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Appeals Court Rules On R&D Expenses
The Appellate Court has ruled that Union Carbide Corporation's (UCC) supply costs are not credible. This comes after a lengthy legal debate surrounding qualified research expenses. Taxand USA takes a look at the history of the case leading to the recent findings.
UCC, which became a wholly owned subsidiary of the Dow Chemical Company in 2001, was engaged in the business of processing raw hydrocarbon feedstocks into building-block chemicals called olefins. UCC claimed nearly $18 million of research credits on its originally filed 1994 and 1995 federal income tax returns using the regular research credit methodology. It later claimed additional credits of over $8 million for those years relating to an additional 106 manufacturing process improvement projects. The Tax Court found that UCC was not entitled to qualified research expenses (QREs) related to their manufacturing process research. The Court disallowed these supply costs because they were incurred "primarily" in the production of goods for sale.
UCC appealed against this ruling saying that the "primarily" language is not found in the law, but was inserted by the Tax Court. In this appeal hearing the Court stated that it would be an absurd result to grant a credit for the cost of materials which would eventually be sold.
The Appellate Court have taken into account the history of this case. It has affirmed the decision of the Tax Court in that UCC was not entitled to research credits for the entire amount spent for the process improvement supplies. Instead, it was entitled to a credit for only those additional supplies that were used to perform the research.
UCC isn't the only taxpayer that claims supply costs used in process improvement research as qualified research expenses. Therefore, it should be expected that a variety of fact patterns will emerge as the IRS tests the limits of this case. The Court's decision could have a significant impact on many taxpayers, as supply costs tend to be large amounts.