A federal tax court judge has thrown a monkey wrench into determining what costs may be included as “qualified research expenses” eligible for the R&D tax credit when companies undertake manufacturing process improvements. Normally, all costs related to research into process innovations, including plant-scale research costs such as raw materials also used in ordinary production runs, are qualified expenses. However, the judge ruled that the supplies costs are “ordinary production costs” and that the company did not prove that the costs qualified for the credit.
On appeal, the NAM filed an amicus brief warning that the judge’s ruling establishes an unreasonable dichotomy between research into new products and research into new processes, to the detriment of process research. But both kinds of research advance the congressional purpose of the R&D tax credit. Process research often involves difficult issues relating to scaling up from small to large production runs, and supplies are a necessary part of this research, even if the supplies ultimately end up in salable products. We urged the court to recognize the importance of process research as a whole toward improved productivity, reduced energy consumption, reduced use of hazardous and non-hazardous materials as inputs in production, reduced emissions and enhanced safety and health. Including the costs of supplies in process research recognizes that such supplies are a critical element of plant-based process research, and denying the costs would discourage experimentation and encourage economic waste.
On 9/7/12, the court upheld the Tax Court’s decision and ruled against the company. It held that the company could not claim the research credit for all the supplies it used in the production process even though research was performed. It could only claim the credit for additional supplies that were used to perform the research. All the other supplies were used to produce a product that was sold, and the credit is only for costs that the manufacturer would not otherwise incur but for the research.