For Rhode Island's research credit, did 'base period research expense' mean the federal base amount, and could a short first period prorate that base?

Plain-English summary

Rhode Island treated the statute's “base period research expense” as the federal “base amount” under IRC § 41(c), but did not allow that base amount to be prorated for a first credit period shorter than twelve months. The five-percent credit depended on the qualified Rhode Island excess research expense actually incurred after July 1, 1994.

The taxpayer developed and sold computer software. Its product-development department worked only on new products and enhancements, and its qualifying federal research costs included salaries, supplies, and rented or leased computers. The taxpayer used a 52- or 53-week fiscal year ending on the Saturday closest to December 31.

R.I. Gen. Laws § 44-32-3 allowed a credit equal to five percent of qualified research expense above base-period research expense. It adopted the federal definitions in IRC § 41 but limited qualifying expenses to those incurred in Rhode Island after July 1, 1994.

The federal statute no longer used “base period research expense” because the Omnibus Budget Reconciliation Act of 1989 had replaced that term with “base amount.” The Division concluded that Rhode Island's cross-reference incorporated the updated federal term.

For the short initial Rhode Island period, the Division rejected base-amount proration. Instead, it looked at how much federal excess expense was actually incurred in Rhode Island after July 1, 1994. Its examples produced different credits depending on when during the year the excess expense occurred, including no credit where all excess expense preceded July 1.

What this means for you

Research-intensive businesses

Track qualifying research expense by location and date. A full-year federal amount did not automatically become eligible for Rhode Island's credit when only part of the year fell after the statutory start date.

Software companies

The taxpayer's qualifying cost categories included development salaries, supplies, and rented or leased computers, but the ruling's main issue was how to calculate the Rhode Island credit rather than whether each cost qualified.

Accountants and tax professionals

Use the federal base-amount concept for the historical statute, then isolate Rhode Island excess expenses incurred after the applicable start date. Do not substitute a simple time-based proration when the statute requires actual expense timing.

Common questions

What did “base period research expense” mean? The same thing as the federal “base amount” under IRC § 41(c).

Could the taxpayer prorate the federal base amount for a period shorter than twelve months? No. The Division said § 44-32-3 neither provided nor required proration.

What amount received the five-percent credit? The qualified Rhode Island excess research expense actually incurred in the state after July 1, 1994.

Did the timing of the expense matter? Yes. The order's examples showed that expenses before July 1 produced no Rhode Island credit, while qualifying excess expenses after that date could produce the full credit.

Who could rely on the ruling? The requesting taxpayer, subject to the ruling's stated law, facts, revocation, and validity terms.

Citations and references

• R.I. Gen. Laws § 42-35-8 — authority for the declaratory-ruling request.
• R.I. Gen. Laws § 44-32-3 — five-percent credit and Rhode Island timing requirement.
• Internal Revenue Code § 41 — federal definitions adopted by the state statute.
• Internal Revenue Code § 41(c) — federal base amount.
• Omnibus Budget Reconciliation Act of 1989 — replaced the federal “base period research expense” term with “base amount.”

Source

• Landing page: Rhode Island Declaratory Rulings
• Declaratory order: Declaratory Order 1995-05

Original ruling text

Ruling Request No. 95-05

Declaratory Rulings

Ruling Request No. 95-05

Re: Request for Ruling Regarding Credit for Qualified Research Expenses

Request for Ruling

You request a declaratory ruling on behalf of your client, (taxpayer), pursuant to section 42-35-8 of the General Laws of Rhode Island relating to the application of the credit for qualified research expenses.

Fact

The taxpayer sells computer software which it develops. They have a product development department whose sole purpose is to work on new product development and enhancements to existing products. The taxpayer has a 52-53 week fiscal year which ends on the Saturday closest to December 31. During 1994 the taxpayer incurred the following costs which qualify for the Federal Section 41 credit:

Salaries

Supplies

Rental/Lease Computers

The taxpayer's qualified research expenses incurred solely in Rhode Island from July 1, 1994 through December 31, 1994 were and the taxpayer's base amount, as determined for Federal income tax purposes was. The Federal form 6765 (Credit for Increasing Research Activities) Line 25 indicated that the taxpayer had Federal excess expenses of.

Rulings Requested

(a) Taxpayer requests a ruling that the term "base period research expense" be interpreted to have the same meaning as the term "base amount" found in IRC 41(c).

(b) Taxpayer requests a ruling that if its qualified Rhode Island research expenses are for a period of less than twelve (12) months, the base amount should be prorated over the same period as the period in which it generates qualified research expenses for its first fiscal year ending after July 1, 1994.

Discussion

Rhode Island General Law 44-32-3, reads in pertinent part as follows:

44-32-3. Credit for qualified research expenses. -- (a) A taxpayer shall be allowed a credit against the tax imposed by chapter 11 or 30 of title 44. The amount of the credit shall be five percent (5%) of the excess (if any) of:

(1) The qualified research expenses for the taxable year, over

(2) The base period research expenses.

(b) The terms "qualified research expenses" and "base period research expenses" shall have the same meaning as defined in section 41 of the Internal Revenue Code [26 U.S.C. 41], provided, however, that such expenses shall have been incurred in this state after July 1, 1994.

As to the issue of interpretation of the term "base period research expense," section 44-32-3, above, states that the term "qualified research expenses" and "base research expenses" shall have the same meaning as defined in section 41 of the Internal Revenue Code [26 U.S.C. 41].

Current IRC Section 41 does not contain a definition of the term "base period research expense." That term was replace with the term "base amount" by the Omnibus Budget Reconciliation Act of 1989.

The credit provided by 44-32-3 was drafted to utilize the definitions in the Federal Credit under Code Section 41. As such the change in Code Section 41 made in the Omnibus Budget Reconciliation Act to refer to the "base amount" is deemed to have replaced the term "base period research expenses" for purpose of the credit for qualified research expenses under 44-32-3.

As to the second issue relating to the proration of qualified Rhode Island research expenses, 44-32-3 does not provide for proration nor is it required under the statute. The determinative factor in arriving at the appropriate credit is how much of the excess expenses were incurred in this state after July 1, 1994. That sum would be the amount to which the five percent (5%) would be applied in order to arrive at the Rhode Island expense credit.

For example, assume that (a) the taxpayer has qualified research expenses (incurred in Rhode Island) for Federal Code Section 41 credit in its current fiscal year of $100,000 and the Federal 41 base amount is $75,000, and (b) the expenses were incurred evenly throughout the year, the credit would be computed as follows:

| | |
Federal Excess Expense | $25,000 | $25,000 | $25,000
Amount incurred in RI after 7/1/94 | $25,000 | 6,250 | 12,500
| [1 year] | [3 mos.] | [6 mos.]
RI R & D Credit @ 5% | $1,250 | $313 | $625

If however, the taxpayer has qualified research expenses for Federal Code Section 41 credit in its current calendar year of $100,000 and the Federal Code Section 41 base amount is $75,000 and the excess expenses were incurred in case #1 below, all in March and April and, in case #2 below, all in November in the credit would be computed as follows:

| Case #1 | Case #2
---|---|---
Year Ending | 12/31/94 | 12/31/94
Qualified Research Expenses | $100,000 | $100,000
Base Amount | 75,000 | 75,000

| |
Federal Excess Expense | $25,000 | $25,000
Amount of Federal Excess Expenses Incurred in RI | 25,000 | 25,000
Amount of RI Expenses Incurred after 7/1/94 | 0 | 25,000

| |
Credit @ 5% | $ 0 | $ 1,250

Ruling

(a) For purposes of the credit provided by 44-32-3, the term "base period research expense" has the same meaning as the term "base amount" pursuant to IRC Code Section 41(c).

(b) If a taxpayer's qualified Rhode Island research expenses are for a period of less than twelve (12) months the applicable credit is arrived at by determining how much of the qualified Rhode Island research expenses were incurred in this state after July 1, 1994.

This ruling may be relied upon by the taxpayer and shall be valid until expressly revoked or until the applicable statutory provisions are amended in a manner requiring a different result or until the underlying factual presentation changes.

**R. Gary Clark

Tax Administrator

September 19, 1995**