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ation or cost recovery allowances (under secs. 167 or 168) in respect of tangible personal property used in the conduct of qualified research would be qualified research expenditures, i.e., would enter into the incremental credit computation.

The amendment made by this provision would be effective, for purposes both of computing the credit and also of computing base period research expenses, for taxable years beginning after 1983.

Change in ACRS treatment Under ACRS as enacted in ERTA, personal property used in connection with research and experimentation is classified as threeyear recovery property (sec. 168(c)2XA)). The regular investment tax credit for property in the three-year class is six percent.

Section 103(b) of the bill would remove research equipment from the three-year class. Accordingly, research equipment would constitute five-year recovery property and would be eligible for a ten-percent investment tax credit.

The amendment made by this provision would apply to property placed in service in taxable years beginning after 1983.

Increase in qualifying percentage of contract research expend

itures The bill would increase, from 65 percent to 75 percent, the percentage of a taxpayer's contract research expenditures which enter into the computation of the section 44F credit. This provision would be effective, for purposes both of computing the credit and also of computing base period research expenses, for taxable years beginning after 1983. Availability of credit to start-up corporations, partnerships, and

other joint ventures Under section 104 of the bill, all otherwise qualifying in-house and contract research expenses paid or incurred by a corporation 11 would be treated as qualified research expenses for credit purposes without regard to the trade or business test of present law. Thus, the research expenditures of a start-up corporation whose activities have not yet reached the level of constituting a trade or business (as defined for purposes of sec. 162) would be eligible for the credit. Also, the bill would make the credit available for corporate expenditures for research endeavors that are not directly related to any of the corporation's existing trades or businesses.

With respect to in-house and contract research expenses paid or incurred by a partnership, the bill would provide that, as a general rule, the trade or business test is to be applied at the partnership level without regard to the trade or business of any partner. If at the partnership level the test is met, any available credit would be apportioned among the partners in accordance with the partnership allocation rules of the Code (sec. 704). Under these rules, the allocation of partnership credits, like the allocation of partnership overall income and loss and items of income, loss, and deduction, is generally determined by the partnership agreement if the allocation has substantial economic effect; if not, the allocation is made in accordance with the partners' interests determined by taking into account all facts and circumstances.

11 For this purpose, the term corporation would not include S corporations (sec. 1361(a)), personal holding companies (sec. 542), or service organizations (sec. 414(m)(3)).

Under the bill, a partnership could elect in two cases to treat an in-house or contract research expense it has paid or incurred other than in carrying on a trade or business of the partnership as a qualified research expense. First, a partnership could so elect if each partner is a corporation;12 thus, the bill would allow corpo rate joint venturers to treat in-house and contract research expenses paid or incurred by the partnership as qualified research expenses without regard to the trade or business requirement. Second, a partnership (all of whose partners are not regular corporations) could so elect if all of the in-house or contract research expenses paid or incurred by the partnership would have satisfied the trade or business requirement as applied to each of the partners had each of the partners directly conducted the research. In either of these two cases, the qualified research expense would be treated as paid or incurred directly by the partners and would be apportioned among the partners in accordance with the Code partnership allocation rules described above.

The amendments made by this provision would be effective for taxable years beginning after 1983.

12 See note 11, supra.

b. Increased credit for corporate support of basic research at uni

versities

Present Law General rule

Under present law, a corporation 13 may take into account, for purposes of computing the section 44F credit for a taxable year, 65 percent of qualifying basic research expenditures for that year (subject to the contract research prepayment limitation). 14 Similarly, this percentage is treated as research expenditures in a base period year when calculating the credit in subsequent years.

The special rule for basic research applies only to expenditures paid or incurred pursuant to a written research agreement between the taxpayer corporation and a college or university, certain tax-exempt scientific research organizations, and certain qualified funds (organized exclusively to make basic research grants to colleges and

universities). For purposes of this special rule, the term "basic research" means any original investigation for the advancement of scientific knowledge not having a specific commercial objective. However, the term basic research does not include expenditures for any activity excluded from the section 44F definition of qualified research, e.g., expenditures for basic research in the social sciences or humanities (including the arts). Illustration of computation

Assume that a corporation makes qualified in-house research expenditures totalling $120 million in each of the years 1980, 1981, and 1982. In addition, in 1981 the corporation makes a $6 million grant to a university for qualifying basic research; all of this amount is expended by the university in that year. In 1983, the corporation makes qualified in-house research expenditures totalling $130 million and also contributes $3 million to a university for basic research pursuant to a written research agreement. The university expends 50 percent of the 1983 contribution funds during 1983 and the rest during 1984.

Under these facts, the corporation's qualified research expenditures for 1983 would equal $130 million plus 65 percent of $1.5 million ($975,000). The corporation's base period expenditures with re spect to 1983 would be the average of its qualified research expenditures for 1980, 1981, and 1982, or $121,300,000. Accordingly, the 25percent credit for 1983 would apply to the excess of total currentyear expenditures ($130,975,000) over the base period average ($121,300,000), or $9,675,000.

13 See note 11, supra.

14 If any contract research amount paid or incurred during a taxable year is attributable to qualified research to be conducted after the close of that taxable year, that amount is treated as paid or incurred in the year or years during which the qualified research is actually conducted. See note 6, supra.

Assume further that in 1984 the total of the corporation's qualified in-house research expenditures increases to $135 million, and that the corporation makes no new basic research expenditures. The corporation is treated as having qualifying basic research expenditures in 1984 equal to 65 percent of $1.5 million, or $975,000. The corporation's base period expenditures with respect to 1984 would be the average of qualified research expenditures for 1981 ($123,900,000), 1982 ($120 million), and 1983 ($130,975,000). Accordingly, under present law the 25-percent credit for 1984 would apply to the excess of current-year expenditures ($135,975,000) over the base period average ($124,958,333), or $11,016,667.

Explanation of Section 201 of the Bill Overview

Under present law, research expenditures entering into the computation of the section 44F incremental credit include 65 percent of a corporation's expenditures (including grants or contributions) pursuant to a written research agreement for basic research to be performed by universities or certain scientific research organizations. Section 201 of the bill would provide more favorable tax treatment for corporate expenditures for basic research performed at universities or at certain scientific research organizations by (1) increasing, from 65 to 75 percent, the percentage of such expenditures which is eligible for a credit; (2) applying a new 25-percent credit to the excess of the percentage amount over a fixed floor based on 1981–83 expenditures, rather than over a moving base period average; and (3) making the prepayment limitation of present law inapplicable to university basic research expenditures.

The excess credit-eligible expenditures over the fixed floor under the bill, to which the new credit would apply, would not also enter into the computation of the present-law incremental credit under section 44F. The amount of credit-eligible basic research expenditures up to the floor would remain eligible for the present-law incremental credit. Qualifying expenditures

For purposes of the new credit and the incremental credit, qualifying university basic research expenditures would be expenditures paid or incurred pursuant to a written agreement between the taxpayer corporation 15 and a university, scientific research organization, or certain other qualified organizations for basic research to be performed by the qualified organization (or by universities receiving funds through the initial recipient qualified organizations). Such corporate expenditures for university basic research would be deemed to satisfy the trade or business test (described above), whether or not the basic research is in the same field as the trade or business of the corporation.

16 The new basic research credit would not be available with respect to university basic research expenditures by corporations that are S corporations (sec. 1371(a)), personal holding companies (sec. 542), or service organizations (sec. 414(mX3)).

Under the bill, qualifying expenditures would include both grants or contributions by the corporation which constitute charitable contributions under section 170, and also payments for contract research to be performed by the university on behalf of the corpo ration. The bill would make inapplicable to university basic research expenditures the prepayment limitation of present law, under which corporate expenditures for university basic research enter into the incremental credit computation only when the university actually expends the funds for basic research.

As under present law, the term "basic research" would be defined as any original investigation for the advancement of scientific knowledge not having a specific commercial objective, other than basic research in the social sciences or humanities (including the arts) or basic research conducted outside the United States. Qualified organizations

To be eligible for a credit, the corporate expenditures must be for basic research to be conducted by a qualified organization. For this purpose, the term qualified organization generally would include colleges or universities, tax-exempt scientific research organizations, and certain qualified funds which are treated as qualified organizations under present law.

The first category of qualified organizations would consist of educational organizations that both described in section 170(b)(1)(A)(ii)16 and constitute institutions of higher education as defined in section 3304(f).17 Scientific organizations that would qualify are tax-exempt organizations that (1) are organized and operated primarily to conduct scientific research, (2) are described in section 501(c)(3) (relating to exclusively charitable, educational, scientific, etc. organizations), and (3) are not private foundations. Also, certain tax-exempt funds which qualify under present law would continue to qualify under the bill.

In addition, the bill would treat as qualified any tax-exempt organization which is organized primarily to promote scientific research by colleges or universities pursuant to written research agreements, which expends on a current basis substantially all its funds through grants and contracts for basic research by colleges and universities and which is described in either section 501(c)(3) (charitable, educational, etc. organizations) or section 501(c)(6) (trade associations).

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16 An educational organization is described in sec. 170(bX1XAXii) “if its primary function is the presentation of formal instruction and it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. The term includes institutions such as primary, secondary, preparatory, or high schools, and colleges and universities”, and includes both public and private schools (Treas. Reg. sec. 1.170A-96X1)).

17 Sec. 3304(1) defines "institution of higher education" as an educational institution which (1) admits as regular students only individuals having a certificate of graduation from a high school, or the recognized equivalent of such a certificate; (2) is legally authorized to provide a program of education beyond high school; (3) provides an educational program for it which awards a bachelor's or higher degree, or provides a program which is acceptable for full credit toward such a degree, or offers a program of training to prepare students for gainful employment in a recognized occupation; and (7) is a public or other nonprofit institution.

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