Does a fabless semiconductor company's production-testing of chips made by contract foundries count as manufacturing for the New York investment tax credit?

Plain-English summary

Standard Microsystems Corporation, headquartered in Hauppauge, New York, designs and supplies semiconductors. It is a fabless provider: it uses third-party contract foundries and assemblers to make wafers, cut them into die, and assemble them into packaged devices, all to its specifications. It then runs a Manufacturing Production Test Process on the packaged devices and asked whether that testing is production of goods by manufacturing for the section 210.12 investment tax credit.

The Department held it is. The testing is a component of manufacturing the semiconductors: the manufacture is not complete until the packaged devices pass the test process, and the acceptable devices are the finished products. That the foundries and assemblers (not Standard) make the wafers/die/packages does not negate that the test process is part of producing the finished goods -- it is like the quality-control activities treated as manufacturing in TSB-M-87(5)C. So the test process is production of goods by manufacturing under section 210.12(b)(ii)(A), and equipment and buildings principally used in it (Regulations section 5-2.4(c)), if they otherwise meet section 210.12(b), qualify for the ITC.

What this means for you

Fabless does not forfeit manufacturing status

Outsourcing the wafer fabrication and assembly to contract foundries does not disqualify your in-house production testing from being "manufacturing" for the ITC. The product is not a finished good until it passes your test process, so that process is part of manufacturing.

Quality-control testing can be manufacturing

Final production testing / quality control that determines which units are acceptable finished products is treated as part of the manufacturing process (TSB-M-87(5)C). Equipment and buildings principally used in it can be ITC-eligible.

Still meet the other ITC conditions

The test-process property must still be principally used in production (Regulations section 5-2.4(c)) and meet the other section 210.12(b) requirements before the credit is allowed.

Common questions

Q: Can a fabless semiconductor company claim the ITC on its test equipment?
A: Yes. Its production test process is manufacturing under section 210.12(b)(ii)(A), so equipment and buildings principally used in it can qualify, even though contract foundries make the chips.

Q: Why is testing considered manufacturing?
A: The manufacture is not complete until the devices pass testing; the acceptable devices are the finished goods. The testing is like the quality-control activities treated as manufacturing in TSB-M-87(5)C.

Q: Does outsourcing fabrication matter?
A: No. That the foundries and assemblers make the wafers, die, and packages does not negate that the company's test process is part of producing the finished goods.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 210.12 (Article 9-A investment tax credit)
- Tax Law section 210.12(b)(ii)(A) (production of goods by manufacturing, processing or assembling)
- Article 9-A Regulations section 5-2.4(c) (property principally used in production of goods)
- TSB-M-87(5)C (quality control as part of manufacturing)
- Standard Microsystems Corporation, TSB-A-04(10)C (May 24, 2004)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_2004.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a04_10c.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-04(10)C
Corporation Tax
May 24, 2004

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C031229B

On December 29, 2003, a Petition for Advisory Opinion was received from Standard
Microsystems Corporation, c/o Weiser LLP, David Schmutter, CPA, Esq., 3000 Marcus Avenue,
Lake Success, New York 11042.
The issue raised by Petitioner, Standard Microsystems Corporation, is whether its
Manufacturing Production Test Process, as described below, constitutes the production of goods by
manufacturing, processing or assembling for purposes of the investment tax credit under section
210.12 of the Tax Law.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner is a worldwide designer, manufacturer and supplier of semiconductors for the
personal computer, peripherals and embedded systems marketplaces. It sells its products to a
worldwide customer base, which includes most of the world’s leading personal computer
manufacturers. Petitioner’s semiconductors reside on the motherboards of personal computer
products sold by personal computer manufacturers.
Petitioner is headquartered in Hauppauge, New York and has operations in North America,
Taiwan, Europe, China, Korea and Japan. Its facilities are staffed with highly skilled design,
product and test engineers, as well as other semiconductor experts. Increasingly common to the
semiconductor industry, Petitioner is a fabless semiconductor provider. A fabless semiconductor
provider uses third party contract foundries and assemblers in the chip-making process to
manufacture wafers, cut the wafers into die and assemble the die into packaged semiconductor
devices that are designed in Petitioner’s facilities in New York.
Almost 100 percent of Petitioner’s packaged devices are shipped from such third party
contract manufacturers to Petitioner’s New York facility. The packaged devices are ready for
production testing. The Manufacturing Production Test Process is contractually required by
Petitioner’s customers as part of the purchase specifications, and is recognized as a necessary
process in the semiconductor industry.
The Manufacturing Production Test Process starts with the development of a Production Test
Program, which is derived from test simulations provided from the actual design of the device. The
vast majority of Petitioner’s semiconductor devices are designed in Petitioner’s facilities in
New York. The purpose of the Production Test Program is to verify the integrity of the assembly
of the die within the packaged device through parametric testing. The overall functionality of the
die itself is then verified through functional patterns and analog/digital scan vectors. Manufacturing
production testing is performed at an elevated temperature of 85°C. The Production Test Program

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is developed by Petitioner’s Test Engineering Department to run on the Automated Test Equipment
located on the Manufacturing Production Test Floor in the New York facilities.
The packaged devices received by Petitioner from the contract manufacturers are in trays and
are sealed in special moisture controlled barrier bags. The moisture controlled barrier bags are
opened and the trays containing the packaged devices are loaded into a Pick and Place Material
Handler by the production test operator. The Automated Test Equipment loads and executes the
Production Test Program while the Pick and Place Material Handler moves the untested parts to the
test site and sorts tested devices based on the final test result.
Once the packaged devices have been cycled through the Automated Test Equipment, the
packaged devices are then sorted by the Pick and Place Material Handler and separated into three
major categories in trays:
1. Acceptable Devices - Packaged devices that pass all parametric and functional testing and
can be shipped to Petitioner’s customers.
2. Parametric Failures - Packaged devices that fail the parametric testing as a result of a
package assembly issue in the manufacturing process. The parts can exhibit failure modes
such as shorted bond wires or bond wires that have not been properly connected. As a result,
these parts cannot be shipped to Petitioner’s customers and are scrapped.
3. Functional Failures - Packaged devices that fail the functional patterns or analog/digital
scan vectors in the Manufacturing Production Test Program. The parts exhibit a point defect
or some other fault at the die level and cannot be shipped to Petitioner’s customers and are
scrapped.
The packaged devices that have been determined to be acceptable devices are then inspected
on a Lead Scanning System to verify the integrity of the leads (QFP-Quad Flat Packages), or solder
balls (BGA-Ball Grid Array), prior to final boxing and shipment to customers. This is performed
on a sample basis on each lot and ensures that the leads or solder balls have not been damaged
during the Manufacturing Production Test Process.
Some of Petitioner’s products contain on-board flash memory that can be used to contain
customer specific software code. This code enables a single part type to be customized for many
customers and multiple board applications. A packaged device of this type would first be tested by
the Production Test Program. The packaged devices which pass this test would then be further
manufactured on Petitioner’s Manufacturing Production Test Floor in New York by programming
individual customer specific code into the flash memory.
To complete the Manufacturing Production Test Process, acceptable packaged devices are
sealed in moisture resistant barrier bags, bubble wrapped, boxed, labeled and marked. Before,
shipping, most of Petitioner’s finished goods inventory is maintained in Hauppauge, New York.

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A typical semiconductor test system includes the Production Test Program, Automated Test
Equipment, Pick and Place Material Handler and Lead Scanning Equipment. Each piece of
Automated Test Equipment was purchased at a cost of approximately $1.0 million, and each Pick
and Place Material Handler costs approximately $250,000. The production test process is conducted
in a clean room environment that requires control of ambient temperature and humidity as well as
static proof flooring. Equipment technicians, test engineers and production test operators are
required to wear static proof garments and footwear while on the production test floor. The
Manufacturing Production Test Process is conducted twenty-four hours a day, in three eight hour
shifts, seven days a week. Petitioner has over 125 employees supporting the Manufacturing
Production Test Process. This process along with final packaging represents approximately
20 percent of the total cost of the product.
The following is a detailed description of the quality assurance function.
Petitioner maintains a Quality Assurance Department separate from the Manufacturing
Production Test Department. It is the responsibility of the Quality Assurance Department to monitor
the quality level of the product being produced on the Manufacturing Production Test Floor. This
is accomplished through the Outgoing Quality Assurance Program that periodically audits material
on the Manufacturing Production Test Floor. Additional responsibilities of the Quality Assurance
Department include monitoring critical foundry and assembly parameters at Petitioner’s suppliers.
Statistical Process Control plays an important role and has been implemented to ensure that all
critical parameters from the contract foundries, contract assemblers and Petitioner’s Manufacturing
Production Test Floor are in control. In addition to the above, Manufacturing Production Test Floor
yields, utilization and efficiency are closely monitored for maximum performance.
Applicable law and regulations
Section 210.12 of the Tax Law contains the provisions for the investment tax credit, and
provides, in part:
(a) A taxpayer shall be allowed a credit, to be computed as hereinafter provided,
against the tax imposed by this article. The amount of the credit shall be the percent
provided for hereinbelow of the investment credit base. The investment credit base is the
cost or other basis for federal income tax purposes of tangible personal property and other
tangible property, including buildings and structural components of buildings, described in
paragraph (b) of this subdivision....
(b)(i) A credit shall be allowed under this subdivision with respect to tangible
personal property and other tangible property, including buildings and structural components
of buildings, which are: depreciable pursuant to section one hundred sixty-seven of the
internal revenue code, have a useful life of four years or more, are acquired by purchase as

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defined in section one hundred seventy-nine (d) of the internal revenue code, have a situs in
this state and are (A) principally used by the taxpayer in the production of goods by
manufacturing, processing, assembling, ...
(ii) For purposes of this paragraph, the following definitions shall apply –
(A) Manufacturing shall mean the process of working raw materials into wares
suitable for use or which gives new shapes, new quality or new combinations to matter
which already has gone through some artificial process by the use of machinery, tools,
appliances and other similar equipment. Property used in the production of goods shall
include machinery, equipment or other tangible property which is principally used in the
repair and service of other machinery, equipment or other tangible property used principally
in the production of goods and shall include all facilities used in the production operation,
including storage of material to be used in production and of the products that are produced.
Section 5-2.4(c) of the Business Franchise Tax Regulations (Article 9-A Regulations),
contains the definition of the term principally used, and provides as follows:
The term principally used means more than 50 percent. A building or addition to a
building is principally used in production where more than 50 percent of its usable business
floor space is used in storage and production. Floor space used for bathrooms, cafeterias and
lounges is not usable business floor space. Space used for offices, accounting, sales and
distribution is not used in production. Dual purpose machinery is principally used in
production when it is used in production more than 50 percent of its operating time.
Opinion
Pursuant to section 210.12(a) of the Tax Law, an investment tax credit is allowed with
respect to tangible personal property and other tangible property, including buildings and structural
components of buildings, which are principally used by the taxpayer in the production of goods by
manufacturing, processing, assembling, etc., if such property meets the other requirements of section
210.12(b) of the Tax Law. For purposes of section 210.12 of the Tax Law, manufacturing means
the process of working raw materials into wares suitable for use or which gives new shapes, new
quality or new combinations to matter which already has gone through some artificial process by
the use of machinery, tools, appliances and other similar equipment. Property used in the production
of goods shall include all facilities used in the production operation, including storage of the
products that are produced.
In Matter of the Petition of Hand Assembly and Packaging, Inc., and Matter of Your Mail
Sack, Inc., Dec Tax AppTrib, August 30, 1990, the issue was whether a glueing machine and shrink
wrap machine were principally used in the production of goods by manufacturing, processing,

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assembling, etc., for purposes of the investment tax credit under section 210.12 of the Tax Law. The
Tribunal considered “what is the final product, i.e., the goods, produced by the manufacturing and
assembly process,” and held that the glueing machine and shrink wrap machine were principally
used in the production of goods by manufacturing and assembly. The Tribunal found that “without
the function of the glueing machine, the products would not be finished.” Moreover, “the final
product manufactured is the whole item which is finally transferred to the purchaser.” With respect
to the shrink wrap machine, the Tribunal found that “the shrink wrap becomes an integral part of
the final product being sold and, therefore, the machine used to apply the wrap is part of the
manufacturing process.”
Technical Services Bureau Memorandum entitled Investment Tax Credit for Computers and
Computer-Related Equipment, May 15, 1987, TSB-M-87(5)C, explains how to determine whether
computers and computer-related equipment are principally used in the production of goods
qualifying for the investment tax credit under section 210.12 of the Tax Law. It includes the
following as one general example:
Corporation C is an electronics manufacturer that makes printed circuit boards. A computer
is used to run the drill press that plots the points to be drilled for insertion of the various
electronic components of the board. After the board is wave-soldered, another computer,
using a test pin fixture, checks each component on the board and prints out locations of
faulty components. Both computers would qualify for the investment tax credit.
In this case, Petitioner is a designer, manufacturer and supplier of semiconductor devices for
the personal computer, peripherals and embedded systems marketplaces. It sells its products to
personal computer manufacturers. Petitioner states that the majority of its semiconductor devices
are designed in its facilities in New York. For the chip-making process, Petitioner uses third party
contract foundries and assemblers to manufacture wafers, cut the wafers into die and assemble the
die into packaged devices. The packaged devices are shipped from the contractors to Petitioner’s
facilities in New York for production testing before the semiconductor devices are considered a
finished product ready for sale and shipment. Petitioner’s Manufacturing Production Test Process
is contractually required by Petitioner’s customers as part of the purchase specifications of the
semiconductor devices produced, and is the final stage of the manufacturing process.
The Manufacturing Production Test Process starts with the development of a Production Test
Program which is derived from test simulations provided from the actual design of the devices
which are designed in Petitioner’s New York facilities. The purpose of the Production Test Program
is to verify the integrity of the assembly of the die within the packaged device through parametric
testing. Then the overall functionality of the die itself is then verified. The packaged devices that
are determined to be acceptable devices are then inspected on a Lead Scanning System on a sample
basis on each lot to verify the integrity of the leads or solder balls. In some cases, some of
Petitioner’s devices contain on-board flash memory that can be used to contain customer specific

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software code. After being tested by the Production Test Program, this type of device will also be
programmed to insert the individual customer specific code into the flash memory. After the
completion of all of these activities, the acceptable packaged semiconductor devices are the finished
goods ready to be boxed for shipment. These semiconductor devices are sealed in moisture resistant
barrier bags, bubble wrapped, boxed, labeled, marked and shipped to Petitioner’s customers. Prior
to shipment, most of the finished goods inventory is maintained in Petitioner’s New York facilities.
Following Hand Assembly, supra, and TSB-M-87(5)C, supra, Petitioner’s Manufacturing
Production Test Process that Petitioner performs on the packaged devices that were made by
contracting foundries and assemblers according to Petitioner’s specifications, is a component of the
process of manufacturing the semiconductor devices that Petitioner sells to its customers. The
manufacture of the semiconductor devices is not complete until the packaged devices have gone
through the Manufacturing Production Test Process, and the acceptable packaged devices are the
semiconductor devices that constitute the finished products. The fact that Petitioner contracts with
foundries and assemblers to produce the wafers, cut them into die and assemble the die into
packaged devices, pursuant to Petitioner’s specifications as designed in Petitioner’s facilities, before
Petitioner conducts the Manufacturing Production Test Process on the packaged devices, does not
negate the fact that Petitioner’s activities with respect to the Manufacturing Production Test Process
are similar to the quality control activities contemplated in the general example describing
Corporation C in TSB-M-87(5)C, supra, and are part of the manufacturing process of producing the
finished product, the acceptable semiconductor devices. Accordingly, Petitioner’s Manufacturing
Production Test Process constitutes the production of goods by manufacturing within the meaning
of section 210.12(b)(ii)(A) of the Tax Law.
If the equipment used in the Manufacturing Production Test Process and any buildings, or
structural components of buildings, are principally used, as described in section 5-2.4(c) of the
Article 9-A Regulations, by Petitioner in the production of goods, and the equipment and buildings,
or structural components of buildings, otherwise meet the requirements of section 210.12(b) of the
Tax Law, such property will qualify for the investment tax credit under section 210.12 of the Tax
Law.

DATED: May 24, 2004

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.