Page images
PDF
EPUB

INTRODUCTION

The Subcommittee on Oversight of the House Committee on Ways and Means has scheduled public hearings on August 2 and 3, 1984, on the Federal income tax credit for certain incremental research expenditures. The hearings are being conducted as part of the Oversight Subcommittee's continuing review of current Internal Revenue Code provisions.

In its press release of June 4, 1984, the Subcommittee listed the following issues to be addressed at the hearings: "(1) whether the tax credit provisions should be allowed to sunset, should be extended, or should be made permanent; (2) whether the credit operates to stimulate additional research expenditures, or simply rewards increased research expenditures which would have been made in the absence of a credit; (3) the types of research expenditures and industry activities that have generated use of the tax credit; (4) whether the categories of qualifying research expenditures should be broadened or narrowed; (5) whether taxpayers and the Internal Revenue Service have been able to accurately distinguish qualifying research expenditures from nonqualifying research-related expenditures, such as indirect, overhead, or administrative wage expenditures, and from nonresearch expenditures, such as costs of market research, quality control, or production; (6) whether the base period computation rules are appropriate and have a positive impact on increasing research and experimental expenditures; (7) whether both a credit and tax deduction should be available for the same research expenditures; (8) the impact of the provisions on federal revenues; (9) the impact of the provisions on industry spending and allocation of research expenditure budgets; (10) whether present law rules on the availability of the use of the credit have been effective to accomplish Congressional intent; and (11) in the event the credit is continued, whether any statutory or administrative changes should be made."

The Subcommittee plans to receive testimony from the Department of the Treasury, the Congressional Budget Office, the National Science Foundation, tax and economic experts, interested industry groups, and other invited and public witnesses. In addition, the General Accounting Office will present the results of a study requested by the Subcommittee regarding the impact of the tax credit on research activities under present law.

This pamphlet, prepared in connection with the hearings, contains a description of the present-law credit provisions and a brief discussion of the issues listed in the Subcommittee's press release.

I. PRESENT LAW

A. Current Deduction for Certain Research Expenditures

General rule

As a general rule, business expenditures to develop or create an asset which has a useful life that extends beyond the taxable year, such as expenditures to develop a new product or improve a production process, must be capitalized. However, Code section 174 permits a taxpayer to elect to deduct currently the amount of "research or experimental expenditures" incurred in connection with the taxpayer's trade or business. For example, a taxpayer may elect to deduct currently the costs of wages paid for services performed in qualifying research activities, and of supplies and materials used in such activities, even though these research costs otherwise would have to be capitalized.

The section 174 election does not apply to expenditures for the acquisition or improvement of depreciable property, or land, to be used in connection with research.1 Thus, for example, the total cost of a research building or of equipment used for research cannot be currently deducted under section 174 in the year of acquisition. However, the amount of depreciation (cost recovery) allowance for a year with respect to depreciable property used for research may be deducted in that year under the election. Under ACRS, machinery and equipment used in connection with research and experimentation are classified as three-year recovery property and are eligible for a six-percent regular investment tax credit.

Qualifying expenditures

The Code does not specifically define "research or experimental expenditures" eligible for the section 174 deduction election, except to exclude certain costs. Treasury regulations (sec. 1.174-2(a)) define this term to mean "research and development costs in the experimental or laboratory sense." This includes generally "all such costs incident to the development of an experimental or pilot model, a plant process, a product, a formula, an invention, or similar property," and also the costs of obtaining a patent on such property.

The present regulations provide that qualifying research expenditures do not include expenditures "such as those for the ordinary testing or inspection of materials or products for quality control or those for efficiency surveys, management studies, consumer surveys, advertising, or promotions." Also, the section 174 election

Also, the statute excludes expenditures to ascertain the existence, location, extent, or quality of mineral deposits, including oil and gas, from eligibility for section 174 elections (sec. 174(d)). However, expenses of developing new and innovative methods of extracting minerals from the ground may be eligible for sec. 174 elections (Rev. Rul. 74-67, 1974-1 C.B. 63). Also, certain expenses for development of a mine or other natural deposit (other than an oil or gas well) may be deductible under sec. 616.

cannot be applied to costs of acquiring another person's patent, model, production, or process or to research expenditures incurred in connection with literary, historical, or similar projects (Reg. sec. 1.174-2(a)).

B. Credit for Increasing Certain Research Expenditures

Overview

General rule.-An income tax credit is allowed for certain qualified research expenditures paid or incurred by a taxpayer during the taxable year in carrying on a trade or business of the taxpayer (Code sec. 44F, enacted in the Economic Recovery Tax Act of 1981). The credit applies only to the extent that the taxpayer's qualified research expenditures for the taxable year exceed the average amount of the taxpayer's yearly qualified research expenditures in the specified base period (generally, the preceding three taxable years). The rate of the credit is 25 percent of the incremental research expenditure amount.

Under present law, the credit applies to qualified research expenditures paid or incurred after June 30, 1981 and before January 1, 1986.

Qualifying expenditures.-For purposes of the incremental credit, the definition of research is the same as that used for purposes of the special deduction rules under section 174, but subject to certain exclusions. A taxpayer's research expenditures eligible for the credit consist of (1) "in-house" expenditures by the taxpayer for research wages and supplies used in research, plus certain amounts paid for research use of laboratory equipment, computers, or other personal property; (2) 65 percent of amounts paid by the taxpayer for contract research conducted on the taxpayer's behalf, and (3) if the taxpayer is a corporation, 65 percent of the taxpayer's payments (including grants or contributions) pursuant to a written research agreement for basic research to be performed by universities or certain scientific research organizations.

Relation to deduction.-The credit is available for incremental qualified research expenditures for the taxable year whether or not the taxpayer has elected under section 174 to deduct currently research expenditures. The amount of any section 174 deduction to which the taxpayer is entitled is not reduced by the amount of any credit allowed for qualified research expenditures.

Trade or business limitations

Under present law, the credit is available only for research expenditures paid or incurred in carrying on a trade or business of the taxpayer. With one exception, the trade or business test for purposes of the credit is the same as for purposes of the business deduction provisions of section 162. Thus, for example, the credit generally is not available to a limited partnership (or to any partners in such partnership, including a general partner which is an operating company) for partnership expenditures for "outside" or contract research intended to be transferred by the partnership to another (such as to the general partner) in return for license or

2 Section 471 of the Deficit Reduction Act of 1984 (P.L. 98-369) renumbers the credit provision as Code section 30, effective for taxable years beginning after 1983.

« PreviousContinue »