The R&D Tax Credit and Dynamic Scoring
Dynamic-Scoring
Dynamic scoring is a process whereby
legislative policy makers attempt to predict and quantify the
overall economic impact that a particular tax provision will
have on the economy. With the tax reform discussions
commencing in the year 2015, it is clear that dynamic scoring
is going to part of the dialogue with all major tax
provisions.
The Federal R&D tax credit is one of the largest tax
expenditure items so it will inevitably be subject to a
dynamic scoring evaluation.
The Research &
Development Tax Credit
Enacted in 1981, the federal Research and
Development (R&D) Tax Credit allows a credit of up to 13%
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 Elimination
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.
The Credit Has Always
Been Temporary
Although the credit was enacted in 1981 and
has enjoyed Bipartisan support it has always been a short term
temporary credit that has had to go through over 15 separate
legislative extensions. The challenge with a
temporary credit is that chief financial officers, financial
analysts, and entrepreneurs cannot utilize the credit for long
term project capital expenditure approvals either internally
or with lenders including banks. Simply stated, a
permanent R&D tax credit would enable more innovative
projects to meet hurdle rates and get approved and
financed.
U.S. State and
International Tax Credit Regimes
State R&D
Tax Credits
Over 30 states have accompanying state R&D tax credits
that often utilize the federal R&D tax credit definitions.
Some of the state tax credits are refundable, so essentially
they serve as state provided venture capital funds. The
country’s three largest states by population namely
California, Florida and Texas all have state R&D tax
credits.
International Tax
Credits
Over 30 countries now have R&D tax credits. The U.S.
is a laggard with a 2008 OECD study of global R&D tax
incentives ranking the U.S. 24th among major developed nations
offering an R&D tax incentive. Some non U.S.
jurisdictions also provide refundable R&D tax credits.
Developed Body of Tax
Case Law
Since 1981 a rich
body of tax case law provides much more clarity regarding the
process a taxpayer can take for securing an R&D credit.
Recent cases have been favorable for:
- CEO innovators
- Software
- Large Assembled Innovative
products
R&D Tax Credit
Dynamic Scoring Empirical Studies
There have been over ten academic empirical
studies regarding the economic impact of R&D tax credits,
with most recent tax return year studies concluding that the
credit induces at least $1.00 and perhaps $2.00 to $3.00 in
additional U.S. R&D spending per incremental dollar of
credit.
What the Critics Have
to Say
There are of course critics of the R&D
tax credit. The critics will often arbitrarily select a
technology sector that they don't feel should be credit
eligible.
Food processors are examples of an industry of critics who
complain about the credit, despite the fact that obesity and
diabetes are recognized as one of the country’s great health
challenges. Others have challenged retail food automation even
though food retailers represent one of America's largest
international businesses and largest employers. Some have even
challenged packaging innovation despite that new products
require new packaging; and much of today's packing innovation
involves sustainable packaging that is often recyclable,
safer, and uses less materials and water.
The bottom line is that a broad based technology incentive
can't itself be an arbitrator of winning and losing
technology.
The United States as
an Innovation Nation
Since the great recession the United States
economy has shifted from an overweight in financial services
to more of a technology based economy. K-12 schools and
universities are making large investments in STEM (Science,
Technology, Engineering, and Math) based curriculum so that
America is prepared for the future. The federal tax system
should support a culture of innovation. American businesses,
America’s education system as the tax system needs to be in
lockstep with the common goals of an innovation nation.
The R&D Tax Credit
Dynamic Scoring Results
The R&D tax credit achieves high
dynamic scoring results. A 2011 Ernst and Young report
found that the R&D credit provides significant
contributions to the U.S. economy in terms of additional
private research spending, employment, and wages at both
national and state level.
