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Jamie C. Yesnowitz
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The Minnesota Tax Court recently considered the computation of the state research and development (R&D) credit in two very similar decisions.1
In partially granting the taxpayers’ motions for summary judgment, the Court determined that the Minnesota “base amount” must be computed using federal gross receipts in the denominator of the fixed-base percentage. The Court also partially granted the Revenue Commissioner’s motions for summary judgment and agreed that Minnesota law incorporated the federal minimum base amount provision as part of the state’s definition of “base amount,” and did not incorporate the federal election allowing use of an alternative simplified credit.
Because the Minnesota R&D credit is based on the corresponding federal credit, the Tax Court considered the statutory language of both the federal and state R&D credits in effect for the 2011 tax year at issue in these cases.2
The formula for determining the federal R&D credit is relatively complicated. Federal law provides in part that the R&D credit equals 20% of the difference between the qualified research expenses for the tax year over the base amount.3
Under Internal Revenue Code (IRC) Sec. 41(c)(1), the base amount is the product of: (i) the fixed-base percentage; and (ii) the taxpayer’s average annual gross receipts for the four tax years preceding the tax year for which the credit is being determined.4
IRC Sec. 41(c)(3) provides that the fixed-base percentage is the percentage which the taxpayer’s aggregate qualified research expenses for the 1984-1988 tax years is of the taxpayer’s aggregate gross receipts for these tax years.5
Under IRC Sec. 41(c)(2), a taxpayer’s federal base amount cannot be less than 50 percent of its qualified research expenses for the credit year.6
Former IRC Sec. 41(c)(5) provided taxpayers with an election to use an alternative simplified credit.7
For the 2011 tax year, Minnesota law provided in relevant part that the amount of the state R&D credit was: (1) 10% of the first $2 million of the difference between the qualified research expenses for the tax year over the base amount; and (2) 2.5% on all additional expenses over $2 million.8
In determining that the Minnesota “base amount” had to be computed using federal gross receipts in the denominator of the fixed-base percentage, the Court considered the extent to which the Minnesota legislature had changed the two terms that are multiplied to compute the federal base amount.9
Minnesota law provides separate definitions for “qualified research expenses,”10
and “base amount.”12
In the first two definitions, Minnesota law altered the numerator
of the fixed-base percentage by limiting the qualified research expenses to be aggregated to the expenses incurred in Minnesota. The third definition provided the average annual gross receipts to be multiplied by the fixed-base percentage were limited to Minnesota sales or receipts. The Court was required to decide whether the Minnesota legislature also modified the denominator
of the fixed-based percentage by limiting “aggregate gross receipts” to Minnesota receipts. The Court noted that the Minnesota R&D credit statute did not use the “aggregate gross receipts” terminology or redefine the term. As explained by the Court, “[b]ecause the term ‘aggregate gross receipts’ was incorporated into state law, but was not modified by state law, it had the same meaning for state-law purposes as it had for federal purposes.”
The Court also considered that the statutory definition of “base amount” was amended in 2017 to provide that the average annual gross receipts and aggregate gross receipts
must be calculated using Minnesota sales or receipts.13
This supported the Court’s conclusion because the separate use of “average annual gross receipts” and “aggregate gross receipts” confirms that the previous version of the statute limited the term “average annual gross receipts” rather than the term “gross receipts” as argued by the Commissioner. Furthermore, by expressly limiting “aggregate gross receipts,” the amendment clarifies that the previous version of the law did not limit this term. The Court agreed with the taxpayers and granted their motions for summary judgment on this issue.
Minimum base amount
The Commissioner successfully argued that the definition of “base amount” that Minnesota incorporated from federal law included the 50% minimum base amount limitation. Minnesota law provided “base amount” meant the term as defined
in IRC Sec. 41(c).14
According to the Court, the determinative question was which provisions of IRC Sec. 41(c) defined “base amount” and were thus incorporated into Minnesota law. After considering the meaning of “define,” the Court concluded that IRC Sec. 41(c)(1) through (c)(3) were all part of the definition of “base amount” and adopted by Minnesota. In particular, IRC Sec. 41(c)(2) performed a definitional function by limiting the general meaning of base amount to 50 percent or more of qualified research expenses. The Court determined that Minnesota law incorporated the federal minimum base amount contained in IRC Sec. 41(c)(2) and granted the Commissioner’s motions for summary judgment on this issue.
Alternative simplified credit
The Court also agreed with the Commissioner that Minnesota did not adopt the federal provision in IRC Sec. 41(c)(5) that allowed taxpayers to make an election to use an alternative simplified credit. As discussed above, the Court concluded that IRC Sec. 41(c)(1) through (c)(3) defined “base amount” for federal purposes and were incorporated into Minnesota law. However, none of the other subsections of IRC Sec. 41(c) defined the meaning of “base amount.” Because IRC Sec. 41(c)(5) did not define “base amount,” it was not adopted by Minnesota.
The Tax Court’s decisions provide a level of clarity regarding the Minnesota R&D credit. Because these decisions may be favorable to the extent that the Minnesota base amount is reduced (which acts to increase the overall amount of the credit), taxpayers are advised to review their Minnesota R&D credit calculations and potentially file protective refund claims, while considering additional issues which the Department might assert. Taxpayers should note that the Minnesota R&D credit was refundable for the 2009-2012 tax years. For tax years prior to 2009 and after 2012, the R&D credit is nonrefundable and any excess credits may be carried forward.
The taxpayers successfully argued that the Minnesota “base amount” had to be computed using federal gross receipts in the denominator of the fixed-base percentage for the 2011 tax year, but the Minnesota law was changed in 2017 (a fact that aided the taxpayers’ argument on how to calculate the Minnesota “base amount” in the tax year at issue). As discussed above, “base amount” was amended to mean the base amount as defined in IRC Sec. 41(c), except that the average annual gross receipts and aggregate gross receipts
must be calculated using Minnesota sales or receipts.15
Therefore, the denominator as well as the numerator of the fixed-base percentage is now limited to Minnesota gross receipts, in line with what the Commissioner had argued in these cases.
The Court agreed with the Commissioner that Minnesota law incorporates the federal 50 percent minimum base period expense provision. As explained by the Court, this limitation is part of the federal definition of “base amount” that is adopted by Minnesota. There is a possibility that the taxpayers or the Commissioner may appeal portions of the decisions.
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