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Clayton & McKervey is a full-service CPA and consulting firm servicing middle-market, growth-driven clients in the industrial automation sector. Based in Detroit we provide tax, accounting, assurance and business advisory services to closely held domestic and international clients. To learn more about Clayton & McKervey, visit claytonm

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Research & Experimentation Funding for Control Groups

POSTED 02/13/2019

A common misconception about the Research and Experimentation Tax Credit for Increasing Research Activities (hereinafter the R&E Credit) arises when control group members share expenses related to qualified research activities; and when the ultimate user or decision maker is not the same entity who conducted the research activities.

Controlled Groups

Question: What is a Controlled Group?

Answer: For purposes of the R&E Credit, a control group is established, most commonly, under one of two scenarios.

  • A parent-subsidiary relationship between two entities, where Company A owns at least 80% of Company B.
  • A brother-sister relationship between two entities, where Individual A owns stock possessing at least 80% of the total voting power or at least 80% of total value of shares outstanding.

For purposes of the R&E Credit, there are no additional requirements to meet the definition of a control group. Most importantly, nationality is not a consideration. Any of the members can be foreign corporations.

Funding R&E Expenses

Question: What does it mean when R&E is funded?

Answer: Generally, in determining if expenses are qualified for the R&E Credit, they cannot be funded by any grants, contracts, a government entity, or by another person. Meaning, that in order to claim R&E expenses for the credit, the company must bear the risks of conducting the research.

However, because of the definition for control groups in place for the R&E Credit, reimbursements for R&E expenses are not considered to be funded research when the entities are determined to be in a controlled group. Meaning, that a parent or subsidiary/brother or sister corporation can reimburse any other member of the group for conducting qualified research. Ultimately, the related entities are considered to be a single taxpayer, regardless of nationality, allowing for all intercompany transfers of assets and liabilities, revenues and expenses, to be disregarded.

Example: Foreign Parent with a US Subsidiary

Facts: Company A is a foreign company that owns 85% of Company B, also a foreign company, who then, in turn, owns 100% of Company C, a US subsidiary, and the relationship meets the definition of a controlled group. Company C conducts qualified research activities within the US. Company A funds all research activities on behalf of Company C and ultimately receives the benefit of the research.

Question: Will Company C be able to receive the benefit of the funded research to apply toward the calculation of the R&E Credit?

Answer: Yes. For purposes of the R&E Credit, control group members are considered to be a single entity. Having the research conducted within the United States and having the expenses incurred domestically, Company C would be able to apply the qualified expenses towards the tax credit.

Conclusion

The above scenario is a common ownership structure and one that provides a tax benefit for conducting qualified research within the US.

To recap, because Company A, B and C form a parent-subsidiary control group, they are considered to be a single taxpayer. Because they are a single taxpayer, the reimbursement of the qualified research costs from Company A does not violate the funding rules of the R&E Credit.

This greater flexibility to finance qualified research expenses is a valuable tool for any corporation increasing research within the United States and offers planning opportunities to maximize an entity’s worldwide taxable benefit. To learn more, contact Clayton & McKervey.