| hood and associated proposed modifications to both
the air intake system and cooling system. This process enables the
taxable entity to eliminate the uncertainties related to the integrated
design of the hood, air intake system, and cooling system. Such activities
constitute 85% of its total activities to update its current model
vehicle. The taxable entity then engages in additional activities
that do not involve a process of evaluating alternatives in order
to eliminate uncertainties. The additional activities constitute only
15% of the taxable entity's total activities to update its current
model vehicle. In this case substantially all of the taxable entity's
activities constitute elements of a process of experimentation because
it evaluated alternatives to achieve a result where the method of
achieving that result, and the appropriate design of that result,
were uncertain as of the beginning of its research activities. The
taxable entity identified uncertainties related to the improvement
of a business component and identified alternatives intended to eliminate
these uncertainties. Furthermore, the taxable entity's process of
evaluating the identified alternatives was technological in nature
and was undertaken to eliminate the uncertainties. Because 85% of
the taxable entity's activities to update its current model vehicle
constitute elements of a process of experimentation that relates to
a new or improved function, performance, reliability, or quality,
all of its activities satisfy the Process of Experimentation Test.
(V) Example 5. A taxable entity is in the business
of providing building and construction services, including the construction
of warehouses, strip malls, office buildings, and other commercial
structures. The taxable entity is engaged to construct a structure
in a part of Texas where foundation problems are common. The taxable
entity's engineers were uncertain how to design the structure to ensure
stability of the structure's foundation because the taxable entity
had never designed a structure in a similar location. The taxable
entity's engineers used their professional experience and various
building codes to determine how to design the foundation based on
the conditions at the construction site. The engineers chose to use
piles in the foundation. The taxable entity constructed a test pile
on site to confirm whether this would work in the conditions present
on the construction site. This test pile would become part of the
foundation of the structure regardless of whether the engineers had
to redesign the additional piles required for the foundation. The
taxable entity's activities in using professional experience and business
codes to design the foundation did not meet the Process of Experimentation
Test because the activities did not resolve technological uncertainties
through an experimental process. Constructing the test pile also did
not meet the Process of Experimentation Test because it was not an
evaluative process.
(VI) Example 6. A taxable entity is in the business
of providing building and construction services, including the construction
of warehouses, strip malls, office buildings, and other commercial
structures. For one of its projects to construct an office building,
the taxable entity was uncertain how to design the layout of the electrical
systems. The taxable entity's employees held on-site meetings to discuss
different options, such as running the wire under the floor or through
the ceiling, but did not actually experiment by installing wire in
different locations. The taxable entity used computer-aided simulation
and modeling to produce the final electrical system layout. While
in some cases computer-aided simulation and modeling may be an experimental
process, in this case, it was not an experimental process because
the taxable entity did not use the computer-aided simulation and modeling
to evaluate different alternatives in a scientific manner. The taxable
entity's activities did not satisfy the Process of Experimentation
Test because it did not conduct an experimental process of evaluating
alternatives to eliminate a technological uncertainty.
(VII) Example 7. A taxable entity is an oil and gas
operator that recently acquired rights to drill in an area in which
it had not previously operated. The taxable entity decided to use
horizontal drilling in this area, but it had never drilled a horizontal
well and was uncertain how to successfully execute the horizontal
drilling. At the time the taxable entity began horizontal drilling,
the technology to drill horizontal wells was established. The taxable
entity selected technology from existing commercially available options
to use in its horizontal drilling program. The taxable entity's activities
did not satisfy the Process of Experimentation Test because evaluating
commercially available options does not constitute a process of experimentation.
(VIII) Example 8. A taxable entity is an oil and gas
operator that recently acquired rights to drill in an area in which
it had not previously operated. The taxable entity decided to use
horizontal drilling in this area. The taxable entity had drilled a
horizontal well before in a different formation and at different depths.
However, it had never drilled a horizontal well in this formation
or at the required depths and was uncertain how to successfully execute
the horizontal drilling. The taxable entity utilized its existing
technology to perform its horizontal drilling operations in this area
and the existing technology was successful. The taxable entity's activities
did not satisfy the Process of Experimentation Test because the taxable
entity merely used its existing technology and did not perform any
experimentation to evaluate any alternative drilling methods.
(IX) Example 9. A taxable entity sought to discover
cancer immunotherapies. The taxable entity was uncertain as to the
appropriate design of the proteins to be used as a drug candidate.
The taxable entity identified several alternative protein constructs
and used a process to test them. The taxable entity's process involved
testing the constructs using in vitro functional assays and binding
assays, and either modifying the designs or discarding them and repeating
the previous steps. The taxable entity took the resulting products
from the in vitro testing and tested the drug candidate in living
organisms. This process evaluated the various alternatives identified
by the taxable entity. The taxable entity's activities satisfied the
Process of Experimentation Test.
(2) Application of the Four-Part Test to business components.
The Four-Part Test is applied separately to each business component
of the taxable entity. Any plant process, machinery, or technique
for commercial production of a business component is treated as a
separate business component from the business component being produced.
(3) Shrink-back rule. The Four-Part Test is first applied
at the level of the discrete business component used by the taxable
entity in a trade or business of the taxable entity. If the requirements
of the Four-Part Test are not met at that level, then they are applied
at the next most significant subset of elements of the business component.
This shrinking back of the product continues until either a subset
of elements of the product that satisfies the requirements of the
Four-Part Test is reached, or the most basic element of the product
is reached, and such element fails to satisfy any part of the Four-Part
Test.
(4) Software development as qualified research. In
determining if software development activities constitute qualified
research, the comptroller will consider the facts and circumstances
of each activity.
(A) Application of Four-Part Test to software development
activities.
(i) A taxable entity must prove that a software development
activity is qualified research and meets all the requirements of the
Four-Part Test under paragraph (1) of this subsection, even if the
activity is likely to qualify as described in subparagraph (B) of
this paragraph.
(ii) A taxable entity may prove that a software development
activity described as unlikely to qualify in subparagraph (C) of this
paragraph, is qualified research by providing evidence that the activity
meets all the requirements of the Four-Part Test under paragraph (1)
of this subsection.
(B) Software development activities likely to qualify.
Types of activities likely to qualify include, but are not limited
to:
(i) developing the initial release of an application
software product that includes new constructs, such as new architectures,
new algorithms, or new database management techniques;
(ii) developing system software, such as operating
systems and compilers;
(iii) developing specialized technologies, such as
image processing, artificial intelligence, or speech recognition;
and
(iv) developing software as part of a hardware product
where the software interacts directly with that hardware in order
to make the hardware/software package function as a unit.
(C) Software development activities unlikely to qualify.
Types of activities unlikely to qualify include, but are not limited
to:
(i) maintaining existing software applications or products;
(ii) configuring purchased software applications;
Cont'd... |
