An Alternative R&D Credit Benefits Business, and the Commonwealth
On August, 13th, Governor Deval Patrick signed H.4377, called an “An Act to Promote Economic Growth in the Commonwealth,” into law. The economic development package provides new tools and training to ensure that Massachusetts’ workforce meets the needs of employers and offers incentives to create jobs and stimulate the economy.
One provision, in particular, is designed to enhance the state’s R&D tax credit. The new legislation provides changes to the existing R&D tax credit and offers businesses a new option, called the Alternative Simplified Credit (ASC).
As for the current credit, Michael J. Widmer, president of the Massachusetts Taxpayers Foundation (MTF)—which took a lead role in the adoption of the R&D credit changes—outlines the shifts as follows: The changes to the existing, or traditional, R&D credit will affect the “fixed-base ratio” calculation, which is used to determine the so-called base amount. Qualified research expenditures over the base amount are eligible for the R&D credit.
Under the R&D credit in effect until the end of 2014, the fixed-base ratio is tied to research spending and business receipts for a period of time in the late 1980s. In other words, the current credit is based on a comparison of current R&D spending to its activity of 25-plus years ago.
“Under the act, beginning in 2015, the fixed-base ratio will use a rolling base period, rather than the 1984 to 1988 period,” Widmer explains. “It would be calculated as: R&D expenditures for the third and fourth years preceding the credit year as a percentage of the gross receipts for those same years. For example, for 2015, the third and fourth preceding years are 2011 and 2012. At this time, it is not clear how the Department of Revenue would treat businesses that have less than four tax years.” (Currently, any business with fewer than three tax years between 1984 and 1988 is classified as a “start-up” and the fixed-base ratio is set at 3 percent.) The key change is that the credit will now be based on a comparison of current R&D spending to R&D spending of only a few years prior, rather than 25 years prior.
If it sounds complex, the ASC should help. In this case, the Massachusetts ASC is similar to the federal version. The ASC permits a credit for R&D expenses that exceed 50 percent of the average R&D expenses for the three preceding years. The amount of the credit increases over a seven-year period, from 5 percent of R&D expenses in calendar year 2015 to 10 percent in calendar year 2021. If there are no research expenses in one of the three preceding years, the credit is set at 5 percent. The ASC does not replace the traditional R&D credit, but lets taxpayers choose the option they prefer.
The ASC also better reflects incremental changes in direct R&D spending. It’s based on a company’s R&D expenditures in a given year, compared to its average R&D spending over prior years. The ASC is focused solely on the changes in a company’s investment in R&D activities, as opposed to the state’s traditional credit, which reflects spending on R&D relative to a company’s gross receipts.
“By basing the credit on a rolling time period, rather than a set historical period, the ASC and changes to the traditional credit will encourage current and sustained investment in Massachusetts,” adds Carolyn Ryan, MTF’s assistant director of policy and research. “These changes also address administrative concerns about the availability of taxpayer records and the increasing difficulty in providing information that is more than 20 years old.”
Encouraging R&D investment can have a myriad of positive effects for Massachusetts and its industry sectors. For the state, it will support growth and innovation because taxpayers will have an incentive to spend on such activities. Since it is not limited to a particular industry, it provides an opportunity to invest in R&D in a wide range of sectors, including technology, science, medical, and more.