New tax credits for semiconductors
A new semiconductor tax credit intended to spur construction of new factories may not lead to much tax equity investment.
Companies entitled to such tax credits can apply to the Internal Revenue Service for cash “refunds.”
The tax credits are in a CHIPS Act that President Biden signed in early August to boost US competitiveness with China, including by increasing US output of semiconductors.
A 25% investment tax credit can be claimed on new factories and expansion of existing factories — called “fabs” — to make semiconductors and semiconductor manufacturing equipment. The credit can only be claimed on such facilities put in service in 2023 or later. Any such facility on which tax credits are claimed must be under construction for tax purposes by the end of 2026.
The tax credit may not be claimed on tax basis built up before 2023 if the facility or expansion was under construction by the end of 2022.
The tax basis in the facility must be reduced by the full investment tax credit claimed.
The new tax credits can be found in section 48D of the US tax code.
Investment tax credits can usually be claimed only on new equipment, but not on buildings. In this case, the credit may also be claimed on buildings and “structural improvements,” but not the part of the building used for offices, administrative services or other functions unrelated to manufacturing.
The credits cannot be claimed by a company “owned by, controlled by, or subject to the jurisdiction or direction of a government of” China, Russia, North Korea or Iran or by any company that has materially expanded its semiconductor manufacturing capacity in one of the four countries during the same tax year.
In fact, a material expansion of semiconductor manufacturing capacity in one of the four countries at any time during the next 10 years after the new factory or factory expansion is put in service will lead to full recapture of the tax credits. A company will have 45 days after being sent a recapture notice by the IRS to “cease or abandon” the expansion to avoid recapture.
Otherwise, normal recapture rules apply. Thus, for example, a sale of the facility within five years after it is completed would trigger recapture of the unvested investment tax credit. The tax credit vests ratably over five years.
Semiconductor manufacturing facilities are depreciated using five-year MACRS depreciation, meaning on a front-loaded basis. That, plus a 25% investment tax credit, would normally make it worthwhile for any company that cannot use the tax benefits efficiently to consider tapping into the tax equity market.
However, the companies entitled to the tax credits can choose to have the IRS pay the cash value. The payment is considered a tax refund and will not be taxed. The refunds would be paid with a time lag. A company must apply for a refund by the due date, including extensions, for its tax return for the year in which the new fab or expansion is placed in service.
In cases where the fab is owned by a partnership, the partnership applies for the refund.
Semiconductor manufacturers without tax capacity may still decide to raise tax equity in some cases.
Raising tax equity provides an opportunity to sell the completed factory or expansion train into a tax equity vehicle at the fair market value of the facility at the end of construction, thereby letting both the tax credit and depreciation be calculated on a higher tax basis.
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 efficiently, of roughly 14¢ per dollar of capital cost of the factory or factory expansion. The tax credits are worth 25¢ per dollar of capital cost. Failure to monetize the depreciation would leave significant value on the table.
Any sale of the factory or expansion train to a tax equity partnership would have to be done before the facility is placed in service. Otherwise, the tax equity investor will be unable to share in the investment tax credit. (See "Partnership Flips: Structures and Issues" in the February 2021 NewsWire.)
A sale-leaseback — another form of tax equity transaction — could be put in place within three months after the facility is placed in service. Another potential structure is an inverted lease where the tax credits move to a tax equity investor at a stepped up tax basis while the depreciation remains with the semiconductor company. (For more detail on sale-leasebacks and inverted leases, see "Solar Tax Equity Structures" in the December 2021 NewsWire.)
However, one challenge with raising tax equity is the limited time the tax credit is available. It can take several years for the tax equity market to warm to a new market segment.