PwC Spots Trouble in Proposed Regs on Controlled Group Research Credit
PwC Spots Trouble in Proposed Regs on Controlled Group Research Credit
- AuthorsShanahan, James R.Coughlan, J. Anthony
- Institutional AuthorsPricewaterhouseCoopers LLP
- Cross-ReferenceFor a summary of REG-133791-02, see Tax Notes, Aug. 4, 2003,
p. 647; for the full text, see Doc 2003-17657 (8 original pages) [PDF],
2003 TNT 149-29
, or H&D, July 29, 2003, p. 1349. - Code Sections
- Subject Area/Tax Topics
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2003-23677 (5 original pages)
- Tax Analysts Electronic Citation2003 TNT 213-23
Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, DC 20224
Dear Madam or Sir:
[1] This letter comments on the above referenced proposed regulations regarding the computation and allocation of the section 41 research credit for members of a controlled group of corporations or a group of trades or businesses under common control.
General Rule
[2] Pursuant to section 41(f)(1), all members of a controlled group of corporations1 and/or all trades or businesses under common control2 shall be treated as a single taxpayer for purposes of calculating the credit under section 41. The group credit, so computed, apportioned to each member of the group "shall be its [the member's] proportionate shares of the qualified research expenses [("QRE")] and basic research payments giving rise to the credit."3
[3] For a controlled group with all its members reporting in the same consolidated return, the calculation and allocation of the credit may not be an issue. However, where any members in the group report on separate returns, the group credit must be allocated to such members for inclusion in their separate returns.
Some Possible Group Credit Allocation Methods
[4] Based on the statute, legislative history and proposed regulations that the IRS has issued, there would seem to be at least three possible methods that could be used to allocate the group credit to the individual members of the group. They are:
1. Gross QREs Method: Based on the statute and its legislative history,4 many controlled groups have allocated the group credit to each member of the group based on the ratio of each member's contribution to the QREs of the group for the current (determination) year. That is, where the group credit is $20 and the group's total current QREs is $1,000 and a given member had $100 of current QREs, then such member would get $2 ($100/$1,000 x $20) of the group's credit allocated to it.
2. 2000 Proposed Regulations: In an earlier set of proposed regulations, published January 2000, the IRS rejected the "Gross QREs Method" of allocation of the group credit.5 The 2000 proposed regulations proposed to allocate the credit based on a group member's increment in QREs over an "as if" base amount. This "as if" base amount was calculated by multiplying the group's fixed base percentage by the member's average annual gross receipts for the four taxable years preceding the credit year.
3. Stand-Alone Entity Method: In a new set of proposed regulations, promulgated July 2003, the IRS rejected the allocation method in the 2000 proposed regulations, withdrew those proposed regulations and proposed yet another method of allocation. The new proposed method requires the group credit to be allocated 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 controlled group. "Stand-alone entity credit" means the credit that would be allowed to a member of the group if the member's credit were computed without regard to the aggregation rules of section 41(f) (i.e., as if the member were not a member of the group). According to the Preamble to these proposed regulations, this new allocation method "is intended to ensure that the amount of group credit allocated to each individual member will be proportionate to the amount of research credit, if any, that the individual member would have been entitled to claim had it not been part of a controlled group."
[5] We believe that while the proposed regulations may have some merit, upon close examination, one notes certain anomalies. We believe that the best way to understand the anomalous nature of the regulations is to examine examples of such anomalies.
Anomalous Examples
[6] Here are two illustrations of how the July 2003 proposed research credit allocation regulations lead to anomalous results:
Example 1
[7] Assume that A, B, and C are three corporations comprising one controlled group of corporations, within the meaning of section 41(f)(5). Assume that their base-period amounts, average annual gross receipts, and their credit-year QREs are as follows:
_______________________________________________________________________
Description A B C Group
_______________________________________________________________________
Credit Year QRE $200,000,000 0 0 $200,000,000
1984-88 QRE 100,000,000 50 50,000,000 150,000,050
1984-88 GR 1,000,000,000 5,000 2,000,000,000 3,000,005,000
Fixed Base % 10% 1% 2.5% 5%
Avg. Annual GR 2,000,000,000 1,000 1,000,000,000 3,000,001,000
Base Amount 200,000,000 10 25,000,000 150,000,050
Increment 0 0 0 49,999,950
Credit 0 0 0 9,999,990
Allocation - 2003 ? ? ?
Proposed Regs
_______________________________________________________________________
[8] Although the group credit is $9,999,950, the stand-alone entity credit of each one of the three corporations is zero. Thus, the proposed regulations' requirement that the group credit be allocated 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 cannot be followed. It is impossible to follow the regulations' requirement because such ratio has zero in the denominator -- an undefined ratio. Thus, the proposed regulations simply do not provide an answer as to how the group credit should be allocated to the various members in this example.
Example 2
[9] Assume the same facts as Example 1 above, except that B has $15 of credit-year QREs:
__________________________________________________________________________
Description A B C Group
__________________________________________________________________________
Credit Year QRE $200,000,000 15 0 $200,000,015
1984-88 QRE 100,000,000 50 50,000,000 150,000,050
1984-88 GR 1,000,000,000 5,000 2,000,000,000 3,000,005,000
Fixed Base % 10% 1% 2.5% 5%
Avg. Annual GR 2,000,000,000 1,000 1,000,000,000 3,000,001,000
Base Amount 200,000,000 10 25,000,000 150,000,050
Increment 0 5 0 49,999,965
Credit 0 1 0 9,999,993
Allocation - 2003 0 9,999,993 0
Proposed Regs
_______________________________________________________________________
[10] In this Example 2, B (and only B) has a stand-alone entity credit. This stand-alone entity credit is only one dollar. Thus, by having $15 of QREs in the credit year, the entire group credit of $9,999,993 gets allocated to B. A mere $15 of expenditures has resulted in a credit allocable to B of almost $10 million.
[11] We believe that the allocations in the four examples provided in REG-133791-02 appear reasonable. We note, however, that the allocations in the first three examples are exactly the same allocations were the gross QREs method applied. Furthermore, the allocation in the fourth example, while not exactly identical to the allocation that the gross QREs method would provide, is very nearly the same allocation. We believe that the problems with the proposed regulations only become apparent when one uses examples where the allocation under the gross QREs method is wildly different from the allocation under the July 2003 proposed regulations method.
Special Allocation Rule for Consolidated Groups
[12] In the preamble to the new proposed regulations, you have stated "Treasury and the IRS have decided not to propose a special allocation rule for consolidated groups." We respectfully ask that you reconsider this position. To illustrate the need to reconsider, assume that one controlled group of corporations has within it one stand-alone corporation, which files its own return, and also one consolidated group, with 500 corporations within it. Thus, the controlled group has a total of 501 corporations. To allocate the credit under the new proposed regulations, this would mean determining the stand-alone entity credit of 501 different corporations; this would in turn require determining the 1984-88 QREs, 1984-88 gross receipts, the average annual gross receipts for the four prior years, and the credit year QREs for each and every entity -- on an entity by entity basis. The bookkeeping and research required by such an allocation would be prohibitive. We respectfully ask that you do propose an elective special allocation rule for consolidated groups so as to simplify such allocation.
Conclusion
[13] We appreciate the efforts of the Treasury and the IRS to date. Please feel free to call either of us to discuss at your convenience.
/s/
James R. Shanahan
Partner
/s/
J. Anothony Coughlan
Senior Manager
PriceWaterhouseCoopers
Washington, DC
1IRC § 41(f)(1)(A).
2IRC § 41(f)(1)(B).
3IRC § 41(f)(1)(A)(ii).
4Changes were made to section 41 by the Revenue Reconciliation Act of 1989 (the 1989 Act) that adopted the fixed base percentage approach to determining the base amount as it exists in the law today. Prior to the 1989 Act, 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." [Emphasis added]. The phrase "increase in" was deleted by the 1989 Act.
5According to the Preamble to the 2000 proposed regulations, reiterated in the Preamble to the new proposed regulations:
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.
REG-105606-99, 65 Fed. Reg. 258, 2000-4 IRB 421 (Jan. 4, 2000); REG- 133791-02, 68 Fed. Reg. 44499, (Jul. 29, 2003) (Emphasis added.)
END OF FOOTNOTES
- AuthorsShanahan, James R.Coughlan, J. Anthony
- Institutional AuthorsPricewaterhouseCoopers LLP
- Cross-ReferenceFor a summary of REG-133791-02, see Tax Notes, Aug. 4, 2003,
p. 647; for the full text, see Doc 2003-17657 (8 original pages) [PDF],
2003 TNT 149-29, or H&D, July 29, 2003, p. 1349. - Code Sections
- Subject Area/Tax Topics
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2003-23677 (5 original pages)
- Tax Analysts Electronic Citation2003 TNT 213-23
