SPOTLIGHTS:

Invest In Your Business With the

R&D Tax Credit

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In the current economic climate, it’s still surprising that more businesses don’t explore all of the tax incentives available to help lighten the financial burden by reducing a company’s tax liability, or in certain cases, offsetting payroll taxes.

ABGi USA provides R&D tax credit assistance for US businesses. ABGi USA has a proven track record of making successful R&D tax credit claims. They know what to claim, how to claim it and, perhaps most importantly of all, the many pitfalls to avoid.

   Background

The R&D tax credit is one of the government’s most generous incentives for rewarding a company’s efforts to innovate.

The principle is very straightforward and is a win–win scenario for both the US economy and eligible companies. If the government can make it easier for companies to invest in innovation, then it is more likely that these companies will undertake innovative projects to benefit their business growth and contribute to the economy’s future success and standing.

The good news is that since its launch, the benefits of the R&D tax credit have increased significantly, so there has never been a better time to make a claim.

   How can your business benefit?

The R&D Tax Credit applies to both profitable companies paying taxes and also companies not paying taxes due to losses. These companies are able to claim for eligible activities. The credit can be received as a reduction in tax liability or, in some cases, as a reduction in payroll taxes. Additionally, unused credits can be carried forward for up to 20 years.

   Does your business qualify?

The R&D tax credit can be confusing which is likely why so many companies fail to recognize their eligibility for tax relief. The R&D tax credit was created to benefit companies striving to achieve technical and scientific advances through projects that expand their knowledge, where uncertainty in the outcome exists, and the methods used to achieve success are not readily deducible.

The simplest way to finding out whether you may be eligible to claim is asking yourself some of the following questions:

    • Have we developed new products, processes, or software?
    • Have we tried to improve our existing products through technical changes?
    • At the start of a project, did we ever think, 'I'm not sure of the best way to do this'?

   How can you make a claim?

They key in achieving the best results is working with a specialized R&D tax credit advisory firm such as ABGi USA, who speaks the language of the IRS and understands your business operations. This collaboration ensures you receive the biggest return for the least possible effort.

   ABGi USA can help

    • ABGI USA employee a large team of scientists, engineers, and lawyers across all sector. Their technical and legal analysts are industry experts, who are equally knowledgeable when it comes to the extensive body of legislation that supports the credit. If you have eligibility no one is better equipped to find it for you.
    • Since its inception in 1985, ABGi USA has realised over $1 billion in benefits for its clients. Currently, we are submitting an average of 1,500 claims per year to the IRS.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

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August 2019

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SPOTLIGHTS:

R&D and the Architecture Industry: Building Freedom to Innovate

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Most companies within the architecture industry understand the amount of time and resources that go into creating innovative, customized designs and keeping up with the environmental codes and safety regulations which seem to change every year. What these architecture firms may not know is that this continuous process of developing new and innovative designs makes this industry a strong candidate for claiming the Research and Development (R&D) tax credit. This tax credit, more commonly known as the Research Tax Credit (RTC), was designed as an incentive for U.S. companies to conduct innovative activities, increase research spending, and keep jobs in America.

   Opportunity

With the RTC now being permanent, the timing has never been riper (pun intended) for winemakers 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 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.

Furthermore, the rules for calculating and claiming the RTC have recently become more taxpayer-friendly. Meaning, if your winery or vineyard has looked into the RTC in the past but was worried about stringent qualification standards or the difficulty of the calculation itself, these recent changes should make you take another look:

    • The Alternative Simplified Credit (ASC) method can now be elected on amended returns instead of only on 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” calculation 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 definitions to clarify the definition to Internal Use Software.

In addition to the federal RTC, over 35 states have an R&D incentive program. These state credits typically follow federal regulations but have different tax rates and utilization methods. As such, taxpayers can benefit from both federal and state R&D credits to minimize their tax liability and be paid to innovate while growing their local economy.

   Qualifications

There is a common 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 a qualified research activity (QRA):

smaller graphic

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.

Almost everything an architecture firm creates is customized and highly innovative. From designing single family homes to developing full-scale commercial buildings, architecture firms are constantly finding new ways to create unique and functional yet energy-efficient designs. Activities related to the design and development of new or improved designs are referred to as business components.

THE SECOND PART OF THE TEST REQUIRES THE ELIMINATION OF A TECHNICAL UNCERTAINTY

This means the activities must be intended to discover information to eliminate uncertainty concerning the capability, methodology, or appropriateness of design for developing or improving a product. Architecture firms are presented with many uncertainties throughout the entire design and development process. These uncertainties typically revolve around the final design or the ideal methodology of development. For example, almost every structure or space created requires a new design and must satisfy specific functionalities and capabilities. Even if you have an initial conceptual idea for the design, certain spatial constraints or design requirements may lead to design changes or improvements in the final product. Additionally, LEED and other environmental requirements are constantly evolving. This may lead to uncertainty regarding the capability and methodology of efficiently integrating energy efficient equipment and materials into the design while also satisfying customer requirements.

THE THIRD PART OF THE TEST REQUIRE A PROCESS OF EXPERIMENTATION

This means that the architecture firm must engage in a technical process that analyzes 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 developing multiple design iterations to computer modeling and conducting simulations. The key here is the evaluation of alternatives:

  Did you analyse multiple designs?

  Did you utilise computer simulations to determine weaknesses in a design and then improve upon that?

  Did you evaluate different types of materials and/or equipment models in order to satisfy both environmental parameters and customer requirements?

  Did unanticipated site changes or customer specifications require you to generate new conceptual or schematic designs?

Architecture firms typically have a defined and formal process of experimentation – including a conceptual or schematic design phase, a design development phase, and a construction document phase. During the early conceptual or schematic design phase, you may undertake an iterative design process in which you create and evaluate multiple design options in the form of sketches, drawings, and diagrams. During the design development phase, you may evaluate alternative drawings utilizing computer modeling or conduct testing to determine the optimal material to be used. During the construction documents phase, you may continue to evaluate and improve the drawings and designs based off the site’s unique requirements and features. All of these activities include a process of experimentation.

If you can answer “yes” to any of these questions, then your winery is most likely undergoing a process of experimentation! As you go through your development process, you will certainly evaluate various ways of finding a technical solution.

FINALLY, THE FOURTH PART OF THE TEST REQUIRES THAT THE ACTIVITY PERFORMED MUST BE TECHNOLOGICAL IN NATURE, FUNDAMENTALLY RELY ON PRINCIPLES OF CHEMISTRY, PHYSICAL OR BIOLOGICAL SCIENCE, ENGINEERING, ETC.

This is an easy one. Architecture firms are continuously utilizing the principles of hard sciences such as architectural engineering, structural and civil engineering, and materials sciences in order to design and develop new or improved structures. For example, did you evaluate multiple materials to determine which could satisfy functionality and performance requirements? Did you conduct seismic testing and modeling to ensure the building would be structurally sound given certain environmental conditions? Maybe you evaluated multiple designs to determine the optimal dimensions and measurements of each room given certain spatial constraints. The examples of qualified scientific principles for this fourth test are endless.

   Credits

So now that we have identified your qualified research activities, how does that translate into tax credits? These activities generate qualified research expenditures (QREs) that fall into one of three buckets: wages, supply costs, and contractor costs.

WAGES – this consists of qualified wage expenses, identified through direct wages of technical employees or primary research personnel (along with support or supervisory personnel) who affect the research. For architecture firms, this can include architects, progect managers, drafters, and even interns assisting with design work.

SUPPLY COSTS – this consists of items used or consumed in the research and experimentation process. This can include materials utilized in the creation of a prototype component or costs associated with equipment that has been modified specifically for a new product or process. Due to the nature of their work, architecture firms do not typically have qualified supply costs.

CONTRACTOR COSTS – these are comprised of payments made to a third party to perform qualified research along with fees paid to consultants or outside testing firms. Examples for the
architecture industry include any costs associated with utilizing third party structural engineers.

   ABGi USA can help

    • As you can see, there are numerous opportunities for architecture firms to take advantage of a benefit that has been around since the early 1980s
    • Our ABGI technical teams are skilled at identifying existing and new potential areas of Qualified Research Expenses (QREs) while simplifying the process by employing a methodology that includes building the nexus between RTC activities and costs to eligible projects while minimizing invasiveness to the client. Since its inception in 1985, ABGi USA has realised over $1 billion in benefits for its clients. Currently, we are submitting an average of 1,500 claims per year to the IRS.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

Author Information:
Emily Schwarze is an RTC Associate at ABGI USA. Emily has helped companies identify R&D opportunities in a variety of industries, including manufacturing and A&E. Emily has a degree in Chemical and Biological Engineering from the University of Alabama. When not helping companies reduce their tax liability, she enjoys travelling, playing tennis, and cheering on The Crimson Tide.

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August 2019

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SPOTLIGHTS:

R&D and the Beer Brewing Industry: Time to Refill Your Pint!

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The beer market is a multi-billion dollar industry in the U.S. that is only expected to grow more in the coming years. The industry continuously demands high quality beers, new recipes, and improved ingredients. The processes involved in malting, mashing, fermenting, bottling, and aging the beer make this industry a strong candidate for claiming the Research and Development (R&D) tax credit. This tax credit, more commonly known as the Research Tax Credit (RTC), was designed as an incentive for U.S. companies to conduct innovative activities, increase research spending, and keep jobs in America.

   Opportunity

Most beer brewers do not realize that tax benefits exist to reward the innovative methods and processesthat go into brewing and crafting new beers. The time and resources invested to ensure your beer remains both competitive and in high demand without compromising on the beer’s quality are very technical and complex. These processes include developing new beer recipes, experimenting with unique ingredients, evaluating various brewing techniques such as roast time and hops varieties, and improving the quality of already existing beer recipes.

With the RTC now being permanent, the timing has never been better for brewmasters to tap this keg and pour some of these often-substantial credits for themselves:

    • 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 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.
    • For small businesses grossing less than $5 million in receipts, the credit can be refunded up to the lower of $250,000 or what the company has paid in social security payroll taxes.
    • There is bipartisan legislation in the works that would expand the small business eligibility to cap to $10 million and raise the refund cap to the lower of $500,000 or all payroll taxes paid.

Additionally, the rules for calculating and claiming the RTC have recently become more taxpayer-friendly. Meaning, if your winery or vineyard has looked into the RTC in the past but was worried about stringent qualification standards or the difficulty of the calculation itself, these recent changes should make you take another look:

    • The Alternative Simplified Credit (ASC) method can now be elected on amended returns instead of only on 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” calculation 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.

In addition to the federal RTC, over 35 states have an R&D incentive program. These state credits typically follow federal regulations but have different tax rates and utilization methods. As such, taxpayers can benefit from both federal and state R&D credits to minimize their tax liability and be paid to innovate while growing their local economy.

   Qualifications

There is a common 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 a qualified research activity (QRA):

smaller graphic

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 is anything ranging from the development of a new beer recipe to implementing an improved manufacturing process that minimizes scrap product within the brewery. With every new emerging brewery, brewmasters are under intense pressure to continuously improve the quality of the beers they produce, requiring heavy investment in product development and testing. Activities related to making new beers, improving upon existing beers, or launching process improvements are referred to as business components.

THE SECOND PART OF THE TEST REQUIRES THE ELIMINATION OF A TECHNICAL UNCERTAINTY

This means the activities seek to discover information to eliminate uncertainty concerning the capability, methodology, or appropriateness of design for developing or improving a formula, product, or process. As a brewmaster, there are many challenges presented throughout the entire beermaking process. For example, unexpected chemical changes during the brewing process or microbial contamination may put you back at square one, requiring the testing process to start completely over. Or perhaps there is uncertainty whether the brewery is capable of making the beer because it is not equipped with the proper storage or measuring equipment to successfully control the precise variables in making certain types of beer. As an expert in the industry, you may have an initial conceptual idea for how to make a new beer, but certain constraints or inefficiencies are discovered during development which lead to changes and improvements to the final product. Lastly, food and beverage regulations place additional challenges to ensure compliance and/or improve shelf-life.

THE THIRD PART OF THE TEST REQUIRE A PROCESS OF EXPERIMENTATION

This means that the brewmaster must engage in a scientific process that analyzes one or more alternatives toachieve 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 conducting yeast trials, testing scale-up methodologies, experimenting with new ingredients, evaluating various filtration techniques to prevent beer contamination, and testing different fermentation methods. The key here is the evaluation of alternatives:

  Did you develop prototype batches?

  Did you experiment with new ingredients to create a specific flavor profile?

  Did you attempt more than one mixing technique?

If you can answer “yes” to any of these questions, then your winery is most likely undergoing a process of experimentation! As you go through your development process, you will certainly evaluate various ways of finding a technical solution.

FINALLY, THE FOURTH PART OF THE TEST REQUIRES THAT THE ACTIVITY PERFORMED MUST BE TECHNOLOGICAL IN NATURE, FUNDAMENTALLY RELY ON PRINCIPLES OF CHEMISTRY, PHYSICAL OR BIOLOGICAL SCIENCE, ENGINEERING, ETC.

This is an easy one. This is an easy one. Brewmasters are continuously using the principles of chemistry, food science, industrial engineering, and mechanical engineering to make and test new beers. For example, did you conduct an analysis of the beer’s chemical composition in a lab? Did you analyze the scale up requirements to take a recipe from small batch to large batch production? Maybe you evaluated your formulation to ensure there would be no microbial contamination. Any of these actions demonstrate your reliance on hard science principles.

   Credits

So now that we have identified your qualified research activities, how does that translate into tax credits? These activities generate qualified research expenditures (QREs) that fall into one of three buckets: wages, supply costs, and contractor costs.

WAGES – this consists of qualified wage expenses, identified through direct wages of technical employees or primary research personnel (along with support or supervisory personnel) who affect the research. For breweries, this can include Senior and Assistant brewmasters, chemists, and any personnel providing direct support to those employees (such as brewers and lab technicians.

SUPPLY COSTS – supplies consist of items consumed in the research and experimentation process. This would include the materials (batch costs) used throughout the trial-and-error process when testing new formulations and ingredients.

CONTRACTOR COSTS – these are comprised of payments made to a third party to perform qualified research along with fees paid to consultants or outside testing firms. An example in the beer 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.

   ABGi USA can help

    • As you can see, there are numerous opportunities for breweries to take advantage of a benefit that has been around since the early 1980s
    • Our ABGI technical teams are skilled at identifying existing and new potential areas of Qualified Research Expenses (QREs) while simplifying the process by employing a methodology that includes building the nexus between RTC activities and costs to eligible projects while minimizing invasiveness to the client. Since its inception in 1985, ABGi USA has realised over $1 billion in benefits for its clients. Currently, we are submitting an average of 1,500 claims per year to the IRS.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

Author Information:
Matthew Rumsey is an RTC Associate at ABGI USA. Matt has helped companies identify R&D opportunities in multiple industries, including architecture firms and technology companies. Matt is currently pursuing his CPA license, and with more than 2 years of public accounting experience, Matt has the proficiency required to analyze and apply the R&D credit within its technical, legislative, and regulatory framework.

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August 2019

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SPOTLIGHTS:

5 Common Myths About the

R&D Tax Credit

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Despite an overall increase in R&D tax credit claims by US businesses, many companies are still not reaping the full benefits of the RTC.

By far, the main reason for companies having some resistance to understanding how the R&D tax credit can benefit their business, is the idea that they are probably not eligible.

SO, IT’S TIME TO VENTURE FORWARD AND DISPEL SOME OF THOSE R&D TAX CREDIT MYTHS!

   1. You're not eligible for R&D tax credits unless you wear a white coat and work in a laboratory.

MYTH! Companies from multiple sectors can be eligible for R&D tax credits - from biotechnology (where they may wear lab coats) to manufacturing, software, food and agriculture, engineering, renewable energy and more. If you are working in a hard science and face technical uncertainty in how to do achieve a specific objective, you could very well be doing R&D.

   2. You can only claim for successful projects.

MYTH! You can claim R&D tax credits for any eligible R&D project whether there was a successful outcome or not. In fact, failure can be a good sign of eligibility - what can be more uncertain than a seemingly impossible project?

   3. You can only claim for your current financial year.

MYTH! You can make a retroactive claim for any open tax years if the statute of limitations has not passed. This means companies new to the tax credit can still go back and claim for older projects rather than missing out.

   4. Claiming R&D tax credits is hard.

MYTH! Ok, sort of a myth. It can be a complicated process that requires knowledge of your business operations (easy for you!) but also an in-depth knowledge of the R&D tax credit legislation and case law, US Treasury Regulations, and the ever-changing tax code (not so easy!). But you can cut out the difficult part by enlisting the help of an R&D tax credit expert who can take on the hard work and complications for you.

   5. All R&D tax credit experts are the same

MYTH! Ok, sort of a myth. It can be a complicated process that requires knowledge of your business operations (easy for you!) but also an in-depth knowledge of the R&D tax credit legislation and case law, US Treasury Regulations, and the ever-changing tax code (not so easy!). But you can cut out the difficult part by enlisting the help of an R&D tax credit expert who can take on the hard work and complications for you.

Speak to ABGi USA

    • ABGi USA is a leading R&D tax credit specialist, guiding companies through the complexities of submitting claims to CPAs, the Big 4, and the IRS
    • ABGI USA's team of legal and technical experts is equipped with legislative and technical background as well as years of industry experience. This combined expertise has resulted in an extremely high success rate in securing R&D tax credit for their clients. Since its inception over 30 years ago, ABGi USA has realised $1 billion in benefits for their clients.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

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August 2019

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Have a question? We’re happy to help!

SPOTLIGHTS:

R&D and the Winemaking Industry:

Time to Refill Your Glass!

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The wine market is a multi-billion dollar industry in the U.S. that is only expected to grow more in the coming years. The industry continuously demands high quality wines, new blends, and improved ingredients. The processes involved in growing, irrigating, harvesting, blending, and aging wine make this industry a strong candidate for claiming the Research and Development (R&D) tax credit. This tax credit, more commonly known as the Research Tax Credit (RTC), was designed as an incentive for U.S. companies to conduct innovative activities, increase research spending, and keep jobs in America.

   Opportunity

Most winemakers and vineyards do not realize that tax benefits exist to reward the innovative methods and processes that go into harvesting and making wine. The time and resources invested to ensure your wine remains both competitive and in high-demand without compromising the wine’s flavor profile are very technical and complex. These processes include developing new wine varietals, conducting yeast trials, evaluating various filtration techniques, and improving the quality of existing wine blends.

With the RTC now being permanent, the timing has never been riper (pun intended) for winemakers 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 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.

Additionally, the rules for calculating and claiming the RTC have recently become more taxpayer-friendly. Meaning, if your winery or vineyard has looked into the RTC in the past but was worried about stringent qualification standards or the difficulty of the calculation itself, these recent changes should make you take another look:

    • The Alternative Simplified Credit (ASC) method can now be elected on amended returns instead of only on 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” calculation 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.

In addition to the federal RTC, over 35 states have an R&D incentive program. These state credits typically follow federal regulations but have different tax rates and utilization methods. As such, taxpayers can benefit from both federal and state R&D credits to minimize their tax liability and be paid to innovate while growing their local economy.

   Qualifications

There is a common 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 a qualified research activity (QRA):

smaller graphic

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 is anything ranging from the development of a new blend or varietal of wine to implementing an improved manufacturing process that minimizes scrap product within the winery. With each harvest, wine makers are under intense pressure to continuously improve the quality of the wines they produce, which requires heavy investment in product development and testing. Activities related to making new wines, improving upon existing wines, or launching process improvements are referred to as ‘business components’.

THE SECOND PART OF THE TEST REQUIRES THE ELIMINATION OF A TECHNICAL UNCERTAINTY

This means the activities are seeking to discover information to eliminate uncertainty concerning the capability, methodology, or appropriateness of design for developing or improving a formula, product, or process. As a wine maker, there are many challenges presented throughout the entire wine-making process. For example, you may not know the appropriate ratios of ingredients required to improve the quality of a specific wine. Additionally, unexpected chemical changes during the fermentation process or microbial contamination may put you back at square one, requiring the testing process to start completely over. You may have uncertainty regarding whether the winery is capable of making the wine because it is not equipped with the proper irrigation and filtration systems to successfully cultivate grapes. As an expert in the industry, you may have an initial conceptual idea for how to make a new blend, but certain constraints or inefficiencies are discovered during development, which lead to changes and improvements to the final product. Lastly, food and beverage regulations place additional challenges to ensure compliance and/or improve shelf-life.

THE THIRD PART OF THE TEST REQUIRE A PROCESS OF EXPERIMENTATION

This means that the winemaker must engage in a scientific process that analyzes 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 conducting yeast trials, testing scale-up methodologies, experimenting with new ingredients, evaluating various filtration techniques to prevent wine contamination, and testing different fermentation methods. The key here is the evaluation of alternatives:

  Did you develop prototype batches?

  Did you experiment with a new combination of ingredients or nutrients to achieve a specific flavor profile?

  Did you attempt more than one mixing technique?

  Did you run barrel trials to determine whether a certain barrel would improve the quality of wine?

  Did you experiment with multiple ratios of other wines to make a new blend?

If you can answer “yes” to any of these questions, then your winery is most likely undergoing a process of experimentation! As you go through your development process, you will certainly evaluate various ways of finding a technical solution.

FINALLY, THE FOURTH PART OF THE TEST REQUIRES THAT THE ACTIVITY PERFORMED MUST BE TECHNOLOGICAL IN NATURE, FUNDAMENTALLY RELY ON PRINCIPLES OF CHEMISTRY, PHYSICAL OR BIOLOGICAL SCIENCE, ENGINEERING, ETC.

This is an easy one. Wine makers are continuously using the principles of chemistry and food science to make and test new wines. For example, did you conduct an analysis of the wine’s chemical composition in a lab? Did you evaluate yeast enzymes and tank fermentation results? Did you test varying mixing methodologies for optimal consistency? Perhaps you analyzed the rate of evapotranspiration to ensure the best soil conditions for grape cultivation. Maybe you evaluated your formulation to ensure there would be no microbiological contamination. Any of these actions demonstrate your reliance on hard science principles.

   Credits

So now that we have identified your qualified research activities, how does that translate into tax credits? These activities generate qualified research expenditures (QREs) that fall into one of three buckets: wages, supply costs, and contractor costs.

WAGES – this consists of qualified wage expenses, which includes the direct wages of technical employees or primary research personnel, along with support or supervisory personnel, who affect the research. For wineries, this can include Senior and Assistant Wine Makers, Enologists, and any personnel providing harvest and cellar support.

SUPPLY COSTS – supplies consist of items used in the research and experimentation process. This includes the materials used throughout the trial-and-error process when testing new formulations and ingredients.

CONTRACTOR COSTS – these are comprised of payments made to a third party to perform qualified research along with fees paid to consultants or outside testing firms. An example in the wine 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.

   ABGi USA can help

    • As you can see, there are numerous opportunities for vineyards and wineries to take advantage of a benefit that has been around since the early 1980s
    • Our ABGI technical teams are skilled at identifying existing and new potential areas of Qualified Research Expenses (QREs) while simplifying the process by employing a methodology that includes building the nexus between RTC activities and costs to eligible projects while minimizing invasiveness to the client. Since its inception in 1985, ABGi USA has realised over $1 billion in benefits for its clients. Currently, we are submitting an average of 1,500 claims per year to the IRS.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

Author Information:
Laura Randeles is a Senior RTC Manager at ABGI USA. Laura has helped companies identify R&D opportunities in multiple industries, including wineries and breweries. As a licensed attorney with over 10 years of experience in the legal industry, Laura has the proficiency required to analyze and apply the R&D credit within its technical, legislative, and regulatory framework.

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August 2019

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SPOTLIGHTS:

White Paper:

A comparison of the "Big 4" and ABGi USA

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With tax reform adding to the complexity of the Internal Revenue Code, companies are searching for ways to reduce overall tax liability through various tax incentives. Companies continue to rely on large accounting firms to assist in identifying and quantifying deductions and tax credits to reduce their potential tax liability. However, relying on large accounting firms to assist comes at a cost. Utilizing large accounting firms, namely the “Big 4” (and similar firms), ultimately shrinks a company’s return on investment (“ROI”). The information below will demonstrate why choosing ABGI USA, a firm focused solely on identifying and quantifying complex tax incentives, provides added value and protects a company’s ROI.

   Discussion

Big 4 firms have an established place in the accounting arena from a macro perspective. Depending on the firm, both the services in preparing tax returns and in performing audits are some of the best available. In an effort to increase their footprint in the tax arena and find new revenue streams, the Big 4 have created “specialized tax incentive” departments to assist with deductions and incentives. However, name recognition does not always mean quality and value when evaluating the intricacies of specialized tax incentives within the Internal Revenue Code.

When evaluating which firm to utilize to assist in identifying these specialized tax incentives, a company may ask: “[W]hich firm will provide me with the greatest value?” To determine which firm provides the greatest value with respect to identifying, quantifying, and supporting specialized tax incentives, a company can ask two important questions:

    • What will be my Company's ROI based off initial incentives identified?
    • If an audit is triggered because of the identified incentives, how much of the incentive will likely be sustained? Further, will the audit defense fees offset the identified incentives?

The answer to all of these questions is simple, but the justification is not as straightforward as reviewing the contractual fee amount of an agreement.

| Big 4 Billing Practices

First, when evaluating which firm to engage to identify these complex incentives, a company might think that, because of the strong name recognition of accounting firms such as the Big 4, whichever firm offers to perform a tax incentive study at the lowest fixed-fee rate is providing the “best value” and the highest ROI. This, however, is not necessarily the case.

To give the appearance that a company is maximizing value by utilizing a Big 4 services firm, a Big 4 firm will typically enter into a fixed-fee type of arrangement for specialized tax services. In this arrangement, Big 4 firms evaluate the approximate number of hours it will take to complete an engagement. In an effort to lower that fixed-fee amount (but maintain hours worked and profitability on the engagement), Big 4 firms almost always shift hours and costs down to the staff level. Further, these firms often outsource some of the work, costs, and your company’s sensitive financial information abroad to lesser developed countries. This deception creates the appearance that significant quality hours are being spent on a project. However, many hours are performed by staff with little to no experience in dealing with specialized tax incentives. For example, if an R&D study takes approximately 600 hours to complete, only a fraction of those hours will be performed by experienced personnel with the necessary specialized knowledge and understanding of the nuances of the R&D tax credit required to properly identify and quantify costs associated with the credit.

| ABGI USA's Solution to Big 4's Billing Practices

ABGI USA offers the right solution to enable companies to maximize available specialized tax incentives. ABGI USA offers its clients a billing model that is client centric and remains unmatched. ABGI USA’s goal with each client is to provide at a minimum a guaranteed 4 to 1 ROI, which is one of the largest ROI’s in the industry.

Every member of ABGI USA’s production team has multiple years of experience in identifying and quantifying specialized tax incentives. This means that if your R&D tax credit study requires 600 hours of work to complete, all 600 of those hours will be performed in-house by experienced members of ABGI USA’s production team. Your ABGI USA team will be comprised of attorneys, engineers, and scientists who have worked on hundreds of R&D studies. No billing hours and none of your company’s sensitive information will be sent overseas to a team with little-to-no experience dealing with the United States Internal Revenue Code and Treasury Regulations.

For further information on ABGI USA’s billing model, when compared to that of the Big 4 firms, please see the side-by-side comparison outlined in Exhibit A and a specific billing example outlined in Exhibit B.

| Big 4 Fails to offer Audit Defense in Tax Incentive Engagements

Next, there is always the unfortunate possibility that identifying and quantifying specialized tax incentives to reduce tax liability may lead to an audit. In the event of an audit, a company needs to protect itself when utilizing a consulting firm. Unfortunately, Big 4 firms nearly always fail to offer such protection in their initial agreements.

Indeed, Big 4 firms offer tax controversy services to assist in audit defense. However, such tax controversy services are nearly always separate and apart from any initial agreement between a company and the Big 4 firm. A separate engagement must be entered into on an hourly fee basis at incredibly high hourly rates for audit defense. This separate engagement generally results in audit fees well beyond $100,000, which significantly shrinks the expected ROI of the tax incentive engagement.

| ABGI USA provides Audit Defence at No Additional Charge

As mentioned previously, ABGI USA strives to provide each client with at least a 4 to 1 ROI. Thus, ABGI USA provides audit defense at no additional charge in its specialized tax incentive contracts. This defense is not limited in scope to only handling the “initial document request” from the IRS (which is the typical audit defense scope from other regional/boutique firms). Instead, ABGI USA will handle any audit being performed on one of its engagements all the way to the final appeal with the IRS. In contrast, for an audit to reach final appeal, a company will certainly spend well beyond $100,000 from a Big 4 tax controversy department.

ABGI USA fully stands behind the work of its professionals. Because of this, ABGI USA includes audit defense protection within its initial engagement. Such audit defense proves invaluable to companies looking to maximize their ROI and eliminate the risk of lowering that ROI because of Big 4 audit fees.

Finally, of special note – in its 32 years of providing R&D Study services, ABGI USA has maintained a 95% sustention rate on every dollar ever claimed.

| ABGI USA has the same advantages as the Big 4 but without disadvantages

ABGI USA absolutely respects the vast breadth of the Big 4. In fact, the ABGI USA team includes numerous former Big 4 employees – including its CEO and Vice President. However, much like you wouldn’t go to a general practitioner for specialized surgery, the Big 4’s breadth is wasted (and expensive) when focused on specialized tax incentives. ABGI USA focuses solely on specialized tax incentives. Because of this, ABGI USA can analyze and maximize all potential tax incentives for your company around the world.

1. ABGI USA is a Global Firm

ABGI USA is a branch of ABGI Group, with additional international headquarters in France, Brazil, and Canada, and satellite offices around the globe. Indeed, it is ABGI Group’s business model to offer local services to its clients. Further, ABGI Group’s clients are some of the biggest companies in the world, and they trust ABGI Group to maximize their tax incentives from a global perspective – no matter where in the world the most beneficial tax savings can be identified.
Thus, like the Big 4, ABGI USA and ABGI Group are truly worldwide – no other non-Big 4 specialized tax incentives provider can honestly state this.

2. ABGI USA's unique approach maximizes benefits while minimizing company interruptions

In addition to providing global reach to its clients, ABGI USA’s proprietary tools and unique approach to identifying and quantifying research expenses maximizes the benefit realized by its clients while minimizing internal company interruptions. Typically, Big 4 firms will use a variation of what is known as a “project-byproject” methodology to identify and quantify R&D activities. A “project-by-project” methodology may be accomplished in one of two ways: by reviewing all projects worked on during a study period or by conducting a statistical sampling analysis.

a. Utilizing the first “project-by-project” approach is an arduous, time-consuming task for companies. It requires a company’s personnel to review, in detail, potentially hundreds of projects and provide documentation for each of those projects. While this approach seemingly maximizes the credit, this methodology actually reduces a company’s ROI because of the significant company resources expended in order to quantify the credit.

b. Often, to avoid the burdensome and arduous task of gathering information and documentation via the “project-by-project” approach, Big 4 firms will utilize a statistical sampling analysis. Big 4 firms typically use an in-house statistician to perform a statistical sample from hundreds or thousands of projects. The statistician will randomly select a number of projects—for example, 20 projects to represent anywhere from 100-1000 projects—for a seemingly more thorough and in-depth analysis. Although this is, in theory, legally allowed via Revenue Procedure 2011-42, if the taxpayer is ever audited, the IRS nearly always attacks statistical samples because the samples do not appear to be randomly generated. It is difficult for a taxpayer to overcome the IRS’ presumption that any statistical sample ever done by any provider, including the Big 4, is not the result of a cherry-picked sample. Thus, if audited, this method almost always turns into an entirely new and incredibly arduous examination because the IRS will almost certainly state it cannot rely on the provider’s underlying analysis of the taxpayer’s claimed qualified expenses, resulting in almost an entirely new study being performed in the audit phase.

In contrast, ABGI USA utilizes a specific approach called the “Business Component Approach with an Established Nexus.” This methodology benefits its clients in a number of ways. On average, this approach can save up to 55% of internal company resources when compared to the “Project-by-Project” or “Statistical Sampling” methodology. Saving internal company resources allows that company to focus its efforts elsewhere while ABGI USA handles the intricacies of calculating the R&D tax credit and other valuable tax incentives.

Finally, the proprietary tools developed and utilized by ABGI USA to analyze a company’s research expenses enable ABGI USA to identify and maximize a company’s credit. Based on prior experience, Big 4 firms typically utilize a Microsoft Access database to input information regarding qualified expenses. The database then calculates the credit. This simple, automated calculation does not allow for a manual review to identify potentially qualified expenses. In contrast, ABGI USA’s proprietary tools allow ABGI USA’s experienced personnel to continuously review the expense data and identify additional areas where research expenses may be captured. Thus, ABGI USA’s approach and proprietary tools allow for a complete review of all potential expenses to maximize benefit. This completely custom approach is absolutely unique to ABGI USA.

   Conclusion

In choosing to use ABGI USA, your company is getting all of the specialized tax incentives, knowledge, and global benefits of a Big 4 firm, but with substantially higher ROI and substantially less risk. Further, because ABGI USA and ABGI Group only work in the specialized tax incentive space, you are assured the most knowledgeable and senior staff are working to maximize clients’ benefits around the world. Finally, because of ABGI USA’s unique approach to quantifying and supporting its specialized tax incentives, as well as the unparalleled audit protection services provided as a part of every single engagement, clients clearly see how ABGI USA effectively and efficiently maximizes ROI.

ABGI USA is here to help you navigate the complicated nature of the R&D tax credit and other specialized tax incentives.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

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July 2019

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SPOTLIGHTS:

U.S Tax Reforms:

 Research and Development Tax Credit

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On December 22, 2017, President Trump signed into law H.R. 1, more commonly referred to as the Tax Cuts and Jobs Act (the Act). While maintaining the permanency of the Research Tax Credit, the Act eliminated the Domestic Production Activities Deduction under Section 199 of the Internal Revenue Code (IRC). With the elimination of the Section 199 deduction, effective for tax years beginning January 1, 2018, the value of the Research Tax Credit could not be more beneficial to U.S. companies than it is now.

In 1981, Congress enacted the Research Tax Credit to incentive taxpayers to invest in research and innovation related to new or improved products, processes, computer software, techniques, formulae, or inventions within the United States. Since its inception, Congress has continuously extended the Research Tax Credit incentive to stimulate the U.S. economy, until making it permanent under the PATH Act in 2015. With the permanency of the Research Tax Credit, U.S. companies can utilize.

   The Act's Enhanced Impact on the Research Tax Credit

| Reduced Corporate Tax Rate 

The Act lowers the corporate tax rate from 35% to 21% which, in effect, provides an increased net benefit from 65% to 79%. This is true even when making the IRC Section 280C(c)(3) election (known as a “280C election”).

A taxpayer generally must add the Research Tax Credit back to its taxable income through an M-1 adjustment. However, a 280C election allows taxpayers to take a reduced credit election and forego any addback related to the credit. Prior to tax reform, the credit was reduced by 35% (the corporate tax rate). Now, with the reduction of the corporate tax rate, the 280C election will only reduce the Research Tax Credit by 21%. Additionally, by electing to reduce the Research Tax Credit under 280C, a taxpayer may reduce potential negative state income tax effects.

Ultimately, the decrease in tax rate serves to make the U.S. corporate tax rate more competitive from a global perspective, which in turn allows for the increased net benefit that taxpayers will see from the Research Tax Credit beginning in tax year 2018.

| Corporate Alternative Minimum Tax

The Act also eliminates the alternative minimum tax (AMT) for tax years beginning after December 31, 2017. Prior to the repeal of AMT for corporations, corporate taxpayers could not utilize the Research Tax Credit to offset AMT, unless the corporate taxpayer was an “eligible small business” under IRC Section 38(c) (5)3. With the elimination of AMT, corporations that have historically been paying AMT now have the opportunity to take advantage of the Research Tax Credit to offset any regular tax liability, subject to general business credit limitations under IRC Section 38(c)(1)4. Under this limitation, a taxpayer may reduce its liability to 25% of the amount of net regular tax liability that exceeds $25,000.

| Net Operating Losses under IRC Section 172

For tax years ending after December 31, 2017, the net operating loss (NOL) deduction is limited to 80% of taxable income. While the Act repeals the current carryback/carryforward provisions under IRC Section 1725, it also allows for an indefinite carryforward for NOLs. Because of this provision under the Act, taxpayers in a NOL position should consider whether or not to forego the 280C election. The Research Tax Credit itself may not be carried forward indefinitely, but if a company is operating under a NOL, foregoing the Section 280C election may be more advantageous. Doing so may increase the Research Tax Credit carryforward because a higher Research Tax Credit may have the ability to offset tax liability for a longer period, extending the taxpayer’s ability to utilize NOL carryforwards.

| Amortization of IRC Section 174 Expenses

Currently, under IRC Section 174, taxpayers may deduct research and experimental expenditures paid or incurred during a tax year, or choose to amortize such costs over no less than 60 months. Alternatively, under IRC Section 59(e), a taxpayer may elect to amortize research expenses over a 10-year period.

For tax years beginning after December 31, 2021, the Act requires taxpayers to capitalize and amortize IRC Section 174 research and experimental expenditures over a period of five years. Additionally, the Act requires that software development costs be treated as research and experimental costs. Therefore, software development costs will also receive the five-year amortization treatment. Further, the Act requires that a taxpayer must capitalize and amortize expenditures related to research conducted outside of the United States over a period of 15 years. The purpose of this provision in the Act is to incentivize taxpayers to move research activities to the United States.

The implications of this provision are far reaching. Taxpayers will lose the immediate ability to reduce tax liability through a current year deduction. In addition, the amortization provision under IRC Section 174, for state purposes, may be substantial if the deduction typically reduces a taxpayer’s state tax burden. However, to overcome the IRC Section 174 implications, taxpayers may be able to characterize a portion of research and experimental expenditures as ordinary and necessary business expenses under IRC Section 162, which would allow for a current year deduction.

One caveat that may prove to be beneficial to taxpayers under IRC Section 174 is that, presently, only “reasonable” research expenditures may be deducted. Under new tax law, the Act removes IRC Section 174 (e), which deems that research expenditures must be “reasonable under the circumstances.” Thus, this may provide taxpayers with the ability to include research and experimental expenditures that have been deemed “unreasonable” under current law.

The important takeaway is that, although capitalization under IRC Section 174 will create higher tax liabilities after December 31, 2021, those liabilities will be present for a short period because of the timing differences generated by amortization. Over time, these liabilities will flatten out as the capitalization of expenses catches up to the five-year amortization schedule.

   Conclusion

Even with the negative impact by IRC Section 174 on current-year deductions beginning after December 31, 2021, the Research Tax Credit under IRC Section 41 remains virtually untouched and intact, and incredibly valuable for minimizing tax liability.

The reduction of the corporate tax rate and the elimination of AMT will not only increase the overall credit benefit to U.S. taxpayers, it will also provide taxpayers, that have historically been deprived of the Research Tax Credit, the ability to benefit from and take advantage of the Credit.

ABGi USA is here to help you navigate the complicated nature of the R&D Tax Credit and other tax incentives.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

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July 2019

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SPOTLIGHTS:

Research and Experimentation (R&E) Credit

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Government support of research and development (R&D) may be appropriate when the social benefits associated with research activities exceed the private benefits. In the absence of such intervention, a market economy would tend to underinvest in research that leads to new ideas, discoveries and knowledge that are helpful in supporting a growing economy. There are numerous ways that governments seek to increase research activity. This paper describes and analyzes one prominent tax expenditure, the research and experimentation (R&E) credit, which encourages businesses in the U.S. to increase investment in research activities.

   Current Law Description

Originally enacted in 1981, the R&E credit was temporarily extended 16 times before finally being made permanent in the Protecting Americans from Tax Hikes (PATH) Act of 2015.

The R&E credit is incremental, the credit amount equals the applicable credit rate times the amount of qualified research expenses (QRE) above a base amount. Under current law, taxpayers may choose one of two methods to calculate the credit.

First, under the regular or “traditional” method the credit rate equals 20 percent and the base amount is the product of the taxpayer’s “fixed base percentage” and the average of the taxpayer’s gross receipts for the four preceding years. The taxpayer’s fixed base percentage is the ratio of its research expenses to gross receipts for the 1984-1988 period. A modified rule is used for taxpayers not in existence during the 1984-1988 time period to determine the fixed base percentage. The base amount cannot be less than 50 percent of the taxpayer’s QRE for the taxable year.

Second, taxpayers can elect the alternative simplified credit (ASC), which equals 14 percent of QRE that exceed a base amount defined as 50 percent of the average QRE for the three preceding taxable years. The ASC rate is reduced to six percent if a taxpayer has no QRE in any of the three preceding taxable years.

Taxpayers are also allowed to deduct (expense), instead of capitalize, research and experimental expenditures. However, taxpayers must either reduce the amount of their deduction of research expenditures by the amount of the credit claimed, or elect to take a smaller credit, one reduced by a proportion equal to the maximum statutory corporate tax rate. (More than 90 percent of corporate taxpayers elect the reduced credit). This “reduced” credit decreases the credit rate from 20 percent to 13 percent under the regular method and from 14 percent to 9.1 percent under the ASC. The proportional adjustment is roughly equivalent to reducing the size of deductible research expenses by the amount of the credit.

QRE include both in-house research expenses and contract research expenses. In-house research expenses include wages, supplies, and computer leasing expenses. Generally only 65 percent of payments for qualified research by the taxpayer to an outside person is included as contract research expenses, except in the case of payments to a qualified research consortium, 75 percent of the payments is included. Qualified research must be undertaken for purpose of discovering information that is technological in nature, must be intended to be useful in the development of a new or improved business component, and substantially all of the activities must relate to a process of experimentation concerning a new or improved function, performance, reliability or quality.

The R&E credit is a component of the general business credit and is generally not allowed to offset alternative minimum tax (AMT) liability. Credit amounts not claimed on the current-year tax return receive a one-year carryback or a carryforward of up to 20 years. The recently passed PATH Act of 2015 created two exceptions to the normal general business credit rules for certain small businesses beginning in 2016. First, eligible small businesses with gross receipts less than $50 million averaged over the past 3 years may apply the credit against AMT liability. Second, a qualified small business may elect to claim up to $250,000 of R&E tax credit as a payroll tax credit against its employer share of Social Security old age, survivors, and disability insurance (OASDI) taxes. To qualify for this payroll tax credit, the gross receipts of the taxpayer must be less than $5 million in the taxable year, and the taxpayer must not have had gross receipts in any taxable year before the 5-year period ending with the current taxable year. For certain research activities, the R&E tax credit allows a separate credit calculation equal to 20 percent of: (1) basic research payments above a base amount; and (2) all eligible payments to an energy research consortium for energy research.

Table 1
Table 2

   Use of the Credit

The R&E credit is one of the largest business tax expenditures. In the past, however, the estimates of its size presented the tax expenditure budget frequently have been understated because the credit was temporary and its revenue effects were assumed to expire on schedule. In recent years, the credit had often expired at the time of the calculation and the tax expenditure reported in the Administration’s budget primarily reflected the use of the large stock of carry forward credit from previous years. For example, in the Fiscal Year 2017 budget, the estimated cost of the R&E credit equaled $20.6 billion for fiscal years 2016-2025 reflecting the expiration of the credit at the end of 2014 under the law at that time. Now the credit is permanent and the recently released Office of Tax Analysis (OTA) estimate of the tax expenditure has increased to $148.0 billion for fiscal years 2017-2026. This ranks the credit as one of largest business tax expenditures over the budget window.

For 2012, a total of $11.6 billion of current-year credit was reported on corporate and individual returns. Corporations accounted for $10.8 billion (93 percent) of the total. However, for a couple of reasons this is not an accurate measure of the revenue loss for that year as a result of the credit. First, taxpayers must either reduce the amount of their deduction of research expenditures by the amount of the credit claimed, or elect to take the reduced credit. In recent years, more than 90 percent of corporate taxpayers chose the reduced credit. But for those who do not choose the reduced credit, an adjustment must be calculated to account for the value of the lost deductions to equalize the value of the credit reported to those taxpayers who use the reduced credit.

Second, many taxpayers do not have current-year tax liability for which to take advantage of the credit immediately. In recent years, roughly half of the current-year credit for both corporate and individual taxpayers is not used in the current taxable year. The credits not used in the current year receive a one-year carryback or a 20-year carryforward. Recent improvements to Form 3800 provide information on the different types of general business credit carryforwards. In 2012, corporations reported $27.3 billion in R&E credit carryforwards, another $0.8 billion in R&E credit carryforwards were reported on individual returns.

Details on the use of the credit for corporate taxpayers in 2012 by sector and size of business are shown in Tables 1 and 2.9. By far the largest sector claiming the research credit was manufacturing, with 6,219 corporate manufacturers claiming almost $6.6 billion of tax credits, which comprises 39 percent of the 15,873 corporate returns and 61 percent of the $10.8 billion in total current-year credits. The largest businesses, i.e., those with receipts of $250 million or more, accounted for 14 percent of all corporate tax filers claiming the credit, but for 84 percent of the total amount of credits claimed. Corporations with gross receipts less than $50 million accounted for just over 72 percent of the returns, but less than 11 percent of the current-year credit. Similarly, 42 percent of the returns belonged to corporations with gross receipts under $5 million, but these small taxpayers generated less than 6 percent of the current-year credit.

Approximately 69 percent of QRE spending is for wages and salaries. Another 15 percent goes towards supplies, and contract research expenses account for 16 percent of QRE. Expenditures for the rental or lease cost of computers accounts for a negligible percentage of QRE. Corporations using the regular method accounted for approximately 31 percent of QRE, while firms using the ASC comprised the remaining 69 percent of QRE.

   Effect of the Credit on R&E Incentives

The credit is intended to subsidize increases in R&E investment above a baseline level. Because the credit is calculated based on incremental investment, and because taxpayers have options for calculating the value of the credit, measuring the incentive effects of the credit is complicated. This section summarizes these incentives. First we calculate the marginal credit rate on incremental R&E expenditures—how much additional tax savings firms receive from increasing their expenditures—and describe how that incentive varies across firms and compares to the average credit rate. Second, to understand how this affects incentives to invest in research, we compare the treatment of marginal research investments to investments in tangible property.

Most corporate taxpayers use the ASC method (51 percent) where the average and effective rates are nearly equal, and these taxpayers account for 69 percent of the research expense reported on tax returns. For taxpayers using the regular method, most are constrained by the 50 percent minimum base and in effect face a flat-rate credit. These taxpayers account for 44 percent of corporate returns and 28 percent of research spending. Under assumptions we describe below, the required user cost of capital for investment in R&D falls by 15 to 26 percent below an alternative investment in a piece of equipment, which translates to a reduction in the required rate of return of approximately 3 to 6 percentage points.

The primary unit of measurement for this discussion will be the present value change in tax liabilities for a marginal one dollar increase in QRE in the current taxable year, which will be labeled the “effective credit rate.” The effective credit rate can vary by the method of calculation, the pattern of research investment over time for the firm, and the tax position of the taxpayer. The average credit rate is also calculated, which is defined as the current-year credit divided by total current-year QRE. In all examples, the taxpayer is assumed to elect the reduced credit.

Sample calculations are provided in Tables 3.1-3.3 for taxpayers using the regular method and the ASC. In each case, the taxpayer is assumed to already have $100 of QRE for the taxable year and then calculates the tax consequences of increasing QRE by 10 percent, to a total of $110. Table 3.1 considers a taxpayer using the regular method where the base amount of $60 exceeds the 50-percent minimum base. For this taxpayer, the full $10 of increased QRE faces the reduced credit rate of 13 percent, implying the effective credit rate also equals 13 percent. The average credit rate is below the marginal effective credit rate as the only the portion of expenditures above the base amount is eligible for the credit. Increasing QRE by $10 increases the average credit rate from 5.2 percent to 5.9 percent as a greater portion of current-year QRE would be above the base amount.

Table 3.2 shows a similar situation, only in this case the base amount of $40 is less than 50 percent of the current-year QRE. This taxpayer is constrained by the 50-percent minimum base requirement. Hence, the $10 increase in QRE also increases the minimum base by $5, implying that the amount of QRE above the base only increases by $5 (see line 6). The increase in credit is then only half as large as in the previous unconstrained example, implying the effective credit rate equals 6.5 percent. The average credit rate equals 6.5 percent before and after the increase in QRE. This illustrates that for taxpayers in the situation, the regular credit is not incremental, but functions as a flat 6.5 percent credit.

table 3
Table 3.3

To calculate the effective credit rate under the ASC, shown in Table 3.3, it is necessary to include the effect of increasing current-year QRE spending on the base amount for the next three years.10 In the current-year (Year 0 in the table) the full amount of the $10 increase in QRE faces the reduced credit rate of 9.1 percent. However, the base amount for each of the next 3 years increases by $1.67, which leads to a decline in the credit received in each of those years of a little more than $0.15. In sum, the increase in current-year credit of $0.91 is offset by a decline in future credits of $0.455. With no discounting of the future credits, the total increase in credits equals $0.455, implying an effective credit rate (4.55 percent) which is half of the reduced rate. Assuming a discount rate of 5 percent, the effective credit rate increases to 5.0 percent. This is very close in magnitude to the average credit rate, which increases from 5.0 percent to 5.4 percent in this example with the increase in QRE.

While these sample calculations portray the typical situation for a firm, there also can be situations where the regular method provides no incentive to increase research on the margin. This could happen if the base amount is larger than the planned level of current-year research. Similarly, under the ASC, the effective credit rate can actually be negative if the planned level of research falls below the base amount. For such firms, marginal increases in research do not generate any current-year credit but increase the base amount of research that will apply in subsequent years. In this case, the effective credit rate is negative because increases in current year research provide no current-year credit and reduce future credit eligibility.

Table 4 summarizes these effective rate calculations and augments them with information from the SOI sample of corporate tax returns for 2013 and other years. The effective credit rates calculated in Tables 3.1-3.3 assume taxpayers are able to use the full amount of the credit to offset current-year (or the previous year) tax liability. In reality, a substantial portion of taxpayers are not able to use the credit in the current year and must carryforward the credit to future years. Based on SOI data, OTA calculates that on a present value basis, 82 percent of the credit will eventually be used assuming a 5 percent discount rate. Thus the effective credit rates of 13, 6.5, and 5.0 percent shown on Line 3 of Table 4 equal 10.7, 5.3, and 4.1 percent, respectively, once the typical amount of carryforward credit is considered (Line 4).

While it is important to understand the marginal incentive effects for each calculation method, taxpayers also care about the total credit received, as reflected by the average credit rate, particularly when choosing the calculation method used when filing the return. The average credit rate reported in Table 4 is based on the 2013 SOI sample of corporate tax returns and is calculated as the total reduced credit divided by the total current-year level of QRE for firms using each method.

The average credit is highest at 6.5 percent for those firms constrained by the 50 percent minimum base for the regular method. For firms using the regular method and not constrained by the minimum base, the average credit can range between 0 and 6.5 percent depending on how close the historical base is to the current-year research spending. For the full sample, the average credit rate for these firms is 5.6 percent. For firms using the ASC, the average credit rate equals 5.2 percent, which is actually higher than the marginal effective credit rate of 5.0 percent when assuming a 5 percent discount rate.15 If the assumed discount rate were instead 8 percent, then the effective and average credit rates would equal under the ASC.

Examining the results for effective and average rates in Table 4, along with the share of research conducted by taxpayers using each of the methods, indicates that the incentive effects of the credit are not much different from a flat-rate credit for most taxpayers. Most corporate taxpayers use the ASC method (51 percent) where the average and effective rates are nearly equal, and these taxpayers account for 69 percent of the research expense reported on tax returns. For taxpayers using the regular method, most are constrained by the 50 percent minimum base and in effect face a flat-rate credit. These taxpayers account for 44 percent of corporate returns and 28 percent of research spending. The final category of taxpayers where the credit is decidedly incremental, those using the regular method and not constrained by the minimum base, account for only 5 percent of corporate returns and 3 percent of research spending.

Table 4

How does the combination of the expensing and the R&E credit affect the incentive to invest in R&D versus alternative investments? Table 5 provides illustrative calculations of the depth of the current tax subsidy to R&E investment compared to an alternative investment in tangible property. All investments are assumed to earn the same real after-tax rate of return of 5 percent, and the table calculates the effective tax rate (ETR), which is the tax wedge between the before and after-tax rate of return. For simplicity, these calculations assume there is only one level of tax at 35 percent and the investment is equity-financed. If the cost of the investment were recovered at the economic rate of depreciation, then the required before-tax rate of return, net of depreciation, equals 7.7 percent and the ETR equals the statutory rate of 35 percent. For investment in equipment, depreciation deductions are generally accelerated relative to economic depreciation. Table 5 shows the case for an investment in a generic piece of equipment with a 7-year tax life. The required before-tax rate of return falls to 6.7 percent and the ETR equals 25 percent.

Providing expensing of R&E expenditures reduces the ETR to zero, as the before-tax rate of return equals the 5 percent after-tax rate of return. This occurs because the upfront deduction for the full cost of the investment equals in present value the amount of tax due on the normal return to the investment. The R&E credit reduces the before-tax rate of return below the after-tax rate of return, which implies a negative ETR. If the firm faced the 13 percent effective credit rate under the regular method, then the before-tax rate of return would fall to 1 percent. When the effective rate under the regular credit is 6.5 percent, then the required before-tax rate of return equals 3 percent. Under the ASC, the 5 percent effective credit rate leads to a before-tax rate of return of 3.5 percent.

To better understand the impact of the credit, it is helpful to consider the impact on the required before-tax gross (of depreciation) rate of return, also referred to as the user cost of capital. For the case when expensing is allowed, but no credit is given, the user cost of capital equals 20 percent under the assumptions given in Table 5. A general result for investment tax credits is that the required user cost of capital declines in proportion to the credit rate, assuming the credit amount reduces the deductible portion of the investment by the amount of the credit, i.e., assuming a basis adjustment. The 20-percent credit rate (13-percent reduced credit) under the regular method reduces the required user cost of capital by 20 percent, to 16 percent. The four percentage-point decline in the user cost of capital is the same four percentage-point decline in the required net rate-of-return (from 5 percent to 1 percent).

This analysis implies that the combination of expensing and the R&E credit provides a strong enough incentive that taxpayers should be willing to accept (before-tax) returns to R&D that fall below what they could earn on investments on tangible capital. Under the assumptions used in Table 5, the required user cost of capital for investment in R&D falls by 15 to 26 percent below an alternative investment in a piece of equipment, which translates to a reduction in the required rate of return of approximately 3 to 6 percentage points.

Table 5

   Effect of the Credit on R&D Spending

The empirical literature generally finds evidence that the R&E credit has increased research spending by private businesses in the U.S. The preliminary evidence on the R&E credit from the early 1980s found very little impact on research spending, e.g., a small elasticity.16 The price elasticity measures the percentage change in quantity caused by a one percent change in price (reported here in terms of absolute value). Evidence from the 1990s finds a roughly dollar-fordollar or greater increase in research spending with respect to the credit. Using financial statements for a sample of manufacturing firms from 1980 to 1991, Hall (1993) estimates that the short-run elasticity ranges between 0.8 and 1.5.17 Hines (1993) estimates the effect of changes in allocation rules of R&E expensing on multinational corporations. Relying on the variation in tax treatment of R&E expenditures across firms, he estimates that the elasticity is between 1.2 and 1.6. Surveying the empirical work at the end of the 1990’s, Hall and Van Reenen (2000) conclude an elasticity of one best represents the literature. More recent estimates suggest that an elasticity of one is still a good benchmark, though as before, there remains considerable variance in the estimates. There is also evidence that in some cases (i.e. smaller financially constrained firms) the elasticity may be larger.18 Bloom, Griffith, and Van Reenen (2002) conduct a cross-country analysis of 9 OECD countries including the U.S. and estimate a short run elasticity of only 0.1 and a long-run elasticity close to one. Comparing the impacts of R&D incentives across countries is difficult, however, as countries construct their policies to encourage research in different ways. For example, the authors use of aggregated data allow for little ability to control for firms in differential tax positions or to account for certain features of the tax incentive that would apply to only a portion of firms. In a more recent paper, Bloom, Schankerman, and Van Reenen (2013) estimate an elasticity of 0.7 using an unbalanced panel of U.S. firms found in Compustat from 1980-2001.

Rao (2016) is the most recent paper examining the U.S. R&E credit, however she only estimates the effect for the first decade of the credit, well before the introduction of the ASC. She uses confidential tax return data from the U.S. from 1981-1991 to re-estimate the effect of the R&E credit. She estimated a short-run elasticity and long-run elasticity that are both close to two, suggesting a strong response of reported QRE to the after-tax user price. She also matches some of the firms in the tax return sample with Compustat data. The measure of research in the Compustat data is broader than QRE reported on tax returns. She finds strong evidence that firms respond to the credit much more by increasing reported QRE than increasing overall research expenditures. Whether this represents a real shift in research activity towards the type of research expenditures that meet the qualifications for the credit, or whether this merely represents a relabeling of research expenditures that were already planned or conducted is unclear. Regardless of whether the shifting reflects a move out of non-qualifying research into qualifying research or relabeling, it does not represent an increase in research overall, and so casts some doubt on the real level of taxpayer responsiveness to the credit. Furthermore, the possibility of such shifting has colored interpretation of much of the earlier empirical literature on the effect of the R&E tax credit, since that research did not control for shifting.

   Rationale for Promoting R&E

Government support of R&D is widely accepted as appropriate by economists and policymakers because of the social benefits associated with research activities. Economic theory suggests that the social return to investment in research in a market economy would be greater than the private
return. Stated another way, investment in technical knowledge has positive spillover benefits that exceed the benefits received by the one making the investment. These spillovers occur because of two properties of technical knowledge. First, once an idea has been developed, it is difficult to prevent others from using the idea, say for example due to reverse engineering. Second, the consumption of an idea by one person does not reduce the amount of knowledge available to others. As a result, businesses may reject some research projects whose benefits to society exceed its private gains, leading to an under-investment in research in the economy.

Though it is difficult to measure the social returns to R&D, the empirical literature largely confirms that the social returns exceed the private returns. Hall, Mairesse, and Mohnen (2010) review of the empirical literature on the returns to R&D conclude that the private returns to R&D are typically higher than those to physical capital. Moreover, the social returns to R&D are almost always estimated to be substantially greater than private returns, though the estimates are often imprecisely estimated. A recent paper by Bloom, Schankerman and Van Reenen (2013) uses 1980-2001 U.S. Compustat data to estimate that the private (gross) rate of return to R&D equals 21 percent while the social rate of return equals 55 percent, more than twice the private return. If this estimate is accurate, then the socially optimal level of R&D is more than double the current level. This paper also estimates that smaller firms have smaller social returns as their technology is more specialized and fewer firms tend to benefit from the knowledge spillover.

There are numerous ways that governments seek to increase research activity. The government can directly conduct research through agencies, it can fund educational institutions, or it can offer grants to private entities to conduct specific research projects. Governments also seek to increase private returns to research spending through the protection of intellectual property rights, such as patents, trademarks and copyrights. Another option is to provide tax incentives that increase the after-tax return to research investment. The U.S. has long provided incentives for research spending through the tax code. Beginning in 1954, the tax code has allowed the deduction (expensing) or amortization of research expenditures, rather than capitalization, in order to eliminate uncertainty about the tax accounting treatment of research expenditures and to encourage taxpayers to carry on research and experimentation. In addition, as discussed above the R&E tax credit was enacted on a temporary basis in 1981 and was recently made permanent after numerous temporary extensions.

Each of these approaches may be appropriately suited for encouraging a certain type of R&D. One advantage of the tax credit is that it is a market-based approach and thus generally would support research activity that generates at least a market rate of return on average. It also allows a host of projects to be selected by many different private investors, and so promotes diversity that is difficult to obtain in government chosen or sanctioned projects. However, one limitation of the credit is that the projects with the highest private returns, and hence likely to be chosen by a profit-seeking taxpayer, are not necessarily those projects with the highest social returns.

   Rationale for Promoting R&E

Government support of R&D is widely accepted as appropriate by economists and policymakers because of the social benefits associated with research activities. Economic theory suggests that the social return to investment in research in a market economy would be greater than the private
return. Stated another way, investment in technical knowledge has positive spillover benefits that exceed the benefits received by the one making the investment. These spillovers occur because of two properties of technical knowledge. First, once an idea has been developed, it is difficult to prevent others from using the idea, say for example due to reverse engineering. Second, the consumption of an idea by one person does not reduce the amount of knowledge available to others. As a result, businesses may reject some research projects whose benefits to society exceed its private gains, leading to an under-investment in research in the economy.

Though it is difficult to measure the social returns to R&D, the empirical literature largely confirms that the social returns exceed the private returns. Hall, Mairesse, and Mohnen (2010) review of the empirical literature on the returns to R&D conclude that the private returns to R&D are typically higher than those to physical capital. Moreover, the social returns to R&D are almost always estimated to be substantially greater than private returns, though the estimates are often imprecisely estimated. A recent paper by Bloom, Schankerman and Van Reenen (2013) uses 1980-2001 U.S. Compustat data to estimate that the private (gross) rate of return to R&D equals 21 percent while the social rate of return equals 55 percent, more than twice the private return. If this estimate is accurate, then the socially optimal level of R&D is more than double the current level. This paper also estimates that smaller firms have smaller social returns as their technology is more specialized and fewer firms tend to benefit from the knowledge spillover.

There are numerous ways that governments seek to increase research activity. The government can directly conduct research through agencies, it can fund educational institutions, or it can offer grants to private entities to conduct specific research projects. Governments also seek to increase private returns to research spending through the protection of intellectual property rights, such as patents, trademarks and copyrights. Another option is to provide tax incentives that increase the after-tax return to research investment. The U.S. has long provided incentives for research spending through the tax code. Beginning in 1954, the tax code has allowed the deduction (expensing) or amortization of research expenditures, rather than capitalization, in order to eliminate uncertainty about the tax accounting treatment of research expenditures and to encourage taxpayers to carry on research and experimentation. In addition, as discussed above the R&E tax credit was enacted on a temporary basis in 1981 and was recently made permanent after numerous temporary extensions.

Each of these approaches may be appropriately suited for encouraging a certain type of R&D. One advantage of the tax credit is that it is a market-based approach and thus generally would support research activity that generates at least a market rate of return on average. It also allows a host of projects to be selected by many different private investors, and so promotes diversity that is difficult to obtain in government chosen or sanctioned projects. However, one limitation of the credit is that the projects with the highest private returns, and hence likely to be chosen by a profit-seeking taxpayer, are not necessarily those projects with the highest social returns.

   Assessing the Effectiveness of the Credit

The R&E credit can improve overall economic efficiency by encouraging firms to undertake R&D investments that provide a social return greater than alternative investments, but have a private return too low to be profitable apart from the tax subsidy. The existing empirical evidence regarding social and private returns to investment does not provide a precise estimate of the optimal size of the R&E credit. However, some evidence suggests that investment in R&D remains below the optimal level, as social returns to R&D are generally measured to be greater than returns to alternative investments. This suggests the credit rate may be insufficiently small or that other features of the credit limit its effectiveness at spurring greater R&D.

For example, high compliance costs are frequently cited as a reason that the credit is not more effective at spurring more R&D. The compliance burden arises from the need to compute the complicated credit and to maintain documentation dating back years (and even decades in some cases). In addition, the R&E credit has been the source of many disputes between taxpayers and the IRS. Some of these difficulties are unavoidable, such as determining and verifying qualifying research, but others stem from the design of the credit.

In addition, for many firms, the credit provides only a weak (or no) incentive because of the lack of tax liability for which to use the credit.

Given the difficulties in measuring the social welfare gains resulting from R&D, some studies have focused on measuring the relative cost-effectiveness of the credit, rather than its overall efficiency. This approach compares government spending through the R&E credit with the government directly funding research. If a dollar spent through foregone tax revenue under the R&E credit increases private research by at least one dollar, then the R&E credit is considered to be at least as cost-effective as a direct grant. The empirical research summarized above suggests that price elasticity is close to one. Thus in terms of first approximation, the tax credit is similar to a government grant in terms of cost effectiveness. It is important to note that because the allocation of R&D investments under a tax credit is not necessarily the same as it would be under a direct grant, the social welfare gains are not necessarily the same across these two vehicles even if these two programs are deemed to be equivalently cost-effective.

This cost-effectiveness comparison to government grants is valid for the next dollar spent, that is, the marginal dollar. The overall benefit-cost ratio for the R&E credit would be higher than the elasticity estimate because of the incremental nature of the credit, which reduces the average cost of the credit below the marginal cost in some cases. However, the difference between the average and marginal effective credit rates currently is not large for most taxpayers. Indeed, for only 3 percent of corporate research spending in 2013 did the marginal effective credit rate substantially exceed the average credit rate. For most research spending, the current research credit functions exactly or nearly as a flat-rate credit.

   Alternative Credit Designs

Several methods of computation have been used in the history of the credit, though all have sought to maintain the incremental nature of the credit. This has been motivated by an attempt to limit windfalls given to taxpayers for research that a business would have undertaken in the absence of the credit, so as to boost the cost-effectiveness of the credit. To limit these windfalls and direct more of the tax expenditure to marginal investments, the credit applies only to research above some base amount. Identifying a practical base amount is challenging. In theory, the most effective base level of research against which additional research spending is determined should correspond to research that would otherwise have been undertaken by a business, a counterfactual that is impossible to identify in practice. Finding a base that is a good proxy for research that would have been done without the credit has been a challenge throughout the history of the credit, and all of the options increase the complexity and compliance costs of the credit.

The original credit calculation used the average level of research spending over the previous 3-years as the base for the credit. However, this left many firms in a position where the effective credit was zero or negative. The regular method, enacted in 1989, replaced that calculation. The advantage of using a base that does not update with time (as used in the regular method) is that current year research spending does not affect the base for future years, and hence reduce the value of the credit in future years. However, the base amount calculation for the regular credit has become increasingly outdated and irrelevant to recent research experiences, and so is increasingly a poor proxy for the level of research that might have been done in the absence of the credit.

Furthermore, the regular method’s computation relies on information from the 1980’s for many taxpayers, which raises compliance costs. For companies that have been in existence and engaged in research activities during that period, obtaining and retaining historic information in the event of an IRS examination is burdensome (and often impossible). As taxpayers engage in corporate acquisitions and dispositions, this historic information may need to be combined with data from acquired businesses or segregated for a disposition. Retaining historic information may be even more challenging for businesses that form part of a controlled group or businesses that are under common control and therefore must aggregate credit information.

The ASC method, enacted in 2006, attempts to address concerns about using a moving average base by reducing the average of the prior years’ research expenses by 50 percent so that it is easier to exceed the base. It has proved a popular alternative to the regular method, and arguably provides a better measure of the base level of research expenses as it is based on recent research experience. Also, the ASC does not need to measure gross receipts, which eliminates one area of potential controversy between the IRS and taxpayers.

It is difficult to precisely measure the total compliance costs of the regular method. However, the popularity of the ASC compared to the regular method, despite the ACS’s relatively less favorable tax benefits (in terms of statutory, effective, and average credit rates), suggests that the compliance costs of the regular method are substantial. Firms using the ASC conduct more than twice the level of qualifying research than firms using the regular method, while receiving on average a smaller total credit. This comparison does not mean that all firms using the ASC receive a smaller credit than if they would have used the regular method. Many of the firms using the ASC likely choose to do so precisely because the ASC generates a larger credit for that year. Nevertheless, the use of the ASC seems greater than would be simply predicted from comparing average credit rates.

Both the regular method and the ASC use past research experience to determine the base amount of research spending for the current year, with the main difference that the regular method uses an experience fixed in time (1984-1988) and the ASC is self-updating through time. Another approach would be to set the base amount according to a rule-of-thumb. For example, the credit could be applied to research spending above a base determined as certain share of gross receipts. This is similar to the design of the alternative incremental research credit (AIRC), a computation method allowed for the R&E credit for years 1996 through 2008. This approach is simpler than the other incremental options, as only current-year information is needed to calculate the credit. However, under this approach, it seems more likely that some taxpayers typically would have research spending below the base and would be ineligible for the tax credit even though they might be responsive to the credit if eligible. This becomes more of a problem the higher the base amount and the greater variance there is among taxpayers (and over time for a given taxpayer). Another problem with an AIRC type credit is bunching, which would occur to the extent that taxpayers delay research projects until they have accumulated enough QRE in one year to exceed the base and qualify for the credit.

Another drawback to incremental credits in practice is that firms face uneven incentives. Some firms face the full marginal rate, some face the capped rate, and other firms may face a zero rate (or negative rate in case of the ASC) under unusual research spending patterns. There are two main problems with this dispersal of rates. First, it is unlikely that the highest marginal rates are faced by firms most likely to undertake the investment projects with the highest social returns fora given year, in which case the different marginal rates are likely to lead to an inefficient allocation of research spending across firms. Second, it is unclear how aware managers are of the firm’s effective credit rate when making decisions regarding research spending, but it would be expected that the possibility that the firm may end up in a low rate situation would mute the incentive effect of the credit

Furthermore, incremental credits are likely to be pro-cyclical.34 That is, at a time of an economy-wide or industry-wide downturn, firms are more likely to be below their base amount, which makes it more likely the credit provides no incentive to expand R&D investment during the downturn. This in turn acts to exacerbate the business cycle.

In its FY 2017 Budget, the Administration proposed modifying and slightly expanding the R&E tax credit. In several ways, the Administration’s budget proposal for the R&E credit would mitigate some of the problems with the current credit. To reduce compliance and administrative burdens, the regular method would be repealed. To maintain incentives for those taxpayers currently using the regular method, the ASC rate would be increased to 18 percent, which would bring the effective credit rate under the ASC to approximately equal the effective credit rate under the regular credit for those constrained by the 50 percent minimum base. This would also boost the incentive for increasing research for those taxpayers already using the ASC, which is consistent with the evidence regarding the optimal size of the subsidy.

Recognizing that the inability to use the credit in the current-taxable year reduces the effective incentive of the credit, the Administration also proposes to allow all taxpayers to claim the credit against AMT liability. This would increase the likelihood that taxpayers could use the credit in the current year and would be simpler as firms near the current gross receipts cut-off will no longer need to track their eligibility. In particular, this would tend to help entities organized as pass-through entities, as AMT liability is more of a barrier for taking the credit for such entities.

Nevertheless, further reforms to the form of the credit may be warranted. One option would be to allow full refundability of the credit. This would increase the incentive effect of the credit and may be helpful in reducing liquidity constraints for certain firms. However, there are some administrative concerns with making the credit fully refundable. The potential for significant taxpayer abuses of the credit would likely lead to an increase in administrative and compliance costs. Nonetheless, the PATH Act of 2015 allows partial refundability of the credit against payroll taxes for qualifying small businesses. The effects of this provision should be examined to see if expanding this option to other firms would be an effective alternative to full refundability.

In addition, the evidence indicates that the current calculation methods are nearly equivalent to a flat-rate credit for the vast majority of taxpayers. This suggests adopting a flat-rate credit with an effective credit rate similar to the current calculation methods would provide similar incentives at a similar budgetary cost, with less administrative and compliance costs, and potentially less concern over collateral effects such as exacerbating the effects of the business cycle.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

References:
Agrawal, Ajay, Carlos Rosell, and Timothy S. Simcoe. 2014. “Do Tax Credits Affect R&D Expenditures by Small Firms? Evidence from Canada. National Bureau of Economic Research Working Paper 20615.

Altshuler, Roseanne. “A Dynamic Analysis of the Research and Experimentation Credit.” National Tax Journal, Vol. 41, No. 4, pp. 453-66, Dec 1988.

Bloom, Nick, Rachel Griffith and John Van Reenen. 2000. “Do R&D Tax Credits Work? Evidence from a Panel of Countries 1979-1997.” Journal of Public Economics 85:1-31.

Bloom, Nicholas, Mark Schankerman, and John Van Reenen. 2013. “Identifying Technology Spillovers and Product Market Rivalry.” Econometrica 81(4):1347-1393.

Dechezleprêtre, Antione, Elias Einiö, Ralf Martin, Kieu-Trang Nguyen, and John Van Reenen. 2016. “Do Tax Incentives for Research Increase Firm Innovation? An RD Design for R&D.” National Bureau of Economic Research Working Paper 22405.

Eisner, Robert, Steven Albert, and Martin Sullivan. “The New Incremental Tax Credit for R&D: Incentive or Disincentive,” National Tax Journal, Vol. 37, No. 2, pp. 171-183, 1984.

General Accountability Office. 2009. The Research Tax Credit’s Design and Administration Can Be Improved. GAO-10-136.

Gravelle, Jane. 1993. “What can Private Investment Incentives Accomplish? The Case of the Investment Tax Credit,” National Tax Journal 46(3):275-90.Guenther, Gary. 2016. Research Tax Credit: Current Law and Policy Issues for the 114th
Congress. Congressional Research Service, RL31181. Hall, Bronwyn. 1993. “R&D Tax Policy During the 1980s: Success of Failure?” in James Poterba, ed. Tax Policy and the Economy. Vol. 7, 1-35.

Hall, Bronwyn, Jacques Mairesse, and Pierre Mohnen. 2010. “Measuring the Returns to R&D,” in Bronwyn Hall and Nathan Rosenberg (eds.) Handbook of the Economics of Innovation (Amsterdam: Elsevier), pp. 1034-1076.

Hall, Bronwyn and John Van Reenen. 2000. “How Effective are Fiscal Incentives for R&D? A Review of the Evidence.” Research Policy, Vol 29, 449-469.

Hines Jr., James. 1993. “On the Sensitivity of R&D to Delicate Tax Changes: The Behavior of U.S. Multinationals in the 1980s.” In Giovannini, A,. Hubbard, R.G., and Slemrod, J. (Eds.) Studies in International Taxation (University of Chicago Press: Chicago), pp.149-194.

Jones, Charles and John Williams. 1998. “Measuring the Social Return to R&D.” The Quarterly Journal of Economics.

Mansfield, Edwin. “The R&D Tax Credit and Other Technology Policy Issues,” American Economic Review, Vol. 72, No. 2, pp 190-194. May 1986.

Rao, Nirupama. 2016. “Do Tax Credits Stimulate R&D Spending? The Effect of the R&D Tax Credit in its First Decade.” Journal of Public Economics, 140:1-12.

spotlight 1

October 2016

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SPOTLIGHTS:

Visiativ Acquires Jumpstart

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   Press Release

Following the signing of a letter of intent forwarded on 20 November 2018, ABGI Group, an international innovation management and financing consultancy firm and a subsidiary of Visiativ, today announces the closing of its acquisition of a majority stake in Jumpstart (93%), a UK-based innovation consultancy firm.

New market for ABGI Group, the Visiativ Group’s innovation management and financing business line

Founded in 2008 in Edinburgh (Scotland), Jumpstart provides innovation financing assistance to around 700 clients via a team of 44 employees working from three locations (Edinburgh, Manchester and Birmingham). Jumpstart posts annual revenues of around £4.7 million (€5.2 million), 9% growth and double-digit profit margins. The company is headed by its Managing Director, Scott Henderson.

This acquisition gives ABGI Group unrivalled expertise in providing support for SMEs (90% of Jumpstart’s clients) as well as a foothold in a fast-growing new market. Following the acquisition, Visiativ’s Consulting business will operate in 5 countries (France, Canada, USA, UK and Brazil via a minority shareholding) and employ around 200 people, half of whom will be based overseas.

The Jumpstart acquisition will provide a further boost to ABGI Group’s growth after its French subsidiary recently won the Excellence 20192 award in recognition of its outstanding growth track record. A major milestone towards fulfilling Visiativ’s Next100 plan to generate revenues of €200 million by 2020. Only a few months after acquiring Innova Systems (SOLIDWORKS distributor based in Cambridge – £3.8 million revenues, growing fast), this latest acquisition will drive the development of Visiativ’s innovation management and financing consultancy business in the UK.

The acquisition enables Visiativ to reach significant mass in the UK (full-year revenues of around €10 million and headcount of 65) and leverage a vast client base in order to develop efficient cross-selling between its SOLIDWORKS integration (Innova Systems) and innovation management consultancy (Jumpstart) business lines serving around 1,700 clients in total.

The acquisition will be carried out according to a management shareholding model: Jumpstart Managing Director Scott Henderson will remain a shareholder of the company and two other managers will have the opportunity of acquiring a shareholding in 2019.

Visiativ Chairman and CEO Laurent Fiard made the following comments:

“We are very excited about this acquisition of a fast-growing player on the UK market, which will allow us to develop a second business line that has already earned its position in Visiativ’s offering, as ABGI Group has posted 30% growth since the beginning of 2018.”

ABGI Group CEO Bruno Demortière stated:

“This acquisition is a unique opportunity for the innovation management and financing consultancy business within the context of Brexit, as the UK will be maintaining a high level of incentives, a policy that has already led to double-digit growth in the number of applicants.”

Jumpstart Managing Director Scott Henderson added:

“The backing of an international player operating throughout the innovation and software consulting value chain, including production via its 3D printing business is highly stimulating for myself and my staff; ABGI Group’s consolidation drive is based on strengths which we share: efficient methods and committed staff.”

Next financial release: FY 2018 revenues: 22 January 2019, after close of trading

   About Visiativ

Integrator of innovative software solutions, Visiativ steps up the digital transformation of companies via its collaborative and social business platform and innovation consultancy offer. Working with mid-caps since its foundation in 1987, the Visiativ Group posted 2017 revenues of €124m and boasts a diverse portfolio of over 18,000 customers. Covering every economic sector in France and with operations in international (Belgium, Brazil, Canada, Luxembourg, Morocco, the Netherlands, UK, USA and Switzerland), Visiativ has nearly 900 employees. The Visiativ share (ISIN code FR0004029478, ALVIV) is listed on Euronext Growth Paris. The share is eligible for the PEA and PEA-PME personal equity plans and FCPI/FIP investments funds, thanks to its status as an “innovative business” recognised by Bpifrance.

spotlight 1

January 2019

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SPOTLIGHTS:

R&D and the Food & Beverage Industry:

Creating a Recipe for Success

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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.

   Opportunity

With the RTC now being permanent, the timing has never been riper (pun intended) for winemakers 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 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 only on 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” calculation 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; and
    • There are new regulations to clarify the definition of Internal Use Software.

In addition to the federal RTC, over 35 states have an R&D incentive program. These state credits typically follow federal regulations but have different tax rates and utilization methods. As such, taxpayers can benefit from both federal and state R&D credits to minimize their tax liability and be paid to innovate while growing their local economy.

   Qualifications

There is a common 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 a qualified research activity (QRA):

smaller graphic

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 REQUIRE 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 attempt more than one mixing technique?

  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.

FINALLY, THE FOURTH PART OF THE TEST REQUIRES THAT THE ACTIVITY PERFORMED MUST BE TECHNOLOGICAL IN NATURE, FUNDAMENTALLY RELY ON PRINCIPLES OF CHEMISTRY, PHYSICAL OR BIOLOGICAL SCIENCE, ENGINEERING, ETC.

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.

   Credits

So now that we have identified your qualified research activities, how does that translate into tax credits? These activities generate qualified research expenditures (QREs) that fall into one of three buckets: wages, supply costs, and contractor costs.

WAGES – this consists of 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.

SUPPLY COSTS – supplies consist of items used 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.

CONTRACTOR COSTS – these are comprised 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.

   ABGi USA can help

    • As you can see, there are numerous opportunities for Food and Beverage companies to take advantage of a benefit that has been around since the early 1980s
    • Our ABGI technical teams are skilled at identifying existing and new potential areas of Qualified Research Expenses (QREs) while simplifying the process by employing a methodology that includes building the nexus between RTC activities and costs to eligible projects while minimizing invasiveness to the client. Since its inception in 1985, ABGi USA has realised over $1 billion in benefits for its clients. Currently, we are submitting an average of 1,500 claims per year to the IRS.

For a free R&D tax credit consultation and analysis of the potential returns you might expect, contact the ABGi USA team by phone: (832) 495-4555 or by email: contact-usa@abgi-group.com

Author Information:
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 framework

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March 2018

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