Good News Regarding Tooling Expenditures & The R&D Tax Credit

October 2018

Summary

A recent concession by the Internal Revenue Service allowed a taxpayer to include all of its tooling expenditures claimed as qualified research expenses (QREs) in the calculation of its R&D tax credit. Although this case cannot be cited as a precedent, it could bolster taxpayer R&D tax credit claims that include tooling expenditures.
 

Details

Tooling expenditures have been a disputed R&D tax credit issue for years. TG Missouri Corporation v. Commissioner (2009) upheld the taxpayer’s treatment of tooling expenditures as QREs. In doing so it refused to follow the IRS’s argument that because supply QREs can’t be made for property of a character subject to the allowance for depreciation, and tooling expenditures are made for such property, tooling expenditures can’t be QREs. Instead, TG Missouri held that they can be QREs because, in that case, the taxpayer didn’t own the tooling and therefore wasn’t in a position to depreciate it. Because the IRS didn’t challenge the taxpayer on the related issues of whether the tooling was used in qualified research and whether there was evidence sufficient to support that claim, the taxpayer in TG Missouri was entitled to the tooling QREs that it claimed.

More recently, the IRS has made such a challenge to a taxpayer.

The taxpayer in question is TSK of America, Inc. (TSK). TSK treated significant tooling expenditures as QREs. The IRS disallowed these QREs on the grounds that (1) there was not significant uncertainty surrounding the development of the tooling and (2) the tooling was for production purposes, not research purposes. TSK filed a petition with the U.S. Tax Court to litigate the disallowance. Instead of defending its position the IRS notified TSK in August 2018 that it was not going to dispute TSK’s credit claim.

Many observers had hoped and believed that this case would set a meaningful precedent regarding tooling expenditures. Now, many believe that the IRS was simply hedging its bets, preferring to wait for a case with a more favorable fact pattern in order to create precedent. With millions of dollars of reported tooling QREs at stake, many manufacturers are watching this issue closely.
 

BDO Insights

Although the concession does not set precedent, the IRS’s hesitation to litigate the case suggests it doesn’t see its position as strong in every possible case. There may be more room now for taxpayers with tooling expenditures to treat those expenses as QREs. Before doing so, such expenses should be discussed with an R&D tax credit expert who can help segregate qualified tooling expenditures from tooling QREs and ensure appropriate evidence regarding the qualified research in which the tooling was used is available.
 

CONTACT:

For more information, please contact one of the following practice leaders: 
 
Chris Bard
National Leader
Los Angeles
  Jonathan Forman
Principal
New York

 
Jim Feeser
Managing Director
Woodbridge
  Chad Paul
Partner
Milwaukee

 
Patrick Wallace
Partner
Atlanta
  David Wong
Partner
Los Angeles

 
Laura Morris
Managing Director
San Francisco
  Brad Poris
Managing Director
Long Island

 
Joe Furey
Managing Director
Chicago
  Gabe Rubio
Managing Director
Los Angeles