Page images
PDF
EPUB

Our research covers a broad range of projects. Metallurgists at our research facilities are involved in low-gravity metal research projects, sharing technology with the National Aeronautics & Space Administration for use on upcoming space shuttle flights. Our goal is to develop a stronger iron. In addition, exhaustive and, I might add, expensive, research contributed to the construction of our newly-opened 2 million square foot, awardwinning Waterloo Tractor Works. This factory has been recognized as the industry leader in state-of-the-art computer based technology. Effective use of research has allowed us to remain a competitive manufacturer of advanced farm and construction equipment with productive innovations which U.S. farmers, contractors and small business owners find necessary to meet their business challenges.

Most will agree that research and development primarily benefits the country in which it is performed. For this reason, other countries offer substantial tax incentives for R&D performed within their borders. However, until 1981, U.S. tax law acted as a disincentive to the performance of R&D in the United States. This disincentive was the ultimate effect of Section 861 (b) of the Internal Revenue Code and Section 1.861-8 (e)(3) of the Regulations. This combination of Statute and Regulation required that the cost of R&D performed in the United States arbitrarily be divided between foreign and domestic income even though the R&D was performed entirely in the United States. The R&D allocated against foreign income has the affect of reducing the limitation for foreign tax credits, which then reduces the foreign tax credit allowable if foreign taxes paid exceed the limitation. This increases the total U.S. tax payable. Let me give you an example to demonstrate this point:

[blocks in formation]
[blocks in formation]

Reduced Foreign Tax Credit Caused by Section 861 Allocation of R&D

Foreign Tax Credit Allowable before R&D Allocation
Foreign Tax Credit Allowable after R&D Allocation
Reduced Foreign Tax Credit

4.6

4.0

.6

The allocation of R&D against foreign source income results in a reduction of the allowable foreign tax credit by $600,000. This taxpayer's penalty for performing $6 million of R&D in the U.S. is therefore $600,000 in additional U.S. income taxes. If that R&D had been performed in any other country, it would have resulted in no such increase in foreign or U.S. taxes. This is so because no other country besides the United States requires such an allocation or apportionment of R&D expenses. When a taxpayer has excess foreign tax credits, the effect of apportioning R&D performed in the U.S. to foreign source income is the same as disallowing a deduction for the R&D performed in the United States. This provides a disincentive to performing R&D in the U.S., encourages the movement of R&D out of this country, and gives foreign companies a competitive advantage over U.S. companies who perform R&D here in this country. The U.S. Treasury gains only a minimal benefit a benefit which we believe would be easily overshadowed by the increased taxes due to the Treasury as a result of the increased productivity.

The Economic Recovery Tax Act of 1981 took an important step forward by temporarily removing this disincentive to perform R&D in the United States.

As you know, it suspended for two years the provisions of Section 861 which required the allocation of R&D expenses against foreign source income. However, this suspension expires at the end of 1983. S. 654 would permanently remove the disincentive by providing that no R&D performed in the United States would be allocated against foreign source income. Deere & Company urges this subcommittee to act favorably on this bill. We do have one additional comment of a technical nature regarding S. 654. We believe the Subcommittee should add language clarifying the fact that the bill would only apply to the calculation of the foreign tax credit and would not affect the DISC in any way.

I would now like to take a moment to address S. 738. As you know, the Economic Recovery Tax Act of 1981 included a provision which allows a tax credit of 25% of the increase in the current year's R&D performed in the U.S. over the average of the three previous years. We at Deere & Company view this as a step in the correct direction. Though other countries routinely provide more significant incentives, a permanent credit for even a small portion of R&D expenses incurred in the United States may well encourage some companies who are considering locating R&D facilities in other countries to remain at home. Let me explain.

John Deere, and most other companies who make substantial expenditures for R&D, often must decide where an R&D facility should be established when a need arises for a new facility. Many factors are considered in the study, including the cost of various taxes. Exhibit A, attached, shows the tax cost of locating an R&D facility in the United States compared to Canada. The analysis assumes an initial cost of the facility of $20 million and an annual expenditure of $10 million for R&D. This shows that Canadian taxes would be $14,760,000 less than U.S. taxes in the first year! The dramatic difference in tax is caused by the fact that Canada has recognized the significance of having R&D performed in that country and has provided the following tax incentives: 1. A deduction for the entire cost of the facility is allowed in the first year. In the U.S., it must be depreciated over 15 years.

2.

An additional deduction is allowed for 50% of the excess of current R&D expenditures, including capital assets, over the prior 3-year average. In the U.S., no additional deduction is allowable.

3.

The R&D credit in Canada is allowed on all R&D expenditures, including capital assets, while the R&D credit in the U.S. is allowed only on direct R&D costs, excluding capital assets, and applies to only the increase in R&D.

The significant benefits available to taxpayers performing R&D in Canada, compared to the U.S., become even more important when one considers Canada's geographical proximity, business environment, language and cultural similarities and economic stability. However, Canada is not alone in encouraging R&D through tax incentives.

• Germany allows a 20% tax credit on the first DM 500,000 and 7.5% on the balance of any amounts spent for assets used for R&D purposes. France provides a deduction equal to 10% of the cost of assets used for R&D purposes. R&D buildings are eligible for a 50% special depreciation allowance. In addition, France will pay cash grants for certain R&D expenditures.

Japan has allowed an R&D credit since 1966. The credit is equal to 20% of the excess of current expenditures over the largest amount of R&D expenditures in any tax year since 1965. Japan also allows a deduction of 40 percent of certain income for companies that receive income from overseas transactions in technical services. Belgium, Denmark, Mexico, Norway, Spain and Sweden offer similar tax incentives to encourage R&D.

In summary, John Deere believes that it is in the best interest of this country to remove the disincentive to perform R&D in the U.S. which is caused by Section 861 by enacting the provisions of S. 654 and S. 738. The increased R&D and greater productivity which should result, will help establish the framework needed for substantial economic growth.

views.

I sincerely appreciate the opportunity to provide to you John Deere's

Bernard L. Hardik

Bernard L. Hardiek
Director of Taxes

DEERE & COMPANY

Exhibit A

Comparison of U. S. & Canadian R & D Tax Laws

Assume a new $20 million research facility which spends $10 million for R & D Compare locating in the U. S. to locating a facility in Canada:

each year.

[blocks in formation]

1. Timing difference on immediate expensing of building instead of depreciating over 15 years

2. Deduction for R & D expenses in excess of prior

Canadian Tax Benefit

$ 8,096,000

[blocks in formation]

Assume 20% foreign sales and excess foreign tax credits

[blocks in formation]

6,900,000 (880,000)

644,000

$14.760.000

« PreviousContinue »