By: Mike Verespej
September 11, 2012
NEW YORK (Sept. 11, 1:30 p.m. ET) — A second court has ruled against Dow Chemical Co. in its effort to obtain a research and development tax credit.
Dow is seeking the credit for supplies it purchases to make finished goods, when research is being conducted at the same time.
A three-judge panel of the U.S. Court of Appeals for the Second Circuit in New York upheld Sept. 7 a previous ruling from the U.S. Tax Court that those supplies do not qualify for a R&D tax credit because they would have been purchased regardless of any research that might have been conducted.
The case stems from an Internal Revenue Service ruling that Union Carbide Corp. was not entitled to $8 million in R&D tax credits during the 1994 and 1995 tax years for supplies the company had purchased for production of goods in three separate instances where it also was conducting research projects at production plants in Hahnville, La.
UCC had argued it was entitled to the credit because the company improved the way existing products were made during the course of production. UCC was purchased by Dow Chemical in 2001.
“Affording a credit for the costs of supplies that the taxpayer would have incurred regardless of any qualified research it was conducting simply creates an unintended windfall,” said the three-judge panel in its 11-page decision.
“We agree with the Tax Court that the costs for which UCC seeks a research credit are ‘at best, indirect research costs excluded from the definition of [qualified research expenses] under section 1.41-2(b)(2) [of the Treasury Regulations].’”
“As the Commissioner argues, [UCC] was entitled to a credit for only those additional supplies that were used to perform the research [because the] raw materials used to make finished goods that would have been purchased regardless of whether UCC was engaged in qualified research.”
Section 41(d)(2)(C) of the U.S. tax code provides that when a taxpayer seeks a research credit related to its production process, the production process must be divided into two business components, one that relates to the process and another that relates to the product, noted the court.
“This indicates that Congress intended to allow taxpayers research credits for research performed to improve their production processes, but ... did not intend for all of the activities that were associated with the production process to be eligible for the research credit if the taxpayer was performing research only with respect to the process, not the product,” said the three-judge panel in its opinion.
“The commissioner’s interpretation is entirely consistent with the purpose of the research tax credit, which is to provide a credit for the cost that a taxpayer incurs in conducting qualified research that he would not otherwise incur,” said the court. “We agree.”
Judge Rosemary Pooler, in a concurring opinion, suggested “that Congress may well have intended to give a tax credit for those supplies which would have been purchased absent any qualified research.”
But if that was the intent of Congress, she added, “it failed to write the statute in such precise terms so as to preclude either the Commissioner’s regulations or his interpretations. Accordingly, I join the majority opinion.”
"Union Carbide Corp. … is disappointed by the decision [and] is now considering its options," said Dow in a statement. "The case raises important issues relating to the availability of the R&D tax credit for plant-related process research. Plant related process R&D plays a central role in helping manufacturers achieve cost and efficiency savings and the availability of the tax credit is important to encourage and enable manufacturers to make these substantial R&D investments. The financial impact of this case to the company is not significant."