[Federal Register Volume 63, Number 231 (Wednesday, December 2, 1998)]
[Proposed Rules]
[Pages 66503-66512]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-31528]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-105170-97]
RIN 1545-AV14
Credit for Increasing Research Activities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations relating to the
computation of the credit under section 41(c) and the definition of
qualified research under section 41(d). The proposed regulations
reflect changes to section 41 made by the Tax Reform Act of 1986, the
Revenue Reconciliation Act of 1989, the Small Business Job Protection
Act of 1996, and the Taxpayer Relief Act of 1997. The proposed
regulations also provide certain technical amendments to the
regulations.
DATES: Written comments must be received no later than March 2, 1999.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105170-97), room
5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
105170-97), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Internet by selecting the ``Tax Regs''
option of the IRS Home Page, or by submitting comments directly to the
IRS Internet site at: http://www.irs.ustreas.gov/prod/tax_regs/
comments.html.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Lisa J. Shuman or Leslie H. Finlow at (202)622-3120 (not a toll-free
number); concerning submission of comments, the hearing, and/or to be
placed on the building access list to attend the hearing, La Nita Van
Dyke at (202)622-7190 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collection of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC
20224. Comments on the collection of information should be received by
March 2, 1999. Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the IRS, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
[[Page 66504]]
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
The collection of information in this proposed regulation is in
Secs. 1.41-4(a) and 1.41-8(b). The information is required by the IRS
to ensure that taxpayers have engaged in qualified research and to
ensure the proper computation of the credit for increasing research
activities under section 41. Section 1.41-4(a) defines a process of
experimentation, as required for credit eligibility, to include the
recording of the results of the experiments. This requirement imposes
no additional recordkeeping burden, because taxpayers engaging in a
bona fide process of experimentation already record the results in any
event (see discussion under Explanation of Provisions, 3.
Documentation, in this preamble). The information required by
Sec. 1.41-8 will be used to determine if the taxpayer has elected or
revoked the election to use the alternative incremental credit allowed
under section 41(c)(4). The collection of information is mandatory. The
likely respondents are businesses or other for-profit institutions and
organizations. Responses to this collection of information are required
to elect to use and to revoke the election to use the alternative
incremental credit computation allowed under section 41(c)(4).
The reporting burden contained in Sec. 1.41-8(b)(2) (relating to
the election of the alternative incremental credit) is reflected in the
burden of Form 6765.
Estimated total annual reporting burden under Sec. 1.41-8(b)(3)
(relating to the revocation of the election to use the alternative
incremental credit): 250 hours.
Estimated average annual burden hours per respondent: 50 hours.
Estimated number of respondents: 5.
Estimated frequency of responses: On occasion.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
The research credit provisions originally appeared in section 44F
of the Internal Revenue Code of 1954 (the 1954 Code), as added to the
1954 Code by section 221 of the Economic Recovery Tax Act of 1981.
Section 471(c) of the Tax Reform Act of 1984 redesignated section 44F
as section 30. Section 231 of the Tax Reform Act of 1986 (the 1986 Act)
redesignated section 30 as section 41 and substantially modified the
research credit provisions. The amendments made to section 41 by the
1986 Act primarily relate to the definition of qualified research in
section 41(d) and the computation of basic research payments under
section 41(e). The Revenue Reconciliation Act of 1989 (the 1989 Act),
the Revenue Reconciliation Act of 1993 (the 1993 Act), the Small
Business Job Protection Act of 1996 (the 1996 Act), and the Taxpayer
Relief Act of 1997 (the 1997 Act) also amended the research credit
provisions. These amendments primarily relate to the trade or business
requirement in section 41(b) and the computation of the credit under
sections 41(c) and 41(f).
On May 17, 1989, the IRS published in the Federal Register (54 FR
21203) final regulations under section 41. The 1989 final regulations
generally do not reflect the amendments to section 41 made by the 1986
Act, the 1989 Act, the 1993 Act, the 1996 Act, and the 1997 Act. The
amendments proposed by this document contain rules relating primarily
to the amendments to section 41(d) made by the 1986 Act. The amendments
proposed by this document also contain some rules relating to
amendments to section 41 made by the 1989 Act, the 1996 Act, and the
1997 Act.
On January 2, 1997, the IRS published in the Federal Register (62
FR 81) proposed regulations (the 1997 proposed regulations) under
section 41 describing when computer software that is developed by (or
for the benefit of) a taxpayer primarily for the taxpayer's internal
use can qualify for the credit for increasing research activities. The
1997 proposed regulations reflect a change to section 41 made by the
1986 Act. The proposed regulations set forth in this notice of proposed
rulemaking complement but otherwise do not affect the 1997 proposed
regulations.
The Tax and Trade Relief Extension Act of 1998 extended the
research credit from June 30, 1998 through June 30, 1999. In the
Conference Report, H.R. Rep. No. 105-825, at 1547-49 (1998), the
conferees address the scope of the term qualified research, comment on
an aspect of the process of experimentation requirement, and note a
lack of clarity in the interpretation of the distinction between
internal-use software and other software. These proposed regulations
reflect the views expressed by the conferees, as well as prior
legislative history, regarding the term qualified research and the
process of experimentation. The IRS and Treasury request comments on
the distinction between internal-use software and other software.
Explanation of Provisions
1. Qualified Research
Congress enacted the research credit to encourage business firms to
perform the research necessary to increase the innovative qualities and
efficiency of the U.S. economy. H.R. Rep. No. 99-426, at 177 (1985); S.
Rep. No. 99-313, at 694 (1986). In extending the research credit in the
1986 Act, Congress expressed concern that, in practice, taxpayers had
applied the existing definition of qualified research too broadly and
some taxpayers had claimed the credit for virtually any expense
relating to product development. H.R. Rep. No. 99-426, at 178; S. Rep.
No. 99-313, at 694-95. Many taxpayers claiming the credit were not in
industries that involved high technology or its application in
developing technologically new and improved products or methods of
production. H.R. Rep. No. 99-426, at 178; S. Rep. No. 99-313, at 695.
To address these concerns, Congress narrowed the scope of the
research credit by providing in the Internal Revenue Code (Code) an
express definition of the term qualified research. In determining
eligibility for the research credit, section 41(d) requires that
qualified research activities satisfy a multi-part test. First, the
taxpayer's expenditures must be eligible to be treated as expenses
under section 174. See Sec. 1.174-2(a)(1) (defining research and
experimental expenditures).
Second, the expenditures must relate to research undertaken for the
purpose of discovering information that is both technological in nature
and the application of which is intended to be useful in developing a
new or improved business component of the taxpayer. The proposed
regulations provide that research is undertaken for the purpose of
discovering information that is technological in nature only if the
research activities are undertaken to obtain knowledge that exceeds,
expands, or refines the common knowledge of skilled professionals in
the particular field of technology or
[[Page 66505]]
science and the process of experimentation utilized fundamentally
relies on principles of physical or biological sciences, engineering,
or computer science. Consistent with the requirement that the research
activities be undertaken to obtain knowledge that exceeds, expands, or
refines the common knowledge of skilled professionals in the particular
field of technology or science, the credit may be available where the
technological advance sought by the taxpayer is evolutionary, and, in
certain circumstances, where the taxpayer is not the first to achieve
the same advance. Moreover, the credit is available regardless of
whether the taxpayer succeeds or fails in achieving the desired
advance.
Third, section 41(d) requires that substantially all of the
activities of the research constitute elements of a process of
experimentation that relates to a new or improved function,
performance, reliability or quality. As noted in the previous
paragraph, the process of experimentation utilized must fundamentally
rely on principles of physical or biological sciences, engineering, or
computer science.
In developing a process of experimentation rule applicable to all
scientific disciplines, IRS personnel met with personnel from the
National Science Foundation and the National Institute of Standards and
Technology. The proposed regulation explains that a process of
experimentation is a process involving the evaluation of more than one
alternative designed to achieve a result where the means of achieving
that result are uncertain at the outset. This requires that the
taxpayer (i) develop one or more hypotheses designed to achieve the
intended result; (ii) design a scientific experiment (that, where
appropriate to the particular field of research, is intended to be
replicable with an established experimental control) to test and
analyze those hypotheses (through, for example, modeling, simulation,
or a systematic trial and error methodology); (iii) conduct the
experiment and record the results; and (iv) refine or discard the
hypotheses as part of a sequential design process to develop or improve
the business component.
The proposed regulation does not require that the results of the
experiments be recorded in any specific manner. The results of the
experiments should be recorded in a manner that is appropriate for the
particular field of science in which the experiment is conducted and
for the type of experimentation involved. In some fields, for example,
experiments are recorded in lab books. When developing computer
software, by contrast, the experiments might be recorded in comment
lines contained in the source code.
In the 1986 Act, Congress also specified that expenditures incurred
in certain research, research-related, or non-research activities are
not eligible for the credit. The excluded activities are: post-
production activities, adaptation, duplication, surveys and studies,
research outside the United States, research in the social sciences,
funded research, and research related to certain internal-use computer
software.
Section 1.41-4 of this proposed regulation contains rules that
clarify the definition of the term qualified research and other terms
used in section 41(d). The proposed regulation also provides rules
relating to activities for which the research credit is not allowed.
2. Application of Tests
In the legislative history to the 1986 Act, Congress stated that if
the requirements of section 41(d) are not met for an entire product,
the term business component means the most significant set of elements
of that product for which all the requirements of section 41(d) are
met. The legislative history provides that this ``shrinking back'' is
to continue until either a subset of elements of the product that
satisfies the requirements is reached, or the most basic element of the
product is reached and such element fails to satisfy the test.
Consistent with the legislative history, Sec. 1.41-4(b) of the
proposed regulation explains that the ``shrinking-back'' concept is the
method for applying the tests in section 41(d) to a business component.
3. Documentation
Taxpayers must (a) record the results of their scientific
experiments (in a manner that is appropriate for the particular field
of science in which the experiment is conducted and for the type of
experiment involved) and (b) comply with the recordkeeping requirements
of section 6001 and the regulations thereunder. The requirement that
taxpayers record the results of their scientific experiments is not
intended to cause taxpayers to create records that otherwise would not
be created. Rather, the recording of results is inherent in a process
of experimentation to discover information that is technological in
nature. Limiting the availability of the credit to taxpayers who record
the results of their scientific experiments is not intended to change
taxpayer behavior, but to identify taxpayers who engage in a bona fide
process of experimentation and thus may be eligible for the credit.
4. Election of the Alternative Incremental Credit
The notice of proposed rulemaking provides rules for electing the
alternative incremental credit, which may be elected under section
41(c)(4). Section 1.41-8 of the proposed regulation provides that the
election is made on Form 6765, ``Credit for Increasing Research
Activities,'' and that the completed form must be attached to the
taxpayer's timely filed original return (including extensions) for the
taxable year to which the election applies.
Proposed Effective Date
In general, the regulations are proposed to be effective for
expenditures paid or incurred on or after the date final regulations
are published in the Federal Register. The regulations addressing the
base amount are proposed to be effective for taxable years beginning on
or after the date final regulations are published in the Federal
Register. The regulations providing for the election and revocation of
the alternative incremental credit are proposed to be effective for
taxable years ending on or after the date final regulations are
published in the Federal Register. No inference should be drawn from
the proposed effective date concerning the application of section 41 to
expenditures paid or incurred or the computation of the base amount
before the proposed effective date.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations. It is hereby certified
that the collection of information contained in these regulations will
not have a significant economic impact on a substantial number of small
entities. Accordingly, a Regulatory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. This
certification is based on the information that follows. The economic
impact of the collection of information contained in these regulations
on any small entity would result from the entity being required: to (1)
Record the results of experiments related to its qualified research
activities, (2) elect on Form 6765 to use the alternative incremental
credit if the
[[Page 66506]]
entity desires to use that method, and (3) obtain permission to revoke
the alternative incremental credit election, if so desired. Because
taxpayers record results in conducting their research activities in any
event (see discussion under Explanation of Provisions, 3.
Documentation, in this preamble), the economic impact of the
recordkeeping requirement in the regulation would not be significant.
The economic impact of electing the alternative incremental credit on
Form 6765 also would not be significant because the election is made on
the same form and is based on the same information that is used to
claim the research credit. Pursuant to section 7805(f), this notice of
proposed rulemaking will be submitted to the Chief Counsel for Advocacy
of the Small Business Administration for comment on its impact on small
business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (preferably a
signed original and eight (8) copies) that are submitted timely (in the
manner described in the ADDRESSES portion of this preamble) to the IRS.
Submissions might include comments on the definition of gross receipts,
comments regarding the exclusion for post-production activities,
comments on whether and how the definition of a process of
experimentation should be refined to ensure that it is appropriate for
all scientific fields, and comments on the interaction of the discovery
requirement and the duplication exclusion and the effect of such
interaction on specific industries. Also, submissions might include
comments on clarifying the distinction between internal-use software
(i.e., software described in section 41(d)(4)(E)) and other software.
All comments will be available for public inspection and copying.
A public hearing will be scheduled in the Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC. The IRS
recognizes that persons outside the Washington, DC area also may wish
to testify at the public hearing through teleconferencing. Requests to
include teleconferencing sites must be received by January 16, 1999. If
the IRS receives sufficient indications of interest to warrant
teleconferencing to a particular city, and if the IRS has
teleconferencing facilities available in that city on the date the
public hearing is to be scheduled, the IRS will try to accommodate the
requests.
The IRS will publish the time and date of the public hearing and
the locations of any teleconferencing sites in an announcement in the
Federal Register. The announcement will include the date by which
persons that wish to present oral comments at the hearing must submit
requests to speak, outlines of the topics to be discussed, and the time
to be devoted to each topic.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information. The principal authors of these proposed
regulations are Lisa J. Shuman and Leslie H. Finlow of the Office of
the Assistant Chief Counsel (Passthroughs and Special Industries).
However, personnel from other offices of the IRS and the Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows.
(Note: These proposed amendments complement the proposed
amendments published at 62 FR 83, January 2, 1997.)
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Revise the undesignated centerheading immediately before
Sec. 1.30-1 to read as follows:
Credits Allowable Under Section 30 through 44B
Par. 3. Remove the undesignated centerheading immediately before
Sec. 1.41-0.
Par. 4. Section 1.41-0 is revised to read as follows:
Sec. 1.41-0 Table of contents.
This section lists the paragraphs contained in Secs. 1.41-0 through
1.41-8.
Sec. 1.41-0 Table of contents.
Sec. 1.41-1 Credit for increasing research activities.
(a) Basic principles.
(b) Amount of credit.
(c) Introduction to regulations under section 41.
Sec. 1.41-2 Qualified research expenses.
(a) Trade or business requirements.
(1) In general.
(2) New business.
(3) Research performed for others.
(i) Taxpayer not entitled to results.
(ii) Taxpayer entitled to results.
(4) Partnerships.
(i) In general.
(ii) Special rule for certain partnerships and joint ventures.
(b) Supplies and personal property used in the conduct of
qualified research.
(1) In general.
(2) Certain utility charges.
(i) In general.
(ii) Extraordinary expenditures.
(3) Right to use personal property.
(4) Use of personal property in taxable years beginning after
December 31, 1985.
(c) Qualified services.
(1) Engaging in qualified research.
(2) Direct supervision.
(3) Direct support.
(d) Wages paid for qualified services.
(1) In general.
(2) ``Substantially all.''
(e) Contract research expenses.
(1) In general.
(2) Performance of qualified research.
(3) ``On behalf of.''
(4) Prepaid amounts.
(5) Examples.
Sec. 1.41-3 Base amount for taxable years beginning on or after
the date final regulations are published in the Federal Register.
(a) and (b) [Reserved]
(c) Definition of gross receipts.
(1) In general.
(2) Amounts excluded.
(3) Foreign corporations.
(d) Consistency requirement.
(1) In general.
(2) Illustrations.
Sec. 1.41-4 Qualified research for expenditures paid or incurred
on or after the date final regulations are published in the Federal
Register.
(a) Qualified research.
(1) General rule.
(2) Requirements of section 41(d)(1).
(3) Discovering information.
(4) Technological in nature.
(5) Process of experimentation.
(6) Substantially all requirement.
(7) Use of computers and information technology.
(8) Illustrations.
(b) Application of requirements for qualified research.
(1) In general.
(2) Shrinking-back rule.
(3) Illustration.
(c) Excluded activities.
(1) In general.
(2) Research after commercial production.
(i) In general.
(ii) Certain additional activities related to the business
component.
(iii) Activities related to production process or technique.
(3) Adaptation of existing business components.
(4) Duplication of existing business component.
(5) Surveys, studies, research relating to management functions,
etc.
[[Page 66507]]
(6) Internal-use computer software.
(7) Activities outside the United States.
(i) In general.
(ii) Apportionment of in-house research expenses.
(iii) Apportionment of contract research expenses.
(8) Research in the social sciences, etc.
(9) Research funded by any grant, contract, or otherwise.
(10) Illustrations.
(d) Documentation.
Sec. 1.41-5 Basic research for taxable years beginning after
December 31, 1986. [Reserved]
Sec. 1.41-6 Aggregation of expenditures.
(a) Controlled group of corporations; trades or businesses under
common control.
(1) In general.
(2) Definition of trade or business.
(3) Determination of common control.
(4) Examples.
(b) Minimum base period research expenses.
(c) Tax accounting periods used.
(1) In general.
(2) Special rule where timing of research is manipulated.
(d) Membership during taxable year in more than one group.
(e) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease payments.
(5) Payment for supplies.
Sec. 1.41-7 Special rules.
(a) Allocations.
(1) Corporation making an election under subchapter S.
(i) Pass-through for taxable years beginning after December 31,
1982, in the case of an S corporation.
(ii) Pass-through, for taxable years beginning before January 1,
1983, in the case of a subchapter S corporation.
(2) Pass-through in the case of an estate or trust.
(3) Pass-through in the case of a partnership.
(i) In general.
(ii) Certain expenditures by joint ventures.
(4) Year in which taken into account.
(5) Credit allowed subject to limitation.
(b) Adjustments for certain acquisitions and dispositions--
Meaning of terms.
(c) Special rule for pass-through of credit.
(d) Carryback and carryover of unused credits.
Sec. 1.41-8 Special rules for taxable years ending on or after the
date final regulations are published in the Federal Register.
(a) Alternative incremental credit.
(b) Election.
(1) In general.
(2) Time and manner.
(3) Revocation.
Par. 5. Section 1.41-1 is revised to read as follows:
Sec. 1.41-1 Credit for increasing research activities.
(a) Basic principles. Section 41 provides a credit for increasing
research activities. The credit is intended to encourage business firms
to perform the technological research necessary to increase the
innovative qualities and efficiency of the U.S. economy. The credit
provides an incentive for business firms to increase their expenditures
for research to obtain new knowledge through a scientific process of
experimentation. Consequently, the credit is not to be applied too
broadly or in a manner such that virtually any expense relating to the
development of a product is eligible for the credit, even if some
portion of the expense of developing the product does qualify for the
credit. Similarly, the credit is not available for an expenditure
merely because the expenditure may be treated as an expense under
section 174. On the other hand, the credit may be available even though
the technological advance sought by the taxpayer is evolutionary, and,
in certain circumstances, even if another taxpayer has previously
achieved the same advance. Moreover, the credit is available regardless
of whether the taxpayer succeeds or fails in achieving the desired
advance. The credit is limited to eligible expenditures paid or
incurred for qualified research, as defined in section 41(d) and
Sec. 1.41-4.
(b) Amount of credit. The amount of a taxpayer's credit is
determined under section 41(a). For taxable years beginning after June
30, 1996, and at the election of the taxpayer, the portion of the
credit determined under section 41(a)(1) may be calculated using the
alternative incremental credit set forth in section 41(c)(4).
(c) Introduction to regulations under section 41. (1) Sections
1.41-2 through 1.41-8 and 1.41-3A through 1.41-5A address only certain
provisions of section 41. The following table identifies the provisions
of section 41 that are addressed, and lists each provision with the
section of the regulations in which it is covered.
------------------------------------------------------------------------
Section of the Internal
Section of the regulation Revenue Code
------------------------------------------------------------------------
Sec. 1.41-2............................ 41(b)
Sec. 1.41-3............................ 41(c)
Sec. 1.41-4............................ 41(d)
Sec. 1.41-5............................ 41(e)
Sec. 1.41-6............................ 41(f)
Sec. 1.41-7............................ 41(f)
41(g)
Sec. 1.41-8............................ 41(c)
Sec. 1.41-3A........................... 41(c) (taxable years beginning
before January 1, 1990)
Sec. 1.41-4A........................... 41(d) (taxable years beginning
before January 1, 1986)
Sec. 1.41-5A........................... 41(e) (taxable years beginning
before January 1, 1987)
------------------------------------------------------------------------
(2) Section 1.41-3A also addresses the special rule in section
221(d)(2) of the Economic Recovery Tax Act of 1981 relating to taxable
years overlapping the effective dates of section 41. Section 41 was
formerly designated sections 30 and 44F. Sections 1.41-0 through 1.41-8
and 1.41-0A through 1.41-5A refer to these sections as section 41 for
conformity purposes. Whether section 41, former section 30, or former
section 44F applies to a particular expenditure depends upon when the
expenditure was paid or incurred.
Sec. 1.41-2 [Amended]
Par. 6. Section 1.41-2 is amended as follows:
1. The last sentence of paragraph (a)(3)(i) is amended by removing
the language ``Sec. 1.41-5(d)(2)'' and adding ``Sec. 1.41-4A(d)(2)'' in
its place.
2. The last sentence of paragraph (a)(3)(ii) is amended by removing
the language ``Sec. 1.41-5(d)(3)'' and adding ``Sec. 1.41-4A(d)(3)'' in
its place.
3. The last sentence of paragraph (a)(4)(ii)(F) is amended by
removing the language ``Sec. 1.41-9(a)(3)(ii)'' and adding ``Sec. 1.41-
7(a)(3)(ii)'' in its place.
4. Paragraph (e)(1)(i) is amended by removing the language
``Sec. 1.41-5'' and adding ``Sec. 1.41-4 or 1.41-4A, whichever is
applicable'' in its place.
Par. 7. An undesignated centerheading is added immediately
following Sec. 1.44B-1 to read as follows:
Research Credit--For Taxable Years Beginning Before January 1, 1990
Sec. 1.41-3 [Redesignated as Sec. 1.41-3A]
Par. 8. Section 1.41-3 is redesignated as Sec. 1.41-3A and added
under the new undesignated centerheading ``Research Credit--For Taxable
Years Beginning Before January 1, 1990.''
Par. 9. New Sec. 1.41-3 is added to read as follows:
Sec. 1.41-3 Base amount for taxable years beginning on or after the
date final regulations are published in the Federal Register.
(a) and (b) [Reserved]
(c) Definition of gross receipts--(1) In general. For purposes of
section 41, gross receipts means the total amount, as determined under
the taxpayer's method of accounting, derived by the taxpayer from all
its activities and from all sources (e.g., revenues derived from
[[Page 66508]]
the sale of inventory before reduction for cost of goods sold).
(2) Amounts excluded. For purposes of this paragraph (c), gross
receipts do not include amounts representing--
(i) Returns or allowances;
(ii) Receipts from the sale or exchange of capital assets, as
defined in section 1221;
(iii) Repayments of loans or similar instruments (e.g., a repayment
of the principal amount of a loan held by a commercial lender);
(iv) Receipts from a sale or exchange not in the ordinary course of
business, such as the sale of an entire trade or business or the sale
of property used in a trade or business as defined under section
1221(2); and
(v) Amounts received with respect to sales tax or other similar
state and local taxes if, under the applicable state or local law, the
tax is legally imposed on the purchaser of the good or service, and the
taxpayer merely collects and remits the tax to the taxing authority.
(3) Foreign corporations. For purposes of section 41, in the case
of a foreign corporation, gross receipts include only gross receipts
that are effectively connected with the conduct of a trade or business
within the United States. See section 864(c) and applicable regulations
thereunder for the definition of effectively connected income.
(d) Consistency requirement--(1) In general. In computing the
credit for increasing research activities for taxable years beginning
after December 31, 1989, qualified research expenses and gross receipts
taken into account in computing a taxpayer's fixed-base percentage and
a taxpayer's base amount must be determined on a basis consistent with
the definition of qualified research expenses and gross receipts for
the credit year, without regard to the law in effect for the taxable
years taken into account in computing the fixed-base percentage or the
base amount. This consistency requirement applies even if the period
for filing a claim for credit or refund has expired for any taxable
year taken into account in computing the fixed-base percentage or the
base amount.
(2) Illustrations. The following examples illustrate the
application of the consistency rule of paragraph (d)(1) of this
section:
Example 1. (i) X, an accrual method taxpayer using the calendar
year as its taxable year, incurs qualified research expenses in
1990. X wants to compute its research credit under section 41 for
the tax year ending December 31, 1990. As part of the computation, X
must determine its fixed-base percentage, which depends in part on
X's qualified research expenses incurred during the fixed-base
period, the taxable years beginning after December 31, 1983, and
before January 1, 1989.
(ii) During the fixed-base period, X reported the following
amounts as qualified research expenses on its Form 6765:
1984........................................................... $100x
1985........................................................... 120x
1986........................................................... 150x
1987........................................................... 180x
1988........................................................... 170x
--------
Total...................................................... $720x
(iii) For the taxable years ending December 31, 1984, and
December 31, 1985, X based the amounts reported as qualified
research expenses on the definition of qualified research in effect
for those taxable years. The definition of qualified research
changed for taxable years beginning after December 31, 1985. If X
used the definition of qualified research applicable to its taxable
year ending December 31, 1990, the credit year, its qualified
research expenses for the taxable years ending December 31, 1984,
and December 31, 1985, would be reduced to $80x and $100x,
respectively. Under the consistency rule in section 41(c)(5) and
paragraph (d)(1) of this section, to compute the research credit for
the tax year ending December 31, 1990, X must reduce its qualified
research expenses for 1984 and 1985 to reflect the change in the
definition of qualified research for taxable years beginning after
December 31, 1985. Thus, X's total qualified research expenses for
the fixed-base period (1984-1988) to be used in computing the fixed-
base percentage is $80 + 100 + 150 + 180 + 170 = $680x.
Example 2. The facts are the same as in Example 1, except that,
in computing its qualified research expenses for the taxable year
ending December 31, 1999, X claimed that a certain type of
expenditure incurred in 1999 was a qualified research expense. X's
claim reflected a change in X's position, because X had not
previously claimed that similar expenditures were qualified research
expenses. The consistency rule requires X to adjust its qualified
research expenses in computing the fixed-base percentage to include
any similar expenditures not treated as qualified research expenses
during the fixed-base period, regardless of whether the period for
filing a claim for credit or refund has expired for any year taken
into account in computing the fixed-base percentage.
Par. 10. Section 1.41-4 is revised to read as follows:
Sec. 1.41-4 Qualified research for expenditures paid or incurred on or
after the date final regulations are published in the Federal Register.
(a) Qualified research--(1) General rule. Research activities
related to the development or improvement of a business component
constitute qualified research only if the research activities meet all
of the requirements of section 41(d)(1) and this section, and are not
otherwise excluded under section 41(d)(3)(B) or (4), or this section.
(2) Requirements of section 41(d)(1). Research constitutes
qualified research only if it is research--
(i) With respect to which expenditures may be treated as expenses
under section 174, see Sec. 1.174-2;
(ii) That is undertaken for the purpose of discovering information
that is technological in nature, and the application of which is
intended to be useful in the development of a new or improved business
component of the taxpayer; and
(iii) Substantially all of the activities of which constitute
elements of a process of experimentation that relates to a new or
improved function, performance, reliability or quality.
(3) Discovering information. For purposes of section 41(d) and this
section, the term discovering information means obtaining knowledge
that exceeds, expands, or refines the common knowledge of skilled
professionals in a particular field of technology or science.
(4) Technological in nature. For purposes of section 41(d) and this
section, information is technological in nature if the process of
experimentation used to discover such information fundamentally relies
on principles of physical or biological sciences, engineering, or
computer science.
(5) Process of experimentation. For purposes of section 41(d) and
this section, a process of experimentation is a process to evaluate
more than one alternative designed to achieve a result where the means
of achieving that result are uncertain at the outset. A process of
experimentation in the physical or biological sciences, engineering, or
computer science requires that the taxpayer--
(i) Develop one or more hypotheses designed to achieve the intended
result;
(ii) Design a scientific experiment (that, where appropriate to the
particular field of research, is intended to be replicable with an
established experimental control) to test and analyze those hypotheses
(through, for example, modeling, simulation, or a systematic trial and
error methodology);
(iii) Conduct the experiment and record the results; and
(iv) Refine or discard the hypotheses as part of a sequential
design process to develop or improve the business component.
(6) Substantially all requirement. The substantially all
requirement of section 41(d)(1)(C) and paragraph (a)(2)(iii) of this
section is satisfied only if 80 percent or more of the research
activities, measured on a cost or other
[[Page 66509]]
consistently applied reasonable basis, constitute elements of a process
of experimentation for a purpose described in section 41(d)(3). The
substantially all requirement is applied separately to each business
component.
(7) Use of computers and information technology. The employment of
computers or information technology, or the reliance on principles of
computer science or information technology to store, collect,
manipulate, translate, disseminate, produce, distribute, or process
data or information, and similar uses of computers and information
technology does not itself establish that qualified research has been
undertaken.
(8) Illustrations. The following examples illustrate the
application of paragraph (a) of this section:
Example 1. (i) Facts. X undertakes to develop for sale a tool
that would improve its suite of application development products.
The desired tool would handle connectivity problems for software
application developers by providing data access via a layer of
software that is more effective than existing software at finding
data in various locations and forms within a network, translating it
if need be, and then delivering the result to whatever application
or user requested it. The means of developing such versatile
database access middleware are not in the common knowledge of
skilled professionals in the relevant technological fields. In order
to determine whether it can successfully develop the desired tool, X
develops, tests, and discards or refines various algorithms and
protocols.
(ii) Conclusion. X's activities to develop the technology to
build the new software development tool may be qualified research
within the meaning of section 41(d)(1) and paragraph (a) of this
section. In developing the technology, X undertook to obtain
knowledge that exceeds, expands, or refines the common knowledge of
skilled professionals in the relevant technological fields.
Example 2. (i) Facts. X acquired a new software environment,
including a new operating system and a new database management
system with related tools. X undertook a project to redeploy its
data processing systems to the new software environment. X
anticipated that, relative to the old system, the new system would
significantly increase the time-sharing capabilities of its computer
system. The project activities included redesign of databases and
user interfaces, and translation of code from one programming
language to another. In migrating to the new software environment, X
relied on techniques and approaches that were within the common
knowledge of skilled professionals in the relevant technological
fields.
(ii) Conclusion. X's activities to redeploy its data processing
systems to the new software environment are not qualified research
within the meaning of section 41(d)(1) and paragraph (a) of this
section. X did not undertake to obtain knowledge that exceeds,
expands, or refines the common knowledge of skilled professionals in
the relevant technological fields.
Example 3. (i) Facts. X operates a computer system that does not
recognize dates beginning in the year 2000. In order to ensure that
its computer system will not malfunction in the year 2000, X incurs
substantial costs having its employees manually search its computer
programs to find all date fields used in the programs and replace
all of the date fields with year 2000 compliant date fields.
(ii) Conclusion. Because the activities of X's employees were
not undertaken to obtain knowledge that exceeds, expands, or refines
the common knowledge of skilled professionals in the relevant
technological fields and do not involve a process of
experimentation, the activities are not qualified research within
the meaning of section 41(d)(1) and paragraph (a) of this section.
Example 4. (i) Facts. X is engaged in the business of developing
and manufacturing widgets. X wants to manufacture an improved widget
made out of a material that X has not previously used. Although X is
uncertain how to use the material to manufacture an improved widget,
the viability and means of using the material to manufacture such
widgets are within the common knowledge of skilled professionals in
the relevant technological fields.
(ii) Conclusion. Even though X's expenditures for the activities
to resolve the uncertainty in manufacturing the improved widget may
be treated as expenses for research activities under section 174 and
Sec. 1.174-2, X's activities to resolve the uncertainty in
manufacturing the improved widget are not qualified research within
the meaning of section 41(d) and paragraph (a) of this section.
Although X's activities were intended to eliminate uncertainty, the
activities were not undertaken to obtain knowledge that exceeds,
expands, or refines the common knowledge of skilled professionals in
the relevant technological fields.
Example 5. (i) Facts. X desires to build a bridge that can
sustain greater traffic flow without deterioration than can existing
bridges. The technology used to build such a bridge is not in the
common knowledge of skilled professionals in the relevant
technological fields. X eventually abandons the project after
attempts to develop the technology prove unsuccessful.
(ii) Conclusion. X's activities to develop the technology to
build the bridge may be qualified research within the meaning of
section 41(d)(1) and paragraph (a) of this section, regardless of
the fact that X did not actually succeed in developing that
technology. In seeking to develop the technology, X undertook to
obtain knowledge that exceeds, expands, or refines the common
knowledge of skilled professionals in the relevant technological
fields.
Example 6. (i) Facts. The facts are the same as in Example 5,
except that Y successfully builds a bridge that can sustain the
greater traffic flow. Thereafter, Z seeks to build a bridge that can
also sustain such greater traffic flow. The technology used by Y to
build its bridge is a closely guarded secret that is not known to Z
and remains beyond the common knowledge of skilled professionals in
the relevant technological fields.
(ii) Conclusion. Z's activities to develop the technology to
build the bridge may be qualified research within the meaning of
section 41(d)(1) and paragraph (a) of this section, even if it so
happens that the technology used by Z to build its bridge is similar
or identical to the technology used by Y. In developing the
technology, Z undertook to obtain knowledge that exceeds, expands,
or refines the common knowledge of skilled professionals in the
relevant technological fields.
Example 7. (i) Facts. X and other manufacturing companies have
previously designed and manufactured a particular kind of machine
using Material S. Material T is less expensive than Material S. X
wishes to design a new machine that appears and functions exactly
the same as its existing machines, but that is made of Material T
instead of Material S. The technology necessary to achieve this
objective is not within the common knowledge of skilled
professionals in the relevant technological fields.
(ii) Conclusion. X's activities to design the new machine using
Material T may be qualified research within the meaning of section
41(d)(1) and paragraph (a) of this section. In seeking to design the
machine, X undertook to obtain knowledge that exceeds, expands, or
refines the common knowledge of skilled professionals in the
relevant technological fields.
Example 8. (i) Facts. X, a tire manufacturer, seeks to build a
tire that will not deteriorate as rapidly under certain conditions
of high speed and temperature as do existing tires. The design of
such a tire is not within the common knowledge of skilled
professionals in the relevant technological fields. X commences
laboratory research on January 1. On April 1, X determines in the
laboratory that a certain combination of materials and additives can
withstand higher rotational speeds and temperatures than the
combination of materials and additives used in existing tires. On
the basis of this determination, X undertakes further research
activities to determine how to design a tire using those materials
and additives, and to determine whether such a tire functions
outside the laboratory as intended under various actual road
conditions. By September 1, but not prior to September 1, X's
research has progressed to the point where, applying X's knowledge
to date, both the viability and means of producing the desired tire
would be within the common knowledge of skilled professionals in the
relevant technological fields. However, X continues to engage in
certain research activities related to the tire after September 1,
and until the first tire rolls off the assembly line on December 1.
(ii) Conclusion. Some or all of X's research activities until
September 1 may be qualified research within the meaning of section
41(d)(1) and paragraph (a) of this section. In seeking to design the
tire, X undertook to obtain knowledge that exceeds, expands, or
refines the common knowledge of skilled professionals in the
relevant technological
[[Page 66510]]
fields. The activities conducted after September 1 are not qualified
research within the meaning of section 41(d)(1) and paragraph (a) of
this section, because those activities were not undertaken to obtain
knowledge that exceeds, expands, or refines the common knowledge of
skilled professionals in the relevant technological fields.
(b) Application of requirements for qualified research--(1) In
general. The requirements for qualified research in section 41(d)(1)
and paragraph (a) of this section, must be applied separately to each
business component, as defined in section 41(d)(2)(B). In cases
involving development of both a product and a manufacturing or other
commercial production process for the product, research activities
relating to development of the process are not qualified research
unless the requirements of section 41(d) and this section are met for
the research activities relating to the process without taking into
account the research activities relating to development of the product.
Similarly, research activities relating to development of the product
are not qualified research unless the requirements of section 41(d) and
this section are met for the research activities relating to the
product without taking into account the research activities relating to
development of the manufacturing or other commercial production
process.
(2) Shrinking-back rule. The requirements of section 41(d) and
paragraph (a) of this section are to be applied first at the level of
the discrete business component to be held for sale, lease or license,
or used by the taxpayer in a trade or business of the taxpayer. If all
aspects of the requirements are not met at the first level, the
requirements are to be applied at the next most significant subset of
elements of the business component. The shrinking-back of the
applicable business component continues until a subset of elements of
the business component satisfies the requirements of section 41(d) and
paragraph (a) of this section (treating that subset of elements as a
business component) or the most basic element fails to satisfy the
requirements.
(3) Illustration. The following example illustrates the application
of this paragraph (b):
Example. X, a motorcycle engine builder, develops a new
carburetor for use in a motorcycle engine. X also modifies an
existing engine design for use with the new carburetor. Under the
shrinking-back rule, the requirements of section 41(d)(1) and
paragraph (a) of this section are applied first to the engine. If
the modifications to the engine when viewed as a whole, including
the development of the new carburetor, do not satisfy the
requirements of section 41(d)(1) and paragraph (a) of this section,
those requirements are applied to the next most significant subset
of elements of the business component. For purposes of this example,
it is assumed that the new carburetor is the next most significant
subset of elements of the business component. The research
activities in developing the new carburetor may constitute qualified
research within the meaning of section 41(d)(1) and paragraph (a) of
this section.
(c) Excluded activities--(1) In general. Qualified research does
not include any activity described in sections 41(d)(3)(B) and (4),
this paragraph (c), and paragraph (e) of this section.
(2) Research after commercial production--(i) In general.
Activities conducted after the beginning of commercial production of a
business component are not qualified research. Activities are conducted
after the beginning of commercial production of a business component if
such activities are conducted after the component is developed to the
point where it is ready for commercial sale or use, or meets the basic
functional and economic requirements of the taxpayer for the
component's sale or use.
(ii) Certain additional activities related to the business
component. The following activities are deemed to occur after the
beginning of commercial production of a business component--
(A) Preproduction planning for a finished business component;
(B) Tooling-up for production;
(C) Trial production runs;
(D) Trouble shooting involving detecting faults in production
equipment or processes;
(E) Accumulating data relating to production processes; and
(F) Debugging or correcting flaws in a business component.
(iii) Activities related to production process or technique. In
cases involving development of both a product and a manufacturing or
other commercial production process for the product, the exclusion
described in section 41(d)(4)(A) and paragraphs (c)(2)(i) and (ii) of
this section applies separately for the activities relating to the
development of the product and the activities relating to the
development of the process. For example, even after a product meets the
taxpayer's basic functional and economic requirements, activities
relating to the development of the manufacturing process still may
constitute qualified research, provided that the development of the
process itself separately satisfies the requirements of section 41(d)
and this section, and the activities are conducted before the process
meets the taxpayer's basic functional and economic requirements or is
ready for commercial use.
(3) Adaptation of existing business components. Activities relating
to adapting an existing business component to a particular customer's
requirement or need are not qualified research. This exclusion does not
apply merely because a business component is intended for a specific
customer.
(4) Duplication of existing business component. Activities relating
to reproducing an existing business component (in whole or in part)
from a physical examination of the business component itself or from
plans, blueprints, detailed specifications, or publicly available
information about the business component are not qualified research.
This exclusion does not apply merely because the taxpayer inspects an
existing business component in the course of developing its own
business component.
(5) Surveys, studies, research relating to management functions,
etc. Qualified research does not include activities relating to--
(i) Efficiency surveys;
(ii) Management functions (except for the direct supervision of
qualified research as defined in Sec. 1.41-2(c)(2)) or techniques,
including such items as preparation of financial data and analysis,
development of employee training programs and management organization
plans, and management-based changes in production processes (such as
rearranging work stations on an assembly line);
(iii) Market research, testing, or development (including
advertising or promotions);
(iv) Routine data collections; or
(v) Routine or ordinary testing or inspections for quality control.
(6) Internal-use computer software. [Reserved] \1\
---------------------------------------------------------------------------
\1\ Section 1.41-4(e), proposed on January 2, 1997 (62 FR 83),
including any revisions to that proposed rule will be incorporated
as this paragraph (c)(6) in the final rule.
---------------------------------------------------------------------------
(7) Activities outside the United States--(i) In general. Research
conducted outside the United States, as defined in section 7701(a)(9),
does not constitute qualified research.
(ii) Apportionment of in-house research expenses. In-house research
expenses paid or incurred for qualified services performed both in the
United States and outside the United States must be apportioned between
the services performed in the United States and the services performed
outside the United States. Only those in-house research expenses
apportioned to the
[[Page 66511]]
services performed within the United States are eligible to be treated
as qualified research expenses, unless the in-house research expenses
are wages and the 80 percent rule of Sec. 1.41-2(d)(2) applies.
(iii) Apportionment of contract research expenses. If contract
research is performed partly in the United States and partly outside
the United States, only 65 percent (or 75 percent in the case of
amounts paid to qualified research consortia) of the portion of the
contract amount that is attributable to the research activity performed
in the United States may qualify as a contract research expense (even
if 80 percent or more of the contract amount is for research performed
in the United States).
(8) Research in the social sciences, etc. Qualified research does
not include research in the social sciences (including economics,
business management, and behavioral sciences), arts, or humanities.
(9) Research funded by any grant, contract, or otherwise. Qualified
research does not include any research to the extent funded by any
grant, contract, or otherwise by another person (or governmental
entity). To determine the extent to which research is so funded,
Sec. 1.41-4A(d) applies.
(10) Illustrations. The following examples illustrate provisions
contained in paragraphs (c)(1) through (9) of this section. No
inference should be drawn from these examples concerning the
application of section 41(d)(1) and paragraph (a) of this section to
these facts:
Example 1. (i) Facts. X, a pharmaceutical company, performs
additional clinical tests on one of its products after that product
has been approved for a specific therapeutic use by the FDA and is
ready for commercial production and sale. The clinical tests study
the drug's long-term morbidity and mortality profile, and are
undertaken to develop information to use in the marketing materials
for the drug.
(ii) Conclusion. Because the additional tests are performed
after the drug is ready for commercial sale, X's activities in
connection with the tests are excluded from the definition of
qualified research under section 41(d)(4)(A) and paragraph (c)(2) of
this section.
Example 2. (i) Facts. The facts are the same as in Example 1,
except that, while studying the long-term morbidity and mortality
profile of the drug product, X discovers that the product may be
useful in treating a different medical condition. X begins new
clinical studies to establish the compound's new potential
therapeutic use.
(ii) Conclusion. Because the new clinical studies are performed
to establish a new therapeutic use of the drug product, the
additional clinical studies performed to establish the new
therapeutic use are not excluded from the definition of qualified
research under section 41(d)(4)(A) and paragraph (c)(2) of this
section.
Example 3. (i) Facts. X, a domestic corporation that
manufactures paper, develops and markets a new type of paper
containing a different chemical composition than the paper generally
available for commercial sale. Prior to manufacturing the paper, X
conducts preproduction planning for the finished paper product,
tools up for production, conducts trial production runs, engages in
trouble shooting involving detecting problems in production
equipment, accumulates production process data, and debugs the
product.
(ii) Conclusion. X's activities of preproduction planning,
tooling up for production, trial production runs, trouble shooting,
accumulation of production process data, and product debugging do
not constitute qualified research with respect to development of the
paper product because the activities are deemed to occur after the
beginning of commercial production of the product. Whether any
activities engaged in by X to develop a process for manufacturing
the paper constitute qualified research depends on whether the
development of the process itself separately satisfies the
requirements of section 41(d) and this section, and whether the
process meets the taxpayer's basic functional and economic
requirements or is ready for commercial use.
Example 4. (i) Facts. X, a computer software development firm,
owns all substantial rights in a general ledger accounting software
core program that X markets and licenses to customers. After
entering into a contractual agreement with a customer, X incurs
expenditures in modifying the core software program to adapt the
program to the customer's requirement or need.
(ii) Conclusion. Because X's activities represent activities to
modify an existing software program to adapt the program to a
particular customer's requirement, X's activities are excluded from
the definition of qualified research under section 41(d)(4)(B) and
paragraph (c)(3) of this section.
Example 5. (i) Facts. An existing gasoline additive is
manufactured by Y using three ingredients, A, B, and C. X seeks to
develop and manufacture its own gasoline additive that appears and
functions in a manner similar to Y's additive. To develop its own
additive, X first inspects the composition of Y's additive, and uses
knowledge gained from the inspection to reproduce A and B in the
laboratory. Any differences between ingredients A and B that are
used in Y's additive and those reproduced by X are insignificant and
are not material to the viability, effectiveness, or cost of A and
B. X desires to use with A and B an ingredient that has a materially
lower cost than ingredient C. Accordingly, X engages in a process of
experimentation to discover potential alternative formulations of
the additive (i.e., the development and use of various ingredients
other than C to use with A and B).
(ii) Conclusion. X's activities in analyzing and reproducing
ingredients A and B involve duplication of existing business
components and are excluded from qualified research under section
41(d)(4)(C) and paragraph (c)(4) of this section. X's
experimentation activities to discover potential alternative
formulations of the additive do not involve duplication of an
existing business component and are not excluded from qualified
research under section 41(d)(4)(C) and paragraph (c)(4) of this
section.
Example 6. (i) Facts. X, an appliance manufacturer, rearranges
employee work stations in its manufacturing assembly line and
develops a new employee training program to train employees for the
rearranged work stations.
(ii) Conclusion. X's activities associated with rearranging the
work stations and developing a new employee training program
represent activities related to management functions or techniques
and are excluded from qualified research under section 41(d)(4)(D)
and paragraph (c)(5) of this section.
Example 7. (i) Facts. X, an insurance company, develops a new
life insurance product. In the course of developing the product, X
engages in research with respect to the effect of pricing and tax
consequences on demand for the product, the expected volatility of
interest rates, and the expected mortality rates (based on published
data and prior insurance claims).
(ii) Conclusion. X's activities related to the new product
represent research in the social sciences, and are thus excluded
from qualified research under section 41(d)(4)(G) and paragraph
(c)(7) of this section.
(d) Documentation. See section 6001 and the regulations thereunder
for the recordkeeping requirements that must be satisfied.
Sec. 1.41-5 [Redesignated as Sec. 1.41-4A, and Amended]
Par. 11. Section 1.41-5 is redesignated as Sec. 1.41-4A, and the
last sentence of paragraph (d)(1) is amended by removing the language
``Sec. 1.41-8(e)'' and adding ``Sec. 1.41-6(e)'' in its place.
Sec. 1.41-6 [Redesignated as Sec. 1.41-5 and Amended]
Par. 12. Section 1.41-6 is redesignated as Sec. 1.41-5 and the
section heading is amended by removing the language ``December 31,
1985'' and adding ``December 31, 1986'' in its place.
Sec. 1.41-7 [Redesignated as Sec. 1.41-5A, and Amended]
Par. 13. Section 1.41-7 is redesignated as Sec. 1.41-5A, and
amended as follows:
1. The section heading is amended by removing the language
``January 1, 1986'' and adding ``January 1, 1987'' in its place.
2. Paragraph (e)(2) is amended by removing the language
``Sec. 1.41-5(c)'' and adding ``1.41-4A(c)'' in its place.
[[Page 66512]]
Sec. 1.41-8 [Redesignated as Sec. 1.41-6, and Amended]
Par. 14. Section 1.41-8 is redesignated as Sec. 1.41-6, and the
last sentence of paragraph (c) is amended by removing the language
``Sec. 1.41-3, except that Sec. 1.41-3(c)(2)'' and adding ``Sec. 1.41-
3A, except that Sec. 1.41-3A(c)(2)'' in its place.
Sec. 1.41-9 [Redesignated as Sec. 1.41-7]
Par. 15. Section 1.41-9 is redesignated as Sec. 1.41-7.
Par. 16. New Sec. 1.41-8 is added to read as follows:
Sec. 1.41-8 Special rules for taxable years ending on or after the
date final regulations are published in the Federal Register.
(a) Alternative incremental credit. At the election of the
taxpayer, the credit determined under section 41(a)(1) equals the
amount determined under section 41(c)(4).
(b) Election--(1) In general. A taxpayer may elect to apply the
provisions of the alternative incremental credit in section 41(c)(4)
for any taxable year of the taxpayer beginning after June 30, 1996. If
a taxpayer makes an election under section 41(c)(4), the election
applies to the taxable year for which made and all subsequent taxable
years.
(2) Time and manner of election. An election under section 41(c)(4)
is made by completing the portion of Form 6765, ``Credit for Increasing
Research Activities,'' relating to the election of the alternative
incremental credit, and attaching the completed form to the taxpayer's
timely filed original return (including extensions) for the taxable
year to which the election applies.
(3) Revocation. An election under this section may not be revoked
except with the consent of the Commissioner. A taxpayer must attach the
Commissioner's consent to revoke an election under section 41(c)(4) to
the taxpayer's timely filed original return (including extensions) for
the taxable year of the revocation.
Par. 17. Section 1.41-0A is added under the new undesignated
centerheading ``Research Credit--For Taxable Years Beginning Before
January 1, 1990'' to read as follows:
Sec. 1.41-0A Table of contents.
This section lists the paragraphs contained in Secs. 1.41-0A, 1.41-
3A, 1.41-4A and 1.41-5A.
Sec. 1.41-0A Table of contents.
Sec. 1.41-3A Base period research expenses.
(a) Number of years in base period.
(b) New taxpayers.
(c) Definition of base period research expenses.
(d) Special rules for short taxable years.
(1) Short determination year.
(2) Short base period year.
(3) Years overlapping the effective dates of section 41 (section
44F).
(i) Determination years.
(ii) Base period years.
(4) Number of months in a short taxable year.
(e) Examples.
Sec. 1.41-4A Qualified research for taxable years beginning before
January 1, 1986.
(a) General rule.
(b) Activities outside the United States.
(1) In-house research.
(2) Contract research.
(c) Social sciences or humanities.
(d) Research funded by any grant, contract, or otherwise.
(1) In general.
(2) Research in which taxpayer retains no rights.
(3) Research in which the taxpayer retains substantial rights.
(i) In general.
(ii) Pro rata allocation.
(iii) Project-by-project determination.
(4) Independent research and development under the Federal
Acquisition Regulations System and similar provisions.
(5) Funding determinable only in subsequent taxable year.
(6) Examples.
Sec. 1.41-5A Basic research for taxable years beginning before
January 1, 1987.
(a) In general.
(b) Trade or business requirement.
(c) Prepaid amounts.
(1) In general.
(2) Transfers of property.
(d) Written research agreement.
(1) In general.
(2) Agreement between a corporation and a qualified organization
after June 30, 1983.
(i) In general.
(ii) Transfers of property.
(3) Agreement between a qualified fund and a qualified
educational organization after June 30, 1983.
(e) Exclusions.
(1) Research conducted outside the United States.
(2) Research in the social sciences or humanities.
(f) Procedure for making an election to be treated as a
qualified fund.
Sec. 1.218-0 [Removed]
Par. 18. Section 1.218-0 is removed.
Sec. 1.482-7 [Amended]
Par. 19. In Sec. 1.482-7, the sixth sentence of paragraph (h)(1) is
amended by removing the language ``Sec. 1.41-8(e)'' and adding
``Sec. 1.41-6(e)'' in its place.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-31528 Filed 12-01-98; 8:45 am]
BILLING CODE 4830-01-P