Are you taking full advantage of the tooling R&D tax credit?
INSIGHT ARTICLE |
Given the relative unpredictability of the economy, companies large and small need to increase cash flow. An often overlooked method to increase cash flow is through federal and state research and development (R&D) tax credit.
Automotive manufacturers and suppliers have a unique opportunity to increase their R&D credit thanks to a misunderstood and underutilized provision associated with tooling.
In a 2009 tax case, the tax court held that a manufacturer of automotive parts may categorize the cost of tooling developed to make the parts as a supply when calculating the R&D credit.1 These allowable costs include both internal and third-party engineering costs to design the tooling as well as the costs for both the soft tooling and the production of hard tooling.
Qualifying for the credit
To qualify these costs in the R&D calculation, two basic requirements are needed:
- The taxpayer needs to bear the economic risk that the tooling will perform adequately. This requires the taxpayer to be responsible for producing the part to the customer specification. The taxpayer cannot transfer this risk to the tool and die maker or any other outside contractor. Generally, this requirement is easily met.
- The taxpayer must transfer ownership of the tool to its customer. This requirement prohibits the taxpayer from owning the tool. The Internal Revenue Code (IRC) section 41 prohibits tangible depreciable property from being used to calculate the R&D credit.2 In TG Missouri Corp. v. Comm’r, the IRS argued that tooling cannot be included in R&D calculation since it is depreciable property. IRC section 41 states supplies cannot be included in the R&D calculation that are “subject to the allowance for deprecation.”3
The tax court disagreed with the IRS’s reading of IRC section 41, ruling that it is not the character of the asset (depreciable or not depreciable) that determines its qualification for the credit, but rather who owns the asset. Similar to many automotive manufactures, TG Missouri Corp. retained tooling in its facility and produced parts for its customers. However, the tooling was not owned by TG Missouri Corp. Since the tooling was not a fixed asset on the company’s financial statements, it was not considered depreciable by TG Missouri Corp. and was therefore qualified as an R&D supply.
The tax court clarified that metal stampers and injection molders are allowed, under the correct facts and circumstances, to substantially increase their R&D credit by including tooling-related expenses. These expenses include the cost of production molds that are paid for by the customer (in some arrangements other than a pure time and material one) but used by the taxpayer.
Automotive manufacturers and suppliers who want to increase cash flow should have their R&D credit reviewed, paying particular focus to whether or not tooling can be included in the calculation.
1TG Missouri Corp. v. Comm’r, 133 T.C. No. 13 (2009)
2IRC section 41(b)(2)(C)(ii)
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