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).

Computation of base period expenditures

General rule.-As a general rule, the section 44F credit applies to the amount of qualified research expenditures for the current taxable year which exceeds the average of the yearly qualified research expenditures in the preceding three taxable years. However, for the taxpayer's first taxable year to which the new credit applied (and which ended in 1981 or 1982), the credit applied to the amount of qualified research expenditures for that year which exceeded the amount of such expenditures in the preceding taxable year. Also, for the taxpayer's second taxable year to which the new credit applied (and which ended in 1982 or 1983), the credit applied to the amount of qualified research expenditures for that year which exceeded the average of yearly qualified research expenditures in the preceding two taxable years.

Because the credit became effective for qualified research expenditures paid or incurred after June 30, 1981, a special rule was provided for computing base period expenditures with respect to the taxpayer's taxable year which included July 1, 1981. A similar rule is to apply in the case of a taxpayer's taxable year which includes December 31, 1985 (when the credit is scheduled to expire).

New businesses.—If the taxpayer was not in existence during a base period year, then the taxpayer is treated as having research expenditures of zero in such year, for purposes of computing average annual research expenditures during the base period, subject to the 50-percent limitation rule.

50-percent limitation rule.-Base period research expenditures are treated as at least equaling 50 percent of qualified research expenditures for the current year. This 50-percent limitation applies both in the case of existing businesses and in the case of newly organized businesses.

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 mil

lion ($975,000). The corporation's base period expenditures with respect to 1983 would be the average of its qualified research expenditures for 1980, 1981, and 1982, or $121,300,000. Accordingly, the 25 percent 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.

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, 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 3, S. 1194

Expenditures for faculty wages and student loans

In general

Under section 3 of the bill, the category of expenditures eligible for a 25-percent credit under Code section 44F would be expanded also to include 65 percent of amounts paid or incurred26 by a corporation27 to a college or university, pursuant to written agreement, for scientific education uses. The latter term would mean the education of students or faculty in mathematics, engineering, computer science, and the physical and biological/biomedical sciences. To qualify as scientific education expenditures, the amounts would have to be used by the educational institution for payment of wages to faculty employees who are directly engaged in providing scientific education, or for funding scholarships or loans for students at the institution who possess a bachelor's degree or its equivalent and who are engaged in postgraduate study in mathematics, the physical or biological/biomedical sciences, engineering, or computer science. In addition, amounts to be used for wages would have to be paid to the college or university pursuant to a written agreement which obligates the taxpayer to render a like or greater amount to the recipient for at least three consecutive years.

Eligible recipients for credit purposes

S. 1194 would define qualified organizations for certain section 44F credit purposes to mean

(1) an educational

educational organization (as described in section 170(b)(1)(A)(ii))28 which is an institution of higher education (as defined in sec. 3304(f));29

26 The bill would repeal the contract research prepayment rule of present law (see note 24, supra).

27 See note 7, supra.

28 See note 4, supra. 29 See note 9, supra.

(2) a tax-exempt organization which is organized primarily to conduct scientific research, which is described in section 501(c)(3), and which is not a private foundation; or

(3) an organization which is organized primarily to promote scientific research or scientific education by qualified organizations, which expends on a current basis substantially all its funds through grants and contracts for basic research or scientific education by a qualified organization, and which is described in either section 501(c)(3) or section 501(c)(6).

Special limitation

Corporate expenditures for scientific education would be eligible for the section 44F credit only to the extent exceeding the average of all charitable contributions made by the taxpayer to colleges and universities during the three preceding taxable years, excluding such contributions which were designated by the taxpayer for scientific education use (as defined for purposes of the credit, as would be amended by the bill).

Exclusion of payments from base period determinations

Under S. 1194, corporate expenditures for either basic research or scientific education which were included in the section 44F credit computation in a prior taxable year would be excluded, in calculating incremental expenditures in the taxable year, from the amount of base period expenditures for that prior year. Thus, as long as the taxpayer did not decrease the amount of its other expenditures qualifying under section 44F, the 25-percent credit would apply to 65 percent of all the taxpayer's qualifying basic research and qualifying scientific education expenditures in the current year (determined after application of the special limitation described above), whether the taxpayer had increased or decreased its basic research or scientific education expenditures in comparison with prior years.

For example, assume that the taxpayer's average in-house research expenditures in the base period are $1 million, and that in the current year the taxpayer again spends $1 million on in-house research wages and supplies plus $100,000 as a grant to a university for basic research and salary support in engineering. Under the bill, the taxpayer's qualifying current-year expenditures would be $1,065,000, and the credit would apply to the $65,000 excess over the base period average.

Assume in the second year that the taxpayer again spends $1 million on in-house research plus $80,000 on university basic research and faculty salary support, so that its qualified research expenditures for that year total $1,052,000. (The example assumes that the special limitation is not triggered.) The base period average would remain $1 million, since under the bill none of the university grants in the prior year would enter into the base period determination. Thus, the 25-percent credit would apply to $52,000 (i.e., 65 percent of the current-year expenditures for university basic research and faculty salary support).

Effective date

The provisions of section 3 of S. 1194 would apply to taxable years beginning after the date of enactment.

Explanation of Section 3, S. 1195 Expenditures for faculty wages and student loans

In general

Under section 3 of the bill, the category of corporate expenditures eligible for a 25 percent credit under Code section 44F would be expanded to include 65 percent of amounts paid or incurred 30 by a corporation31 to a qualified educational organization, pursuant to written agreement, for scientific education uses. The latter term would mean the education of students or faculty in engineering or engineering technologies, the physical, biological, and computer sciences or technologies, mathematics, and electronic and automated medical, industrial, and agricultural equipment and instrumentation operation.

To qualify as scientific education expenditures, the amounts would have to be used by the educational institution for payment of wages to faculty employees who are directly engaged in providing scientific education, or for funding scholarships or loans for students at the institution who possess a bachelor's degree or its equivalent and who are engaged in postgraduate study in mathematics, computer science and applications, engineering, or the physical or biological sciences. In addition, amounts to be used for wages would have to be paid to the educational institution pursuant to a written agreement which obligates the taxpayer to render a like amount to the recipient for at least three consecutive years. Eligible recipients for credit purposes

S. 1195 would define qualified organizations for certain section 44F purposes to mean

(1) an educational organization (as described in section 170(b)(1)(A)(ii)32 which is an institution of higher education (as defined in sec. 3304(f));33

(2) an area vocational education school (as defined in P.L. 94482):34

(3) an organization which is organized primarily to conduct scientific research, which is described in section 501(c)(3), and which is not a private foundation; or

(4) an organization which is organized primarily to promote scientific research or scientific education by qualified organizations, which expends on a current basis substantially all its funds through grants and contracts for basic research or scientific education by a qualified organization, and which is described in either section 501(c)(3) or section 501(c)(6).

30 The bill would repeal the contract research prepayment rule of present law (see note 24, supra).

31 See note 7, supra.

32 See note 4, supra. 33 See note 9, supra. 34 See note 19, supra.

Exclusion of payments from base period determinations

Under S. 1195, corporate expenditures for either basic research or scientific education which were included in the section 44F credit computation in a prior taxable year would be excluded, in calculating incremental expenditures in the taxable year, from the amount of base period expenditures for that prior year. Thus, as long as the taxpayer did not decrease the amount of its other expenditures qualifying under section 44F, the 25 percent credit would apply to 65 percent of all the taxpayer's qualifying basic research and scientific education expenditures in the current year, whether the taxpayer had increased or decreased its basic research or scientific education expenditures in comparison with prior years. For example, assume that the taxpayer's average in-house research expenditures in the base period are $1 million, and that in the current year the taxpayer again spends $1 million on in-house research wages and supplies plus $100,000 as a grant to a university for basic research and salary support in engineering. Under the bill, the taxpayer's qualifying current-year expenditures would be $1,065,000, and the credit would apply to the $65,000 excess over the base period average.

Assume in the second year that the taxpayer again spends $1 million on in-house research plus $80,000 on university basic research and faculty salary support, so that its qualified research expenditures for that year total $1,052,000. The base period average would remain $1 million, since under the bill none of the university grants in the prior year would enter into the base period determination. Thus, the 25-percent credit would apply to $52,000 (i.e., 65 percent of the current-year expenditures for university basic research and faculty salary support).

Effective date

The provisions of section 3 of S. 1195 would apply to taxable years beginning after the date of enactment.