[Federal Register Volume 65, Number 2 (Tuesday, January 4, 2000)]
[Proposed Rules]
[Pages 258-263]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-33815]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105606-99]
RIN 1545-AX05


Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
computation of the credit for increasing research activities (the 
research credit) for members of a controlled group and the allocation 
of the credit under section 41(f) of the Internal Revenue Code. These 
proposed regulations are intended to provide guidance on the proper 
method for computing the research credit for members of a controlled 
group and the proper method for allocating the group credit to members 
of the group. These proposed regulations reflect changes to section 41 
made by the Revenue Reconciliation Act of 1989 (the 1989 Act). This 
document also provides notice of a public hearing on these regulations.

DATES: Written or electronic comments must be received no later than 
April 5, 2000. Outlines of topics to be discussed at the public hearing 
scheduled for April 26, 2000 at 10 a.m. must be received by April 5, 
2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105606-99), room 
5226, 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-
105606-99), 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.gov/prod/taxregs/regslist.html. 
The public hearing will be held in room 2615, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Lisa J. Shuman 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 6, 2000. 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
    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 
contained in the preamble under the heading ``Proposed Effective 
Date.'' The information is required by the IRS to ensure that members 
of a controlled group filing claims for refund based on a change in 
method of allocating the research credit to members of the group do not 
together claim in excess of 100% of the credit with respect to prior 
taxable years.
    Estimated total annual reporting burden: 200 hours.
    Estimated average annual burden hours per respondent: 20 hours.
    Estimated number of respondents: 10.
    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

[[Page 259]]

of the Tax Reform Act of 1986 (the 1986 Act) redesignated section 30 as 
section 41 and substantially modified the research credit provisions. 
The 1989 Act substantially revised the computation of the research 
credit.
    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, and other subsequent legislative revisions to the 
research credit.
    The amendments proposed by this document contain proposed rules 
relating to the computation of the research credit for members of a 
controlled group and the allocation of the credit under section 41(f). 
These proposed regulations reflect changes to the research credit rules 
made by the 1989 Act and Small Business Job Protection Act of 1996, 
which introduced the alternative incremental research credit.

Pre-1990 Rules for Computing the Research Credit for Members of a 
Controlled Group and Allocating the Credit among Members of the Group

    Prior to the enactment of the 1989 Act, the research credit was 
computed by multiplying the credit rate by the excess of the taxpayer's 
current year qualified research expenses over the average of the 
taxpayer's qualified research expenses for the preceding three years.
    Before amendment by the 1989 Act, section 41(f)(1) provided rules 
for computing the research credit for members of a controlled group 
(generally a group of corporations or unincorporated businesses linked 
by common ownership of more than 50 percent). Section 41(f)(1) treated 
all members of a controlled group as a single taxpayer for purposes of 
computing the credit and allocated the credit to the members of the 
group based on the member's proportionate share of the increase in 
qualified research expenses giving rise to the credit.
    The legislative history to the 1981 Act indicates that the research 
credit aggregation rules were enacted to ensure that the research 
credit would be allowed only for actual increases in research 
expenditures. The aggregation rules were intended to prevent artificial 
increases in research expenditures by shifting expenditures among 
commonly controlled or otherwise related persons. H. Rep. No. 97-201, 
1981-3 C.B. (Vol. 2) 364 and Sen. Rep. 97-144, 1981-3 C.B. (Vol. 2) 
442.
    An example that appears in both Sec. 1.41-8(a)(4) of the 1989 
regulations and the legislative history to the 1981 Act illustrates the 
computation and allocation of the research credit under section 
41(f)(1) before the 1989 Act amendments to the research credit 
computation. In the example, the allowable group research credit is 
allocated among the members experiencing an increase in qualified 
research expenses over their base period research expenses. The member 
allocation is based on the ratio that each member's increase in its 
qualified research expenses over its base period research expenses 
bears to the sum of the group's increases in qualified research 
expenses.

Post-1989 Rules for Computing the Research Credit for Members of a 
Controlled Group and Allocating the Regular Research Credit among 
Members of the Group

    In the 1989 Act, Congress revised the computation of the research 
credit. Congress retained the incremental structure of the credit but 
altered the computation to focus on whether and the extent to which a 
taxpayer increases the proportion of its qualified research expenses 
relative to its gross receipts.
    Under section 41, as amended in 1989, the research credit is 
computed by multiplying the credit rate by the excess of the taxpayer's 
current year qualified research expenses over a ``base amount.'' The 
base amount is defined in section 41(c) as the greater of: (1) Fifty 
percent of the taxpayer's credit year qualified research expenses (the 
minimum base amount); or, (2) the taxpayer's ``fixed-base percentage'' 
times the taxpayer's average annual gross receipts for the four taxable 
years preceding the taxable year for which the credit is being 
determined.
    In general, a taxpayer's fixed-base percentage is defined in 
section 41(c)(3)(A) as the ratio that the taxpayer's aggregate 
qualified research expenses for its taxable years beginning after 
December 31, 1983, and before January 1, 1989 bear to its aggregate 
gross receipts for the same period. Section 41(c)(3)(B) provides rules 
for computing the fixed-base percentage for start-up companies. Section 
41(c)(3)(C) provides that the maximum fixed-base percentage is 16%.
    Section 41(f)(1), as amended by the 1989 Act, continues to provide 
rules for computing the research credit for members of a controlled 
group. As under prior law, all members of a controlled group are 
treated as a single taxpayer for purposes of computing the credit. 
However, the allocation rule was amended to eliminate any reference to 
an ``increase'' in qualified research expenses. Under the amended 
allocation rule, the group credit is allocated among the members of the 
group based on each member's ``proportionate share of the qualified 
research expenses and basic research payments giving rise to the 
credit.''
    In explaining the 1989 Act revisions to the research credit, the 
House Report simply states that the rules relating to the aggregation 
of related persons and changes in ownership are the same as under 
present law with the modification that when a business changes hands, 
qualified research expenses and gross receipts for periods prior to the 
change of ownership are treated as transferred with the trade or 
business which gave rise to those expenditures and receipts for 
purposes of recomputing a taxpayer's fixed-base percentage. H. Rep. No. 
101-247 at 1202. The legislative history to the 1989 Act does not refer 
to the elimination of the word ``increase'' from the allocation rule.
    In the light of the statutory changes enacted in 1989, taxpayers 
have questioned the proper method for computing the research credit for 
members of a controlled group and the proper method for allocating the 
group credit to members of the group under the new rules.
    The proposed regulations provide that, for purposes of computing 
the group credit, all of the computational rules of section 41 are 
applied on an aggregate basis. This is consistent with the statutory 
prescription that the controlled group be treated as a single taxpayer 
and is necessary to preclude taxpayers from creating artificial 
increases in the credit by shifting qualified research expenses and 
gross receipts among commonly controlled or otherwise related persons.
    In proposing rules for the allocation of the credit, Treasury and 
the IRS considered, but were not persuaded by, certain taxpayers' 
argument that the elimination of the word ``increase'' from the 
allocation rule in the statute requires that the credit be allocated on 
the basis of the gross amount of qualified research expenses incurred 
by the various members of the controlled group. Treasury and the IRS 
believe that elimination of the word ``increase'' was necessitated by 
the 1989 statutory amendments to the computation of the research 
credit, which afford a credit in certain circumstances even where the 
taxpayer (or each member of a controlled group) is decreasing its gross 
amount of qualified research expenses (e.g., because the taxpayer's 
gross receipts also are decreasing). However,

[[Page 260]]

there is no indication that the elimination of the word ``increase'' 
was intended to suggest that the credit be allocated without regard to 
its incremental nature. To the contrary, the statutory prescription 
that the credit be allocated according to each member's proportionate 
share of the qualified research expenses ``giving rise to'' the credit 
supports a rule that allocates the credit to those members whose share 
of current year qualified research expenses exceeds their share of the 
base amount. Thus, the proposed regulation provides that the group 
research credit is allocated to each member based on the ratio that the 
member's increase in its qualified research expenses over its base 
amount bears to the sum of each member's increase in qualified research 
expenses over its base amount. The member's base amount is computed by 
multiplying the group fixed-base percentage by the member's average 
annual gross receipts for the four preceding tax years.
    In order to prevent manipulation of the amount of credit allocated 
to a consolidated group of corporations that is a member of a 
controlled group with other taxpayers, Treasury and the IRS considered 
a special rule for allocating the research credit that would treat all 
members of a consolidated group as a single taxpayer for purposes of 
allocating the research credit among members of the controlled group. 
Treasury and the IRS request comments on special rules for allocating 
the research credit among members of a controlled group that contains a 
consolidated group of corporations.

Allocation of the Credit for Basic Research Payments and the 
Alternative Incremental Research Credit

    The proposed regulations also address the computation and 
allocation of the group credit for basic research payments (certain 
amounts paid to qualified organizations for basic research) and for the 
alternative incremental research credit (an elective alternative method 
of computing the research credit, under which taxpayers are assigned a 
lower three-tiered fixed base percentage, and the credit rate is 
reduced).
    As in the case of the regular credit for qualified research 
expenses, the proposed regulations provide that all computations with 
respect to the group credit for basic research payments and the 
alternative incremental research group credit are undertaken on an 
aggregate basis. Similarly, these group credits are allocated to the 
various group members on an incremental basis.

Proposed Effective Date

    The regulations generally are proposed to be applicable for taxable 
years ending on or after the date proposed regulations are filed with 
the Federal Register, but are also proposed to be retroactive in 
certain limited circumstances to prevent abuse. To prevent taxpayers 
that are members of a controlled group from together claiming in excess 
of 100% of the credit with respect to prior taxable years, the rules 
for allocating the group credit would apply to any taxable year 
beginning after December 31, 1989, in which, as a result of 
inconsistent methods of allocation, the members of a controlled group 
as a whole claimed more than 100% of the allowable group credit. In the 
case of a group whose members have different taxable years and whose 
members used inconsistent methods of allocation, the members of the 
group as a whole shall be deemed to have claimed more than 100% of the 
allowable group credit.
    No claim for refund (1) Attributable to a change in method of 
allocation; (2) Pertaining to a taxable year ending before the date the 
proposed regulations are filed with the Federal Register; and (3) Filed 
after the date these proposed regulations are filed with the Federal 
Register will be allowed unless the taxpayer submits a statement 
identifying all members of the controlled group for the taxable year at 
issue. The statement must contain a declaration signed by the taxpayer 
under penalties of perjury that states: ``To the best of my knowledge 
and belief, taking into account prior claims, this amended claim and 
any related adjustments, no more than the total amount of the group 
credit will be allocated to the members of the controlled group.''

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
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. This certification is based on 
the expectation that few, if any, small entities will file claims for 
refund attributable to a change in method of allocating the research 
credit among members of its controlled group. Accordingly, a Regulatory 
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) is not required. Pursuant to section 7805(f) of the Internal 
Revenue Code, 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) or electronic comments are 
submitted timely to the IRS. Treasury and the IRS request comments on 
the clarity of the proposed regulations and how they may be made easier 
to understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for April 26, 2000 at 10 a.m. 
in room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington, DC. Due to building security procedures, visitors must 
enter at the 10th Street entrance, located between Constitution and 
Pennsylvania Avenues, NW. In addition, all visitors must present photo 
identification to enter the building. Because of access restrictions, 
visitors will not be admitted beyond the immediate entrance area more 
than 15 minutes before the hearing starts. For information about having 
your name placed on the building access list to attend the hearing, see 
the FOR FURTHER INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written or 
electronic comments and an outline of the topics to be discussed and 
the time to be devoted to each topic (preferably a signed original and 
eight (8) copies by April 5, 2000). A period of 10 minutes will be 
allotted to each person making comments.
    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 author of these proposed regulations is Lisa J. 
Shuman 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.

[[Page 261]]

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:

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. In Sec. 1.41-0, the table of contents is amended by 
revising the entries for Sec. 1.41-8(a), (a)(1), (a)(4), and (b) and 
adding entries for Sec. 1.41-8(a)(5) and (a)(6) to read as follows:


Sec. 1.41-0  Table of contents.

* * * * *
    1.41-8  Aggregation of expenditures.
    (a) Controlled group of corporations; trades or businesses under 
common control.
    (1) In general.
* * * * *
    (4) Allocation of credit for basic research payments.
    (5) Allocation of alternative incremental research credit.
    (6) Examples.
    (b) For taxable years beginning before January 1, 1990.
* * * * *
    Par. 3. In Sec. 1.41-8, paragraphs (a)(1), (a)(4), (b), and (c)(1) 
are revised and paragraphs (a)(5) and (a)(6) are added to read as 
follows:


Sec. 1.41-8  Aggregation of expenditures.

    (a) Controlled group of corporations; trades or businesses under 
common control--(1) In general. In determining the amount of the credit 
for increasing research activities allowed with respect to a trade or 
business that at the end of its taxable year is a member of a 
controlled group of corporations or a member of a group of trades or 
businesses under common control, all members of the group are treated 
as a single taxpayer. Thus, for purposes of determining the amount of 
the credit, all of the rules in section 41, including, for example, the 
rules in section 41(c)(2) (pertaining to the minimum base amount), 
section 41(c)(3)(B) (pertaining to the fixed-base percentage for start-
up companies), and section 41(c)(3)(C) (pertaining to maximum base 
amount) are applied only to the aggregate computation of the base 
amount. The credit (if any) allowed to any member is determined on the 
basis of the ratio that its increase (if any) in its qualified research 
expenses over its base amount bears to the aggregate increases in 
qualified research expenses over the base amount of all members of the 
group. For purposes of the preceding sentence, a member computes its 
base amount by multiplying the group fixed-base percentage by the 
member's average annual gross receipts for the four preceding tax 
years.
* * * * *
    (4) Allocation of credit for basic research payments. The credit 
(if any) attributable to basic research payments allowed to a member is 
determined on the basis of the ratio that its excess (if any) of basic 
research payments over its qualified organization base period amount 
bears to the aggregate excess of basic research payments over the 
qualified organization base period amount of all members in the group. 
For purposes of the preceding sentence, a member computes its qualified 
organization base period amount using similar principles to those used 
in paragraph (a)(1) to determine the member's base amount.
    (5) Allocation of alternative incremental research credit. If the 
credit is computed under the alternative incremental research credit 
rules, the credit (if any) allowed to the member is determined on the 
basis of the ratio that its excess (if any) of qualified research 
expenses over 1% of its average annual gross receipts for the four 
taxable years preceding the taxable year for which the credit is being 
determined bears to the aggregate excess of qualified research expenses 
over 1% of the average annual gross receipts of all members of the 
group for the four taxable years preceding the taxable year for which 
the credit is being determined.
    (6) Examples. The following examples illustrate the provisions of 
this paragraph (a):

    Example 1. (i) Facts. A controlled group of three corporations 
(all of which are calendar-year taxpayers) had qualified research 
expenses for the credit year 1999, qualified research expenses for 
the period 1984 through 1988, gross receipts for the period 1984 
through 1988, and average annual gross receipts for the four years 
preceding the credit year as follows:

----------------------------------------------------------------------------------------------------------------
                                            A                   B                   C                Total
----------------------------------------------------------------------------------------------------------------
Credit year qualified research     $200x.............  $20x..............  $110x.............  $330x
 expenses.
1984-1988 qualified research        40x..............   10x..............   100x.............   150x
 expenses.
1984-1988 gross receipts.........   1,000x...........   350x.............   150x.............   1500x
Average annual gross receipts for   1,200x...........   200x.............   300x.............   1700x
 4 years preceding credit year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit. (A) The group research 
credit is computed as if the three corporations are one taxpayer. 
The research credit is equal to 20 percent of the excess of the 
group's aggregate credit year qualified research expenses over the 
group's base amount.
    (B) The group's base amount equals the greater of fifty percent 
of the group's credit year qualified research expenses (the minimum 
base amount); or, the group's fixed-base percentage times the 
group's average annual gross receipts for the four taxable years 
preceding the credit year. The group's fixed-base percentage is the 
ratio that the group's aggregate qualified research expenses for the 
taxable years beginning after December 31, 1983, and before January 
1, 1989 bear to its aggregate gross receipts for the same period. 
Therefore, the group's fixed-base percentage is 150x/1500x or 10% 
and the group's base amount is $170x, the greater of 50% of $330 or 
10% of $1,700x.
    (C) The group's research credit is equal to 20 percent of the 
excess of the group's aggregate credit year qualified research 
expenses over the group's base amount. That is 20% of ($330x--$170x) 
or $32x.
    (iii) Allocation of the group credit. The group research credit 
of $32x is allocated to the members of the group based on the ratio 
that the member's increase in its qualified research expenses over 
the member's base amount bears to the sum of the member increases in 
qualified research expenses over their base amounts. The member's 
base amount is computed by multiplying the group fixed-base 
percentage of 10% by the member's average annual gross receipts for 
the four preceding tax years. The $32x credit is allocated as 
follows:

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                                     Credit year  qualified
               Member                  research  expenses      Member base amount           Increase                Ratio                  Credit
--------------------------------------------------------------------------------------------------------------------------------------------------------
A..................................  $200x.................  $120x.................  $80x.................  80/160...............  $16x

[[Page 262]]

 
B..................................   20x..................   20x..................  .....................   0...................
C..................................   110x.................   30x..................   80x.................   80/160..............   16x
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 2. (i) Facts. The facts are the same as in Example 1 
except that A had no qualified research expenses during the credit 
year. The following table shows the group's qualified research 
expenses for the credit year, qualified research expenses for the 
period 1984 through 1988, gross receipts for the period 1984 through 
1988, and average annual gross receipts for the four years preceding 
the credit year:

----------------------------------------------------------------------------------------------------------------
                                            A                   B                   C                Total
----------------------------------------------------------------------------------------------------------------
Credit year qualified research     0.................  $20x..............  $110x.............  $130x
 expenses.
1984-1988 qualified research       $40x..............   10x..............   100x.............   150x
 expenses.
1984-1988 gross receipts.........   1,000x...........   350x.............   150x.............   1500x
Average annual gross receipts for   1,200x...........   200x.............   300x.............   1700x
 4 years preceding credit year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit. Under these facts, the 
controlled group's credit year qualified research expenses are less 
than the group's base amount of $170x, and no credit is allowed to 
the group unless the group elects to use the alternative incremental 
research credit under section 41(c)(4). If the group elects to use 
the alternative incremental credit under section 41(c)(4), the group 
is allowed a credit equal to .0165($25.5x-$17x) + .022($34x-$25.5x) 
+ .0275($130x-$34x) or $2.96725x.
    (iii) Allocation of the group credit. Assuming that the group 
elects to use the alternative incremental research credit under 
section 41(c)(4), the group research credit of $2.96725x is 
allocated to the members of the group based on the ratio that the 
member's qualified research expenses over one percent of the 
member's average annual gross receipts for the four preceding years 
bears to the sum of the member increases in qualified research 
expenses over one percent of their average annual gross receipts for 
the four preceding years. The $2.96725x credit is allocated as 
follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                              1 percent of  member
                                     Credit year  qualified   average  annual gross
               Member                  research  expenses        receipts for 4             Increase                Ratio                  Credit
                                                               preceding tax years
--------------------------------------------------------------------------------------------------------------------------------------------------------
A..................................  0.....................  $12x..................  0....................  0....................
B..................................  $20x..................   2x...................  $18x.................  18/125...............  .427284x
C..................................   110x.................   3x...................   107x................  107/125..............  2.539966x
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 3. (i) Facts. A controlled group of three corporations 
(all of which are calendar-year taxpayers) had qualified research 
expenses for the credit year 1999, qualified research expenses for 
the period 1984 through 1988, gross receipts for the period 1984 
through 1988, and average annual gross receipts for the four years 
preceding the credit year as follows:

----------------------------------------------------------------------------------------------------------------
                                            A                   B                 C \1\              Total
----------------------------------------------------------------------------------------------------------------
Credit year qualified research     $200x.............  $20x..............  $50x..............  $270x
 expenses.
1984-1988 qualified research        55x..............   15x..............   0................   70x
 expenses.
1984-1988 gross receipts.........   1000x............   400x.............   0................   1400x
Average annual gross receipts for   1200x............   200x.............   0................   1400x
 4 years preceding credit year.
----------------------------------------------------------------------------------------------------------------
\1\ C began business in 1999.

    (ii) Computation of the group credit. (A) The group research 
credit is computed as if the three corporations are one taxpayer. 
The research credit is equal to 20 percent of the excess of the 
group's aggregate credit year qualified research expenses over the 
group's base amount.
    (B) The group's base amount equals the greater of: fifty percent 
of the group's credit year qualified research expenses (the minimum 
base amount), or, the group's fixed-base percentage times the 
group's average annual gross receipts for the four taxable years 
preceding the credit year. The group's fixed-base percentage is the 
ratio that the group's aggregate qualified research expenses for the 
taxable years beginning after December 31, 1983, and before January 
1, 1989 bear to its aggregate gross receipts for the same period. 
Therefore, the group's fixed-base percentage is 70x/1400x or 5% and 
the group's base amount is $135x, the greater of 50% of $270x or 5% 
of $1,400x.
    (C) The group's research credit is equal to 20 percent of the 
excess of the group's aggregate credit year qualified research 
expenses over the group's base amount. That is 20% of ($270x-$135x) 
or $27x.
    (iii) Allocation of the group credit. The group research credit 
of $27x is allocated to the members of the group based on the ratio 
that the member's increase in its qualified research expenses over 
the member's base amount bears to the sum of the member increases in 
qualified research expenses over their base amounts. The member's 
base amount is computed by multiplying the group fixed-base 
percentage of 5% by the member's average annual gross receipts for 
the four preceding tax years. The $27x credit is allocated as 
follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                     Credit year  qualified
               Member                  research  expenses      Member base amount           Increase                Ratio                  Credit
--------------------------------------------------------------------------------------------------------------------------------------------------------
A..................................  $200x.................  $60x..................  $140x................  14/20................  $18.9x
B..................................   20x..................   10x..................   10x.................  1/20.................   1.35x
C..................................   50x..................   0....................   50x.................  5/20.................   6.75x
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 263]]

    Example 4. (i) Facts. The facts are the same as in Example 3 
except that C began business in 1989. A, B, and C had qualified 
research expenses for the credit year 1999, qualified research 
expenses for the period 1984 through 1988, gross receipts for the 
period 1984 through 1988, and average annual gross receipts for the 
four years preceding the credit year as follows:

----------------------------------------------------------------------------------------------------------------
                                            A                   B                   C                Total
----------------------------------------------------------------------------------------------------------------
Credit year qualified research     $200x.............  $20x..............  $50x..............  $270x
 expenses.
1984-1988 qualified research        55x..............   15x..............   0................   70x
 expenses.
1984-1988 gross receipts.........   1,000x...........   400x.............   0................   1,400x
Average annual gross receipts for   1,200x...........   200x.............   1,000x...........   2,400x
 4 years preceding credit year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit. (A) The group research 
credit is computed as if the three corporations are one taxpayer. 
The research credit is equal to 20 percent of the excess of the 
group's aggregate credit year qualified research expenses over the 
group's base amount.
    (B) The group's base amount equals the greater of: fifty percent 
of the group's credit year qualified research expenses (the minimum 
base amount), or, the group's fixed-base percentage times the 
group's average annual gross receipts for the four taxable years 
preceding the credit year. The group's fixed-base percentage is the 
ratio that the group's aggregate qualified research expenses for the 
taxable years beginning after December 31, 1983, and before January 
1, 1989 bear to its aggregate gross receipts for the same period. 
Therefore, the group's fixed-base percentage is 70x/1400x or 5% and 
the group's base amount is $135x, the greater of 50% of $270x or 5% 
of $2,400x.
    (C) The group's research credit is equal to 20 percent of the 
excess of the group's aggregate credit year qualified research 
expenses over the group's base amount. That is 20% of ($270x-$135x) 
or $27x.
    (iii) Allocation of the group credit. The group research credit 
of $27x is allocated to the members of the group based on the ratio 
that the member's increase in its qualified research expenses over 
the member's base amount bears to the sum of the member increases in 
qualified research expenses over their base amounts. The member's 
base amount is computed by multiplying the group fixed-base 
percentage of 5% by the member's average annual gross receipts for 
the four preceding tax years. The $27x credit is allocated as 
follows:

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                                     Credit year  qualified
               Member                  research  expenses      Member base amount            Change                 Ratio                  Credit
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A..................................  $200x.................  $60x..................  $140x................  14/15................  $25.2x
B..................................   20x..................   10x..................   10x.................  1/15.................   1.8x
C..................................   50x..................   50x..................   0...................   0...................   0
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    (b) For taxable years beginning before January 1, 1990. For taxable 
years beginning before January 1, 1990, see Sec. 1.41-8 in effect prior 
to December 29, 1999 as contained in 26 CFR part 1 revised April 1, 
1999.
    (c) Tax accounting periods used--(1) In general. The credit 
allowable to a member of a controlled group of corporations or of a 
group of trades or businesses under common control is that member's 
share of the aggregate credit computed as of the end of such member's 
taxable year. In computing the aggregate credit in the case of a group 
whose members have different taxable years, a member shall generally 
treat the taxable year of another member that ends with or within the 
credit year of the computing member as the credit year of that other 
member. In computing the aggregate base amount, the gross receipts 
taken into account with respect to another member shall include that 
other member's gross receipts for the four taxable years of that other 
member preceding the credit year of that other member.
* * * * *
John M. Dalrymple,
Acting Deputy Commissioner of Internal Revenue.
[FR Doc. 99-33815 Filed 12-29-99; 2:06 pm]
BILLING CODE 4830-01-U