Boost Your Competitive Advantage Through R&D

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Businesses that develop a research and development (R&D) strategy are more likely to grow and succeed.

Why is this? In performing R&D, companies must internally review their processes and technologies in order to identify issues. With these weaknesses targeted, both the products and services offered can be improved upon.

Innovation enables productivity and customer satisfaction to increase thereby strengthening the company’s competitive advantage.

 

Developing a Strategy

Each strategy is unique, depending on the drive and size of the company. For a small business it is beneficial to focus on perfecting the chain of production or delivery of service in order to enhance customer experience gaining trust and mutually beneficial relationships.

A larger company would also benefit from this but typically once a business is well established R&D turns toward introducing new products and services to expand further into the market.

 

Supporting Your Growing Business

While R&D is extremely necessary to increase competitive advantage, it is often times very costly. For a small business this can be challenging especially when your business is not yet profitable. The good news is that the R&D Tax Credit recognises this.

Research and development does not need to happen in a test tube to be eligible for return.

If  you would like to discuss the R&D Tax Incentive further, please do not hesitate to contact one of Swanson Reed’s offices today.

Issues Facing Multinationals After Apple’s Tax Headlines

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Apple in Ireland

This week Apple has taken a blow from the European Commission as the EU demands Apple pay their withstanding taxes to Ireland to the tune of about 14.5 billion US dollars. While Apple would be the one with a large bill, the focus lies heavily on the Irish government for what the EU defines as selective treatment or creating a special benefit for an individual or company. However, Ireland refuses to claim the taxes. Why?

By accepting the $14.5 billion Ireland will put at risk its reputation for being a cheap and stable market in which to perform business. As of 2014, Ireland had $350 billion or 311 billion euros of foreign direct investment which was 165% of GDP. Despite what is sure to be a costly fight with the European Commission, Ireland can not afford to lose these large investors. This, in effect, will damage Ireland’s relationship with the many multinationals functioning there such as Facebook and Google who have their European headquarters in the country.

Apple & the Big Brother

Apple CEO, Tim Cook, has issued a clear letter addressing Europe’s Apple community stating that the opinion issued by the European Commission has no factual basis as Apple pays the taxes it owes. The company continued to say that as nearly all of Apple’s R&D (research and development) is performed in California the vast majority of their profits are taxed within the US. This year Apple is lined up to spend about $10 billion on R&D increasing their research spending by about 30% from 2015. The letter concluded by drawing attention to proactive rather than retroactive lawmaking and by committing to further investment in Ireland and the European market.

Why has the US government supported Apple in this fight? For some time there has been conversation regarding the repatriation of profits being made abroad. While bringing the era of parking money offshore to an end would be beneficial for the US, allowing Apple to pay the sum would potentially add to the federal deficit. Additionally, Washington has stated its concern regarding the European Commission encroaching on US Government Jurisdiction. However it seems that not only the US is getting involved.

Bigger Fish to Fry

This is only the beginning of much more to come – governments worldwide have been struggling with how to tax the intangible multinationals and now the conversation has been opened. The question is; will these multinationals be forced to pay for their previous agreements or will rulings move from the current period forward?

If you would like to discuss the R&D Tax Incentive further, please do not hesitate to contact one of Swanson Reed’s offices today.

R&D Recreating Business

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Competitive Differentiation

We are all beyond aware of the rapidity of innovation today. In less than twenty years we have seen the technological dreams of Sci-Fi favorites come to life. Just this July we watched as the launch of Pokemon GO transformed the business sphere overnight, creating new methods of engaging consumers. As we accelerate our technological capabilities the challenge we face is to balance that technological innovation within human spheres such as workplaces, learning environments and business.

In a review of R&D transformation in relation to digitalization, SAP Vice President – Thomas Ohnemus, wrote that, “only five percent of companies say they’ve mastered digital transformation to the point of competitive differentiation.” In this quickly evolving market, competitive differentiation can be achieved through rapid response to the demand for innovation. This is where R&D must constantly be one step ahead of the game.

Shifting Business Structure 

While this race of market prediction is typically seen in the electronic industry, Ohnemus draws attention to the frequency in which companies are shifting from offering products to offering services. In this way companies must rethink the way they perform business; selling a service often requires continued customer relations, troubleshooting and preventative care to keep the service running smoothly.   

Innovating to Create Innovation

As the industry itself transforms, so must the workplace and the expectations surrounding furthered education within companies. Google has been one of the greatest workplace innovators – as the source of much of the world’s information Google employees are encouraged to take full advantage of the resource. Furthering education on topics of interest as well as using the company’s wide range of technological innovations to improve company culture and communication. This can be extended from personal interests to company training as education methods become faster and more accessible harnessing the strengths of millennials.


A famous example of this is Google’s 20 percent projects. Google allowed creativity to blossom and subsequently produce major projects such as Gmail and Google News by allotting for 20 percent of working hours to be dedicated to furthering personal projects and interests. While the 20 percent project time is rumored to have lost momentum it is true that, “any company can benefit from learning how to better attract and manage innovators, foster engagement and ultimately lead to success.” Thomas Ohnemus suggests that nowhere are these innovative techniques more important than in R&D.


If you would like to discuss the R&D Tax Incentive further, please do not hesitate to contact one of Swanson Reed’s offices today.

Norwest Corporation v. Commissioner, 110 T.C. 454 (1998)

Background

Norwest Corporation v. Commissioner, 110 T.C. 454

Between 1986 and 1991, Norwest Corporation and its subsidiaries developed and modified software for the internal management and administration of its businesses. The issue at hand is whether internal software activities constitute as qualified research. Eight of Norwest’s software projects were selected to test if they constituted as R&D.

Basic Facts

In order for internal use software to qualify as a qualified research expense (QRE) for the Research and Experimentation Tax Credit, the taxpayer must seek to discover new technological information that is definitively separate from previous products it has developed. On top of the general 4-Part Test, Congress introduced a three-part “high threshold of innovation” test to qualify internal use software (IUS).

The Seven- Part Test is as follows:

  1.  There must be “technical uncertainty.” 
  2.  There must be “new functionality.”
  3. A “process of experimentation” must be involved.
  4. The new product or process must be “technological in nature.”
  5. The software needs to be “innovative.”
  6. The development of the software must involve “significant economic risk.”
  7.  The software is NOT “commercially available.”

Court’s Decision

The Court found that  one of Norwest’s software projects, SBS customer module: Strategic Banking System, constituted as qualified research and the other 7 internal software projects failed to satisfy the tests required to obtain the tax credit.

Click Here to view the full case: Norwest Corporation v. Commissioner, 110 T.C. 454 (1998).

Fortunato J. Mendes v. Commissioner of Internal Revenue 121 T.C. 308 (t.C. 2003)

Background

Mendes v. Commissioner T.C. No. 16032-95.

This Tax Court case concerns tax deficiencies and additions to tax for the 1988 taxable year. The IRS denies that Fortunato J. Mendes (Mendes) is entitled to any claimed deduction and dependency exemptions.

Basic Facts

In 1995, the IRS noticed a deficiency in Mendes’ tax returns from 1988 which Mendes did not file until 1997. The Court finds that petitioner lacked reasonable cause for his failure to timely file the 1988 return, it follows that his underpayment was due to negligence as he was incarcerated at the time for a murder he committed.

Because this tax report was filed over 2 years after a notice was issued to the petitioner, he essentially waived his right to the escape from any possible liabilities and thus prohibited from using this amended tax return to calculate the penalty.

Findings

The Court sustains respondent’s inclusion of $40,347 in petitioner’s gross income for the audit year, and hold that
petitioner is not entitled to a deduction for loss of the IBM sale proceeds of $27,573 as an offset to that income inclusion.  The Court further sustains respondent’s determination under section 6654, in which the petitioner is responsible for the addition to tax pursuant.

Click Here to view the full case: Fortunato J. Mendes v. Commissioner of Internal Revenue 121 T.C. 308 (t.C. 2003)

David M. and Teri L. Saykally v. Commissioner of Internal Revenue. 247 Fed. Appx. 914. 9th Cir. T.C. Memo. 2003-152

Background

Saykally v. Commissioner T.C. Memo. 2003-152

This tax court memo concerns the Saykally family and the following issues are up for debate:

  1. Whether petitioners are entitled to deduct expenses claimed for research and development for taxable years 1995 and
    1996 in the respective amounts of $67,534 and $1,421,645;
  2. Whether petitioners are entitled to deduct certain expenses on their Schedules C, Profit and Loss From Business, for
    the taxable years 1994, 1995, and 1996;
  3. Whether petitioners are liable for accuracy-related penalties pursuant to section 6662 for the taxable years 1994,
    1995, and 1996.

Basic Facts

Saykally has extensive experience in the computer software industry. After a falling out with a previous marketing company for which research and business had been conducted, research was then solely responsible by Saykally. During 1995 and 1996, CPSG, Inc., by and through its wholly owned subsidiaries, paid $67,543 and $1,361,006 of research and development costs on behalf of petitioner.

Deductions generally have the burden of proof fall on the taxpayer to provide evidence to support these deductions. If the Court finds that Saykally is not entitled then CPSG would be so entitle and because CPSG abdondend this argument, there is no opinion to this issue. The next issue addressed is whether petitioners are entitled to deduct certain expenses. At the time Saykally incurred the R&D expenditures, he did not have the objective intent to enter into a future business of his own with the developed technolog but rather to conduct business with other companies and license this to an existing business and there is no evidence on record that Saykally intended to use this research for his own business.  The last issue is whether petitioners are liable for accuracy related penalties. There is no evidence to support the deductions claimed and for the other deductions in regards to R&D, the petitioner testified that they sought advice from a tax professional so the penalties associated with deductions for this would not be appropriate in this case.

Findings

This Opinion finds that respondent’s imposition of a penalty for an erroneously claimed double deduction was substantially justified, they do not find petitioners’ argument that respondent failed to identify which deductions were denied persuasive and they find that at the time this case was filed, the Saykally’s did not engage in research that had the intention of engaging in their own business with the developed technology from research.

Click Here to view the full case: David M. and Teri L. Saykally v. Commissioner of Internal Revenue. 247 Fed. Appx. 914 (9th Cir. 2007)

Bayer Corporation and Subsidiaries v. United States, Civil No. 09-351 (W.D. Pa. 2012)

Background

Bayer Corporation v. United States Civil No. 09-351

This is in regards to a denial of federal research tax credits from Bayer Corporation and Subsidiaries for 1990-2006.  Bayer presents an Amended Motion based on statistical sampling.

Basic Facts

Qualified Research Expenses (QREs) were established in 1981 to increase productivity.  Bayer Corporation and Subsidiaries employ more than 20,000 employees and have several divisions in its company including healthcare, material science and crop science. Bayer conducts research in the US as well as the United Kingdom, Singapore, Germany and several other countries.  Bayer calculates its QREs through accounting records consisting of Word documents, Excel files, patent applications and substantiates QREs for the purpose of claiming tax credits through evidence provided by former and current employees who performed the research.  After completing the Deloitte study in 1998, Bayer filed a claim for additional QRE credits and the IRS denied this claim and also denied credits for QREs that they had previously agreed upon.

The parties’ Joint Motion for a Hearing on Bayer’s amended Sampling motion was granted and a hearing held in 2011, which would seek clarification in regards to the QREs discussed above.

Bayer spent over 13,000 hours devoted to retrieving documents and evidence pertaining to this case as well as offering testimony and documentation.  The government states that Bayer has not met its burden of identifying business components for which the QREs are claimed and therefor cannot quantify the amount of QRE credits that Bayer is entitled to.

Bayer acknowledges that sampling may have been used in tax cases however the references used in the past have all been rejected.

Court’s Decision

The Court is not persuaded by Bayer’s arguments that denial of the Amended Sampling Motion would create a credit for the QREs they were claiming for the purpose of research credit. In addition, Bayer’s argument regarding bookkeeping and evidence requirements should be directed to the Legislative Branch, not this Court.

Click Here to view the full case: Bayer Corporation and Subsidiaries v. United States, Civil No. 09-351 (W.D. Pa. 2012).

Fudim v. Commissioner, T.C. Memo. 1994-235

Background

T.C. Memo 1994-235

This tax court memo concerns Efrem V. Fudim (Fudim), who in 1988, the Kansas City Service Center informed petitioner that the amount of research credit they claimed exceeded the amount allowable for that year.  They disallowed $3,222 of the $6,176 research credit and directed the petitioners to explain why they had not erred in their original amount reported.

Basic Facts

Efrem V. Fudim (Fudim) and Margarita L. Fudim (Mrs. Fudim) formed Light Sculpting Co. in 1985 and engaged in research. The rapid modeling procedure utilized ultraviolet lights to fabricate plastic objects and they attempted to perfect this method by trying other models and alternatives. Sculpting Co. obtained two patents on this process that was developed that improved the forming of three dimensional objects.

The petitioners attached a Credit for Increasing Research Activities form as part of their income tax return however they ignored the explanation of the limitation and they erroneously reduced their tax. The respondent sent a second letter detailed what the petitioner owed and the petitioners denied they owed anything.

The petitioner contend that the Tax Court should shift the burden of proof in this case to the respondent because they improperly reopened the case but there is not authority or truth to t his argument. The petitioner also argues that the respondent’s assessment of the disallowed excess portion was erroneous because no notice was given but the law states that the respondent may not access this information until an issuance of a notice of deficiency to the taxpayer has been put through.

Most importantly, research credits must be decided if they are acceptable for the years 1986 -1988. If accepted, only the wages paid related to the qualifying services constitute in-house research expenses.  The Court is satisfied that the petitioner’s subsidiaries spent time engaged in qualified services and that Mrs. Fudim spent at least 80% of her time engaged in qualified services.

Court’s Decision

The Court states that on the basis of these findings, petitioner’s research credits for 1986, 1987 and 1988 and allowable carrybacks must be recomputed accordingly.

Click Here to view the full case: Fudim v. Commissioner, T.C. Memo. 1994-235.

Fairchild Industries Incorporated v. United States, 71 F.3d 868 (Fed. Circ. 1995)

Background

Fairchild Industries Corporation v. United States discusses the regulations in regards to qualified research expenses and the role of “funding”. Qualified Research Expenses (QREs) shall not include the following:

  • research conducted outside of the United States
  • research in the humanities or social sciences sectors
  • research funded by any contract, grant or any other person including a government entity

The research tax credit was established in 1981 to provide incentives to American industries to invest in research.  The main issue in this case is the application and implementation of regulations to Fairchild’s contract with the Air Force. 

Basic Facts

In 1982, Fairchild Industries Incorporated and the Air Force entered into a fixed-price incentive contract where Fairchild would design and produce a “next generation trainer” aircraft intended to train new pilots.  This design included many phases of production, development and testing which also had over 1,000 pages of technical specifications and performance standards that were Fairchild were required to adhere to. For Fairchild’s 1982-1985 federal income tax returns they reported $109.4 million of qualified research expenses related to this project of which the IRS disallowed around $19.6 million not related to this program. Because the Air Force funded 55.8% of Fairchild’s research, the IRS disallowed $5.8 million in research tax credits claimed for those years. The interpretation of the statute and regulation for this case is up for debate and review. The question here is whether Fairchild’s research is considered “funded” by the Air Force in terms of research credits. Fairchild claims that the Air Force “funded” none of its research because their right to pay was considered upon the success of the research project.  The government argues that the determination of whether the research is funded or not does not depend on whether the contract reserves the right to pay for unsuccessful research. Fairchild remained at risk throughout this process time until the research was successfully completed. The Regulation places importance on the fact that in order for the researcher to claim credit, accounts payable under the agreement must be contingent upon success.

Court’s Decision

Fairchild’s QREs were not considered “funded” and they are entitled to the research tax credit.  The decision of the Court of Federal Claims is reversed and further proceedings will determine how much Fairchild is owed.

Click Here to view the full case: Fairchild Industries Incorporated v. United Sates, 71 F.3d 868 (Fed. Circ. 1995).

Eustace v. Commissioner. 313 F.3d 905 (7th Cir. 2002) aff’g, T.C. Memo 2001-66.

Background

T.C. Memo 2001-66

This tax court memo concerns Applied Systems, a subchapter S corporation that develops and sells software that independent agencies would use to manage their businesses.  In the 1990s they improved their software packages and the investors want to take a tax credit for the research and development expenses incurred in these years. The Tax Court concluded that Applied Systems did not pass two tests required to receive the tax credit because the research was not designed to dispel uncertainty about the technological possibility of developing software of this kind. T.C. Memo 2001-66 (2001).

Basic Facts

Applied Systems performed normal software development throughout this time. They made adaptations and changes to several features however none of these were groundbreaking and pioneering and they could be found in other developers’ products.  The Tax Court decided that Applied Systems failed the “process of experimentation” and the “discovering information” requirements.

Applied Systems did not argue this in court and supplied no further evidence or documentation that could prove this. Applied Systems asked the Court to use the proposed regulations for the definition of “discovering information” however proposed regulations do not have any legal effect and the proposed regulations refer to taxable years ending on or after December 21, 2001 so Applied Systems would not qualify for this regulation.  Applied Systems also asked the court to disregard another court case document that was brought up (Wicor and United Stationers) yet the definitions they are arguing for are not relevant to their case. Applied Systems developed software to sell to customers while the previous two cases, the taxpayer contracted with a consulting firm to develop a program they would use for their own benefit.

Court’s Decision

Regardless of what court case documents have been consulted, simple software development does not qualify for research tax credit.  The judgment of the Tax Court is AFFIRMED.

Click Here to view the full case: Eustace v. Commissioner. 313 F.3d 905 (7th Cir. 2002) aff’g, T.C. Memo 2001-66.