R&D in the USA
Claiming Research & Development or R&E in the US has now become easier. Many US manufacturers are beginning to experience the negative impacts of cheap offshore labor. Lower labor rates in the east and higher global competition is becoming an ever more present threat to the manufacturing base of the United States.
Governments in western countries such as the United States understand that in order for companies to remain competitive in a global market, technology and innovation is their greatest asset, not cheap labor. Companies that spend the most on technical product and process development are the ones that are most likely to remain in business, hire skilled labor, and contribute to the local economic tax base. These same companies tend to also be more resilient in bad economic times. Governments also realize that tax relief in the form of tax credits encourages companies to undertake projects with risk. The R&D Tax credit provides American companies with excess money for capital expenditures to reduce costs, positive cash-flow, and extra marketing dollars to promote commercialization efforts.
All members of G7 countries have an R&D tax credit program in place, and in fact over 28 countries around the world have R&D programs in place. In all cases, the definitions are consistent with the internationally accepted definition used by the Organization for Economic Co-operation and Development (OECD). In the United States, the R&D tax credit provides companies with a 20% tax credit on qualified expenditures.
Salaries or wages of technical staff who work directly or manage the development projects. Salaries or wages of other staff that support the technical staff on the development projects e.g. administration.
Materials that were consumed or scrapped during the development project. Materials, jigs, tools, presses and so forth that were discarded during the development projects.
Subcontractor charges for work performed in the development project.
US Program Overview
Up until 2001, the R&D tax credit program in the US primarily rewarded companies that conduct intensive “research and development” type of activities. The regulations passed by the Clinton Treasury limited the value of the current research credit and made it rather difficult for companies to qualify and obtain. In December of 2001, the Bush Administration issued new IRS regulations, which made it significantly easier to qualify for the Research and Development tax credit. The program was streamlined and broadened to allow “Experimental Development” type of activities to qualify, not just pure Research and Development”.
Currently the program is only $9 billion dollars a year, proportionately less than Canada’s $3.5 billion dollar a year program. Of the $9 billion dollars, 80% of the fund is consumed only by few of the nation’s largest companies, making it an immediate source of untapped cash for many small to medium sized companies. Many small to medium sized companies fail to claim because they are unaware of the recent changes that were passed to allow experimental development to qualify. These same companies also tend to contract the services of smaller accounting firms who typically have little in-house experience and knowledge of the R&D tax credit program, as it requires a highly skilled level of engineering competence to properly identify and claim. Many companies develop new products and processes to keep ahead of the competition, to improve their existing products, and/or to reduce their costs. Their objective is not necessarily to improve the Knowledge State of the public domain. They achieve their objectives through Experimental Development 'ED' activities rather than Basic Research. Their motives are related to the global competitive position in the market and there is nothing wrong with such a motive. To the contrary, the ITA requires that the activities must be related to their business. Regulations in the USA specify that the activities be required to enhance a business component.
Typical Qualified Experimental Development Activities
These may include work on developing prototypes, custom designed machinery, software, new manufacturing processes, developing new materials and manufacturing techniques. The techniques of such projects are neither available in the public domain, nor known as standard practice in their industry. Many of these activities may be perceived as 'routine' engineering, yet certain aspects may qualify as R&D, in part or in total, due to their complexity. To qualify, they must lead to the evolution of new Technologies, Methodologies, or the resolution of Technological Uncertainty. If your company is involved in the following activities, you may be eligible for the R&D tax credit: manufacture products develop new, improved, or more reliable products and processes develop prototypes or models experiment with new materials design of custom machinery, tooling, dies, and molds apply for patents develop custom software or implemented new systems built new manufacturing facilities automate internal process pay outside consultants and subcontractors
3 Criteria must be met to qualify for an R&D Tax Credit:
1. Scientific or technological advancement Occurs when the goal of the project is to achieve a new technical improvement or a cost reduction through a technological application that is new to your business, not the industry. The knowledge and information gained from this project will generate an advanced understanding of this technology. Example: If the work performed is custom and cannot be purchased off the shelf or if there is no specific “how to” instructions available in the public domain such as in textbooks, Internet, or industry journals, then the work would qualify as technological advancement.
2. Scientific and Technological Uncertainty Occurs whether the end result or the objective at the onset of a project can be achieved. If your company is unsure as to how the objectives will be met and has to undertake a process of experimentation to determine the best technical path to meet the customer’s requirements, then the likelihood of uncertainty exists. Routine engineering however does not qualify under this program. Routine engineering occurs when a series of publicly known steps and instructions are faithfully followed to successfully produce the desire results without error or experimentation. Important to note that “routine engineering” that supports a qualified technical advancement is eligible. Example: If a mold maker produces a mold that has to achieve extremely difficult and tight tolerances as set by the customer, and they are unsure that they can be met, then the mold maker is confronted with uncertainty.
3. Scientific or Technological Content Occurs when work is undertaken in a systematic and investigative process by qualified personnel with relevant experience to solve the scientific or technological uncertainty. There must be an initial consideration of options and engineering sound choices to determine the best course of action. Example: You receive a request for quotation with detailed specifications that your project must meet. You review the criteria and come up with your quotation on how you are going to build it utilizing which components. This work is your initial hypothesis, the work that then takes place to complete the project and de-bugging shows the testing and changes that you went through to make it work.
Work performed may be A) Basic Research, namely work undertaken for the advancement of scientific knowledge without a specific practical application in view. B) Applied Research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view. C) Experimental Development, namely, use of the results of basic or applied research for the purpose of creating new, or improving existing materials, devices, products or processes, work with respect to engineering, design, operation research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support of the work described in (a), (b), or (c).
US Tax Credit Opportunity
Costly misconceptions about the R&D Tax Credit Many companies are unaware of the significant tax saving incentive that is available through the IRS. The R&D tax credit is often overlooked by organizations that do not normally associate R&D to their business or industry. Many of our clients used to regard their day-to-day business as “just doing my job”, when in fact they have been performing R&D qualifying activities all along. The R&D tax credit, which can be carried forward for 20 years, is not a deduction but rather a dollar for dollar credit against taxes paid or taxes owing.
New Changes in Regulation
Congress and the IRS are working in harmony to streamline the R&D program by broadening the scope of activities that qualify as R&D and making it easier for companies to apply. The IRS now offers greater flexibility for record keeping requirements and significantly expanded the definitions for Research and Development by allowing Experimental Development-related activities.
To properly identify and claim an R&D activity, it is very much a judgment call, which is dependent on one’s own ENGINEERING competence, expertise and experience in relation to the nature of the claim.