Claim R&D Tax Credits

Claim R&D Tax Credits

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Privately Speaking ISSUE 2: TACKLING INNOVATION ON A TIGHT BUDGET

Claim R&D Tax Credits

Private companies in almost any industry can benefit from federal and state tax credits for research and development (R&D) projects, which can help offset the cost of innovation activities and reserve cash to fund future innovation activities.

 

Francois Chadwick, partner in KPMG’s Federal Tax practice, says most mature private companies that are profitable, and therefore taxable, are probably taking the R&D tax credit already. However, entrepreneurial ventures and growth stage companies that are moving from losses to potential profits should be considering what steps they need to take to qualify for these credits. This can also be a strong benefit for private companies with goals to go public or hoping to be acquired. It is important companies fully understand the requirements for these credits so that their claims can be defended upon audit and they are properly identifying all potential credits for which they may be eligible

 

Meeting the requirements

To claim the credit, privately-backed companies must generally qualify R&D activities against a four-part test in the tax code. At a high level, qualifying research must satisfy the following;

  • Technological in nature (e.g., relies on principles of engineering, physical or biological sciences, or computer science)
  • Undertaken to eliminate uncertainty as to capability, method or appropriate design

  • Undertaken for a permitted purpose (i.e., new or improved function, performance, reliability or quality)

  • Substantially all of which consists of elements of a process of experimentation (e.g., modeling, simulation, prototyping, or even good old fashioned systematic trial and error)

 

For example, to satisfy the requirement “consists of a process of experimentation”, a software business could show evidence of its beta testing process, minutes from programming meetings, or status reports from programmers to executives. After identifying qualified R&D activities, the business must then quantify expenses related to those projects.

 

“The taxpayer needs to supply the IRS with extensive documentation to start using the credit and to keep the credit if they’re audited,” Chadwick says. “They generally need to find documentation that was created during the time of the project that truly shows the project passes all parts of the test.” However, credible oral testimony can also be used to support a research credit claim.

 

In addition, certain internal-use software (generally defined as software that is not being held for commercial sale, lease or license to third parties and software that is not designed to provide computer services to customers) can also qualify for the credit if it meets three additional tests: 

  • It is innovative
  • It involves significant economic risk because of technical reasons

  • The software is not commercially available without modifications that would be innovative and involve significant economic risk

Start Planning Now 
Attempting to compile this information years after the R&D activities took place can be a daunting task. It is beneficial to collect all potentially relevant documentation on an ongoing basis, even if the credit can’t be used immediately. Implementing tools and software like KPMG’s LINK R&D Exchange can help organizations streamline this process by providing a centralized system for managing the on-going collection of information related to R&D activities.
 
Private companies may also be able to claim the R&D tax credit for prior years in which they were not profitable. For a growth stage company, that could be back to the date of incorporation. The benefit is that even if the company is unable to use the credits now, the federal credits don’t expire for 20 years and some state credits never expire. 
 
Even taxable companies can seize the opportunity to claim the credit if they have not yet taken it through an amended tax return. 
 
“Lots of growth companies don’t want to figure out R&D credit and make it audit defensible if they aren’t going to use it anytime soon,” says Chadwick. “But if they are burning through their losses and are going to produce tax soon, they should certainly consider it.” 
 
 
 
 
 
 

 

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