FR Doc 03-17870

[Federal Register: July 29, 2003 (Volume 68, Number 145)]
[Proposed Rules]
[Page 44499-44506]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29jy03-20]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-133791-02 and REG-105606-99]
RINS 1545-BA88 1545-AX05

Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking; notice of public hearing; and
withdrawal of previously proposed regulations.

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SUMMARY: This document contains proposed regulations relating to the
computation and allocation of the credit for increasing research
activities for members of a controlled group of corporations or a group
of trades or businesses under common control. These proposed
regulations reflect changes made to section 41 by the Revenue
Reconciliation Act of 1989 and the Small Business Job Protection Act of
1996, which introduced the alternative incremental research credit.
This document also provides notice of a public hearing on these
proposed regulations and withdraws the proposed regulations published
in the Federal Register on January 4, 2000 (65 FR 258).

DATES: Written or electronic comments must be received by October 27,
2003. Requests to speak and outlines of the topics to be discussed at
the public hearing scheduled for November 13, 2003 at 10 a.m. must be
received by October 23, 2003.

ADDRESSES: Send submissions to: CC:PA:RU (REG-133791-02), room 5226,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. Submissions may also be hand delivered Monday through Friday

[[Page 44500]]

between the hours of 8 a.m. and 4 p.m. to: CC:PA:RU (REG-133791-02),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC 20224. Alternatively, taxpayers may submit comments
electronically via the Internet by submitting comments directly to the
IRS Internet site at: http://www.irs.gov/regs. The public hearing will
be held in the IRS Auditorium (7th Floor), Internal Revenue Building,
1111 Constitution Avenue, NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations,
Jolene J. Shiraishi at (202) 622-3120 (not a toll-free call);
concerning submissions of comments, the hearing, and to be placed on
the building access list to attend the hearing, Guy Traynor at (202)
622-7180 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Background

On January 4, 2000, Treasury and the IRS published in the Federal
Register (65 FR 258) proposed amendments to the regulations under
section 41(f) (2000 proposed regulations) relating to the computation
and allocation of the credit for increasing research activities
(research credit) for members of a controlled group of corporations or
a group of trades or businesses under common control (controlled
group). The 2000 proposed regulations reflected changes made to section
41 by the Revenue Reconciliation Act of 1989 (the 1989 Act) and the
Small Business Job Protection Act of 1996. Treasury and the IRS
received written comments from two commentators. A public hearing was
held on April 26, 2000. After considering the written comments and the
statements at the public hearing, Treasury and the IRS are withdrawing
the 2000 proposed regulations and are proposing new regulations.

Summary of Comments and Explanation of Provisions

Overview

These new proposed regulations for members of a controlled group
under section 41(f) follow the research credit computation rule
contained in the 2000 proposed regulations. The computation of the
research credit for a controlled group (group credit) under these new
proposed regulations is done by treating all of the members of a
controlled group as a single taxpayer. Unlike the 2000 proposed
regulations, these new proposed regulations then allocate the group
credit among the members of the controlled group based on the relative
amounts of each individual member's stand-alone entity credit--the
credit, if any, that a member of a controlled group would be entitled
to claim if it were not a member of a controlled group. These new
proposed regulations generally will apply to taxable years beginning on
or after the date that final regulations are published in the Federal
Register.

Computation of the Group Credit

Section 41(f)(1)(A)(i) provides that in determining the amount of
the research credit under section 41, ``all members of the same
controlled group of corporations shall be treated as a single
taxpayer.'' Section 41(f)(1)(B)(i) provides a similar rule for a group
of trades or businesses under common control. Accordingly, for purposes
of determining the amount of the group credit, the 2000 proposed
regulations applied all of the section 41 computational rules on an
aggregate basis. The commentators agreed that with respect to the
computation of the group credit, the 2000 proposed regulations are
consistent with the provisions of section 41(f). These new proposed
regulations, therefore, do not change the method for computing the
group credit. These new proposed regulations, however, clarify the
application of the start-up company rules under section 41(c)(3)(B) to
a controlled group with respect to the computation of the group credit.

Allocation of the Group Credit Among Members of the Controlled Group

Section 41(f)(1)(A)(ii) provides that ``the [portion of the group]
credit (if any) allowable by this section to each such member shall be
its proportionate shares of the qualified research expenses and basic
research payments giving rise to the credit.'' Section 41(f)(1)(B)(ii)
provides a similar rule for a group of trades or businesses under
common control. These new proposed regulations apply these provisions
by allocating the group credit based on the relative amounts of each
individual member's stand-alone entity credit.

2000 Proposed Regulations

The 2000 proposed regulations allocated the group credit based on
the amounts by which each individual member's qualified research
expenses (QREs) exceeded a base amount for that member. An individual
member's base amount, for purposes of allocating the group credit under
the 2000 proposed regulations, was determined by applying the
controlled group's fixed-base percentage to the member's average annual
gross receipts for the four taxable years preceding the credit year.
The group credit was allocated to a member having an excess amount of
QREs by multiplying the group credit by a fraction having the
individual member's excess amount as the numerator and the aggregate
excess amount of all the members of the controlled group as the
denominator. A similar allocation method was provided for the credit
for basic research payments and for the alternative incremental
research credit.
The preamble to the 2000 proposed regulations stated that the
purpose of this method was to allocate the group credit to ``those
members whose share of current year qualified research expenses exceeds
their share of the [controlled group's] base amount.'' In particular,
the preamble noted that in providing a rule that reflects the
incremental nature of the research credit, Treasury and the IRS
declined to follow comments noting that amendments to section 41 made
by the 1989 Act required that the allocation of the group credit be
based on the relative amounts of total QREs incurred separately by
members of the controlled group:

In proposing rules for the allocation of the credit, Treasury and
the IRS considered, but were not persuaded by, certain taxpayers'
argument that the elimination of the word ``increase'' from the
allocation rule in the statute requires that the credit be allocated
on the basis of the gross amount of qualified research expenses
incurred by the various members of the controlled group. Treasury
and the IRS believe that elimination of the word ``increase'' was
necessitated by the 1989 statutory amendments to the computation of
the research credit, which afford a credit in certain circumstances
even where the taxpayer (or each member of a controlled group) is
decreasing its gross amount of qualified research expenses (e.g.,
because the taxpayer's gross receipts also are decreasing). However,
there is no indication that the elimination of the word ``increase''
was intended to suggest that the credit be allocated without regard
to its incremental nature. To the contrary, the statutory
prescription that the credit be allocated according to each member's
proportionate share of the qualified research expenses ``giving rise
to'' the credit supports a rule that allocates the credit to those
members whose share of current year qualified research expenses
exceeds their share of the base amount.

Comments on the 2000 Proposed Regulations

Two commentators submitted a series of comments in response to the
2000 proposed regulations. As noted above, both commentators agreed
that the method for computing the group credit contained in the 2000
proposed regulations is consistent with the provisions of section
41(f). The commentators diverged significantly, however, with respect
to the method for allocating the group credit. The first

[[Page 44501]]

commentator supported the allocation rule contained in the 2000
proposed regulations. The second commentator reiterated the earlier
expressed view that the allocation of the group credit should be done
on the basis of each member's total QREs (gross QREs method).
The second commentator set out a number of reasons why a gross QREs
method should be adopted instead of the method contained in the 2000
proposed regulations. In particular, the commentator stated that a
gross QREs method is the only method consistent with the plain meaning
of section 41(f). As a related point, the commentator claimed that a
statutory amendment made by the 1989 Act supports its plain meaning
argument. The commentator also noted that the allocation method
contained in the 2000 proposed regulations, by incorporating both
individual member and controlled group elements, was at odds with the
computation method provided by the statute and failed to allocate
rationally the group credit.
Treasury and the IRS continue to believe that, compared to a gross
QREs method, an allocation method based on a group member's QREs in
excess of a base amount more fully carries out the purposes of section
41 in general and the section 41(f) controlled group credit rules. The
research credit is not, and has never been, a credit computed as a
percentage of total qualifying expenses. Rather, the research credit
generally is allowed only when a taxpayer's QREs exceed a base amount.
Prior to the 1989 Act, the research credit was computed by multiplying
the credit rate by the excess of the taxpayer's current year QREs over
the taxpayer's average QREs for the preceding three years. The 1989 Act
significantly modified the computation of the research credit while
retaining the incremental approach of the pre-1989 Act credit. In
general, the research credit computation is based on whether and the
extent to which a taxpayer increases the proportion of its QREs
relative to its recent gross receipts, compared to a historical base
period. Ultimately, this computation measures the extent to which a
taxpayer's current year QREs exceed a base amount.
Treasury and the IRS conclude that the controlled group allocation
rules set out in section 41(f) were not intended to result in the
allocation of the group credit to individual members of the group in a
manner wholly at odds with the incremental nature of the research
credit. The legislative history to the research credit, as originally
enacted in 1981, indicates that the group credit rules were enacted to
ensure that the research credit would be allowed only for actual
increases in research expenditures. These rules were intended to
prevent taxpayers from creating artificial increases in research
expenditures by shifting expenditures among commonly controlled or
otherwise related persons. H. Rep. No. 97-201, 1981-2 C.B. (Vol. 2)
364, and S. Rep. 97-144, 1981-2 C.B. (Vol. 2) 442. In effect, the group
credit computation rule serves as a cap on the maximum amount of credit
that the members of the group, in the aggregate, may claim. A rule that
then allocates the group credit based solely on the total amount of
QREs incurred by each individual member, however, would be inconsistent
with the incremental nature of the credit and would not further the
purpose of the section 41(f) group credit rules.
As during the consideration of the 2000 proposed regulations,
Treasury and the IRS do not find persuasive the second commentator's
argument that a plain reading of the statute, following the deletion of
the phrase ``increase in'' in sections 41(f)(1)(A)(ii) and
41(f)(1)(B)(ii) by the 1989 Act, mandates a gross QREs method for
allocating the group credit. Prior to the 1989 Act, for example,
section 41(f)(1)(A)(ii) provided that the research credit, if any,
allowable to each member of a controlled group was the member's
``proportionate share of the increase in qualified research expenses
giving rise to the credit.'' The phrase ``increase in'' was deleted by
the 1989 Act. The commentator maintained that a gross QREs method gives
effect to the phrase ``giving rise to the credit'' as well as to the
deletion of the phrase ``increase in'' from the statute by the 1989 Act
because ``each dollar of the group's QREs gives rise to [the] excess
over the group's base amount'' or ``(s)tated otherwise, if you
eliminate a dollar of qualified research expenses from any member of
the group, the group's credit will be reduced proportionately.''
The reason for the deletion of the phrase ``increase in'' is not
addressed in the legislative history to the 1989 Act. The changes to
the computation of the research credit made by the 1989 Act, however,
made a taxpayer's QREs for prior years, other than taxable years
beginning after December 31, 1983, and before January 1, 1989 (base
years), irrelevant to the computation of the credit. Instead, the
amount of the research credit now depends on whether and the extent to
which a taxpayer increases the proportion (compared to that of the base
years) of its QREs relative to its average annual gross receipts from
the prior four years. Accordingly, although the research credit is
still based on the amount by which current year QREs exceed a base
amount, that base amount, unlike the general research credit
computation prior to the 1989 Act, is not a rolling average of QREs
incurred in the three years prior to the credit year. Treasury and the
IRS, therefore, conclude that the deletion of the phrase ``increase
in'' was intended to reflect this change, and not to indicate that the
allocation of the group credit was to be made using a gross QREs
method.
The second commentator noted, in arguing that the allocation method
in the 2000 proposed regulations impermissibly mixed controlled group
and individual member calculations, that the allocation method favors
those members whose current ratio of QREs to recent gross receipts
exceeds the controlled group's fixed-base percentage, regardless of
whether that member's ratio, in fact, was increasing or decreasing. As
stated by the commentator, ``[t]he group's fixed-base percentage can be
wildly different from the fixed-base percentage for an individual
member depending on the individual member's separate QREs and separate
gross receipts during the [base years]. In other words, the amount of
group credit that would be allocated to an individual member under the
2000 proposed regulations may bear little or no relationship to what
the individual member would be entitled to on a stand-alone basis,
depending on how similar the individual member's separate fixed-base
percentage was to the group's fixed-base percentage.

Proposed Allocation Rule

After considering the statute, the legislative history, the written
comments, and the statements at the public hearing, Treasury and the
IRS have determined that the allocation method contained in the 2000
proposed regulations does not fully carry out the purpose of the
research credit statute and, in particular, the amendments made by the
1989 Act. Treasury and the IRS continue to believe that the method for
allocating the group credit must take into account the incremental
nature of the credit. In considering the consequences of the allocation
method contained in the 2000 proposed regulations, as highlighted by
the commentators, Treasury and the IRS believe that the method may not,
in certain cases, appropriately balance the purpose of the group credit
computation and allocation rules contained in section 41(f) with the
general purpose of the research credit, which is to encourage research
activities.

[[Page 44502]]

Accordingly, these new proposed regulations allocate the group
credit among the members of the controlled group by first computing
each individual member's stand-alone entity credit and then multiplying
the group credit by the ratio that the member's stand-alone entity
credit bears to the sum of the stand-alone entity credits of all the
members of the controlled group. This new allocation method ensures
that the amount of group credit allocated to each individual member
will be proportionate to the amount of research credit that the
individual member would have been entitled to claim had it not been
part of a controlled group. This new allocation method therefore
addresses the concerns expressed by the commentators that the
allocation method contained in the 2000 proposed regulations could
result in individual members receiving little or no research credit--
or, conversely, a disproportionately greater amount of research
credit--compared to what they would have been entitled to on a stand-
alone basis, solely as a result of being part of a controlled group.

Special Allocation Rule for Consolidated Groups

In the preamble to the 2000 proposed regulations, Treasury and the
IRS requested comments with respect to a special rule that would treat
all members of a consolidated group within a controlled group as a
single member for purposes of allocating the group credit among the
members of a controlled group. After considering the comments received,
Treasury and the IRS have decided not to propose a special allocation
rule for consolidated groups.

Effective Date

The 2000 proposed regulations provided that they would be
effective, when finalized, for taxable years ending on or after the
date the proposed regulations were filed with the Federal Register
(i.e., December 29, 1999). The 2000 proposed regulations, however, were
proposed to be retroactive in certain instances to prevent abuse:

To prevent taxpayers that are members of a controlled group from
together claiming in excess of 100% of the credit with respect to
prior taxable years, the rules for allocating the group credit would
apply to any taxable year beginning after December 31, 1989, in
which, as a result of inconsistent methods of allocation, the
members of a controlled group as a whole claimed more than 100% of
the allowable group credit. In the case of a group whose members
have different taxable years and whose members used inconsistent
methods of allocation, the members of the group as a whole shall be
deemed to have claimed more than 100% of the allowable group credit.

The two commentators disagreed as to the appropriateness of this
proposed effective date. In particular, the second commentator stated
that it would be ``unconscionable'' for final regulations containing
the allocation method set out in the 2000 proposed regulations to be
applied retroactively. The second commentator therefore proposed that
final regulations be applied prospectively and that for prior years,
taxpayers be permitted to rely on final regulations or any other method
that is reasonable, including a gross QREs method. Finally, the second
commentator disputed ``that there is a potential for abuse if members
of a controlled group take inconsistent methods of allocation for past
years. The fact that members of the same controlled group may, in the
aggregate, claim more than 100% of the group's Research Credit should
not make any difference.''
The group credit rules in section 41(f) provide for a total group
credit. There is nothing in the statute or the legislative history that
suggests that it then should be permissible for the members of the
controlled group to claim, in the aggregate, an amount of research
credit exceeding the group credit. Treasury and the IRS continue to
believe that the purpose of the section 41(f) group credit rules would
be undermined if the members of a controlled group applied different
allocation methods to claim more than 100 percent of the group credit.
The preamble to the 2000 proposed regulations and those proposed
regulations themselves eliminated any ambiguity that may have existed
with respect to the Treasury and IRS position on this point.
Accordingly, Treasury and the IRS propose that final regulations be
effective for taxable years beginning on or after the date that these
regulations are published in the Federal Register as final regulations.
Treasury and the IRS further propose that the final regulations be
retroactive in limited circumstances to prevent abuse. Generally, a
taxpayer may use any reasonable method of computing and allocating the
credit for taxable years beginning before the date these regulations
are published in the Federal Register as final regulations. However,
paragraph (b) relating to the computation of the group credit and
paragraph (c), relating to the allocation of the group credit, will
apply to taxable years ending on or after December 29, 1999, if the
members of a controlled group, as a whole, claimed more than 100
percent of the amount that would be allowable under paragraph (b). In
the case of a controlled group whose members have different taxable
years and whose members use inconsistent methods of allocation, the
members of the controlled group shall be deemed to have, as a whole,
claimed more than 100 percent of the amount that would be allowable
under paragraph (b).

Special Analyses

It has been determined that these proposed regulations do not
constitute a significant regulatory action as defined in Executive
Order 12866. Therefore, a regulatory assessment is not required. It
also has been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act
(5 U.S.C. chapter 6) do not apply to these proposed regulations.
Pursuant to section 7805(f) of the Internal Revenue Code, these
proposed regulations will be submitted to the Administrator of the
Small Business Administration for comment on their impact on small
business.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Withdrawal of Proposed Amendments to the Regulations

Accordingly, under the authority of 26 U.S.C. 7805, the notice of
proposed rulemaking (REG-105606-99) published in the Federal Register
on January 4, 2000, (65 FR 258) is withdrawn.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. In Sec. 1.41-0, the table of contents is amended as
follows:
1. The entry for Sec. 1.41-6(a)(4) is revised.
2. The entries for Sec. 1.41-6(b) through (e) are revised.
3. New entries are added for Sec. 1.41-6(f) through (i).
The revisions and additions read as follows:

Sec. 1.41-0 Table of contents.

* * * * *

Sec. 1.41-6 Aggregation of expenditures.

(a) * * *
(4) Definition of group credit.
(b) Computation of the group credit.

[[Page 44503]]

(1) In general.
(2) Start-up companies.
(c) Allocation of the group credit.
(1) In general.
(2) Stand-alone entity credit.
(d) Examples.
(e) For taxable years beginning before January 1, 1990.
(f) Tax accounting periods used.
(1) In general.
(2) Special rule where timing of research is manipulated.
(g) Membership during taxable year in more than one group.
(h) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease payments.
(5) Payment for supplies.
(i) Effective date.
* * * * *

Par. 3. Section 1.41-6 is amended as follows:
1. Paragraph (a)(1) is revised.
2. Paragraph (a)(4) is revised.
3. Paragraph (b) is revised.
4. Paragraphs (c), (d), and (e) are redesignated as paragraph (f),
(g), and (h), respectively.
5. New paragraphs (c), (d), and (e) are added.
6. Newly designated paragraph (f)(1) is revised.
7. New paragraph (i) is added.
The revisions and additions read as follows:

Sec. 1.41-6 Aggregation of expenditures.

(a) * * * (1) In general. To determine the amount of research
credit (if any) allowable to a trade or business that at the end of its
taxable year is a member of a controlled group of corporations or a
group of trades or businesses under common control, a taxpayer must--
(i) Compute the group credit in the manner described in paragraph
(b) of this section, and
(ii) Allocate the group credit among the members of the group in
the manner described in paragraph (c) of this section.
* * * * *
(4) Definition of group credit. For purposes of this section, the
term group credit means the research credit (if any) allowable to a
controlled group of corporations or a group of trades or businesses
under common control.
(b) Computation of the group credit--(1) In general. All members of
a controlled group of corporations or a group of trades or businesses
under common control 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.
(2) Start-up companies. A controlled group of corporations or a
group of trades or businesses under common control is treated as a
start-up company for purposes of determining the group's fixed-base
percentage under section 41(c)(3)(B)(ii) only if each member of the
group qualifies as a start-up company under section 41(c)(3)(B)(i).
(c) Allocation of the group credit--(1) In general. To determine
the amount of the group credit (if any) computed under paragraph (b) of
this section that is allocated to a member of the group, a taxpayer
must--
(i) Compute the member's stand-alone entity credit; and
(ii) Multiply the group credit by the ratio that the member's
stand-alone entity credit bears to the sum of the stand-alone entity
credits of all the members of the group:
[GRAPHIC] [TIFF OMITTED] TP29JY03.001

(2) Stand-alone entity credit. For purposes of this section, the
term stand-alone entity credit means the research credit (if any) that
would be allowable to a member of a group if the credit were computed
without regard to section 41(f). In computing a member's stand-alone
entity credit, a taxpayer must use the same method (i.e., the
computation method provided in section 41(a) or the elective method
provided in section 41(c)(4)) that was used to compute the group
credit. Therefore, if the research credit determined under section
41(a) is not allowable to the group and the group credit is computed
using the alternative incremental research credit (AIRC) rules of
section 41(c)(4), each member's stand-alone entity credit also must be
computed using the AIRC rules, even if the research credit determined
under section 41(a) would be allowable to a member if that member were
not a part of the group.
(d) Examples. The following examples illustrate the provisions of
this section:

Example 1. Research credit--(i) Facts. A, B, and C, all of which
are calendar-year taxpayers, are members of a controlled group of
corporations. Neither A, B, nor C made any basic research payments
for their taxable year ending December 31, 2003. For purposes of
computing the group credit for the 2003 taxable year (the credit
year), A, B, and C had the following:

----------------------------------------------------------------------------------------------------------------
A B C Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year Qualified Research $200x $20x $110x $330x
Expenses (QREs).
1984-1988 QREs................... $40x $10x $100x $150x
1984-1988 Gross Receipts......... $1,000x $350x $150x $1,500x
Average Annual Gross Receipts for $1,200x $200x $300x $1,700x
4 Years Preceding the Credit
Year.
----------------------------------------------------------------------------------------------------------------

[[Page 44504]]

percentage, therefore, is 10 percent, which is the lesser of: $150x/
$1,500x, which equals 10 percent, or 16 percent.
(iii) Allocation of the group credit. The group credit of $32x
is allocated among the members of the group based on the ratio that
each member's stand-alone entity credit bears to the sum of the
stand-alone entity credits of all the members of the controlled
group. The $32x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........ $20x $2x $11x $33x
Allocation Ratio (Stand-Alone 20/33 2/33 11/33 .................
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit...... $32x $32x $32x .................
Equals: Credit Allocated to $19.39x $1.94x $10.67x $32x
Member.
----------------------------------------------------------------------------------------------------------------

Example 2. Member is a start-up company--(i) Facts. D, E, and F,
all of which are calendar-year taxpayers, are members of a
controlled group of corporations. F is a start-up company under
section 41(c)(3)(B)(i). D and E are not start-up companies under
section 41(c)(3)(B)(i). Neither D, E, nor F made any basic research
payments during the 2003 taxable year. For purposes of computing the
group credit for the 2003 taxable year (the credit year), D, E, and
F had the following:

----------------------------------------------------------------------------------------------------------------
D E F Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................. $200x $20x $50x $270x
1984-1988 QREs................... $55x $15x $0x $70x
1984-1988 Gross Receipts......... $1,000x $400x $0x $1,400x
Average Annual Gross Receipts for $1,200x $200x $0x $1,400x
4 Years Preceding the Credit
Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit--(A) In general. The
research credit allowable to the group is computed as if the three
corporations were one taxpayer. The group credit is equal to 20
percent of the excess of the group's aggregate credit year QREs
($270x) over the group's base amount ($135x). The group credit is
0.20 x ($270x-$135x), which equals $27x.
(B) Group's base amount--(1) Computation. The group's base
amount equals the greater of: the group's fixed-base percentage (5
percent) multiplied by the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year
($1,400x), or the group's minimum base amount ($135x). The group's
base amount, therefore, is $135x, which is the greater of: 0.05 x
$1,400x, which equals $70x, or $135x.
(2) Group's minimum base amount. The group's minimum base amount
is 50 percent of the group's aggregate credit year QREs. The group's
minimum base amount is 0.50 x $270x, which equals $135x.
(3) Group's fixed-base percentage. Because only one member of
the group, F, is a start-up company under section 41(c)(3)(B)(i),
the group is not a start-up company under paragraph (b)(2) of this
section. Therefore, the group's fixed-base percentage is the lesser
of: the ratio that the group's aggregate QREs for the taxable years
beginning after December 31, 1983, and before January 1, 1989, bears
to the group's aggregate gross receipts for the same period, or 16
percent (the statutory minimum). The group's fixed-base percentage,
therefore, is 5 percent, which is the lesser of: $70x/$1,400x, which
equals 5 percent, or 16 percent.
(iii) Allocation of the group credit. The group credit of $27x
is allocated among the members of the group based on the ratio that
each member's stand-alone entity credit bears to the sum of stand-
alone entity credits of all the members of the controlled group. The
$27x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
D E F Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........ $20x $2x $5x $27x
Allocation Ratio (Stand-Alone 20/27 2/27 5/27 .................
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit...... $27x $27x $27x .................
Equals: Credit Allocated to $20x $2x $5x $27x
Member.
----------------------------------------------------------------------------------------------------------------

Example 3. Group is a start-up company--(i) Facts. G, H, and I,
all of which are calendar-year taxpayers, are members of a
controlled group of corporations. Each of G, H, and I qualifies as a
start-up company under section 41(c)(3)(B)(i). The 2003 taxable year
is the fifth taxable year beginning after December 31, 1993, for
which each of G, H, and I has QREs. Because each of G, H, and I
qualifies as a start-up company under section 41(c)(3)(B)(i), the
group is treated as a start-up company under paragraph (b)(2) of
this section. The 2003 taxable year is the fifth taxable year
beginning after December 31, 1993, for which the group has QREs.
Neither G, H, nor I made any basic research payments during the 2003
taxable year. For purposes of computing the group credit for the
2003 taxable year (the credit year), G, H, and I had the following:

----------------------------------------------------------------------------------------------------------------
G H I Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................. $255x $25x $100x $380x
1984-1988 QREs................... $0x $0x $0x $0x
1984-1988 Gross Receipts......... $0x $0x $0x $0x
Average Annual Gross Receipts for $1,600x $340x $300x $2,240x
4 Years Preceding the Credit
Year.
----------------------------------------------------------------------------------------------------------------

[[Page 44505]]

receipts for the 4 taxable years preceding the credit year
($2,240x), or the group's minimum base amount ($190x). The group's
base amount, therefore, is $190x, which is the greater of: 0.03 x
$2,240x, which equals $67.2x, or $190x.
(2) Group's minimum base amount. The group's minimum base amount
is 50 percent of the group's aggregate credit year QREs. The group's
minimum base amount is 0.50 x $380x, which equals $190x.
(3) Group's fixed-base percentage. Each member of the group is a
start-up company under section 41(c)(3)(B)(i), therefore, the group
is a start-up company under paragraph (b)(2) of this section.
Because the 2003 taxable year is the fifth taxable year beginning
after December 31, 1993, for which the group has QREs, under section
41(c)(3)(B)(ii)(I), the group's fixed-base percentage is 3 percent.
(iii) Allocation of the group credit. The group credit of $38x
is allocated among the members of the group based on the ratio that
each member's stand-alone entity credit bears to the sum of stand-
alone entity credits of all the members of the controlled group. The
$38x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
G H I Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........ $25.5x $2.5x $10x $38x
Allocation Ratio (Stand-Alone 25.5/38 2.5/38 10/38 .................
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit...... $38x $38x $38x .................
Equals: Credit Allocated to $25.5x $2.5x $10x $38x
Member.
----------------------------------------------------------------------------------------------------------------

Example 4. Group alternative incremental research credit--(i)
Facts. J, K, and L, all of which are calendar-year taxpayers, are
members of a controlled group of corporations. The research credit
under section 41(a) is not allowable to the group for the 2003
taxable year because the group's aggregate QREs for the 2003 taxable
year are less than the group's base amount. The group credit is
computed using the AIRC rules of section 41(c)(4). For purposes of
computing the group credit for the 2003 taxable year (the credit
year), J, K, and L had the following:

----------------------------------------------------------------------------------------------------------------
J K L Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................. $0x $20x $110x $130x
Average Annual Gross Receipts for $1,200x $200x $300x $1,700x
4 Years Preceding the Credit
Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit. The research credit
allowable to the group is computed as if the three corporations were
one taxpayer. The group credit is equal to the sum of: 2.65 percent
of so much of the group's aggregate QREs for the taxable year as
exceeds 1 percent of the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year, but does
not exceed 1.5 percent of such average; 3.2 percent of so much of
the group's aggregate QREs as exceeds 1.5 percent of such average
but does not exceed 2 percent of such average; and 3.75 percent of
so much of such QREs as exceeds 2 percent of such average. The group
credit is [0.0265 x [($1,700x x 0.015)-($1,700x x 0.01)]] + [0.032 x
[($1,700x x 0.02)-($1,700x x 0.015)]] + [0.0375 x [$130x-($1,700x x
0.02)]], which equals $4.10x.
(iii) Allocation of the group credit. The group credit is
allocated to each member of the group by multiplying the group
credit by the ratio that each member's stand-alone entity credit
bears to the sum of the stand-alone entity credits of all the
members of the group. The $4.10x group credit is allocated as
follows:

----------------------------------------------------------------------------------------------------------------
J K L Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit........ $0x $.66x $3.99x $4.65x
Allocation Ratio (Stand-Alone 0/4.65 0.66/4.65 3.99/4.65 .................
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit...... $4.10x $4.10x $4.10x .................
Equals: Credit Allocated to $0x $.58x $3.52x $4.10x
Member.
----------------------------------------------------------------------------------------------------------------

(e) For taxable years beginning before January 1, 1990. For taxable
years beginning before January 1, 1990, see Sec. 1.41-6 as contained
in 26 CFR part 1, revised April 1, 2003.
(f) Tax accounting periods used--(1) In general. The credit
allowable to a member of a controlled group of corporations or a group
of trades or businesses under common control is that member's share of
the group credit computed as of the end of that member's taxable year.
In computing the group credit for a group whose members have different
taxable years, a member generally should treat the taxable year of
another member that ends with or within the credit year of the
computing member as the credit year of that other member. For example,
M, N, and O are members of a controlled group of corporations. M and N
file a calendar year consolidated return. O files a separate return
using a fiscal year ending June 30. For purposes of computing the group
credit at the end of the M's and N's (the computing members') calendar
year on December 31, O's fiscal year ending June 30, which ends within
the M's and N's calendar year, is treated as O's credit year.
* * * * *
(i) Effective date. Paragraphs (a)(1), (a)(4), (b), (c), (d), and
(f)(1) of this section are applicable for taxable years beginning on or
after the date these regulations are published in the Federal Register
as final regulations. Generally, a taxpayer may use any reasonable
method of computing and allocating the credit for taxable years
beginning before the date these regulations are published in the
Federal Register as final regulations. However, paragraph (b) relating
to the computation of the group credit and paragraph (c), relating to
the allocation of the group credit, will apply to taxable years ending
on or after December 29, 1999, if the members of a controlled group, as
a whole, claimed more than 100 percent of the amount that would be
allowable under paragraph (b). In the case of a controlled group whose
members have different taxable years and whose members use inconsistent
methods of allocation, the members of the controlled group shall be
deemed to have, as a whole, claimed more than 100 percent of the amount

[[Page 44506]]

that would be allowable under paragraph (b).

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 03-17870 Filed 7-28-03; 8:45 am]

BILLING CODE 4830-01-P