Spring 2015 issue of Horizons

The Research and Experimentation (R&E) tax credit is an income tax credit that rewards companies for developing innovative solutions to many of the challenges they encounter on a daily basis. Also known as the “R&D tax credit,” or “Research tax credit,” the R&E tax credit applies to taxpayers engaged in the development and/or improvement of a product, process, formula, technique, software or invention. Expenses that may qualify for the credit include those for in-house wages and supplies, as well as those for contract research, which are costs incurred for third-party services that would have been qualified had they taken place within the company. According to a 2011 report from the United States Department of the Treasury, Office of Tax Policy, “The Research & Experimentation (R&E) tax credit encourages innovation and provides a powerful incentive for businesses to continue to invest in research projects. Investments in research and experimentation produce technological advancements that drive productivity growth and improvements in U.S. living standards. Businesses may underinvest in research, however, because they may not be able to capture the full benefit of their spending. The R&E tax credit is designed to address this underinvestment and to increase the total amount of research activity undertaken in the United States.” Using the latest available figures from 2011, R&D expenditures in the United States stood at $424 billion. This is approximately 30% of the worldwide total of over $1.4 trillion in the same year. Although a very significant percentage, the U.S. share of the global total has been steadily decreasing since 2001, when it stood at 37%. Not surprisingly, China has seen an explosive rate of growth in R&D expenditures, averaging around 20% annually in the period between 2001 and 2011, reports the National Science Foundation. This international picture defines the competitive landscape for R&D spending and is indicative of the need to continue to provide incentives to U.S. companies to keep the research spending and associated technical jobs within our shores.

The R&E tax credit has evolved substantially over the years, with significant changes and clarity coming from a variety of sources, including the U.S. Treasury Department, the judicial system and Congress. Many of these changes have been taxpayer friendly. The biggest change occurred when the Treasury Department issued Treasury Decision (TD) 9104 in 2004, which backed away from what was called “the discovery test.” At the credit’s inception, an extremely high level of innovation was needed for a taxpayer to qualify for the credit. The level of innovation needed to pass the discovery test was that the research had to expand or refine knowledge within the industry. This usually required a patent to support the position. TD 9104 removed the discovery test language, effectively lowering the “innovation bar” to where it only has to be new to the company.

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