CHIPS Act: What Companies Need to Know

On August 9, 2022, President Biden signed into law the highly anticipated CHIPS Act of 2022 (the “CHIPS Act”). Presented as being crucial to ensuring U.S. leadership in global chip production and technical capability against the backdrop of an ascendant China, the legislation aims to, among other things, boost domestic semiconductor manufacturing in the United States. 

On August 25, 2022, President Biden issued an Executive Order on Implementation of the CHIPS Act of 2022 (the “Order”) outlining certain preliminary measures to facilitate the effective implementation of the CHIPS Act.  On the same day, the Department of Commerce launched Chips.gov to serve as a channel to communicate with the public about CHIPS Act initiatives.

Key takeaways of the CHIPS Act:

• Expanding Manufacturing Capability: The statute allocates $39 billion over the next five years for direct federal financial assistance to develop facilities to fabricate, produce, test, assemble, package or research semiconductors, materials used to manufacture semiconductors or semiconductor manufacturing equipment.
• R&D and Workforce Development: The statute allocates $13.7 billion for semiconductor R&D and workforce development, including funding to establish the National Semiconductor Technology Center (“NSTC”) and semiconductor-related Manufacturing USA institutes and to support the Microelectronics Commons.
• Tax Credit: The statute establishes a new federal income tax credit (the “48D Tax Credit”) worth 25% of the cost of certain qualifying property placed in service as part of a facility for the manufacturing of semiconductors or semiconductor manufacturing equipment. The credit will exist in a new section of the U.S. Internal Revenue Code and will be regulated by the Department of the Treasury.
• Clawback: “Guardrail” provisions subject CHIPS Act funding recipients to clawback of the entirety of the funding amount if they (i) knowingly engage in any joint research or technology effort relating to a technology considered to be critical to national security with certain entities, including entities subject to Chinese jurisdiction or (ii) expand semiconductor manufacturing capability below the 28nm level for logic in China or other foreign countries of concern. Tax credit recipients are subject to restrictions generally similar, but not identical to, the expansion-related clawback.
• “Foreign Entity of Concern”: Neither the funding nor the 48D Tax Credit is available to any “foreign entity of concern.” The term is defined broadly to include sanctioned entities as well as entities owned by, controlled by, or subject to the jurisdiction or direction of the governments of China, North Korea, Russia or Iran.
• Implementing Regulations: The CHIPS Act grants the Department of Commerce and the Department of the Treasury broad authority to interpret the statute and prescribe regulations and other guidance that is likely to significantly impact how the CHIPS Act is implemented.

What’s in the CHIPS Act?

The CHIPS Act funds and expands the previously enacted semiconductor-related provisions in the 2021 National Defense Authorization Act. In particular, the CHIPS Act (i) expands funding eligibility to upstream suppliers of semiconductor equipment and materials (in addition to semiconductor manufacturers), (ii) permits funding to non-profit entities, (iii) provides tax credits for certain investments in the United States, (iv) enhances the U.S. government’s control over semiconductor-related investments in China by introducing a China expansion clawback of both the funding and tax credit, (v) authorizes the Department of Commerce to provide funding in the form of loans or loan guarantees, (vi) sets aside $2 billion for “mature technology nodes” and (vii) clarifies application criteria and eligibility.

Broadly, the CHIPS Act’s financial benefits for the private sector are generally implemented through both a grant funding mechanism and a tax credit mechanism. First, as described in detail below, the CHIPS Act allocates $52.7 billion in funding from the federal government to incentivize domestic manufacturing of semiconductors as well as related research and development and workforce development initiatives.

Second, it establishes the 48D Tax Credit to incentivize investments in semiconductor manufacturing and semiconductor equipment manufacturing facilities. The Department of the Treasury is responsible for administering the credit.

FUNDING

• Domestic Manufacturing Incentives: $39 billion to incentivize investment in facilities and equipment in the United States for the fabrication, assembly, testing, advanced packaging, production or research and development of semiconductors, materials used to manufacture semiconductors, or semiconductor manufacturing equipment. This amount includes $6 billion for direct loans and loans guarantees, which can be used to deploy up to $75 million in loans based on the applicable credit risk premium associated with any such loans. It also includes $2 billion to focus solely on the production of “mature technology nodes” with priority for critical manufacturing industries, such as the automotive industry.
• R&D and Workforce Development Incentives: $11 billion to semiconductor research and development initiatives, which include the NSTC, the National Advanced Packaging Manufacturing Program, microelectronics research at the National Institute of Standards and Technology and Manufacturing USA institutes. The NSTC will be a public-private partnership to conduct advanced semiconductor manufacturing R&D and prototyping, invest in new technologies, and expand workforce training and development opportunities.
• Department of Defense / Microelectronics Commons: $2 billion to the Department of Defense through the CHIPS for America Defense Fund to support the Microelectronics Commons, a national network for onshore, university-based prototyping, lab-to-fab transition of semiconductor technologies—including Department of Defense-unique applications—and semiconductor workforce training.
• Department of State – Certain International Efforts: $500 million to the Department of State through the CHIPS for America International Technology Security and Innovation Fund Department of State to coordinate certain international information and communications technology security and semiconductor supply chain activities.
• National Science Foundation – Workforce and Education: $200 million to the National Science Foundation through the CHIPS for America Workforce and Education Fund to promote the growth of the semiconductor workforce.

Eligibility and Consideration for Domestic Manufacturing Incentives Funding

Semiconductor manufacturers and semiconductor materials and equipment manufacturers looking to construct, expand or modernize U.S. semiconductor facilities are eligible to apply for the domestic manufacturing incentives funding. While foreign entities are eligible to apply, funding must be used in the United States and no funding may be disbursed to a “foreign entity of concern.”

Eligibility for the funding also requires, among other things, commitments to worker and community investment (including through training and education benefits programs to expand employment opportunity for economically disadvantaged individuals); commitments from regional educational and training entities and institutions of higher education to provide workforce training; and an executable plan to sustain the facility without additional funding under the CHIPS Act.

Before disbursing funding, the Department of Commerce must determine that the project for which funding is sought is in the economic and national security interests of the United States. Moreover, the Department of Commerce may consider in its review whether the applicant is responsive to the national security needs or requirements established by the Intelligence Community, the National Nuclear Security Administration, or the Department of Defense.

China-Related Clawbacks

The CHIPS Act includes “guardrails” to prohibit beneficiaries of the manufacturing incentives funding from engaging in actions that are considered to benefit foreign adversaries, and in particular, China.

Technology Clawback

The CHIPS Act directs the Department of Commerce to reclaim or clawback the full funding amount provided to an entity under the statute if, contrary to funding requirements, the recipient knowingly engages in certain joint research or technology licensing efforts with a “foreign entity of concern.” This “technology clawback” is implicated when the joint research or licensing effort involves a technology or product that raises national security concerns, as determined by the Department of Commerce and communicated to the recipient before engaging in such joint research or technology licensing. As a result, the technology clawback appears to require several levels of “volitional” acts on behalf of the grant recipient and is not intended to pick-up unintentional acts. Further guidance from the Department of Commerce will be necessary to understand how these restrictions will be implemented.

Expansion Clawback

The “expansion clawback” requires the Department of Commerce to clawback the full funding amount if a manufacturing incentives funding recipient engages in, at any time during a period of ten years after receiving grant funding, any “significant transaction” involving a material expansion of “semiconductor manufacturing” capacity in China or any other foreign country of concern.

• Agreement with the Department of Commerce. To receive funding, a recipient must enter into an agreement with the Department of Commerce to operationalize the expansion clawback restrictions.
• Key Terminology Undefined. “Semiconductor manufacturing” will be defined by the Department of Commerce and includes front-end semiconductor fabrication. The term “significant transaction” will at a minimum be defined in the agreement between the parties, which raises the possibility that it may be subject to negotiation between the funding recipient and the Department of Commerce.
• Restriction Applies to Certain Non-U.S. Affiliates: The expansion clawback restrictions would apply to the funding recipient’s “affiliated group,” as that term is defined in Section 1504(a) of the Internal Revenue Code (but excluding Section 1504(b)(3) of the Code and therefore capturing foreign corporations). Generally speaking, an “affiliated group” is a group of corporations where a common parent corporation directly (or in certain cases indirectly) possesses at least 80% of both the total voting power and value of the stock of each of the corporations. For example, if a foreign parent corporation’s wholly owned U.S. subsidiary enters into such agreement with the Department of Commerce, the foreign parent’s wholly owned non-U.S. subsidiaries would be subject to the restrictions.
• Exceptions: The expansion clawback does not apply to (i) existing facilities or equipment of a “covered entity” for manufacturing “legacy semiconductors” or (ii) expansion of semiconductor manufacturing capacity for “legacy semiconductors” that predominantly serve the Chinese market or the market of another foreign country of concern. “Legacy semiconductors” include chips that are of the 28nm generation or older for logic or any other additional semiconductor technology identified by the Department of Commerce in a public notice.
• Notification and Mitigation: Recipients must notify the Department of Commerce of any planned transaction that may violate the expansion clawback restrictions. The Department of Commerce may enter into a mitigation agreement with the recipient. If mitigation is not feasible, the recipient has 45 days to prove that such transaction has ceased or been abandoned. If the recipient cannot prove that the transaction has ceased or is abandoned, the Department of Commerce must clawback the entirety of the funding provided to the recipient.

No Stock Buybacks or Dividends

In addition to China-related restrictions, the CHIPS Act establishes additional “guardrails” on the use of funds and prohibits funding recipients from using CHIPS Act funds for stock buybacks, dividend payments or making other capital distributions.

Loans and Loan Guarantees

Of the $39 billion allocated to domestic manufacturing initiatives, $6 billion may be used for the cost of direct loans and loan guarantees. The interest rate on such loans cannot exceed the cost of funds to the Department of the Treasury for obligations of comparable maturity. The loan term can be up to 25 years. Funds received from the loan may not be used to construct, modify, or improve a facility outside of the United States. Loans can be used to supplement grant funding received to be able to provide a low cost of capital to covered entities to implement projects across the United States.

48D TAX CREDIT

The CHIPS Act also includes the 48D Tax Credit, which is a new federal income tax credit worth 25% of a taxpayer’s investment in certain qualifying property placed in service as part of a facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment (“an advanced manufacturing facility”). In lieu of claiming the tax credits directly, taxpayers are permitted to receive the value of the tax credits in the form of a tax refund from the Internal Revenue Service. The 48D Tax Credit can be retroactively “recaptured” if a taxpayer undertakes certain activities in China or another foreign country of concern.

Tax Credit Eligibility

The 48D Tax Credit is available to any “eligible taxpayer,” which is broadly defined to include any taxpayer other than (a) a “foreign entity of concern” and (b) an entity that has engaged in an “applicable transaction” (as described in more detail below) during the taxable year.

The 48D Tax Credit is available for “qualified property” placed in service by a taxpayer which is part of an advanced manufacturing facility. “Qualified property” is defined as (a) tangible personal property, (b) with respect to which depreciation (or amortization in lieu of depreciation) is allowable, (c) which is constructed, reconstructed or erected by the taxpayer or the original use of which commences with the taxpayer and (d) which is integral to the operation of the advanced manufacturing facility. Qualified property includes buildings and structural components that meet these requirements, but does not include a building (or portion of a building) used for offices, administrative services, or other activities unrelated to manufacturing, or for which a historic rehabilitation tax credit is claimed.

Only qualified property that is placed in service after December 31, 2022, qualifies for the 48D Tax Credit. Property the construction of which begins before January 1, 2023, can still qualify for the 48D Tax Credit (assuming the property is not placed in service before January 1, 2023), but the 48D Tax Credit would be limited to the taxpayer’s basis in the property attributable to construction, reconstruction or erection after August 9, 2022. The 48D Tax Credit terminates for property that has not begun construction before 2027.

Elective Payment

Taxpayers are permitted to elect to treat the 48D Tax Credit as a payment against income tax for which they will receive the cash value of the 48D Tax Credit in the form of a tax refund. The election is not available before May 6, 2023 (i.e., earlier than 270 days after the effective date of the CHIPS Act). Any such payment would be treated as tax-exempt income to the recipient. The CHIPS Act directs the Department of the Treasury to issue regulations or other guidance to implement the elective payment provisions.

Tax Credit Recapture for Certain Expansions

An applicable taxpayer may not engage in, for a period of ten years, any “significant transaction” involving the material expansion of semiconductor manufacturing capacity of such applicable taxpayer in China. Undertaking such a transaction would result in a recapture of the tax credits.

• Applicability Appears to be Limited to the Taxpayer: The 48D Tax Credit recapture provisions of the CHIPS Act appear to apply less broadly than the expansion clawback provisions applicable to companies that receive grant funding. The recapture provisions apply only to an “applicable taxpayer” (i.e., the taxpayer who claims the 48D Tax Credit). Accordingly, the CHIPS Act seems to permit affiliates of such taxpayer who are treated as separate from the taxpayer for federal tax purposes (e.g., who file separate income tax returns) to engage in manufacturing activities in China or a foreign country of concern without implicating the recapture provisions.
  
  Furthermore, the recapture would only be implicated if the transaction involves an expansion of such applicable taxpayer’s facilities for semiconductor manufacturing in China.
  
  However, the CHIPS Act instructs the Department of the Treasury to publish regulations and guidance related to the recapture rules. Future guidance could expand the recapture provisions.
• Key Terminology Undefined. “Semiconductor manufacturing” is not defined for the purposes of the tax provisions. Similarly, “significant transaction” – the trigger for tax credit recapture, is also undefined. It appears likely that the Department of Commerce and the Department of the Treasury will align on the definitions.
• Exceptions. The recapture would not be implicated for transactions involving “legacy semiconductors.”
• Mitigation. Recapture can be avoided if the taxpayer can demonstrate the expansion transaction has been ceased or abandoned within 45 days of a determination and notice by the Department of the Treasury.

Executive Order and Chips.gov

As we mentioned above, on August 25, 2022, President Biden issued the Order to facilitate the effective implementation of the CHIPS Act. The Order establishes the CHIPS Implementation Steering Council to coordinate policy development to ensure effective implementation of the CHIPS Act within the executive branch. The council will be co-chaired by the Assistant to the President for Economic Policy, the Assistant to the President for National Security Affairs, and the Director of the Office of Science and Technology Policy. Members will include the Secretaries of State, Treasury and Defense as well as the Directors of National Intelligence and the National Science Foundation. 

The Order also establishes six primary priorities to guide implementation of the CHIPS Act: protect taxpayer dollars; meet U.S. economic and national security needs; ensure the U.S.’s long-term leadership in the semiconductor sector; strengthen and expand regional manufacturing and innovation clusters; catalyze private sector investment; and generate benefits for a broad range of stakeholders and communities.

On the same day, the Department of Commerce introduced Chips.gov, a website intended to serve as a central resource for parties interested in the manufacturing and research and development funds available through the Department of Commerce.  Going forward, the Department of Commerce will provide information about departmental priorities, funding opportunities, timelines, and requirements via Chips.gov.

Other Considerations

Government Contracting Restrictions. To enable efficient execution of funding, the CHIPS Act appears to provide the Department of Commerce with “other transactions” authority. This would authorize the Department of Commerce to enter into agreements other than procurement contracts, grants or cooperative agreements. "Other transactions" agreements are not subject to certain comprehensive and cumbersome contract requirements, including the Federal Acquisition Regulations.

However, depending on the funding mechanisms used, funding recipients could be subject to many of the same restrictions that apply to companies performing under federal procurement contracts. These include requirements relating to intellectual property rights and workplace safety. Pursuant to the 2021 Infrastructure Investment and Jobs Act, which includes the Build America, Buy America Act, the Department of Commerce retains discretion as to whether the funding under the CHIPS Act will be subject to the Buy America requirements. If the funding is subject to the Buy America requirements, semiconductor facilities constructed with such funds will need to utilize American made or produced steel, iron, manufactured-goods and construction materials, which will likely increase the cost of construction. Where Buy America required products are not readily available in the United States, a waiver can be sought; however, such waivers are largely discouraged.

Intensive Compliance Scrutiny. The Order, as part of its emphasis on the protection of taxpayer dollars, anticipates robust compliance and accountability requirements for funding recipients. Further, Congress is expected to push for vigorous enforcement of CHIPS Act “guardrails” and other restrictions. In fact, members who opposed the statute may go beyond compliance with the statute itself and seek to expose other alleged wrongdoing by funding recipients, such as alleged China-related trade violations.

Potential Chinese Response. The guardrails are designed to serve as an obstacle to semiconductors firms with operations in China. In effect, they endeavor to freeze advanced semiconductor manufacturing capacity in China. The impact of the CHIPS Act should be considered within the framework of the increasingly tense U.S.-China relations. In response to the CHIPS Act, China may choose to pursue retaliatory measures.

Comparing Funding and 48D Tax Credit

The chart below briefly summarizes key details of the domestic manufacturing incentives-related funding and the 48D Tax Credit. However, the CHIPS Act grants the Department of Commerce and the Department of the Treasury broad authority to interpret the statute and prescribe regulations and other guidance that are likely to significantly impact how the Act is implemented. The chart below does not address the treatment of funds allocated to the various R&D and workforce development initiatives, including the NSTC and the Manufacturing USA institutes.