Research Tax Credit : Statutory Construction, Regulatory Interpretation and Policy Incoherence

Authors

• David L. Cameron, Northwestern University School of Law

Abstract

Section 41 of the Internal Revenue Code establishes a research tax credit in connection with "qualified research expenses" and "basic research payments," frequently referred to as the incremental research credit and the basic research credit, respectively. The incremental research credit is equal to 20 percent of the qualified research expenses for the tax year in excess of a base amount, and the basic research credit is equal to 20 percent of any basic research payments in excess of a base amount. The purpose of the credit is to provide an incentive for increased research activities in the private sector.

The following pages describe the research tax credit in some detail. Part II describes the statutory requirements that constitute the definition of qualified research. This discussion outlines the significant difficulty that the Treasury Department and the Service have encountered in providing content to such statutory terms as "discovering information," "technological in nature," and "process of experimentation" under a number of versions of Proposed and final Regulations. Part III provides a discussion of the judicial and administrative efforts to provide content to the statutory framework in the absence of regulatory guidance. Although these judicial decisions are not controlling now that final Regulations defining qualified research expenditures for purposes of section 41 have been promulgated, they do provide an alternative interpretation of the statutory language that illuminates the substantive content of the Regulations themselves. Part IV considers the problems arising from the application of the "high threshold of innovation" requirement applicable to internal-use computer software. Because final Regulations concerning internal-use computer software have yet to be promulgated, judicial decisions provide the principal source of guidance in this area. Together, Parts II, III, and IV serve to illustrate the complex interrelationship of Congress, the Treasury Department and the Service, and the courts in the regulatory process.

Finally, Part V describes the calculation of the research tax credit, including the incremental research tax credit, the alternative incremental research tax credit, and the basic research tax credit. The changes that Congress has introduced in this regard illustrate the challenges that exist in designing a tax provision that provides taxpayers with an economic incentive to increase research and development expenditures over time. Unfortunately, the precise formulation of such a credit remains elusive as the effectiveness of the two methods that Congress has enacted to calculate the incremental research tax credit since its introduction in 1981 have been the subject of significant debate. Currently, taxpayers can elect between two methods of calculating the research tax credit, the incremental research tax credit and the alternative incremental research tax credit. Because of the different economic and technological circumstances confronting taxpayers in various industries, the provision of alternative methods of obtaining tax benefits may be the only feasible means of realizing the policy objectives underlying the research tax credit.

Recommended Citation

David L. Cameron, Research Tax Credit : Statutory Construction, Regulatory Interpretation and Policy Incoherence, 9 Computer L. Rev. & Tech. J. 63 (2004)