(VIII) Example 8. 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. The taxable entity had drilled a
horizontal well before in a different formation and at different depths.
However, it had never drilled a horizontal well in this formation
or at the required depths and was uncertain how to successfully execute
the horizontal drilling. The taxable entity utilized its existing
technology to perform its horizontal drilling operations in this area
and the existing technology was successful. The taxable entity's activities
did not satisfy the Process of Experimentation Test because the taxable
entity merely used its existing technology and did not perform any
experimentation to evaluate any alternative drilling methods.
(IX) Example 9. A taxable entity sought to discover
cancer immunotherapies. The taxable entity was uncertain as to the
appropriate design of the proteins to be used as a drug candidate.
The taxable entity identified several alternative protein constructs
and used a process to test them. The taxable entity's process involved
testing the constructs using in vitro functional assays and binding
assays, and either modifying the designs or discarding them and repeating
the previous steps. The taxable entity took the resulting products
from the in vitro testing and tested the drug candidate in living
organisms. This process evaluated the various alternatives identified
by the taxable entity. The taxable entity's activities satisfied the
Process of Experimentation Test.
(2) Application of the Four-Part Test to business components.
The Four-Part Test is applied separately to each business component
of the taxable entity. Any plant process, machinery, or technique
for commercial production of a business component is treated as a
separate business component from the business component being produced.
(3) Shrink-back rule. The Four-Part Test is first applied
at the level of the discrete business component used by the taxable
entity in a trade or business of the taxable entity. If the requirements
of the Four-Part Test are not met at that level, then they are applied
at the next most significant subset of elements of the business component.
This shrinking back of the product continues until either a subset
of elements of the product that satisfies the requirements of the
Four-Part Test is reached, or the most basic element of the product
is reached, and such element fails to satisfy any part of the Four-Part
Test.
(4) Software development as qualified research. In
determining if software development activities constitute qualified
research, the comptroller will consider the facts and circumstances
of each activity.
(A) Application of Four-Part Test to software development
activities.
(i) A taxable entity must prove that a software development
activity is qualified research and meets all the requirements of the
Four-Part Test under paragraph (1) of this subsection, even if the
activity is likely to qualify as described in subparagraph (B) of
this paragraph.
(ii) A taxable entity may prove that a software development
activity described as unlikely to qualify in subparagraph (C) of this
paragraph, is qualified research by providing evidence that the activity
meets all the requirements of the Four-Part Test under paragraph (1)
of this subsection.
(B) Software development activities likely to qualify.
Types of activities likely to qualify include, but are not limited
to:
(i) developing the initial release of an application
software product that includes new constructs, such as new architectures,
new algorithms, or new database management techniques;
(ii) developing system software, such as operating
systems and compilers;
(iii) developing specialized technologies, such as
image processing, artificial intelligence, or speech recognition;
and
(iv) developing software as part of a hardware product
where the software interacts directly with that hardware in order
to make the hardware/software package function as a unit.
(C) Software development activities unlikely to qualify.
Types of activities unlikely to qualify include, but are not limited
to:
(i) maintaining existing software applications or products;
(ii) configuring purchased software applications;
(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.
Cont'd... |