Treasury and IRS Release Final Regulations on Advanced Manufacturing Investment Credit

On October 22, 2024, the Treasury Department and the Internal Revenue Service (IRS) issued final regulations concerning the advanced manufacturing investment credit (“Credit”) under section 48D of the Internal Revenue Code (“Code”), which was added to the Code by the Chips Act of 2022 to incentivize the manufacture of semiconductors and semiconductor manufacturing equipment within the United States. The final regulations adopt, with certain modifications, proposed regulations issued in March of 2023 to implement the Credit, along with applicable recapture rules under Section 50 of the Code.

Importantly, the final regulations clarify and modify key defined terms related to the manufacturing of semiconductors and “significant transactions” involving the material expansion of semiconductor manufacturing capacity in foreign countries of concern.

Summary of Credit

Under Section 48D of the Code, “eligible taxpayers” may claim the Credit for a tax year, amounting to 25% of their “qualified investment” in “semiconductor manufacturing” during that year. A “qualified investment” for a tax year is the basis of any “qualified property” placed in service by the taxpayer during the tax year, which is part of an “advanced manufacturing facility.” By statute, the term “advanced manufacturing facility” is one where the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment.  Section 48D does not define “primary purpose.”

Qualified Property is tangible, depreciable property, including personal property and buildings or a building's structural components, that are “integral to the operation of the advanced manufacturing facility.” The property must meet one of the following criteria:

1. It is constructed, reconstructed, or erected by the taxpayer, or
2. It is acquired by the taxpayer if the “original use” of such property begins with the taxpayer. 

The property must be placed into service after December 31, 2022. However, the Credit will not apply to property for which construction begins after December 31, 2026. Consistent with long-standing guidance issued by the IRS with respect to construction of energy property under Section 48 of the Code, a taxpayer may establish that construction of an item of property begins by using either of the following methods:

• Physical work test: Significant physical work must have occurred, or
• 5% safe harbor: At least 5% of the total cost of the facility is paid or incurred.

Additionally, taxpayers must adhere to a “continuity requirement,” which requires the taxpayer to maintain continuous construction involving physical work or “continuous efforts” to complete the facility after commencing construction under either method. Importantly, for purposes of applying these tests, multiple items of qualified property that are operated as part of a “single advanced manufacturing facility project” are treated as a single item of property.

Eligible Taxpayer

An “eligible taxpayer” is defined as any taxpayer that is not a “Foreign Entity of Concern” (i.e., a sanctioned entity or those owned by, controlled by, or subject to the jurisdiction or direction of the government of the People's Republic of China, North Korea, Russia or Iran) and has not made an “applicable transaction” during the tax year. An “applicable transaction” refers to a significant transaction that materially expands the taxpayer's semiconductor manufacturing capacity in China, Russia, or another “foreign country of concern.”

Recapture and Basis Adjustment Rules

The recapture and basis adjustment rules under Section 50 of the Code, which apply to all investment tax credits, also apply to the Credit under Section 48D. Additionally, a special recapture rule, known as the “applicable transaction recapture rule,” applies to certain expansions in connection with advanced manufacturing facilities. Under this rule, if an “applicable taxpayer” engages in an “applicable transaction” before the end of a 10-year “applicable period” (beginning on the date that an applicable taxpayer placed in service property that is eligible for Credit), then 100% of the tax benefits attributable to any Credit realized by the taxpayer (the “applicable transaction recapture amount) is subject to recapture.  However, an exception exists for applicable taxpayers that demonstrate to the satisfaction of the IRS that the applicable transaction has timely been ceased or abandoned.

Direct Pay Election

Finally, taxpayers have the option to make an elective payment election, sometimes referred to as a “direct pay election,” instead of claiming the Credit on their tax return. Once the direct pay election is made, it is irrevocable and generally applies to any Credit for the tax year in which the election is made.  Final regulations providing guidance on the direct pay election, including the time and manner for making the election, were issued by the Treasury Department and the IRS in March of 2024.

Final Regulations - Key Takeaways

This article provides a summary of key items addressed in the regulations. While a comprehensive overview is not included, the following highlights are essential for understanding the regulations:

Semiconductors and Semiconductor Manufacturing

• Semiconductor: Consistent with the Department of Commerce Final Rules (15 CFR 231.115), the final regulations define a “semiconductor” as an integrated electronic device or system 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.  These devices and systems include, but are not limited to, analog and digital electronics, power electronics, and photonics used for memory, processing, sensing, actuation, and communications applications. Contrary to numerous comments, the Treasury Department and the IRS declined to expand the definition of "semiconductor" to include additional products and substances such as polysilicon, ingot/boules, wafers, and similar materials.
• Semiconductor Manufacturing includes Semiconductor Wafer Production: The final regulations clarify that the term “semiconductor manufacturing” is synonymous with the term “manufacturing of semiconductors.” It includes fabrication, packaging, and wafer production. However, it explicitly excludes manufacturing processes related to precursor materials such as polysilicon.  The term "semiconductor wafer production" is defined to include "processes of growing single-crystal ingots and boules, wafer slicing, etching and polishing, bonding, cleaning, epitaxial deposition, and metrology."
• Semiconductor Fabrication: The final regulations clarify that the term "semiconductor fabrication" is defined to mean "the process of forming devices such as transistors, poly capacitors, non-metal resistors, and diodes, as well as interconnects between such devices, on a wafer of semiconductor material."
• Semiconductor Packaging includes Assembly and Testing: In response to numerous comments, the final regulations clarify that semiconductor packaging includes assembly and testing.  This process involves enclosing a semiconductor in a protective container (package) and providing external power and signal connectivity for the assembled integrated circuit. The definition includes assembly and testing processes and advanced packaging of semiconductors. This modification is welcomed by the industry, as the assembly, test, and packaging (ATP) stage, commonly referred to as “back-end” manufacturing, is viewed as an integral part of the manufacturing process.  “Assembly” is defined to include, but is not limited to, “wafer-dicing, die-bonding, wire bonding, solder bumping, and encapsulation,” while “testing” is defined to include, but is not limited to, “probing, screening, and burn-in work.”
• Semiconductor Manufacturing Equipment: The final regulations clarify that “semiconductor manufacturing equipment” means the highly engineered and specialized equipment used in the manufacturing of semiconductors and the subsystems that enable or are incorporated into the manufacturing equipment. The final regulations make clear consumable materials, including chemicals or gas, are not included within the scope of the term.

Advanced Manufacturing Facility

• Primary Purpose Requirement: In response to comments requesting the inclusion of a minimum threshold for the "primary purpose" requirement, the final regulations now clarify that this requirement is satisfied if more than 50% of production costs, revenue received in an arm's length transaction, or units produced are attributable to the manufacturing of semiconductors or semiconductor manufacturing equipment. Examples are provided to illustrate the application of this rule, including scenarios involving semiconductor wafer production and a vertically integrated manufacturer.
• What is “Integral” to an Advanced Manufacturing Facility?The final regulations set forth a non-exhaustive list of properties considered integral to an advanced manufacturing facility, including:
  • Deposition equipment and tools, etching equipment and lithography equipment
  • Inspection and metrology equipment
  • Clean room facilities and equipment
  • Electrical power facilities, cooling facilities, chemical supply systems, and wastewater and wastewater treatment systems
  • Electricity distribution equipment
  • Sub-fab levels containing pumps, transformers, abatement systems, ultrapure water systems, uninterruptible power supplies, boilers, pipes, storage systems, wafer routing systems and databases, backup systems, quality assurance equipment and computer data centers
  • Utility level equipment
  • Industrial automation and control equipment
  • Industrial automation communications devices, networks and software for industrial automation control products and systems

Beginning of Construction

• Single Advanced Manufacturing Facility Project: The final regulations introduce a single project test that aligns with recent IRS guidance related to investment tax credits.  Specifically, multiple properties or facilities will be treated as a single project if, at any point during construction, they are owned by a single entity and meet at least two of the following factors described in Reg. 1.48D-5(a)(3)(i), such as (i) the properties or facilities are constructed on contiguous pieces of land, and (ii) the properties or facilities share a common electricity and/or water supply.   
• On-Site and Off-Site Activities: Examples of on-site and off-site work are provided to help taxpayers determine “whether physical work of a significant nature has occurred” for purposes of satisfying the physical work test.
• Continuous Efforts: The final regulations clarify that a taxpayer satisfies the requirement for continuous efforts by paying or incurring five percent or more of the total property cost in each calendar year following the year during which construction of the property began. This determination is made in accordance with the definitions outlined in Reg. 1.461-1(a)(1) and (2).

Definition of “Significant Transaction”

• Economic Threshold: The proposed regulations initially defined a "significant transaction" as any investment valued at $100,000 or more, which included mergers, acquisitions, and the formation of joint ventures. However, in response to comments, the monetary threshold for "significant transaction" has been removed. The revised definition now focuses on the type of transaction that could result in material expansion.  Specifically, the term "significant transaction" has been modified to include:
  • Investments, whether proposed, pending, or completed, including any capital expenditure, loan, or gift
  • Formation of subsidiaries, whether classified as a corporation or partnership for Federal tax purposes
  • Mergers, acquisitions, or takeovers, including the acquisition of a new or additional ownership interest in an entity, the acquisition of a material portion of the assets of an entity, or a consolidation
  • Formation of joint ventures
  • Long-term leases or concession arrangements under which a lessee (or equivalent) makes substantially all business decisions concerning the operation of a leased entity (or equivalent) as if it were the owner

• Required Agreements Control: When a taxpayer has a required agreement with the Secretary of Commerce (e.g., related to a funding arrangement), the terms in that agreement will govern the definition of "significant transaction." 

The final regulations offer long-awaited guidance to taxpayers seeking to qualify for the Credit.  However, questions regarding the application of the rules to specific scenarios are likely to persist.   For additional information, please contact Carl F. Staiger.