1st Quarter, 2010
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1st Quarter, 2010 |
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The R&D Credit and the TG Missouri Case: An Asset in the Right Hands is Better Than Two Assets in the Bush
By David Luke, CPA, Tax ManagerStarting in 1981, Congress began to reward companies that engaged in research activities which would lead to new efficiencies in production and new product innovation. The vehicle used to encourage these activities is a twenty percent tax credit on qualified research and development (R&D) expenditures. In recent years, the IRS has been very aggressive in disputing the R&D tax credit claims of taxpayers due to perceived abuses. In a recent U.S. Tax Court decision, the IRS was dealt a severe blow which may limit their ability to recharacterize expenditures eligible for the R&D credit as capitalized expenditures. One effective strategy that the IRS has been employing to reduce the R&D tax credit of taxpayers is to classify certain expenditures as depreciable assets. The IRS asserted the position that any analysis as to if an asset is depreciable should focus on the asset itself. If the asset had a useful life of more than one year and was subject to wear and tear, the government classified this as a depreciable asset, thus rendering any cost associated with that asset ineligible for the R&D tax credit. The IRS asserted the above argument in the TG Missouri case, in essence ignoring the question of who is depreciating this asset, and focusing on the asset itself. The taxpayer in the case pointed out the fallacy of this argument because it ignores the ability of the taxpayer to take depreciation deductions on the cost of the property. The taxpayer correctly stated that assuming an asset has a useful life of greater than one year and is subject to wear and tear, it still must be depreciable in the hands of the taxpayer to be a depreciable asset. Therefore, if the taxpayer claiming the credit cannot depreciate the asset, regardless of the fact that the asset itself is depreciable, then the asset is not depreciable “in the hands of the taxpayer,” and the costs associated with that asset are elegible for the tax credit. A brief synopsis of the facts should help emphasize the holding. The taxpayer in the TG Missouri case is in the business of manufacturing injection-molded products for the automobile industry which they either manufacture internally or outsource to a third-party toolmaker. After the mold has been developed and tested for use, it then becomes part of the manufacturing process by which auto parts are created. Although the mold itself is used in the process to manufacture the auto parts, the ownership of the mold does not always remain with the taxpayer. If the taxpayer retains ownership of the purchased mold it depreciates the cost over the prescribed useful life and also charges the customer an increased unit price. The alternative is for the customer to take title to the mold in which case the taxpayer expenses the cost and captures it as qualified research expenditures. In the above situation, the asset in question, a mold which is clearly a depreciable asset because it is used in the manufacturing process, will be subject to wear and tear and has a useful life greater than one year. When the taxpayer retains ownership, it is correctly depreciated and thus its costs are not eligible for the R&D credit. However, when the mold is sold to the customer, the asset itself is still depreciable, just not in the hands of the taxpayer. Thus, the taxpayer cannot recover the costs through depreciation. The inability to depreciate the asset in the hands of the taxpayer opens up the costs associated with the asset to be used in the R&D credit calculation. Other articles in this newsletter:
5-Year NOL Carryback Extended and Expanded Fin 48 and Non-Public Entities |
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David has over nine years of professional experience and serves as a Tax Manager in the Houston office of HEIN & ASSOCIATES LLP. He assists mostly private company clients in the manufacturing and distribution industry with tax planning and consultation, and specializes in the review and preparation of Federal and state tax returns, including the review of partnership agreements and transactions as they affect those returns. He also works closely with his clients in the preparation of their tax provisions and FIN 48 analysis.