Qualifying vs Non-Qualifying R&D Tax Credit Activities

The R&D tax credit, worth approximately $7 billion annually in recent years, saw 17,700 corporations claim $6.6 billion in R&D Tax Credits on their tax returns in 2005 alone. Bearing in mind the broad application of the credit and recent changes to the eligibility criteria, the R&D tax credit could be a huge game changer for companies of all sizes. Whilst the many economic benefits of the R&D tax credit are well documented, there remains much confusion about the process of claiming the credit and what qualifies.

As the cut-off for lodgement of R&D tax claims approaches on April 15th, companies should now be turning their focus to the preparation and registration of their R&D activities for 2015. In light of this, we’ve broken down the elements of qualifying and non-qualifying R&D activities pertaining to the R&D Tax Credit.

To begin with, qualifying R&D activities generally fall into one of four general categories:

  • New Product Development
  • Incremental Product Development
  • New Process Development
  • Incremental Process Development

The use of the word ‘new’ or ‘incremental’ is typically determined as related to an individual company, rather than the world.

To elaborate on these four categories, additional examples of qualifying activities may be:

  • Design and development of new products – principally products that are safer, more effective or have increased functionality, better performance or longer shelf life;
  • research of new applications for existing products;
  • testing for compliance with domestic or foreign regulatory requirements;
  • design, development and implementation of new reagents, testing methods or protocols;
  • product experimentation and modification to increase yield or decrease reaction times;
  • improvement of manufacturing or production technologies, processes, techniques or procedures to increase yield, reduce waste and by-products, improve safety, improve energy efficiency or comply with regulatory requirements;
  • design and development of scaled-up manufacturing processes;
  • development of prototype pilot batches of new product candidates for testing and validation;
  • implementation of automated processes or robotics to increase production efficiency;
  • Software development or information technology initiatives related to product or process improvements; and

In contrast, when claiming the R&D tax credit, there are also activities which are unlikely to have a direct link to R&D activities, and hence are deemed non-qualifying activities.

Examples of Non-qualifying activities include:

  • routine testing or inspection activities for quality control;
  • development related purely to aesthetic properties of a product or packaging;
  • testing and qualification of production lines;
  • production line modifications which don’t involve technical uncertainty, i.e. trouble shooting involving detecting faults in production equipment or processes;
  • market research for advertising or promotions;
  • routine data collections;
  • research conducted outside the U.S., Puerto Rico or any possession of the U.S.;
  • research that is funded by a third party other than the taxpayer; and
  • any other activities that don’t meet all of the four tests previously outlined.

As shown above, the eligibility for the credit is much vaster than assumed and the credit’s definition of “R&D” is more expansive than just white coat research taking place in a lab. In effect, if you are making a product or process faster, cheaper, greener or more efficient — counting nearly all software and technology development done in the U.S. — then you may qualify.

Since the credit is now permanent, business owners can confidently include the credit as part of their annual tax planning. Ultimately, tax savings can hugely benefit businesses by injecting money back into the company. Contact Texas Tax Credit today if you would like to know more about how the R&D Tax Credit works and if you’re eligible.