Update on the IRC Section 41 Research Tax Credit 1 Michael A. Krajcer, JD, CPA Office: (440) Mobile: (216)

 Interpretation – The Courts  Regulation – IRS/Treasury  Legislation – Congress/President 2

 FedEx v. United States  TG Missouri Corporation v. Commissioner  Trinity Industries Inc. v. United States  Deere v. commissioner  Procter & Gamble v. United States 3

FedEx v. United States, 103 A.F.T.R. 2d (W.D. Tenn. 6/9/09)  Taxpayer developing Internal Use Software, wants to rely on the qualification tests found in the 2001 final regulations, but modified to recognize the elimination of the “Discovery Test” pursuant to the 2003 final regulations.  IRS argued that its Announcement precluded the taxpayer from doing so.  Holding: ◦ For the taxpayer ◦ Announcement is not due substantial deference since it is contrary to the IRS’ stated intent in adopting the 2003 regulations and contrary to the IRS’ stated understanding of Congressional intent 4

TG Missouri Corporation v. Commissioner, 133 T.C. 278 (Nov. 12, 2009)  Taxpayer contracted for production molds it would use to make automotive parts for its customers. The molds were held as inventory until complete, then sold to the related customer.  The IRS argued that the cost of the molds could not qualify as supply QREs, since they were “property of a character subject to depreciation”.  Holding: ◦ The court held for the taxpayer, stating that the particular taxpayer and such taxpayer’s use of the property must be referenced when determining if the property is in fact “property of a character subject to depreciation”. 5

Trinity Industries Inc. v. United States, 691 F. Supp.2d 688 (Jan. 29, 2010)  Issues: ◦ Business Component Test – made-to-order prototypes ◦ Substantially All Test  Holding: ◦ For the taxpayer  Research conducted for a particular customer will qualify for the research credit  Where the taxpayer provided sufficient evidence that “substantially all” (i.e. 80%) of a project’s activities qualified, then all the costs of the project were allowed in calculating the credit.  Note: ◦ Had the taxpayer retained documentation to verify that something less than “substantially all” of a project qualified, the court would have followed the “shrinking back” theory to allow the qualified portion of the project. 6

Deere v. Commissioner, 133 T.C. 246 (Oct. 22, 2009)  Taxpayer argued that the gross receipts of foreign branches should be excluded from the calculation of the credit, similar to the exclusion specifically granted to foreign corporation gross receipts that are not effectively connected with the conduct of a trade or business within the United States.  Holding: ◦ Noting that the "silence of Congress is strident," the Tax Court found that if Congress had wanted to exclude income from foreign branches from gross receipts, it would have done so explicitly. 7

Procter & Gamble v. United States, 733 F. Supp. 2d 877 (June 25, 2010)  The taxpayer excluded receipts from intercompany transactions, including foreign subsidiary amounts, for purposes of calculating “Gross Receipts”.  The IRS argued that for foreign subsidiaries, IRC Section 41(f) applies only to research expenditures, not gross receipts.  Holding: ◦ For the taxpayer: ◦ The district court rejected the IRS's argument concluding that for a controlled group of corporations, both QREs and Gross Receipts should be determined on a single-taxpayer basis. 8

IRS/Treasury Department issue final regulations regarding election of the Alternative Simplified Credit  Taxpayers cannot make or revoke an election for the ASC after they file their original tax returns.  No Section 9100 relief is available.  TD 9528; 76 FR  Effective June 9,

Administration Proposal:  Permanent Credit  Increase ASC rate from 14% to 17% Congressional Bills:  S. 1577: Greater Research Opportunities with Tax Help Act of 2011 (GROWTH Act) ◦ Permanent Credit ◦ Increase ASC rate from 14% to 20%  H.R. 1693: Research and Development Tax Credit Extension Act of 2011 ◦ Permanent Credit ◦ Increase ASC rate from 14% to 17% 10

Michael A. Krajcer, JD, CPA Over 25 years experience in tax consulting and tax controversy resolution B.B.A in Accounting, Kent State University J.D., Cleveland Marshall College of Law 13 years with the IRS Previous leader of Ernst &Young’s IRS Practice and Procedure Group in Cleveland and member of E & Y’s National Tax Practice, and VP at National City Bank Adjunct professor, Cleveland Marshall College of Law 11