Should a young company calculate Virginia's R&D credit fixed-base percentage using every prior year it was in business or only years it operated in Virginia?

Plain-English summary

Virginia held that the company's fixed-base percentage had to use both prior years it was in business, even though it had operated in Virginia for only one of those years. The company began business in 2010, entered Virginia in 2011, and applied for the 2012 Research and Development Expenses Tax Credit.

The company used its Virginia qualified research-and-development expenses and total gross receipts for 2010 and 2011. The Department initially recomputed the credit using only 2011 because that was the sole prior year the company operated in Virginia.

The Commissioner rejected that limitation. For a taxpayer in business fewer than three taxable years but at least one, the formula averages the Virginia qualified research expenses and total gross receipts for the number of years the taxpayer has been in business. Nothing restricted the calculation to years when the taxpayer also conducted business in Virginia.

Virginia therefore accepted the two-year fixed-base percentage and adjusted the 2012 credit accordingly.

What this means for you

• The relevant historical formula counted years in business, not merely years with Virginia operations.
• Each included year still used Virginia qualified research-and-development expenses in the numerator.
• Total gross receipts for the same business years formed the denominator.
• A company with fewer than three prior business years used the years actually available.

Common questions

Q: Which years did this company use?
A: Taxable Years 2010 and 2011 for its 2012 credit.

Q: Why did 2010 count if the company was not yet operating in Virginia?
A: The formula looked to years in business and did not require Virginia operations in each included year.

Q: Did Virginia accept the company's calculation?
A: Yes. The Department adjusted the credit using the corrected two-year percentage.

Q: What if a company has at least three prior years?
A: The ruling states that the formula uses the three taxable years preceding the credit year.

Citations and references

• Va. Code § 58.1-439.12:08.
• IRC § 41(c).
• Virginia Research and Development Expenses Tax Credit Guidelines.

Subject

Research and Development Expenses Tax Credit Fixed Base Percentage

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-124

Original ruling text

July 2, 2013

Re: Research and Development Expenses Tax Credit Fixed Base Percentage

Dear *:

This is in response to your letter to the Virginia Department of Taxation ("the Department") in which you request clarification regarding the calculation of a company's fixed base percentage for purposes of the Virginia Research and Development Expenses Tax Credit. When you filed * ("the Company's") application for the Research and Development Expenses Tax Credit, you computed the Company's fixed base percentage using Virginia qualified research and development expenses and total gross receipts for the two taxable years that the Company was in business. You request confirmation that this calculation is correct, rather than using only the Company's Virginia qualified research and development expenses and total gross receipts for the one taxable year the Company was in business in Virginia.

FACTS

The Company has been in business since 2010 and has been in business in Virginia since 2011. The Company submitted Form RDC, Application for Research and Development Expenses Tax Credit, for Taxable Year 2012. When computing the credit amount, the company calculated its fixed base percentage using its Virginia qualified research and development expenses and total gross receipts for Taxable Years 2010 and 2011, the two prior taxable years when the Company was in business.

The Department adjusted the amount of the Company's Research and Development Expenses Tax Credit for Taxable Year 2012 based on the fact that the Company was only in business in Virginia during Taxable Year 2011. The recomputed fixed base percentage used the Company's Virginia qualified research and development expenses and total gross receipts for Taxable Year 2011 only, since this was the only taxable year when the taxpayer was in business in Virginia.

DETERMINATION

Under Va. Code § 58-1-439.12:08, a taxpayer may claim the Virginia Research and Development Tax Credit in an amount equal to 15 percent or 20 percent of its Virginia qualified research and development expenses, to the extent that such expenses exceed its Virginia base amount. "Virginia base amount" is defined as the base amount as defined in IRC § 41(c) that is attributable to Virginia by (i) substituting "Virginia qualified research and development expense" for "qualified research expense," (ii) substituting "Virginia qualified research" for "qualified research," and (iii) substituting Virginia's formula for computing fixed base percentage for the federal formula.

As set forth in Va. Code § 58.1-439.12:08 A and in the Research and Development Expenses Tax Credit Guidelines, a taxpayer's fixed base percentage is determined:

1. By dividing the average amount of the taxpayer's Virginia qualified research and development expenses for the three taxable years preceding the year in which the tax credit is being claimed by the average amount of the taxpayer's total gross receipts for the three taxable years preceding the year in which the tax credit is being claimed; or

2. If the taxpayer has been in business for less than three taxable years, but for at least one taxable year, by dividing the average amount of the taxpayer's Virginia qualified research and development expenses for the number of years that the taxpayer has been in business by the average amount of the taxpayer's total gross receipts for the number of years that the taxpayer has been in business.

There is no requirement that these formulas be applied using only the taxpayer's Virginia qualified research and development expenses and total gross receipts for taxable years in which the taxpayer was in business in Virginia. In fact, these formulas must be applied using Virginia qualified research and development expenses and total gross receipts for taxable years in which the taxpayer was in business, regardless of whether the taxpayer was in business in Virginia. Accordingly, the Company correctly applied Virginia's formula for calculating fixed base percentage for Taxable Years 2010 and 2011 on its Taxable Year 2012 Form RDC.

CONCLUSION

For the foregoing reasons, the amount of the Company's Research and Development Expenses Tax Credit for Taxable Year 2012 will be adjusted using the corrected fixed base percentage. The Code of Virginia sections cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's website. If you have additional questions, please contact * in the Office of Tax Policy, Policy Development Division, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner