Continuing Uncertainty on Research Credit Definition of Gross Receipts

The definition of gross receipts for Sec. 41 research credit purposes in the affiliated group context remains uncertain. This definition is important in calculating a taxpayers base amount, to which current-year qualified research expenditures are compared in computing the research credit.

Background

Chief Counsel Advice (CCA) 200233011 concluded that a taxpayer (a domestic corporation) and its majority owned foreign subsidiaries would be treated as a single taxpayer for Secs. 41(f) and 1563(a) purposes. Thus, product sales between the taxpayer and its affiliated foreign subsidiaries would be disregarded in computing the taxpayers gross receipts for research credit purposes. In light of Sec. 41(f)(5), which refers to the meaning of controlled group in Sec. 1563(a), CCA 200233011 concluded that the single taxpayer concept applies to an affiliated group, even if that group includes a foreign corporation not consolidated for domestic return purposes.

Although CCA 200233011 seems to offer a degree of certainty in the computation of gross receipts by large corporations with foreign subsidiaries, it is not precedent under Sec. 6110(k)(3). Further, its conclusion, although based on a straightforward reading of the statute, may have raised questions as to its general applicability to other taxpayers; the final paragraph reads:

We have determined that given the particular facts and circumstances of this case that Taxpayer may exclude the sales to its foreign subsidiaries for purposes of determining its base amount under section 41(c). For the years at issue, Taxpayer should consistently exclude such sales from gross receipts for purposes of both the fixed-base percentage and the average annual gross receipts for the four taxable years preceding the credit year.

CCA 200233011 did not set forth the particular facts and circumstances that the Chief Counsels office found significant; thus, its general applicability may be unclear. On the one hand, its analysis appeared to rely on a technical reading of the statute that would seem to apply regardless of factual context; however, it referred to the taxpayers particular facts and circumstances. Given the uncertainty, it is not surprising that the IRS Office of Examinations (Examinations) and some taxpayers have taken different positions; as of yet, no definitive resolution on the issue exists.

IRS Position

Currently, Examinations has been raising the computation of gross receipts as an issue and, in many cases, has taken a position contrary to CCA 200233011s conclusion. At times, it also has claimed that the CCAs rationale applies only to sales and not to other intra-group transactions, such as payments of dividends or interest. As a basis for its position, the Service argues that Regs. Sec. 1.41-8(e)(1), issued in May 1989 (TD 8251)providing [b]ecause all members of a group under common control are treated as a single taxpayer for purposes of determining the research credit, transfers between members of the group are generally disregardeddoes not apply to gross receipts calculations, because those regulations were promulgated when Sec. 41 did not include a gross receipts element in the research credit calculation. The element of gross receipts was added to Sec. 41 later that year. The Service reasons that because the 1989 regulations have not been changed to refer to a gross receipts computation, a different rule applies for that purpose. Thus, affiliated group gross receipts are aggregated, even if generated wholly by intra-group transactions.

Taxpayer Position

Some taxpayers take the position that the 1989 final regulations adopting a single-taxpayer concept for purposes of determining the research credit apply as well to all aspects of the credit calculation, including gross receipts. Regulations proposed on Dec. 2, 1998 (REG-105170-97) retained language found in the 1989 regulations that all members of a group under common control are treated as a single taxpayer for purposes of determining the research credit, [and] transfers between members of the group are generally disregarded. Then, on Jan. 4, 2000, the IRS published proposed regulations under Sec. 41(f) (REG-105606-99) to reflect changes made to Sec. 41 by the Revenue Reconciliation Act of 1989 and the Small Business Job Protection Act of 1996. The proposed regulations specifically provided all of the computational rules of section 41 are applied on a single-taxpayer basis to determine the group credit.

On July 29, 2003, the IRS withdrew the 2000 proposed regulations and reproposed the research credit allocation regulations (REG-133791-02), including the renumbered 1.41-8 regulations (now the 1.41-6 regulations) under Sec. 41(f), for computing and allocating the research credit for members of a controlled group or a group of trades or business under common control. The preamble to the 2003 proposed regulations states, [t]he computation of the research credit for a controlled group...under these new proposed regulations is done by treating all of the members of a controlled group as a single taxpayer. Thus, the most recent proposed regulations, like the 2000 proposed regulations, would mandate that gross receipts are to be computed using a single-taxpayer approach and intra-group transactions are to be disregarded. Note: The proposed regulations provide that for years prior to the final regulations effective date, a taxpayer may use any reasonable method of computing and allocating the credit.

Observations

CC2003-014 clarified generally the effect of proposed publications and IRS ruling positions. According to the notice, Chief Counsel attorneys ordinarily should not take any position in litigation or advice that would yield a result that would be harsher to the taxpayer than what the taxpayer would be allowed under the proposed regulations. Because the proposed regulations cited above would call for a single-taxpayer approach, CC2003-014 leads to the conclusion that the IRS would probably not question a gross-receipts computation using the single-taxpayer approach. However, the lack of generally applicable formal guidance specifically stating so continues to cause uncertainty.

From Dan Wiles, J.D., and Ruth Perez, J.D., Washington, DC