Federal – Page 17 – Swanson Reed | Specialist R&D Tax Advisors

The Trans-Pacific Partnership, I.P. and R&D

In a recent interview with Marketplace host Kai Ryssdal, Obama stated that China is open to the idea of joining the Trans-Pacific Partnership (TPP), which would make the TPP an even bigger deal than it already is.

The TPP, which currently includes the U.S. and 11 of its trading partners in the Pacific area, would facilitate in linking the economies of the cooperating countries by increasing the exchange of products and services between participating countries through decreased regulation, supporting increased economic innovation and economic growth.

Having the second biggest economy in the world involved in the trade would take it a step further, but is this a good or bad thing? Congress is split on the TPP, with most opponents being Democrats, Obama’s usual supporters. They are in fear of TPP resulting in lower wages and lost jobs in America, as the North American Free Trade Agreement did when enforced in 1994.

So what does this deal mean for American innovation and R&D?

A big debate about the TPP is how Intellectual Property is going to be handled. In his interview with Rysdall, Obama states that “11 of the leading economies in the Asia-Pacific region have agreed to enforceable strong I.P. protections.” Opponents of the deal believe this is not the way to go and have been campaigning to weaken the I.P. provisions.

In his Huffington Post article, Robert D. Atkinson, Ph.D gives a good example of why this is the case.

“For example, in the case of I.P.protections for biopharmaceuticals, the various anti-trade constituencies believe the appropriate amount of protection is near-zero, believing that this is the best way to get needed treatments to people, especially in lower-income nations.”

The other side believes that “despite important new drug discoveries, society needs continued and rapid improvements in R&D so that the next generation of health challenges can be overcome. And achieving this won’t be free,” said Atkinson. “In fact, new treatments for cancer and other diseases are only possible through enormous investments of time (over a decade) and money (upwards of $1.4 billion). Robust I.P. protection makes it possible for innovators to take the risk of investing sizable sums.”

More money invested in R&D amounts to more Intellectual Property which results in more social good.

“China to Surpass U.S. As World’s Top Investor in R&D”

The Chinese government and Chinese corporations are pushing to make China the world leader in innovation.

Innovation and technology are gaining a lot of attention across Chinese industries. Last year, Strategy &, a global management consulting firm established in the U.S. in 1914, released their China Innovation Survey which stated that innovation is now the top priority for 42% of Chinese companies, compared to 21% of multinational companies.

The government is encouraging the trend with multiple pro-innovation policies. China’s current five-year plan (2011-2015) establishes a particular innovation goal of 3.3 patents per 10,000 people. Due to this policy, Chinese patent applications have grown from 40,000 in 2003 to 800,00 in 2013.

The U.S. National Science Board conducted a study last year showing China’s share of global high-tech manufacturing had increased from 8% in 2003 to 24% in 2012. American companies such as Pfizer, Microsoft and General Motors, now have R&D centers in China due to the low-cost engineers and scientists, government innovation policies, a fast-growing market and a sea of young, go-getting entrepreneurs.

Based on this continuous upward climb in Chinese innovation, The Organization for Economic Cooperation and Development which promotes policies that will improve the economic and social well-being of people around the world, projects that China will surpass the U.S. as the world’s top investor in R&D by 2020.

House Passes COMPETES Bill

On the same day H.R. 880, the American Research and Competitiveness Act of 2015 was passed by the House, so was H.R. 1806, the America Competes Reauthorization Act, in a 217-205 vote.

The America Competes Reauthorization Act of 2015 would provide nearly $33 billion in funding for federal scientific research between 2016 and 2020, to be dispersed between the National Science Foundation, the Office of Science and Technology Policy, the National Institute of Standards and Technology and specific offices at the U.S. Department of Energy.

Opponents of the bill labeled it “anti-science” and criticized its reductions in approved funding for climate change and other research endeavors. Advocates saw the bill in a very different light. Lamar Smith (R-TX), House Science, Space and Technology Committee Chairman, described the bill as a “pro-science, fiscally responsible bill that sets America on a path to remain the world’s leader in innovation,” according to the American Institute of Physics.

President Obama is siding with the opponents on this one. On May 18, the White House released a statement saying it “strongly opposes House passage of H.R.1806…which would undermine critical investments in science, technology and research. The Administration believes that H.R. 1806 would be damaging to the Administration’s actions to move American competitiveness, innovation, and job growth forward through a world-leading science, technology, and innovation enterprise. If the President were presented with H.R. 1806, his senior advisors would recommend that he veto the bill.”

The COMPETES Act was received in the Senate on May 21, 2015, read twice and referred to the Committee on Commerce, Science and Transportation.

Chemical Manufacturing Group Asks Senate for Permanent R&D Credit

A specialty chemicals group publicly applauded the House last week for passing the American Research and Competitiveness Act, and are now calling on the Senate to take the same action.

The Society of Chemical Manufacturers and Affiliates (SOCMA) is one of many associations backing The American Research and Competitiveness Act which would make the Research and Development Tax Credit permanent and raise the credit rate.

SOCMA says about one-fifth of their members’ workforce is involved in R&D and one-tenth of the companies are dedicated to research.

“By nature, specialty chemical manufacturing is innovative, and many SOCMA members rely on the R&D tax credit to help them remain competitive in the global marketplace,” said William Allmond, SOCMA’s senior lobbyist, according to Chem.Info.

The American Research and Competitiveness Act passed the House with a total vote of 274-145 which included 37 yes’ from Democrats. SOCMA and other supporters are worried that the bill won’t have the same outcome once it hits the Senate floor, or the President’s desk, if it even makes it there.

“If we’re going to get away from deficit spending, you’ve got to pay for things,” said Representative Xavier Becerra (D-CA). “Don’t act like you can do these things for free.”

Last year, two attempts to make the R&D credit permanent were shot down once they reached the Senate. SOCMA, along with many companies whose business relies on R&D are pleading for a different outcome this year.

Spotlight on the R&D Tax Credit

After taking a long, hard look at America’s Research and Development Tax Credit, Congress realized that it was due for a much-needed makeover, and 2015 is the year to do it.

In February of 2015, the bipartisan COMPETE Act was introduced by Senators Tom Carper (R-DE) and Pat Toomey (R-PA) to drastically improve the R&D Tax Credit.

On May 20, 2015 the House passed the American Research and Competitiveness Act of 2015, which increases the R&D tax credit rate and makes the credit permanent.

That same day, the House received the most recently proposed improvement to the credit, the Domestic Research Enhancement Act of 2015, which modernizes the R&D Tax Credit to make certain contract research eligible.

Pharmaceutical, biotech and medical device companies can be heard cheering since contract research plays such a critical part in the development of new devices within these industries.

Another major supporter of the Domestic Research Enhancement Act of 2015 is the Association of Clinical Research Organizations (ACRO). ACRO represents companies that provide a range of specialized services that support the development of new pharmaceuticals, biologics and medical devices.

On May 21, 2015, Jamie Macdonald, the Chairman of ACRO and CEO of INC Research, issued the following statement in support of the Domestic Research Enhancement Act of 2015.

“ACRO commends Representatives Pat Meehan (R-PA), George Holding (R-NC) and G.K. Butterfield (D-NC) for co-sponsoring the Domestic Research Enhancement Act of 2015. This important piece of bipartisan legislation will help ensure that the United States remains a leader in medical innovation and encourages employment in the high-wage research sector. Pennsylvania and North Carolina remain the leading states for contract clinical research with more than 13,000 employees combined. By enabling contract research organizations to capture a portion of the R&D tax credit that is currently abandoned, this legislation will enable the United States to remain competitive globally. Similar provisions are included in the bi-partisan COMPETE Act introduced earlier this year by Senators Tom Carper and Pat Toomey. We look forward to enactment this year.”

Congressman Introduces Legislation to Modernize and Make Permanent the R&D Tax Credit

U.S. Congressman Kevin Brady recently wrote a piece for The Woodlands Villager as a guest columnist titled, “Keeping America Safe, Strong and Innovative.”

Brady begins his article by describing the real world we live in today and the everyday threats we face from the terrorism that exists around us.

“In Congress, my most important constitutional duty is the defense of our country and the Americans who live within it. The world is a dangerous place these days. This is no time to allow our military or intelligence to be hollowed out. In the next few weeks, Congress will consider measures to ensure our military and intelligence warriors have what it takes to keep our families and communities safe.”

Two weeks ago, a bipartisan bill was passed by the Senate that requires Congress to vote on any nuclear deal with Iran proposed by the President before further action occurs.

The House will be voting on the bill next, along with Brady’s newly proposed legislation to “restore America’s leadership in innovation.”

Brady’s bill will make the Research and Development tax credit modernized and permanent, promoting R&D investment in America instead of overseas.

Brady says the legislation is necessary to “create jobs, breakthrough technologies and economic growth here in the U.S.”

“America is rapidly falling behind our global competitors in research — especially China, which could surpass us by the end of the decade. Unless we act to encourage more U.S. research, our economy will suffer while middle-class families and talented college graduates will see jobs and opportunity lost to foreign countries.”

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:

There must be “technical uncertainty.”
There must be “new functionality.”
A “process of experimentation” must be involved.
The new product or process must be “technological in nature.”
The software needs to be “innovative.”
The development of the software must involve “significant economic risk.”
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:

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;
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;
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).