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Internal Revenue Code ("IRC") section 41 provides for
a federal research and development credit for certain qualified
research expenses, basic research payments, and other enumerated
expenses.1 California allows a similar, but not
identical, research and development credit ("R&D
Credit") for the amounts paid or incurred for research and
development in California. Generally, the California credit is
allowed in accordance with IRC section 41, as modified by
2 sections 17052.12 (personal income tax) and 23609
(corporation tax).
Less than a year ago, the FTB issued Legal Division Guidance
2011-06-01, which addressed two questions regarding the California
R&D Credit. First, it explained California does not conform to
the definition of "gross receipts" set forth in IRC
section 41(c)(7) because California excludes from
the definition receipts that are not "sales of
property...."3 Accordingly, the FTB stated that
such items as throwback sales, as well as receipts from services,
rents, operating leases and interest are excluded from the
California definition of "gross receipts." 4
Second, that guidance stated that pure service companies cannot
claim the California R&D Credit.5 The FTB took the
position that a pure service company with only service receipts has
no "gross receipts" as defined under section 23609.
Consequently, such a company cannot establish that it correctly
calculated its California base amount and fixed-base percentage
– the figures used to compute the R&D
Credit6.
A month later, and after receiving comments from the taxpayer
community, the FTB issued Legal Division Guidance 2011-07-01, which
withdrew Legal Division Guidance 2011-06-01. The reason stated for
the withdrawal was to allow the FTB "to explore alternative
methods to issue authoritative guidance,"7
suggesting that perhaps an FTB Legal Notice or Legal Ruling would
be forthcoming.
On March 16, 2012, and after further consultation with the IRS
on the nature of the federal credit, the FTB instead issued another
Legal Division Guidance. Legal Division Guidance 2012-03-01
("Guidance") now supersedes Legal Division Guidance
2011-06-01. The Guidance reaffirmed the FTB's prior position on
California's definition of "gross receipts" for
purposes of the R&D Credit.8 Looking to the language
of sections 17052.12(g)(3) and 23609(h)(3), the FTB states in the
Guidance that California's definition of "gross
receipts" excludes all receipts other than those that are
"'from the sale of property held primarily for sale to
customers in the ordinary course of the taxpayer's trade or
business that is delivered or shipped to a purchaser within this
state ....'"9
The Guidance also revisits the FTB's prior, but withdrawn,
position in Legal Division Guidance 2011-06-01 on the application
of the R&D Credit to pure service companies. Changing course,
the Guidance explains that taxpayers with no "gross
receipts" for purposes of the R&D Credit (e.g., pure
service companies or companies with only service receipts) may
nevertheless claim the credit, although a reduced credit rate
applies.10 Specifically, for taxable years 2000 and
later, taxpayers with no "gross receipts" for purposes of
the R&D Credit can take: (1) a credit equal to 7.5 percent of
the qualified research expense (as defined) for the credit year; or
(2) the reduced credit under IRC section 280C(c)(3).11
The Guidance states that the FTB may publish additional guidelines
on the mechanics of taking the R&D Credit.
While nevertheless helpful, one must keep in mind that Legal
Division Guidance 2012-03-01 merely "represents informal
advice" provided by the FTB "to external specialty
publishers and non-legal staff in a form not generally reduced to
formal written guidance," and that items published under Legal
Division Guidance are not considered "written advice"
that may be relied upon within the meaning of section 21012 and FTB
Notice 2009-09.12
Footnotes
1 See IRC § 41(a).
2 All statutory references herein are to the California
Revenue and Taxation Code, unless otherwise indicated.
3 See FTB Legal Division Guidance
2011-06-01.
4 See id.
5 See id.
6 See id. Gross receipts are used to compute both
the base amount and the fixed-base percentage. (See IRC
§ 41(c)(1) and (3).)
7 See FTB Legal Division Guidance
2011-07-01.
8 See FTB Legal Division Guidance
2012-03-01.
9 Id.
10 See id.
11 IRC section 280C(c)(3) gives a taxpayer an election to
take a reduced credit in exchange for the allowance of certain
deductions. (See IRC § 280C(c).)
Because of the generality of this update, the information
provided herein may not be applicable in all situations and should
not be acted upon without specific legal advice based on particular
situations.
The Internal Revenue Service has recently published an IRS Large Business & International Directive, which updates an earlier directive to field agents addressing the examination of capitalization and repair costs issues.
A state cannot include income in the apportionable base and then exclude the receipts and related factors that generated that very same income from the apportionment formula.
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