Dow tax case raises R&D questions

US chemical firm Dow has lost a legal battle over claims for R&D tax credits – on 7 September, a US appeals court ruled that the money the company was trying to recoup constituted indirect research costs. Legal experts say the case will serve as a cautionary tale for companies that invest heavily in R&D.

This case will especially make large companies look at whether they are using up supplies during research…rather than in the production process

The three-judge panel upheld an earlier tax court ruling that the work in question didn’t qualify for the R&D tax credit. The panel said the interpretation of the court was ‘entirely consistent with the purpose of the research tax credit, which is to provide a credit for the cost that a taxpayer incurs in conducting qualified research that he would not otherwise incur’.

Mike Silvio, managing director for US accounting and tax advisory firm CBIZ MHM was unsurprised by the ruling. ‘They were trying to take supplies that they would have already used as part of a finished product and claim them as R&D expenses,’ he says. ‘I had never before seen a company try to take production supplies as R&D.’

The direct financial impact on Dow is small: a loss of about $8 million (£4.9 million) worth of tax credits for Union Carbide Corporation (UCC), a Dow subsidiary, according to Reuters. But the legal defeat is expected to have strong reverberations.

Legal experts say the lesson for companies is to segregate and track R&D supply costs to preserve their eligibility for the R&D tax credit. This will allow them to demonstrate how these supplies were used during the course of research to prevent the US Internal Revenue Service (IRS) from labelling them as ‘indirect’ R&D costs.

‘This case will especially make large companies look at whether they are using up supplies during research … rather than in the production process,’ Silvio tells Chemistry World. ‘If so, they will have to separate that out and test the supplies as such.’

A ‘significant issue’

The Dow case involves three research projects that UCC conducted at two production plants in 1994 and 1995. The first involved pre-treating cracking coils of ethylene-producing industrial furnaces with an anti-coking compound developed by Amoco.

The second was about lowering production costs associated with high-grade polyethylene products and the third was to determine whether using sodium borohydride during the manufacture of crude butadiene would reduce the presence of acetaldehyde, an unwanted byproduct. UCC discontinued all three projects for various reasons.

The American Chemistry Council (ACC) says the R&D tax credit ‘continues to be a significant issue’ for its member companies. The Dow case involved the R&D credit for ‘process research’, which relates to research intended to determine whether a new or improved production process that works under laboratory conditions can still achieve efficiencies and lower costs when applied to scaled-up manufacturing.

The US tax code specifically allows a credit for ‘process research’, the ACC says, but taxpayers or the IRS may regard the definition as ‘uncertain’.

For its part, Dow said it was ‘disappointed’ by the appeals court’s decision and UCC is now considering its legal options. Dow agreed that the case raises important issues relating to the availability of the R&D tax credit: ‘Plant related process R&D plays a central role in helping manufacturers achieve cost and efficiency savings and the availability of the tax credit is important to encourage and enable manufacturers to make these substantial R&D investments,’ the company said.