ceeding $500 ($250 for computer software) generally would be eligible for the new augmented deduction.

The augmented deduction under S. 1194 generally would not be allowed to the extent that, determined on a product-by-product basis, the number of transferred items exceeds 20 percent of the number of such items sold by the taxpayer during the year. Also, while the transfers would not be required to qualify as charitable contributions in order for the enhanced deduction to apply, the taxpayer's aggregate deduction in one year for both charitable contributions and transfers under the new provision would be limited to 10 percent of taxable income (computed with certain modifications), with a five-year carryforward of any excess.

In the case of computer equipment transfers to secondary schools, etc., the augmented deduction would apply only during the five-year period beginning on enactment of the bill. Also, S. 1194 would require that the transferor of such computer equipment generally must provide, at no cost to the recipient school, etc., sufficient orientation to make at least one employee of the recipient per data processor proficient in use of the transferred property in the direct education of students.

S. 1195 (section 2)

In place of the special charitable deduction rule enacted in ERTA, the bill would enact a new deduction provision, generally of broader scope, outside the charitable deduction rules. The provision would be effective for taxable years beginning after the date of enactment.

Under the new provision, corporations would receive deductions for amounts in excess of basis for transfers, without consideration, of scientific or technical equipment (including property used in the transferor's business and computer software) to colleges, universities, or vocational education schools or programs, for use in either research or education in certain scientific or technological fields, and for transfers, without consideration, of newly manufactured computer equipment (including software) to secondary or elementary schools, for use in education. In addition, augmented deductions would be allowed for the costs of performing certain maintenance and repair services in connection with such property transfers. With certain exceptions, only an item having a value exceeding $250 would be eligible for the new augmented deduction.

The augmented deduction under S. 1195 generally would not be allowed to the extent that, determined on a product-by-product basis, the number of transferred items exceeds 20 percent of the number of such items sold by the taxpayer during the year. Also, while the transfers would not be required to qualify as charitable contributions in order for the augmented deduction to apply, the taxpayer's aggregate deduction in one year for both charitable contributions and transfers under the new provision would be limited to 10 percent of taxable income (computed with certain modifications), with a five-year carryforward of any excess.

In the case of computer equipment transfers to schools, the augmented deduction would apply only during the five-year period beginning on enactment of the bill. Also, S. 1195 would require that the transferor of such computer equipment must provide, at no cost

to the school or its teachers, sufficient orientation to make at least one teacher per data processor proficient in use of the transferred property in the direct education of students.

b. Expansion of Section 44F Credit

Present law

An income tax credit is allowed for certain qualified research expenditures incurred in carrying on a trade or business (Code sec. 44F, enacted in ERTA). The credit applies only to the extent that the taxpayer's qualified research expenditures for the taxable year exceed the average amount of 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, research expenditures eligible for the section 44F incremental 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 expenditures (including grants or contributions) pursuant to a written research agreement for basic research to be performed by universities or certain scientific research organizations.

S. 1194 (section 3)

Expansion of credit.-Under the bill, the category of corporate expenditures eligible for a 25-percent credit under Code section 44F would be expanded also to include 65 percent of amounts paid 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, the amounts would have to be used 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 are engaged in postgraduate study in certain scientific fields. 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 amount to the recipient for at least three consecutive years.

Under a special limitation in the bill, 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.

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 for the current taxable year, from the amount of base period ex

penditures 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 or qualifying scientific education expenditures in the current year (determined after application of the special limitation described above).

Effective date.-The amendments to the section 44F credit made by the bill would apply to taxable years beginning after the date of enactment.

S. 1195 (section 3)

Expansion of credit.-Under the bill, the category of corporate expenditures eligible for a 25 percent credit under Code section 44F would be expanded also to include 65 percent of amounts paid to a college, university, or area vocational education school, 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 orientation.

To qualify, the amounts would have to be used for payment of wages to faculty employees who are directly engaged in providing scientific education, or for funding scholarships or loans for students who are engaged in postgraduate study in certain scientific fields. 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.

Based period computation.-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 for the current 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.

Effective date.-The amendments to the section 44F credit made by the bill would apply to taxable years beginning after the date of enactment.

c. Tax Treatment of Payments and Loan Forgiveness Received by Certain Graduate Science Students

Present law

Scholarship exclusion.-Subject to several limitations, gross income does not include amounts received as a scholarship at an educational institution or as a fellowship grant (Code sec. 117).

In general, scholarships or fellowship grants are not excludable from gross income if they constitute compensation for past, present, or future employment services or for services subject to the direction or supervision of the grantor, or if the funded studies

or research are primarily for the benefit of the grantor (Treas. Regs. sec. 1.117-4(c)). However, amounts received under Federal programs that are used for qualified tuition and related expenses are not disqualified from the exclusion merely because the recipient agrees to perform future services as a Federal employee or in a health manpower shortage area (sec. 117(c)).

Forgiveness of debt.-As a general rule, income is realized when indebtedness is forgiven or cancelled (sec. 61(a)(12)).

S. 1194 (section 4) and S. 1195 (section 4)

The bills would provide a new Code section under which gross income would not include amounts received by graduate science students as a scholarship, fellowship grant, or qualified student loan forgiveness, notwithstanding that the recipient is required to perform future teaching services as a condition of receiving such amounts.

The new provision would apply to students who are engaged in postgraduate study as degree candidates in mathematics, engineering, the physical or biological sciences, or certain computer fields at qualified educational organizations. To be eligible for the exclusion where future teaching services are required, the scholarship, grant, or loan forgiveness amount must be used for qualified tuition and related expenses, including tuition and fees, books, supplies, and equipment required for courses.

The scholarship and loan forgiveness provisions of the bills would apply to taxable years beginning after the date of enactment.

II. DESCRIPTION OF BILLS

1. S. 654-Senators Wallop, Armstrong, Symms, Boren, Durenberger, Danforth, Roth, Glenn, Heinz, Packwood, Chafee, Bentsen, and Baucus

Rules for Allocating Research Expenditures to U.S.-Source

Income

Treasury Regulations

In determining foreign-source taxable income for purposes of computing the foreign tax credit limitation (sec. 904), and for other tax purposes, Code sections 861-863 require taxpayers to allocate or apportion expenses between foreign-source income and U.S.-source income. Treasury Regulation section 1.861-8 sets forth rules for allocating and apportioning these expenses.

Under this regulation, research and development expenditures ("research expenditures") are allocated to income based on a broad classification of 32 product groups enumerated in the Standard Industrial Classification ("SIC") Manual. Research expenditures are not allocable solely to the income generated by the particular product which benefited from the research activity. Instead, these expenditures are allocable to all the income within the SIC product group in which the product is classified. Accordingly, once a research expenditure is identified with a SIC product group, it is apportioned to foreign sources based on the ratio of total foreign source sales receipts or income within the SIC product group to the total worldwide sales receipts or income within the SIC product group.

Treasury Regulation section 1.861-8 provides certain "safe harbors" when more than 50 percent of the research expenditures are incurred either within or without the United States. For years beginning in 1979, the regulation allows a taxpayer to apportion 30 percent of the research expenditures to the geographic source in which more than 50 percent of such expenditures were incurred. The regulation also provides that if the taxpayer's results of operations justify a geographic apportionment of research expenditures to the country in which the research is performed that would be higher than the 30 percent allowed under this safe harbor rule, then the taxpayer may make such higher allocation. The remaining portion of the research expenditures is then apportioned based upon the SIC formula.

Explanation of 1981 Provision

In the Economic Recovery Tax Act of 1981 (ERTA), the Congress directed the Treasury Department to study the impact of the research expenditure allocation provisions of Treasury Regulation