IRS releases new guidance for the ASC 730 R&D credit safe harbor
TAX ALERT |
The IRS recently released two new documents that provide further clarification on the process of utilizing the LB&I ASC 730 Directive Safe Harbor to claim an R&D Credit. The first document, titled ASC 730 – How it Relates to IRC 41 and 174, compares the ASC 730 R&D rules with their IRC 41 and 174 counterparts and offers commentary on the significant differences. The second document, titled ASC 730 Directive - Computing Qualified Research Expenses, goes into detail on how a taxpayer should compute their qualified research expenses (QREs) for an R&D credit completed in accordance with the LB&I ASC 730 Directive. In discussing the relation to IRC 41 and 174, ASC 350-40 (Internal-Use Software) and ASC 985-20 (Costs of Software to be Sold, Leased, or Marketed) are included given the ASC 730 R&D implications.
Highlights of the Guidance
ASC 730 research and development – how it relates to IRC 41 and 174
This document summarizes the provisions of ASC 730 R&D, and compares them to both IRC 41 and IRC 174 as they relate to accounting for R&D expenses. Within, the IRS generally discusses key topics from ASC 730, providing general summaries as well as detailed explanations of the provisions. The IRS also offers comments as to the significant differences between a given ASC 730 provision and the related Treasury Regulation or IRC Section.
Specifically, the document discusses research expenses not allowable under ASC 730, including those related to contract research, general and administrative process improvements, and engineering and design activities related to construction, relocation, rearrangement, or start-up of facilities or equipment (unless a pilot plant or solely for research and development purposes).
The document also discusses expenses allowed under ASC 730 but not IRC 41 and 174, including those related to searching for applications of new research findings, if the research was for a nontechnical product (like literary work), performing conceptual formulation activities related to a customer to identify what they want in a product, evaluating third-party products (unless in a qualified process of experimentation), developing screen layout design based on fonts, colors, sounds, and claiming expenses for a whole pilot plant (under certain circumstances). The document also discusses that ASC 730 does not contain a shrink back rule, or a reasonableness requirement for wages.
There are multiple differences discussed regarding the inclusion of software development expenses, specifically as it relates to internal use and dual function software. For example, under ASC 730, internaluse software is only includable when the software is a pilot project similar to a pilot plant under ASC 730-10-55-1 (relatively rare), or when the taxpayer uses the software in a particular research project that is similar to the exclusion for software used in a qualifying research activity under Treas. Reg. 1.414(c)(6)(ii)(A) (this exclusion removes the additional three-part High Threshold of Innovation Test). Because a taxpayer typically accounts for software under ASC 350-40, special consideration should be given to these distinctions.
ASC 730 Directive – computing qualified research expense
This document is much more instructive, going into detail regarding the process a taxpayer should follow when computing an R&D credit in accordance with the LB&I ASC 730 Directive (Sept. 11, 2017, hereinafter “the Directive”). It includes a summary of the process, description of the process, and walks the taxpayer through the necessary steps with high level examples of the computation. The document is particularly helpful in its discussion of the optional steps a taxpayer can take to include additional QREs generally excluded from the Directive, as well as discussion of important considerations under the Directive, and the impact the Directive has on an audit.
The Directive originally contained general instructions for five steps to compute an R&D credit in accordance with its provisions. The new document contains more detailed descriptions of steps 1-5 as originally discussed, and significantly adds instructions for the optional steps 6-10 that allow the taxpayer to include QREs that are not listed in the Directive. These optional QREs include additional ASC 730 wages, contract costs, non-ASC 730 wages and stock options, and non-ASC 730 non-wage costs. A short set of instructions are included directing the Taxpayer where to report these additional costs. It is important to note however, that these additional QREs are not covered in the safe harbor created by the Directive.
Finally, the IRS provides a brief discussion of the general considerations a taxpayer should make when computing an R&D credit under the Directive, and the impact it will have on their audit. This includes general procedures for the required audit certification statement, discussion of treatment to consolidated groups, and the documentation that must be retained.
ASC 730 Research and Development – How it Relates to IRC 41 and 174 gives a helpful comparison of the research expense allowable in a traditional R&D credit and those outlined in ASC 730. ASC 730 Directive – Computing Qualified Research Expense provides additional insight into the process a taxpayer should follow to be in compliance with the Directive and IRS regulations.