing." Treasury and the IRS clarify in the final regulations that wafer production, including activities such as "the processes of growing single-crystal ingots and boules, wafer slicing, etching and polishing, bonding, cleaning, epitaxial deposition, and metrology," is included within the scope of "semiconductor manufacturing," as are semiconductor fabrication and packaging (Treas. Reg. § 1.48D-2(n)). The final regulations also clarify that the production of materials used in the manufacture of semiconductors is not "semiconductor manufacturing" for purposes of the section 48D credit. This means that the credit is not available for investments in production of "upstream" materials from which wafers are produced, such as polysilicon, or the gases and chemicals that are used in the semiconductor manufacturing process.

As with the proposed rules, the final regulations define an "advanced manufacturing facility" by reference to a principal purpose test. While the determination of whether a facility meets the principal purpose requirement is based on all facts and circumstances, the final regulations clarify that a facility whose total output (measured by costs incurred to produce, revenue received in an arm's length transaction, or units) comprises more than 50 percent semiconductors or semiconductor manufacturing equipment will be treated as having satisfied the requirement (Treas. Reg. § 1.48D-4(c)(1)). In addition, the final regulations provide examples of manufacturing activities that would not satisfy the primary purpose test's 50 percent threshold, including manufacturing, growing, or producing upstream materials supplied to an advanced manufacturing facility (Treas. Reg. § 1.48D-4(c)(2)).

The final regulations also clarify key terms on the special recapture provision under section 50(a)(3) that applies to certain investments in China and other foreign countries of concern. A taxpayer that has benefited from the credit must forfeit its entire benefit, including amounts claimed in prior years, if it engages in an "applicable transaction" within 10 years of placing qualifying property in service. Under the final regulations, an "applicable transaction" means a significant transaction that results in the material expansion of semiconductor manufacturing capacity. The final regulations also offer guidance on how to determine whether an investment in an existing facility triggers recapture. Ordinary course upgrades or productivity improvements to an existing facility should not constitute a "material expansion" or a "significant renovation" under the final regulations (see Treas. Reg. §§ 1.50-2(b)(7), (9); see also preamble, at 89 Fed. Reg. 84,747). Rather, those terms are tailored to include only capital investments, such as the addition of cleanroom space, a product line, or other physical space. Relatedly, the final regulations do not require a facility to have been operating at full capacity for it to be considered an "existing facility;" rather, its manufacturing capacity will be determined as of the date it was placed into service (Treas. Reg. § 1.50-2(b)(5)). 

Treasury and the IRS emphasize throughout the preamble to the final regulations their effort to coordinate with the Department of Commerce (Commerce) to align, where practical, the final regulations with the Commerce regulations implementing the Act's grant program. One notable example of this alignment is allowing a taxpayer that has entered into an agreement with Commerce to receive a grant under the Act to use the definition of "significant transaction" set forth in the taxpayer's contractual agreement with Commerce (Treas. Reg. § 1.50-2(b)(10)(ii)). Thus, to the extent the term in a taxpayer's agreement deviates from the parameters set forth in the final regulations, that taxpayer will be permitted to follow its agreement with Commerce when determining whether it has engaged in a significant transaction.

The final regulations go into effect on December 23, 2024, and apply with respect to property placed in service after December 31, 2022, and in a tax year that ends on or after October 23, 2024. Treasury and the IRS issued separate regulations on the direct pay election on March 5, 2024. See our coverage of those regulations here.

Observations

While the final regulations make significant strides toward aligning its definitions with those set forth by Commerce, there is not complete harmonization. The final regulations expand eligibility for the credit by providing broader definitions for key terms, including "semiconductor manufacturing" and "semiconductor manufacturing equipment." The final regulations also provide several non-exhaustive lists of examples, including: 1) activities that are considered to be "integral to" the manufacture of semiconductors or semiconductor manufacturing equipment; 2) property that is considered "semiconductor manufacturing equipment"; and 3) activities that may support the factual determination that a facility satisfies the principal purpose test to qualify as an "advanced manufacturing facility." All of these examples provide much anticipated clarity to taxpayers as they make the relevant determinations. Finally, the final regulations clarify that no "…provision under section 48D require[s] a taxpayer to own the advanced manufacturing facility as a prerequisite to determining" the credit. Taxpayers in the semiconductor industry should carefully consider the guidance in determining eligibility for the credit and the potential application of the recapture rules to activities they may have undertaken or plan to undertake in foreign countries of concern. 

For more information, please contact:

Loren C. Ponds, lponds@milchev.com, 202-626-5832

Samuel A. Lapin, slapin@milchev.com, 202-626-5807

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