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Jamie C. Yesnowitz
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On July 31, 2019, the Minnesota Supreme Court upheld two 2018 Minnesota Tax Court decisions concerning the computation of the state research and development (R&D) credit.1
In affirming the partial granting of 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 affirmed the partial granting of the Revenue Commissioner’s motions for summary judgment and agreed that Minnesota law incorporated the 50% federal minimum base amount limitation provision as part of the state’s definition of “base amount.”
Since the Minnesota R&D credit is based on the corresponding federal credit, the Minnesota Supreme 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% of its qualified research expenses for the credit year.6
For the 2011 tax year, Minnesota law provided that the amount of the state R&D credit was:
- 10% of the first $2 million of the difference between the qualified research expenses for the tax year over the base amount
- 2.5% on all additional expenses over $2 million7
In determining that the Minnesota “base amount” had to be computed using federal gross receipts in the denominator of the fixed-base percentage, the Minnesota Supreme Court considered the extent to which the Minnesota legislature had changed the two terms that are multiplied to compute the federal base amount.8
Minnesota law provides separate definitions for “qualified research expenses,”9
and “base amount.”11
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 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-base 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, “[w]hen the Legislature uses limiting or modifying language in one part of a statute, but omits it in another, we regard that omission as intentional and will not add those same words of limitation or modification to parts of the statute where they were not used.” The Court agreed with the taxpayers, and affirmed the Minnesota Tax Court’s granting of their motions for summary judgment on this issue.
The Minnesota Tax Court’s decisions12
on this issue took into consideration 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
Specifically, the Tax Court observed that this 2017 change to the statute supported its 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. In its decisions, the Minnesota Supreme Court noted that the 2017 statutory change was not retroactive, and thus was not relevant to its analysis.14
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 that “base amount” meant the term as defined
in IRC Sec. 41(c).15
In upholding the Commissioner’s argument, the Minnesota Supreme Court rejected the taxpayers’ position that the Minnesota legislature only incorporated paragraph (1) of IRC Sec. 41(c) as the definition of “base amount,” thereby excluding the 50% limitation found under paragraph (2) of IRC Sec. 41(c).
In its analysis, the Minnesota Supreme Court noted that the arguments and plain-language interpretations made by both the Commissioner and the taxpayers “have a reasonable basis in the statutory text.” As a result, the Court concluded that Minn. Stat. Sec. 290.068, subd. 2(c) was ambiguous. Thus, the Court looked to the legislative history and canons of construction to decide which interpretation should prevail. In concluding that the Commissioner’s argument should prevail, the Court noted that both in 1982 when the Minnesota legislature first incorporated the IRC’s definition of “base amount,” and again in 1991 when the current version of IRC Sec. 41 was incorporated into Minn. Stat. Sec. 290.068, the federal provisions included the 50% minimum base amount limitation. Therefore, the Court rejected the taxpayers’ assertion that one paragraph under IRC Sec. 41(c) should not be incorporated into Minnesota law while retaining the other paragraphs.
The Minnesota Supreme Court’s decisions provide additional clarity regarding the Minnesota R&D credit. Because these decisions may be favorable to the extent the Minnesota base amount is reduced (which acts to increase the overall amount of the credit), taxpayers should review their Minnesota R&D credit calculations and potentially file refund claims for tax years prior to 2017, while considering additional issues which the Department might assert. Taxpayers should note that the Minnesota R&D credit was refundable for the 2010–2012 tax years. For tax years prior to 2010 and after 2012, the R&D credit is nonrefundable, but any excess credits may be carried forward. Furthermore, for tax years after 2012, the R&D credit may be shared among Minnesota combined reporting group members.
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. 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.16
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% minimum base period expense provision. As explained by the Court, this limitation is part of the federal definition of “base amount” adopted by Minnesota. Further, the Court noted that in instances where positions asserted by both the Commissioner and the taxpayer have a reasonable basis in the text of the statute, such language is ambiguous, which opens the door for the Court to consider legislative history, legislative intent, and other canons of statutory construction outside of a plain-language reading of the statutory language.
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