Does equipment used to design and develop computer hardware and software products qualify for New York's investment tax credit and research and development credit, and can an unprofitable startup get the investment credit refunded rather than carried forward?

Plain-English summary

Protocom Devices, Inc., incorporated in 1983, designs, develops, and manufactures data-communications hardware and software that let vendor-specific computer equipment connect to X.25 packet-switched networks -- specialized technical products with no off-the-shelf substitute. Its research and development equipment includes PC-based development stations, data analyzers and scopes, test/debug tools, a multi-user development system, printers and terminals for various computer platforms, modems, and a mainframe used for developing data-communications software protocols. Protocom had not yet earned any profit and asked three things: does this equipment qualify for the Article 9-A investment tax credit; does it separately qualify for the research and development credit; and since the company has no tax liability to offset, can any investment tax credit be refunded immediately rather than carried forward to a future profitable year.

The Department worked through the federal-to-state linkage carefully. New York's research and development deduction/credit provisions borrow language from the federal definition of "research or experimental expenditures" (26 CFR 1.174-2), and New York's statutes direct that undefined terms be read consistently with federal tax law absent a contrary intent. The IRS, in Revenue Procedure 69-21, already treats software development costs as closely resembling federal research and experimental expenditures. Following that same reasoning, the Department concluded Protocom's equipment used to develop its computer software products qualifies as research and development property, and its equipment used to build experimental hardware prototypes likewise qualifies -- as long as no particular item is instead used for ordinary testing/quality-control, efficiency surveys, management studies, consumer surveys, or advertising (which would disqualify that specific item). Property that qualifies as R&D property under this test can be elected, under section 210.12(f), to be treated as manufacturing/production property for investment tax credit purposes -- OR the taxpayer can instead claim the separate, dedicated 10% research and development credit under section 210.18. Critically, a taxpayer can't claim both credits on the same property; it's an either/or election.

On refundability, New York's investment tax credit is ordinarily just a carryforward if it exceeds the tax otherwise due -- but a "new business" (broadly, a corporation not majority-owned by, and not substantially similar in ownership/operation to, another entity already taxed under Article 9-A/32/33 or the old personal income tax article, and not itself previously subject to Article 9-A for more than four years) can elect instead to have the excess treated as an overpayment and refunded. Since nothing in the facts suggested Protocom fails that new-business test, the Department confirmed it may elect a refund of any investment tax credit carryover -- though the follow-on employment incentive credit is never refundable under any circumstances, and if Protocom qualifies for the investment credit, it will also separately qualify for the employment incentive credit in the following years (as long as its New York employment stays at least 101% of its base-year level).

What this means for you

Software and technology startups with pre-profit R&D spending

New York follows the federal IRS position (Revenue Procedure 69-21) that software development costs are research and experimental expenditures -- so equipment used to develop software, not just physical hardware prototypes, can qualify for New York's investment tax credit or research and development credit. And if you qualify as a statutory "new business" with no current tax liability to offset, the investment credit doesn't have to sit unused as a carryforward -- it can be refunded as a cash overpayment.

Choosing between the investment tax credit and the research and development credit

These are mutually exclusive on the same property -- you must elect one or the other for each qualifying item, and the choice affects both the credit rate (the ordinary 5-6% investment credit rate vs. the flat 10% R&D credit) and whether a follow-on employment incentive credit becomes available (only the investment tax credit route unlocks that).

Taxpayers who miss claiming a credit in the year they first qualify

The credit must be claimed in the taxable year the taxpayer first qualifies; if missed, amended returns can be filed within the standard refund limitations period (three years from filing or two years from payment, whichever is later) to claim it retroactively.

Common questions

Q: Does software development equipment automatically qualify just because it's used by a tech company?
A: No -- it must actually be used for genuine research/experimental development (following the federal Rev. Proc. 69-21 standard), not for routine testing, quality control, management, or promotional purposes; equipment used for those excluded purposes doesn't qualify even at an R&D-focused company.

Q: Can a company claim both the investment tax credit and the research and development credit on the same equipment?
A: No -- the statute requires an either/or election per item of qualifying property; a taxpayer can't claim both.

Q: What disqualifies a company from the "new business" refund election?
A: Being majority-owned by (or substantially similar in ownership/operation to) another entity already taxed under Article 9-A, Article 32, Article 33, or certain other Tax Law articles, or having been subject to Article 9-A tax for more than four prior taxable years.

Q: Can another company rely on this specific ruling?
A: No. It binds the Department only for this petitioner's facts and can't be relied upon by other taxpayers, even similarly situated technology startups.

Q: Is this the same ruling as Protocom's manufacturing equipment question?
A: No -- this ruling addresses R&D/development equipment specifically; see the companion ruling TSB-A-87(14)C (same petitioner, same filing date) for the separate MANUFACTURING equipment analysis.

Citations and references

Statutes and regulations:

• Tax Law § 210.12, § 210.12(f), § 210.12(j) (investment tax credit, R&D election, new-business refund)
• Tax Law § 210.3(e)(2)-(3) (R&D deduction election); § 210.12-A (employment incentive credit); § 210.18 (research and development credit)
• Tax Law § 1087(a) (refund claim limitations period)
• Business Corporation Franchise Tax Regulations § 4-8.7, § 5-3.2(a)
• 26 CFR 1.174-2; Revenue Procedure 69-21 (software development cost treatment)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1987.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a87_17c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-87 ( 17) C
Corporation Tax
June 24, 1987

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C861215C

On December 15, 1986, a Petition for Advisory Opinion was received from Protocom
Devices, Inc., 1666 Bathgate Avenue, Bronx, New York 10457.
The issues raised are (1) whether Petitioner, an Article 9-A taxpayer, is allowed an
investment tax credit, pursuant to section 210.12 of the Tax Law, with respect to research and
development equipment used in the design and development of computer hardware and software
to be used in a data communications environment and (2) whether Petitioner qualifies for a
research and development credit, pursuant to section 210.18 of the Tax Law with respect to such
equipment. Also, since Petitioner has not earned any profits to date, can the investment tax credit
be allowed in the current taxable year, as a refund, rather than carrying the credit to future years.
Petitioner was incorporated in February 1983, and is engaged in the design, development
and manufacture of high performance communications processors that interface electronic data
processing equipment (both synchronous and asynchronous) to state of the art X.25 packet
switched networks. (X.25 is an international standard that defines the operation of a packet
switched network.) Without such highly sophisticated products, vendor specific electronic data
processing equipment could not connect to nor communicate over packet switched networks.
Among Petitioner's developed products are packet assembler/ disassemblers that support the
broadest variety of vendor specific synchronous equipment.
Petitioner designs, develops and manufactures software packages that provide network
management and permit network access to personal computers. Petitioner has expertise in
network design and consulting, as well as the production of customized interface products that
satisfy unique requirements dictated by non-standard operating environments or desired by
customers.
Petitioner also designs, develops and manufactures hardware products that contain the
software products developed by Petitioner and function as the physical connective points
between vendor specific equipment and X.25 packet switched networks.
The equipment used in Petitioner's research and development is depreciable and was
acquired since February, 1983. The equipment consists of:
PC based development stations - used for software development
Data analyzers - used to monitor and analyze data transmission and can be
programmed to emulate host and terminal processors
Data scopes - used to monitor data transmissions

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

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Data analyzer/simulator - used for simulation of network environment, data
analysis and test procedures
Test units
Test/debug equipment - in-circuit emulators, used to control processor execution
during software debugging phase of development
Ironics 1600 development system - multi-user development environment for
68000 based products
Asynchronous terminals - used for testing/debug of software and access Ironics
System
Sperry printer, terminal and controller - used to develop and maintain Sperry
based products
Burroughs printer and terminal - used to develop and maintain Burroughs based
products
Honeywell printer and terminal - used to develop and maintain Honeywell based
products
Various modems - used to construct test environment for product development
Digital equipment corporation VAX11/780 mainframe - used for development of
data communications software protocols and other R & D maintenance of
data (including required software)
ISSUE (1)
Section 210.12 of the Tax Law allows an investment credit against the tax
imposed under Article 9-A of the Tax Law equal to six percent of the cost or other basis
of equipment which:
(1)

is acquired, constructed, reconstructed or erected after June 30, 1982;

(2)

is depreciable pursuant to section 167 of the Internal Revenue Code or
recovery property with respect to which a deduction is allowable under
section 168 of the Internal Revenue Code;

(3)

has a useful life of four years or more;

(4)

is acquired by purchase as defined in section 179(d) of the Internal
Revenue Code;

(5)

has a situs in New York State; and

(6)

is principally used by the taxpayer in the production of goods by
manufacturing, processing, assembling, refining, mining, extracting,
farming, agriculture, horticulture, floriculture, viticulture or commercial
fishing.

The investment tax credit is not allowed for any property which is leased by the
taxpayer to any other person or corporation.

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Corporation Tax
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Section 210.12(f) of the Tax Law provides that:
(f)
At the option of the taxpayer . . . research and development
facilities which qualify for elective deduction under subparagraphs
two and three of paragraph (e) of subdivision three of this section
may be treated as property principally used by the taxpayer in the
production of goods by manufacturing, processing, assembling,
refining, mining, extracting, farming, agriculture, horticulture,
floriculture, viticulture or commercial fishing, provided the
property otherwise qualifies under paragraph (b) of this
subdivision, in which event... a credit shall not be allowed under
such subdivision eleven and a deduction shall not be allowed under
such subparagraph three of paragraph (e).
Section 210.3(e)(2) and (3) of the Tax Law and section 4-8.7 of the Business Corporation
Franchise Tax regulations (hereinafter Article 9-A regulations) provide that a taxpayer may elect
to deduct from allocated entire net income expenditures paid or incurred during the taxable year
for the construction, reconstruction, erection or acquisition of any new property used or to be
used for purposes of research and development in the experimental or laboratory sense. Such
purposes do not include the ordinary testing or inspection of materials or products for quality
control, efficiency surveys, management studies, consumer surveys, advertising promotions or
research in connection with literary, historical or similar projects. For tangible property to
qualify for the deduction it must be depreciable pursuant to section 167 of the Internal Revenue
Code, have a situs in New York State and be used in the taxpayer's trade or business.
It appears that the language contained in section 210.3(e)(2) and (3) was derived from
section 1.174-2 of the federal income tax regulations, which states:
(a) In general. (1) The term "research or experimental expenditures", as used in
section 174, means expenditures incurred in connection with the taxpayer's trade
or business which represent research and development costs in the experimental
or laboratory sense. The term includes generally all such costs incident to the
development of an experimental or pilot model, a plant process, a product, a
formula, an invention, or similar property, and the improvement of already
existing property of the type mentioned. The term does not include expenditures
such as those for the ordinary testing or inspection of materials or products for
quality control or those for efficiency surveys, management studies, consumer
surveys, advertising, or promotions...nor does it include expenditures paid or
incurred for research in connection with literary, historical, or similar projects.
(emphasis added) 26 CFR 1.174-2

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In applying federal income tax regulation section 1.174-2, Revenue Procedure 69-21
established guidelines to be used in connection with the examination of federal income tax
returns involving the costs of computer software. Revenue Procedure 69-21 provides that the
costs of developing software (whether or not the particular software is patented or copyrighted)
in many respects so closely resemble the kind of research and experimental expenditures that fall
within the purview of section 174 of the Internal Revenue Code as to warrant accounting
treatment similar to that accorded such costs under section 174.
Section 1-2.1 of the Article 9-A regulations provides that any term used in such
regulations shall, unless a different meaning is clearly required, presumably have the same
meaning as when used in a comparable context in the laws of the United States relating to federal
income taxes and regulations promulgated thereunder. In addition, section 607(a) of the Tax Law
relating to personal income tax provides that "[a]ny term used in this article shall have the same
meaning as when used in a comparable context in the laws of the United States relating to federal
income taxes, unless a different meaning is clearly required." It is now beyond question that
when an interpretation of a law of the United States relating to federal income taxes is
established by the Internal Revenue Service through a Revenue Ruling or a Revenue Procedure,
such federal interpretation will be followed for New York State personal income tax purposes, as
well.
It follows that the cost of equipment used in the design and development of computer
software products, which is treated as research or experimental expenditures for federal income
tax purposes, pursuant to Revenue Procedure 69-21, should be accorded the same treatment for
research and development purposes under section 210.3(e)(2) and (3) of the Tax Law. Therefore,
the research and development expenditures of Petitioner for equipment used in the design and
development of computer software products is deemed to be used for purposes of research and
development in the experimental or laboratory sense for purposes of section 210.3(e)(2) and (3).
Petitioner's equipment that is used in the design and development of computer hardware,
is used to create experimental models of the hardware products. As such, the equipment is clearly
used for purposes of research and development in the experimental sense for purposes of section
210.3(e)(2) and (3) of the Tax Law.
However, if any item of Petitioner's research and development equipment is used in the
ordinary testing or inspection of materials or products for quality control, efficiency surveys,
management studies, consumer surveys or advertising promotions such item does not qualify for
the deduction under section 210.3(e)(2) and (3) of the Tax Law.
It is determined that Petitioner's research and development equipment is used in its trade
or business for purposes of research and development and if it is depreciable pursuant to section
167 of the Internal Revenue Code and has a situs in New York State, the equipment meets the
other requirements of section 210.3(e)(2) and (3) of the Tax Law, and such equipment may be
treated as property principally used by Petitioner in the production of goods by manufacturing,

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Corporation Tax
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processing, etc. for purposes of the investment tax credit pursuant to section 210.12(f) of the Tax
Law. If such property also meets the other requirements for eligible property under section
210.12 of the Tax Law, Petitioner may elect to claim an investment tax credit based on the cost
or other basis of such equipment.
Section 210.12-A of the Tax Law allows an employment incentive tax credit against the
tax imposed under Article 9-A of the Tax Law in each of the three years succeeding the taxable
year for which an investment tax credit has been allowed under section 210.12 of the Tax Law.
The amount of the credit allowed in each of the three years is fifty percent of the investment tax
credit allowed. However, the credit is allowed only in taxable years when the average number of
employees during each such year is at least 101 percent of the average number of employees
during the taxable year immediately preceding the taxable year for which the investment tax
credit is allowed.
Section 5-3.2(a) of the Article 9-A regulations provides:
The average number of employees in a taxable year as used in this Subpart is computed as
follows:
(1)

ascertain the number of employees within New York State, except general
executive officers, employed by the taxpayer on March 31st, June 30th,
September 30th, and December 31st in the taxable year;

(2)

add together the number of employees ascertained on each of such dates;
and

(3)

divide the sum by the number of such dates occurring within the taxable
year. 20 NYCRR 5-3.2

Where a taxpayer qualifies for an investment tax credit with respect to eligible property,
the taxpayer may also qualify for an employment incentive tax credit for each of the three years
next succeeding the taxable year for which the taxpayer qualified for the investment tax credit.
The taxpayer will qualify for the credit in each of the years in which the average number of
taxpayer's employees is at least 101 percent of the average number of employees during the
taxable year immediately preceding the taxable year for which the investment was allowable (the
base year). Each year's qualification is determined separately. If a taxpayer fails to have a
sufficient number of employees in one or two of the three years, it will nevertheless qualify for
the credit in the year or years in which it has a sufficient number of employees.

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Accordingly, if Petitioner qualifies for the investment tax credit, it will also qualify for
the employment incentive tax credit in each of the next succeeding three years if the number of
its employees is a least 101 percent of the number of its employees in the base year. The amount
of Petitioner's credit in each of the three years will equal one-half of Petitioner's investment tax
credit (i.e. one-half of six percent) for a total of nine percent if Petitioner qualifies in all three
years. This amount is in addition to the six percent credit allowed for the investment tax credit.
If Petitioner does not elect to claim the investment tax credit, Petitioner may not claim the
employment incentive tax credit pursuant to section 210.12-A of the Tax Law for the appropriate
taxable years.
A taxpayer must claim the investment tax credit for the first taxable year in which the
property becomes eligible property. Section 210.12(e) of the Tax Law provides that the
investment tax credit allowed for any taxable year shall not reduce the tax due below the fixed
minimum tax and that when a taxpayer has an excess amount it may be carried over to the
following year or years and may be deducted from the taxpayer's tax for such succeeding year or
years. In lieu of such carryover, a taxpayer which qualifies as a new business may elect to treat
the amount of such carryover as an overpayment of tax to be refunded.
Pursuant to section 210.12(j) of the Tax Law, a "new business" includes any corporation,
except a corporation which:
(1)

over 50 percent of the number of shares of stock entitling the holders thereof to
vote for the election of directors or trustees is owned by a taxpayer subject to tax
under Article 9-A; section 183, 184, 185 or 186 of Article 9; Article 32 or Article
33 of the Tax Law; or

(2)

is substantially similar in operation and in ownership to a business entity (or
entities) taxable, or previously taxable, under Article 9-A; section 183, 184, 185
or 186 of Article 9; Article 32 or Article 33 of the Tax Law; Article 23 of the Tax
Law or which would have been subject to tax under such Article 23 (as such
article was in effect on January 1, 1980) or the income (or losses) of which is (or
was) includable under Article 22 of the Tax Law whereby the intent and purpose
of paragraph (j) and (e) of subdivision 12 of section 210 of the Tax Law with
respect to refunding of credit to new business would be evaded; or

(3)

has been subject to tax under Article 9-A for more than four taxable years
(excluding short taxable years) prior to the taxable year during which the taxpayer
first becomes eligible for the investment tax credit.

Accordingly, Petitioner may elect to treat any allowable investment tax credit carryover,
as an overpayment to be refunded for the taxable years that Petitioner qualifies as a new business
pursuant to section 210.12(j) of the Tax Law. The employment incentive tax credit is not
refundable.

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ISSUE (2)
Section 210.18 of the Tax Law allows a research and development credit against the tax
imposed under Article 9-A of the Tax Law equal to ten percent of the cost or other basis of
equipment which:
(1)

is acquired, constructed, reconstructed or erected by the taxpayer after June 30,
1982;

(2)

is depreciable pursuant to section 167 of the Internal Revenue Code or recovery
property with respect to which a deduction is allowable under section 168 of the
Internal Revenue Code;

(3)

has a useful life of four years or more;

(4)

is acquired by purchase as defined in section 179(d) of the Internal Revenue Code;

(5)

has a situs in New York State; and

(6)

is used or are to be used for purposes of research and development in the
experimental or laboratory sense. Such purposes do not include the ordinary
testing or inspection of materials or products for quality control, efficiency
surveys, advertising promotions, or research in connection with literary, historical
or similar projects.

Generally, the credit is allowed for all property used directly to perform research to
develop experimental or pilot models, plant processes, formulas, inventions and similar
properties and improvements of already existing properties of the type mentioned.
Inasmuch as it has already been determined that the property here at issue, qualifies as
equipment used for purposes of research and development in the experimental or laboratory
sense for purposes of section 210.3(e)(2) and (3) of the Tax Law, it is also concluded that such
property also qualifies as property used for purposes of research and development in the
experimental or laboratory sense within the meaning of section 210.18 of the Tax Law.
It should be noted that the research and development credit under section 210.18 of the
Tax Law is not allowed for any property for which the research and development deduction
under section 210.3(e)(3) of the Tax Law has been taken; the eligible business facility credit
under section 210.11 of the Tax Law has been taken; the eligible business facility credit under
section 210.11 of the Tax Law has been taken or the investment tax credit under section 210.12
of the Tax Law has been taken. Thus, if Petitioner's property qualifies for both the investment tax
credit under section 210.12 of the Tax Law and the research and development credit under
section 210.18 of the Tax Law, Petitioner must elect to claim one credit or the other. It may not
claim both. Additionally, the credit is not allowed if the property is leased to any other person or
corporation.

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Such credit must be claimed for the taxable year in which the taxpayer first qualifies for
the credit.
If a taxpayer fails to claim the research and development credit, the investment tax credit,
or the employment incentive tax credit for the taxable year in which it first qualifies for the
credit, it may not claim the credit in a subsequent year. However, in such a case, the taxpayer
may file amended returns for the taxable years in which the credits should have been claimed (as
long as the period for filing such amended returns has not expired) and thereby claim the credit.
Section 1087(a) of the Tax Law provides that a claim for credit or refund of an
overpayment of tax must be filed by a taxpayer within three years from the date the return was
filed or two years from the date the tax was paid, whichever of such periods expires later. If a
taxpayer files such an amended return, it may claim a refund to taxes previously paid (subject to
the limitations set forth in sections 210.12(e), 210.12-A(c) and 210.18(e)) or it may carry over
the credits to the following year or years and apply the credits against taxes for such year or
years.

DATED: June 24, 1987

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.