| (I) land;
(II) depreciable property;
(III) the ordinary testing or inspection of materials
or products for quality control;
(IV) efficiency surveys;
(V) management studies;
(VI) consumer surveys;
(VII) advertising or promotions;
(VIII) the acquisition of another's patent, model,
production, or process; or
(IX) research in connection with literary, historical,
or similar projects.
(iv) Although expenditures for depreciable property
are not eligible to be treated as expenditures under IRC, §174,
those expenditures qualify for the purposes of the sales tax research
and development exemption, provided that the research activities otherwise
satisfy the Four-Part Test and are not excluded under subsection (d)
of this section.
(B) Discovering Technological Information Test. The
research must be undertaken for the purpose of discovering information
that is technological in nature.
(i) Research is undertaken for the purpose of discovering
technological information if it is intended to eliminate uncertainty
concerning the development or improvement of a business component.
Uncertainty exists if the information available to the taxpayer does
not establish the capability or method for developing or improving
the business component, or the appropriate design of the business
component.
(ii) In order to satisfy the requirement that the research
is technological in nature, the process of experimentation used to
discover information must fundamentally rely on principles of the
physical or biological sciences, engineering, or computer science.
A taxpayer may employ existing technologies and may rely on existing
principles of the physical or biological sciences, engineering, or
computer science to satisfy this requirement.
(iii) A determination that research is undertaken for
the purpose of discovering information that is technological in nature
does not require that the taxpayer:
(I) seek to obtain information that exceeds, expands,
or refines the common knowledge of skilled professionals in the particular
field of science or engineering in which the taxpayer is performing
the research; or
(II) succeed in developing a new or improved business
component.
(C) Business Component Test. The application of the
technological information for which the research is undertaken must
be intended to be useful in the development of a new or improved business
component of the taxpayer, which may include any product, process,
computer software, technique, formula, or invention that is to be
held for sale, lease, or license, or used by the taxpayer in a trade
or business of the taxpayer.
(i) If a taxpayer provides a service to a customer,
the service provided to that customer is not a business component
because a service is not a product, process, computer software, technique,
formula, or invention. However, a product, process, computer software,
technique, formula, or invention used by a taxpayer to provide services
to its customers may be a business component.
(ii) A design is not a business component because a
design is not a product, process, computer software, technique, formula,
or invention. While uncertainty as to the appropriate design of a
business component is a qualifying uncertainty for the Section 174
Test and the Discovering Technological information test, the design
itself is not a business component. For example, the design of a structure
is not a business component, although the structure itself may be
a business component. Similarly, a blueprint or other plan used to
construct a structure that embodies a design is not a business component.
(D) Process of Experimentation Test. Substantially
all of the research activities must constitute elements of a process
of experimentation for a qualified purpose. A process of experimentation
is undertaken for a qualified purpose if it relates to a new or improved
function, performance, reliability, or quality of a business component.
Any research relating to style, taste, cosmetic, or seasonal design
factors does not satisfy the Process of Experimentation Test.
(i) A process of experimentation is a process designed
to evaluate one or more alternatives to achieve a result where the
capability or the method of achieving that result, or the appropriate
design of that result, is uncertain as of the beginning of the taxpayer's
research activities.
(ii) A process of experimentation must:
(I) be an evaluative process and generally should be
capable of evaluating more than one alternative; and
(II) fundamentally rely on the principles of the physical
or biological sciences, engineering, or computer science and involve:
(-a-) the identification of uncertainty concerning
the development or improvement of a business component;
(-b-) the identification of one or more alternatives
intended to eliminate that uncertainty; and
(-c-) the identification and the conduct of a process
of evaluating the alternatives through, for example, modeling, simulation,
or a systematic trial and error methodology.
(iii) A taxpayer may undertake a process of experimentation
if there is no uncertainty concerning the taxpayer's capability or
method of achieving the desired result so long as the appropriate
design of the desired result is uncertain as of the beginning of the
taxpayer's research activities. Uncertainty concerning the development
or improvement of the business component (e.g., its appropriate design)
does not establish that all activities undertaken to achieve that
new or improved business component constitute a process of experimentation.
(iv) The substantially all requirement of this subparagraph
is satisfied only if 80% or more of a taxpayer's research activities,
measured on a cost or other consistently applied reasonable basis
constitute elements of a process of experimentation that relates to
a new or improved function, performance, reliability, or quality.
The substantially all requirement is satisfied even if the remainder
of a taxpayer's research activities with respect to the business component
do not constitute elements of a process of experimentation that relates
to a new or improved function, performance, reliability, or quality.
(v) Non-experimental methods, such as simple trial
and error, brainstorming, or reverse engineering, are not considered
a process of experimentation.
(vi) The following are factors that may be considered
in determining whether a trial and error methodology is experimental
systematic trial and error or non-experimental simple trial and error.
Evidence provided to determine the type of trial and error is not
limited to these factors, nor is evidence of each factor required.
These factors only apply to determining whether a process of experimentation
is systematic trial and error. Systematic trial and error is not the
only qualifying process of experimentation. These factors are:
(I) whether the person conducting the trial and error
methodology stops testing alternatives once a single acceptable result
is found or continues to find multiple acceptable results for comparison;
(II) whether all the results of the trial and error
methodology are recorded for evaluation;
(III) whether there is a written procedure for conducting
the trial and error methodology; and
(IV) whether there is a written procedure for evaluating
the results of the trial and error methodology.
(vii) Examples.
(I) Example 1. A taxpayer is engaged in the business
of developing and manufacturing widgets. The taxpayer wants to change
the color of its blue widget to green. The taxpayer obtains several
different shades of green paint from various suppliers. The taxpayer
paints several sample widgets, and surveys its customers to determine
which shade of green its customers prefer. The taxpayer's activities
to change the color of its blue widget to green do not satisfy the
Process of Experimentation Test because its activities are not undertaken
for a qualified purpose. All of the taxpayer's research activities
are related to style, taste, cosmetic, or seasonal design factors.
(II) Example 2. The taxpayer in Example 1 chooses one
of the green paints. The taxpayer obtains samples of the green paint
from a supplier and determines that it must modify its painting process
to accommodate the green paint because the green paint has different
characteristics from other paints it has used. The taxpayer obtains
detailed data on the green paint from its paint supplier. The taxpayer
also consults with the manufacturer of its paint spraying machines.
The manufacturer informs the taxpayer that it must acquire new nozzles
that operate with the green paint it wants to use because the current
nozzles do not work with the green paint. The taxpayer tests the new
nozzles, using the green paint, to ensure that they work as specified
by the manufacturer of the paint spraying machines. The taxpayer's
activities to modify its Cont'd... |
