Does a pathology-testing company qualify as a 'biotechnology company' entitled to the 15-year carryforward of Connecticut's research-and-experimental-expenditure corporation business tax credit?

Plain-English summary

Connecticut's corporation business tax offers a research-and-experimental-expenditure credit under Conn. Gen. Stat. § 12-217j: a corporation gets a credit equal to 20% of the increase in what it spent, year over year, directly on research and experimental expenditures (as defined in 26 U.S.C. § 174) conducted in Connecticut. For most corporations, any part of the credit they can't use in the year (because it exceeds the tax due) is lost — it can't be carried forward. But a "biotechnology company" gets a special break: it may carry unused credit forward to future years until fully used, up to a maximum of 15 years.

The company here is the same pathology testing lab as in the companion sales-tax ruling. It tests blood, tissue, and other patient specimens and reports to physicians and managed-care organizations for cancer screening, prognosis, and recurrence testing. It wanted to be treated as a "biotechnology company" so it could use the 15-year carryforward.

DRS said no. The statutory definition of "biotechnology company" in § 12-217j is essentially the same as the sales-tax "biotechnology" definition (§ 12-412(89)), and its verbs — produce or modify, improve, develop, identify, transform — describe R&D that produces products, not diagnostic testing of specific patients. The legislative history (the biotechnology "cluster" initiative) confirmed the credit was meant for companies doing biotechnology R&D focused on producing products. The lab does not produce or modify products, develop microorganisms, identify pharmaceutical targets, or transform biological systems — it tests specimens and turns findings over to physicians for diagnosis, prognosis, monitoring, and management of disease. Because a tax credit, like an exemption, is legislative grace and is strictly construed against the taxpayer (New England Yacht Sales), the lab falls outside the definition.

The bottom line is nuanced: the lab can still take the R&E credit in the year it is earned — that's available to any corporation — it just cannot carry an unused portion forward for 15 years, because it isn't a "biotechnology company." (The companion sales-tax ruling, Ruling No. 97-7, reached the parallel result under § 12-412(89); named here in prose, not linked.)

What this means for you

Diagnostic and testing companies claiming the R&E credit

You may qualify for the base research-and-experimental-expenditure credit like any corporation that increases qualifying Connecticut R&D spending. But the enhanced 15-year carryforward is reserved for a "biotechnology company," and a business whose service is testing specimens to help physicians diagnose and manage disease generally won't meet that definition — even if it uses biotech methods. Model the credit assuming no carryforward unless you genuinely fit the definition.

Genuine biotechnology R&D companies

If your company produces or modifies products, develops microorganisms, identifies pharmaceutical targets, or transforms biological systems into useful products/processes, you may qualify as a "biotechnology company" and preserve unused R&E credit for up to 15 years — a meaningful benefit for pre-revenue R&D firms with little current tax to offset. Keep documentation tying your activities to the statutory verbs.

Corporate tax professionals

Note the parallel drafting: § 12-217j's "biotechnology company" and § 12-412(89)'s "biotechnology" share essentially the same definition, so a taxpayer that fails one likely fails the other — DRS decided both here on the same day. Credits, like exemptions, are strictly construed against the taxpayer (New England Yacht Sales). The base credit is 20% of the increase in Connecticut § 174 research spending over the prior year.

Common questions

Q: What is the § 12-217j research credit?
A: A corporation business tax credit equal to 20% of the increase in a corporation's direct research and experimental expenditures (per 26 U.S.C. § 174) conducted in Connecticut, compared with the prior income year.

Q: What's special about a "biotechnology company"?
A: A biotechnology company may carry forward unused credit until it's fully used, up to 15 years. Most corporations can't carry the credit forward at all.

Q: Why isn't a pathology lab a "biotechnology company"?
A: Because it doesn't produce/modify products, develop microorganisms, identify pharmaceutical targets, or transform biological systems. It tests specimens so physicians can diagnose and manage disease. The definition (strictly construed against the taxpayer) targets product-producing R&D.

Q: Can the lab still use the credit at all?
A: Yes — it can take the credit in the year it is earned, like any corporation. It just can't carry an unused portion forward for 15 years, because it isn't a biotechnology company.

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-217j (corporation business tax credit for 20% of the year-over-year increase in Connecticut research and experimental expenditures; 15-year carryforward available to a "biotechnology company"; statutory definition of "biotechnology company")
• 26 U.S.C. § 174 (federal definition of research and experimental expenditures)

Case law cited by the ruling:

• New England Yacht Sales, Inc. v. Commissioner of Revenue Services, 198 Conn. 624 (1986) (a tax credit, like an exemption, is legislative grace strictly construed against the taxpayer)
• Petco Insulation Co. v. Crystal, 231 Conn. 315 (1994) (statutory construction seeks legislative intent)

Companion ruling:

• Ruling No. 97-7 (same facts; pathology lab not "biotechnology" for the sales and use tax exemption under § 12-412(89))

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 97-6

Original ruling text

Ruling 97-6, Corporation Business Tax / Research and Experimental Expenditure Credit

FACTS:

A company (the "Company") provides pathology testing services to physicians and managed care organizations. The Company tests blood, tissue and other specimens furnished by the service recipients and prepares a comprehensive report which it provides to the service recipients. The Company’s services are used by physicians who are screening for cancer, forecasting the course of an existing cancer or testing for the recurrence of a previously treated cancer in a specific patient.

ISSUE:

Whether a provider of pathology testing services which are used by physicians and managed care organizations in the diagnosis, prognosis, monitoring and general management of diseases and other clinical conditions qualifies as a "biotechnology company" for the purposes of Conn. Gen. Stat. § 12-217j.

DISCUSSION:

Conn. Gen. Stat. § 12-217j allows to any corporation a corporation business tax credit that is equal to twenty per cent of the excess of (A) the amount spent during the income year by the corporation directly on research and experimental expenditures, as defined in 26 U.S.C. § 174, where the research and experimentation are conducted in Connecticut, over (B) the amount spent during the immediately preceding income year by the corporation directly on such research and experimental expenditures, where the research and experimentation are conducted in Connecticut.

For most corporations, any portion of the credit that is not used (because, e.g. , the amount of the credit exceeds the tax otherwise due and owing) may not be carried forward to succeeding income years. A "biotechnology corporation", however, may carry any portion of the credit that is not used "forward to each of the successive income years until such credit, or applicable portion of the credit, is fully taken," Conn. Gen. Stat. § 12-217j, but, "[in no case shall a credit, or any portion of a credit, that is not used by a biotechnology company be carried forward for a period of more than fifteen years." Id. For the purposes of Conn. Gen. Stat. §12-217j, "biotechnology company" means:

a company engaged in the business of applying technologies, such as recombinant DNA techniques, biochemistry, molecular and cellular biology, genetics and genetic engineering, biological cell fusion techniques, and new bioprocesses, using living organisms, or parts of organisms, to produce or modify products, to improve plants or animals, to develop microorganisms for specific uses, to identify targets for small molecule pharmaceutical development, or to transform biological systems into useful processes and products or to develop microorganisms for specific uses."

(Emphasis added). This is essentially the same definition used to define biotechnology in Conn. Gen. Stat. §12-412(89) for the purpose of the sales and use taxes. The highlighted verbs -- "to produce or modify," "to improve," "to develop," "to identify" and "to transform" -- indicate that the exemption was intended for activities that would lead towards progress in the area of biotechnology, as opposed to merely diagnosing illnesses in specific patients.

To the extent that the language of the exemption may be ambiguous, it is appropriate to review the intent of the General Assembly in enacting it. ("It is fundamental that statutory construction requires us to ascertain the intent of the legislature and to construe the statute in a manner that effectuates that intent." Petco Insulation Co. v. Crystal , 231 Conn. 315, 321, 649 A.2d 790 (1994).) The legislation enacting the tax credit was part of an initiative to promote the "cluster-based development" of the biotechnology industry, as one of the "new industries of the future." 39 H.R. Proc., Pt. 14, 1996 Sess., pp. 4742-4744 (remarks of Rep. Merrill, who introduced the bill). According to Representative Merrill, "cluster-based development" is a "broad-based range of industries that interact together, both in terms of market, in terms of product development, in terms of research and development." Id. at p. 4744. The biotechnology "cluster" was chosen as one of the first industries to receive a legislative incentive, because Connecticut already possesses the "synergism" to attract biotechnology companies in its quality of life, its educational institutions and the pharmaceutical manufacturers already located here. Id . at pp. 4759-4760 (remarks of Rep. Ward). It appears from the legislative history, as well as the General Assembly’s choice of the types of activities listed in the statute, that the tax credit was intended to benefit companies that engage in biotechnology research and development focusing on producing products (whether or not such production will be done by the business engaging in the research and development).

The Company fails to meet the definition of a "biotechnology company," because the Company does not produce or modify products, does not develop microorganisms for specific uses, does not identify targets for small molecule pharmaceutical development and does not transform biological systems into useful processes and products. The Company provides testing services and then turns its findings over to physicians to use in diagnosis, prognosis, monitoring and general management of a disease. A tax credit, like an exemption, is a matter of legislative grace and thus is strictly construed against the taxpayer. See New England Yacht Sales, Inc. v. Commissioner of Revenue Services , 198 Conn. 624, 637, 504 A.2d 506 (1986).

Because the Company fails to meet the definition of a "biotechnology company", it may take the corporation business tax credit for research and experimental expenditures in the year the credit is earned but it may not carry forward the credit for a period of 15 years.

RULING:

A provider of pathology testing services which are used by physicians and managed care organizations in the diagnosis, prognosis, monitoring and general management of diseases and other conditions does not qualify as a "biotechnology company" for the purposes of Conn. Gen. Stat. §12-217j.

LEGAL DIVISION

December 31, 1997