Life Science Leader Magazine

MAR 2015

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LIFESCIENCELEADER.COM 41 MARCH 2015 models and the personnel utilizing the data to make R&D; decisions have poten- tial to qualify for the research credit. With recent data breaches and cyberterrorism cases, data security is now one of the major concerns for life sciences companies and governmental agencies such as the FDA, Federal Communications Commission, and Federal Trade Commission. In the FDA's recent draft guidance on software, emphasis was placed on ensuring con- fidentiality, integrity, and availability of information in medical software. The investments that companies make to further safeguard drug, device, and patient data is an area of opportunity for the research credit. Consolidation among hospitals and insurers has made it necessary for a company to drive more than just mar- ginal product innovation in order to justify product adoption. A strategy companies can implement to achieve higher product functionality and obtain reimbursement is to specialize in prod- ucts incorporating service components, thereby offering higher quality of care at a lower overall cost for the health system. Development of these new integrated products and solutions can be technologically challenging and often requires expertise in areas such as mate- rial sciences, biochemistry, software, product strategy, design, manufactur- ing, materials selection, product testing, mold flow, failure effect and analysis, and predictive engineering. Work done by each of these cross-functional teams could qualify for the research credit based on its contributions to the final design. In different situations, a company may collaborate on research with outside institutions such as other cor- porations, college research labs, think tanks, and outsource organizations. The dollars provided to the company's collaborators may also qualify, subject to a review of the intellectual property rights and financial risk rules within the negotiated contract. CALCULATING THE R&D; TAX CREDIT There are two methods for calculating the R&D; Tax Credit; both reward taxpayers for increasing the amount spent on research over a base amount from earlier years. The traditional method (also referred to as the "regular" method) uses a base period from the mid-1980s if the company existed during these years. Under the tra- ditional method, the R&D; tax credit is equal to 20 percent of qualifying expen- ditures in excess of the base amount. The alternative method, called the Alternative Simplified Credit (ASC), became avail- able in 2007. The ASC method uses the average qualifying expenditures from the three years prior to the credit year as a base period. Under the ASC method, the R&D; tax credit is equal to 14 percent of qualifying expenditures in excess of the base amount. The traditional R&D; Tax Credit benefit can be higher than under the ASC, but the recordkeeping and income restrictions can be onerous and may make the ASC method typically more attractive for clients. To substantiate the credit, a taxpayer should gather documentation that cre- ates a nexus between the costs incurred and the activities performed. Examples of supporting documentation vary from company to company, but can include lab notebooks, specification documents, computer-aided designs, status updates, presentations, white papers, test results, patent applications, and emails. Establishing the connection between specific expenditures and research performed by the taxpayer fulfills the supporting documentation requirement. In addition, there usually is a mini- mally invasive interview process of key scientists and engineers for collection of additional support. The interview process of key personnel allows the taxpayer's accounting department or outside consultants to effectively marry up the tax law with the qualifying scientific undertakings. A QUALIFYING R&D; EXAMPLE An actual example we had in our life sciences practice included a small phar- maceutical company that undertook a project to synthesize a chemical com- pound and improve the related chemical synthetic processes. The compound was intended to be used to treat breast cancer that is advanced or has metastasized. The optimal synthesis pathway that would optimize yield and purity and the ability of the company to success- fully implement the synthesis were unknown. Additional challenges that were unknown at the beginning of the development, but which presented themselves during the process, included loss of material on drying, optimization of crystallization temperature to increase yield, and yield loss when incorporating a wash after solids isola- tion. All of the activities involved in this project were technological in nature and relied on synthetic organic chemistry and analytical chemistry. The develop- ment involved substantial laboratory work. After extensive analysis of the expenditures and interviews with the key scientists involved in the project, it was determined it qualified for the pur- poses of the R&D; Tax Credit. The client was able to obtain $176,000 in federal credits and an additional $128,000 in state research tax credits. R&D; CREDIT OUTLOOK Although the credit has been extended 15 times since its inception in 1981, as of November 2014 it has not been renewed for tax years beginning after Dec. 31, 2013. The U.S. House of Representatives has recently approved legislation (H.R. 4438) that would perma- nently extend and simplify the R&D; Tax Credit, as well as raise the percentage used in ASC methodology from 14 per- cent to 20 percent. The U.S. Senate has also passed legislation (S. 2260) that extends the current R&D; credit through 2015 and allows some start-ups to claim the credit against payroll taxes and allows some privately held companies' owners to claim the credit against their alternative minimum tax (AMT). Neither piece of legislation has yet been enacted. Taxpayers should do the minimum groundwork necessary now to make an assessment as to whether or not they can qualify for the research credit, so if it is extended or made permanent they will be well-positioned to take advantage of this powerful opportunity. L

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