| 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 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.
Cont'd... |
