34 Tex. Admin. Code § 3.340 - Qualified Research
(a) Definitions.
The following words and terms, when used in this section, shall have the
following meanings, unless the context clearly indicates otherwise.
(1) Business component--A business component
is any product, process, computer software, technique, formula, or invention,
which is to be held for sale, lease, or license, or used by the taxpayer in a
trade or business of the taxpayer.
(2) Combined group--Taxable entities that are
part of an affiliated group engaged in a unitary business and that are required
to file a combined group report under Tax Code, §
171.1014 (Combined
Reporting; Affiliated Group Engaged in Unitary Business). For more information
about combined groups, see §
3.590 of this title (relating to
Margin: Combined Reporting).
(3)
Directly used in qualified research--Having an immediate use in qualified
research activity, without an intervening or ancillary use.
(4) Four-Part Test--The test described in
IRC, §41(d) (Qualified research defined) that determines whether research
activities are qualified research. The four parts of the test are the Section
174 Test, the Discovering Technological Information Test, the Business
Component Test, and the Process of Experimentation Test.
(5) Franchise tax research and development
activities credit--A credit against franchise tax for qualified research
activities that is allowed under Tax Code, Chapter 171, Subchapter M (Tax
Credit for Certain Research and Development Activities).
(6) Internal Revenue Code (IRC)--The Internal
Revenue Code of 1986 in effect on December 31, 2011, excluding any changes made
by federal law after that date, but including any regulations adopted under the
code applicable to the tax year to which the provisions of the code in effect
on that date applied. A regulation adopted after December 31, 2011 is only
included in this term to the extent that a taxpayer could have applied the
regulation to the 2011 federal income tax year. Examples of treasury
regulations included in this definition are:
(A) Treasury Regulation, §1.174-2
(Definition of research and experimental expenditures) as contained in 26 CFR
part 1 (revised as of July 21, 2014);
(B) Treasury Regulation, §1.41-4
(Qualified research for expenditures paid or incurred in taxable years ending
on or after December 31, 2003) as contained in 26 CFR part 1 (revised as of
November 3, 2016), except for paragraph (c)(6) (Internal use software). For
paragraph (c)(6), as provided in the last sentence of Treasury Regulation,
§1.41-4 (e) (Effective/applicability dates), taxpayers may elect to follow
either of the following versions of paragraph (c)(6):
(i) Treasury Regulation, §1.41-4(c)(6)
(Internal-use computer software) as contained in 26 CFR part 1 (revised as of
April 1, 2003) and IRB 2001-5; or
(ii) Proposed Treasury Regulation,
§1.41-4(c)(6) (Internal use software for taxable years beginning on or
after the December 31, 1985) as contained in IRB 2002-4.
(7) Qualified research--This term
has the meaning given in IRC, §41(d), except that the research must be
conducted in Texas. Qualified research activities must satisfy each part of the
Four-Part Test.
(8) Registrant--A
taxpayer who holds a Texas Qualified Research Registration Number issued by the
comptroller.
(9) Registration
number--The Texas Qualified Research Registration Number issued by the
comptroller to a taxpayer who submits the Texas Registration for Qualified
Research and Development Sales Tax Exemption form.
(10) Taxable entity--This term has the
meaning given by Tax Code, §
171.0002 (Definition of
Taxable Entity).
(b)
Depreciable tangible personal property used in qualified research.
(1) Subject to paragraph (2) of this
subsection, the sale, storage, or use of tangible personal property is exempt
from Texas sales and use tax if the property:
(A) has a useful life that exceeds one
year;
(B) is subject to
depreciation under:
(i) generally accepted
accounting principles; or
(ii) IRC,
§167 (Depreciation) or §168 (Accelerated cost recovery system);
and
(C) is sold, leased,
rented to, stored, or used by a taxpayer engaged in qualified research;
and
(D) is directly used in
qualified research. Depreciable tangible personal property is directly used in
qualified research if it is used in the actual performance of activities that
are part of the qualified research. For example, machinery, equipment,
computers, software, tools, laboratory furniture such as desks, laboratory
tables, stools, benches, and storage cabinets, and other tangible personal
property used by personnel in the process of experimentation are directly used
in qualified research. Tangible personal property is not directly used in
qualified research if it is used in ancillary or support activities such as
administration, maintenance, marketing, distribution, or transportation
activities, or if it is used in activities excluded from qualified research.
For example, machinery and equipment used by administrative, accounting, or
clerical personnel are not directly used in qualified research.
(2) A taxpayer may not claim the
exemption if that taxpayer will, as a taxable entity or as a member of a
combined group, claim a franchise tax research and development activities
credit on a franchise tax report based on the accounting period during which
the depreciable tangible personal property used in qualified research would
first be subject to Texas sales or use tax.
(3) A claim for a carryforward of an unused
franchise tax research and development activities credit under Tax Code, §
171.659(Carryforward)
does not affect a taxpayer's ability, as a taxable entity or as a member of a
combined group, to claim the sales and use tax exemption provided by paragraph
(1) of this subsection.
(4)
Property satisfies paragraph (1)(B) of this subsection if it is subject to
depreciation under generally accepted accounting principles, IRC, §167, or
IRC, §168 even if the taxpayer does not actually depreciate that
property.
(5) Property satisfies
paragraph (1) of this subsection only if it is tangible personal property
subject to depreciation at the time a taxpayer purchases it. For example,
assume a taxpayer purchases tangible personal property that is not subject to
depreciation. The taxpayer later incorporates that property into real property
that is subject to depreciation. Although the real property with the
incorporated tangible personal property is subject to depreciation, the
tangible personal property, on its own, was never subject to depreciation. The
tangible personal property does not satisfy paragraph (1) of this subsection
because it was never subject to depreciation as tangible personal
property.
(6) A taxpayer has the
burden of establishing its entitlement to the exemption by clear and convincing
evidence, including proof that the research activities meet the definition of
qualified research and applying the shrink-back rule described in subsection
(c)(3) of this section. All qualified research activities must be supported by
contemporaneous business records.
(7) An Internal Revenue Service audit
determination of eligibility for the federal research and development credit
under IRC, §41 (Credit for increasing research activities), whether that
determination is that the taxpayer qualifies or does not qualify for the
federal research and development credit, is not binding on the comptroller's
determination of eligibility for the exemption.
(c) Application of the Four-Part Test.
Research activities must satisfy each part of the Four-Part Test, as described
in paragraph (1) of this subsection, to be qualified research.
(1) Four-Part Test.
(A) Section 174 Test. Expenditures related to
the research must be eligible to be treated as expenses under IRC, §174
(Research and experimental expenditures).
(i)
Expenditures are eligible to be treated as expenses under IRC, §174, if
the expenditures are incurred in connection with the taxpayer's trade or
business and represent a research and development cost in the experimental or
laboratory sense. Expenditures represent research and development costs in the
experimental or laboratory sense if they are for activities intended to
discover information that would eliminate uncertainty concerning the
development or improvement of a product. Uncertainty exists if the information
available to the taxpayer does not establish the capability or method for
developing or improving the product or the appropriate design of the
product.
(ii) For the purposes of
this test, the term "product" includes any pilot model, process, formula,
invention, technique, patent, or similar property, and includes products to be
used by the taxpayer in its trade or business as well as products to be held
for sale, lease, or license.
(iii)
Expenditures for the following are not eligible to be treated as expenses under
IRC, §174:
(I) land;
(II) depreciable property;
(III) the ordinary testing or inspection of
materials or products for quality control;
(IV) efficiency surveys;
(V) management studies;
(VI) consumer surveys;
(VII) advertising or promotions;
(VIII) the acquisition of another's patent,
model, production, or process; or
(IX) research in connection with literary,
historical, or similar projects.
(iv) Although expenditures for depreciable
property are not eligible to be treated as expenditures under IRC, §174,
those expenditures qualify for the purposes of the sales tax research and
development exemption, provided that the research activities otherwise satisfy
the Four-Part Test and are not excluded under subsection (d) of this
section.
(B) Discovering
Technological Information Test. The research must be undertaken for the purpose
of discovering information that is technological in nature.
(i) Research is undertaken for the purpose of
discovering technological information if it is intended to eliminate
uncertainty concerning the development or improvement of a business component.
Uncertainty exists if the information available to the taxpayer does not
establish the capability or method for developing or improving the business
component, or the appropriate design of the business component.
(ii) In order to satisfy the requirement that
the research is technological in nature, the process of experimentation used to
discover information must fundamentally rely on principles of the physical or
biological sciences, engineering, or computer science. A taxpayer may employ
existing technologies and may rely on existing principles of the physical or
biological sciences, engineering, or computer science to satisfy this
requirement.
(iii) A determination
that research is undertaken for the purpose of discovering information that is
technological in nature does not require that the taxpayer:
(I) seek to obtain information that exceeds,
expands, or refines the common knowledge of skilled professionals in the
particular field of science or engineering in which the taxpayer is performing
the research; or
(II) succeed in
developing a new or improved business component.
(C) Business Component Test. The application
of the technological information for which the research is undertaken must be
intended to be useful in the development of a new or improved business
component of the taxpayer, which may include any product, process, computer
software, technique, formula, or invention that is to be held for sale, lease,
or license, or used by the taxpayer in a trade or business of the taxpayer.
(i) If a taxpayer provides a service to a
customer, the service provided to that customer is not a business component
because a service is not a product, process, computer software, technique,
formula, or invention. However, a product, process, computer software,
technique, formula, or invention used by a taxpayer to provide services to its
customers may be a business component.
(ii) A design is not a business component
because a design is not a product, process, computer software, technique,
formula, or invention. While uncertainty as to the appropriate design of a
business component is a qualifying uncertainty for the Section 174 Test and the
Discovering Technological information test, the design itself is not a business
component. For example, the design of a structure is not a business component,
although the structure itself may be a business component. Similarly, a
blueprint or other plan used to construct a structure that embodies a design is
not a business component.
(D) Process of Experimentation Test.
Substantially all of the research activities must constitute elements of a
process of experimentation for a qualified purpose. A process of
experimentation is undertaken for a qualified purpose if it relates to a new or
improved function, performance, reliability, or quality of a business
component. Any research relating to style, taste, cosmetic, or seasonal design
factors does not satisfy the Process of Experimentation Test.
(i) A process of experimentation is a process
designed to evaluate one or more alternatives to achieve a result where the
capability or the method of achieving that result, or the appropriate design of
that result, is uncertain as of the beginning of the taxpayer's research
activities.
(ii) A process of
experimentation must:
(I) be an evaluative
process and generally should be capable of evaluating more than one
alternative; and
(II) fundamentally
rely on the principles of the physical or biological sciences, engineering, or
computer science and involve:
(-a-) the
identification of uncertainty concerning the development or improvement of a
business component;
(-b-) the
identification of one or more alternatives intended to eliminate that
uncertainty; and
(-c-) the
identification and the conduct of a process of evaluating the alternatives
through, for example, modeling, simulation, or a systematic trial and error
methodology.
(iii) A taxpayer may undertake a process of
experimentation if there is no uncertainty concerning the taxpayer's capability
or method of achieving the desired result so long as the appropriate design of
the desired result is uncertain as of the beginning of the taxpayer's research
activities. Uncertainty concerning the development or improvement of the
business component (e.g., its appropriate design) does not establish that all
activities undertaken to achieve that new or improved business component
constitute a process of experimentation.
(iv) The substantially all requirement of
this subparagraph is satisfied only if 80% or more of a taxpayer's research
activities, measured on a cost or other consistently applied reasonable basis
constitute elements of a process of experimentation that relates to a new or
improved function, performance, reliability, or quality. The substantially all
requirement is satisfied even if the remainder of a taxpayer's research
activities with respect to the business component do not constitute elements of
a process of experimentation that relates to a new or improved function,
performance, reliability, or quality.
(v) Non-experimental methods, such as simple
trial and error, brainstorming, or reverse engineering, are not considered a
process of experimentation.
(vi)
The following are factors that may be considered in determining whether a trial
and error methodology is experimental systematic trial and error or
non-experimental simple trial and error. Evidence provided to determine the
type of trial and error is not limited to these factors, nor is evidence of
each factor required. These factors only apply to determining whether a process
of experimentation is systematic trial and error. Systematic trial and error is
not the only qualifying process of experimentation. These factors are:
(I) whether the person conducting the trial
and error methodology stops testing alternatives once a single acceptable
result is found or continues to find multiple acceptable results for
comparison;
(II) whether all the
results of the trial and error methodology are recorded for
evaluation;
(III) whether there is
a written procedure for conducting the trial and error methodology;
and
(IV) whether there is a written
procedure for evaluating the results of the trial and error
methodology.
(vii)
Examples.
(I) Example 1. A taxpayer is
engaged in the business of developing and manufacturing widgets. The taxpayer
wants to change the color of its blue widget to green. The taxpayer obtains
several different shades of green paint from various suppliers. The taxpayer
paints several sample widgets, and surveys its customers to determine which
shade of green its customers prefer. The taxpayer's activities to change the
color of its blue widget to green do not satisfy the Process of Experimentation
Test because its activities are not undertaken for a qualified purpose. All of
the taxpayer's research activities are related to style, taste, cosmetic, or
seasonal design factors.
(II)
Example 2. The taxpayer in Example 1 chooses one of the green paints. The
taxpayer obtains samples of the green paint from a supplier and determines that
it must modify its painting process to accommodate the green paint because the
green paint has different characteristics from other paints it has used. The
taxpayer obtains detailed data on the green paint from its paint supplier. The
taxpayer also consults with the manufacturer of its paint spraying machines.
The manufacturer informs the taxpayer that it must acquire new nozzles that
operate with the green paint it wants to use because the current nozzles do not
work with the green paint. The taxpayer tests the new nozzles, using the green
paint, to ensure that they work as specified by the manufacturer of the paint
spraying machines. The taxpayer's activities to modify its painting process are
not qualified research. The taxpayer did not conduct a process of evaluating
alternatives in order to eliminate uncertainty regarding the modification of
its painting process. Rather, the manufacturer of the paint machines eliminated
the taxpayer's uncertainty regarding the modification of its painting process.
The taxpayer's activities to test the nozzles to determine if the nozzles work
as specified by the manufacturer of the paint spraying machines are in the
nature of routine or ordinary testing or inspection for quality
control.
(III) Example 3. A
taxpayer is engaged in the business of manufacturing food products and
currently manufactures a large-shred version of a product. The taxpayer seeks
to modify its current production line to permit it to manufacture both a
large-shred version and a fine-shred version of one of its food products. A
smaller, thinner shredding blade capable of producing a fine-shred version of
the food product is not commercially available. Thus, the taxpayer must develop
a new shredding blade that can be fitted onto its current production line. The
taxpayer is uncertain concerning the design of the new shredding blade because
the material used in its existing blade breaks when machined into smaller,
thinner blades. The taxpayer engages in a systematic trial and error process of
analyzing various blade designs and materials to determine whether the new
shredding blade must be constructed of a different material from that of its
existing shredding blade and, if so, what material will best meet its
functional requirements. The taxpayer's activities to modify its current
production line by developing the new shredding blade satisfy the Process of
Experimentation Test. Substantially all of the taxpayer's activities constitute
elements of a process of experimentation because it evaluated alternatives to
achieve a result where the method of achieving that result, and the appropriate
design of that result, were uncertain as of the beginning of the taxpayer's
research activities. The taxpayer identified uncertainties related to the
development of a business component, and identified alternatives intended to
eliminate these uncertainties. Furthermore, the taxpayer's process of
evaluating identified alternatives was technological in nature and was
undertaken to eliminate the uncertainties.
(IV) Example 4. A taxpayer is in the business
of designing, developing and manufacturing automobiles. In response to
government-mandated fuel economy requirements, the taxpayer seeks to update its
current model vehicle and undertakes to improve aerodynamics by lowering the
hood of its current model vehicle. The taxpayer determines, however, that
lowering the hood changes the air flow under the hood, which changes the rate
at which air enters the engine through the air intake system, which reduces the
functionality of the cooling system. The taxpayer's engineers are uncertain how
to design a lower hood to obtain the increased fuel economy, while maintaining
the necessary air flow under the hood. The taxpayer designs, models, simulates,
tests, refines, and re-tests several alternative designs for the hood and
associated proposed modifications to both the air intake system and cooling
system. This process enables the taxpayer to eliminate the uncertainties
related to the integrated design of the hood, air intake system, and cooling
system. Such activities constitute 85% of its total activities to update its
current model vehicle. The taxpayer then engages in additional activities that
do not involve a process of evaluating alternatives in order to eliminate
uncertainties. The additional activities constitute only 15% of the taxpayer's
total activities to update its current model vehicle. In this case
substantially all of the taxpayer's activities constitute elements of a process
of experimentation because it evaluated alternatives to achieve a result where
the method of achieving that result, and the appropriate design of that result,
were uncertain as of the beginning of its research activities. The taxpayer
identified uncertainties related to the improvement of a business component and
identified alternatives intended to eliminate these uncertainties. Furthermore,
the taxpayer's process of evaluating the identified alternatives was
technological in nature and was undertaken to eliminate the uncertainties.
Because 85% of the taxpayer's activities to update its current model vehicle
constitute elements of a process of experimentation that relates to a new or
improved function, performance, reliability, or quality, all of its activities
satisfy the Process of Experimentation Test.
(V) Example 5. A taxpayer is in the business
of providing building and construction services, including the construction of
warehouses, strip malls, office buildings, and other commercial structures. The
taxpayer is engaged to construct a structure in a part of Texas where
foundation problems are common. The taxpayer's engineers were uncertain how to
design the structure to ensure stability of the structure's foundation because
the taxpayer had never designed a structure in a similar location. The
taxpayer's engineers used their professional experience and various building
codes to determine how to design the foundation based on the conditions at the
construction site. The engineers chose to use piles in the foundation. The
taxpayer constructed a test pile on site to confirm whether this would work in
the conditions present on the construction site. This test pile would become
part of the foundation of the structure regardless of whether the engineers had
to redesign the additional piles required for the foundation. The taxpayer's
activities in using professional experience and business codes to design the
foundation did not meet the Process of Experimentation Test because the
activities did not resolve technological uncertainties through an experimental
process. Constructing the test pile also did not meet the Process of
Experimentation Test because it was not an evaluative process.
(VI) Example 6. A taxpayer is in the business
of providing building and construction services, including the construction of
warehouses, strip malls, office buildings, and other commercial structures. For
one of its projects to construct an office building, the taxpayer was uncertain
how to design the layout of the electrical systems. The taxpayer's employees
held on-site meetings to discuss different options, such as running the wire
under the floor or through the ceiling, but did not actually experiment by
installing wire in different locations. The taxpayer used computer-aided
simulation and modeling to produce the final electrical system layout. While in
some cases computer-aided simulation and modeling may be an experimental
process, in this case, it was not an experimental process because the taxpayer
did not use the computer-aided simulation and modeling to evaluate different
alternatives in a scientific manner. The taxpayer's activities did not satisfy
the Process of Experimentation Test because it did not conduct an experimental
process of evaluating alternatives to eliminate a technological
uncertainty.
(VII) Example 7. A
taxpayer is an oil and gas operator that recently acquired rights to drill in
an area in which it had not previously operated. The taxpayer decided to use
horizontal drilling in this area, but it had never drilled a horizontal well
and was uncertain how to successfully execute the horizontal drilling. At the
time the taxpayer began horizontal drilling, the technology to drill horizontal
wells was established. The taxpayer selected technology from existing
commercially available options to use in its horizontal drilling program. The
taxpayer's activities did not satisfy the Process of Experimentation Test
because evaluating commercially available options does not constitute a process
of experimentation.
(VIII) Example
8. A taxpayer is an oil and gas operator that recently acquired rights to drill
in an area in which it had not previously operated. The taxpayer decided to use
horizontal drilling in this area. The taxpayer had drilled a horizontal well
before in a different formation and at different depths. However, it had never
drilled a horizontal well in this formation or at the required depths and was
uncertain how to successfully execute the horizontal drilling. The taxpayer
utilized its existing technology to perform its horizontal drilling operations
in this area and the existing technology was successful. The taxpayer's
activities did not satisfy the Process of Experimentation Test because the
taxpayer merely used its existing technology and did not perform any
experimentation to evaluate alternative any drilling methods.
(IX) Example 9. A taxpayer sought to discover
cancer immunotherapies. The taxpayer was uncertain as to the appropriate design
of the proteins to be used as a drug candidate. The taxpayer identified several
alternative protein constructs and used a process to test them. The taxpayer's
process involved testing the constructs using in vitro functional assays and
binding assays, and either modifying the designs or discarding them and
repeating the previous steps. The taxpayer took the resulting products from the
in vitro testing and tested the drug candidate in living organisms. This
process evaluated the various alternatives identified by the taxpayer. The
taxpayer's activities satisfied the Process of Experimentation Test.
(2)
Application of the Four-Part Test to business components. The Four-Part Test is
applied separately to each business component of the taxpayer. Any plant
process, machinery, or technique for commercial production of a business
component is treated as a separate business component from the business
component being produced.
(3)
Shrink-back rule. The Four-Part Test is first applied at the level of the
discrete business component used by the taxpayer in a trade or business of the
taxpayer. If the requirements of the Four-Part Test are not met at that level,
then they are applied at the next most significant subset of elements of the
business component. This shrinking back of the product continues until either a
subset of elements of the product that satisfies the requirements of the
Four-Part Test is reached, or the most basic element of the product is reached
and such element fails to satisfy any part of the Four-Part Test.
(4) Software development as qualified
research. In determining if software development activities constitute
qualified research, the comptroller shall consider the facts and circumstances
of each activity.
(A) Application of Four-Part
Test to software development activities.
(i)
A taxpayer must prove that a software development activity is qualified
research and meets all the requirements of the Four-Part Test under paragraph
(1) of this subsection, even if the activity is likely to qualify as described
in subparagraph (B) of this paragraph.
(ii) A taxpayer may prove that a software
development activity described as unlikely to qualify in subparagraph (C) of
this paragraph, is qualified research by providing evidence that the activity
meets all the requirements of the Four-Part Test under paragraph (1) of this
subsection.
(B) Software
development activities likely to qualify. Types of activities likely to qualify
include, but are not limited to:
(i)
developing the initial release of an application software product that includes
new constructs, such as new architectures, new algorithms, or new database
management techniques;
(ii)
developing system software, such as operating systems and compilers;
(iii) developing specialized technologies,
such as image processing, artificial intelligence, or speech recognition;
and
(iv) developing software as
part of a hardware product where the software interacts directly with that
hardware in order to make the hardware/software package function as a
unit.
(C) Software
development activities unlikely to qualify. Types of activities unlikely to
qualify include, but are not limited to:
(i)
maintaining existing software applications or products;
(ii) configuring purchased software
applications;
(iii) reverse
engineering of existing applications;
(iv) performing studies, or similar
activities, to select vendor products;
(v) detecting flaws and bugs directed toward
the verification and validation that the software was programmed as intended
and works correctly;
(vi) modifying
an existing software business component to make use of new or existing
standards or devices, or to be compliant with another vendor's product or
platform;
(vii) developing a
business component that is substantially similar in technology, functionality,
and features to the capabilities already in existence at other
companies;
(viii) upgrading to
newer versions of hardware or software or installing vendor-fix
releases;
(ix) re-hosting or
porting an application to a new hardware such as from mainframe to PC, or
software platform, such as Windows to UNIX, or rewriting an existing
application in a new language, such as rewriting a COBOL mainframe application
in C++;
(x) writing hardware device
drivers to support new hardware, such as disks, scanners, printers, or
modems;
(xi) performing data
quality, data cleansing, and data consistency activities, such as designing and
implementing software to validate data fields, clean data fields, or make the
data fields consistent across databases and applications;
(xii) bundling existing individual software
products into product suites, such as combining existing word processor,
spreadsheet, and slide presentation software applications into a single
suite;
(xiii) expanding product
lines by purchasing other products;
(xiv) developing interfaces between different
software applications;
(xv)
developing vendor product extensions;
(xvi) designing graphic user
interfaces;
(xvii) developing
functional enhancements to existing software applications/products;
(xviii) developing software as an embedded
application, such as in cell phones, automobiles, and airplanes;
(xix) developing software utility programs,
such as debuggers, backup systems, performance analyzers, and data
recovery;
(xx) changing from a
product based on one technology to a product based on a different or newer
technology; and
(xxi) adapting and
commercializing technology developed by a consortium or open software
group.
(d) Excluded research activities. Qualified
research does not include the activities described in this subsection.
(1) Research after commercial production. Any
research conducted after the beginning of commercial production of the business
component.
(A) Activities are conducted after
the beginning of commercial production of a business component if such
activities are conducted after the component is developed to the point where it
is ready for commercial sale or use or meets the basic functional and economic
requirements of the taxpayer for the component's sale or use.
(B) The following activities are deemed to
occur after the beginning of commercial production of a business component:
(i) preproduction planning for a finished
business component;
(ii) tooling-up
for production;
(iii) trial
production runs;
(iv)
troubleshooting involving detecting faults in production equipment or
processes;
(v) accumulating data
relating to production processes;
(vi) debugging flaws in a business component;
and
(vii) any activities that
involve the use of an item for which the taxpayer claimed the manufacturing
exemption under Tax Code, §
151.318.
(C) In cases involving development of both a
product and a manufacturing or other commercial production process for the
product, the research after commercial production exclusion applies separately
for the activities relating to the development of the product and the
activities relating to the development of the process. For example, even after
a product meets the taxpayer's basic functional and economic requirements,
activities relating to the development of the manufacturing process may still
constitute qualified research, provided that the development of the process
itself separately satisfies the requirements of this section, and the
activities are conducted before the process meets the taxpayer's basic
functional and economic requirements or is ready for commercial use.
(D) Clinical testing of a pharmaceutical
product prior to its commercial production in the United States is not treated
as occurring after the beginning of commercial production even if the product
is commercially available in other countries. Additional clinical testing of a
pharmaceutical product after a product has been approved for a specific
therapeutic use by the Food and Drug Administration and is ready for commercial
production and sale is not treated as occurring after the beginning of
commercial production if such clinical testing is undertaken to establish new
functional uses, characteristics, indications, combinations, dosages, or
delivery forms for the product. A functional use, characteristic, indication,
combination, dosage, or delivery form shall be considered new only if such
functional use, characteristic, indication, combination, dosage, or delivery
form must be approved by the Food and Drug Administration.
(E) Examples.
(i) Example 1. A taxpayer is a tire
manufacturer and develops a new material to use in its tires. The taxpayer
conducts research to determine the changes that will be necessary for it to
modify its existing manufacturing processes to manufacture the new tire. The
taxpayer determines that the new tire material retains heat for a longer period
of time than the materials it currently uses for tires, and, as a result, the
new tire material adheres to the manufacturing equipment during tread cooling.
The taxpayer evaluates several alternatives for processing the treads at cooler
temperatures to address this problem, including a new type of belt for its
manufacturing equipment to be used in tread cooling. Such a belt is not
commercially available. Because the taxpayer is uncertain of the belt design,
it develops and conducts sophisticated engineering tests on several alternative
designs for a new type of belt to be used in tread cooling until it
successfully achieves a design that meets its requirements. The taxpayer then
manufactures a set of belts for its production equipment, installs the belts,
and tests the belts to make sure they were manufactured correctly. The
taxpayer's research with respect to the design of the new belts to be used in
its manufacturing of the new tire may be qualified research under the Four-Part
Test. However, the taxpayer's expenses to implement the new belts, including
the costs to manufacture, install, and test the belts were incurred after the
belts met the taxpayer's functional and economic requirements and are excluded
as research after commercial production.
(ii) Example 2. For several years, a taxpayer
has manufactured and sold a particular kind of widget. The taxpayer initiates a
new research project to develop a new or improved widget. The taxpayer's
activities to develop a new or improved widget are not excluded from the
definition of qualified research under this paragraph. The taxpayer's
activities relating to the development of a new or improved widget constitute a
new research project to develop a new business component and are not considered
activities conducted after the beginning of commercial production.
(iii) Example 3. For the purposes of this
example, assume that the taxpayer's development of its products and
manufacturing processes satisfies the Four-Part Test described by subsection
(c) of this section and is not otherwise excluded under this subsection. A
taxpayer is a manufacturer of integrated circuits for use in specific
applications. The taxpayer develops various integrated circuit devices and
associated manufacturing processes. The taxable entity assembles various
product configurations for testing. After an internal process of testing, the
taxpayer delivers a sample quantity of the integrated circuit to a potential
customer for further testing. At the time when the samples are delivered to the
taxpayer's potential customer, the potential customer has not agreed to
purchase any integrated circuits from the taxpayer. This process of testing by
both the taxpayer and its potential customer continues until an acceptable
product and manufacturing process to produce the product is achieved. At that
point, the taxpayer and the potential customer enter an agreement for the
delivery of an order of the integrated circuits. In some cases, no acceptable
product or manufacturing process is achieved, and no agreement is reached with
the potential customer. Research activities occurring prior to an agreement are
not considered activities conducted after the beginning of commercial
production because the integrated circuits were not yet ready for commercial
use. Any research that occurs after an agreement is reached are excluded as
activities conducted after the beginning of commercial production because the
integrated circuits were ready for commercial use once the product and
associated manufacturing process was accepted by the potential
customer.
(2)
Adaptation of existing business components. Activities relating to adapting an
existing business component to a particular customer's requirement or need.
This exclusion does not apply merely because a business component is intended
for a specific customer. For example:
(A)
Example 1. A taxpayer is a computer software development firm and owns a
general ledger accounting software core program that it markets and licenses to
customers. The taxpayer incurs expenditures in adapting the core software
program to the requirements of one of its customers. Because the taxpayer's
activities represent activities to adapt an existing software program to a
particular customer's requirement or need, its activities are excluded from the
definition of qualified research under this paragraph.
(B) Example 2. Assume that the customer from
Example 1 pays the taxpayer to adapt the core software program to the
customer's requirements. Because the taxpayer's activities are excluded from
the definition of qualified research, the customer's payments to the taxpayer
are not for qualified research and are not considered to be contract research
expenses.
(C) Example 3. Assume
that the customer from Example 1 uses its own employees to adapt the core
software program to its requirements. Because the customer's employees'
activities to adapt the core software program to its requirements are excluded
from the definition of qualified research, the wages the customer paid to its
employees do not constitute in-house research expenses.
(D) Example 4. A taxpayer manufactures and
sells rail cars. Because rail cars have numerous specifications related to
performance, reliability and quality, rail car designs are subject to
extensive, complex testing in the scientific or laboratory sense. A customer
orders passenger rail cars from the taxpayer. The customer's rail car
requirements differ from those of the taxpayer's other existing customers only
in that the customer wants fewer seats in its passenger cars and a higher
quality seating material and carpet that are commercially available. The
taxpayer manufactures rail cars meeting the customer's requirements. The rail
car sold to the customer was not a new business component, but merely an
adaptation of an existing business component that did not require a process of
experimentation. Thus, the taxpayer's activities to manufacture rail cars for
the customer are excluded from the definition of qualified research because the
taxpayer's activities represent activities to adapt an existing business
component to a particular customer's requirement or need.
(E) Example 5. A taxpayer is a manufacturer
and undertakes to create a manufacturing process for a new valve design. The
taxpayer determines that it requires a specialized type of robotic equipment to
use in the manufacturing process for its new valves. Such robotic equipment is
not commercially available. Therefore, the taxpayer purchases existing robotic
equipment for the purpose of modifying it to meet its needs. The taxpayer's
engineers identify uncertainty that is technological in nature concerning how
to modify the existing robotic equipment to meet its needs. The taxpayer's
engineers develop several alternative designs, conduct experiments using
modeling and simulation in modifying the robotic equipment, and conduct
extensive scientific and laboratory testing of design alternatives. As a result
of this process, the taxpayer' s engineers develop a design for the robotic
equipment that meets its needs. The taxpayer constructs and installs the
modified robotic equipment on its manufacturing process. The taxpayer's
research activities to determine how to modify the robotic equipment it
purchased for its manufacturing process are not considered an adaptation of an
existing business component.
(F)
Example 6. A taxpayer is an oil and gas operator and has been engaged in
horizontal drilling for the past ten years. Recently, the taxpayer was hired by
a customer to drill in a formation. The drilling objectives included targeting
an interval within that formation for horizontal drilling. The taxpayer was
uncertain about the successful execution of the horizontal drilling because it
had not previously drilled a horizontal well in that formation. The taxpayer
was also uncertain about the economic results from the targeted interval. The
taxpayer drilled several horizontal wells before its customer was satisfied
with the economic results. The taxpayer modified its existing horizontal
drilling program based on these results. The taxpayer's activities to identify
a horizontal drilling process are excluded from the definition of qualified
research because the activities consisted of adapting an existing business
component, its existing horizontal drilling process, and did not involve
creating a new or improved business component.
(G) Example 7. For the purposes of this
example, assume that the taxpayer's development of its products satisfies the
Four-Part Test described by subsection (c) of this section and is not otherwise
excluded under this subsection. A taxpayer is a manufacturer of rigid plastic
containers. The taxpayer contracts with major food and beverage manufacturers
to provide suitable bottle and packaging designs. The products designed by the
taxpayer may be for repeat customers and the sizes and types of bottle may be
similar to previous products. The development of each new product, and the
production process necessary to produce the products at sufficient production
volume, starts from new concept drawings developed by engineers. The taxpayer
uses a qualifying process of experimentation to evaluate alternative concepts
for the product and production processes. The taxpayer's activities related to
both the product and the production process are not excluded from the
definition of qualified research as an adaptation of an existing business
component.
(3)
Duplication of existing business component. Any research related to the
reproduction of an existing business component, in whole or in part, from a
physical examination of the business component itself or from plans,
blueprints, detailed specifications, or publicly available information with
respect to such business component. This exclusion does not apply merely
because the taxpayer examines an existing business component in the course of
developing its own business component.
(4) Surveys, studies, etc. Any efficiency
survey; activity relating to management function or technique; market research,
testing or development (including advertising or promotions); routine data
collection; or routine or ordinary testing or inspection for quality
control.
(5) Computer software. Any
research activities with respect to internal use software.
(A) For the purposes of this paragraph,
internal use software is computer software developed by, or for the benefit of,
the taxpayer primarily for internal use by the taxpayer.
(B) This exclusion does not apply to software
used in:
(i) an activity that constitutes
qualified research, or
(ii) a
production process that meets the requirements of the Four-Part Test.
(6) Social sciences,
etc. Any research in the social sciences, arts, or humanities.
(7) Funded research. Any research funded by
any grant, contract, or otherwise by another person or governmental entity.
(A) Research is considered funded if:
(i) the taxpayer performing the research for
another person retains no substantial rights to the results of the research;
or
(ii) the payments to the
researcher are not contingent upon the success of the research.
(B) For the purposes of
determining whether a taxpayer retains substantial rights to the results of the
research:
(i) Incidental benefits to the
researcher from the performance of the research do not constitute substantial
rights. For example, increased experience in a field of research is not
considered substantial rights.
(ii)
A taxpayer does not retain substantial rights in the research it performs if
the taxpayer must pay for the right to use the results of the
research.
(C) If a
taxpayer performing research does not retain substantial rights to the results
of the research, the research is considered funded regardless of whether the
payments to the researcher are contingent upon the success of the research. In
this case, all research activities are considered funded even if the researcher
has expenses that exceed the amount received by the researcher for the
research.
(D) If a taxpayer
performing research does retain substantial rights to the results of the
research and the research is considered funded under subparagraph (A)(ii) of
this paragraph, the research is only funded to the extent of the payments and
fair market value of any property that the taxpayer becomes entitled to by
performing the research. If the expenses related to the research exceed the
amount the researcher is entitled to receive, the research is not considered
funded with respect to the excess expenses. For example, a taxpayer performs
research for another person. Based on the contract, the research activities are
considered funded under subparagraph (A)(ii) of this paragraph because payments
to the researcher are not contingent on the success of the research. The
taxpayer retains substantial rights to the results of the research. The
taxpayer is entitled to $100,000 under the contract but spent $120,000 on the
research activities. In this case, the research is considered funded with
respect to $100,000 and is not considered funded with respect to
$20,000.
(E) A taxpayer performing
research for another person must identify any other person paying for the
research activities and any person with substantial rights to the results of
the research.
(F) All agreements,
not only research contracts, entered into between the taxpayer performing the
research and the party funding the research shall be considered in determining
the extent to which the research is funded.
(G) The provisions of this paragraph shall be
applied separately to each research project undertaken by the
taxpayer.
(e)
Texas Qualified Research and Development Exemption Registration. In order to
claim an exemption under this section, a taxpayer must first register with the
comptroller and obtain a registration number.
(1) Registration procedure. To obtain a
registration number, a taxpayer must complete Form AP-234, Texas Registration
for Qualified Research and Development Sales Tax Exemption, its electronic
equivalent, or any form promulgated by the comptroller that succeeds such form.
(A) The taxpayer requesting the registration
number must certify that it will not, as a taxable entity or as a member of a
combined group, claim a franchise tax research and development activities
credit on a franchise tax report based on an accounting period during which it
claims an exemption under subsection (b) of this section.
(B) The taxpayer requesting the registration
number must provide all data and information required by the comptroller to
administer the exemption and comply with Tax Code, §
151.3182(c)
(Certain Property Used in Research and Development Activities; Reporting of
Estimates and Evaluation).
(2) Retroactive registration. A taxpayer may
request that a registration number be given retroactive effect.
(A) A taxpayer may request that a
registration number have retroactive effect by following the procedures
required under paragraph (1) of this subsection and by completing an annual
information report, described in paragraph (3) of this subsection, for each
prior year for which the registration number is to be effective.
(B) The registration number may be made
retroactive to the later of January 1, 2014, or a date requested by a
registrant that is no more than four years prior to the date the registration
is received, if the date requested is not within an accounting period during
which the registrant, as a taxable entity or as a member of a combined group,
claimed the franchise tax research and development activities credit.
(C) A registrant who is issued a retroactive
registration number may file a claim for refund of Texas sales and use tax paid
on purchases made on or after the later of January 1, 2014, or the effective
date of the registration number, that qualify for exemption under subsection
(b) of this section, in accordance with the requirements of §
3.325 of this title (relating to
Refunds and Payments Under Protest).
(D) A claim for a carryforward of an unused
franchise tax research and development activities credit under Tax Code, §
171.659 does not affect a
taxpayer's ability, as a taxable entity or as a member of a combined group, to
request a retroactive registration.
(3) Annual information report. A registrant
must submit an annual information report for each calendar year its
registration number is effective, irrespective of the date on which the
original registration occurred.
(A) The
registrant must provide all data and information required by the comptroller to
administer the exemption and comply with Tax Code, §
151.3182(c).
(B) The annual information report must be
submitted electronically unless the comptroller issues a waiver. A registrant
who cannot comply with this requirement due to hardship, impracticality, or
other valid reason must submit a written request to the comptroller for a
waiver of the requirement.
(C) The
due date for the annual information report for the preceding calendar year is
March 31. If March 31 falls on a Saturday, Sunday, or a legal holiday, the due
date is the next business day.
(i) An annual
information report filed electronically must be completed and submitted by
11:59 p.m. central time on the due date to be considered timely.
(ii) Reports submitted on paper must be
postmarked on or before the due date to be considered timely.
(D) A registrant who fails to
timely file an annual information report for its registration number will be
given written notice of the failure to file. If an annual information report is
not submitted within 60 days of the date of the notice of failure to file, the
registration number will be cancelled by the comptroller in accordance with
paragraph (5) of this subsection.
(4) Direct payment permit holders. A direct
payment permit holder must obtain a registration number as required by
paragraph (1) of this subsection in order to claim an exemption under this
section. A direct payment permit holder with a registration number must file an
annual information report for each year the number is effective as required by
paragraph (3) of this subsection.
(5) Cancellation of registration number by
the comptroller. The comptroller will cancel the registration number of a
registrant who fails to comply with the provisions of this section. For
example, the comptroller may cancel the registration number of a registrant who
fails to file an annual information report or who claims the franchise tax
research and development activities credit without first cancelling its
registration number, as required by paragraph (8) of this subsection. The
comptroller shall give written notice of the cancellation to the registrant.
The notice may be personally served on the registrant or sent by regular mail
to the registrant's address as shown in the comptroller's records. The former
registrant may not claim an exemption under this section during the period when
the registration number is cancelled. A former registrant that purchases an
item under a cancelled registration number may be subject to a criminal penalty
under Tax Code, §
151.707 (Resale or Exemption
Certificate; Criminal Penalty) and §
3.287(d)(3) of
this title (relating to Exemption Certificates).
(6) Effective date of cancellation. A
registrant whose registration number is cancelled by the comptroller is
responsible for remitting Texas sales and use tax, and penalty and interest
from the date of purchase, on any items purchased tax-free pursuant to Tax
Code, §
151.3182 on or after the
effective date of cancellation. In the case of a registrant whose registration
number is cancelled because of a failure to file an annual information report,
the effective date of the cancellation is December 31 of the last year for
which the registrant filed an annual information report. In the case of a
registrant whose registration number is cancelled because the registrant, as a
taxable entity or as a member of a combined group, claimed the franchise tax
research and development activities credit, the effective date of cancellation
is the beginning date of the accounting period covered by the franchise tax
report on which the credit was claimed.
(7) Reinstatement following cancellation. A
former registrant who has had its registration number cancelled by the
comptroller may submit a request in writing to have the registration number
reinstated.
(A) A former registrant whose
registration number has been cancelled may request reinstatement of the number
be given retroactive effect. The registrant must file an annual information
report for each prior year for which the registration number is to be
effective.
(B) A registration
number will not be reinstated for periods during which the former registrant is
not eligible for the exemption under this section.
(C) Before the comptroller will reinstate a
registration number, the former registrant must remit any Texas sales and use
taxes, as well as applicable penalties and interest from the date of purchase,
on all purchases made tax-free under this section during periods when the
registrant was not eligible for the exemption under this section.
(8) Cancellation of registration
number by registrant. A registrant who has received a registration number and
subsequently chooses to claim the franchise tax research and development
activities credit must cancel the registration number. The registrant is
responsible for remitting Texas sales and use tax, and penalty and interest
from the date of purchase, on any items purchased tax-free under this section
during any accounting periods covered by a franchise tax report on which the
credit is claimed.
(f)
Texas Qualified Research Sales and Use Tax Exemption Certificate. Beginning
January 1, 2014, a retailer may accept a valid and complete Form 01-931, Texas
Qualified Research Sales and Use Tax Exemption Certificate or any form
promulgated by the comptroller or that succeeds such form, in lieu of Texas
sales and use tax on the sale of depreciable tangible personal property that
qualifies for exemption under subsection (b) of this section. To be valid and
complete, a Texas Qualified Research Sales and Use Tax Exemption Certificate
must bear the registration number issued to the registrant by the comptroller
and must be signed by the registrant or the registrant's authorized agent.
Texas Qualified Research Sales and Use Tax Exemption Certificates are subject
to the requirements of §
3.287(d) of this
title. A retailer must maintain a copy of the Texas Qualified Research Sales
and Use Tax Exemption Certificate accepted in lieu of tax on a sale and all
records supporting that transaction. Refer to §
3.281 of this title (relating to
Records Required; Information Required).
(g) Divergent use. When a registrant uses an
item purchased under a valid Texas Qualified Research Sales and Use Tax
Exemption Certificate in a taxable manner, the registrant is liable for payment
of Texas sales and use tax, plus penalty and interest as applicable, based on
the fair market rental value of the tangible personal property for the period
of time used in the taxable manner. This subsection applies to an item that is
used for any purpose other than for use in qualified research, whether that use
occurs before, during, or after the time when the item is used in qualified
research. Refer to Tax Code, §
151.155 (Exemption
Certificate).
(h) Refund of Texas
sales and use tax paid on depreciable tangible personal property used in
qualified research. A registrant with a valid registration number may file a
claim for refund of Texas sales and use tax paid on purchases made on or after
the later of January 1, 2014, or the effective date of the registration number,
that qualify for exemption under subsection (b) of this section in accordance
with the requirements of §
3.325 of this title.
(i) Effective dates.
(1) The provisions of this section apply to
the sale, storage, or use of tangible personal property occurring on or after
January 1, 2014.
(2) The sales and
use tax exemption for depreciable tangible personal property used in qualified
research expires on December 31, 2026.
Notes
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