| (C) Example 3. Assume that the customer from Example
1 uses its own employees to adapt the core software program to its
requirements. Because the customer's employees' activities to adapt
the core software program to its requirements are excluded from the
definition of qualified research, the wages the customer paid to its
employees do not constitute in-house research expenses.
(D) Example 4. A taxpayer manufactures and sells rail
cars. Because rail cars have numerous specifications related to performance,
reliability and quality, rail car designs are subject to extensive,
complex testing in the scientific or laboratory sense. A customer
orders passenger rail cars from the taxpayer. The customer's rail
car requirements differ from those of the taxpayer's other existing
customers only in that the customer wants fewer seats in its passenger
cars and a higher quality seating material and carpet that are commercially
available. The taxpayer manufactures rail cars meeting the customer's
requirements. The rail car sold to the customer was not a new business
component, but merely an adaptation of an existing business component
that did not require a process of experimentation. Thus, the taxpayer's
activities to manufacture rail cars for the customer are excluded
from the definition of qualified research because the taxpayer's activities
represent activities to adapt an existing business component to a
particular customer's requirement or need.
(E) Example 5. A taxpayer is a manufacturer and undertakes
to create a manufacturing process for a new valve design. The taxpayer
determines that it requires a specialized type of robotic equipment
to use in the manufacturing process for its new valves. Such robotic
equipment is not commercially available. Therefore, the taxpayer purchases
existing robotic equipment for the purpose of modifying it to meet
its needs. The taxpayer's engineers identify uncertainty that is technological
in nature concerning how to modify the existing robotic equipment
to meet its needs. The taxpayer's engineers develop several alternative
designs, conduct experiments using modeling and simulation in modifying
the robotic equipment, and conduct extensive scientific and laboratory
testing of design alternatives. As a result of this process, the taxpayer'
s engineers develop a design for the robotic equipment that meets
its needs. The taxpayer constructs and installs the modified robotic
equipment on its manufacturing process. The taxpayer's research activities
to determine how to modify the robotic equipment it purchased for
its manufacturing process are not considered an adaptation of an existing
business component.
(F) Example 6. A taxpayer is an oil and gas operator
and has been engaged in horizontal drilling for the past ten years.
Recently, the taxpayer was hired by a customer to drill in a formation.
The drilling objectives included targeting an interval within that
formation for horizontal drilling. The taxpayer was uncertain about
the successful execution of the horizontal drilling because it had
not previously drilled a horizontal well in that formation. The taxpayer
was also uncertain about the economic results from the targeted interval.
The taxpayer drilled several horizontal wells before its customer
was satisfied with the economic results. The taxpayer modified its
existing horizontal drilling program based on these results. The taxpayer's
activities to identify a horizontal drilling process are excluded
from the definition of qualified research because the activities consisted
of adapting an existing business component, its existing horizontal
drilling process, and did not involve creating a new or improved business
component.
(G) Example 7. For the purposes of this example, assume
that the taxpayer's development of its products satisfies the Four-Part
Test described by subsection (c) of this section and is not otherwise
excluded under this subsection. A taxpayer is a manufacturer of rigid
plastic containers. The taxpayer contracts with major food and beverage
manufacturers to provide suitable bottle and packaging designs. The
products designed by the taxpayer may be for repeat customers and
the sizes and types of bottle may be similar to previous products.
The development of each new product, and the production process necessary
to produce the products at sufficient production volume, starts from
new concept drawings developed by engineers. The taxpayer uses a qualifying
process of experimentation to evaluate alternative concepts for the
product and production processes. The taxpayer's activities related
to both the product and the production process are not excluded from
the definition of qualified research as an adaptation of an existing
business component.
(3) Duplication of existing business component. Any
research related to the reproduction of an existing business component,
in whole or in part, from a physical examination of the business component
itself or from plans, blueprints, detailed specifications, or publicly
available information with respect to such business component. This
exclusion does not apply merely because the taxpayer examines an existing
business component in the course of developing its own business component.
(4) Surveys, studies, etc. Any efficiency survey; activity
relating to management function or technique; market research, testing
or development (including advertising or promotions); routine data
collection; or routine or ordinary testing or inspection for quality
control.
(5) Computer software. Any research activities with
respect to internal use software.
(A) For the purposes of this paragraph, internal use
software is computer software developed by, or for the benefit of,
the taxpayer primarily for internal use by the taxpayer.
(B) This exclusion does not apply to software used
in:
(i) an activity that constitutes qualified research,
or
(ii) a production process that meets the requirements
of the Four-Part Test.
(6) Social sciences, etc. Any research in the social
sciences, arts, or humanities.
(7) Funded research. Any research funded by any grant,
contract, or otherwise by another person or governmental entity.
(A) Research is considered funded if:
(i) the taxpayer performing the research for another
person retains no substantial rights to the results of the research;
or
(ii) the payments to the researcher are not contingent
upon the success of the research.
(B) For the purposes of determining whether a taxpayer
retains substantial rights to the results of the research:
(i) Incidental benefits to the researcher from the
performance of the research do not constitute substantial rights.
For example, increased experience in a field of research is not considered
substantial rights.
(ii) A taxpayer does not retain substantial rights
in the research it performs if the taxpayer must pay for the right
to use the results of the research.
(C) If a taxpayer performing research does not retain
substantial rights to the results of the research, the research is
considered funded regardless of whether the payments to the researcher
are contingent upon the success of the research. In this case, all
research activities are considered funded even if the researcher has
expenses that exceed the amount received by the researcher for the
research.
(D) If a taxpayer performing research does retain substantial
rights to the results of the research and the research is considered
funded under subparagraph (A)(ii) of this paragraph, the research
is only funded to the extent of the payments and fair market value
of any property that the taxpayer becomes entitled to by performing
the research. If the expenses related to the research exceed the amount
the researcher is entitled to receive, the research is not considered
funded with respect to the excess expenses. For example, a taxpayer
performs research for another person. Based on the contract, the research
activities are considered funded under subparagraph (A)(ii) of this
paragraph because payments to the researcher are not contingent on
the success of the research. The taxpayer retains substantial rights
to the results of the research. The taxpayer is entitled to $100,000
under the contract but spent $120,000 on the research activities.
In this case, the research is considered funded with respect to $100,000
and is not considered funded with respect to $20,000.
(E) A taxpayer performing research for another person
must identify any other person paying for the research activities
and any person with substantial rights to the results of the research.
(F) All agreements, not only research contracts, entered
into between the taxpayer performing the research and the party funding
the research shall be considered in determining the extent to which
the research is funded.
Cont'd... |
