| (iii) reverse engineering of existing applications;
(iv) performing studies, or similar activities, to
select vendor products;
(v) detecting flaws and bugs directed toward the verification
and validation that the software was programmed as intended and works
correctly;
(vi) modifying an existing software business component
to make use of new or existing standards or devices, or to be compliant
with another vendor's product or platform;
(vii) developing a business component that is substantially
similar in technology, functionality, and features to the capabilities
already in existence at other companies;
(viii) upgrading to newer versions of hardware or software
or installing vendor-fix releases;
(ix) re-hosting or porting an application to a new
hardware such as from mainframe to PC, or software platform, such
as Windows to UNIX, or rewriting an existing application in a new
language, such as rewriting a COBOL mainframe application in C++;
(x) writing hardware device drivers to support new
hardware, such as disks, scanners, printers, or modems;
(xi) performing data quality, data cleansing, and data
consistency activities, such as designing and implementing software
to validate data fields, clean data fields, or make the data fields
consistent across databases and applications;
(xii) bundling existing individual software products
into product suites, such as combining existing word processor, spreadsheet,
and slide presentation software applications into a single suite;
(xiii) expanding product lines by purchasing other
products;
(xiv) developing interfaces between different software
applications;
(xv) developing vendor product extensions;
(xvi) designing graphic user interfaces;
(xvii) developing functional enhancements to existing
software applications/products;
(xviii) developing software as an embedded application,
such as in cell phones, automobiles, and airplanes;
(xix) developing software utility programs, such as
debuggers, backup systems, performance analyzers, and data recovery;
(xx) changing from a product based on one technology
to a product based on a different or newer technology; and
(xxi) adapting and commercializing technology developed
by a consortium or open software group.
(d) Excluded research activities. Qualified research
does not include the activities described in this subsection.
(1) Research after commercial production. Any research
conducted after the beginning of commercial production of the business
component.
(A) Activities are conducted after the beginning of
commercial production of a business component if such activities are
conducted after the component is developed to the point where it is
ready for commercial sale or use or meets the basic functional and
economic requirements of the taxable entity for the component's sale
or use.
(B) The following activities are deemed to occur after
the beginning of commercial production of a business component:
(i) preproduction planning for a finished business
component;
(ii) tooling-up for production;
(iii) trial production runs;
(iv) troubleshooting involving detecting faults in
production equipment or processes;
(v) accumulating data relating to production processes;
(vi) debugging flaws in a business component; and
(vii) any activities that involve the use of an item
for which the taxable entity claimed the manufacturing exemption under
Tax Code, §151.318.
(C) In cases involving development of both a product
and a manufacturing or other commercial production process for the
product, the research after commercial production exclusion applies
separately for the activities relating to the development of the product
and the activities relating to the development of the process. For
example, even after a product meets the taxable entity's basic functional
and economic requirements, activities relating to the development
of the manufacturing process may still constitute qualified research,
provided that the development of the process itself separately satisfies
the requirements of this section, and the activities are conducted
before the process meets the taxable entity's basic functional and
economic requirements or is ready for commercial use.
(D) Clinical testing of a pharmaceutical product prior
to its commercial production in the United States is not treated as
occurring after the beginning of commercial production even if the
product is commercially available in other countries. Additional clinical
testing of a pharmaceutical product after a product has been approved
for a specific therapeutic use by the Food and Drug Administration
and is ready for commercial production and sale is not treated as
occurring after the beginning of commercial production if such clinical
testing is undertaken to establish new functional uses, characteristics,
indications, combinations, dosages, or delivery forms for the product.
A functional use, characteristic, indication, combination, dosage,
or delivery form shall be considered new only if such functional use,
characteristic, indication, combination, dosage, or delivery form
must be approved by the Food and Drug Administration.
(E) Examples.
(i) Example 1. A taxable entity is a tire manufacturer
and develops a new material to use in its tires. The taxable entity
conducts research to determine the changes that will be necessary
for it to modify its existing manufacturing processes to manufacture
the new tire. The taxable entity determines that the new tire material
retains heat for a longer period of time than the materials it currently
uses for tires, and, as a result, the new tire material adheres to
the manufacturing equipment during tread cooling. The taxable entity
evaluates several alternatives for processing the treads at cooler
temperatures to address this problem, including a new type of belt
for its manufacturing equipment to be used in tread cooling. Such
a belt is not commercially available. Because the taxable entity is
uncertain of the belt design, it develops and conducts sophisticated
engineering tests on several alternative designs for a new type of
belt to be used in tread cooling until it successfully achieves a
design that meets its requirements. The taxable entity then manufactures
a set of belts for its production equipment, installs the belts, and
tests the belts to make sure they were manufactured correctly. The
taxable entity's research with respect to the design of the new belts
to be used in its manufacturing of the new tire may be qualified research
under the Four-Part Test. However, the taxable entity's expenses to
implement the new belts, including the costs to manufacture, install,
and test the belts were incurred after the belts met the taxable entity's
functional and economic requirements and are excluded as research
after commercial production.
(ii) Example 2. For several years, a taxable entity
has manufactured and sold a particular kind of widget. The taxable
entity initiates a new research project to develop a new or improved
widget. The taxable entity's activities to develop a new or improved
widget are not excluded from the definition of qualified research
under this paragraph. The taxable entity's activities relating to
the development of a new or improved widget constitute a new research
project to develop a new business component and are not considered
activities conducted after the beginning of commercial production.
(iii) Example 3. For the purposes of this example,
assume that the taxable entity's development of its products and manufacturing
processes satisfies the Four-Part Test described by subsection (c)
of this section and is not otherwise excluded under this subsection.
A taxable entity is a manufacturer of integrated circuits for use
in specific applications. The taxable entity develops various integrated
circuit devices and associated manufacturing processes. The taxable
entity assembles various product configurations for testing. After
an internal process of testing, the taxable entity delivers a sample
quantity of the integrated circuit to a potential customer for further
testing. At the time when the samples are delivered to the taxable
entity's potential customer, the potential customer has not agreed
to purchase any integrated circuits from the taxable entity. This
process of testing by both the taxable entity and its potential customer
continues until an acceptable product and manufacturing process to
produce the product is achieved. At that point, the taxable entity
and the potential customer enter into an agreement for the delivery
of an order of the integrated circuits. In some cases, no acceptable
product or manufacturing process is achieved, and no agreement is
reached with the potential customer. Research activities occurring
prior to an agreement are not considered activities conducted after
the beginning of commercial production because the integrated circuits
were not yet ready Cont'd... |
