The factory has so far produced the Passat, but has been competing for the new crossover SUV against a VW plant in Mexico. The battle to get the SUV was at the center of a unionization vote in February. After being defeated, the United Auto Workers formed a local last week that is not recognized by the carmaker.
VW Chairman Martin Winterkorn called the capacity expansion "a strong signal of the long-term commitment of Volkswagen to the region."
"This vehicle will be a real American -- large, attractive and with many high-tech features on board. Above all, the midsize SUV will be made by real Americans," he said.
The company hopes to put the SUV into production by 2016, with the goal of selling 800,000 SUVs by 2018. The company will also build a a research and development center taking the total investment to $600 million.
"This vehicle will play a big role in our success here in America," said Christian Koch, head of VW's Chattanooga operations.
The new SUV will be based on the CrossBlue concept vehicle showed at the 2013 North American International Auto Show in Detroit. VW has said that the new SUV is being developed keeping in mind the North American market but hasn't given further details about its design.