Webinar Recap: The R&D Tax Credit: Opportunities for Retailers

Though retail and research and development (R&D) may seem like strange bedfellows, the wholesale and retail industry is responsible for claiming seven percent of the available R&D tax credit, with 1,100 returns claiming the credit in 2013, according to the IRS. Earlier this month, we hosted a webinar to share key takeaways on what’s new with the R&D tax credit for retailers and how they can take advantage of it.

Following the passage of the Protecting Americans from Tax Hikes (PATH) Act in December 2015, the R&D tax credit was made permanent under IRC Section 41 for some small businesses and start-ups starting in tax year 2016 or later. As our colleagues Chris Bard, Janet Bernier and Chai Hoang recently discussed on CFO.com, the PATH Act offers two new opportunities for certain eligible small businesses to offset the Alternative Minimum Tax (AMT) with R&D credits or for qualified small businesses to elect annually for five taxable years to take up to $250,000 in credits against the employer’s portion of federal payroll taxes (FICA).

Federal R&D tax credits can cover myriad activities, from basic R&D to innovating weaving techniques and many in between. In addition to the federal credit, most states offer R&D credits, but criteria may differ in key areas. To be eligible for any federal or state R&D credit, your research activity must satisfy the following:
  • Permitted Purpose Test:Activities must be intended to develop or improve the functionality, performance, reliability or quantity of a product, manufacturing process, software, invention, technique or formula. Importantly, the activity does not have to be successful to qualify.
  • Process of Experimentation Test: Activities must be designed to evaluate one or more alternatives to achieve a result. This test can be either formal or informal.
  • Technological in Nature Test: Activities must fundamentally rely on the principles of engineering or the physical, biological or computer sciences.
  • Uncertainty Test: Activities must attempt to eliminate uncertainty regarding how to develop or improve the component or the component’s appropriate design. When performing the uncertainty test, bear in mind the three major forms:
    • Capability uncertainty is present when the possibility of physically achieving research goals is in question.
    • Methodology uncertainty is when there’s confidence it’s possible to achieve research goals, but the “how” is in question. This form of uncertainty is typically the most expensive and is most often used by start-ups.
    • Appropriate design uncertainty, the most common type, is present when an experimentation process is required to ensure the design of the new component or process is appropriate for its application.
Once you’ve ensured your activities fall under the qualifying guidelines, your net benefit eligibility is determined based on Qualified Research Expenses (QREs) and must avoid statutorily excluded activities, such as routine data collection and more. See the full webinar for a complete list of QREs and statutorily excluded activities.

Taking a look at how the credit benefits companies in practice, imagine Product Company A is developing a combination hair dryer and styler, a frozen drink blender, a new shampoo formula and is undergoing a manufacturing line redesign to reduce defects. This company has $15 million in QREs in three years, including wages, supplies and contract research expenses. With proper accounting and guidance, this company’s net benefit in three years could be $1 million.

What’s new?

In October of 2016, new and final regulations for internal-use software (IUS) were issued effective for tax years ending on or after January 20, 2015. This included a narrowed definition of IUS and a clarification to two High Threshold of Innovation (HIT) tests for IUS. These new regulations are particularly important now because 2017 is the third tax year—the relevant timeline for credit eligibility. The recent developments create opportunities for all companies, especially those in the retail industry, that commit resources to developing software that interacts with third parties.