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Research Credit Supply Expenses at Risk
The latest chapter in the evolution of the research tax credit is the appeal of the Tax Court's 2009 Union Carbide memorandum decision, heard in New York City on March 29 by the Second Circuit Court of Appeals. Union Carbide may be the most significant Tax Court opinion involving an Internal Revenue Code Section 41 research credit issue since the final Section 41 regulations were issued in December of 2003. In Union Carbide, the Tax Court provided guidance on several important Section 41 issues in a nearly 300-page memorandum opinion. Taxand US analyses the Union Carbide case and how the appeal could have an impact on many taxpayers.
While the Tax Court awarded Union Carbide Corporation a minimal amount of its credit claim, the decision did provide positive precedent for taxpayers in general. In its appeal, Union Carbide maintains that the Court incorrectly disallowed millions of dollars in supply expenses related to qualified process improvement research activities.
The Second Circuit's decision regarding Union Carbide's appeal could have a significant impact on many taxpayers. The decision could either increase the eligibility of supply costs or limit supply costs allowed for the research credit. Further, the decision could make Section 41's process of experimentation requirement more difficult to satisfy. And in a larger context, there is a chance that an adverse ruling from the Second Circuit could stifle manufacturing process research and reduce innovation and economic competiveness of US manufacturers.
If the Second Circuit adopts the Tax Court's distinction between indirect supply costs and direct supply costs, it will greatly expand the population of supply expenses that the IRS may attempt to disallow during exam.