R&D Case – Union Carbide (UCC) Appeal – Supplies Must be Direct R&D Expenses

In a decision dated September 7, 2012 relating to the Union Carbide (UCC) case, the Appellate Court agreed with the Tax Court on the topic of R&D tax credit supply costs. UCC argued it should be entitled to R&D costs and the credit for both supplies purchased for R&D testing purposes, as well as supplies that would have been purchased regardless of any R&D testing incurred during a production run.

The Appellate Court in Union Carbide (formerly Dow Chemical) concluded that supplies purchased to make a product for sale, irregardless of whether those supplies were also used in a test run, are not eligible for the R&D credit; rather, those supplies go towards making a salable product and were not purchased for R&D purposes.

Thus, going forward, it is clear that for example G/L supply accounts used by an R&D or lab for testing purposes should continue to qualify for the R&D tax credit, even if some of those supplies go into a finished product. However, supplies that are part of a production run in which some R&D testing also occurs are not eligible for the research credit.

It is important to segregate and track R&D supply costs to preserve their eligibility for the credit and also demonstrate if challenged how they were used in the conduct of the research to prevent the IRS from calling them ‘indirect’ R&D costs per this decision. Also note the core R&D departments at Union Carbide, presumably including R&D G/L accounts were not challenged by the IRS and were not subject to this decision. Thus, Union Carbide likely obtained research credits in part from supply costs, but in this case, materials used in determining whether certain production processes were viable at the plant level were not eligible supplies.

UnionCarbide 2nd Circuit Decision Sept 7 2012

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