Many food processing companies lose significant amounts of cash each year by not claiming the Research and Development (R&D) tax credit. This credit, a government subsidy for innovation, can provide dramatic tax benefits for those companies whose advisors are “a foot wide and a mile deep” in this complex area of tax law.
R&D is not new to U.S. tax law. In fact, R&D has been available to taxpayers since the early 1980s and promoted heavily, as this tax credit has proven to translate into job growth. However, the types of activities that qualify have not been communicated consistently, creating confusion and skepticism among the taxpayer community. Finally, in 2001 and 2004, the Treasury Department provided much-needed guidance by issuing regulatory revisions and clarifications to the tax law. Not only did this guidance serve to enhance the understanding of qualifying activities, but it also broadened the definitions of what qualifies for R&D treatment.
Qualifying Activities
The food industry is rich in R&D, and qualifying R&D activities are pervasive. The inhibitor usually is centered on the fact that companies (particularly those in the middle-market, whose annual sales approximate $15 million to $500 million) simply are not aware of what the IRS considers to be R&D and when the R&D process begins and ends.The following activities are indicative that the qualification requirements of R&D have been met:
- New product and line extension development--product conceptualization,
- Recipe blending and formulation,
- Ingredient research,
- Ingredients consumed for sampling and new process initial runs,
- Sensory evaluation testing,
- Shelflife analysis/testing,
- Formulating ingredients to achieve pre-determined “sensory” requirements and specifications--flavor, smell, texture, nutritional requirements, etc.,
- Package design for functional (versus artistic) purposes (shelflife, ergonomics, bacterial prevention, etc.),
- Developing/improving manufacturing and packaging processes and
- Test kitchen/food scientists.
Seizing the Benefits
For companies to secure the full R&D credit, it requires more than knowledge of the tax law. A deep understanding of manufacturing processes and business practices in the food industry is required to develop an appropriate methodology for uncovering activities eligible for the credit. The opportunity to secure credits stems from the tax law, but is found less in tax law and more in understanding and identifying business, manufacturing and food science practices.The vast majority of general tax preparers has never performed an R&D study and, as a result, has no experience in identifying activities and employees connected with R&D. Such a study is a job for an R&D expert solely committed to this discipline and with the experience of many studies. There is a direct correlation between the amount of credit identified and the experience history of the team performing the study. Anyone can calculate and claim the credit. Not many professionals can establish the methodology with the necessary engineering, operational considerations and tax influences, resulting in the maximum defensible credit a company is entitled to claim. The refunds often are substantial but, if the experience of the advisor is not sound, it can be missed.
The amount of tax refunds that a company can secure will depend upon various factors, such as its level of R&D activities, whether there are profitability limitations and other factors. However, the annual potential tax refunds for food processors make it well worth the time to investigate. It is not at all unusual for a middle-market food processing business to secure refunds (sometimes totaling several hundred thousand dollars) pertaining to tax years still open by statute. In addition, assuming that R&D-related activities continue in future years, these credits should be viewed as a rare gift from the government that keeps on giving each year.
