Definition of supplies clarified for purpose of R&D credit.

• Author: Fairbanks, Greg A.
• Position: Research and development

Tax advisers that use supplies in their research and development (R&D) efforts should reevaluate the costs they include in their R&D credit computations in light of a recent Tax Court decision (TG Missouri Corp., 133 T.C. No. 13 (2009)). This ruling provides significant potential benefits to certain taxpayers claiming the R&D credit under Sec. 41--especially those that purchase supplies during their R&D efforts for prototypes, products, or equipment that they then sell to customers.

Tax Court Decision

TG Missouri manufactures injection-molded products such as steering wheels, air bags, and body side molding for customers in the automotive industry. As part of its business, the company also develops and uses production molds, contracting with third-party toolmakers. TG Missouri either sells the completed production molds to its customers or retains ownership of the molds. In either case, TG Missouri keeps the molds in its facilities and uses them for the production of automotive parts.

At issue in the case were certain supply costs TG Missouri claimed for the R&D credit on its 1998 and 1999 tax returns--specifically, the company claimed the amounts it paid to the third-party tool-makers for molds it subsequently modified and sold to its customers as qualified supply costs. The IRS disallowed the costs, arguing that the completed molds were subject to wear and tear, exhaustion, or obsolescence and had a useful life beyond one year. Thus, the IRS concluded, the supplies used in the molds were property "of a character" subject to the allowance for depreciation and thus not includible for the credit (although they were not depreciable assets for TG Missouri because it did not retain ownership of the molds).

The Tax Court, in siding with TG Missouri, determined that the molds were not subject to depreciation in the hands of the taxpayer; therefore, the amounts paid related to the molds were includible as supply costs for purposes of the R&D credit. The court's opinion shows that the exclusion for supplies of a character subject to depreciation requires not only that the property generally be a type of property that is typically subject to depreciation but that it also specifically be depreciable property in the hands of the taxpayer.

Potential Impact

The TG Missouri ruling provides much-needed clarification for taxpayers using supplies in their R&D efforts. Despite the lack of statutory or regulatory language, the IRS has often taken the position...