A common misconception about the Research and Development Tax Credit for Increasing Research Activities (the R&D Credit) arises when control group members share expenses related to qualified research activities; and when the ultimate user or decision-maker is not the same entity who conducted the research activities.
Controlled Groups
Question: What is a Controlled Group?
Answer: For purposes of the R&D Credit, a control group is established, most commonly, under one of two scenarios.
- A parent-subsidiary relationship between two entities, where Company A owns at least 80% of Company B.
- A brother-sister relationship between two entities, where Individual A owns stock possessing at least 80% of the total voting power or at least 80% of total value of shares outstanding.
For purposes of the R&D Credit, there are no additional requirements to meet the definition of a control group. Most importantly, nationality is not a consideration. Any of the members can be foreign corporations.
Funding R&D Expenses
Question: What does it mean when R&D is funded?
Answer: Generally, in determining if expenses are qualified for the R&DCredit, they cannot be funded by any grants, contracts, a government entity, or by another person. Meaning, that in order to claim R&D expenses for the credit, the company must bear the risks of conducting the research.
However, because of the definition for control groups in place for the R&D Credit, reimbursements for R&D expenses are not considered to be funded research when the entities are determined to be in a controlled group. Meaning, that a parent or subsidiary/brother or sister corporation can reimburse any other member of the group for conducting qualified research. Ultimately, the related entities are considered to be a single taxpayer, regardless of nationality, allowing for all intercompany transfers of assets and liabilities, revenues and expenses, to be disregarded.
Example: Foreign Parent with a US Subsidiary
Facts: Company A is a foreign company that owns 85% of Company B, also a foreign company, who then, in turn, owns 100% of Company C, a US subsidiary, and the relationship meets the definition of a controlled group. Company C conducts qualified research activities within the US. Company A funds all research activities on behalf of Company C and ultimately receives the benefit of the research.
Question: Will Company C be able to receive the benefit of the funded research to apply toward the calculation of the R&D Credit?
Answer: Yes. For purposes of the R&D Credit, control group members are considered to be a single entity. Having the research conducted within the United States and having the expenses incurred domestically, Company C would be able to apply the qualified expenses towards the tax credit.
Conclusion
The above scenario is a common ownership structure and one that provides a tax benefit for conducting qualified research within the US.
To recap, because Company A, B and C form a parent-subsidiary control group, they are considered to be a single taxpayer. Because they are a single taxpayer, the reimbursement of the qualified research costs from Company A does not violate the funding rules of the R&D Credit.
Continue the Conversation
This greater flexibility to finance qualified research expenses is a valuable tool for any corporation increasing research within the United States and offers planning opportunities to maximize an entity’s worldwide taxable benefit. To learn more, contact Clayton & McKervey.
