[COMPANY NAME] Research & Development Tax Credit Assessment n For tax year ended December 31, 20xx

Transcription

1 [COMPANY NAME] Research & Development Tax Credit Assessment n For tax year ended December 31, 20xx Prepared for ABC Manufacturing, Inc. Estimate for the Tax Year Ended December 31, 2015 Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein Habif, Arogeti & Wynne, LLP Page 1 of 7

2 Company Background Company/Location: ABC Manufacturing, Rome, GA Nature of Business: Manufacturing Executive Summary HA&W CEO Tools, LLC engaged Habif, Arogeti & Wynne, LLP ( HA&W ) on behalf of ABC Manufacturing, Inc. ( ABC or The Company or them ) to assist them in determining an estimate for its Credit for Increasing Research Activities reported on Form 6765 of the Federal and Form IT- RD of the Georgia tax returns. ABC began operations in Rome, GA in The Company develops widgets used primarily in the automotive and aerospace industry. They continuously engage in Research and Development ( R&D ) activities to provide customers with the most cutting edge technology. They also research and design methods to improve the quality of their manufacturing process. The Company currently engages in approximately five product development and improvement R&D projects a year and three process development and improvement R&D projects a year. The estimate was prepared in accordance with the Internal Revenue Code ( IRC ) Sections ( ) 41 and 174, which allows taxpayers a tax credit for increasing research activities. The legal standard employed to determine credit eligibility is the IRC of 1986, as amended, and related associated Treasury Regulations ( TR ). The methodology employed for capturing estimated Qualified Research Expenditures ( QREs ) involves interviews and data analysis. Please note that this the credit amount listed above is just an estimate and may vary when performing the actual Study. As such, ABC may be entitled to approximately the following R&D Tax Credit benefit: Credit Type 2014 Federal $70,000 Georgia $95,000 Grand Total $165, HA&W CEO Tools, LLC Page 2 of 7

3 Identification of Qualified Costs A. ABC Personnel i. Keith Richards, CEO, provided the following for the Company s 2015 tax year: 1. Estimated wages for the Company. 2. Estimated general ledger amounts of qualified supplies. 3. Estimated amounts paid to contractors. ii. SMEs determined the following: 1. Estimated percentage of time employees at the Company and contractors spent performing qualified research activities. 2. Estimated percentage of qualified supplies expenses for the Company s 2015 tax year. Qualification Criteria A. Activities Conducted within the United States As stated in IRC 41(d)(4)(F), any research conducted outside the United States ( U.S. ), or any possession of the U.S. shall not be deemed qualified research with regards to the credit under IRC 41. However, as stated in Reg A(b)(1), in- house and contract research expenses for services performed within and without the U.S. should be apportioned between the services performed in each jurisdiction. Since only the portion of these expenses attributable to qualified research performed within the U.S. is qualified research, HA&W applied only those projects and related activities that were conducted within the U.S. to the credit s calculation. B. Taxpayer Must Assume the Financial Burden of the Research Activities Research that is funded by any grant, contract, or otherwise by another person (or governmental entity) is excluded from qualified research under IRC 41(d)(4)(H). Reg A(d)(1) provides that amounts payable that are contingent on the success of the research are considered paid for the product or results of the research and are not treated as funding. As a result, HA&W and the Company undertook to determine whether a project was funded by another person or business in such a manner that the taxpayer did not bear the economic risk of the research activities. The determination was based upon who bears the research costs upon project failure and not upon the likelihood of success by the researcher; thus, only those activities associated with projects where the Company bore the financial burden of performing qualified research activities were included HA&W CEO Tools, LLC Page 3 of 7

4 C. Taxpayer Entitled to Substantial Rights in the Research As outlined in TR (a)(3)(ii), if the taxpayer performs research on behalf of other persons in carrying on a trade or business but retains substantial rights in the research, the taxpayer shall take otherwise qualified expenses for that research into account for purposes of IRC 41 to the extent provided in TR A(d)(3). Reg A(d)(2) states that incidental benefits from the performance of research, such as increased experience in a particular subject matter, are not considered substantial rights in the research. Furthermore, the taxpayer does not retain substantial rights in the research if the taxpayer must pay for the right to use the results of the research. A taxpayer may retain substantial rights in a particular subject matter even when others do as well; therefore, substantial rights need not be exclusive rights. TR (a)(1) provides that a contract research expense is not a QRE if the product or result of the research is intended to be transferred to another in return for license or royalty payments and the taxpayer does not use the product of the research in the taxpayer's trade or business. Therefore, HA&W and the Company determined that ABC has maintained substantial rights for their research related to those QRAs. Four- Part Test A. Permitted Purpose IRC 41 states that the application of the research must be intended to be useful in the development of a new or improved business component of the taxpayer IRC 41(d)(1)(B)(ii). In order to qualify for credit eligibility, the research activities must be conducted for a permitted purpose, i.e., to create or improve a business component s function, performance, reliability, and quality under IRC 41(d)(3)(A). A business component is defined by IRC 41(d)(2)(B) as any product, process, computer software, technique, formula, or invention which is to be (i) held for sale, lease or license, or (ii) used by the taxpayer in a trade or business of the taxpayer. The term product includes any pilot model, process, formula, invention, technique, patent, or similar property, and includes products to be used by the taxpayer in its trade or business as well as products to be held for sale, lease, or license. IRC 41(d)(4) specifically disqualifies the following types of research activities: (i) adaptation of existing business components, (ii) duplication of existing business components, (iii) research conducted outside the United States, (iv) research conducted in the social sciences, arts, or humanities, (v) routine data collection, routine or ordinary testing, or inspection for quality control, (vi) market research, efficiency surveys, or (vii) any activities related to management function or technique. Congress further disqualified activities undertaken to assure achievement of the intended function, performance, etc. of the business item after the beginning of commercial production of the item do not constitute qualified experimentation. In addition, activities relating to style, taste, cosmetic, or seasonal design factors do not constitute qualified experimentation HA&W CEO Tools, LLC Page 4 of 7

5 B. Technological in Nature The second test outlined in IRC 41 states that qualified research is research which is undertaken for the purpose of discovering information which is technological in nature IRC 41(d)(1)(B)(i). This means that the qualified activity must involve research and development in the hard sciences, including, but not limited to, physical science, biological science, engineering, and computer science. For tax years ending on or after December 31, 2003, Final Regulations (a)(3)(ii): Application of the discovering information requirement is the determination that research is undertaken for the purpose of discovering information that is technological in nature and does not require the taxpayer be seeking to obtain information that exceeds, expands, or refines the common knowledge of skilled professionals in the particular field of science or engineering in which the taxpayer is performing the research. In addition... [this] does not require that the taxpayer succeed in developing a new or improved business component. For tax years ending on or after December 31, 2003, Final Regulations (a)(4): A taxpayer may employ existing technologies and may rely on existing principles of the physical sciences, biological sciences, engineering, or computer sciences to satisfy this requirement. C. Elimination of a Technical Uncertainty The development activities must be intended to discover information that would eliminate uncertainty about the development or improvement of a business component IRC (a)(3)(i). Uncertainty exists if the taxpayer did not know if or how it could achieve the desired result, or did not know the appropriate design of the business component. The activity may pass this test if a taxpayer knows that it is possible to develop the new or improved function, but is uncertain about how to develop or improve the product or the exact design of the product. The following expenditures are excluded: (i) The ordinary testing or inspection of materials or products for quality control (quality control testing); (ii) Efficiency surveys; (iii) Management studies; (iv) Consumer surveys; (v) Advertising or promotions; (vi) The acquisition of another s patent, model, production or process; (vii) Research in connection with literary, historical, or similar projects; or (viii) Administrative activities HA&W CEO Tools, LLC Page 5 of 7

6 Process of Experimentation The final test states that qualified research is substantially all 1 of the activities of which constitute elements of a process of experimentation IRC 41(d)(1)(C). This means that the qualified activity must involve a process of evaluating and testing different alternatives designed to eliminate the uncertainty about the development at the outset of the activities. It is an evaluative process and often involves refining the understanding of the uncertainty, modifying the alternatives being evaluated to eliminate that uncertainty, or modifying the process used to evaluate those alternatives. The taxpayer s activities must be directed at resolving uncertainty regarding the development or improvement of a business component and must fundamentally rely on principles of physical sciences, biological sciences, engineering, or computer sciences. Also, TR (4)(a)(6) provides further guidance that provides that substantially all activities constitute elements of a process of experimentation if 80% or more of the research activities are elements of a process of experimentation. Such a process should involve developing, testing, refining and/or discarding hypotheses, as part of the development. Because industrial research settings do not always resemble academic research settings, formalized documentation of hypothesis formation and evaluation is often replaced or precluded by actual trial- and- error experimentation. A process of experimentation may exist if a taxpayer performs research to establish the appropriate design of a business component even when the capability and method for developing or improving the business component are not uncertain. A taxpayer's activities do not constitute elements of a process of experimentation where the capability and method of achieving the desired new or improved business component and the appropriate design of the desired new or improved business component are readily discernible and applicable as of the beginning of the taxpayer's research activities so that true experimentation would not have to be undertaken to test, analyze, and choose among viable alternatives. 1 TD 8930 states that the substantially all requirement of IRC 41(d)(1)(C) is satisfied only if 80% or more of the research activities, measured on a cost or other consistently applied reasonable basis (and without regard to IRC (d)(2)), constitute elements of a process of experimentation for a purpose described in IRC 41(d)(3). This requirement is applied to each business component. This can be satisfied even if some portion of a taxpayer s activities is not for a qualified purpose. The substantially all requirement is satisfied if 20 percent or less of a taxpayer's research activities do not constitute elements of a process of experimentation for a purpose described in IRC 41(d)(3), as long as these remaining activities satisfy the requirements of IRC 41(d)(1)(A) and are not otherwise excluded under IRC 41(d)(4). Example (6) of IRC (a)(8) of the 2001 proposed regulations has been modified to illustrate the application of this rule, and appears as example (4) in these final regulations HA&W CEO Tools, LLC Page 6 of 7

7 Thank you for taking our Research & Development Tax Credit Assessment For more information on HA&W R&D tax credits visit us at planning- preparation/tax- credits/r- d- tax- credits or contact Carli McDonald Senior Manager, HA&W R&D Tax Credits HA&W CEO Tools, LLC Page 7 of 7