What the Inflation Reduction and CHIPS acts could mean for US importers

Editor: Mary Van Leuven, J.D., LL.M.

A pair of new U.S. laws will invest potentially hundreds of billions of dollars in spending and tax breaks in an effort to accelerate private investment, address supply chain and national security concerns, and reduce carbon emissions. The Inflation Reduction Act of 2022, P.L. 117-169, and the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act), P.L. 117-167, offer incentives for investments in clean energy production and semiconductor manufacturing in the United States. The two laws provide potentially significant benefits to U.S. importers. However, because of various intersecting business and compliance concerns, it remains to be seen whether these significant pieces of legislation will result in an immediate change to the current trade landscape.

While the onshoring and reshoring incentives under the CHIPS Act may present an opportunity for importers and manufacturers of semiconductors (and related technology) to open factories for production in the United States, the significant investment needed to relocate to the United States and the requirement to cut ties with China may prove too burdensome for all but the largest chip manufacturers. Further, under the Inflation Reduction Act, several bonus clean energy tax incentives are conditioned upon the taxpayer’s compliance with the Buy America Act (BAA), often a complicated and costly endeavor for companies that are unfamiliar with the BAA.

At the same time, U.S. allies in the European Union (EU) argue that the protectionist underpinnings of the Inflation Reduction and CHIPS acts are potentially discriminatory and a reversal of the historical trend toward globalization of supply chains. As a result, taxpayers should closely monitor the response by U.S. trading partners to mitigate potential actions and longterm consequences while continuing to consider more traditional duty and tariff mitigation strategies.

The following discussion considers what the Inflation Reduction and CHIPS acts could mean for U.S. importers, beginning with the CHIPS Act.

Incentives and requirements under the CHIPS Act

The Section 301 tariffs on Chinese-origin goods and the supply chain shortages exacerbated by the pandemic continue to beleaguer the automotive, manufacturing, technology, and solar industries, which not only bear the brunt of the tariffs but have also been acutely affected by semiconductor supply shortages. As the United States passes the four-year anniversary of the Section 301 tariffs assessed on many Chinese-origin goods, companies importing semiconductors and goods incorporating semiconductors have reluctantly accepted the tariffs as a cost of doing business, due to China’s dominance in the industry. Few U.S. companies have the means or skilled workforce to bring manufacturing or research and development in house or even to find new suppliers, and the significant investment of time and money required to manufacture semiconductors in the United States has deterred many would-be producers from opening facilities, which the CHIPS Act aims to correct.

Passed in August 2022, the CHIPS Act incentivizes manufacturers to bring semiconductor manufacturing to the United States to create more skilled manufacturing jobs and make the United States self-sufficient and independent of China. Among a variety of science and technology incentive programs, Section 102(a) of the CHIPS Act contributes $50 billion allocated over five years to the “CHIPS for America Fund,” specifically for research and development and workforce development conducted in the United States. Within this $50 billion allocation, $39 billion will be dedicated to incentive programs, with $2 billion of that amount dedicated to legacy chip production for the advancement of U.S. economic and national security interests and production of semiconductors necessary for the military, automotive, and other critical industries (CHIPS Act, §102(a)(3)).

The remaining $11 billion is dedicated to research and development and workforce development, including funding programs such as the national semiconductor technology center, the National Advanced Packaging Manufacturing Program, and other workforce development programs (CHIPS Act, §102(a)).

In addition, Section 103 of the CHIPS Act seeks to restrict the continued investment in and expansion of semiconductor manufacturing in China by prohibiting incentive recipients from participating in any significant transaction involving the material expansion of semiconductor manufacturing capacity in China, or any other country of concern, for 10 years after receiving the incentive. Although the prohibition does not extend to existing facilities or equipment, it may be difficult to comply for those manufacturers looking to grow their facilities but unable to immediately transfer their supply chains out of China (see CHIPS Act, §103(b)(5)). Further, the technologies subject to the prohibition and the countries of concern may continue to be updated at the discretion of the secretaries of Defense and State and the director of national intelligence (CHIPS Act, §103(a)(7)).

Domestic content requirements of the Inflation Reduction Act

Turning to the Inflation Reduction Act, the legislation makes significant investments in clean energy production, such as providing tax credits aimed at reducing carbon emissions. The law creates new tax incentives and investment tax credits and modifies existing ones that historically have supported investment in wind, solar, and other renewable energy infrastructure projects. Of special importance to U.S. importers are the law’s Buy America provisions.

In addition to base investment tax credits (ITCs) and energy production tax credits (PTCs) for qualifying projects, many of the clean energy tax provisions offer bonus credits to projects that meet certain domestic content requirements. (Other factors in receiving the credits include the location of the project, wages paid, and apprenticeship requirements.) Specifically, Inflation Reduction Act Sections 13101, 13102, 13701, and 13702 provide domestic content requirements that taxpayers must satisfy to qualify for bonus tax credits. Notably, IRC Secs. 45(b)(9)(A) and 45Y(g)(11)(A) provide for a 10% domestic content credit if the domestic content requirements are satisfied, while Secs. 48(a)(12)(C) and 48E(a)(3)(B) provide for a domestic content bonus credit reduction from 10% to 2% if certain other requirements are not satisfied.

In general, these sections provide that, with respect to a qualified facility, the domestic content requirement is satisfied if the taxpayer certifies to the secretary of the Treasury, at such time and in such form and manner as the secretary may prescribe, that any steel, iron, or manufactured product that is a component of the facility (upon completion of construction) was produced in the United States, as determined under the Federal Transit Administration’s “Buy America” requirements at 49 C.F.R. Section 661. While Buy America generally refers to several statutes and regulations requiring that certain goods purchased with federal funds be manufactured primarily in the United States, the specific Buy America provisions applicable here are those of the Federal Transit Administration.

To qualify for the ITC or PTC domestic content bonus credit, taxpayers would be required to certify that the iron, steel, and manufactured products that are components of power-generating facilities are produced domestically. According to Sec. 45(b)(9) (B), all iron and steel and at least 40% of the cost of all manufactured products used to build the project would have to be produced in the United States. Thus, for iron and steel products, taxpayers must look to the Federal Transit Administration’s Buy America regulations (specifically, 49 C.F.R. §661.5) to determine whether the iron and steel products are “produced in the United States.” For manufactured products, however, no additional clarity has been provided on how to determine whether a “manufactured product” is to be considered “mined, produced, or manufactured in the United States.”

The Inflation Reduction Act permits a waiver of domestic preference requirements as a condition for receiving tax benefits when domestic products would increase the overall cost of the facility by more than 25% and when satisfactory domestic products are not available, which are exceptions common in existing domestic preference laws (see Sec. 45(b)(10)(D)).

Global response to the CHIPS and Inflation Reduction acts

U.S. importers also need to be aware of the global reaction to the two new laws. Following passage of the Inflation Reduction Act, some EU leaders have taken the position that Buy America requirements are potentially discriminatory against EU companies (particularly in the electric vehicle sector). Similarly, the CHIPS Act has also created concerns among those who view the law as a potential subsidy, with China and South Korea announcing their intentions to launch semiconductor manufacturing incentives of their own. As the U.S. implementation of each act continues, countries claiming the acts are illegal subsidies could potentially lodge challenges with the World Trade Organization. U.S. importers should closely monitor the response by U.S. trading partners.

Duty and tariff mitigation strategies also an option

To supplement the incentives offered by the Inflation Reduction and CHIPS acts, importers of relevant products may also be prudent to shore up their supply chain strategies with traditional duty mitigation approaches to reduce costs and increase cash flow. For instance, importers may be able to mitigate exposure to Section 301 tariffs by confirming the correct classification of their current products to evaluate whether those items continue to be subject to Section 301 tariffs. In addition, while the Office of the U.S. Trade Representative has announced only limited extensions of Section 301 exclusions, there may be an opportunity to benefit under the remaining exclusions that have been extended through Sept. 30, 2023 (see 87 Fed. Reg. 78187).

There may also be opportunities for importers to establish or utilize a foreign trade zone (FTZ), which could offer cash flow benefits while simultaneously decreasing exposure to the Section 301 tariffs. An FTZ may be established by an importer for a variety of reasons, the most relevant here being the intention to manufacture within the FTZ. The FTZ must be established per Customs regulations and, in effect, creates an area outside the customs territory of the United States. As goods enter an FTZ, they generally enter duty-free and may be further manufactured or stored until they are removed from the FTZ and enter into U.S. commerce, at which point duty would be owed on the goods. Many importers also consolidate entries into a zone, thereby saving on harbor maintenance and merchandise processing fees.

For many items manufactured in the FTZ, goods from China could potentially enter duty-free, be manufactured and substantially transformed into an item with a U.S. origin, and exit the FTZ into U.S. commerce with no duty assessed. Additionally, goods may enter a zone for manufacturing and be subsequently exported outside the customs territory of the United States. Because the goods would never enter U.S. commerce, no U.S. duty would be owed. Thus, FTZs could result in significant cost savings for domestic producers and global distributors alike.

The applicability of FTZ incentives under the CHIPS Act may be further defined as Treasury publishes implementing regulations. Currently, under the CHIPS Act, manufacturers may benefit from the incentives if they remain within the jurisdiction of the government entity granting the incentive (15 U.S.C. §4651(3)(A)). The FTZ regulations further specify that a zone continues to be subject to federal, state, and local laws; however, the CHIPS Act is silent as to the applicability of incentives to manufacturing in an FTZ. As Treasury releases implementing regulations, importers may wish to monitor the availability of incentives that could complement current trade strategies.

Lastly, importers should consider the potential application of duty drawback, where importers can recover up to 99% of paid import duties, including Section 301 duties, on goods that are subsequently exported from the United States. The most common forms are manufacturing drawback (i.e., duty-paid imported goods are incorporated into products manufactured in the United States and subsequently exported) and unused merchandise drawback (i.e., merchandise imported into the United States is exported without further processing).

Each potential opportunity should be carefully evaluated to determine the potential return on investment, the availability of incentives under the CHIPS Act, and the cost of program setup and ongoing maintenance.

Careful planning needed

The CHIPS Act and Inflation Reduction Act provide potentially significant benefits to U.S. importers and producers. Thus, companies should begin evaluating whether and how to modify existing supply chains and trade compliance programs to realize those benefits. This calculus should weigh the potential global response to the new laws as well as any additional restrictions and incremental costs of compliance. Supplemental tariff reduction strategies should also be considered to further mitigate costs. For importers that are able to successfully integrate tried-and-tested tariff strategies along with these new incentives into their supply chains, the potential benefit can be significant, particularly for importers operating in industries hardest hit by the current high tariff levels.

Editor notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C. Contributors are members of or associated with KPMG LLP. For additional information about these items, contact Van Leuven at 202-533-4750 or mvanleuven@kpmg.com.

The information in these articles is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained in these articles is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. The articles represent the views of the authors only, and do not necessarily represent the views or professional advice of KPMG LLP.