Notice 2013-20 [PDF 97 KB] reflects changes made to section 41 by the American Taxpayer Relief Act of 2012, for tax years beginning after December 31, 2011.
All members of a controlled group are treated as a single taxpayer for purposes of computing the research credit. The group credit is computed by applying all of the section 41 computational rules on an aggregate basis. After the group credit is computed, it must be allocated among the members of the group.
Previously, section 41 provided that the research credit allowable to a controlled group member is “its proportionate shares of” the qualified research expenses, basic research payments, and amounts paid or incurred to energy research consortiums (collectively, referred to as QREs) “giving rise to the credit.”
Regulations in effect since 2006 require a controlled group to allocate the group credit in a two-step procedure:
- First, in proportion to each member's stand-alone entity credit, in situations when the group credit does not exceed the sum of the stand-alone entity credits of all of the members; and
- Second, if the group credit exceeds this sum, by allocating the excess group credit in proportion to the QREs of the members of the controlled group
A provision of the American Taxpayer Relief Act of 2012 (enacted January 2, 2013) requires the allocation of research credits to each controlled group member “…on a proportionate basis to its share of the aggregate of the qualified research expenses, basic research payments, and amounts paid or incurred to energy research consortiums, taken into account by such controlled group for purposes of this section.’’
These changes provide that the group credit is allocated to group members based on a member’s share of QREs—without regard to whether the member would have a stand-alone entity credit or what the amount of any such credit would be.
This provision is effective retroactively—for tax years beginning after December 31, 2011.
When the IRS proposed the regulations on allocation of the group credit that were adopted in 2006, KPMG tax professionals spoke at an IRS-Treasury hearing in opposition to the two-step allocation method, and supported a method similar to what has now become the rule in tax years beginning after 2011.
Notice 2013-20, consistent with the new statutory language, provides that for tax years beginning after December 31, 2011, controlled groups must allocate the group credit to each member of the controlled group in proportion to each member’s contribution of QREs to the controlled group’s total QREs for the tax year. This allocation methodology must also be applied to determine the portion of a group credit that is allocated to, and within, a consolidated group that is a member of a controlled group.
- For tax years beginning before January 1, 2012, the provisions of Reg. section 1.41-6 continue to apply in their entirety.
- For later tax years, this regulation is applied without reference to the allocation method previously prescribed and without any references to such things as the stand-alone entity credit.
Notice 2013-20 provides the following example of the new allocation rule.
X, a controlled group consisting of three members—B, C, and D—has a $100 credit for the tax year. X’s total QREs for the tax year are $1,000. B paid $200 of the QREs; C paid $300 of the QREs; and D paid $500 of the QREs during the tax year. Based on the proportion of each member’s contribution of QREs to the controlled group’s total QREs for the tax year, B is allocated a $20 credit, C is allocated a $30 credit, and D is allocated a $50 credit.
Notice 2013-20 states that the Treasury Department and IRS intend to revise the regulations (Reg. section 1.41-6) and the examples demonstrating the allocation of the controlled group credit consistent with the allocation methodology presented in this notice.
Similar rules for other Code sections
Notice 2013-20 states that similar rules also apply for purposes of:
- Section 45C concerning clinical testing expenses for certain drugs for rare diseases or conditions
- Section 45G concerning the railroad track maintenance credit
- Section 45O concerning the agricultural chemicals security credit
- Section 280C and certain expenses for which credits are allowable
Therefore, an allocation method similar to the method required under Notice 2013-20 must be used for purposes of allocating credits to controlled group members under those other Code sections.
Effective date, request for comments
Notice 2013-20 is effective for tax years beginning after December 31, 2011.
The IRS has requested comments on issues relating to Notice 2013-20. Comments must be received on or before June 6, 2013.
Following enactment of the American Taxpayer Relief Act of 2012, the IRS and Treasury quickly added guidance relating to the new allocation rule for the research credit of a controlled group on its Priority Business Plan.
The legislation made another substantive change to the research credits, also effective for tax years beginning after December 31, 2011. The other change relates to adjustments to the research credit computation when a taxpayer acquires the major portion of a trade or business, such as the purchase of a division of a corporation. The IRS and Treasury have not announced any plans to issue guidance relating to this other change.