TD 9296 – Summary of Comments and Explanation of Provisions
Allocation of the Group Credit
The 2005 regulations required that the group credit that did not exceed the sum of the stand-alone entity credits of all the members of the group be allocated among the members of a controlled group in proportion to the relative amounts of each individual member’s stand-alone entity credit, computed for each member using the method that would have yielded the largest standalone entity credit for that member. Any excess of the group credit over the sum of the stand-alone entity credits of all the members of the group was allocated among all the members of the group based on the ratio of an individual member’s qualified research expenditures (QREs) to the sum of all the members’ QREs.
Although commentators generally agreed that the 2005 regulations fixed the anomalous results (for example, none of the group credit would be allocated to the members of the controlled group if no member had stand-alone entity credits) created by the method in the 2003 proposed regulations, some commentators continued to disagree with the standalone entity credit method. Commentators again suggested that the members of a controlled group should be permitted to use any reasonable method to allocate the group credit as long as the group’s members collectively do not claim more than 100 percent of the group credit, or that if one method must be prescribed for all situations, a method that allocates the group credit based on the relative amounts of each member’s total QREs (gross QREs method) is more appropriate than any other method.
The Treasury Department and the IRS continue to believe that the allocation method under section 41(f) should be based on a group member’s QREs in excess of a base amount, and that the stand-alone entity credit method reflects the incremental nature of the credit. The Treasury Department and the IRS believe that the stand-alone entity credit method of the 2005 regulations is consistent with the purpose of section 41(f) and its underlying legislative history. Further, a single, prescribed method is necessary to ensure the group’s members collectively do not claim more than 100 percent of the group credit. For the reasons stated above and in the preamble to the 2005 regulations, the final regulations do not adopt the changes suggested by the commentators, and retain the allocation method contained in the 2005 regulations.
Special Allocation Rule for Consolidated Groups
The 2005 regulations provide that, for purposes of allocating the group credit among the members of a controlled group (first-tier allocation), a consolidated group (whose members are members of the controlled group) is treated as a single member of the controlled group, and a single standalone 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 (second-tier allocation) in proportion to the stand-alone entity credits of the members of the consolidated group. Under the 2005 regulations, this rule applied only to taxable years ending on or after May 24, 2005.
One commentator argued that the treatment of a consolidated group as a single member of a controlled group is contrary to the statutory language of sections 41(f)(5) and 1563. The Secretary is granted broad authority under section 1502 to provide rules regarding the determination of the tax liability of an affiliated group of corporations filing a consolidated return. The Treasury Department and the IRS believe that the treatment of a consolidated group as a single member of a controlled group of corporations for purposes of section 41(f) is within the broad authority of section 1502. Moreover, this treatment is consistent with the single entity treatment of a consolidated group under certain other provisions of the Code.
One commentator argued that treating a consolidated group as a single member of the controlled group adds unnecessary complexity and is administratively burdensome because it requires additional rounds of allocations of each consolidated group’s credit among its members and additional computations of each consolidated group member’s stand-alone entity credit. One commentator urged that, if the consolidated group rule is retained, then the final regulations should not provide specific rules for how the second-tier allocation is to be made.
The Treasury Department and the IRS continue to believe that computing a stand-alone entity credit for each member of a consolidated group does not impose a greater burden than computing a stand-alone entity credit for a corporation that is not a member of a consolidated group. The Treasury Department and the IRS also believe that specific allocation rules are necessary with respect to the second-tier allocation in order to prevent distortions and provide certainty concerning each consolidated group member’s share of the credit, for example, if a member ceases to be a member of the consolidated group or if a member’s share of credits becomes subject to section 383. Accordingly, the final regulations retain the rules contained in the 2005 regulations. The final regulations make clear, however, that the special allocation rule for consolidated groups applies prospectively only. Accordingly, the consolidated group rule contained in these final regulations applies only to taxable years ending on or after the date these final regulations are published in the Federal Register. For taxable years ending on or after May 24, 2005, and before the date these final regulations are published in the Federal Register, taxpayers must use the special allocation rule for consolidated groups contained in the 2005 regulations. However, taxpayers may choose to apply the rule retroactively to taxable years ending before May 24, 2005, provided that all the members of the controlled group treat the consolidated group as a single member of the controlled group.
One commentator stated that the 2005 regulations are unclear whether, for purposes of the second-tier allocation, each consolidated group member’s stand-alone entity credit is to be computed in the same manner as a controlled group member’s stand-alone entity credit is computed for purposes of a first-tier allocation (that is, using the method that would have yielded the largest stand-alone entity credit for that consolidated group member). The Treasury Department and the IRS believe that the final regulations are clear that this is the rule, as they provide that ‘‘the principles of paragraph (c)’’ (which contains the rule) apply for purposes of the second-tier allocation. In addition, this rule is illustrated in Example 3 of § 1.41–6(e).
Start-Up Companies
For purposes of computing the group credit, § 1.41–6T(b)(2) of the 2005 regulations treated a controlled group as a start-up company if 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 there were fewer than 3 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. One commentator suggested that the rule was not clear in a situation in which one member of the group has both gross receipts and QREs in a taxable year beginning before January 1, 1984. Although the Treasury Department and IRS believe that the temporary regulations are clear that the start-up rules do not apply if the group had QREs and gross receipts in a year beginning before January 1, 1984, no matter which member(s) of the group had the QREs and gross receipts, the final regulations clarify the start-up company rule of § 1.41–6(b)(2) to make it explicit.
Alternative Incremental Research Credit
Section 41(c)(4) provides an election to determine the research credit using the alternative incremental research credit (AIRC) computation. Section 41(c)(4)(B) provides that the election to use the AIRC method applies to all succeeding taxable years unless revoked with the consent of the Secretary. The 2005 regulations generally provide that elections (or revocations) of the AIRC method are made by completing the portion of Form 6765, ‘‘Credit for Increasing Research Activities,’’ relating to the AIRC method (in the case of an election of the AIRC method) or to the regular method (in the case of a revocation of the AIRC method), and attaching the completed form to the taxpayer’s timely filed original Federal income tax return for the year to which the election (or revocation) applies. Once an election (or revocation) is made for a taxable year, the taxpayer may not change the election (or revocation) on an amended return. The 2005 regulations provide that the provisions relating to AIRC elections and revocations apply to taxable years ending on or after May 24, 2005.
The 2005 regulations provide special rules for making (or revoking) an election for controlled groups under section 41(f)(1) (in which one or more of the members do not join in filing a consolidated return). In such cases, the designated member must make (or revoke) the AIRC election on behalf of the group’s members. The election (or revocation) by the designated member is binding on all the members of the group for the taxable year to which the election (or revocation) relates. The 2005 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. If all the members of a controlled group are members of a single consolidated group, the AIRC election (or revocation) is made by the agent of the consolidated group, determined pursuant to the rules of § 1.1502–77.
One commentator suggested that the language contained in § 1.41–8T(b)(4)(i) of the 2005 regulations be clarified to avoid any implication that additional requirements (other than completing the appropriate portion of Form 6765 and attaching the form to a timely filed original Federal income tax return) apply to a designated member seeking to elect (or revoke) the AIRC method. The final regulations clarify that a designated member must follow the same procedures for making (or revoking) an AIRC election that apply to other taxpayers.
A commentator also noted that the regulations do not address whether and how changes to a member’s research credit information after the original Federal income tax return is timely filed may affect its status as the designated member. The commentator suggested that the final regulations clarify what happens if the designated member at the time of filing subsequently is determined not to be the designated member. The Treasury Department and the IRS agree that clarification regarding this issue is needed. Accordingly, the final regulations are clarified to provide that the term designated member means the member of the group that is allocated the greatest amount of the group credit under paragraph (c) of § 1.41–6 based on the amount of credit reported on the original timely filed Federal income tax return.
A commentator questioned what happens if the designated member fails to timely file an original Federal income tax return. The Treasury Department and the IRS believe that the designated member must timely file a return in order for the group to elect (or revoke) the AIRC method. Accordingly, if the designated member fails to timely file for the current credit year (and thus, fails to elect (or revoke) the AIRC method for that year), then the method used by the group in the immediately preceding credit year remains the method in effect for the current credit year. The final regulations are amended to clarify this rule.
The commentator also suggested that the final regulations allow the members of a controlled group to decide which member of the group will be the designated member. The Treasury Department and the IRS believe that it is necessary to have a bright-line test, applicable to all controlled groups, to provide certainty as to the identity of the designated member, and that to allow the members of a controlled group to decide which member’s election (or revocation) will bind all the members of the group would not provide certainty n all situations. Accordingly, this comment has not been adopted.
Another commentator urged the Treasury Department and the IRS to allow taxpayers to elect the AIRC method on an amended return. Alternatively, the commentator argued that if taxpayers cannot elect the AIRC method on an amended return, the final regulations should provide a special rule under which a taxpayer’s research credit, computed by the taxpayer under the regular method, may not be adjusted on audit below the amount that would have been allowable under the AIRC method. The Treasury Department and the IRS believe that requiring an election to be made only on a timely filed original Federal income tax return is consistent with the statute and the doctrine of elections, and that the commentator’s suggestion would inappropriately limit the authority of the IRS to conduct examinations. Thus, these final regulations retain the rules as contained in the 2005 regulations.
Finally, a commentator suggested that, with respect to the AIRC provisions, the effective date for the 2005 regulations should not be limited to taxable years ending on or after May 24, 2005, but should apply as well to any taxable year ending before that date, provided that the original Federal income tax return for that year has not yet been filed. The Treasury Department and the IRS believe that making this option available retroactively to taxpayers that have not yet filed their returns would treat similarly situated taxpayers differently. For example, taxpayers that already had filed their returns would have been required to request permission for a revocation, while taxpayers that had not filed their returns would be eligible for the automatic revocation procedures set forth in the 2005 regulations. Thus, the Treasury Department and the IRS believe that it is appropriate to limit the application of this rule to prospective use only. The final regulations are effective for taxable years ending on or after the date these final regulations are published in the Federal Register. For taxable years ending on or after May 24, 2005, and before the date these final regulations are published in the Federal Register, taxpayers must use the rules contained in the 2005 regulations.
Other
Several commentators mentioned that the definition of trade or business in the 2005 regulations was changed from the prior regulations. The change in the 2005 regulations was inadvertent, and the definition has been returned to the language from the regulations existing prior to the issuance of the 2005 regulations. For taxable years prior to the effective date of these final regulations, taxpayers may rely upon the definition of trade or business in these final regulations.
Another commentator requested that the regulations provide guidance as to whether the section 280C(c) election is made member by member or by the entire controlled group. This issue is beyond the scope of these final regulations, as guidance would have to be provided under the authority of section 280C rather than section 41. The Treasury Department and the IRS may consider addressing this issue in separate guidance.
