New Changes in R&D Tax Break Will Benefit Many Businesses

Posted by Jeffrey Feingold on 09.23.13

The U.S. Government has proposed new rules for the R&D tax credit that will make more businesses eligible for tax breaks and clear up some of the areas of conflict between the IRS and the taxpayers. The research tax credit will be applicable to supply and production costs if approved. The proposed rules changes are open for public comment, and the IRS has scheduled a hearing on January 8, 2014.

Two of these changes are significant and far reaching. The first is of great importance to manufacturers and food processors. Food processors and agriculture might benefit from these proposed changes if they could claim the tax breaks as they develop new products. For example, if a peanut butter producer creates a new way to crush peanuts for peanut butter they could claim research tax breaks for production costs associated with it as they test the new manufacturing process. These testing costs could be deductible as experimental research. Many food producers can prosper from this.

Secondly, the Treasury Department has also proposed that the cost of a prototype qualifies even if it later sells as a completed unit. This line between prototypes and production models has often been a source of legal conflict between companies and the IRS. The government hopes to make the distinction clearer. If approved, the rules would apply to future tax filings and could not be enforced until finalized. The new rules stand to make a lot of companies happy. They will clear up a large area of disputable rules in the current law.

A good example of this conflict is the Lockheed Martin Corporation. They claimed $13.6 million of research tax credits. This aerospace company filed a lawsuit against the IRS in December, saying the IRS wrongly rejected the research tax credits that Lockheed claimed for making prototypes resulting from research on a space rocket launcher and a New York City surveillance system. The Lockheed papers which were filed with the court stated that some of the credits were claimed for prototypes which had new designs that were unproven and should therefore qualify as research. The court date is yet to be set in this case. The precedent is that in September 2012, Dow Chemical Co lost a case in U.S. appeals court involving $8 million in research tax credits. Union Carbide, a Dow company, tried to apply credits retroactively to cover the cost of supplies on a prototype that was later sold as finished goods.

There still seem to be gray areas on documentation and how to determine the costs to deduct. This ruling change may not address the fact that Germany's Bayer is facing off against the IRS over $170 million of disputed research credits spanning 17 years. The Bayer Corporation is well known for a variety of products, from aspirin to plastics to fertilizers. It calculated its qualified research expenses (QREs) using a cost center approach. The IRS is denying it. Bayer says the documentation asked for is beyond reason and is requesting that documentation be furnished only in a statistically significant sample. The numbers are significant. For tax years 1990 through 1994, the amount of the credits claimed was $80 million, a number initially agreed upon by the IRS, but now at issue. Based on the tax credit study, Bayer sought a refund for the amount of $49 million. It seems that companies requesting refunds are being looked at more closely than others.

Texas - based Trinity Industries, Inc., one of North America's largest manufacturers of transportation, construction and industrial products, is also fighting a court battle over research tax credits. They are appealing a $5 million tax credit dispute. The court rejected the government's restrictive interpretation of the law and found in favor of the taxpayer. Although the case was a win for taxpayers on some R&D Credit issues, Trinity Industries lost a significant amount of their R&D Tax Credit benefit due solely to their lack of project-level documentation.

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