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Boeing Supplements Comments on Proposed Regs on Research and Experimental Expenses

FEB. 18, 2014

Boeing Supplements Comments on Proposed Regs on Research and Experimental Expenses

DATED FEB. 18, 2014
DOCUMENT ATTRIBUTES
  • Authors
    Terr, Leonard B.
    Webber, A. Duane
    Linguanti, Thomas V.
  • Institutional Authors
    Baker & McKenzie LLP
  • Cross-Reference
    Prior related comments 2013 TNT 237-21: Public Comments on Regulations.

    REG-124148-05 2013 TNT 173-4: IRS Proposed Regulations.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2014-4224
  • Tax Analysts Electronic Citation
    2014 TNT 38-25

 

February 18, 2014

 

 

Ms. Alexa M. Claybon

 

Attorney-Advisor

 

Department of the Treasury

 

1500 Pennsylvania Avenue, NW

 

4204-B MT

 

Washington, DC 20220

 

Proposed Regulations: Amended Definition of Research and Experimental Expenditures Under Section 174 of the Internal Revenue Code (REG-124148-05)

 

Dear Ms. Claybon,

This letter supplements the comments submitted on behalf of The Boeing Company ("Boeing") with a letter to David McDonnell, dated December 5, 2013 ("Comment Letter"), with respect to proposed regulations REG-124148-05 (Research Expenditures) ("Proposed Regulations") published by the U.S. Department of the Treasury ("Treasury Department") on September 6, 2013, regarding the amendment to the definition of research and experimental expenditures under section 174 of the Internal Revenue Code.1 Boeing continues to support the revisions described in the Comment Letter, but offers the further suggestions set out below for consideration.2

I. The Rule in (a)(5) (the "Shrinking-Back" Rule).

Boeing proposes the following revisions to Proposed Regulation section 1.174-2(a)(5):

 

Shrinking back rule. Product components and subcomponents. If the requirements of paragraph (a)(1) of this section are not met at the level of a product (as defined in paragraph (a)(3) of this section), then whether expenditures represent research and development costs is determined at the level of the component or subcomponent of the product. The presence of uncertainty concerning the development or improvement of certain components of a product does not necessarily indicate the presence of uncertainty concerning the development or improvement of other components of the product or the product as a whole. The rule in this paragraph (a)(5) is not itself applied as a reason to exclude research or experimental expenditures from section 174 eligibility with respect to the product as a whole. Instead, this rule confirms that paragraph (a)(1) of this section may be met with respect to the development or improvement of one or more components or subcomponents of a product even if there is no uncertainty concerning the development or improvement of other components of the product or the product as a whole. The rule in this paragraph (a)(5) is to be applied and administered in a manner that is consistent with the principles underlying the shrinking back rule in § 1.41-4(b)(2).

 

We propose an additional example immediately preceding Proposed Regulation section 1.174-2(a)(11) Example 8:

 

Y is a manufacturer of aircraft engines. Y is researching and developing a new type of aircraft engine that utilizes a new compressor blade. To test the appropriate designs of the new engine and compressor blade, Y produces an aircraft engine model that has been designed, to work with the new compressor blade. The costs of producing and developing the new aircraft engine and compressor blade represent research and development costs in the experimental or laboratory sense. Because Y produced the aircraft engine model to resolve uncertainty regarding the appropriate design of the engine, the engine as a whole is a pilot model under paragraph (a)(4) of this section. Therefore, the costs that Y incurred to produce the engine qualify as research or experimental expenditures under section 174. See paragraph (a)(1) of this section (relating to research or experimental expenditures).

 

We propose the following revisions to Proposed Regulation section 1.174-2(a)(11) Example 8:

 

Y is a manufacturer of aircraft engines. Y is researching and developing an alternative new type of compressor blade, a component of the an aircraft engine, to improve its existing aircraft engine design's performance the operation of the compressor. Y is not otherwise evaluating any change to the aircraft engine but has determined that the particular contemplated changes to the compressor blade in this instance do not create uncertainty with respect to the design of the aircraft engine as a whole. To test the appropriate design of the new compressor blade and evaluate the impact of fatigue on the design, Y produces and installs the compressor blade on an aircraft engine produced by Y. The costs of producing and installing the compressor blade component that Y incurred represent research and development costs in the experimental or laboratory sense. Because Y produced the compressor blade component to resolve uncertainty regarding the appropriate design of the component, the component is a pilot model under paragraph (a)(4) of this section. Therefore, the costs that Y incurred to produce and install the component qualify as research or experimental expenditures under section 174. See paragraph (a)(5) of this section (shrinking back rule product components and subcomponents). However, section 174 does not apply to Y's costs of producing the aircraft engine on which the component was installed do not qualify as research or experimental expenditures under section 174. See paragraph (a)(2) of this section (relating to production costs).

 

II. Use of Multiple Pilot Models to Eliminate Uncertainty.

We propose the following revisions to Proposed Regulation section 1.174-2(a)(11) Example 5:

 

V is a manufacturer that designs a new product. V incurs $5,000 to produce several models of the product that are to be used in testing the appropriate design before the product is mass-produced for sale. The $5,000 of costs represents research and development costs in the experimental or laboratory sense. V has determined that mMultiple models are necessary to test the design of the product in a variety of different environments (exposure to extreme heat, exposure to extreme cold, submersion, and vibration). Upon completion of several years of testing, V enters into a contract to sell one of the models to a customer, and uses another model in its trade or business. The remaining models were rendered inoperable as a result of the testing process. Because V produced the models to resolve uncertainty regarding the appropriate design of the product, the models are pilot models under paragraph (a)(4) of this section. Therefore, the $5,000 that V incurred in producing the models qualifies as research or experimental expenditures under section 174. See also paragraph (a)(1) of this section (ultimate use is not relevant).

 

III. Type of Research Expenses Deductible Under Section 174.

We propose the following revisions to Proposed Regulation section 1.174-2(a)(11) Example 7:

 

X is a manufacturer of aircraft. X is researching and developing a new, experimental aircraft that is quieter and more fuel-efficient can take off and land vertically. To evaluate and resolve uncertainty during the development or improvement of the product and test the appropriate design of the experimental aircraft, X produces a working aircraft at a cost of $5,000,000. The $5,000,000 of costs represents research and development costs in the experimental or laboratory sense. In a later year, X sells the aircraft. Because X produced the aircraft to resolve uncertainty regarding the appropriate design of the product during the development of the experimental aircraft, the aircraft is a pilot model under paragraph (a)(4) of this section. Therefore, the $5,000,000 of costs that X incurred in producing the aircraft qualifies as research or experimental expenditures under section 174. Further, it would not matter if X sold the pilot model or incorporated it in its own business as a demonstration model. See paragraph (a)(1) of this section (ultimate use is not relevant).

 

Boeing recognizes the substantial effort and creative problem-solving reflected in the Proposed Regulations and urges the prompt promulgation of those regulations with the modifications suggested in Boeing's Comment Letter, or, in the alternative, the revisions to the Proposed Regulations described herein. If you have any questions or would like to discuss these matters further, please contact us directly at 202-452-7087.
Best regards,

 

 

Leonard B. Terr

 

A. Duane Webber

 

Thomas V. Linguanti

 

Baker & McKenzie LLP

 

Counsel for The Boeing Company

 

Baker & McKenzie LLP

 

Washington, DC

 

Cc:

 

Mark Mazur, Assistant Secretary Tax Policy, Treasury

 

Lisa Zarlenga, Tax Legislative Counsel, Treasury

 

Nicole Cimino, Senior Technical Reviewer, Branch 5, ACC (PSI), IRS

 

Maya Linderman, Intern, IRS

 

FOOTNOTES

 

 

1 All "section" references are to the Internal Revenue Code (26 U.S.C.) (I.R.C.) and to the Treasury regulations (26 C.F.R.) (Treas. Reg.) thereunder currently in effect, unless otherwise noted.

2 Proposed additions to the Proposed Regulations are double underlined and proposed deletions have been struck through.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Terr, Leonard B.
    Webber, A. Duane
    Linguanti, Thomas V.
  • Institutional Authors
    Baker & McKenzie LLP
  • Cross-Reference
    Prior related comments 2013 TNT 237-21: Public Comments on Regulations.

    REG-124148-05 2013 TNT 173-4: IRS Proposed Regulations.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2014-4224
  • Tax Analysts Electronic Citation
    2014 TNT 38-25
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