David L. Cameron (Northwestern) has published Research Tax Credit: Statutory Construction, Regulatory Interpretation and Policy Incoherence, 9 Computer L. Rev. & Tech. J. 63 (2005). Here is the Conclusion:
Each of the three problems that afflict the current version of the research tax credit — its lack of permanence, the difficulty in articulating the very definition of qualified research, and the calculation of the credit itself-evidence an underlying policy incoherence. Although the temporary nature of the credit when originally enacted in 1981 was justified because of uncertainties concerning its effectiveness, the fact that the credit has not become a permanent part of the tax code in the past twenty-plus years suggests that those uncertainties remain. It is possible that Congress is not convinced that the tax credit is sufficiently effective in satisfying its policy goals or justified as a use of federal funds.
The controversy surrounding the definition of qualified research is further evidence of policy confusion and uncertainty underlying the research tax credit. In reformulating the credit as part of the Tax Reform Act of 1986, Congress explicitly required that qualified research for purposes of section 41 had to satisfy a higher standard than research and experimentation for purposes of section 174. Nevertheless, under the current Regulations, the uncertainty test of section 174 is virtually identical to the discovery requirement under section 41. Furthermore, the requirement that the research be technological in nature for purposes of section 41 imposes little, if any, substantive limitation compared to the types of research and experimentation that qualify under section 174. Although the process of experimentation requirement under section 41 could provide a significant distinction between research and experimentation under section 174 and qualified research under section 41, the final Regulations provide such a vacuous definition of the requirement as to render it largely one of form and not substance.
The regulatory requirements under the high threshold of innovation test applicable to internal-use computer software also suggest that no clear definition of qualified research has been articulated. In permitting internal-use computer software that satisfies the high threshold of innovation eligible for the research tax credit, Congress clearly intended that the research efforts in developing such software must go beyond those incurred in connection with qualified research. An examination of the requirements under the high threshold of innovation test — i.e., that the software be innovative and that its development effort involve significant economic risk because of technical uncertainty-provides little, if any, insight into how these requirements differ from the discovery and process of experimentation requirements under the general definition of qualified research. Although the Norwest Corp. Tax Court compared the requirement that internal-use computer software be innovative-that it result in a reduction in cost or improvement in speed that is substantial and economically significant — with the general requirement that qualified research need only result in a "new or improved" business component, this distinction is merely a difference in degree rather than kind. Similarly, the Tax Court compared the general eligibility requirement (that the taxpayer engage in a process of experimentation which requires the existence of uncertainty) with the significant economic risk test applicable to internal-use computer software (which requires the existence of substantial uncertainty). Again, a difference in degree rather than kind suggests that, at a minimum, taxpayers and the Service will continue to be ensnared in controversy.
The difficulty in articulating the very definition of qualified research also evidences deep policy differences — this time between Congress and the Treasury Department. Taxpayers were highly critical of the original Proposed and final Regulations issued during the Clinton administration, both of which imposed strict standards with respect to the discovery and the process of experimentation requirements under the definition of qualified research. These standards were effectively endorsed by the Tax Court and two Courts of Appeals based on the legislative history and independent interpretations of the statutory language. However, the revised Proposed Regulations and the final Regulations promulgated under the Bush administration have significantly relaxed the applicable standards, resulting in a greater range of research eligible for the credit. The significant differences between the original version of the Regulations and the revised version of the Regulations, each of which claimed to reflect the intent of Congress, again suggest that the policy basis for the research tax credit is significantly uncertain.
Finally, the calculation of the research tax credit itself evidences uncertainty regarding the extent to which government revenues should be reduced to support research and development. The underlying purpose for the research tax credit is to create an incentive for increased investment in research and development. However, because of the manner in which the base amount is currently formulated, the research tax credit may not be available to taxpayers who have increased their expenditures for research and development but whose gross revenues have risen even faster. Commentators have suggested that this aspect of the research tax credit penalizes those taxpayers whose earlier research and development efforts have been most successful. In addition – this time because of the use of the fixed-base percentage – eligibility for the research tax is related to economic and technological factors from the mid-1980s that may be irrelevant under current economic and technological conditions. Consequently, it is unsurprising that doubts persist concerning the effectiveness of the current research tax credit.
Due to wide political approval of government support for research and development and continuously raised claims that additional support is necessary if private industry in the United States is to remain competitive in a global economy, pressures will be exerted to find a mechanism to provide that support. In addition, because direct government expenditures to support research and development involve their own political difficulties, the tax code will undoubtedly be viewed as an appropriate vehicle through which to provide that support. Congress must do a better job of articulating a coherent policy on which statutory and regulatory language can be based in order to avoid the difficulties that have arisen under the current research tax credit.
