The R&D Tax Credit Aspects of Innovation in Maine



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        The local economy in Maine is undergoing a transformation that involves new technologies, innovation, and research and development.  Once known for ship building, paper making, and fishing, a new service economy that involves finance, healthcare, tourism, and education is beginning to emerge.  

        Since the financial crises of 2008, the finance industry has seen increasing pressure to adopt new technologies and more creative ways of delivering services.  In healthcare, the aging baby-boomer population is creating an unprecedented number of patients who need access to services.  

        Education is one of the main cornerstones of R&D nationwide and Maine is no exception, with several world class universities such as the University of Maine which typically spends over $177 million annually on R&D.
 
        Traditional sectors of the economy are innovating as well.  Maine still relies on shipbuilding for about 2% of its total economic output.  The General Dynamics shipyard in Bath is one of the few in the country capable of building large naval vessels, cruise ships, and deep-draft ocean going commercial ships.  In fishing, aquaculturalists are developing new ways of breeding, raising, and harvesting fish in order to meet the growing worldwide demand for healthy, lean proteins.

        The paper making industry is also innovating as environmental concerns have led to innovative recycling and reuse of paper.  Consolidations and mergers in the industry have resulted in some of the larger companies expanding their R&D operations.

        R&D however is not limited to large companies.   Maine has very few large companies that maintain headquarters in the state.  Portland and the surrounding areas rely on a strong business culture of small to mid-size, privately owned companies - a characteristic that many residents see as a competitive advantage.  These smaller organizations have unique interactions with each other and the local community that often results in creativity and innovation.  


The Federal R&D Tax Credit

        Enacted in 1981, the Federal Research and Development (R&D) Tax Credit allows a credit of up to 13 percent of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:

  • New or improved products, processes, or software
  • Technological in nature
  • Elimination of uncertainty
  • Process of experimentation

        Eligible costs include employee wages, cost of supplies, cost of testing, contract research expenses, and costs associated with developing a patent.  On December 19, 2014 President Obama signed the bill extending the R&D Tax Credit for the 2014 tax year. As of this writing, proposed tax extender legislation would extend the tax credit through December 31, 2016.


Maine Research & Development Tax Credit

        The Maine R&D state credit is based on a percentage of the federal R&D Tax Credit for Increasing Research Activities.  The credit is limited to 5% of the excess qualified research expenses (QREs) over the previous three-year average plus 7.5% of the basic research payments under IRC § 41(e)(1)(A). The credit is further limited to 100% of the first $25,000 in tax liability plus 75% of the tax liability in excess of $25,000. Additionally, the credit cannot be carried back, however, it can be carried forward for up to 15 years.


Healthcare

        Roughly 8 percent of Maine’s population works in the healthcare and social assistance industry.  Jobs in this industry include everything from doctors to patient transporters. It’s been among the state’s fastest growing sectors in the past 10 years and has led to more healthcare workers per capita than the national average, according to a state labor report. .

        The Agency for Healthcare Research and Quality (AHRQ) cited Maine as the state having made the most progress in improving the overall quality of health care in 2010.  In addition, the most recent AHRQ State Snapshots showed Maine ranking third in the country for highest ranking in overall health care performance.

        Broadly speaking, healthcare innovations in Maine involve reducing costs, improving health, and improving the patient experience.  These include everything from pharmaceutical and medicinal developments to bioengineering and life sciences innovations.  Even robotics companies are contributing to the efforts with non-invasive surgical machines, prosthetic limbs that can function like real ones, and humanoids (robots that look like humans) that may soon work alongside humans to care for the increasing elderly population.   


Construction

        Construction in Maine has started to bounce back from the recession with increasing opportunities for new workers.  Roughly 4 percent of the state’s population works in some form of construction.  According to the National Association of Home Builders, Maine has issued more building permits in 2014 than in 2013, which suggests that construction activity is on the rise.  

        Cutting edge construction projects often involve eligible research and development expenses. Many new facilities contain state-of-the-art heating and lighting systems.  Sometimes designers and engineers use innovative approaches to lower energy costs and meet sustainability standards in green buildings.  Other times, the natural landscape which serves as a foundation for the building is not quite suitable for construction.  In this case, innovative designs are created that involve technical challenges.  


Manufacturing

        Manufacturing is the largest sector in the state's economy.  Maine is a leading producer of paper and wood products in addition to food production and transportation equipment.  The principle recipients of the R&D credit nationwide are manufacturing companies.  In this industry, success is usually dependent on either product development or a more efficient method of production.  Both the product and process development are R&D tax credit eligible activities.


Agriculture

        Maine’s leading agricultural products include seafood, poultry and eggs, dairy products, cattle, blueberries, apples and maple sugar. Despite conventional thinking the agriculture/farming industry is quite innovative.   Farmers in Maine, as well as around the country, are incorporating innovative new techniques to combat issues of fertilizing and pesticides; using robots and state-of-the-art machinery to assist with planting and harvesting; and integrating drones and sensors to monitor soil and crop conditions.  


Ship Building

        Ship building in Maine is an ancient industry.  It began in 1607 at Popham Beach when a group of Englishmen built an ocean going vessel named Virginia for the Queen of England and has continued in various forms ever since. Today, the ‘Pine Tree State’ is still home to some of the nation’s largest ship manufacturers.  Bath Iron Works in Bath and Portsmouth Naval Yard in Kittery overhaul, repair, and modernize U.S. Navy ships and submarines.  

        Although an ancient industry, shipbuilding is also an innovative one.  Government and commercial ship building contracts typically contain precise specifications for manufacturers.  Many of these specifications require technical solutions that involve innovative problem solving.  In a recent R&D Tax Credit case, the U.S. District Court’s Northern District of Texas allowed the entire cost of certain ships to qualify as an R&D expense for purposes of the R&D Tax Credit because the shipbuilder, Trinity Industries Inc., had entered into a fixed-price contract with the government to deliver a first in class ship (essentially a prototype).  

        The IRS basically argued that because the ships were special order, rather than sold out of inventory, they would not be qualifying R&D expenses. The government, however, cited no authority for that proposition and the court saw the argument as unpersuasive.

        Conversely, the court saw the nature of the contracts to contain inherent financial risk because there was a possibility that technological solutions could eventually prove unfeasible.  When technical uncertainty is present, there is often a good opportunity for the R&D tax credit even if the research is performed in pursuit of a contract with a third party.  This was the major positive take away from the case and the same principle applies throughout all industries.  

        In addition, the court also elaborated on the correct treatment of integrating subassemblies into a ship when those subassemblies themselves were not particularly innovative.  The government suggested that this process was nothing more than ordering off a menu: pick a hull from column A, a propulsion system from column B, an HVAC from column C, etc.   The court found that this greatly oversimplified the process and rejected the argument.  Justice Godbey elaborated:


“First, many of the systems at issue are not monolithic entities, but rather families of products with considerable flexibility in their configuration. Determining which configuration out of the universe available can in particular cases itself involve a significant research effort.

Second, the systems do not exist in a vacuum. They interact with each other, sometimes in complex and non-intuitive ways. A change in electronics may require a change in power generation and distribution, which may require a change in the engine plant, any one of which may affect the weight distribution and performance of the vessel as a whole.

The government, on the other hand, insists that Trinity must break out every expense and determine whether it is a QRE; for example, the government criticized Trinity for claiming the cost of painting a first in class, pointing out that painting a ship was not experimental.

The Court conceptually agrees with Trinity. If a first in class ship is sufficiently experimental, the risk of failure attaches to the entire project. The potential loss includes not just the experimental aspects, but also the paint. The regulations support this view.”


Fishing

        As the world population continues to increase and consumers become more health conscious about their dietary choices, the demand for lean proteins continues to increase.  Aquaculturalists in Maine typically raise everything from Atlantic salmon and Rainbow trout to oysters, mussels and sand worms.  The aquaculture industry in Maine is particularly innovative.  Common challenges involve genetics and breeding, innovative fish nets, antibiotics, feeding systems, and low-environmental impact production processes.  


Maine Center for Creativity

        The Maine Center for Creativity is a group of organizations and professionals that work together to energize the state’s economy through creativity and innovation.  The mission of the organization is to forge alliances between arts and industry that make Maine economically vital and culturally vibrant, as a place where innovation and creativity thrive .  It is part of an emerging global trend to foster collaboration among innovators.  

        Other economies have similar agendas.   Most of them involve bringing innovations born in academia to the commercial market.  Since academic scientists and engineers conduct a large part of the nation’s basic research, it is important that they be connected to entrepreneurs who can bring their ideas to life.  It is equally important that commercial innovators be aware of the resources that academia has to offer.  The University of Maine, for example, has a vast array of databases, offices, centers, and institutes that are accessible not only to academics but commercial users as well.  


Conclusion

        The local economy in Maine is undergoing a transformation that involves new technologies, innovation and research and development.  Federal and state R&D Tax Credits are available to help support and stimulate these Maine innovations.

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