| (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 taxable
entity'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 taxable entity may undertake a process of experimentation
if there is no uncertainty concerning the taxable entity'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
taxable entity'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 taxable entity'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 taxable entity'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 taxable entity is engaged in the business
of developing and manufacturing widgets. The taxable entity wants
to change the color of its blue widget to green. The taxable entity
obtains several different shades of green paint from various suppliers.
The taxable entity paints several sample widgets, and surveys its
customers to determine which shade of green its customers prefer.
The taxable entity'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 taxable entity's research activities are related to style, taste,
cosmetic, or seasonal design factors.
(II) Example 2. The taxable entity in Example 1 chooses
one of the green paints. The taxable entity 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 taxable entity obtains detailed data on the green paint from its
paint supplier. The taxable entity also consults with the manufacturer
of its paint spraying machines. The manufacturer informs the taxable
entity 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 taxable entity tests the new nozzles, using the
green paint, to ensure that they work as specified by the manufacturer
of the paint spraying machines. The taxable entity's activities to
modify its painting process are not qualified research. The taxable
entity did not conduct a process of evaluating alternatives in order
to eliminate uncertainty regarding the modification of its painting
process. Rather, the manufacturer of the paint machines eliminated
the taxable entity's uncertainty regarding the modification of its
painting process. The taxable entity's activities to test the nozzles
to determine if the nozzles work as specified by the manufacturer
of the paint spraying machines are in the nature of routine or ordinary
testing or inspection for quality control.
(III) Example 3. A taxable entity is engaged in the
business of manufacturing food products and currently manufactures
a large-shred version of a product. The taxable entity seeks to modify
its current production line to permit it to manufacture both a large-shred
version and a fine-shred version of one of its food products. A smaller,
thinner shredding blade capable of producing a fine-shred version
of the food product is not commercially available. Thus, the taxable
entity must develop a new shredding blade that can be fitted onto
its current production line. The taxable entity is uncertain concerning
the design of the new shredding blade because the material used in
its existing blade breaks when machined into smaller, thinner blades.
The taxable entity engages in a systematic trial and error process
of analyzing various blade designs and materials to determine whether
the new shredding blade must be constructed of a different material
from that of its existing shredding blade and, if so, what material
will best meet its functional requirements. The taxable entity's activities
to modify its current production line by developing the new shredding
blade satisfy the Process of Experimentation Test. 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 the taxable
entity's research activities. The taxable entity identified uncertainties
related to the development of a business component, and identified
alternatives intended to eliminate these uncertainties. Furthermore,
the taxable entity's process of evaluating identified alternatives
was technological in nature and was undertaken to eliminate the uncertainties.
(IV) Example 4. A taxable entity is in the business
of designing, developing and manufacturing automobiles. In response
to government-mandated fuel economy requirements, the taxable entity
seeks to update its current model vehicle and undertakes to improve
aerodynamics by lowering the hood of its current model vehicle. The
taxable entity determines, however, that lowering the hood changes
the air flow under the hood, which changes the rate at which air enters
the engine through the air intake system, which reduces the functionality
of the cooling system. The taxable entity's engineers are uncertain
how to design a lower hood to obtain the increased fuel economy, while
maintaining the necessary air flow under the hood. The taxable entity
designs, models, simulates, tests, refines, and re-tests several alternative
designs for the Cont'd... |
