The R&D Tax Aspects of Nutritional Science

        The pandemic of obesity and correlated illnesses, such as diabetes and cardiovascular diseases, has fueled a renewed interest in nutritional science as a means to promote healthier eating habits. Increasingly informed consumers are shifting preferences towards natural and functional foods, emerging markets that bring major economic opportunities. This article will discuss the most recent trends in nutritional research and present the tax credit opportunity available for innovative food companies.

        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 18, 2015, President Obama signed the bill making the R&D Tax Credit  permanent.  Beginning in 2016, the R&D credit can be used to offset Alternative Minimum tax and startup businesses can utilize the credit against payroll taxes.

        Several aspects contribute to the unprecedented relevance of nutritional research. An increase in the obese and overweight population has amplified health concerns, particularly when it comes to weight-related illnesses, such as heart disease, stroke, and diabetes.

        The average American male is now 194 pounds and the average female is now 165 pounds. Compared to weight levels from 1960, men are 28 pounds heavier on average, and women 24 pounds, while at the same time neither gender is more than an inch and a half taller.

        According to the Centers for Disease Control and Prevention, more than one-third (34.9 percent or 78.6 million) of U.S. adults are obese.  A 2012 study published in the Journal of Health Economics estimated the annual medical spending for an obese person to be $3,271, as opposed to $512 for the non-obese. At a national scale, this comes to $190 billion a year in additional medical spending as a result of obesity, or 20.6 percent of U.S. health care expenditures.  

        The accompanying map illustrates the prevalence of self-reported obesity among U.S. adults in 2013. Shockingly, no state has a prevalence of less than 20 percent.

        In response to the global pandemic of obesity and its consequent burden on public health budgets, governments have enabled tighter regulations for the food industry. These include food labeling requirements that help consumers make informed choices and maintain healthy dietary practices.

        Soon to be implemented, the Food and Drug Administration’s proposed Nutritional Facts label will require manufacturers to separately list added sugars and to make the amount of calories more prominent.

        In November 2014, more than 75 percent of voters in Berkley, California approved a special tax on sugary drinks, making it the first U.S. city to pass such a measure. The tax consists of a penny-per-ounce on sugar-sweetened beverages, such as soda, energy drinks, and juices.  This precedent is likely to create momentum for other cities to implement stricter regulations aimed at discouraging the consumption of unhealthy food and beverage.

        Nutritional science is key when responding to an increased pressure that comes not only from governmental regulations but also from ever more health-conscious consumers. The U.S. has experienced a shift in consumer attitude concerning the nutritional content of food and beverage and its relation to wellbeing.

        A recent survey by the nonprofit organization International Food Information Council revealed that 71 percent of consumers considered healthfulness a major determinant of how they bought food, a 10 percentage-point increase from the 61 percent registered in 2012.  
   
        Naturality and functionality are two major trends in the current food and beverage market. Nutritional and material sciences are the basis for innovative efforts aimed at creating new, healthier products and altering the structure of existing ones.

        The growing demand for “natural” food and beverage has become an overarching driver of innovation. As naturality becomes a basic consumer requirement, more and more companies engage in making their products as natural as possible.

        Though definitions vary, naturality is often related to being free from artificial colors, preservatives, or additives. It is also linked to having as few ingredients as possible. The transformative power of naturality is seen in the following trends:   

  
I. Organic and Gluten-Free: Recent studies have proven that organic crops and organic-crop-based foods contain higher concentrations of antioxidants than conventionally grown foods. Conventional crops also present greater concentrations of residual pesticides and the toxic metal cadmium.

        With an unprecedented demand and a growing presence among traditional grocers, organic brands have experienced major growth over the last few years. Organics are no longer the domain of trendy; they are, actually, everywhere.

        According to the latest United States Organic Food Market Forecast & Opportunities, the U.S. organic food market should experience a CAGR of 14 percent between 2013 and 2018.  The Nutritional Business Journal expected the sales of organic products to reach $35 billion in 2014, as shown in the accompanying chart.

        In 2014, organic products sold under Kroger’s store brand reached over $1 billion. Kroger has more than 35,000 products that are organic or natural, with about one-sixth of those added in the past year.

        Incorporating the nutritional and safety benefits of organic foods into their products is a major challenge for many companies. The surge in demand for organic food has fueled an increased interest in local or small-scale brands with strong focus on organics. Examples include General Mills’ $820 million acquisition of Annie’s, a California-based maker of natural and organic pastas, meals, and snacks. 

        Gluten-free is also one of the fastest-growing food categories. Market Research Company, Mintel, estimates the category will produce more than $15 billion in annual sales in 2016, a 48 percent growth from 2013.

        Over the past few years, gluten-free has gone from a celiac disease-targeted, niche product to mainstream. According to Nielsen, the portion of households reporting purchases of gluten-free food products hit 11 percent in 2013, rising from 5 percent from 2010.

        The value of gluten-free consumers cannot be overlooked – their average grocery basket amounts to around $100, while the one of a regular consumer is only $33. No wonder that a growing number of food companies are engaged in nutritional research aimed at expanding their lines of gluten-free products. The challenge is to offer the same taste, texture, and overall product performance of non gluten-free versions.

        According to Rebecca Thompson, a marketing manager at General Mills, when introducing gluten-free brownies, cookies, and cakes, Betty Crocker went through a highly experimentative process, which sometimes required doing a thousand different samples to get the right recipe.  

        Ongoing innovation efforts focus on enhancing the quality of gluten-free items, particularly when it comes to better texture, longer shelf life, and increased levels of nutritional benefits, including fiber, protein, omega-3 fatty acids, and vitamins.


II. Fruits and Vegetables: Research has continuously uncovered the benefits of fruits and vegetables, which include their relation to digestive health, immunity, satiety, sports recovery, glucose uptake and insulin response, energy, and mood.

        With the objective of capitalizing on consumers’ growing demand for such natural health benefits, companies are making fruit and vegetable innovation a new strategic focus. In 2011, PepsiCo opened a fruit and vegetable research and development center in Hamburg, Germany. The €17 million state-of-the-art facility is intended to improve the quality and taste of existing products and develop new product lines.

        Acknowledging that many juices lack some of the nutrients present in the whole fruit or vegetable, the company has developed a method for improving the nutritional profile of juices. It consists of adding fiber and polyphenol-rich co-products from fruit and vegetable juice extraction back to juices. PepsiCo’s research has shown that juices containing skin, peel, pulp, and seeds provide various benefits, such as increased satiety, better glycemic control, and improved gut health. 

        Spanish-French multinational corporation Danone is also investing in the healthy juice market. Over the last years the company acquired specialized businesses such as smoothie maker Immedia and probiotic juice brand ProViva. It also engaged in a joint venture with Charlotte, North Carolina-based Chiquita Brands International, to market fruit-based drinks.

        The U.S. has seen a proliferation of the juice market, particularly raw and cold-pressed juices, which retain more nutrients and oxidize more slowly than juices produced from centrifugal machines with a blade. Promising benefits such as increased energy, rejuvenated skin, and normalized digestion, the so-called juice cleanses are booming all over the country.

        Natural snacks are also an important trend. Companies are investing in innovative methods that preserve fruits and vegetables, making sure they become a part of modern, on-the-go lifestyles. Such is the case of Crunchies Food Company, America’s leading natural snacking brand. Crunchies’ patented freeze-drying process takes away water while maintaining fibers and nutrients. Without the need for additives or preservatives, the gluten-free, GMO-free snacks are of great appeal to health conscious consumers.


III. Sugar and Salt Reduction: Research from the Harvard School of Public Health has recently tied sugary drinks to an epidemic of obesity in the United States.  Evidence is growing that exaggerated sugar consumption can lead to fatty liver disease, type 2 diabetes, cardiovascular disease, and kidney disease.

        In the U.S., added sugar is used in approximately 75 percent of packaged foods. It is added to foods by an industry whose goal is to engineer products to be as irresistible possible. Recent studies have shown that sugar is addictive and presents drug-like properties, such as cross-sensitization, cross-tolerance, cross-dependence, reward, and opioid effects. 

        In a context of increasing awareness about the health implications of sugar consumption, the rise of alternative sweeteners stands out as an example of how naturality can redefine the food market. Plant-based sweeteners, such as stevia and Lo Han Guo, are gaining ground as substitutes of artificial, arguably toxic aspartame.

        According to Mintel and Leatherhead Food Research, the value of stevia as an additive for use in food and beverage manufacture totaled $110 million in 2013 and should to grow to $275 million by 2017.  Major companies are already turning towards stevia to cut calories – Coca-Cola uses the natural sweetener in more than two-dozen products globally.

        Truvía, the stevia brand owned by Minneapolis-based Cargill, is taking advantage of this market opportunity. In addition to Truvía packets and spoonable versions, the company developed the Truvía Brown Sugar Blend and Baking Blend, both specially designed to replace sugar in desserts and baked goods while cutting 75 percent of calories.
   
        In the U.S., too much sugar comes together with too much salt. Nine out of ten Americans consume exaggerated amounts of sodium, most of it being in their food before it gets to the table. Excess sodium consumption can lead to high blood pressure, stroke, heart failure, osteoporosis, stomach cancer, kidney disease, kidney stones, enlarged heart muscle, osteoporosis, and headaches. 

        According to a review published in the New England Journal of Medicine, consuming too much salt is responsible for more than 1.6 million cardiovascular-related deaths annually.

        The U.S. Food and Drug Administration is expected to issue new salt guidelines for the food industry aimed at reducing sodium consumption. Research is underway to find potential substitutes – seaweed granules, molasses, and nutritional yeast are considered promising options. 

        The major challenge for food producers is that product choices are typically shaped by longstanding habits and ingrained preferences. In other words, one’s favorite food consistently tastes the same. Meaningful changes in core ingredients for food products require laboratory activity. For this reason, large food manufacturers have huge contingents of chemists, scientists, and nutritionists constantly seeking solutions to concerns created by emerging awareness, particularly when it comes to sugar and salt reduction.

        Unilever, for instance, has already reduced the use of salt in its products by 25 percent and is engaged in reducing the sodium content by a further 15-20 percent. In addition to pursuing alternatives to conventional salt, the company is working on technologies that address sensory and taste perception and would help understand ways that consumers can experience satisfying taste while enjoying food with reduced salt levels. The study of salt receptors in the tongue is particularly promising.

        Some fast-food chains have been successful in reducing sodium in their menus as well. Subway, for instance, reduced sodium by 35 percent in their Fresh Fit sandwiches and 30 percent across its entire sandwich menu in the past four years. This was possible by cutting sodium in their bread and deli meats.

        Industry leaders have also made significant progress towards sugar reduction. As part of its commitment to improve the nutritional profile of its products, Nestlé has reduced the amount of table sugar in its products by 32 percent between 2000 and 2013. They have committed to a further reduction of 10 percent in certain products by 2016.

        Proactive wellness is currently a leading consumer dietary trend. As a result, functionality has become another buzzword in the food and beverage industries. Consumers increasingly look for products that bring benefits beyond basic nutrition.

        The so-called “functional foods” promise to promote better health, increase longevity, and prevent the onset of chronic diseases. The most popular functional foods often contain fibers, antioxidants, heart-healthy ingredients, vitamins and minerals, omega-3 fatty acids, vitamin D, calcium, and whole grains.

        Over the next three years, the U.S. is expected to become the world’s largest market for functional foods, outperforming Japan, which is currently the number one. According to Leatherhead Food Research, the global market for functional foods was worth $43.27 billion in 2013, an increase of 26.7 percent over four years. The U.S. was responsible for $16.5 billion of such sales, a 29 percent increase in relation to 2009.

        The outstanding performance and revenue potential of the functional food market has triggered significant innovation and encouraged companies to explore new territories. In America, the recent Greek yogurt boom is an iconic example. The category, which represented merely 1 percent of total yogurt sales in 2007, captured 44 percent of the market in 2013, leading traditional yogurt brands, such as Dannon and Yoplait, to introduce their own Greek lines. 

        Throughout the country, food and beverage companies are engaged in nutritional research aimed at developing new products and formulations that contribute to consumers’ health and wellness. The following sections explore the most prominent trends in the functional food market.


I. Weight Management and the Protein Opportunity: Food and beverage companies are consolidating their presence in a niche previously dominated by supplements and meal replacements. Weight management has become one of the most important issues for the launching of new, functional products.

        Companies are investing in fiber and protein-enriched products that offer enhanced satiety and help control the appetite for longer. Kellogg’s Special K illustrates the huge potential of the weight management market – the brand’s sales went from $300 million in 2001 to $1.5 billion in 2010.

        Special K’s intensive R&D has led to the development of a wide range of products, including cereals, bars, chips, crackers, and even treats, such as brownies and pretzels. Innovation has focused on developing new recipes that help consumers “outsmart temptation”.  Recent examples include high protein cereals and bars as well as the Nourish line, a unique multi-grain blend of superfoods like quinoa, oats, wheat, and barley.

        General Mills has also invested in weight management products, including Progresso Light, a line of more than 40 soups with 100 calories or less per serving, and Fiber One, a brand of fiber-rich products, such as bars, cereals, brownies, and muffin mixes.

        The idea of a high protein, low carbohydrate diet as a strategy for weight management has become increasingly popular. Scientific and marketing efforts have consistently linked protein ingestion to health and healthy weight, fueling a significant surge in demand.

        According to research firm Nielsen, U.S. sales of packaged foods with protein-related claims on their labels rose to $7.5 billion in the year ending Feb. 15, 2014, a gain of more than 50 percent in comparison to the same period four years ago.

        In this context, companies are developing new, more convenient and on-the-go products that capitalize on the pro-protein trend. Examples include Oscar Mayer’s recently launched P3 Portable Protein Packs, which contain 13 grams of protein from food, such as cheese, meat, and nuts; Hormel’s REV brand, which offers meat and cheese wraps with up to 16 grams of protein; and Hillshire Snacking, all natural, gluten-free, protein-rich snacks.

        The pro-protein trend is also behind major financial transactions, such as Post Holdings’ $2.45 billion acquisition of Michael Foods, a Minnesota-based producer of eggs and dairy goods, and private-equity firm TPG’s $750 million investment in Chobani, America’s number one Greek yogurt company. 


II. Energy and Performance Nutrition: Increasingly health-conscious consumers are also more active than ever. No longer restricted to hardcore athletes and bodybuilders, a renewed sports nutrition segment has emerged, appealing to recreational sports participants, casual athletes, and gym exercisers.

        A recent report by Persistence Market Research valued the 2012 global sports nutrition market at $20.7 billion and projected a CAGR of 9 percent between 2013 and 2019, when it would reach $37.7 billion. 

        The most popular products in this category are sports drinks, which contribute to better performance and easier exercise recovery. According to data from Euromonitor International, sales of sports and energy drinks are expected to grow by 15 percent in off-trade value terms between 2013 and 2018, reaching $17.9 billion.

        Important trends in the sports drinks segment include the development of ready-to-drink (RTD) protein drinks. California-based Cytosport, the creator of the Muscle Milk brand, has recently expanded its RTD line, which currently offers six different products, including an organic, gluten-free protein shake.  Part of Gatorade’s rebranding strategy, the Post Game Recovery Beverage, which contains protein for muscle recovery, also exemplifies this trend.
   
        Energy snacks are an important area in the sports nutrition market. This segment has experienced a 14 percent CAGR between 2007 and 2012. Based in Emeryville, California, Clif Bar & Company has been at the forefront of energy nutrition. The company created a wide range of innovative snacks for athletes and active people which include organic energy bars, chewable and gel energy shots to be consumed while training and racing, and electrolyte hydration shots that help the body absorb and retain fluid for effective hydration.

        Faced with ever more demanding consumers, the sports nutrition industry must turn to science. Current challenges include the development of high-quality products that address endurance, muscle support, energy, and recovery. In addition to complying with increasingly strict regulations, such products must also appeal to a very diverse market, which comprises athletes of all shapes, sizes, and sports. 

        In this context, energy drinks stand out as a particularly promising category. They have outpaced the growth in carbonates in the last few years, and present a solid opportunity for beverage manufacturers. Despite recent FDA scrutiny regarding the safety of such beverages, 2013 energy drink sales registered a 6.7 percent increase in the U.S. alone, totaling $6.67 billion. 

        This positive trend should persist in the near future, as energy drinks expand beyond their previous focus on consumers aged 18-25 to reach older audiences. A recent report from specialist food and drink consultancy Zenith International argued that energy drinks is one of the most dynamic soft drinks segments, with hundreds of new products being introduced in the past three years. The recent multiplication of “energy shot” brands is a telling example. 

        Research and development efforts have allowed for the creation of innovative energy drinks with new functional claims, such as memory and metabolic enhancement. The development of more natural energy drinks has been the objective of various companies, which aim at combining functionality and naturality. According to Zenith International, other innovation areas include new flavors, low calorie and low sugar, innovative energy boosting ingredients, added functionality, and organic ingredients.

        Based in Corona, California, Monster Beverage is the leading innovator in the energy drinks category. The company is expanding its market share by introducing new products and bold formulations, which include the noncarbonated Monster Rehab, a combination of tea, lemonade, electrolytes, and energy blend, designed to refresh, rehydrate, and revive consumers.


III. Health-Enhancing and Nutraceuticals: It is widely known that diet and nutrition can contribute to the treatment and prevention of diseases. An increasing number of innovative food and beverage companies are developing new, health-enhancing products that give renewed meaning to the notion of “food as medicine”.

        Major focus areas include diabetes, digestive health, high cholesterol, and bone health. Present in over 30 countries, Benecol is an example of a medical nutrition brand. Its products contain a cholesterol-lowering ingredient called Plant Stanol Esters, which is scientifically proven to help block cholesterol from being absorbed into the digestive system, reducing "bad" LDL cholesterol levels while maintaining "good" HDL cholesterol levels.

        With a predicted CAGR of 10.43 percent between 2013 and 2018, the diabetic food market is a particularly promising area for innovation.   In fact, more than 1.6 million new cases of diabetes are diagnosed in the U.S. every year.

        In response to this daunting trend, Mendham, New Jersey-based FIFTY 50 Foods is engaged in developing better tasting products for people with diabetes. From peanut butter and table syrup to cookies and chocolates, the company offers a wide range of sugar-free food. FIFTY 50 is committed to donating 50 percent of profits to diabetes research and has contributed over $11 million since 1992.

        Though consumers of all ages are increasingly concerned with being healthy, seniors remain over-represented among buyers of brands with health benefits.

        Based on current trends, by 2020, 1 out of 5 people will be over age 65 and 3 out of 5 will die from a chronic disease.  Nutritional therapy, and the so-called nutraceuticals, can change existing medical paradigms, providing alternative methods for disease risk reduction and management.

        In this context, the Nestlé Institute of Health Sciences aims to develop new products that effectively bridge the fields of nutrition and health care. By bringing game-changing nutritional solutions to the market, the institute hopes to elevate the role of nutrition across six areas, namely, 1) Aging Medical Care, 2) Critical Care and Surgery, 3) Pediatric Medical Care, 4) Brain Health, 5) Metabolic Health, and 6) Gastrointestinal Health.

        Over the last four years, Nestlé Health Science made several acquisitions and investments, the most recent being a $65 million investment in Seres Health, a biotech start-up based in Cambridge, Massachusetts. Specialized in restoring the microbiome, Seres Health should help find innovative ways to treat diseases through the manipulation of the body’s microbial organisms instead of through traditional drugs.

        Anticipating major opportunities in the nutritional therapy field, Nestlé also announced a partnership with Flagship Ventures, a Boston-based venture capital firm, to help incubate nutritional health start-ups.

        Danone is also an important player in this market. The Nutricia Medical Nutrition division aims to improve the quality of life of people made vulnerable by age or illness. It is responsible for two major innovations that promise to increase the physical and intellectual independence of the elderly – Fortfit, a nutritional supplement that slows age-related loss of muscle mass; and Souvenaid, a nutrient-fortified beverage for early-stage Alzheimer’s patients, developed in partnership with the MIT.

        As consumers become increasingly concerned with health and wellness, food and beverage companies must turn to innovation to remain competitive. Federal R&D tax credits are available to support nutritional R&D efforts aimed at responding to an unprecedented demand for natural and functional foods and drinks.

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

Andrea Albanese is a Manager with R&D Tax Savers.

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

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