The R&D Tax Credit Aspects of Blockchain for Supply Chains



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Blockchain-Supply-Chains  
        Blockchain has emerged as a digitized, decentralized, public ledger that allows market participants to monitor cryptocurrency transactions. Created as the accounting method for the virtual currency Bitcoin, it has been considered one of the most revolutionary inventions since the Internet itself. With a range of potential applications that go way beyond the financial sector, this innovative technology promises to make it easier and safer to conduct business, potentially generating major efficiency gains. This is especially true for complex and intricate operations, such as those that integrate the modern supply chain.

        The present article will discuss how distributed ledger technology can fundamentally change supply chain management, helping companies from various industries enhance efficiency and respond to ever more intense demands for transparency. It will also present the R&D tax credit opportunity available to support companies engaged in deploying blockchain technology to create innovative supply chain management solutions.

The Research & Development Tax Credit

        Enacted in 1981, the now permanent Federal Research and Development (R&D) Tax Credit allows a credit that typically ranges from 4%-7% of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:

  • Must be technological in nature
  • Must be a component of the taxpayers business
  • Must represent R&D in the experimental sense and generally includes all such costs related to the development or improvement of a product or process
  • Must eliminate uncertainty through a process of experimentation that considers one or more alternatives

        Eligible costs include U.S. employee wages, cost of supplies consumed in the R&D process, cost of pre-production testing, U.S. contract research expenses, and certain costs associated with developing a patent.

        On December 18, 2015, President Obama signed the PATH Act, making the R&D Tax Credit permanent. Beginning in 2016, the R&D credit can be used to offset Alternative Minimum tax for companies with revenue below $50MM and for the first time, pre-profitable and pre-revenue startup businesses can obtain up to $250,000 per year in payroll taxes and cash rebates.

Understanding Blockchain Technology

        Blockchain is a type of distributed ledger technology (DLT). It represents a new approach to database structuring that uses independent nodes to record, distribute, and synchronize transactions in their electronic ledgers instead of keeping information centralized.  This groundbreaking record-keeping mechanism creates a database in which “blocks” of organized data are connected to one another, as links in a chronological chain. By recording and adding blocks, it generates a permanent and incorruptible information trail. While users are allowed to access, inspect, and add data, they cannot alter or delete information. In other words, blockchain technology creates a database of indelible and immutable records whose authenticity can be verified by the entire community of users instead of just one centralized authority, as it is the case for most conventional ledgers.

        Blockchains can be public, public permissioned, or private. IBM’s Blockchain blog highlights that all of them are peer-to-peer, append-only ledgers of digitally signed transactions. They all offer guarantees of immutability and give participants access to replicas of the data, which are synced through consensus mechanisms. However, there are important differences regarding who is allowed to participate in each type of network. While a public blockchain, such as Bitcoin, for instance, is completely open, public-permissioned and private networks implement certain restrictions to participation, which often require invitation or validation through a set of rules.  

        Blockchain could revolutionize accounting and payment networks considerably by simplifying operations. It can generate major cost savings due to lower maintenance costs and reduced labor needs as well as fewer errors and delays commonly associated with the reconciliation of records and the implementation of international transactions. Additional benefits include enhanced transparency and ease of auditing, which could also reduce compliance costs. According to a recent Goldman Sachs report, blockchain could help capital markets save as much as $6 billion a year in reduced personnel and IT improvements.

        Though originally designed as an accounting method for the virtual currency Bitcoin, blockchain can be utilized to record, monitor, and verify transactions of virtually anything. Beyond the financial sector, blockchain is an interesting alternative to face various challenges related to both security and efficiency of operations. Potential applications include insurance, the Internet of Things, voting systems, medical records, weapon or vehicle registration systems, among many others. 

        DLT could enhance security, flexibility, and efficiency of a very diverse range of operations. The diversity of potential applications points to a considerable expansion in the near future. According to Accenture’s projections, the blockchain services market should experience a compound annual growth rate of more than 60 per cent, amounting to around $7 billion in 2021.

        Implementing blockchain technology remains, however, a complex task. Besides requiring significant computation power, it demands advanced front and back-end programming and custom software design in order to guarantee seamless interaction between DLT and other operational processes. There is no “one-size-fits-all” solution – optimized integration requires careful consideration of existing infrastructure as well as an examination of all partners involved. It is also necessary to deal with a considerable lack of understanding of what blockchain technology is. To this end, the creation of effective communication strategies and innovative user interfacing tools are key to successful initiatives.

        Despite these challenges, a growing number of companies across various industries are engaged in research and development initiatives aimed at harnessing the disruptive potential of blockchain technology. These innovative companies should take advantage of the R&D tax credit opportunity available to support their efforts.

Blockchain and the Supply Chain

        With ever more globalized production processes and transactions, supply chain management has reached unprecedented complexity. It includes a growing number of individuals and entities, as well as various production and distribution stages throughout several geographical locations. It also generates a complicated web of paperwork through extended periods of time, requiring a continuous exchange of information different stakeholders and their respective record-keeping methods.

        In this scenario, it has become clear that traditional supply chain management solutions lack transparency and efficiency in dealing with all the aspects of producing and distributing goods. In order to remain competitive, companies need more agile supply chains capable of quickly responding to changing needs and demands. Through a decentralized approach to data management and sharing, blockchain technology emerges as a promising alternative.

        This groundbreaking approach offers a shared ledger that is updated and validated in real time, giving supply chain participants visibility of events as well as access to information on asset location, custody, and condition at any point. Data visibility is paired with the immutability of records, which creates an incorruptible database of product history, from production to sale. In addition, comprehensive supply chain data allows for significant process optimization along with better demand management based on real-time insights.

        Supply Chain 247 lists five key tasks that can benefit from blockchain technology, namely: i) recording the quantity and transfer of assets as they move through the supply chain; ii) tracking trade-related documents, such as purchase orders, change orders, receipts, and shipment notifications; iii) assigning or verifying certifications or certain properties of physical products; iv) linking physical goods to serial numbers, bar codes, digital tags like RFID, etc.; v) sharing information about manufacturing processes, assembly, delivery, and maintenance of products with suppliers and vendors.

        A recent article by the Boston Consulting Group and the MIT Digital Currency Initiative points out that blockchain technology is “uniquely able to resolve important issues of trust and visibility in far-flung, increasingly fluid manufacturing and supply networks”. It presents different ways by which DLT can improve efficiency and transparency of supply chain management activities, among which:

  • Time-stamping, tracking, and automating transactions, thus ensuring that events can be audited in real time;
  • Minimizing third-party involvement, including bankers, insurers, and brokers;
  • Implementing self-executing contracts that automate repetitive tasks, such as billing and shipping;
  • Creating proof of quality, provenance, payment, and performance as means to prevent counterfeiting and fraud;
  • Assigning digital IDs that make it easier, faster, and cheaper to onboard new vendors and partners.

        Other potential advantages include enhanced transparency, better visibility into procurement, reduced risks related to fraud and human errors, improved inventory management, lower courier costs, reduced delays due to paperwork, faster problem identification, and increased trust all around.

        There is growing demand for transparency in the supply chain, particularly when it comes to proving the origin of products. Consumers are increasingly aware of potential biases that arise from opaque supply chains and selective information disclosure. Blockchain technology is uniquely equipped to overcome these biases and foster trust through more reliable and comprehensive access to information. As assets move through the supply chain, unalterable records are generated containing every event they went through and everyone involved. This game-changing capability automates product tracking and traceability across multiple supply chain tiers.  Not only does it favor consumer trust, but it also facilitates the detection of counterfeits and resolves issues of provenance, such as those surrounding conflict minerals.

        A recent study by Accenture underlines that blockchain can end the “hall-of-mirrors” effect that haunts ever more intricate supply chains. The report points to the inefficiencies of having copies of documents and transactions flowing across a multitude of partners, which not only generates desynchronization but also makes it very difficult to control the veracity of information. This myriad of “copies of copies” favors errors and duplicity - the study conservatively estimates that 10 percent of freight invoices in high-volume shipping companies are problematic. Distributed ledger technology promises to solve many of these inefficiencies, by storing all transactions in a tamper-proof platform. The “hall of mirrors” of paperwork is replaced by a simple trail of verified transactions. 

        Global innovation blockchain leader at EY Paul Brody expands this idea by highlighting the benefits of blockchain-based digital contracts and their potential to considerably reduce the time between completing a task or delivering a product and being paid for it. This “analog gap” is a widespread, expensive problem that could be solved by DLT. In blockchain’s event-driven, smart contracts each term and condition is a line of code with self-executing capabilities. For instance, payable-upon-receipt smart clauses would integrate delivery and payment, creating a seamless and automated flow across supply chain participants, logistics partners, and financial institutions.  Similarly, codified rules specifically designed for each blockchain network can automate trade-related documentation and inventory management tasks, generating major efficiency gains.

Blockchain and the IoT

        Internet of Things (IoT) capabilities can be strategically applied to bridge the physical and the digital world, especially when it comes to feeding reliable supply chain information into the blockchain. A recent report by Deloitte underlines that the integration of IoT and blockchain technologies promises to transform the way different stakeholders in a supply chain “capture, communicate, and access information on a secure, shared, and transparent platform”.

        IoT capabilities can enhance automation and precision within the blockchain network, making sure data is directly linked to materials and products throughout the entire supply chain. In other words, the combination of IoT and blockchain makes sure there is an accurate, unbiased connection between data and materials even as they are transformed, shipped, and processed by numerous stakeholders.

        Sensors, electronic and RFID seals, tags, and DNA identification can be used to collect data and monitor objects as they move through the supply chain.  Concurrently, blockchain technology enables the authentication of collected data and creates a transparent, standardized, and streamlined platform accessible to all interested parties.

Industry Applications

        Applying blockchain technology to supply chain management can be particularly beneficial for certain industries in which access to provenance and quality information is critical. The following sections present examples of pioneering applications in the manufacturing, life sciences and pharmaceuticals, food and beverage, and defense industries.

Food and Beverage Industry
        Supply chain visibility and accountability are particularly important for food and beverage companies, as they strive to maintain rigid food safety standards, such as those established by the Food Safety Modernization Act (FSMA).  Ever more sophisticated and globalized supply chains make it extremely difficult for producers and retailers to guarantee product provenance. In fact, the complexity of food safety concerns has reached unprecedented levels, with FDA regulated products coming into the U.S. from over 300 thousand facilities in 150 different countries.   Moreover, a growing number of consumers require reassurances of quality and proof of claims such as “healthy” and “organic”.

        DLT ensures transparency from farm to table, facilitating the identification of contamination sources and enabling faster and more effective recall strategies. It promises to enable full digital traceability and authentication of food and beverage products, from suppliers to retailers and even consumers. Reduced wastage, lower operational costs, and greater consumer trust are other potential benefits.

        In 2017, IBM partnered with major consumer packaged goods and food companies to apply blockchain to the food supply chain. The consortium assembles major industry names, such as Walmart, Nestle, Unilever, and Tyson, representing more than half a trillion dollars in annual sales. The goals are to improve food safety and ingredient transparency.

        Powered by the IBM Blockchain Platform, IBM Food Trust aims to enhance visibility and accountability in the supply chain by creating a network of growers, processors, wholesalers, distributors, manufacturers, and retailers. By unifying supply chain data, the network fosters consistency and creates a clear audit trail in cases of tampering or contamination.

        Walmart has been a pioneer in integrating blockchain into its food supply chain. In 2016, the retailer has initiated a pilot program with IBM, which focused on shipments of pork from China. The initiative was considered a success that reduced the time it took to access a product’s tracking information from nearly a week to a matter of seconds. 

        A growing number of food-focused blockchain startups are setting the pace for the development and implementation of supply chain solutions. Examples include UK’s Provenance, with over 200 food businesses, as well as San Francisco, California-based Arc-Net, which focuses on food fraud, and ripe.io, which combines blockchain and the IoT to enable transparency from farm to fork.

Life Sciences and Pharmaceuticals
        Blockchain technology allows life sciences and pharmaceuticals companies to monitor drugs from development to healthcare providers and dispensaries, giving access to real-time information on drugs’ status and location. The technology also facilitates compliance with growingly strict regulations, including the European Union’s Falsified Medicines Directive, which requires serialization of drug products for track-and-trace by February 2019 and the US Drug Supply Chain Security Act from 2013, which gives the industry until 2023 to institute full, unit-level track-and-trace systems.

        As the number and range of innovative therapies rise, the supply chain needs to keep up with life sciences advancements. Efficient and trust-worthy mechanisms are key to ensuring that the breakthroughs of medicine reach patients in a secure, timely, and appropriate way. Blockchain technology gives full visibility into crucial information such as the provenance of materials and how the product was handled throughout the supply chain (including storage and transportation conditions, which can be crucial for specialty, cold chain logistics).

        DLT promises to help life sciences and pharmaceutical companies overcome inefficiencies and avoid the risks that arise from exchanging information across diverse record-keeping ecosystems. Permissioned blockchain platforms can be strategically used to increase speed and foster trust within life sciences supply chains, making sure data can be shared while allowing for restrictive access to sensitive commercial information. Besides, product traceability can directly benefit patients, considerably reducing complications in cases of recall.

        Blockchain technology also reduces the risks of counterfeits, which are a significant threat to public health. According to the World Health Organization, the sale of counterfeit drugs reached $75 billion in 2010. Leading global logistics company DHL and Accenture have developed a blockchain-based serialization prototype to monitor pharmaceuticals across the supply chain. Lab-simulations have indicated that the technology could process over seven billion serial numbers and 1,500 transactions per second. Keith Turner, CIO at DHL Supply Chain points out that “by utilizing the inherent irrefutability within blockchain technologies, we can make great strides in highlighting tampering, reducing the risk of counterfeits and actually saving lives.”  

        Headquartered in Redwood City, California, Cryptowerk provides industry-specific, blockchain-based solutions targeted at pharmaceutical companies. By creating an unalterable, tamperproof record of key events and data throughout the supply chain, Cryptowerk enables pharma companies to detect when counterfeit or inferior drugs enter the supply chain and prevent those components from ever making it to the retail shelf, ultimately saving money and lives.

Manufacturing
        DLT ensures real-time visibility into the availability, location, and condition of supplies thus facilitating just-in-time planning and inventory management tasks. Manufacturing companies can utilize blockchain technology as a means to improve quality control, reduce wastage, and prevent counterfeiting of parts and materials.

        Located in Loveland, Ohio, Supply Dynamics utilizes a combination of advanced technologies to create a digital thread across the distributed manufacturing supply chain. The SDX Multi-Enterprise Platform provides manufacturers end-to-end visibility and control over the raw materials and off-the-shelf components that flow into their outsourced assemblies and parts. It facilitates collaboration with sub-tier suppliers, enabling manufacturers to monitor, influence, validate, and control raw material cost and compliance at all tiers of supply. Supply Dynamics CEO Trevor Stansbury predicts that “in our lifetimes we will see the frictionless, closed loop, end-to-end supply chain become a reality and blockchain will play an important role in that, especially when paired with machine learning, natural language processing (NLP), additive manufacturing and other IoT devices. It’s an exciting time to be in manufacturing.
 
        Founded in 2016, Sky Republic offers a private blockchain platform built from the ground up to synchronize manufacturing businesses at scale. Headquartered in Scottsdale, Arizona, the company combines the power of blockchain, smart contracts, enterprise middleware, and cloud approaches to offer workflow automation and visibility, real-time transaction settlement and compliance, digital asset management, as well as interoperability and data sharing. The Sky Platform enables continuous, real-time access to supply chain events, allowing companies to accurately predict when and in which conditions goods will arrive. Furthermore, traceability ensures that manufacturers know the detailed history of each material, making sure, for instance, that the metal they receive contains the right mixture of alloys.

Military
        Mission-critical companies within the military and defense industry can greatly benefit from DLT solutions, particularly as it simplifies compliance with rigid government protocols and facilitates product traceability. The National Defense Authorization Act for fiscal year 2018 included a provision ordering the Department of Defense (DoD) to conduct a comprehensive study of blockchain, particularly in relation to cybersecurity. Some pioneering applications include the use of DLT to deliver secure messaging to deployed troops and for protecting the digital 3D printing supply chain for ships at sea or units in the field.

        Estimated at nearly $100 billion, DoD’s inventory relies on the purchase of parts from a global web of sub-suppliers. Tracking and managing this multi-tier, sophisticated supply chain is a highly complex task with potentially serious implications to the safety of troops and missions. Counterfeit parts and inferior components, for instance, can compromise system performance, often requiring costly and time-consuming fixes.

        Even though there are concerns regarding potential security breaches and DoD’s sensitivity to offshore data, it is clear that blockchain technology could simplify supply chain management and enable more effective anti-counterfeit measures. Some companies within the military industry are already experimenting with blockchain. Lockheed Martin has been among the first US defense contractors to incorporate blockchain technology for supply chain risk management and other developmental processes. Working with Virginia-based GuardTime Federal, the global security and aerospace company aims to create more efficient and assured offerings to the federal government, leveraging blockchain to address ever more present cyber-focused threats.

        Similarly, worldwide designer, manufacturer, and integrator of precision control components and systems for high-performance military aircraft and missiles, Moog Inc. has partnered with the National Center for Manufacturing Sciences to explore and develop capabilities for a smart digital supply chain. The collaboration aims to apply Moog’s blockchain-enabled VeriPart® solution to additive manufacturing, while allowing DoD to assess blockchain adaptability to mission-critical supply chain processes, particularly in creating a digital thread for 3D printed components. 

Challenges Ahead

        Despite the major potential benefits it represents, blockchain-based supply chain solutions are still in their early days. Whether it will be successfully implemented on a large scale remains an open question that will require extensive research and experimentation, particularly when it comes to six practical concerns, as pointed out by a Supply Dynamics’ white paper: 

I.    Difficulties in dealing with material goods versus immaterial;
II.    The complexity of the goods (necessecity of inspections and verification, value-added changes, etc.);
III.    Numbers of tiers of supply;
IV.    Difficulties in dealing with unstructured data;
V.    Uncertainty as to the advantages and disadvantages of open versus closed blockchain networks (considering the specific needs of different business operations); and,
VI.    The issue of compatibility with existing tools.

        Even though early adopters may have to face these challenges, they are likely to be rewarded by getting a head start in what promises to be a revolutionary technology. This can be especially true if they take advantage of R&D tax credits to increase their chances of success in overcoming these obstacles.

Conclusion

        Though initially developed to monitor digital transactions, the blockchain is making its way into the world of tangible goods. There is growing indication that distributed ledger technology could be at the basis of wide-ranging innovation within the supply chain. With major potential gains in efficiency, transparency, and security, blockchain technology promises to fundamentally change supply chain management applications especially in highly competitive and strictly regulated industries, such as food and beverage, life sciences, and defense. Paired with IoT capabilities, DLT has the potential to enable a truly smart supply chain that bridges the physical and the digital worlds. As with any nascent technology, however, developing and implementing blockchain supply chain solutions require extensive research and experimentation. Companies engaged in such activities can benefit from R&D tax credits as they step into a new era of smart and secure supply chains.

Article Citation List

   


Authors

Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.

Andressa Bonafé is a Tax Analyst with R&D Tax Savers.


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