[Federal Register Volume 68, Number 145 (Tuesday, July 29, 2003)]
[Proposed Rules]
[Pages 44499-44506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-17870]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-133791-02 and REG-105606-99]
RINS 1545-BA88 1545-AX05


Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking; notice of public hearing; and 
withdrawal of previously proposed regulations.

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SUMMARY: This document contains proposed regulations relating to the 
computation and allocation of the credit for increasing research 
activities for members of a controlled group of corporations or a group 
of trades or businesses under common control. These proposed 
regulations reflect changes made to section 41 by the Revenue 
Reconciliation Act of 1989 and the Small Business Job Protection Act of 
1996, which introduced the alternative incremental research credit. 
This document also provides notice of a public hearing on these 
proposed regulations and withdraws the proposed regulations published 
in the Federal Register on January 4, 2000 (65 FR 258).

DATES: Written or electronic comments must be received by October 27, 
2003. Requests to speak and outlines of the topics to be discussed at 
the public hearing scheduled for November 13, 2003 at 10 a.m. must be 
received by October 23, 2003.

ADDRESSES: Send submissions to: CC:PA:RU (REG-133791-02), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may also be hand delivered Monday through Friday

[[Page 44500]]

between the hours of 8 a.m. and 4 p.m. to: CC:PA:RU (REG-133791-02), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC 20224. Alternatively, taxpayers may submit comments 
electronically via the Internet by submitting comments directly to the 
IRS Internet site at: http://www.irs.gov/regs. The public hearing will 
be held in the IRS Auditorium (7th Floor), Internal Revenue Building, 
1111 Constitution Avenue, NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations, 
Jolene J. Shiraishi at (202) 622-3120 (not a toll-free call); 
concerning submissions of comments, the hearing, and to be placed on 
the building access list to attend the hearing, Guy Traynor at (202) 
622-7180 (not a toll-free call).

SUPPLEMENTARY INFORMATION: 

Background

    On January 4, 2000, Treasury and the IRS published in the Federal 
Register (65 FR 258) proposed amendments to the regulations under 
section 41(f) (2000 proposed regulations) relating to the computation 
and allocation of the credit for increasing research activities 
(research credit) for members of a controlled group of corporations or 
a group of trades or businesses under common control (controlled 
group). The 2000 proposed regulations reflected changes made to section 
41 by the Revenue Reconciliation Act of 1989 (the 1989 Act) and the 
Small Business Job Protection Act of 1996. Treasury and the IRS 
received written comments from two commentators. A public hearing was 
held on April 26, 2000. After considering the written comments and the 
statements at the public hearing, Treasury and the IRS are withdrawing 
the 2000 proposed regulations and are proposing new regulations.

Summary of Comments and Explanation of Provisions

Overview

    These new proposed regulations for members of a controlled group 
under section 41(f) follow the research credit computation rule 
contained in the 2000 proposed regulations. The computation of the 
research credit for a controlled group (group credit) under these new 
proposed regulations is done by treating all of the members of a 
controlled group as a single taxpayer. Unlike the 2000 proposed 
regulations, these new proposed regulations then allocate the group 
credit among the members of the controlled group based on the relative 
amounts of each individual member's stand-alone entity credit--the 
credit, if any, that a member of a controlled group would be entitled 
to claim if it were not a member of a controlled group. These new 
proposed regulations generally will apply to taxable years beginning on 
or after the date that final regulations are published in the Federal 
Register.

Computation of the Group Credit

    Section 41(f)(1)(A)(i) provides that in determining the amount of 
the research credit under section 41, ``all members of the same 
controlled group of corporations shall be treated as a single 
taxpayer.'' Section 41(f)(1)(B)(i) provides a similar rule for a group 
of trades or businesses under common control. Accordingly, for purposes 
of determining the amount of the group credit, the 2000 proposed 
regulations applied all of the section 41 computational rules on an 
aggregate basis. The commentators agreed that with respect to the 
computation of the group credit, the 2000 proposed regulations are 
consistent with the provisions of section 41(f). These new proposed 
regulations, therefore, do not change the method for computing the 
group credit. These new proposed regulations, however, clarify the 
application of the start-up company rules under section 41(c)(3)(B) to 
a controlled group with respect to the computation of the group credit.

Allocation of the Group Credit Among Members of the Controlled Group

    Section 41(f)(1)(A)(ii) provides that ``the [portion of the group] 
credit (if any) allowable by this section to each such member shall be 
its proportionate shares of the qualified research expenses and basic 
research payments giving rise to the credit.'' Section 41(f)(1)(B)(ii) 
provides a similar rule for a group of trades or businesses under 
common control. These new proposed regulations apply these provisions 
by allocating the group credit based on the relative amounts of each 
individual member's stand-alone entity credit.

2000 Proposed Regulations

    The 2000 proposed regulations allocated the group credit based on 
the amounts by which each individual member's qualified research 
expenses (QREs) exceeded a base amount for that member. An individual 
member's base amount, for purposes of allocating the group credit under 
the 2000 proposed regulations, was determined by applying the 
controlled group's fixed-base percentage to the member's average annual 
gross receipts for the four taxable years preceding the credit year. 
The group credit was allocated to a member having an excess amount of 
QREs by multiplying the group credit by a fraction having the 
individual member's excess amount as the numerator and the aggregate 
excess amount of all the members of the controlled group as the 
denominator. A similar allocation method was provided for the credit 
for basic research payments and for the alternative incremental 
research credit.
    The preamble to the 2000 proposed regulations stated that the 
purpose of this method was to allocate the group credit to ``those 
members whose share of current year qualified research expenses exceeds 
their share of the [controlled group's] base amount.'' In particular, 
the preamble noted that in providing a rule that reflects the 
incremental nature of the research credit, Treasury and the IRS 
declined to follow comments noting that amendments to section 41 made 
by the 1989 Act required that the allocation of the group credit be 
based on the relative amounts of total QREs incurred separately by 
members of the controlled group:

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, 
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.

Comments on the 2000 Proposed Regulations

    Two commentators submitted a series of comments in response to the 
2000 proposed regulations. As noted above, both commentators agreed 
that the method for computing the group credit contained in the 2000 
proposed regulations is consistent with the provisions of section 
41(f). The commentators diverged significantly, however, with respect 
to the method for allocating the group credit. The first

[[Page 44501]]

commentator supported the allocation rule contained in the 2000 
proposed regulations. The second commentator reiterated the earlier 
expressed view that the allocation of the group credit should be done 
on the basis of each member's total QREs (gross QREs method).
    The second commentator set out a number of reasons why a gross QREs 
method should be adopted instead of the method contained in the 2000 
proposed regulations. In particular, the commentator stated that a 
gross QREs method is the only method consistent with the plain meaning 
of section 41(f). As a related point, the commentator claimed that a 
statutory amendment made by the 1989 Act supports its plain meaning 
argument. The commentator also noted that the allocation method 
contained in the 2000 proposed regulations, by incorporating both 
individual member and controlled group elements, was at odds with the 
computation method provided by the statute and failed to allocate 
rationally the group credit.
    Treasury and the IRS continue to believe that, compared to a gross 
QREs method, an allocation method based on a group member's QREs in 
excess of a base amount more fully carries out the purposes of section 
41 in general and the section 41(f) controlled group credit rules. The 
research credit is not, and has never been, a credit computed as a 
percentage of total qualifying expenses. Rather, the research credit 
generally is allowed only when a taxpayer's QREs exceed a base amount. 
Prior to the 1989 Act, the research credit was computed by multiplying 
the credit rate by the excess of the taxpayer's current year QREs over 
the taxpayer's average QREs for the preceding three years. The 1989 Act 
significantly modified the computation of the research credit while 
retaining the incremental approach of the pre-1989 Act credit. In 
general, the research credit computation is based on whether and the 
extent to which a taxpayer increases the proportion of its QREs 
relative to its recent gross receipts, compared to a historical base 
period. Ultimately, this computation measures the extent to which a 
taxpayer's current year QREs exceed a base amount.
    Treasury and the IRS conclude that the controlled group allocation 
rules set out in section 41(f) were not intended to result in the 
allocation of the group credit to individual members of the group in a 
manner wholly at odds with the incremental nature of the research 
credit. The legislative history to the research credit, as originally 
enacted in 1981, indicates that the group credit rules were enacted to 
ensure that the research credit would be allowed only for actual 
increases in research expenditures. These rules were intended to 
prevent taxpayers from creating artificial increases in research 
expenditures by shifting expenditures among commonly controlled or 
otherwise related persons. H. Rep. No. 97-201, 1981-2 C.B. (Vol. 2) 
364, and S. Rep. 97-144, 1981-2 C.B. (Vol. 2) 442. In effect, the group 
credit computation rule serves as a cap on the maximum amount of credit 
that the members of the group, in the aggregate, may claim. A rule that 
then allocates the group credit based solely on the total amount of 
QREs incurred by each individual member, however, would be inconsistent 
with the incremental nature of the credit and would not further the 
purpose of the section 41(f) group credit rules.
    As during the consideration of the 2000 proposed regulations, 
Treasury and the IRS do not find persuasive the second commentator's 
argument that a plain reading of the statute, following the deletion of 
the phrase ``increase in'' in sections 41(f)(1)(A)(ii) and 
41(f)(1)(B)(ii) by the 1989 Act, mandates a gross QREs method for 
allocating the group credit. Prior to the 1989 Act, for example, 
section 41(f)(1)(A)(ii) provided that the research credit, if any, 
allowable to each member of a controlled group was the member's 
``proportionate share of the increase in qualified research expenses 
giving rise to the credit.'' The phrase ``increase in'' was deleted by 
the 1989 Act. The commentator maintained that a gross QREs method gives 
effect to the phrase ``giving rise to the credit'' as well as to the 
deletion of the phrase ``increase in'' from the statute by the 1989 Act 
because ``each dollar of the group's QREs gives rise to [the] excess 
over the group's base amount'' or ``(s)tated otherwise, if you 
eliminate a dollar of qualified research expenses from any member of 
the group, the group's credit will be reduced proportionately.''
    The reason for the deletion of the phrase ``increase in'' is not 
addressed in the legislative history to the 1989 Act. The changes to 
the computation of the research credit made by the 1989 Act, however, 
made a taxpayer's QREs for prior years, other than taxable years 
beginning after December 31, 1983, and before January 1, 1989 (base 
years), irrelevant to the computation of the credit. Instead, the 
amount of the research credit now depends on whether and the extent to 
which a taxpayer increases the proportion (compared to that of the base 
years) of its QREs relative to its average annual gross receipts from 
the prior four years. Accordingly, although the research credit is 
still based on the amount by which current year QREs exceed a base 
amount, that base amount, unlike the general research credit 
computation prior to the 1989 Act, is not a rolling average of QREs 
incurred in the three years prior to the credit year. Treasury and the 
IRS, therefore, conclude that the deletion of the phrase ``increase 
in'' was intended to reflect this change, and not to indicate that the 
allocation of the group credit was to be made using a gross QREs 
method.
    The second commentator noted, in arguing that the allocation method 
in the 2000 proposed regulations impermissibly mixed controlled group 
and individual member calculations, that the allocation method favors 
those members whose current ratio of QREs to recent gross receipts 
exceeds the controlled group's fixed-base percentage, regardless of 
whether that member's ratio, in fact, was increasing or decreasing. As 
stated by the commentator, ``[t]he group's fixed-base percentage can be 
wildly different from the fixed-base percentage for an individual 
member depending on the individual member's separate QREs and separate 
gross receipts during the [base years]. In other words, the amount of 
group credit that would be allocated to an individual member under the 
2000 proposed regulations may bear little or no relationship to what 
the individual member would be entitled to on a stand-alone basis, 
depending on how similar the individual member's separate fixed-base 
percentage was to the group's fixed-base percentage.

Proposed Allocation Rule

    After considering the statute, the legislative history, the written 
comments, and the statements at the public hearing, Treasury and the 
IRS have determined that the allocation method contained in the 2000 
proposed regulations does not fully carry out the purpose of the 
research credit statute and, in particular, the amendments made by the 
1989 Act. Treasury and the IRS continue to believe that the method for 
allocating the group credit must take into account the incremental 
nature of the credit. In considering the consequences of the allocation 
method contained in the 2000 proposed regulations, as highlighted by 
the commentators, Treasury and the IRS believe that the method may not, 
in certain cases, appropriately balance the purpose of the group credit 
computation and allocation rules contained in section 41(f) with the 
general purpose of the research credit, which is to encourage research 
activities.

[[Page 44502]]

    Accordingly, these new proposed regulations allocate the group 
credit among the members of the controlled group by first computing 
each individual member's stand-alone entity credit and then multiplying 
the group credit by the ratio that the member's stand-alone entity 
credit bears to the sum of the stand-alone entity credits of all the 
members of the controlled group. This new allocation method ensures 
that the amount of group credit allocated to each individual member 
will be proportionate to the amount of research credit that the 
individual member would have been entitled to claim had it not been 
part of a controlled group. This new allocation method therefore 
addresses the concerns expressed by the commentators that the 
allocation method contained in the 2000 proposed regulations could 
result in individual members receiving little or no research credit--
or, conversely, a disproportionately greater amount of research 
credit--compared to what they would have been entitled to on a stand-
alone basis, solely as a result of being part of a controlled group.

Special Allocation Rule for Consolidated Groups

    In the preamble to the 2000 proposed regulations, Treasury and the 
IRS requested comments with respect to a special rule that would treat 
all members of a consolidated group within a controlled group as a 
single member for purposes of allocating the group credit among the 
members of a controlled group. After considering the comments received, 
Treasury and the IRS have decided not to propose a special allocation 
rule for consolidated groups.

Effective Date

    The 2000 proposed regulations provided that they would be 
effective, when finalized, for taxable years ending on or after the 
date the proposed regulations were filed with the Federal Register 
(i.e., December 29, 1999). The 2000 proposed regulations, however, were 
proposed to be retroactive in certain instances 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.

    The two commentators disagreed as to the appropriateness of this 
proposed effective date. In particular, the second commentator stated 
that it would be ``unconscionable'' for final regulations containing 
the allocation method set out in the 2000 proposed regulations to be 
applied retroactively. The second commentator therefore proposed that 
final regulations be applied prospectively and that for prior years, 
taxpayers be permitted to rely on final regulations or any other method 
that is reasonable, including a gross QREs method. Finally, the second 
commentator disputed ``that there is a potential for abuse if members 
of a controlled group take inconsistent methods of allocation for past 
years. The fact that members of the same controlled group may, in the 
aggregate, claim more than 100% of the group's Research Credit should 
not make any difference.''
    The group credit rules in section 41(f) provide for a total group 
credit. There is nothing in the statute or the legislative history that 
suggests that it then should be permissible for the members of the 
controlled group to claim, in the aggregate, an amount of research 
credit exceeding the group credit. Treasury and the IRS continue to 
believe that the purpose of the section 41(f) group credit rules would 
be undermined if the members of a controlled group applied different 
allocation methods to claim more than 100 percent of the group credit. 
The preamble to the 2000 proposed regulations and those proposed 
regulations themselves eliminated any ambiguity that may have existed 
with respect to the Treasury and IRS position on this point.
    Accordingly, Treasury and the IRS propose that final regulations be 
effective for taxable years beginning on or after the date that these 
regulations are published in the Federal Register as final regulations. 
Treasury and the IRS further propose that the final regulations be 
retroactive in limited circumstances to prevent abuse. Generally, a 
taxpayer may use any reasonable method of computing and allocating the 
credit for taxable years beginning before the date these regulations 
are published in the Federal Register as final regulations. However, 
paragraph (b) relating to the computation of the group credit and 
paragraph (c), relating to the allocation of the group credit, will 
apply to taxable years ending on or after December 29, 1999, if the 
members of a controlled group, as a whole, claimed more than 100 
percent of the amount that would be allowable under paragraph (b). In 
the case of a controlled group whose members have different taxable 
years and whose members use inconsistent methods of allocation, the 
members of the controlled group shall be deemed to have, as a whole, 
claimed more than 100 percent of the amount that would be allowable 
under paragraph (b).

Special Analyses

    It has been determined that these proposed regulations do not 
constitute 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) and the Regulatory Flexibility Act 
(5 U.S.C. chapter 6) do not apply to these proposed regulations. 
Pursuant to section 7805(f) of the Internal Revenue Code, these 
proposed regulations will be submitted to the Administrator of the 
Small Business Administration for comment on their impact on small 
business.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Withdrawal of Proposed Amendments to the Regulations

    Accordingly, under the authority of 26 U.S.C. 7805, the notice of 
proposed rulemaking (REG-105606-99) published in the Federal Register 
on January 4, 2000, (65 FR 258) is withdrawn.

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 as 
follows:
    1. The entry for Sec.  1.41-6(a)(4) is revised.
    2. The entries for Sec.  1.41-6(b) through (e) are revised.
    3. New entries are added for Sec.  1.41-6(f) through (i).
    The revisions and additions read as follows:


Sec.  1.41-0  Table of contents.

* * * * *


Sec.  1.41-6  Aggregation of expenditures.

    (a) * * *
    (4) Definition of group credit.
    (b) Computation of the group credit.

[[Page 44503]]

    (1) In general.
    (2) Start-up companies.
    (c) Allocation of the group credit.
    (1) In general.
    (2) Stand-alone entity credit.
    (d) Examples.
    (e) For taxable years beginning before January 1, 1990.
    (f) Tax accounting periods used.
    (1) In general.
    (2) Special rule where timing of research is manipulated.
    (g) Membership during taxable year in more than one group.
    (h) Intra-group transactions.
    (1) In general.
    (2) In-house research expenses.
    (3) Contract research expenses.
    (4) Lease payments.
    (5) Payment for supplies.
    (i) Effective date.
* * * * *

    Par. 3. Section 1.41-6 is amended as follows:
    1. Paragraph (a)(1) is revised.
    2. Paragraph (a)(4) is revised.
    3. Paragraph (b) is revised.
    4. Paragraphs (c), (d), and (e) are redesignated as paragraph (f), 
(g), and (h), respectively.
    5. New paragraphs (c), (d), and (e) are added.
    6. Newly designated paragraph (f)(1) is revised.
    7. New paragraph (i) is added.
    The revisions and additions read as follows:


Sec.  1.41-6  Aggregation of expenditures.

    (a) * * * (1) In general. To determine the amount of research 
credit (if any) allowable to a trade or business that at the end of its 
taxable year is a member of a controlled group of corporations or a 
group of trades or businesses under common control, a taxpayer must--
    (i) Compute the group credit in the manner described in paragraph 
(b) of this section, and
    (ii) Allocate the group credit among the members of the group in 
the manner described in paragraph (c) of this section.
* * * * *
    (4) Definition of group credit. For purposes of this section, the 
term group credit means the research credit (if any) allowable to a 
controlled group of corporations or a group of trades or businesses 
under common control.
    (b) Computation of the group credit--(1) In general. All members of 
a controlled group of corporations or a group of trades or businesses 
under common control are treated as a single taxpayer for purposes of 
computing the research credit. The group credit is computed by applying 
all of the section 41 computational rules on an aggregate basis.
    (2) Start-up companies. A controlled group of corporations or a 
group of trades or businesses under common control is treated as a 
start-up company for purposes of determining the group's fixed-base 
percentage under section 41(c)(3)(B)(ii) only if each member of the 
group qualifies as a start-up company under section 41(c)(3)(B)(i).
    (c) Allocation of the group credit--(1) In general. To determine 
the amount of the group credit (if any) computed under paragraph (b) of 
this section that is allocated to a member of the group, a taxpayer 
must--
    (i) Compute the member's stand-alone entity credit; and
    (ii) Multiply the group credit by the ratio that the member's 
stand-alone entity credit bears to the sum of the stand-alone entity 
credits of all the members of the group:
[GRAPHIC] [TIFF OMITTED] TP29JY03.001

    (2) Stand-alone entity credit. For purposes of this section, the 
term stand-alone entity credit means the research credit (if any) that 
would be allowable to a member of a group if the credit were computed 
without regard to section 41(f). In computing a member's stand-alone 
entity credit, a taxpayer must use the same method (i.e., the 
computation method provided in section 41(a) or the elective method 
provided in section 41(c)(4)) that was used to compute the group 
credit. Therefore, if the research credit determined under section 
41(a) is not allowable to the group and the group credit is computed 
using the alternative incremental research credit (AIRC) rules of 
section 41(c)(4), each member's stand-alone entity credit also must be 
computed using the AIRC rules, even if the research credit determined 
under section 41(a) would be allowable to a member if that member were 
not a part of the group.
    (d) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. Research credit--(i) Facts. A, B, and C, all of which 
are calendar-year taxpayers, are members of a controlled group of 
corporations. Neither A, B, nor C made any basic research payments 
for their taxable year ending December 31, 2003. For purposes of 
computing the group credit for the 2003 taxable year (the credit 
year), A, B, and C had the following:

----------------------------------------------------------------------------------------------------------------
                                            A                   B                   C           Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year Qualified Research     $200x               $20x                $110x               $330x
 Expenses (QREs).
1984-1988 QREs...................  $40x                $10x                $100x               $150x
1984-1988 Gross Receipts.........  $1,000x             $350x               $150x               $1,500x
Average Annual Gross Receipts for  $1,200x             $200x               $300x               $1,700x
 4 Years Preceding the Credit
 Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if the three 
corporations were one taxpayer. The group credit is equal to 20 
percent of the excess of the group's aggregate credit year QREs 
($330x) over the group's base amount ($170x). The group credit is 
0.20 x ($330x-$170x), which equals $32x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: the group's fixed-base percentage (10 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($1,700x), or the group's minimum base amount ($165x). The group's 
base amount, therefore, is $170x, which is the greater of: 0.10 x 
$1,700x, which equals $170x, or $165x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $330x, which equals $165x.
    (3) Group's fixed-base percentage. The group's fixed-base 
percentage is the lesser of: the ratio that the group's aggregate 
QREs for the taxable years beginning after December 31, 1983, and 
before January 1, 1989, bears to the group's aggregate gross 
receipts for the same period, or 16 percent (the statutory minimum). 
The group's fixed-base

[[Page 44504]]

percentage, therefore, is 10 percent, which is the lesser of: $150x/
$1,500x, which equals 10 percent, or 16 percent.
    (iii) Allocation of the group credit. The group credit of $32x 
is allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of the 
stand-alone entity credits of all the members of the controlled 
group. The $32x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                            A                   B                   C                Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........  $20x                $2x                 $11x                $33x
Allocation Ratio (Stand-Alone      20/33               2/33                11/33               .................
 Entity Credit/Sum of Stand-Alone
 Entity Credits).
Multiplied by: Group Credit......  $32x                $32x                $32x                .................
Equals: Credit Allocated to        $19.39x             $1.94x              $10.67x             $32x
 Member.
----------------------------------------------------------------------------------------------------------------

    Example 2. Member is a start-up company--(i) Facts. D, E, and F, 
all of which are calendar-year taxpayers, are members of a 
controlled group of corporations. F is a start-up company under 
section 41(c)(3)(B)(i). D and E are not start-up companies under 
section 41(c)(3)(B)(i). Neither D, E, nor F made any basic research 
payments during the 2003 taxable year. For purposes of computing the 
group credit for the 2003 taxable year (the credit year), D, E, and 
F had the following:

----------------------------------------------------------------------------------------------------------------
                                            D                   E                   F           Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs.................  $200x               $20x                $50x                $270x
1984-1988 QREs...................  $55x                $15x                $0x                 $70x
1984-1988 Gross Receipts.........  $1,000x             $400x               $0x                 $1,400x
Average Annual Gross Receipts for  $1,200x             $200x               $0x                 $1,400x
 4 Years Preceding the Credit
 Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if the three 
corporations were one taxpayer. The group credit is equal to 20 
percent of the excess of the group's aggregate credit year QREs 
($270x) over the group's base amount ($135x). The group credit is 
0.20 x ($270x-$135x), which equals $27x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: the group's fixed-base percentage (5 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($1,400x), or the group's minimum base amount ($135x). The group's 
base amount, therefore, is $135x, which is the greater of: 0.05 x 
$1,400x, which equals $70x, or $135x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $270x, which equals $135x.
    (3) Group's fixed-base percentage. Because only one member of 
the group, F, is a start-up company under section 41(c)(3)(B)(i), 
the group is not a start-up company under paragraph (b)(2) of this 
section. Therefore, the group's fixed-base percentage is the lesser 
of: the ratio that the group's aggregate QREs for the taxable years 
beginning after December 31, 1983, and before January 1, 1989, bears 
to the group's aggregate gross receipts for the same period, or 16 
percent (the statutory minimum). The group's fixed-base percentage, 
therefore, is 5 percent, which is the lesser of: $70x/$1,400x, which 
equals 5 percent, or 16 percent.
    (iii) Allocation of the group credit. The group credit of $27x 
is allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of stand-
alone entity credits of all the members of the controlled group. The 
$27x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                            D                   E                   F                Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........  $20x                $2x                 $5x                 $27x
Allocation Ratio (Stand-Alone      20/27               2/27                5/27                .................
 Entity Credit/Sum of Stand-Alone
 Entity Credits).
Multiplied by: Group Credit......  $27x                $27x                $27x                .................
Equals: Credit Allocated to        $20x                $2x                 $5x                 $27x
 Member.
----------------------------------------------------------------------------------------------------------------

    Example 3. Group is a start-up company--(i) Facts. G, H, and I, 
all of which are calendar-year taxpayers, are members of a 
controlled group of corporations. Each of G, H, and I qualifies as a 
start-up company under section 41(c)(3)(B)(i). The 2003 taxable year 
is the fifth taxable year beginning after December 31, 1993, for 
which each of G, H, and I has QREs. Because each of G, H, and I 
qualifies as a start-up company under section 41(c)(3)(B)(i), the 
group is treated as a start-up company under paragraph (b)(2) of 
this section. The 2003 taxable year is the fifth taxable year 
beginning after December 31, 1993, for which the group has QREs. 
Neither G, H, nor I made any basic research payments during the 2003 
taxable year. For purposes of computing the group credit for the 
2003 taxable year (the credit year), G, H, and I had the following:

----------------------------------------------------------------------------------------------------------------
                                            G                   H                   I           Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs.................  $255x               $25x                $100x               $380x
1984-1988 QREs...................  $0x                 $0x                 $0x                 $0x
1984-1988 Gross Receipts.........  $0x                 $0x                 $0x                 $0x
Average Annual Gross Receipts for  $1,600x             $340x               $300x               $2,240x
 4 Years Preceding the Credit
 Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if the three 
corporations were one taxpayer. The group credit is equal to 20 
percent of the excess of the group's aggregate credit year QREs 
($380x) over the group's base amount ($190x). The group credit is 
0.20 x ($380x - $190x), which equals $38x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: the group's fixed-base percentage (3 
percent) multiplied by the group's aggregate average annual gross

[[Page 44505]]

receipts for the 4 taxable years preceding the credit year 
($2,240x), or the group's minimum base amount ($190x). The group's 
base amount, therefore, is $190x, which is the greater of: 0.03 x 
$2,240x, which equals $67.2x, or $190x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $380x, which equals $190x.
    (3) Group's fixed-base percentage. Each member of the group is a 
start-up company under section 41(c)(3)(B)(i), therefore, the group 
is a start-up company under paragraph (b)(2) of this section. 
Because the 2003 taxable year is the fifth taxable year beginning 
after December 31, 1993, for which the group has QREs, under section 
41(c)(3)(B)(ii)(I), the group's fixed-base percentage is 3 percent.
    (iii) Allocation of the group credit. The group credit of $38x 
is allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of stand-
alone entity credits of all the members of the controlled group. The 
$38x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                            G                   H                   I                Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........  $25.5x              $2.5x               $10x                $38x
Allocation Ratio (Stand-Alone      25.5/38             2.5/38              10/38               .................
 Entity Credit/Sum of Stand-Alone
 Entity Credits).
Multiplied by: Group Credit......  $38x                $38x                $38x                .................
Equals: Credit Allocated to        $25.5x              $2.5x               $10x                $38x
 Member.
----------------------------------------------------------------------------------------------------------------

    Example 4. Group alternative incremental research credit--(i) 
Facts. J, K, and L, all of which are calendar-year taxpayers, are 
members of a controlled group of corporations. The research credit 
under section 41(a) is not allowable to the group for the 2003 
taxable year because the group's aggregate QREs for the 2003 taxable 
year are less than the group's base amount. The group credit is 
computed using the AIRC rules of section 41(c)(4). For purposes of 
computing the group credit for the 2003 taxable year (the credit 
year), J, K, and L had the following:

----------------------------------------------------------------------------------------------------------------
                                            J                   K                   L           Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs.................  $0x                 $20x                $110x               $130x
Average Annual Gross Receipts for  $1,200x             $200x               $300x               $1,700x
 4 Years Preceding the Credit
 Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit. The research credit 
allowable to the group is computed as if the three corporations were 
one taxpayer. The group credit is equal to the sum of: 2.65 percent 
of so much of the group's aggregate QREs for the taxable year as 
exceeds 1 percent of the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year, but does 
not exceed 1.5 percent of such average; 3.2 percent of so much of 
the group's aggregate QREs as exceeds 1.5 percent of such average 
but does not exceed 2 percent of such average; and 3.75 percent of 
so much of such QREs as exceeds 2 percent of such average. The group 
credit is [0.0265 x [($1,700x x 0.015)-($1,700x x 0.01)]] + [0.032 x 
[($1,700x x 0.02)-($1,700x x 0.015)]] + [0.0375 x [$130x-($1,700x x 
0.02)]], which equals $4.10x.
     (iii) Allocation of the group credit. The group credit is 
allocated to each member of the group by multiplying the group 
credit by the ratio that each member's stand-alone entity credit 
bears to the sum of the stand-alone entity credits of all the 
members of the group. The $4.10x group credit is allocated as 
follows:

----------------------------------------------------------------------------------------------------------------
                                            J                   K                   L                Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........  $0x                 $.66x               $3.99x              $4.65x
Allocation Ratio (Stand-Alone      0/4.65              0.66/4.65           3.99/4.65           .................
 Entity Credit/Sum of Stand-Alone
 Entity Credits).
Multiplied by: Group Credit......  $4.10x              $4.10x              $4.10x              .................
Equals: Credit Allocated to        $0x                 $.58x               $3.52x              $4.10x
 Member.
----------------------------------------------------------------------------------------------------------------

    (e) For taxable years beginning before January 1, 1990. For taxable 
years beginning before January 1, 1990, see Sec.  1.41-6 as contained 
in 26 CFR part 1, revised April 1, 2003.
    (f) Tax accounting periods used--(1) In general. The credit 
allowable to a member of a controlled group of corporations or a group 
of trades or businesses under common control is that member's share of 
the group credit computed as of the end of that member's taxable year. 
In computing the group credit for a group whose members have different 
taxable years, a member generally should 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. For example, 
M, N, and O are members of a controlled group of corporations. M and N 
file a calendar year consolidated return. O files a separate return 
using a fiscal year ending June 30. For purposes of computing the group 
credit at the end of the M's and N's (the computing members') calendar 
year on December 31, O's fiscal year ending June 30, which ends within 
the M's and N's calendar year, is treated as O's credit year.
* * * * *
    (i) Effective date. Paragraphs (a)(1), (a)(4), (b), (c), (d), and 
(f)(1) of this section are applicable for taxable years beginning on or 
after the date these regulations are published in the Federal Register 
as final regulations. Generally, a taxpayer may use any reasonable 
method of computing and allocating the credit for taxable years 
beginning before the date these regulations are published in the 
Federal Register as final regulations. However, paragraph (b) relating 
to the computation of the group credit and paragraph (c), relating to 
the allocation of the group credit, will apply to taxable years ending 
on or after December 29, 1999, if the members of a controlled group, as 
a whole, claimed more than 100 percent of the amount that would be 
allowable under paragraph (b). In the case of a controlled group whose 
members have different taxable years and whose members use inconsistent 
methods of allocation, the members of the controlled group shall be 
deemed to have, as a whole, claimed more than 100 percent of the amount

[[Page 44506]]

that would be allowable under paragraph (b).

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 03-17870 Filed 7-28-03; 8:45 am]
BILLING CODE 4830-01-P