Tax Compliance after M&As: Elections, Carryovers, and Debt Offer Plenty of Issues to Track Following Either a Stock or an Asset Deal
The federal research tax credit is a well-established planning tool that in the authors' experience is often one of the largest tax incentives available to U.S. companies engaging in product development, manufacturing, and process technology. Companies annually reduce federal and, in many cases, state tax liability by the costs incurred to develop or improve products, processes, and software. However, financial institutions and other providers of financial services delivered or facilitated through software platforms and web-based programs have historically underused the research credit. Part of the reason for this is that whether software developed for internal business use or for interaction with customers is eligible for the credit has been a highly contested IRS issue. Previously, the uncertainty in this area could be blamed on a lack of clear guidance and inconsistent IRS regulations and administration. Hence, financial service companies that have invested in technology focused on unique financial modeling and enterprise tools, data security mechanisms, and diverse modules developed to provide improved services to customers have routinely failed to include those costs in calculating their research credit. In many instances, these organizations missed the opportunity altogether to claim the research credit. On Oct. 3, 2016, the IRS issued final regulations on the treatment of internal-use software for purposes of calculating the research credit (T.D. 9786). The final regulations largely mirror the taxpayer-friendly proposed regulations (REG-153656-03) issued in 2015 with some changes. Because of the new regulations, service-based companies investing in technology now have support for the position that those costs are eligible for the research credit. This development is especially important for financial services companies but applies to all companies using technology to provide services that rely on data collection and analytics, and any company that has invested in technology to increase operational speed or efficiency, or to reduce cost. The proposed and final regulations focus heavily on whether a software program qualifies as internal-use software. Both internal-use software and non-internal-use software are eligible for the research credit, but internal-use software requires a heightened level of innovation and risk to qualify. The new regulations further expand and clarify the types of software that fall outside of the higher-scrutiny internal-use category, which significantly enhances the ability of U.S. companies to include technology development programs in their research credit calculations. Nonetheless, taxpayers must provide documentation to prove their programs qualify. One final note: Whether software is developed for internal use or some other purpose, costs for programs or projects that did not succeed may qualify for the research credit. As is true for all research credit costs, failed or partially failed projects are often rife with eligible research credit costs. Following is a summary of the major clarifications, changes, and new definitions introduced by the 2015 proposed regulations, along with additional changes contained in the 2016 final regulations. DEFINITION OF INTERNAL-USE SOFTWARE Proposed regulations Software is developed by (or for the benefit of) the taxpayer primarily for internal use if the software is developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer's trade or business. General and administrative functions are further defined as: * Financial management functions: Programs involving the taxpayer's financial management and supporting recordkeeping. * Human resource management functions: Programs developed to manage the taxpayer's workforce. * Support services functions: Software developed to support the taxpayer's day-to-day operations, such as data processing or facilities services. …