It has been a tough few years.
Between an unprecedented and painful economic contraction due to the COVID-19 pandemic and the subsequent supply-side shocks and inflationary pressures, businesses are eager to find ways to save money and improve their bottom line by any means, while also seeking to innovate to better perform in an ever-increasingly competitive environment. For many businesses, this includes renewed exploration of local, state, and federal incentives to help reduce tax liabilities. For a large number of industries, research and development (R&D) tax credits may provide an effective tool in recouping crucially needed cash spent on developing new or improved products or processes. Better still, many companies can take advantage of both federal and state R&D programs concurrently to enjoy even greater benefits.
It has been a tough few years.
At the end of June 2022 the new Circular Bio-based Europe Joint Undertaking (CBE-JU) announced a €2 billion partnership between the European Union and the Bio-based Industries Consortium (BIC), funding projects with cash grants which advance the competitive circular bio-based industries in Europe.
The time to reverse the changes made by the 2017 Tax Cuts and Jobs Act (TCJA) is quickly running out. These changes force companies to begin amortizing research and development expenses over a period of 5 years rather than deduct them entirely in the year in which it was claimed. A measure to help offset the revenue lost from cutting the corporate tax rate from 35% to 21%, the change to I.R.C. section 174 removes the option of a current year deduction in full.
This week farmers, growers, or foresters in England will be able to apply for a portion of £8 million in cash grants for project costs that aim to drive the development and demonstration of solutions that have the potential to substantially improve overall productivity, profitability, and environmental sustainability and help the sector mitigate greenhouse gas emissions and adapt to the effects of climate change.
For most tax return preparers, the end of the day on October 15th marks a joyous occasion—the end of a frequently grueling tax filing season and a much-needed reprieve before the cycle begins again in January. Unfortunately, the Service cut the party short in the world of R&D tax credits with its issuance of a new memorandum. This memorandum, published by the Internal Revenue Service Office of Chief Counsel on October 15th, issued new guidance regarding what required information a taxpayer must now include in its claim for an R&D tax credit.
On February 11, 2021, the tax court issued a new memorandum opinion in Little Sandy Coal Company v. Commissioner. In this case, the taxpayer—a shipbuilding subsidiary—was denied its claimed R&D credit based on the development of 11 vessels by the IRS. After receiving its notice of deficiency, the taxpayer brought suit in the tax court seeking a redetermination. For the sake of expediency, the parties agreed to limit review to just 4 of the 11 projects at issue; the court’s opinion addressed only two of these—the Apex Tanker and Dry Dock Projects.
On January 11, 2021, the tax court issued a new opinion concerning the application of the Federal Credit For Increasing Research Activities. In Tangel v. Commissioner, the taxpayer—a designer and manufacturer of integrated controls and switchgears utilized in power generation—was denied its claimed R&D credit by the IRS. After receiving its notice of deficiency, the taxpayer brought suit in the tax court seeking a redetermination. For procedural reasons, the court limited its opinion and ruling to a single project performed under contract by the taxpayer. The Service argued that the research performed by the taxpayer under this third-party contract was “funded” as defined under section 41 of the code. Specifically, the government contended that under the contract, the taxpayer retained no substantial rights in the results of the research.
Updated Dec 28, 2020
Officially signed into law on December 27th, the recent omnibus Covid-19 relief bill H.R. 133 reversed the Service’s previous stance regarding the deductibility of PPP-related expenditures. Among the bill’s voluminous provisions, section 276 (beginning on page 2004) makes clear that no deduction shall be denied as a result of a PPP loan’s forgiveness. Consequently, a taxpayer’s potential federal research credit will be unaffected as a result of the taxpayer’s utilization of a PPP loan and subsequent loan forgiveness. This protection is extended both to loans under the original Paycheck Protection Program as well as future loans to be granted under the bill’s expanded program.
Populous Holdings, Inc. v. Commissioner marks a highly favorable case decision for taxpayers claiming the research and development tax credit in general, and for the architecture industry in particular. In Populous Holdings, the court granted summary judgment in favor of the architectural design services taxpayer, holding that all five representative contracts at issue in the case were unfunded and therefore eligible for inclusion in calculating the tax credit.
A recent opinion by the California Office of Tax Appeals (OTA) ruling against an apparel industry taxpayer demonstrates a continuing trend by federal and state taxing authorities to focus on a taxpayer’s ability to substantiate adherence to meeting each element of the four-part test under section 41—most notably the process of experimentation requirement. In addition, the ruling indicates increasing scrutiny regarding a project’s activities having been undertaken for a permitted purpose.