Tax Court Ruling Boosts Prospects for R&D Credit

A recent ruling by the Tax Court could be highly favorable for taxpayers looking to claim the Research and Development Tax Credit.

The Tax Court issued the ruling on Nov. 12 in TG Missouri Corp. v. Commissioner, deciding that molds used for production, if not depreciable by the taxpayer, may be eligible for the credit. The IRS had previously disallowed the cost of such supplies for the R&D credit.

The case involved a company, TG Missouri, which made automotive parts on a contract-manufacturing basis. For each part that it manufactured, TG Missouri made a mold. Often, the company contracted with outside manufacturers to produce an initial mold. TG Missouri then altered these molds to suit its needs. In many instances, once the mold was finished, TG Missouri’s customers would take title to the mold while TG Missouri retained possession of the mold in order to produce the relevant part.

Under Section 41(b)(2)(C) of the Tax Code, the cost of property that is of a character subject to depreciation cannot be claimed as a qualified research expense. The IRS has long contended that depreciable property is not allocable to the R&D tax credit, regardless of who owns the depreciable property. The company in this case contended that Section 41(b)(2)(C) applies only if the property is depreciable in the hands of the taxpayer claiming the credit.

The court sided with taxpayers in ruling that TG Missouri could claim the cost of molds owned by its customers for the research credit because the property was not depreciable in TG Missouri’s hands. In doing so, the court effectively overruled previous IRS guidance on the interpretation of the phrase, “property of a character subject to depreciation.”

The TG Missouri case is big news for contract manufacturers, tool and die shops, and anyone else that uses property depreciable in the hands of another taxpayer in their R&D activities, according to alliantgroup, a tax advisory services firm. The ruling contradicts the IRS’s notion that supplies must be consumed or destroyed in order to qualify for the credit.

The molds at issue were sold to customers and used in TG Missouri’s production operations. Thus, the Tax Court’s ruling with respect to supplies should cause many taxpayers to reevaluate the costs that they have claimed for the R&D credit.

“I expect that taxpayers may be eligible for an even bigger credit thanks to this new ruling,” said alliantgroup national director Dean Zerbe in a statement. “This decision may have a wide-ranging impact on all industries in determining supply costs that are eligible for the R&D tax credit. Continuing a trend of taxpayer-friendly R&D cases that have been issued this year, TG Missouri represents another step forward for taxpayers seeking to claim the research credit under Section 41.”