NAM Charges Stakeholders Had No Say in Research Credit Refund Rules

January 3, 2022

Ms. Nikole Flax
Commissioner
Large Business & International Division
Internal Revenue Service
1111 Constitution Ave. NW
Washington, DC 20224

Ms. Holly Paz
Deputy Commissioner
Large Business & International Division
Internal Revenue Service
1111 Constitution Ave. NW
Washington, DC 20224

Re: Internal Revenue Code Section 41 Research Credit Refund Claims

Dear Ms. Flax and Ms. Paz:

The National Association of Manufacturers respectfully submits this letter in response to the additional filing requirements for a valid refund claim for the R&D tax credit announced by the Internal Revenue Service in IR-2021-203 on Oct. 15, 2021, and its accompanying Chief Counsel memorandum (CCM 20214101F).¹

The NAM is the largest manufacturing association in the United States, representing manufacturers of all sizes in every industrial sector and all 50 states. Manufacturing employs more than 12 million men and women who make things in America, contributes more than $2.52 trillion to the U.S. economy annually and has the largest economic impact of any major sector.

Driving more innovation than other sectors, R&D is the lifeblood of manufacturing. Manufacturers perform nearly 58% of all private-sector R&D. The industry's ability to pursue first-in-the-world research would be harmed by the new filing requirements' limitations on claims for refund based on research and experimental expenditures. In other words, these new limits on the ability to use the R&D tax credit would hurt innovation and the high-paying jobs supported by the nearly $300 billion the sector spent on R&D in 2020. Moreover, manufacturers would be impacted disproportionately by the filing requirements given that manufacturing corporations “claimed nearly 60 percent of the total dollar value of research credits in 2017” according to a recent report by the Joint Committee on Taxation.²

The NAM is also concerned with the manner in which the IRS has issued the new filing requirements and accordingly respectfully requests that the IRS delay the effective date to provide stakeholders the appropriate opportunity to provide feedback given the impact of these requirements on the ability of taxpayers to file for R&D tax credit refund claims.

Background on the R&D Tax Credit

Generally speaking, the R&D tax credit comes in the form of either a regular or alternative simplified tax credit with both designed to incentivize R&D investments above a base amount. While the credits are computed differently, they are governed by a four-part test and share the same types of expenses for purposes of computing the credit. The four-part test, which involves a fact-intensive analysis, is as follows:

• The research and experimental expenditures test whereby research expenses are “incurred in connection with the taxpayer's trade or business which represent research and development costs in the experimental or laboratory sense”;³

• The technological information test whereby research results in information that is “technological in nature”;⁴

• The business component test, in which the information is “intended to be useful in the development of a new or improved business component of the taxpayer”;⁵ and

• The process of experimentation test, which “relates to a new or improved function, performance, reliability or quality [of the business component].”⁶

The types of expenses that are used in computing the credit include wages of individuals who are performing qualified work (e.g., direct research, supervising research), supplies (e.g., prototyping costs), contract research (e.g., contracting with third-party engineering services) and computer rental costs.

A taxpayer claiming the R&D credit on an original or amended return is generally not required to include qualitative information supporting the claim but must be able to substantiate the claim in the event of an exam.⁷ With respect to R&D expenses, the taxpayer only needs to disclose the totals for qualified research expenses by type (e.g., total wages). For refund claims, a taxpayer must also meet the so-called specificity requirement, which requires that a taxpayer “set forth in detail each ground upon which a credit or refund is claimed.”⁸ Taxpayers have historically complied with this requirement by filing a refund claim and attaching the R&D tax credit form (Form 6765) to their amended return.

The IRS' New Filing Requirements Would Impose Significant New Burdens, Create Taxpayer Uncertainty and Hurt the Ability of Taxpayers to File a Valid R&D Tax Credit Refund Claim

The new filing requirements are scheduled to go into effect after Jan. 10, 2022, with a one-year transition period whereby taxpayers would be granted a 30-day period to perfect their refund claims. Taxpayers will need to provide the following types of information to file a valid refund claim:

• Identification of all the business components to which the research claim relates;

• Identification of all research activities performed for each business component;

• Identification of all individuals who performed each research activity for each business component;

• Identification of all the information each individual sought to discover for each business component; and

• Total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expense.

Moreover, taxpayers will need to provide the information through a written statement as opposed to a “production of documents.”⁹ If a taxpayer does provide documents, it will need to note the appropriate pages, as a “mere volume of documents will not suffice to meet a taxpayer's obligation.”¹⁰

In other words, the administrative burden on taxpayers will be increased significantly. The benefit from the new, highly detailed information required to file a valid claim is far exceeded by the burden imposed on taxpayers. Consider a taxpayer having to account for 1,000 engineers doing R&D. Under this new regime, the taxpayer will need to provide information relating to what each individual sought to discover on each of the business components on which they worked.

Moreover, these new requirements create significant uncertainty, in that requiring “all” information is a broad standard. If the taxpayer fails to meet this standard despite a good-faith effort to comply, the IRS could invalidate the claim based on the specificity requirement. Additionally, as drafted, the regime potentially leaves taxpayers without a key piece of information: whether they have filed a valid claim or not. After the one-year transition period, the IRS is not required to inform a taxpayer that a claim is deficient, meaning that taxpayers may then need to challenge the IRS legally to get an answer. Even then, the filing requirements may serve as a roadblock by enabling the IRS to charge that taxpayers have no legal standing because they filed a deficient claim. The net result is that these requirements will act to hinder the ability of taxpayers to claim the R&D tax credit.

The IRS Should Delay Implementation to Enable Meaningful Feedback

The IRS' new filing requirements for R&D credit refund claims implement a narrower interpretation of Treas. Reg. § 301.6402-2(b)(1)'s specificity requirement that departs from the IRS' and taxpayers' prior practice and understanding. Despite this significant change, the IRS issued the new requirements without engaging in any notice and comment process. Given the burdensome impact to taxpayers, the IRS should delay implementation to allow time for further deliberation, including meaningful feedback from stakeholders.

In closing, we welcome the opportunity to further discuss our concerns. If you have questions, please contact me at (202) 637-3077.

Sincerely,

Chris Netram
Vice President
Tax and Domestic Economic Policy
National Association of Manufacturers