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Congressional tax reform proposals to end immediate deductions of research and development expenses would raise the taxable income of companies and discourage research, according to industry officials.
Under the House bill ( H.R. 1) and the Senate legislative text, the option to immediately deduct R&D-related expenses, such as supplies for research and salaries paid to researchers, would be off the table. Such expenses would have to be capitalized and amortized over five years. (For a road map of where to find key provisions and compare the House and Senate bills, read Bloomberg Tax’s analysis.)
Expenses related to research outside of the U.S. would be subject to an even lengthier 15-year capitalization and amortization period. The underlying R&D tax credit, however, remains unchanged in both the House and Senate tax plans.
“This change would not encourage U.S. R&D and would raise the cost of performing risky and uncertain research in the U.S.,” Ronald Dickel, chairman of the R&D Credit Coalition and vice president of global tax at Intel Corp., said in a statement Nov. 15. The coalition is composed of companies such as Boeing Co., Apple Inc., and Exxon Mobil Corp.
Currently, companies with qualifying R&D expenses under tax code Section 174 have two choices in writing off R&D expenditures. They can deduct R&D expenses as current business expenditures and have the deduction recognized that year or choose to spread the payments equally over 60 months or more.
“All of these Section 174 costs are now being proposed to be required for capitalization and amortization, depending on whether they are domestic or foreign, and that’s a pretty big change compared from the way things have been historically done since 1954,” Tyrone Montague, managing director in the Washington National Tax practice of KPMG LLP, told Bloomberg Tax Nov. 17.
Most companies engaged in R&D choose to immediately write off R&D expenses to lower taxable income, David Wong, a partner with BDO USA LLP’s Specialized Tax Services practice for the West Region, who specializes in R&D tax credits, told Bloomberg Tax.
Under the proposed tax measures, companies may face higher taxable income said Wong, and may need to adjust budgeting and operating expenses to plan for increased taxes.
“For those that will be facing higher taxes, it will be important to plan for cash flow and look for business opportunities that may help them reduce tax, which from the proposed tax plans, appear to be friendlier to companies looking to invest and incur expenses domestically,” he said.
“This taxable income increase will place even more importance on R&D credits,” said Wong.
R&D is a significant part of most every industry sector, said Montague.
“The R&D that goes on in the U.S. cuts across almost every industry you can imagine,” he said, “mostly because of software development, which is such a major part of what’s driving innovation and efficiencies across every aspect of the economy.”
For example, Boeing told Bloomberg Tax in an email Nov. 20 that it “spends about $6 billion per year in research and development and capital expenditures.”
According to the 2017 Global Innovation 1000 study by PricewaterhouseCoopers, which analyzed the world’s largest publicly listed corporate R&D spenders, Boeing spends the most on R&D in comparison with other aerospace and defense companies. So far this year, Boeing has posted $4.6 billion in R&D spending while United Technologies Corp. has spent $2.3 billion this year on R&D related expenses, according to the report.
Research performed outside of the U.S. isn’t considered a qualified expense under the R&D tax credit and therefore can’t be applied to offset a company’s total tax liability. In combination with the proposed 15-year capitalization and amortization timeline, researchers will likely think twice about the financial impact of foreign R&D expenses, Wong said.
“Regarding foreign R&D expenses, this will certainly further incentivize companies to reconsider the financial impact under the new rules since it will further increase taxable income by reducing the current year expenses,” Wong said in an email.
Compared with other provisions in the House and Senate tax plans, the R&D write-off provision would be enacted much later. The R&D provision would take effect after Dec., 31, 2022, in the House bill and after Dec. 31, 2025, in the Senate tax plan.
The reasoning behind a delayed enactment period, said Montague, is to give the R&D industry time to react and make plans, and also to account for planned R&D budgets that extend into 2018 and beyond.
“Often times, budgets for technology plans are not only for one year periods but for three- to five-year periods,” said Montague. “If there is going to be this big paradigm shift, many of our clients are asking Congress to ‘please, give time to prepare for this.”
The provision erasing immediate deductions of R&D expenses was probably included in the House and Senate proposals to help offset the costs of other provisions with the tax reform bills, said Wong.
According to the Joint Committee on Taxation, the amortization of R&D expenses under the Senate plan would increase revenue by $62.1 billion between 2018 to 2027.
“Many of our clients are saying that while we acknowledge the need for revenue offsets as part of tax reform, maybe there can be some other trade off because there is no one size fits all,” said Montague.
“The potential change could be fair for some companies but less for others, and many are asking that something else be done rather than affect this really critically important incentive,” he said.
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