Publication Date - June, 2005 * Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and the Treasury Regulations. NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date. Chapter 5 | Table of Contents | Chapter 7 6. The consistency requirement Section 41(c)(5)(A) provides that the QREs and gross receipts taken into account in computing the fixed base percentage must be determined on a basis which is consistent with the determination of qualified research expenses for the credit year, regardless of whether the period for filing a claim for credit or refund has expired for any taxable year that is taken into account in determining the fixed base percentage. To satisfy this consistency requirement, the taxpayer must show consistency between the QREs in the credit year and its QREs during the base years, as well as consistency between gross receipts in the base years and the prior four years’ average. Thus, if an expense is not qualified in the current credit year, it must be removed from the base year expenses, without regard to the law in effect during the base years. The consistency rule is designed to insure that there is an accurate determination of the relative increase in qualified research expenses over the amount “typically” spent by the taxpayer relative to its gross receipts. The increase will be accurately measured only if the taxpayer includes the same type of expenses in the credit computation for both the base years and the credit year. This rule would apply, for example, where the taxpayer has failed to include a particular type of expense in both the base years and credit year computations, thus distorting the true increase in qualified research expenses. 14 If a taxpayer claims a certain type of expense is a QRE in the credit year that it never previously treated as a QRE, it must adjust its fixed base percentage to reflect similar expenses that were paid or incurred during the base years. The research credit is an incremental credit and, thus, the taxpayer must prove that there has been an increase qualified research expenses relative to the base period. It is imperative that taxpayer establish its base year expenses. Taxpayers may not rely upon extrapolation of recent years’ data as their support for the fixed-base percentage computation. Thus, base year records should be analyzed to determine the proper amount of expenses. Since you are examining an open credit year, which requires consideration of the earlier years, the statute of limitations for the earlier years is not controlling. Consider the following questions with respect to the consistency requirement: Is the fixed-base percentage (the ratio of 84-88 QREs to gross receipts) in the base years substantially lower than current research ratios? If so, why? Do past annual reports or 10Ks support the reported base years’ QREs? If the research credit was claimed in prior years, were the same base years’ attributes used? If not, why not? Was there a prior research credit examination? Did it cover one or more of the base years? Exercise judgment (risk analysis) in examining base years’ information. For example, if the taxpayer’s base amount is subject to the “50 percent limitation” rule, an upward adjustment in the base years’ research percentage (the fixed base percentage) might have little or no effect on audit results. 14 For example, in a case decided under the prior "rolling base period" rules, Research, Inc. v. United States, 95-1 USTC ¶ 50,407 (D. Minn. 1995), the taxpayer was denied the research credit because it could not quantify the base period research expenses attributable to its "special system projects." The expenses associated with these special projects were included in the credit year and the taxpayer admitted that it incurred the same type of expenses in the base period. The taxpayer could not, however, determine the amount it incurred in the base period because it had destroyed the relevant documentation. The court disallowed the credit because the relative increase in qualified research expenses could not be measured without considering the expenses incurred during the base period for the same type of projects included in the credit year. Chapter 5 | Table of Contents | Chapter 7
