CHIPS Act Guardrails: Congressional Efforts to Limit Investment in China

Nineteen months after Congress first authorized the CHIPS for America Fund, and following months of unproductive conference committee negotiations, the Senate has moved Congress closer to funding a slimmed down—albeit still massive—program to aid the expansion of domestic semiconductor manufacturing.

On July 19, the Senate held the first procedural vote to begin consideration of the CHIPS Act funding package. We expect the Senate to pass the package next week, unless members agree to speed up consideration of the package. The House is expected to consider the package shortly thereafter.

Known informally as the CHIPS+ package, the revised legislation includes $37 billion for semiconductor industry manufacturing grants, $11 billion for “advanced microelectronics” research and development, and $2 billion for “mature technology nodes.” The legislation also includes an “advanced manufacturing investment credit” worth up to 25% of the cost of qualifying property for semiconductor manufacturing or the manufacturing of semiconductor tooling equipment. Taxpayers may elect to receive the credit as a payment from the Treasury Department, rather than a credit. Construction of eligible property must begin before January 1, 2027 (but eligible property must be placed into service after December 31, 2022).

Many of the contentious provisions considered over the last year-and-a-half have been stripped from the CHIPS+ package. However, one of the hot-button issues—how to ensure CHIPS Act funding does not benefit China—will be included, though closely tailored to funded projects, rather than as a broad investment restriction, as Congress initially proposed.”

Specifically, dubbed the “guardrails provision,” a provision in the updated text of the bill requires a “covered entity” seeking CHIPS Act funding to enter into an agreement (dubbed a “guardrail agreement”) with the Commerce Secretary stipulating that, for a 10-year period beginning on the date of a CHIPS Act award, the “covered entity” will not engage in any “significant transaction” involving the “material expansion of semiconductor manufacturing” in China or any other foreign country of concern. (The bill defines a “foreign country of concern” to include China, North Korea, Russia, and Iran under 10 USC § 4872(d)(2), as well as any country the Commerce Secretary, in consultation with the secretaries of Defense and State, and the Director of National Intelligence, determines to be engaged in conduct that is detrimental to the national security of foreign policy of the United States.)

The legislation provides substantial latitude in determining a “significant transaction,” forcing the parties to negotiate that term as part of the guardrail agreement .

Excluded from the concept of a “significant transaction” are investments in legacy chips—both with respect to investments in facilities or equipment to manufacture legacy chips and to investments expanding semiconductor manufacturing capacity to produce legacy chips predominantly for the market of a foreign country of concern. The bill defines legacy chips as, for logic, the 28 nanometer generation or older, and for memory, analog and packaging, any legacy generation relative to that, as determined by the Secretary of Commerce in consultation with the Secretary of Defense and Director of National Intelligence. Chips that are critical to national security are excluded from being considered legacy chips.

The updated text of the bill builds on the definition of a “covered entity” at 15 USC § 4651 to include nonprofit entities and to expand the scope of activities covered. As a result, a “covered entity” includes nonprofit entities, private entities or a consortium of public and private entities with a “demonstrated ability to substantially finance, construct, expand, or modernize a facility” related to the “fabrication, assembly, testing, advanced packaging, production, or research and development of semiconductors, materials used to manufacture semiconductors, or semiconductor manufacturing equipment.” The updated text of the bill also expands the definition of a “covered entity” to include the covered entity’s “affiliated group” under section 1504(a) of the tax code, “without regard to section 1504(b)(3).”

Under section 1504 of the tax code, an “affiliated group” is one or more chains of includible corporations connected through stock ownership with a common parent corporation, if:

• The common parent directly owns stock possessing at least 80% of the total voting power of at least one of the other includible corporations and has a value equal to at least 80% of the total value of the stock of the corporation; and
• Stock meeting the 80% test in each includible corporation other than the common parent is owned directly by one or more of the other includible corporations.

Typically, “foreign corporations” are not considered an “includable corporation” for purposes of an “affiliated group.” In this case, however, the bill disregards the foreign corporation exclusion under section 1504(b)(3), and thus, foreign companies would be considered within the CHIPS Act definition of an “affiliated group.” As a result, a foreign parent company that meets the “affiliated group” test outlined above would be bound by whatever guardrail agreement its subsidiary enters into with the Commerce Secretary. Violations of the agreement could result in the claw back of all CHIPS Act funding and the investment tax credit.

While a broader outbound investment review proposal, championed by Sens. Bob Casey (D-PA) and John Cornyn (R-TX), that would have created a Committee on National Critical Capabilities to review outbound US investments, did not make it into the final package, Sen. Cornyn recently said Commerce Secretary Gina Raimondo may create an administrative rule requiring firms to notify the Commerce Department of major investments in China. Should those efforts fail, the original sponsors may try to get the bill added to the Senate’s version of the National Defense Authorization Act (NDAA), which the Senate will consider after the August recess. Although the current package includes “guardrails” for CHIPS Act beneficiaries, we expect congressional interest in an outbound investment screening mechanism to continue after the CHIPS+ Act is signed into law.

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.