On August 9, 2022, President Biden signed the Creating Helpful Incentives to Produce Semiconductors Act (CHIPS Act), which is intended to jumpstart the US semiconductor industry by providing significant loans, loan guarantees, and new investment tax credits to qualified investments in semiconductor and certain advanced manufacturing facilities. The CHIPS Act allocates $52 billion for semiconductor manufacturing incentives and research investments and a new temporary tax credit equal to 25% of the tax basis of a qualified property, which is part of an advanced manufacturing facility, placed in service during the taxable year. Placed in service means that a facility is ready for a specifically assigned function, whether for use in a trade or business, for the production of income. While the CHIPS Act appears to be a great shot in the arm for the domestic semiconductor industry, investors seeking to take advantage of the tax credit will need to exercise caution.

To be eligible for the new tax credit, a qualified property must be placed in service after December 31, 2022 and begin construction before January 1, 2027. If construction begins before January 1, 2023, only the costs added to the tax basis after August 9, 2022 (when the President signed the bill into law) will qualify for the tax credit.

The new tax credit provisions in the CHIPS Act provides for a direct pay option, which allows companies without sufficient tax liability to take advantage of the tax credit while avoiding complicated tax equity financing deals. This essentially treats the taxpayer as having made a payment on its taxes. If the IRS later determines there was an excess payment, the tax imposed on the taxpayer will be increased by the excess amount plus a penalty of 20% of the excess payment unless the taxpayer can demonstrate it had reasonable cause for claiming the excess payment.

Taxpayers should also be aware of other potential clawbacks of the credit. If the qualified investment ceases to be eligible for the tax credit or if the taxpayer disposes of the investment, each within five years after the date on which the property is placed in service, the credit may be subject to recapture. Furthermore, the taxpayer is prohibited from making any “significant transactions” with China and certain other countries with respect to such taxpayer’s semiconductor manufacturing capacity within ten years.

The new tax credit is structured and written similarly to the Section 48 investment tax credit (“ITC”), which provides an incentive for investment in renewable energy projects. This energy credit has been substantially modified, expanded, and extended several times, most recently in late 2020 as Congress passed a second large stimulus bill aimed at softening the economic disruptions caused by COVID-19. Its popularity can be seen in the estimated $6.8 billion in energy credit tax expenditures in 2020. However, just like the ITC, investors seeking to take advantage of the new CHIPS Act tax credit will need to navigate complicated new rules to determine how to qualify investments under the new tax credit regime, including regarding what activities qualify as beginning construction.

For example, the CHIPS Act provides that any property which is integral to the operation of the advanced manufacturing facility will qualify but also includes a provision that excludes from the tax credit offices, administrative services, or other functions unrelated to manufacturing. The tax credit may, however, cover certain parts of a building that is not actual manufacturing, such as research units that may be critical to semiconductor production.

Like with the energy tax credits, investors can expect the Internal Revenue Service to provide new rules and guidance on some of the ambiguities in the CHIPS Act. Such guidance will provide much needed certainty to taxpayers making substantial investments with the expectation of qualifying for the new tax credit. Specifically, guidance on what capital expenditures qualify by specifying what is integral to the operation of a facility, how to treat mixed-use properties, and what activities constitute beginning of construction can help clarify some of the ambiguities in the CHIPS Act.