Texas adopts significant changes to research and development tax credit rule (2022)

In brief

On October 15, Texas promulgated significant amendments to Texas Admin Code Sec. 3.599 concerning the research and development activities franchise tax credit.

The amendments do not provide a general applicable date. Existing franchise tax rule Sec. 3.599 applies to “franchise tax reports originally due on or after January 1, 2014.” Accordingly, the Comptroller may seek to apply the changes retroactively. The amendments provide the Comptroller’s interpretation and implementation for state tax purposes of IRC Section 41 and applicable regulations adopted thereunder.

For consideration: The amendments offer a significant departure from IRC statute and regulations when addressing the definitions of qualified research and qualified research expenditures. The changes also provide significant administrative challenges to taxpayers by requiring the research credit to be computed for each legal entity and records to be maintained beyond the normal statute of limitations.

Taxpayers should review their facts and the rule amendments to analyze the impact. Taxpayers may experience significant credit reductions for any open tax period relating to internal-use software, prototype research activities, or supplies used in a product or process improvement. The Comptroller has clarified that the credit will be calculated at the combined group level, but has provided additional guidance, such as for a change to the combined group, where a taxpayer may lose access to the carryforward.

Texas adopts significant changes to research and development tax credit rule (1)

In detail

In April 2021, the Comptroller submitted significant proposed amendments to Texas Admin Code Sec. 3.599, concerning the research and development activities franchise tax credit.

On October 15, 2021, the amendments became final by virtue of their publication in the Texas Register. The final amendments generally are consistent with the proposed amendments, with certain differences noted below.

Background

Effective for reports originally due on or after January 1, 2014, Texas allows a franchise tax credit to entities performing qualified research. Pursuant to Texas Tax Code Ann. § 171.651(3), “qualified research” has the meaning assigned by IRC Section 41(d) and associated federal regulations, except that the research must be conducted in Texas. “Qualified research expenditures” (QREs) has the meaning assigned by IRC Section 41(b) and associated federal regulations.

Applicability

The amendments do not provide a general applicable date. Existing Texas Administrative Code § 3.599 applies to “franchise tax reports originally due on or after January 1, 2014.” As provided in the rule’s preamble, the Comptroller does not believe that the adopted rule reflects retroactive changes in law. The Comptroller states that the changes are expositions of existing Comptroller policy rather than changes. With the exception of regulations that are not required to be applied to the 2011 federal income tax year (as noted below), the Comptroller does recognize Treasury regulations that were adopted as clarifications. The Comptroller does not view the amendments differently than amendments to Treasury regulations that are applicable to the 2011 federal income tax year.

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Conformity to federal regulations

For purposes of the credit, Texas law defines the “Internal Revenue Code” as the Code in effect on December 31, 2011, and includes Treasury regulations “applicable to the tax year to which provisions of the code in effect on that date applied.”

The amendments interpret conformity to federal regulations by providing that a federal regulation adopted after December 31, 2011, is included only “to the extent that the regulation requires a taxpayer to apply the regulation to the 2011 federal income tax year” (emphasis added).

In the rule’s preamble, the Comptroller provides an example of a federal regulation to which Texas would not conform. Treas. Reg. Sec. 1.41-4, adopted on November 3, 2016, provides that regulatory guidance for internal-use software applies for tax years beginning on or after October 4, 2016. Because such guidance was not mandatory for the 2011 tax year, the Comptroller has interpreted that it is not incorporated into the definition of “Internal Revenue Code” for Texas purposes.

Another example provided by the Comptroller addresses changes to the definition of research and experimental expenditures in Treas. Reg. Sec. 1.174-2 adopted on July 21, 2014. Certain changes were applicable for tax years ending on or after July 21, 2014. Because these changes were not applicable to the 2011 tax year, they are not included in the definition of “Internal Revenue Code” for Texas purposes.

(Video) "Texas TREC Legal/Ethic and Standards of Practice" Webinar with Clay Collins, CPI

Observation: The Comptroller’s interpretation of the Internal Revenue Code as of December 31, 2011, provides strict limitations on Treasury regulations that may have been proposed or outstanding as of the 2011 effective date. While the subsequent federal regulations have been interpreted to be clarifying in nature, the Comptroller has effectively opined that it will not allow internal-use software or prototype research activities described under subsequent federal regulations to meet the requirements under the Texas statute.

Supplies used in a manufacturing product or process improvement excluded

The amendments exclude from “qualified research” any item of tangible personal property where the taxpayer would not have paid Texas sales and use tax due to the manufacturing exemption or the sale for resale exemption.

Observation: This treatment requires taxpayers to choose either a sales and use tax exemption or a research and development supplies credit. As the sales tax exemption effectively reduces tax by approximately 8% and a claim for a credit under this section results in an approximate 2.5% credit, manufacturers likely would choose the sales and use tax exemption.

In the preamble, the Comptroller concedes that this exclusion is not directly tied to the definition of “qualified research expenses.” Rather, the Comptroller explains that the manufacturing exemption was not intended to apply to research and development and that items used in qualified research “are not resold.”

Observation: Taxpayers undertaking research in the development of a new product or process generally may intend to create a new or improved product for sale. Treas. Reg. Sec. 1.174-2(a)(1) addressed the distinction to be made between qualified and nonqualified research expenditures utilized in producing a product:

The ultimate success, failure, sale, or use of the product is not relevant to a determination of eligibility under section 174. Costs may be eligible under section 174 if paid or incurred after production begins but before uncertainty concerning the development or improvement of the product is eliminated.

Internal-use software excluded

The amendments exclude from “qualified research” any research activities with respect to internal-use software.

Internal-use software is computer software developed by, or for the benefit of, the taxpayer primarily for the taxpayer’s internal use. Software developed by a taxpayer primarily for internal use by an entity that is part of an affiliated group to which the taxpayer also belongs is considered internal-use software.

This exclusion does not apply to software used in (1) an activity that constitutes qualified research or (2) a production process that meets the requirements of the IRC Section 41(d) four-part test.

The Comptroller also provided examples of software development activities that likely would be deemed to satisfy the qualified research definition. These include “developing software as part of a hardware product where the software interacts directly with that hardware in order to make the hardware/software package function as a unit.”

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Observation: The Comptroller’s rule does not specifically define what should be considered “internal-use” software. However, it does provide what is not internal-use — software that is “sold, leased, licensed, or otherwise marketed for separately stated consideration to unrelated third parties.” Accordingly, the Comptroller may decide based upon facts and circumstances as to whether their software is deemed internal-use software.

Exclusions of other software activities

The Comptroller provides several examples of how the four-part test applies to software development activities. The Comptroller also identifies a list of software development activities that likely would be considered qualified research and a list of 21 software development activities that are unlikely to be considered qualified research. The examples and lists are adapted from the IRS Audit Guidelines on the Application of Process of Experimentation for All Software.

Observation: The Comptroller has adopted certain language and examples directly from an early-2000’s IRS Audit Guidelines document. However, there are several differences. Within the referenced guide, there are 21 activities that are stated as “high-risk” and “moderate-risk” activities subject to further review and investigation. There are also four noted “low-risk” activities. The Comptroller has taken the position that “high-risk” and “moderate-risk” activities are “unlikely to qualify” within the proposed amendments and stated that “low-risk” activities are “likely to qualify.”

The IRS Audit Guidelines technological references (e.g., Y2K Program Changes) do not address today's cellular phone technology, blockchain, web-based services, or the proliferation of cloud computing technologies which drive current research expenditures. As a result, the IRS Audit Guide and thus the amendments may offer only limited guidance as to the types of qualifying research projects currently being reviewed and approved by the IRS for the IRC Section 41 credit.

Exclusion of funded research from qualified research expenditures

The amendments provide that qualified research does not include the activities of “funded research.” Research is considered funded if (1) the taxpayer retains no substantial rights to the research and (2) the payments to the researcher are not contingent upon the success of the research. If the taxable entity retains substantial rights, then research is only funded to the extent of the payments and fair market value of any property that the taxable entity becomes entitled to by performing the research. If the expenses related to the research exceed the amount the researcher is entitled to receive, the research is not considered funded only with respect to the excess expenses.

Observation: The amendments depart from the IRC statutory provision that attempts to prevent the double counting of research and development expenses by various parties who may not retain rights to the research. The regulation provides an example stating that regardless of whether rights are retained to the research, only those expenses in excess of the consideration received would qualify as qualified research expenditures. Taxpayers in the aerospace and defense industry and software contractors who retain rights should evaluate the example provided within the amendments.

Update: The Comptroller has stated in the preamble to the final rule that they will take into consideration federal case law for interpretation of the respective statutes on a case-by-case basis.

Combined reporting

The combined group is the taxable entity for purposes of the credit. The total qualified research expenses of each member of the combined group are added together to determine the total credit claimed on the combined report.

If there is a change in membership of the combined group, the resulting combined group is a new taxable entity; the resulting combined group is not entitled to the credit carryforward because it no longer is the same taxable entity as the taxable entity that established the credit carryforward. The rule provides only a limited number of examples of when no change in membership occurs.

Observation: In a departure from the April 2021 proposed changes, the Comptroller will compute QREs on an entity-by entity-basis, then combine those QREs to begin computing the base-period and current-period QREs. Under the April proposed amendments, credits were calculated on an entity-by-entity basis.

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Observation: A significant departure from the April proposed amendments is the potential to lose credit carryforwards if a combined group “changes.” It remains uncertain how the Comptroller will define a
“change in combined group.” The Comptroller appears to be reverting to positions taken in 2008-2010 when the agency’s position was that acquiring or selling a single entity could result in the loss of the temporary credit carryforward amount for the entire combined group. It is uncertain whether such an approach should be considered consistent with the statutory treatment for credit transfers and carryforwards.

Requirements for claiming the credit

The amendments provide that:

  • The taxable entity has the burden of proof to establish its entitlement to, and value of, the credit by clear and convincing evidence.
  • All QREs must be connected to specific qualified research activities.
  • All QREs must be supported by contemporaneous business records.
  • Any determination by the IRS that a taxable entity is entitled to the federal research and development credit does not bind the Comptroller when determining a taxable entity's eligibility for the credit.

Observation: Even though Texas incorporates IRC Section 41 into its R&D credit rule, under the amendments, an IRS determination that certain expenditures qualify for the federal credit would not be deemed binding upon the Comptroller.

Calculation and audits for years closed under the normal statute of limitations

The amendments allow the Comptroller to verify the QREs used to compute the prior-year average even if the statute of limitations for the prior year has expired. This verification will not result in an adjustment to tax, penalty, or interest for any report year for which the statute of limitations is closed.

Similarly, the amendments allow the Comptroller to verify credit carryforwards by verifying the qualified research activities on which the credit that created the carryforward was based. This verification may occur even if the statute of limitations has expired for the report year on which the original credit was claimed. This verification will not result in an assessment of tax, penalty, or interest for any period for which the statute of limitations is closed, but may result in an adjustment to the credit carryforward for any periods for which the statute of limitations is open.

Changes from April proposed amendments

The adopted rule does not reflect any significant changes from the proposed rule other than the following:

  • The final rule provides that while case law on various issues is persuasive, it is not binding on the Comptroller. However, the Comptroller intends to follow federal case law regarding the definition of funded research.
  • The burden of proof does not align with the federal standard; rather, the rule includes a section on the agency’s “clear and convincing evidence” standard.
  • The Comptroller no longer will calculate the credit individually for each legal entity but instead will compute QREs on an entity-by entity-basis and then combine those QREs to calculate the combined group’s credit.
  • If a combined group “changes” then the ability to claim the carryforward amount may be lost.
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FAQs

How do I use my research and development tax credit? ›

Businesses can claim the R&D Credit by filing IRS Form 6765, Credit for Increasing Research Activities. As part of the process, they need to identify qualifying expenses and provide adequate documentation that shows how these costs meet the requirements under Internal Revenue Code Section 41.

Is the research and development tax credit refundable? ›

The R&D Tax Credit isn't refundable. If you don't owe income tax or if the credit is worth more than what you owe, you won't receive a check from the IRS. Most businesses will use the 20-year carryforward to apply their unused credit to future years' taxes.

Does Texas have an R&D tax credit? ›

Any entity (including combined group) creating or claiming a research and development activities credit in Texas must file a Texas franchise tax report. Any amount spent with a public or private institution of higher education will be able to generate a 25% higher Texas R&D tax credit.

How much is the research and development tax credit? ›

Start-up companies and small businesses may be eligible to apply up to $1.25 million—or $250,000 each year for up to five years—of the federal R&D credit to offset the Federal Insurance Contributions Act (FICA) portion of their payroll taxes each year.

How do you write off research and development? ›

Generally speaking, the Internal Revenue Service treats R&D as a capital expense. For example, if you spent $100,000 on R&D, capital expense tax accounting rules require you to deduct $20,000 per year if amortizing over five years. You must use Form 4562 to spread R&D costs over at least 60 months when amortizing.

How is the research credit calculated? ›

Regular research credit .

The RRC is an incremental credit that equals 20% of a taxpayer's current-year QREs that exceed a base amount, which is determined by applying the taxpayer's historical percentage of gross receipts spent on QREs (the fixed-base percentage) to the four most recent years' average gross receipts.

What qualifies as research and development? ›

Research and development (R&D) includes activities that companies undertake to innovate and introduce new products and services. It is often the first stage in the development process. The goal is typically to take new products and services to market and add to the company's bottom line.

When can you claim R&D credit? ›

You file your accounts to 31 March each year. You have until 31 March 2022 to make a claim for your accounting period ended 31 March 2020. The actual deadline is midnight on 31 March 2022. After that it won't be possible to claim tax relief on R&D qualifying expenditure incurred between 1 April 2019 and 31 March 2020.

How long does it take to receive R&D tax credits? ›

R&D tax credit repayment time

So overall, it could take around 35 days in total from the submission of your claim to receiving your R&D tax credit.

Is Texas getting child tax credit? ›

How is this helping Texas families? Nearly every family is eligible to receive the 2021 Child Tax Credit. Families that haven't filed a tax return and families that didn't have recent income this year are eligible. Eligible families will receive up to $3,600 for each child age 0-5, and $3,000 for each child age 6-17.

Are prototypes taxable in Texas? ›

The revised rules clarify that the federal regulations (Reg. section 1.174-2) regarding pilot models and prototypes, among other items, are not applicable to the Texas credit. A taxpayer cannot claim a manufacturing or resale sales tax exemption for tangible property claimed as a research expense.

What is credit Franchise Tax? ›

A franchise tax, also known as a privilege tax, is a tax paid by certain companies that wish to conduct business in specific states. It gives businesses the ability to be chartered and to operate within the said state.

What happens to unused R&D credits? ›

What happens to unused R&D credits? Unused R&D tax credits may still be available to eligible businesses if they file amended tax returns for the years in which they failed to claim the credit. Businesses can then carry forward the unused credits for up to 20 years after first carrying them back for one year.

What expenses qualify for research & development tax relief? ›

What costs qualify? Direct and externally provided staff, subcontracted R&D, consumables, software, trials, prototyping and independent research costs may all qualify for R&D relief. Capital expenditure does not qualify under this scheme, nor does expenditure on the production and distribution of goods and services.

Can you capitalize research and development costs? ›

Current law requires companies to capitalize all of their R&D costs, including software development costs, incurred in tax years beginning after December 31, 2021.

How do you calculate research and development costs? ›

The calculation for ROC is very simple: we take the current year's gross profit dollars and divide it by the previous year's R&D expense. The numerator, or gross profit, is normally located on the current year's income statement.

What are gross receipts for R&D credit? ›

In Notice 2017-23, the IRS clarifies that gross receipts include total sales (net of returns and allowances), all amounts received for services, and any income from investments and other incidental sources.

How do you calculate fixed base percentage for R&D credit? ›

R&D tax credit calculation using the traditional method is based on 20% of a company's current year QREs over a base amount. First, however, the fix-based percentage must be obtained by dividing the QREs for tax years during a base period by the gross receipts from the same period.

What are the five criteria identifying R&D? ›

For an activity to be an R&D activity, it must satisfy five core criteria. The activity must be: novel, creative, uncertain, systematic, transferable and/or reproducible.

What is an example of research and development? ›

For example, a spaghetti sauce brand's many variations on the original product – “Chunky Garden,” “Four Cheese,” and “Tomato Basil Garlic”– are the results of extensive R&D. Any business that creates and sells a product or service, whether it's software or spark plugs, invests in some level of R&D.

What are the three major types of research and development? ›

2.24 There are three types of r&d: basic research ● applied research ● experimental development.

Can I write off research expenses? ›

Currently, businesses can choose to fully expense the costs of research and development (R&D); that is, they can deduct the costs of R&D from their taxable income in the year that those costs occur.

Do R&D tax credits count as state aid? ›

The RDEC scheme is not considered as Notified State Aid, meaning that companies that have received funding can also claim R&D Tax Relief under the scheme.

What is a large company for R&D? ›

Whilst more generous relief applies to SMEs, large companies are still able to benefit under the R&D Expenditure Credit (RDEC) regime. A company is considered 'large' for R&D purposes if it has either: • 500 or more employees; or.

Do I have to pay back the Child Tax Credit? ›

The law authorizing the monthly child credit payments specifically says that any excess amounts must be paid back when you file your 2021 tax return if your income is above a certain amount. There are exceptions to this rule for middle- and lower-income families, but they're limited.

Are we getting a Child Tax Credit in April 2022? ›

Get this year's expanded Child Tax Credit

File your taxes to get your full Child Tax Credit — now through April 18, 2022. Get help filing your taxes and find more information about the 2021 Child Tax Credit.

Will there be a new Child Tax Credit in 2022? ›

As of 2022, the child tax credit has reverted to $2,000 per child under 17 with no advance monthly checks. The 2021 expanded child tax credit helped reduce child poverty by about 30% as of December, as measured by monthly income, according to the Center on Budget and Policy Priorities.

What are non taxable services in Texas? ›

Texas does not impose a tax on all goods and services, however.
  • Food and Beverages. Food sold for immediate consumption is taxable, but food the purchaser must prepare or eat at home is not. ...
  • Drugs and Medical Supplies. ...
  • Newspapers and Magazines. ...
  • Services. ...
  • Products for Resale or Manufacturing. ...
  • Agricultural Products.
26 Sept 2017

What purchases are tax exempt in Texas? ›

Common Texas sales tax exemptions include those for necessities of life, including most food and health-related items. In addition, goods for resale, such as wholesale items, are exempt from sales tax, as well as newspapers, containers, previously taxed items, and certain goods used for manufacturing.

Who is exempt from franchise tax in Texas? ›

The Texas Tax Code provides an exemption from franchise tax and sales tax to: Nonprofit organizations with an exemption from Internal Revenue Service (IRS) under IRC Section 501(c) (3), (4), (8), (10) or (19);

Why do I owe the franchise tax Board? ›

If you owe money for unpaid tickets or fines, the Franchise Tax Board will be charged with collecting those fees plus any late fees and delinquencies. Once again, these may include involuntary actions such as wage garnishment or bank levies.

Who is eligible for earned income credit 2022? ›

The EITC is generally available to workers without qualifying children who are at least 19 years old with earned income below $21,430 for those filing single and $27,380 for spouses filing a joint return. The maximum credit for taxpayers with no qualifying children is $1,502.

What taxes does an LLC pay in Texas? ›

The two types of business taxes for an LLC in Texas are sales tax and the Texas franchise tax. All businesses are subject to sales tax.

What is the Section 174 test? ›

The Section 174 Test. In order to meet the section 174 test, the expenditure must (1) be incurred in connection with the taxpayer's trade or business, and (2) represent a research and development cost in the experimental or laboratory sense.

Can you sell federal R&D tax credits? ›

Unfortunately, selling the R&D tax credit is not as simple as it could be. The seller must: Be a tech or biotech company. Sell their credits for at least 80% on their value.

How long does it take to receive R&D tax credits? ›

R&D tax credit repayment time

So overall, it could take around 35 days in total from the submission of your claim to receiving your R&D tax credit.

What qualifies as research and development? ›

Research and development (R&D) includes activities that companies undertake to innovate and introduce new products and services. It is often the first stage in the development process. The goal is typically to take new products and services to market and add to the company's bottom line.

Can sole traders claim R&D tax credits? ›

Are sole traders able to claim R&D Tax Credits? Sole traders don't pay Corporation Tax, therefore as R&D Tax Credits are a Corporation Tax relief they are not eligible to apply.

What is R&D Grant? ›

It its core, R&D Grant Funding is a government scheme designed to support the development of competitive new products, processes and services. A standard project using the scheme might typically run between 6 months and 3 years, with grants funding up to 70% of the costs involved.

What is an RDEC claim? ›

R&D expenditure credit ( RDEC ) replaced the large company scheme in April 2016. R&D expenditure credit can also be claimed by small and medium-sized enterprises ( SMEs ) who have been subcontracted to do R&D work by a large company and have either: received a grant or subsidy for their R&D project.

Who is eligible for RDEC? ›

You are classed as an RDEC qualifying company if you, and all connected companies, employ more than 500 staff. Even if you and all connected companies employ fewer staff, but you have a turnover of more than €100 million and more than €86 million in gross assets, you qualify for the RDEC scheme.

What is a large company for R&D? ›

Whilst more generous relief applies to SMEs, large companies are still able to benefit under the R&D Expenditure Credit (RDEC) regime. A company is considered 'large' for R&D purposes if it has either: • 500 or more employees; or.

What is an example of research and development? ›

For example, a spaghetti sauce brand's many variations on the original product – “Chunky Garden,” “Four Cheese,” and “Tomato Basil Garlic”– are the results of extensive R&D. Any business that creates and sells a product or service, whether it's software or spark plugs, invests in some level of R&D.

What are the three major types of research and development? ›

2.24 There are three types of r&d: basic research ● applied research ● experimental development.

When can you claim R&D credit? ›

You file your accounts to 31 March each year. You have until 31 March 2022 to make a claim for your accounting period ended 31 March 2020. The actual deadline is midnight on 31 March 2022. After that it won't be possible to claim tax relief on R&D qualifying expenditure incurred between 1 April 2019 and 31 March 2020.

Can a subcontractor claim R&D? ›

Yes, an SME carrying out research and development (R&D) will usually be able to claim 65% of the costs paid to any subcontractor for qualifying activities.

Can a partnership claim R&D tax credits? ›

Limited Liability Partnerships (LLPs) do not pay UK Corporation Tax and as a result they usually cannot claim R&D tax credits. R&D tax credits are a form of Corporation Tax relief and so, as a limited liability partnership (LLP), you cannot usually claim as you are not registered for UK corporation tax.

Can an LLP claim R&D tax credits? ›

No, an LLP cannot directly apply for the R&D tax credit.

What are R&D activities? ›

R&D: Research and experimental development (R&D) activities are defined as creative and systematic work undertaken in order to increase the stock of knowledge—including knowledge of people, culture, and society—and to devise new applications using available knowledge.

Do R&D tax credits count as state aid? ›

The RDEC scheme is not considered as Notified State Aid, meaning that companies that have received funding can also claim R&D Tax Relief under the scheme.

October 13, 20212021-1860

Incorporating, in general, the four-part test for the federal research credit articulated in IRC Section 41(d) Amending the definition of "qualified research expense" to mean the sum of all in-house research and contract research expenses Clarifying that the applicable reference to the IRC for R&D credit purposes is the IRC in effect as of December 31, 2011, and specifying that any federal regulation adopted after this date is only included in this term to the extent a taxpayer must apply that regulation in the 2011 tax year Listing activities that do not constitute qualified research activities (such as "internal use software") Clarifying that tangible personal property will not qualify as a research expense for purposes of the TX R&D credit if the taxpayer claimed a manufacturing or resale sales tax exemption when purchasing that property Modifying credit eligibility requirements Providing guidance to Texas franchise tax combined groups claiming the Texas R&D credit. According to the Preamble, new Section 3.599(c) "discusses the application of the Four-Part Test to explain the basic requirement for research activities to be qualified research" and is based primarily on the federal R&D rules set out in IRC Section 41(d) and Treas.. The final rule on the exclusion from qualified research for funded research states that "a taxable entity performing research for another person must identify any other person paying for the research activities and any person with substantial rights to the results of the research.". The final rule further requires (1) all qualified research expenses to be paid or incurred in connection with qualified research activities; and (2) all qualified research expenses to be supported by contemporaneous business records.. The TX Comptroller declined to accept a public comment suggesting that it apply the same burden of proof and contemporaneous documentation required for the federal R&D credit, noting that the standards and requirements adopted in the final rule generally apply to all Texas franchise tax credits.. The final rule, which was significantly modified from the proposed amendments, clarifies that the combined group is the taxable entity for purposes of combined reporting, and requires the total qualified research expense of each member of the combined group to be added together to determine the total credit claimed on the combined report.. Because the TX Comptroller's final rule excludes a large category of software development activities from Texas R&D credit eligibility, taxpayers may wish to consider other states' R&D, location and/or employment credits and incentives regimes when deciding where to perform software development activities.. 2 As noted in the Preamble, the TX Comptroller rejected a number of other public comments, including suggestions that it not redefine "qualified research" and that it eliminate Section 3.599(b)(8)(A)(iii), which excludes from being an in-house research expense a taxable item for which the taxable entity claimed a sales or use tax exemption and the exemption is for use other than in qualified research.

PART 1. COMPTROLLER OF PUBLIC ACCOUNTS

The comptroller amends the definition of "qualified research" in. renumbered paragraph (7) to explain that qualified research must be. research conducted in Texas and that qualified research must satisfy. the Four-Part Test.. (10) Taxable entity--This term has the meaning given. by Tax Code, §171.0002 (Definition of Taxable Entity).. (4) Software development as qualified research.. Because the taxpayer's activities are excluded from. the definition of qualified research, the customer's payments to the. taxpayer are not for qualified research and are not considered to. be contract research expenses.. The taxpayer's activities related. to both the product and the production process are not excluded from. the definition of qualified research as an adaptation of an existing. business component.. The taxable entity's activities to. modify its painting process are not qualified research.. The taxable entity's activities. did not satisfy the Process of Experimentation Test because the taxable. entity merely used its existing technology and did not perform any. experimentation to evaluate any alternative drilling methods.. (4) Software development as qualified research.. Because the taxable entity's activities are. excluded from the definition of qualified research, the customer's. payments to the taxable entity are not for qualified research and. are not considered to be contract research expenses.. Thus, the taxable entity's activities to manufacture. rail cars for the customer are excluded from the definition of qualified. research because the taxable entity's activities represent activities. to adapt an existing business component to a particular customer's. requirement or need.. The taxable entity's research activities. to determine how to modify the robotic equipment it purchased for. its manufacturing process are not considered an adaptation of an existing. business component.. The taxable entity's activities related to both the product and the. production process are not excluded from the definition of qualified. research as an adaptation of an existing business component.. (1) A taxable entity is not eligible to claim a credit. on a franchise tax report for qualified research expenses incurred. during the period on which the report is based if the taxable entity,. or a member of the combined group, if the taxable entity is a combined. group, received an exemption from sales and use tax under Tax Code, §151.3182. (Certain Property Used in Research and Development Activities; Reporting. of Estimates and Evaluation) during that period.

The TCJA resulted in significant changes to the treatment of R&E expenditures that will require substantial work for many companies to implement this year.

Because most taxpayers will need to reconcile costs treated as QREs under Section 41 and/or book R&D expense as defined under ASC 740 to determine Section 174 costs, this article also includes an analysis of these costs.. Under Section 41, Taxpayers are permitted to include certain R&D costs as QREs for purposes of Section 41 related to activities that meet a four-part test defined under Section 41(d)(1).. Laboratory research aimed at discovery of new knowledge Searching for applications of new research findings or other knowledge Conceptual formulation and design of possible product or process alternatives Testing in search for or evaluation of product or process alternatives Modification of the formulation or design of a product or process Design, construction, and testing of preproduction prototypes and models Design of tools, jigs, molds, and dies involving new technology Design, construction, and operation of a pilot plant that is not of a scale economically feasible to the entity for commercial production Engineering activity required to advance the design of a product to the point that it meets specific functional and economic requirements and is ready for manufacture, and Design and development of tools used to facilitate R&D or components of a product or process that are undergoing R&D activities.. From a cost perspective, taxpayers will need to determine if the costs included from a book R&D expense perspective properly include all costs incident to the research as defined under Section 174.. Impact on research credit Since conforming provisions for Section 41(d)(1)(A) were made to align with Section 174, taxpayers must treat costs as Section 174 for them to be includible in computing the research credit under Section 41.. Prior to the TCJA changes becoming law, Section 41 only required the expenditures to be eligible for treatment under Section 174; however, the taxpayer may have treated them differently under another code section such as Section 162.. Section 263(a) impact Taxpayers have likely taken positions that certain costs centers and related costs can be excluded from the Section 263A computation because they are Section 174 costs.

On May 21, 2020, the Securities and Exchange Commission (the SEC) adopted rule amendments that will impact the requirement of Investment Companies (as defined below) to disclose the financial statements of certain of its portfolio companies or of a fund that the Investment Company acquires (the Final Rules). The amendments in the Final Rules were initially proposed in May 2019 (the Proposed Rules) and, as described below, the SEC adopted the Final Rules with certain modifications to the Proposed Rules.1 The...

As described more fully below, the Final Rules adopted a new definition of “significant subsidiary” in Rule 1-02(w)(2) that is tailored to Investment Companies by: (i) modifying the investment test and income test, and (ii) eliminating the asset test currently in the definition of “significant subsidiary” in Rule 1-02(w).. The investment test under new Rule 1-02(w)(2) will instead measure whether an Investment Company’s investment in and advances to the tested subsidiary exceeds 10% of the value of the total investments of the Investment Company on a consolidated basis as of the end of the most recently completed fiscal year.. The SEC acknowledged that the asset test is generally not meaningful and confusing when applied to Investment Companies, and eliminating it will simplify compliance for Investment Companies when determining whether a portfolio company is deemed to be a “significant subsidiary.” Eliminating the asset test for Investment Companies will further align the definition of “significant subsidiary” in new Rule 1-02(w)(2) with Rule 8b-2 of the 1940 Act, which does not include the asset test.. The income test in new Rule 1-02(w)(2) will adopt the income test in Rule 8b-2 of the 1940 Act that measures the total investment income of a portfolio company against the investment income of the Investment Company and its consolidated subsidiaries, with certain modifications.. The new Rule 6-11 will address financial reporting relating to a fund acquisition by an Investment Company of another Investment Company, a private fund, or any private account managed by an investment adviser, and will be based on the amended Rule 3-05 but tailored to Investment Companies.. While the application of this test is consistent with Rule 3-05, new Rule 6-11 will be tailored to a fund acquisition by further identifying the following circumstances to consider when determining if a fund acquisition has occurred: (i) the acquisition of all or substantially all portfolio investments held by another fund; and (ii) an acquisition of a fund’s portfolio investments that would comprise all or substantially all of the initial assets of the Investment Company (e.g., formation transactions undertaken prior to electing to be regulated as an Investment Company).. The Final Rules provide more tailored conditions pursuant to which Investment Companies will determine whether a portfolio company is deemed a “significant subsidiary.” By applying conditions that more accurately measure the actual impact of a portfolio company on an Investment Company’s financial conditions, new Rule 1-02(w)(2) will help reduce the significant time and expenses that Investment Companies incur in preparing separate financial statements or summary financial information under Rules 3-09 and 4-08(g), respectively.. In this regard, Investment Companies can begin preparing now by assessing whether any portfolio company that is currently deemed to be a “significant subsidiary” under the current definition of “significant subsidiary” in Rule 1-02(w) will be deemed a “significant subsidiary” under the new Rule 1-02(w)(2) and whether financial information required by Rules 3-09 or 4-08(g) is required in the Investment Company’s upcoming periodic report.

This article discusses the modifications made to Sec. 174 and Sec. 41, which will affect taxpayers’ R&D tax credit claims for tax years after Dec. 31, 2021.

174, as well as corresponding changes to Sec.. 41, which will affect taxpayers' R&D tax credit claims for tax years beginning after Dec. 31, 2021.. While the tax rate changes may reduce some taxpayers' income tax liability, the modification of the corporate tax rate also increased the value of the R&D tax credit that corporate and noncorporate taxpayers may claim when electing to claim a reduced credit.. 2000-50 remain the same for tax years beginning before Jan. 1, 2022, but, for tax years beginning after Dec. 31, 2021, the TCJA eliminates the option to deduct R&D expenditures currently and requires taxpayers to charge them to a capital account and amortize them over five tax years, beginning with the midpoint of the tax year in which the specified research or experimental expenditures are paid or incurred (Sec.. Taxpayers that have used Sec.. How the Sec.. Currently, many taxpayers may claim expenditures for the R&D tax credit under Sec.. 162 or Sec.. 41 expenditures as "specified research or experimental expenditures" under Sec.. 174 and Sec.. To illustrate, for the 2018 tax year, a corporate taxpayer could currently expense $100,000 of research or experimental expenditures.. While taxpayers may be currently focused on tax rates and other modifications made to the Code by the TCJA, they need to consider changes to research or experimental expenditures beginning after 2021.

Overview and frequently asked questions about exemptions and credits for qualified research.

Who can claim the sales tax exemption?The sale, storage or use of depreciable tangible personal property directly used in qualified research is exempt from Texas sales and use tax if the property is sold, leased or rented to, or stored by, a person who:. is engaged in qualified research; will not, as a taxable entity or as a member of a combined group, claim a franchise tax research credit on a franchise tax report for the period during which the depreciable tangible personal property used in qualified research would first be subject to Texas sales or use tax; and registers with the Comptroller's office.. For the purpose of the sales tax exemption, the depreciable item must be directly used in qualified research.. How do I register for the sales tax exemption for qualified research?How do I claim the sales tax exemption?If you purchase an item under a valid qualified research exemption certificate and use that item in a taxable manner, you are liable for payment of sales tax and applicable penalty and interest based on the fair market rental value of the tangible personal property for the period of time used.. How do I file an annual information report?Registrants claiming the sales tax exemption must file an Annual Information Report (AIR) with the Comptroller's office on or before March 31 each calendar year in which they claimed the sales tax exemption to avoid cancellation of the registration.. The AIR allows registrants to renew their registration number and report required information about the amount of qualified research they performed in Texas; the number of employees engaged in research and development in Texas; and data regarding sales tax revenue.. The Comptroller or the registrant may cancel the sales tax exemption.. All persons registered for the sales tax exemption are required to file an Annual Information Report (AIR).. The AIR also allows a registrant to renew its registration number, so the registrant can claim the sales tax exemption on qualifying purchases for the next period.. You cannot claim the qualified research exemption during the period for which the registration number is cancelled.. Whether the Comptroller or the registrant cancels or otherwise terminates the registration number, the registrant will be required to pay the tax, penalty and interest due from the date of purchase on all ineligible tax-free purchases.. The purchaser can request a refund of the tax directly from the Comptroller if the retailer gives the purchaser Form 00-985, Assignment of Right to Refund (PDF) .. A retailer is not required to verify a registration number before accepting a qualified research exemption certificate from a purchaser at the time of sale.. How do purchasers and retailers handle refunds?A retailer is required to charge sales tax if the person claiming the sales tax exemption for qualified research does not give you a signed and properly completed qualified research exemption certificate, including the registration number, at the time of purchase.. If the purchaser did not have a valid registration number when the purchase was made, the retailer should assign the right to refund to the purchaser to allow the purchaser to request the refund directly from the Comptroller.

Legislation enacted in 2013 and recent guidance issued by the Texas Comptroller of Public Accounts allow taxpayers engaged in qualified research in Texas to claim

Legislation enacted in 2013 and recent guidance issued by the. Texas Comptroller of Public Accounts allow taxpayers engaged in. qualified research in Texas to claim either: (i) a sales and use. tax exemption on certain property directly used in qualified. research; or (ii) a Revised Texas Franchise Tax (RTFT) credit based. on qualified research expenses.. 1 The taxpayer cannot. claim both the sales tax exemption and the franchise tax credit for. the same year.. Taxpayers with qualified research activities in Texas can choose. between a sales tax exemption and franchise tax credit on an annual. basis.. Taxpayers must register with the Comptroller's office before. claiming the exemption on qualifying purchases.. This registration. form (AP-234: Texas Registration for Qualified Research and. Development Sales Tax Exemption) is available on the. Comptroller's website.. An Annual Information Report (AIR) must be filed with the. Comptroller's office by March 31st of the year following the. calendar year in which the sales tax exemption was claimed.. As an alternative to the sales tax exemption, taxpayers may. claim a franchise tax credit on qualified research expenses in. Texas.. Qualified research expenses (QRE) are defined under IRC. Section 41 as wages, supplies and contract research and must be. related to research conducted in Texas.. Unlike the sales tax exemption, registration is not required to. claim the franchise tax credit.. 18 If a taxpayer. registers for the sales tax exemption and decides to claim the. franchise tax credit for a future report year, the registrant. should ensure that it cancels its sales tax exemption registration. with the Comptroller as of a date that would not fall within the. accounting period that would be included in the report year in. which the franchise tax credit would be claimed.. For example, if a. calendar year taxpayer was currently claiming the sales tax. exemption and wanted to claim the franchise tax credit on the 2016. report year, it would need to ensure that the exemption. registration was cancelled as of December 31, 2014, so that none of. the 2015 calendar year would be subject to the exemption.. Determining the optimal answer does require additional time and. analysis for taxpayers incurring qualifying expenditures that would. result in an exemption and a credit (and may require multiple sales. tax exemption registrations).. The review would ideally occur prior to the beginning. of a new accounting period (whether a calendar year or fiscal year. company) in order to either obtain the exemption Registration. Number prior to making eligible purchases or to cancel the. exemption registration before tax-free purchases are made during a. year in which a franchise tax credit is to be claimed.. 19 For example, if a taxpayer decided to. claim the exemption for a particular report year's research. expenditures, the taxpayer would still be able to utilize research. credit carryforwards from prior years on the current RTFT report.

In Brief The federal research and development tax credit can be a boon to businesses, but as with any portion of the tax code, the rules surrounding it

The second document, a process unit ( http://bit.ly/2m2lW20 ), provides an explanation of how to implement an LB&I directive related to computing qualified research expenses (QRE) under IRC section 41.. The activities treated as R&D in ASC 730 have many similarities with those covered by IRC sections 41 and 174, and thus the amount reported in the financial statements provides a starting point to identify R&D costs.. According to ASC 730, the general rule for accounting for R&D costs is to expense them when incurred because their future economic benefit is uncertain.. While the similarities between ASC 730, IRC section 41, and IRC section 174 far outweigh the differences, there are situations where ASC 730 includes some costs as R&D costs that do not qualify under either tax code section, and vice versa.. ASC 730 and IRC sections 41 and 174 generally exclude the same activities, such as those related to commercial production (i.e., engineering follow-through, product testing, trouble-shooting), improvement or design change of an existing product, or legal work related to patents, such as application, litigation, sale, and licensing.. In September 2017, the Commissioner of the LB&I Division issued a directive, “Guidance for Allowance of the Credit for Increasing Research Activities under IRC 41 for Taxpayers that Expense Research and Development Costs on their Financial Statements pursuant to ASC 730.” Its purpose is to provide both taxpayers and revenue agents with a methodical and efficient manner for determining QREs.. The process unit provides a multistep approach for taxpayers to adjust the amount reported as R&D costs on their financial statements to the amount reported as QRE for income tax purposes, and to reconcile the differences in those two amounts.. An additional (and optional) five steps provide guidance for separately identifying R&D expenses that exceed the adjusted ASC 730 R&D amount.. Determine the financial statement R&D expenses under ASC 730; this is the amount reported as “Research and Development.”. Remove costs that qualify as R&D for financial reporting purposes but do not meet the requirements of IRC sections 41 and 174.. Determine contract costs excluded from ASC 730 expenses.. This step and step 9 identify and explain qualified research expenses reported outside of ASC 730 for financial reporting purposes.. Businesses that account for R&D costs under ASC 730 for financial reporting purposes and then attest that the costs reported as QREs for tax reporting are book ASC 730 R&D costs, less specifically excluded costs (such as foreign research), may still be examined, but the scope of the examination, as well as its cost for both the taxpayer and the IRS, will be significantly reduced.

Effective January 6, 2022, the Texas Comptroller of Public Accounts adopted sweeping revisions to the bad debt provisions of 34 Tex. Admin. Code § 3.302.

Code § 3.302 (Accounting Methods, Credit Sales, Bad Debt Deductions, Repossessions, Interest on Sales Tax, and Trade-Ins) (“Rule 3.302”).. Tax Code § 151.426 allows a seller to withhold payment or claim a refund or credit for sales tax on the unpaid portion of the sales price of a taxable item determined to be a “bad debt.” Two provisions of the statute, however, impose a continuing obligation to pay tax upon receipt of further payments.. Subsection (b) generally requires a seller to report and pay additional sales tax if the seller receives further payment on an account previously determined to be a bad debt.. Similarly, subsection (h) requires a “person” that previously claimed a credit or refund for a bad debt to report and pay additional sales tax “on any payments received on an account that has been written off and claimed as a bad debt.”. A person who later collects any payment on a bad debt or sells a repossessed item for which a credit or refund was claimed must report the total amount collected or received from the sale as a taxable sale in the reporting period in which the collection or sale occurs, except when the previous credit or refund amount was calculated by estimating post-sale collections for sold accounts in accordance with subsection (d)(3)(E) of this section.. If the retailer or private label credit provider claims a refund or credit that includes accounts sold to a third party, the retailer or private label credit provider must provide the detailed collection amounts for sold accounts.. If the person claiming the refund or credit does not have the actual collection information, the comptroller will estimate the post-sale collections in calculating the amount eligible for a refund or credit.. Under these new provisions, a seller’s bad debt refund, credit, or deduction is reduced by amounts that might, in the future, be collected by a third party to whom the bad debt was sold.. As noted above, the statute merely requires a seller to report tax when the seller subsequently collects on a debt and, likewise, requires payment of additional tax to the extent the person who previously claimed a refund or credit receives further payments on the account.. The rule goes much further, purporting to make the seller liable for sales tax on any amount collected by a third party at any point in the future, after the seller has sold the debt and thus abandoned any opportunity to collect anything beyond the amount for which the debt was sold.. It is worth noting, however, that the buyer of the bad debt is not liable for sales tax on amounts recovered in connection with their purchase if the seller of the accounts (claimant of the refund) uses the “safe harbor estimate.” However, if the buyer receives the express assignment allowed under Rule 3.302(a)(2) when they purchase their accounts, they have a reporting requirement for subsequent collections if they request a bad debt refund.. Rule 3.302(d)(2)(B) provides that “[o]nly one person is entitled to a credit or refund for sales and use tax paid to the comptroller on each bad debt or repossession.” This restriction did not exist in the prior rule.. Subsection (d)(5) of the new rule provides that the statute of limitations for claiming a bad debt refund or credit is four years from the date a debt is charged off for federal income tax purposes.. The previous Rule 3.302(d)(1)(B) provided that a bad debt refund or credit had to be claimed within four years from “the date the account is entered in the retailer’s books as a bad debt.” This change should make it easier to determine when the clock starts ticking on the claim.. A person who holds, “or held at the time of the sale,” a Texas sales tax permit may either file a refund claim for tax paid on the bad debt or claim credit on the person’s sales tax report “only if the person files the tax report electronically and claims the credit in the reporting period in which the person’s books reflect the bad debt or subsequent reporting periods…” A nonpermitted person is limited to requesting a refund from the Comptroller.

On May 21, 2020, the SEC adopted final amendments to the rules governing the required financial information for business acquisitions and dispositions.

On May 21, 2020, the SEC adopted final amendments to the rules governing the. required financial information for business acquisitions and. dispositions.. As amended, the rules should reduce the circumstances. in which audited financial statements of acquired businesses are. required and will reduce the required number of years presented.. Registrants are required to provide audited financial statements. of an acquired business based on its significance to the. registrant.. Under the new rules, the tests are applied. as follows:. Gone is the former requirement to provide three years of audited. financial statements when any of the significance tests exceed. 50%.. Instead, under the final rules, the acquirer. will need to provide pro forma financial information showing the. material aggregate effects of all such individually insignificant. businesses.. In measuring significance under the income test,. acquired businesses with profits must be aggregated separately from. those reporting losses, and, if either group exceeds 50%. significance, the disclosure requirements apply to all of the. acquired businesses.. In the final rules, pro forma financial information. must include transaction accounting adjustments under U.S. GAAP or. IFRS and autonomous entity adjustments that apply in a spin-off.. These rules were amended to conform to the. changes to S-X Rule 3-05 and Article 11.. The final rules also include certain changes tailored to the. financial reporting requirements for investment companies and. business development companies, including new rules to cover the. financial reporting of fund acquisitions.

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