A new semiconductor tax credit intended to spur the construction of new factories may not generate much investment in tax fairness.
Businesses eligible for these tax credits can apply to the Internal Revenue Service for cash “refunds”.
The tax credits are in a CHIPS law that President Biden signed in early August to boost U.S. competitiveness with China, including by increasing U.S. production of semiconductors.
A 25% investment tax credit can be claimed on new factories and the expansion of existing factories – known as “fabs” – to manufacture semiconductors and semiconductor manufacturing equipment. The credit can only be claimed on those installations commissioned in 2023 or later. Any such facility for which tax credits are claimed must be under construction for tax purposes by the end of 2026.
The tax credit cannot be claimed on the tax base built before 2023 if the facility or expansion was under construction at the end of 2022.
The facility’s tax base must be reduced by the full amount of the investment tax credit claimed.
The new tax credits are found in Section 48D of the US tax code.
Investment tax credits can generally only be claimed on new equipment, but not on buildings. In this case, the credit can also be claimed on buildings and “structural improvements”, but not on the part of the building used for offices, administrative services or other non-manufacturing functions.
Credits cannot be claimed by a company “owned by, controlled by, or subject to the jurisdiction or direction of any government” of China, Russia, North Korea, or Iran or by any company that has significantly increased its semiconductor manufacturing capacity in any of the four countries in a single tax year.
In fact, a significant expansion of semiconductor manufacturing capacity in any of the four countries at any time in the next 10 years after the commissioning of the new plant or plant expansion will cause full recovery of tax credits. A business will have 45 days after receiving a repossession notice from the IRS to “cease or abandon” the expansion to avoid repossession.
Otherwise, normal recovery rules apply. So, for example, the sale of the facility within five years of its completion would trigger the recapture of the unearned investment tax credit. The tax credit is acquired pro rata over five years.
Semiconductor manufacturing facilities are depreciated on the basis of a five-year MACRS depreciation, ie on an anticipated basis. That, plus a 25% investment tax credit, would normally make it worthwhile for any company that cannot use the tax benefits effectively to consider taking advantage of the tax fairness market.
However, businesses eligible for the tax credits may choose to have the cash value paid by the IRS. The payment is considered a tax refund and will not be taxed. Refunds would be paid with a time lag. A business must apply for a refund before the due date, including extensions, for its tax return for the year in which the new plant or expansion is commissioned.
In cases where the fab is owned by a partnership, the partnership requests reimbursement.
Semiconductor makers without tax capacity can still decide to increase tax fairness in some cases.
The tax equity increase provides the option of selling the completed plant or expansion train in a tax equity vehicle at the fair market value of the facility upon completion of construction, allowing the both the tax credit and the depreciation to be calculated on a higher tax base.
Applying to the IRS for a refund of the investment tax credit leaves the depreciation unused. The tax savings from depreciation have a present value, if used effectively, of about 14¢ per dollar of capital cost of the plant or plant expansion. The tax credits are worth 25¢ per dollar of capital cost. Failure to monetize depreciation would leave significant value on the table.
Any sale of the plant or expansion train to a tax equity partnership should be completed before the facility is commissioned. Otherwise, the investor participating in the tax sharing will not be able to participate in the investment tax credit. (See “Partnership Flips: Structures and Issues” in the February 2021 issue NewsWire.)
A sale-leaseback – another form of tax equity transaction – could be put in place within three months of the installation being commissioned. Another potential structure is a reverse lease in which tax credits are transferred to a tax equity investor on an enhanced tax basis, while depreciation remains with the semiconductor company. (For more details on sale-leasebacks and reverse leases, see “Solar Tax Equity Structures” in the December 2021 NewsWire.)
However, one of the challenges in increasing tax fairness is the limited time the tax credit is available. It may take several years for the tax fairness market to develop into a new market segment.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.