We use cookies to personalise the website and offer you the greatest added value. They are, among other purposes, used to analyse visitor usage in order to improve the website for you. By using this website, you agree to their use. Further information can be found in our data privacy statement.



Research and Development Tax Credits: Qualifying Requirements

PrintMailRate-it

Rödl & Partner Tax Matters Vol 2014 – 6, published in March 2014

 

Federal and state credits are available to organizations that increase their research and development activities above a certain base amount. The information below summarizes the general requirements for activities to qualify for a Research and Development Tax Credit (R&D Credit). Please note that this information is an overview intended to provide general guidance in determining whether expenditures related to certain activities qualify for the R&D Credit. It is not a substitute for the Internal Revenue Code and Regulations and related case law. 

 

A taxpayer must meet both qualitative and quantitative components in order to satisfy the requirements to obtain an R&D Credit. The qualitative component, and the main basis for the R&D Credit, is defined as and satisfied by meeting the requirements of the following Four Part Test: 
  • The cost of the activity must be deductible, non-capitalized research and development expenditures,
  • The activity must be undertaken for the purpose of discovering information that is technological in nature,
  • The application of the technological information must be intended to be useful in a new or improved business component, and
  • The vast majority of the activities related to the research effort must constitute elements of a process of experimentation and must have started with technological uncertainties.

 

A more detailed explanation of each component of the Four Part Test is below.

 

Deductible Research and Development Expenditures

To determine which expenses are related to research and development, the taxpayer must consider the expenditures that are reasonable costs incurred in a trade or business for activities intended to discover and provide information which is technological in nature. These costs include those related to:
  • Qualified Wages
  • Qualified Supplies
  • Qualified Contract Research

 

Technological in Nature

Research must be undertaken for the purpose of discovering information that is technological in nature in an attempt to resolve uncertainties. To be considered technological in nature, activities must relate to "hard" sciences that include, among others, the principles of:
  • Physics
  • Chemistry
  • Biology
  • Engineering
  • Computer Sciences

 

New or Improved Business Component

Research must be undertaken to affect a business component that includes one of the following items:
  • Product
  • Process
  • Technique
  • Formula
  • Invention
  • Computer Software

 

In conducting research, the purpose of the R&D activities as relates to any one of the above business components, must be to develop a new or improved:
  • Function
  • Performance
  • Reliability
  • Quality

 

Process of Experimentation

A process of experimentation is defined as "a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities." More specific requirements of this definition include: 
  • The activities must be directed at resolving uncertainty
  • Experimentation must fundamentally rely on the principles of a physical or biological science (see "Technological In Nature" above)
  • Experimentation involves the identification of one or more alternatives intended to eliminate uncertainty, and the identification and the conducting of a process of evaluating the alternatives (e.g., through modeling, simulation, or a systematic trial and error methodology).

 

As relates to the Four Part Test and qualified activities, other factors include:
  • It is not necessary for R&D efforts to be successful
  • It is not required to attempt to obtain information that exceeds, expands, or refines the common knowledge of skilled professionals in the particular field of science or engineering in which research is performed
  • It is not necessary to be the only company in an industry to have developed a particular business component, as long as the process of R&D to do so met the Four Part Test

 

While the Four Part Test lists what is needed to be qualifying R&D activities, some activities that do not meet the requirement due to their nature, location, financing and timing, include: 
  • Research conducted after the beginning of commercial production of a business component
  • Research related to the adaptation of an existing business component to a particular customer's requirement or need
  • The reproduction of an existing business component from reverse engineering from plans, blueprints, detailed specifications, a physical item or publicly available information with respect to such business component
  • Research conducted outside the United States of America
  • Research funded by a third party or customer to which no economic risk is involved for the company wanting to claim the R&D Credit.  This can include research performed under a grant, contract, or governmental entity.  Questions to ask in this regard are:
    • Is payment for the contractor's research activities "contingent upon the success of the research"?
    • Does the contractor retain "substantial rights" in the results of the research activities?

 ​

If 'no' is the answer to both of these questions, then the research is considered funded and would likely not be considered qualified research. 

 

More excluded activities include items that are routine or do not rely on a particular hard science, including:
  • Efficiency surveys
  • Management functions or techniques
  • Market research and testing
  • Advertising and promotions development
  • Regular or ordinary testing or inspection for quality control of already created business components
  • Research in the social sciences, arts, humanities or finance
  • Research related to style, taste, cosmetic, or seasonal design factors

 

If you have any questions, please contact your Rödl & Partner office.

 

 

This publication contains general information and is not intended to be comprehensive or to provide legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Consult your advisor.

We have made reasonable efforts to ensure the accuracy of the information contained in this publication, however this cannot be guaranteed. Neither Rödl Langford de Kock LP nor any of its subsidiaries nor any affiliate thereof or other related entity shall have any liability to any person or entity which relies on the information contained in this publication, including incidental or consequential damages arising from errors or omissions. Any such reliance is solely at user's risk.

Any tax and/or accounting advice contained herein is based on our understanding of the facts, assumptions we have been asked to make, and on the tax laws and/or accounting principles in effect as of the date of this advice. No assurance is given that the conclusions would be the same if the facts or assumptions change, or are not as we understand them, or that the tax laws and/or accounting principles will not change subsequent to the issuance of these conclusions. In addition, we do not undertake any continuing obligation to advise on future changes in the tax laws and/or accounting principles, or of the impact on the conclusions herein.

No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Rödl Langford de Kock LP.

Copyright © August 2018 Rödl Langford de Kock LP
All rights reserved.