Expanding R&D Tax Credits May Spur Innovation

New legislation may make it easier to get more types of R&Dpaid for by the U.S. government.

By Douglas Kalman, PhD, MS, RD, CCRC, FACN

Pursuing the development of intellectual property (IP) may soon become easier, thanks to Representative Jerry McNerney, a Democrat representing Pleasanton, CA, who recently introduced a bill (HR 5681) to make tax credits for R&D permanent. In a letter to the Speaker of the House, Nancy Pelosi, he called for, at the very least, a multi-year extension of the R&D Tax Credit to bolster the technology and manufacturing sectors, which rely heavily on scientific research.

The legislation would simplify what is currently a confusing and convoluted process to seek the R&D Tax Credit by providing one overarching tax credit, currently referred to as the Alternative Simplified Credit. It strengthens the credit by implementing a phased increase in the amount of the credit, from 16% in 2008 to 18% in 2009 to 20% thereafter, and makes the tax credit permanent.

“My bill makes it easier for businesses to take full advantage of the credit and plan for future investment,” said Rep. McNerny. “In a weak economy, we should be doing everything we can to spur on innovation and the type of family-wage jobs that increased research and development will create.”

This is certainly a research incentive the nutraceuticals industry should be taking a closer look at.

Understanding R&D Basics

It is important to understand what’s considered R&D. The definitions of the types of research include:

• The research is undertaken to discover technological information that is “intended to eliminate uncertainty concerning the development or improvement of a business component.” The process of experimentation “must be an evaluative process and generally...capable of evaluating more than one alternative.”
• The research experimentation relies fundamentally “on principles of the physical or biological sciences, engineering or computer science.”
• The research experimentation “relates to a new or improved function, performance, reliability or quality of the business component.” Research undertaken for “style, taste, cosmetic or seasonal design factors” doesn’t count. However (and this is a big however), if your R&D is completed for any of the aforementioned factors and the research is creating a novel way to change the taste then that might qualify (i.e., designing a flavor improvement system might qualify, but just altering the flavor or taste of a product does not).

These definitions are wide in scope, which is why it pays to have an expert team on your side to analyze how your company works, in order to tease out all of the potential tax creditable projects ongoing within your organization. A company called alliantgroup excels at this with a very high success rate in the nutrition industry. Costs that qualify for credit include:

• W-2 wages for employees engaged in the qualified research activity (staffing and consultants)
• Non-capitalizable materials and supplies
• 65% of the costs of an outside consultant hired for research
• Potentially up to 100% (minimum 75%) of contracted clinical trials

This information deserves much more attention—Internal Revenue Codes 41 and 174 to be more specific. For example, if you have a beverage and you plan on doing a study to demonstrate that it offers a tangible benefit to the consumer population, then the study would be tax creditable. However, if you have only created a new label for a product, then the cost of the label production is not true R&D, and thus not defendable as a credit. (The R&D credit is claimed on IRC (IRS) Form 6765, Credit for Increasing Research Activities.)

What Rep. McNerney Says

Rep. McNerney’s bill, which has been referred to the Ways and Means Committee for further consideration, is entitled the “Innovation Tax Credit Act.” According to Rep. McNerney, “Research and development tax credits have inspired the research and innovation that has led to major breakthroughs in all different types of products from wind turbine parts to life-saving medical technologies and computers.”

For a little history on the R&D tax credit, it was first introduced in 1981. But its existence has always been temporarily renewed, 12 times in fact, leading to uncertainty about its existence and difficulty in planning for future investment.

Additionally, there are currently five different credits, or ways to claim credit, which fall under the “Research and Development Tax Credit” heading. This has led to a notoriously complicated and complex process to compute and claim the credit. As a result, many businesses are not able to take full advantage of the tax credits.

Several studies have found that the U.S. economy benefits from a two-to-one and even a three-to-one return on investment through R&D tax credits. There is also evidence that the R&D credit effectively stimulates investment in research, which offers a net benefit to the U.S. economy in terms of economic development. Moreover, a 2005 study by Berkeley’s Haas School of Business found that R&D tax credits help attract and maintain research investments in the U.S. when the pressure to conduct such research in other countries is great.

The effort to simplify, increase and make permanent the R&D tax credit, as Rep. McNerney’s bill does, is supported by major research universities, telecommunications and bio-tech firms, aerospace and defense companies, as well as the automotive industry, among others.

What Others Say

If you are unsure about whether or not your firm can qualify to reap the rewards of spending money on R&D—rewards that include both the tax credit and the advantage of intellectual property/market advantage—then it is time to meet with a good accounting firm. The educated guess here is that all firms in the natural products industry (supplement, functional foods, etc.) would qualify as long as they follow the law in terms of how their organizations are structured. Dairy farmers, computer companies, pharmaceutical firms and many others have qualified. If your firm spends internal or external R&D money on a new process to make the way you manufacture or produce a product more efficient, then you can benefit from a tax credit.

“The R&D credit is a great deal, and you’d be surprised how many different types of businesses qualify,” said Tony Szczepaniak, a managing director with RSM McGladrey, a firm that specializes in federal tax issues.

The alliantgroup’s CEO, Art Goessel, notes that companies have been surprised by how much credit and savings can be achieved when the corporate structure is set correctly for the legal exploitation of state and federal tax credits.

Rep. McNerney has introduced a bill that could foster growth in the food, nutraceutical, dietary supplement and related business sectors. It is a bill the industry should lend its support to. Think about it this way, how can it be bad to get money back from the federal government on a permanent basis for doing the R&D that you probably would have done anyway?NW