R&D and the Food & Beverage
Industry: Creating a Recipe for
Mar. 15, 2018
The Research and Development (R&D) tax credit, more commonly known as the Research Tax Credit
(RTC), was designed as an incentive for U.S. companies to increase research spending. The RTC was
initially established as a temporary tax incentive that originally expired in 1985. It was subsequently
extended 16 times until it was finally made permanent as a tax regulation in December 2015.
With the RTC now being permanent, the timing has never been more right for food manufacturers to
take advantage of these often substantial credits:
- The RTC provides a dollar for dollar reduction in a company’s tax liability;
- In addition to current year tax savings, the credit can generate a refund of taxes previously paid for open
tax years (generally the prior three years); and
- The credit can also be used as a carry-back for one
year and a carry-forward for 20 years if your company does not have immediate utilization for these credits.
If this isn’t convincing enough, the rules for calculating and claiming the RTC have recently become more tax payer friendly. So, if your company has looked into the RTC in the past but was scared away by stringent qualification standards or the difficulty of the calculation itself, these recent changes might make you take another look:
- The Alternative Simplified Credit (ASC) method can now be elected on amended returns
instead of just original filed returns. Introduced in 2006, the ASC is equal to 14% of total qualified research expenses that exceed 50% of the average qualified research expenses for the three preceding taxable years. This method is less complicated than the “regular credit” created in 1981 and does not rely on antiquated data;
- The definition of prototypes has been more clearly defined and made easier to qualify. This is often where you will find opportunities for a large portion of qualified research expenses;
- There are new regulations to clarify the definition of Internal Use Software.
In addition to the federal RTC, over 40 states have an R&D incentive program. These state credits
typically follow federal regulations but have different tax rates and utilization methods. Taxpayers can
benefit from federal and state tax benefits to continue investing in R&D activities and growing their
Now, who would think that food manufacturing could qualify for R&D tax credits? There is a
misconception that R&D only occurs in laboratories of high-tech research facilities, but the definition of
R&D activity is quite broad and includes multiple industries and types of activities. The RTC utilizes a
four-part test to determine what constitutes as a qualified research activity (QRA):
- The first part of the test is that the activity must relate to a new or improved product or
process relating to function, performance, reliability, or quality. This could be anything
from a new formulation for a new or existing product to an improved manufacturing process
that improves efficiencies within your manufacturing facility. In an industry fueled by
constant innovation and demands from the market, food and beverage companies should
have no shortage of these types of activities, referred to as business components.
- The second part of the test requires the elimination of a technical uncertainty. This means
the action must be intended to discover information to eliminate uncertainty concerning the
capability, methodology, or appropriateness of design for developing or improving a product
or process. As a food manufacturer, you have questions or challenges that need to be
resolved. It could be whether your facility is even capable of developing a new product idea or
improving upon a manufacturing process. More than likely, the uncertainty will revolve
around the final design or ideal methodology of a product or process. Your company may
have an initial conceptual idea for how to make a new product, but certain constraints or
inefficiencies are discovered during development, which lead to changes and improvements
to these initial designs and processes. For the food and beverage industry, a prime example is
the challenges faced involving regulatory requirements and the many changes needed to
ensure compliance or improve shelf-life.
- The third part of the test requires a process of experimentation. This means that the
taxpayer must engage in an evaluative process capable of identifying and analyzing one or
more alternatives to achieve a result. Don’t let this test scare you off by envisioning lab coats
and beakers! Although those types of activities certainly constitute a process of experimentation, this test includes anything from modeling and simulation to running trials
and testing scale-up methodologies. In other words, this is the work being done to resolve
uncertainties. The key here is the evaluation of alternatives:
- Did you analyze multiple designs?
- Did you use engineering simulation models to find weaknesses in a design and then improve on that?
- Did you develop multiple prototypes and run those through a series of
performance or functional tests to determine a final design or ideal methodology
process to manufacture?
Maybe your company has a very defined and formal process for new product development like a stage-gate process - a process of experimentation involving various “gates” in the development process where a new product must meet certain parameters before moving into
the next stage of development. Or maybe your company has a much less formal and rigid way of developing new products or new processes, and these are no less qualified. For instance, you may have jotted down an idea for a product or process on the back of a napkin, and now you and your team have set about to determine how to bring it to fruition. As you go through your development process, you will certainly evaluate various ways of finding a technical solution. This is your process of experimentation! Trial and error –analyzing a prototype and/or a a methodology and determining if there is a better way.
v Finally, the fourth part of the test requires that the activity performed must be
technological in nature, fundamentally relying on principles of physical or biological science, engineering, or computer science. This is an easy one. The activities described above must depend on hard science. During your analysis, did you evaluate the physics of your product or look at the biology behind it? Did you test at varying mixing methodologies for optimal viscosity? Maybe you looked at the thermodynamics involved in the process or evaluated your formulation to ensure there would be no microbiological contamination. The examples of qualified scientific principles for this fourth test are endless.
So now that we have identified your qualified research activities, how does that translate into credits? These activities generate qualified research expenditures (QRE’s) that fall into one of three buckets: wages, supply costs, and contractor costs.
- The first bucket is qualified wage expenses, identified through direct wages of technical employees, engineers, or primary research personnel (along with support or supervisory personnel) who affect the research.
2. The second bucket (supply costs) consists of items consumed in the qualified activity and
prototype component/equipment costs. This would include the materials utilized in the creation of a prototype component part but could also include ingredients used in the development of a new formulation during the evaluation of various alternatives. There is also the possibility of taking equipment costs for equipment purchased and modified specifically for the development of a new manufacturing product or process.
3. The third and final bucket is contractor costs. These consist of payments made to a third party
to perform qualified research along with fees paid to consultants or engineering firms. An example in the food and beverage industry would be any costs associated with utilizing a third party to provide certain tests on a new product or equipment as required by a regulatory body.
Additionally, if an outside party is building fixtures for the manufacture of a new product (or as part of a new process), these costs could also be taken as either a supply or contractor cost depending on the work
Luke Rushing is an RTC Senior Manager at ABGI USA. Luke has helped companies
identify R&D opportunities in multiple industries, including manufacturing,
biotech, and A&E for over 7 years. With an education and background in the life
sciences and business administration, Luke has the proficiency required to analyze
and apply the R&D credit within its technical, legislative, and regulatory
Our services range from strategic planning or one day tutorials to large-scale studies
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