P&G and the IRS have had a long-standing accepted method on Gross Receipts computation as it relates to the Section 41 credit determination. Historically, the accepted method was to treat all members of its “controlled group of corporations” as a single taxpayer, and as such aggregated its Research Expenses and Gross Receipts for the controlled group as a whole and excluded intercompany transactions when calculating the credit.
In February 2006, the IRS Office of Chief Counsel issued a new Advisory, which revised the agency’s position on Gross Receipts. The agency’s reversal took the position, that a “controlled group” should “only disregard generally intra-group transfers with respect to research expenditures, not gross receipts.” Because of this revised position, it then revised the 2001 – 2005 tax year P&G computations to include intercompany transactions with foreign members of its controlled group and therefore effectively raised P&G’s base year computation which ultimately reduced the amount of the P&G R&E credit.
Section 41 of the Internal Revenue Code is clear that “in determining the amount of the credit under this section – (i) all members of the same controlled group of corporations shall be treated as a single taxpayer”, 26 U.S.C. § (f)(1)(A), and, therefore, intercompany transfers between members of the same group are to be disregarded. The court further explained, “P&G disregarded transfers between members of the group in the manner clearly delineated within the Treasury Regulations.” 26 U.S.C. § 1.41-6(T)(i).
The United States argued that Section 41(f) deals with expenditures rather than Gross Receipts. Although the subsection heading labeled “Aggregation of Expenditures” was created when the statue was first enacted in 1981, the research credit was determined solely by reference to prior-year expenditures, and the Gross Receipts component to the calculation was not added to the statute until 1989. The IRS’ regulations make clear at Section 1.41-6T that Gross Receipts should be aggregated in the same manner as Research Expenses.
Additionally, it was identified that the IRS incorrectly interpreted and improperly relied upon two court rulings, Deere 7 Co. vs. Commissioner, No. 20320-06, 133 T.C. No. 11 (Oct. 22, 2009), and Union Carbide Corp. vs. Commissioner, No. 11119-99, T.C. Memo 2009-50, 2009 WL 605161 (Mar. 10, 2009) to argue that legislative intent and the plain meaning interpretation of Section 41 weigh in favor of including international intercompany transfers in the Gross Receipts calculation.
Based on the evidence of record, the Court found that there are no genuine issues of material fact for trial, and that P&G is entitled to judgment as a matter of law relating to the Gross Receipts research credit issue.
About the Author:
Greg Lormand is Director, Tax Services for BCP Engineers & Consultants where he concentrates on supporting clients on niche’ tax areas such as Research & Experimentation (R&E). Mr. Lormand has a BS degree in Mechanical Engineering and Masters Business Administration from Louisiana State University.