Spring 2015 issue of Horizons

FEATURE | No White Lab Coats Needed! Your Company Can Take Advantage of the R&E Tax Credit

“Research” Defined “We don’t have scientists wearing white lab coats using beakers and test tubes. Improving our products and processes is a normal part of our company culture. How can this be research?” This is a common reaction when introducing the R&E tax credit to companies. People often think of research as needing to revolutionize an industry or redefine a technology to qualify for a research credit. While these activities are indeed research in the traditional sense, the innovation no longer has to pass the discovery test to be eligible for the credit. When looking at research activities as possibly qualifying for the tax credit, the U.S. Tax Code’s current requirements have a unique definition of research and experimentation. A four-part test must be met for projects and activities to be eligible for the research credit. ∙ The first, known as the “Business Component” test, references the six project types — product, process, formula, technique, software or invention.

∙ The final requirement calls for the existence of a process of experimentation, which can include: modeling, simulation and a systematic process of trial and error.

Activities that Do Not Qualify for the Credit ∙ Activities after commercial production

∙ Adaptation of existing research

∙ Duplication of existing research

∙ Surveys and studies

∙ Research performed outside the U.S.

∙ Research in the social sciences

∙ Research deemed to be funded ( A research project is deemed to be funded if the taxpayer is not at economic risk for the research or does not retain substantial rights to the outcome of the research. ) Examples of Experimentation According to the definitions referenced above, the concept of experimentation is evidenced by a variety of everyday activities within various industries. For example, companies that develop and/or improve proprietary products, but outsource the manufacturing of these products, can claim the credit just for the product development portion. Conversely, many contract manufacturing and “job shops” do not design the products they produce, but use trial and error to develop or improve the process needed to meet their customers’ specifications. These specifications might include dimensional requirements, metallurgical or mechanical properties or other factors related to function, performance, quality and/or reliability.

∙ The second requires the existence of uncertainty in one of three categories:

– Capability (Can we do it?)

– Method (How do we do it?)

– The appropriateness of the design (What will it look like?)

The ultimate success or failure of the project is not relevant.

∙ The third requirement is that the research must be technological in nature; fundamentally relying on the principles of the physical or biological sciences, engineering or computer science.

page 20 | horizons Spring 2015