TD 9205 – Summary of Comments and Explanation of Provisions
CONTENTS:
Computation of the Group Credit
Allocation of the Group Credit
Special Allocation Rule for Excess Group Credit Situations
Computation of Stand-Alone Entity Credits
Special Allocation Rule for Consolidated Groups
Alternative Incremental Research Credit
Computation of the Group Credit
Section 41(f)(1)(A)(i) provides that ‘‘all members of the same controlled group of corporations shall be treated as a single taxpayer’’ in determining the amount of the research credit under section 41. Section 41(f)(1)(B)(i) provides a similar rule for a group of trades or businesses under common control. The 2003 proposed regulations applied the section 41 computational rules on an aggregate basis for purposes of determining the amount of the group credit. Additionally, a controlled group would have been treated as a start-up company for purposes of determining the group’s fixed-base percentage only if each member of the group qualified as a start-up company. Therefore, a controlled group with only two members would have been subject to the start-up rules if one member of the group had QREs but no gross receipts in 1983 and the other member had gross receipts but no QREs in 1983.
Commentators generally agreed with the proposed rules for computing the group credit. Commentators were concerned, however, with perceived ambiguities related to the application of the start-up company rules to a controlled group. For example, commentators asked that the regulations clarify what a controlled group’s startup date is if all the members of the group are start-up companies with different start-up dates.
These temporary regulations retain the rules in the 2003 proposed regulations for the computation of the group credit, except for the start-up company rules. The temporary regulations state that a controlled group is treated as a start-up company for purposes of computing the group credit if (A) the first taxable year in which at least one member of the group had gross receipts and at least one member of the group had QREs begins after December 31, 1983, or (B) there were fewer than three taxable years beginning after December 31, 1983, and before January 1, 1989, in which at least one member of the group had gross receipts and at least one member of the group had QREs. Consistent with this approach, the first taxable year in which a controlled group has gross receipts for purposes of the start-up company rules is the first year in which at least one member of the group has gross receipts. Likewise, the first taxable year in which a controlled group has QREs for purposes of the start-up company rules is the first year in which at least one member of the group has QREs. The Treasury Department and the IRS believe that this approach is more consistent with treating a controlled group as a single taxpayer because a controlled group with two members is not subject to the start-up rules if one member of the group had QREs but no gross receipts in 1983 and the other member had gross receipts but no QREs in 1983. Additionally, the temporary regulations specifically state that for purposes of determining the fixed-base percentage, the first taxable year after December 31, 1993, for which a controlled group has QREs is the first taxable year in which at least one member of the group has QREs.
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Allocation of the Group Credit
Section 41(f)(1)(A)(ii) provides that ‘‘the [portion of the group] credit (if any) allowable by this section to each such member shall be its proportionate shares of the qualified research expenses and basic research payments giving rise to the credit.’’ Section 41(f)(1)(B)(ii) provides a similar rule for a group of trades or businesses under common control. The 2003 proposed regulations apply these provisions by allocating the group credit based on the relative amounts of each individual member’s stand-alone entity credit.
A number of commentators requested changes to the method of allocating the group credit contained in the 2003 proposed regulations. In general, these comments reflected dissatisfaction either with the stand-alone entity credit method in the 2003 proposed regulations or with any single, prescribed method. Consequently, commentators either proposed specific alternatives or stated that final regulations should allow members to allocate the group credit using any reasonable method. One commentator advocated that a method that allocates the group credit based on the relative amounts of each member’s total QREs (gross QREs method) is the only allocation method permitted under the statute. Another commentator urged the Treasury Department and the IRS to adopt an allocation method that, based on techniques of differential calculus, allocates the group credit based on the marginal contribution to the group credit of each member’s QREs for the current year, QREs for the base years, and gross-receipts for the base years, as well as the controlled group’s fixed-base percentage and the growth in gross receipts for the controlled group (marginal contribution method). Other commentators suggested that no single allocation method can appropriately allocate the group credit in all cases; therefore, members of a controlled group should be permitted to use any reasonable method to allocate the group credit. For the reasons discussed below, these temporary regulations generally retain the stand-alone entity credit method of the 2003 proposed regulations with some modifications.
The preamble to the 2003 proposed regulations sets out at length the reasons why the Treasury Department and the IRS believe that the allocation method under section 41(f) should be based on a group member’s QREs in excess of a base amount. The stand-alone entity credit method reflects the incremental nature of the credit and also is consistent with the Treasury Department and the IRS’ view of the purpose of section 41(f). As stated in the preamble to the 2003 proposed regulations:
The legislative history to the research credit, as originally enacted in 1981, indicates that the group credit computation and aggregation rules were enacted to ensure that the research credit would be allowed only for actual increases in research expenditures. These aggregation rules were intended to prevent taxpayers from creating artificial increases in research expenditures by shifting expenditures among commonly controlled or otherwise related persons. H. Rep. No. 97–201, 1981–3 C.B. (Vol. 2) 364, and Sen. Rep. 97–144, 1981–3 C.B. (Vol. 2) 442. In effect, the group credit computation rule serves as a cap on the maximum amount of credit that the members of the group, in the aggregate, may claim.
Prior to the 1989 Act, the research credit was computed by multiplying the credit rate by the excess of the taxpayer’s current year QREs over the taxpayer’s average QREs for the preceding three years. Final regulations issued in 1989, prescribing rules for the allocation of the group credit prior to the 1989 Act, allocated the group credit based on what effectively would have been each member’s stand-alone entity credit (without giving effect to the minimum base period amount in computing each member’s stand-alone entity credit). The 1989 Act significantly modified the computation of the credit while retaining the incremental approach of the pre-1989 Act credit. Congress did not indicate in either the statute or the legislative history that either the purpose or the application of section 41(f) was being changed. Although the phrase ‘‘increase in’’ in sections 41(f)(1)(A)(ii) and 41(f)(1)(B)(ii) was deleted by the 1989 Act, for the reasons set out in the preamble to the 2003 proposed regulations, the Treasury Department and the IRS concluded that this change to the statute was intended to reflect only the fact that a taxpayer’s entitlement to the research credit after the 1989 Act no longer depended on whether the taxpayer had increased its current year QREs over its average QREs for the preceding three years.
With respect to the alternative allocation methods suggested by the commentators, the Treasury Department and the IRS conclude that these methods are inconsistent with the purpose of section 41 generally and section 41(f) specifically. A gross QREs method is at odds fundamentally with the incremental nature of the research credit, and the Treasury Department and the IRS continue to believe that neither the statute nor the legislative history suggests that Congress intended that the allocation of the group credit be based solely on a member’s total QREs without reference to whether those QREs exceed a base amount.
Similarly, the Treasury Department and the IRS do not believe that the suggested marginal contribution method is consistent with section 41(f). The Treasury Department and the IRS recognize the potential for that method to more closely associate the amount of group credit allocated to a particular member to the contributions of that member’s QREs for the current year, gross receipts for the current year, QREs for the base years, and gross receipts for the base years to the amount of the group credit. The marginal contribution method proposed, however, has significant flaws that would change the function of the aggregation rules in section 41(f) in a manner that the Treasury Department and the IRS do not believe was intended by Congress. First, the method would allow allocations of credit to members that have no QREs, a result the Treasury Department and the IRS believe is contrary to the statutory directive to allocate the group credit in proportion to a member’s share of QREs giving rise to the credit. Second, the method uses different formulas for groups that are affected by special rules, such as the maximum fixed-base percentage rule. As a result, it is possible that a member of a group that increases its QREs by a relatively small amount, that is enough to make the group subject to a special rule, could be allocated proportionately less credit than if the member had not increased its QREs. Finally, by relying on the group’s gross receipts and the group’s fixed-base percentage, the marginal contribution method appears to encourage planning and shifting among group members, a result that is inconsistent with the purpose of section 41(f). The Treasury Department and the IRS believe that an appropriate allocation method should encourage a member to focus on incrementally increasing its own research efforts.
The Treasury Department and the IRS also decline to adopt an allocation rule that would permit the members of a controlled group to use any reasonable method to allocate the group credit. Neither the statute nor the legislative history indicates that Congress intended the allocation of the group credit to be based on any reasonable method selected by a member individually or the controlled group collectively. Furthermore, a rule permitting the use of any reasonable method to allocate the credit could result in continuing controversy. As discussed in the preamble to the 2003 proposed regulations, the Treasury Department and the IRS believe that the purpose of section 41(f) is undermined if the members of a controlled group use different allocation methods to claim more than 100 percent of the group credit. The Treasury Department and the IRS believe that a single, prescribed method is necessary to preclude such potential for abuse.
Accordingly, the Treasury Department and the IRS continue to believe that the purposes of the research credit statute generally and the provisions of section 41(f) specifically are best furthered by an allocation method that allocates the group credit based on each member’s stand-alone entity credit.
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Special Allocation Rule for Excess Group Credit Situations
Under the 2003 proposed regulations, if the group credit exceeded the sum of the stand-alone entity credits of the members of a controlled group, the members with stand-alone entity credits would be entitled to the entire group credit. In addition, if no member of the controlled group had a stand-alone entity credit, none of the group credit would be allocated to the members of the controlled group.
To address these situations, these temporary regulations modify the allocation method of the 2003 proposed regulations in cases in which the group credit exceeds the sum of the members’ stand-alone entity credits, including cases in which no member has a standalone entity credit. If the group credit exceeds the sum of the members’ standalone entity credits, each member is allocated an amount of group credit equal to that member’s stand-alone entity credit. The remaining, or excess, amount of group credit is then allocated among all the members of the controlled group based on the ratio of an individual member’s QREs to the sum of all the members’ QREs.
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Computation of Stand-Alone Entity Credits
Commentators questioned whether members must use the same method, i.e., the method described in section 41(a) (regular credit method) or the alternative incremental research credit (AIRC) method described in section 41(c)(4), in computing the stand-alone entity credit as that used to compute the group credit. The Treasury Department and the IRS do not believe that requiring taxpayers to be consistent in the method used to compute the group credit and the stand-alone entity credit would serve the purpose of section 41. Section 41(f) was intended to encourage taxpayers to increase their individual research efforts to maximize the group credit and thus their share of the group credit. The Treasury Department and the IRS believe that allowing the members to compute their stand-alone entity credits without regard to the method used to compute the group credit will encourage increasing research efforts. Thus, the temporary regulations provide that a member’s stand-alone entity credit must be computed using whichever method results in the greater stand-alone entity credit for that member, without regard to the method used to compute the group credit.
Commentators also pointed out that the computation of the stand-alone entity credits under the 2003 proposed regulations would no longer require the intra-group transaction rules of § 1.41–6(e) (re-designated in these temporary regulations as § 1.41–6(i)) to apply. Although the intent of the stand-alone entity credit rule is to compute a credit that is similar to that to which a member would be entitled if there were no research credit aggregation rules for controlled groups, the intent was not to render the intra-group transaction rules or the acquisition/disposition rules of section 41(f)(3) inapplicable. Therefore, these temporary regulations specifically provide that taxpayers must apply the intra-group transaction rules and the acquisition/disposition rules when computing the stand-alone entity credits. For example, to the extent that a member’s gross receipts and QREs have been reduced for purposes of computing the group credit as a result of the application of the acquisition/disposition rules, the member’s standalone entity credit must be computed using the same gross receipts and QREs.
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Special Allocation Rule for Consolidated Groups
The preamble to the 2003 proposed regulations states that the Treasury Department and the IRS considered comments requesting a special allocation rule for consolidated groups, but decided not to adopt such a rule. Several commentators further commented on that issue. One commentator suggested that if the group credit were allocated in proportion to QREs, no special consolidated group rule would be necessary. Given that this commentator’s proposed allocation method is not the one adopted in these temporary regulations, the Treasury Department and the IRS are not persuaded that a special consolidated group rule is unnecessary. Another commentator suggested that a consolidated group should be treated as a single member of a controlled group for purposes of allocating the group credit and that the failure to treat the consolidated group in such a manner would result in abuse.
The Treasury Department and the IRS believe that treating a consolidated group as a single member of a controlled group for purposes of allocating the group credit is consistent with the treatment of a consolidated group as a single taxpayer under a number of the consolidated return regulations. Therefore, these temporary regulations provide that, for purposes of allocating the group credit, a consolidated group whose members are members of a controlled group is treated as a single member of the controlled group. Accordingly, a consolidated group whose members are members of a controlled group is treated as a single member of the controlled group and a single stand-alone entity credit is computed for the consolidated group. If the consolidated group is the only member of the controlled group, the stand-alone entity credit computed for the consolidated group is equal to the group credit.
The portion of the group credit allocated to a consolidated group must be allocated among the members of the consolidated group. The Treasury Department and the IRS believe that the method of allocating among the members of the consolidated group the portion of the group credit allocated to the consolidated group should be no different than the method of allocating the group credit among members of the controlled group. Therefore, a standalone entity credit is computed for each member of the consolidated group, and the portion of the group credit allocated to the consolidated group is allocated among the members of the consolidated group in proportion to the stand-alone entity credits of the members of the consolidated group. One commentator argued that separately computing the stand-alone credit for each member of a consolidated group would be prohibitively burdensome. The Treasury Department and the IRS, however, do not believe that computing a standalone entity credit for each member of a consolidated group imposes a greater burden than computing a stand-alone entity credit for a corporation that is not a member of a consolidated group. Moreover, providing a rule for allocating the portion of the group credit allocated to a consolidated group among its members that is different than the method used for allocating the controlled group credit would create additional administrative complexity that seems unwarranted.
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Alternative Incremental Research Credit
Section 41(c)(4) provides an election to determine the research credit using the AIRC computation. Section 41(c)(4)(B) provides that the election to use the AIRC applies to all succeeding taxable years unless revoked with the consent of the Secretary. Many issues have arisen regarding how the AIRC election is made in the case of a consolidated group and in the case of a controlled group, all members of which are not included on a single consolidated federal income tax return. These issues include: (1) How is an AIRC election made by members of a controlled group for purposes of computing the group credit under section 41(f)(1); (2) what happens when a controlled group has made an AIRC election and a member leaves the group or a member that has not made an AIRC election enters the group; (3) what happens if a member that has made an AIRC election joins a controlled group that has not made an AIRC election; and (4) when will a request to revoke an AIRC election be granted.
Generally, the Treasury Department and the IRS assume that taxpayers will elect to use the AIRC method if the AIRC method provides more credit than the regular method, or if a taxpayer does not have the books and records necessary to compute the base amount under the regular method. Once a taxpayer elects the AIRC method, the Treasury Department and the IRS believe that the AIRC method will continue to be the better method in the future as well, unless the taxpayer has a substantial change in its trade or business, such as the acquisition or disposition of an entire trade or business. If such a substantial change occurs, the Treasury Department and the IRS believe that it is appropriate to allow the taxpayer to revoke its AIRC election. The IRS has received many requests for consent to revoke AIRC elections from taxpayers in such situations. To reduce the burden on taxpayers, provide simplification, and ease administrative burden, the Treasury Department and the IRS have determined that it is appropriate to grant automatic consent to revoke an AIRC election on a prospective basis in situations in which a taxpayer makes the revocation on an original return. The Treasury Department and the IRS do not believe, however, that allowing an AIRC election or revocation on an amended return furthers the goal of simplification and ease of administration.
Therefore, these temporary regulations provide that a taxpayer that has made an AIRC election is deemed to have requested and been granted consent to revoke the election if the taxpayer completes the portion of Form 6765, ‘‘Credit for Increasing Research Activities,’’ relating to the regular credit and attaches the completed form to the taxpayer’s timely filed original return for the year to which the revocation applies. This provision is similar to the provisions in the existing regulations for making an AIRC election, which require the taxpayer to complete the portion of Form 6765 relating to the AIRC and attach the completed form to the taxpayer’s timely filed original return for the year to which the election applies. Once an election/revocation is made for a taxable year, the taxpayer may not change the election/revocation on an amended return.
The temporary regulations provide special rules for controlled groups under section 41(f)(1) (in which one or more of the members do not join in filing a consolidated return). As discussed above, in this situation many questions have arisen regarding which members of a controlled group must make (or revoke) an AIRC election to have a valid election (or revocation) for the controlled group. Attempting to track elections across members of a controlled group, in which one or more of the members do not join in filing a consolidated return would create additional administrative complexity and increase the potential for controversy. Thus, to reduce the additional administrative complexity created by the additional computation, these temporary regulations provide that in the case of a controlled group, all the members of which are not included on a single consolidated return, the designated member must make (or revoke) an AIRC election on behalf of the members of the group. The election (or revocation) by the designated member is binding on all of the members of the group for the taxable year to which the election (or revocation) relates. The temporary regulations provide that the designated member is that member of the group that is allocated the greatest amount of the group credit. In the event the members of a group compute the group credit using different methods (either the regular method or the AIRC method) and at least two members of the group qualify as the designated member, the designated member is the member that computes the group credit using the method that yields the greater group credit. The Treasury Department and the IRS believe that these rules will simplify the election and revocation of the AIRC method. Furthermore, granting automatic consent to revoke an AIRC election also simplifies acquisitions and dispositions of members of controlled groups. For example, when a new member joins a group, the member must use the method used by the controlled group. In the taxable year after a member leaves a group, the member is free to use either method, assuming the member has not joined another controlled group. If all members of a controlled group are members of a single consolidated group, the AIRC election is made by the agent of the consolidated group, determined pursuant to the rules of § 1.1502–77.
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