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:: Credit for Increasing Research Activites - The Consistency
Requirement
6. THE
CONSISTENCY REQUIREMENT
Section
41(c)(5)(A) provides that the
QREs and gross receipts taken
into account in computing the
fixed base percentage must be
determined on a basis which is
consistent with the
determination of qualified
research expenses for the credit
year, regardless of whether the
period for filing a claim for
credit or refund has expired for
any taxable year that is taken
into account in determining the
fixed base percentage. To
satisfy this consistency
requirement, the taxpayer must
show consistency between the
QREs in the credit year and its
QREs during the base years, as
well as consistency between
gross receipts in the base years
and the prior four years’
average. Thus, if an expense is
not qualified in the current
credit year, it must be removed
from the base year expenses,
without regard to the law in
effect during the base years.
The consistency
rule is designed to insure that
there is an accurate
determination of the relative
increase in qualified research
expenses over the amount
“typically” spent by the
taxpayer relative to its gross
receipts. The increase will be
accurately measured only if the
taxpayer includes the same type
of expenses in the credit
computation for both the base
years and the credit year. This
rule would apply, for example,
where the taxpayer has failed to
include a particular type of
expense in both the base years
and credit year computations,
thus distorting the true
increase in qualified research
expenses. 14
If a taxpayer
claims a certain type of expense
is a QRE in the credit year that
it never previously treated as a
QRE, it must adjust its fixed
base percentage to reflect
similar expenses that were paid
or incurred during the base
years. The research credit is
an incremental credit and, thus,
the taxpayer must prove that
there has been an increase
qualified research expenses
relative to the base period. It
is imperative that taxpayer
establish its base year
expenses. Taxpayers may not
rely upon extrapolation of
recent years’ data as their
support for the fixed-base
percentage computation. Thus,
base year records should be
analyzed to determine the proper
amount of expenses. Since you
are examining an open credit
year, which requires
consideration of the earlier
years, the statute of
limitations for the earlier
years is not controlling.
Consider the
following questions with respect
to the consistency requirement:
-
Is the
fixed-base percentage
(the ratio of 84-88
QREs to gross receipts)
in the base years
substantially lower than
current research
ratios? If so, why?
-
Do past
annual reports or 10Ks
support the reported
base years’ QREs?
-
If the
research credit was
claimed in prior years,
were the same base
years’ attributes used?
If not, why not?
-
Was
there a prior research
credit examination? Did
it cover one or more of
the base years?
Exercise
judgment (risk analysis) in
examining base years’
information. For example, if
the taxpayer’s base amount is
subject to the “50 percent
limitation” rule, an upward
adjustment in the base years’
research percentage (the fixed
base percentage) might have
little or no effect on audit
results.
14
For example, in a case decided
under the prior "rolling base
period" rules, Research,
Inc. v. United States,
95-1 USTC ¶ 50,407 (D. Minn.
1995), the taxpayer was denied
the research credit because it
could not quantify the base
period research expenses
attributable to its "special
system projects." The expenses
associated with these special
projects were included in the
credit year and the taxpayer
admitted that it incurred the
same type of expenses in the
base period. The taxpayer could
not, however, determine the
amount it incurred in the base
period because it had destroyed
the relevant documentation. The
court disallowed the credit
because the relative increase in
qualified research expenses
could not be measured without
considering the expenses
incurred during the base period
for the same type of projects
included in the credit year.
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