FIRMS MAY DISREGARD REIMBURSEMENTS BY CONTROLLED GROUP MEMBERS WHEN CALCULATING ALLOWABLE RESEARCH CREDIT.

Index Nos.: 0044.00-00, 1563.00-00

July 23, 1986

ISSUE II

Whether reimbursements for research expenditures received by Corporations A and B from Corporation E constitute qualified research expenses for Corporations A and B for purposes of computing their allowable research credits under section 44F of the Code?

FACTS

Corporation A and Corporation B, domestic (U.S.) corporations, are both wholly owned subsidiaries of Corporation C, the U.S. parent with which Corporations A and B file consolidated U.S. tax returns. Corporation C is a wholly owned subsidiary of Corporation D, a Country X corporation, with D being a wholly owned subsidiary of Corporation E, also a Country X corporation. Corporation E does not file a U.S. tax return.

Corporations A and B are principally engaged in the research, development, and manufacture of Product Z and related items. In * * * Corporation E entered into research contracts with Corporations A and B:

o for certain projects concerning Corporations A and B, Corporation E will be deemed to own all research results an d documents, with Corporation E granting Corporations A and B exclusive licenses (for the U.S. and Country Y only) for th e products which result from these projects. Corporation E agreed to reimburse Corporation A and B for * * * of their costs incurred plus * * * or overhead and profits.

o for other projects concerning Corporation A only, Corporati on A will be deemed to own all research results, with Corporat ion A granting Corporation E an exclusive license (worldwide except for the U.S. and Country Y) for the products which result from these projects. Corporation E agreed to reimbur se Corporation A for * * * of its costs plus * * * or overhead and profits.

We shall assume without deciding that a portion of the above expenditures, incurred by Corporations A and B and reimbursed by Corporation E, may be treated as "qualified research expenses" under section 44F(b) of the Code.

In * * * and prior years, Corporations A and B included qualified research expenditures net of the funding by Corporation E in computing their allowable research credits under section 44F of the Code. In computing their allowable research credits for * * * however, Corporations A and B disregarded the funding by Corporation E, and calculated such credits based on their gross expenditures.

LAW AND RATIONALE, ISSUE I

The computation of the qualified research expenditures tax credit under section 44F of the Code is subject to special rules for aggregation of expenditures in the case of a controlled group of corporations.

Section 44F(f)(1)(A) of the Code provides that in determining the amount of credit under section 44F, all members of the same controlled group of corporations shall be treated as a single taxpayer, and the credit (if any) allowable to each such member shall be its proportionate share of the increase in qualified research expenses giving rise to the credit.

Section 44F(f)(5) provides, in part, that for purposes of the research credit, a "controlled group of corporations" has the same meaning given to such term by section 1563(a), except that "more than 50 percent" shall be substituted for "at least 80 percent" each place it appears in section 1563(a)(1).

Section 1563(a)(1) of the Code provides that a parent-subsidiary controlled group exists where one or more chains of corporations are connected through stock ownership with a common parent corporation if the stock ownership percentage requirements of the section are met. In the instant case, the corporations are connected through 100 percent stock ownership with a common parent and therefore the percentage of ownership is not an issue.

Section 1563(b) states when a corporation is a "component member of a controlled group of corporations". Section 1563(b)(2)(c) of the Code excludes foreign corporations which are subject to tax under section 881 from being treated as a COMPONENT member of a controlled group of corporations. (Emphasis added).

For purposes of section 44F(f)(5), the term "controlled group of corporations" means two or more corporations connected through stock ownership as described in section 1563(a). Neither section 44F(f)(5) nor section 1563(a) incorporates section 1563(b) in its definition. Thus, a corporation can be a member of a controlled group of corporations and yet be an excluded member if it comes within the purview of section 1563(b)(2). Nonetheless, such a corporation is still a member of a "controlled group of corporations" within the meaning of section 1563(a) for purposes of section 44F(f)(5).

LAW AND RATIONALE, ISSUE II

Section 44F(a)(1) of the Code provides that there shall be allowed as a credit against the tax imposed by this chapter for the taxable year an amount equal to 25 percent of the excess (if any) of the qualified research expenses for the taxable year over the base period research expenses.

Section 44F(b)(1) of the Code states that the term "qualified research expenses" means the sum of in-house research expenses and contract research expenses which are paid or incurred by the taxpayer during the taxable year in carrying on any trade or business of the taxpayer.

Section 44F(d) of the Code provides that for purposes of this section the term "qualified research" has the same meaning as the term research or experimental has under section 174, except that such term shall not include (1) qualified research conducted outside the United States, (2) qualified research in the social sciences or humanities, and (3) qualified research to the extent funded by any grant, contract, or otherwise by another person (or any governmental entity).

In the subject case, Corporations A and B are claiming credits under section 44F of the Code for qualified research which they have conducted within the United States. See, H.R.Rep.No. 201 at 116, which states that the test for qualified research is whether the laboratory experiments, etc., actually take place in the United States. Such qualified research was funded by Corporation E, the foreign parent and 100 percent shareholder of Corporations A and B.

Although section 44F(d)(3) of the Code states that research shall not constitute "qualified research" to the extent funded by another person, section 44F(f)(I)(A) states that a "controlled group of corporations" shall be treated as a single taxpayer. It follows that funding between members of such a commonly controlled group should generally be disregarded.

CONCLUSION, ISSUE I

Corporation E and Corporations A and B are members of a "controlled group of corporations" under section 44F(f)(1)(A) of the Code (as defined in section 44F(f)(5) of the Code).

CONCLUSION, ISSUE II

Corporations A and B may disregard Corporation E's reimbursements for research expenditures for purposes of computing their allowable research credits under section 44F of the Code.

A copy of this technical advice memorandum is to be given to the taxpayer. Section 6110(j)(3) of the Internal Revenue Code provides that it may not be used or cited as precedent. Temporary or final regulations pertaining to one or more of the issues addressed in this memorandum have not yet been adopted. Therefore, this memorandum will be modified or revoked by the adoption of temporary or final regulations to the extent the regulations are inconsistent with any conclusion in the memorandum. See section 11.03 of Rev. Proc. 86-2, 1986-1 1.R.B. 19, 25. However, a technical advice memorandum involving a continuing transaction generally is not revoked or modified retroactively if the taxpayer can demonstrate that the criteria in section 11.04 of Rev. Proc. 86-2 are satisfied.