Credit for Increasing Research Activities

Federal RegisterJan 4, 2000

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105606-99]

RIN 1545-AX05

Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the

computation of the credit for increasing research activities (the

research credit) for members of a controlled group and the allocation

of the credit under section 41(f) of the Internal Revenue Code. These

proposed regulations are intended to provide guidance on the proper

method for computing the research credit for members of a controlled

group and the proper method for allocating the group credit to members

of the group. These proposed regulations reflect changes to section 41

made by the Revenue Reconciliation Act of 1989 (the 1989 Act). This

document also provides notice of a public hearing on these regulations.

DATES: Written or electronic comments must be received no later than

April 5, 2000. Outlines of topics to be discussed at the public hearing

scheduled for April 26, 2000 at 10 a.m. must be received by April 5,

2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105606-99), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered Monday through

Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-

105606-99), Courier's Desk, Internal Revenue Service, 1111 Constitution

Avenue NW., Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet by selecting the ``Tax Regs''

option of the IRS Home Page, or by submitting comments directly to the

IRS Internet site at: http://www.irs.gov/prod/taxregs/regslist.html.

The public hearing will be held in room 2615, Internal Revenue

Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,

Lisa J. Shuman at (202) 622-3120 (not a toll-free number); concerning

submission of comments, the hearing, and/or to be placed on the

building access list to attend the hearing, La Nita Van Dyke at (202)

622-7190 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed

rulemaking has been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on the collection of information should be

sent to the Office of Management and Budget, Attn: Desk Officer for the

Department of the Treasury, Office of Information and Regulatory

Affairs, Washington, DC 20503, with copies to the Internal Revenue

Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC

20224. Comments on the collection of information should be received by

March 6, 2000. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the

proper performance of the functions of the IRS, including whether the

information will have practical utility;

The accuracy of the estimated burden associated with the proposed

collection of information (see below);

How the quality, utility, and clarity of the information to be

collected may be enhanced;

How the burden of complying with the proposed collection of

information may be minimized, including through the application of

automated collection techniques or other forms of information

technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is

contained in the preamble under the heading ``Proposed Effective

Date.'' The information is required by the IRS to ensure that members

of a controlled group filing claims for refund based on a change in

method of allocating the research credit to members of the group do not

together claim in excess of 100% of the credit with respect to prior

taxable years.

Estimated total annual reporting burden: 200 hours.

Estimated average annual burden hours per respondent: 20 hours.

Estimated number of respondents: 10.

Estimated frequency of responses: On occasion.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

The research credit provisions originally appeared in section 44F

of the Internal Revenue Code of 1954 (the 1954 Code), as added to the

1954 Code by section 221 of the Economic Recovery Tax Act of 1981.

Section 471(c) of the Tax Reform Act of 1984 redesignated section 44F

as section 30. Section 231

[[Page 259]]

of the Tax Reform Act of 1986 (the 1986 Act) redesignated section 30 as

section 41 and substantially modified the research credit provisions.

The 1989 Act substantially revised the computation of the research

credit.

On May 17, 1989, the IRS published in the Federal Register (54 FR

21203) final regulations under section 41. The 1989 final regulations

generally do not reflect the amendments to section 41 made by the 1986

Act, the 1989 Act, and other subsequent legislative revisions to the

research credit.

The amendments proposed by this document contain proposed rules

relating to the computation of the research credit for members of a

controlled group and the allocation of the credit under section 41(f).

These proposed regulations reflect changes to the research credit rules

made by the 1989 Act and Small Business Job Protection Act of 1996,

which introduced the alternative incremental research credit.

Pre-1990 Rules for Computing the Research Credit for Members of a

Controlled Group and Allocating the Credit among Members of the Group

Prior to the enactment of the 1989 Act, the research credit was

computed by multiplying the credit rate by the excess of the taxpayer's

current year qualified research expenses over the average of the

taxpayer's qualified research expenses for the preceding three years.

Before amendment by the 1989 Act, section 41(f)(1) provided rules

for computing the research credit for members of a controlled group

(generally a group of corporations or unincorporated businesses linked

by common ownership of more than 50 percent). Section 41(f)(1) treated

all members of a controlled group as a single taxpayer for purposes of

computing the credit and allocated the credit to the members of the

group based on the member's proportionate share of the increase in

qualified research expenses giving rise to the credit.

The legislative history to the 1981 Act indicates that the research

credit aggregation rules were enacted to ensure that the research

credit would be allowed only for actual increases in research

expenditures. The aggregation rules were intended to prevent artificial

increases in research expenditures by shifting expenditures among

commonly controlled or otherwise related persons. H. Rep. No. 97-201,

1981-3 C.B. (Vol. 2) 364 and Sen. Rep. 97-144, 1981-3 C.B. (Vol. 2)

442.

An example that appears in both Sec. 1.41-8(a)(4) of the 1989

regulations and the legislative history to the 1981 Act illustrates the

computation and allocation of the research credit under section

41(f)(1) before the 1989 Act amendments to the research credit

computation. In the example, the allowable group research credit is

allocated among the members experiencing an increase in qualified

research expenses over their base period research expenses. The member

allocation is based on the ratio that each member's increase in its

qualified research expenses over its base period research expenses

bears to the sum of the group's increases in qualified research

expenses.

Post-1989 Rules for Computing the Research Credit for Members of a

Controlled Group and Allocating the Regular Research Credit among

Members of the Group

In the 1989 Act, Congress revised the computation of the research

credit. Congress retained the incremental structure of the credit but

altered the computation to focus on whether and the extent to which a

taxpayer increases the proportion of its qualified research expenses

relative to its gross receipts.

Under section 41, as amended in 1989, the research credit is

computed by multiplying the credit rate by the excess of the taxpayer's

current year qualified research expenses over a ``base amount.'' The

base amount is defined in section 41(c) as the greater of: (1) Fifty

percent of the taxpayer's credit year qualified research expenses (the

minimum base amount); or, (2) the taxpayer's ``fixed-base percentage''

times the taxpayer's average annual gross receipts for the four taxable

years preceding the taxable year for which the credit is being

determined.

In general, a taxpayer's fixed-base percentage is defined in

section 41(c)(3)(A) as the ratio that the taxpayer's aggregate

qualified research expenses for its taxable years beginning after

December 31, 1983, and before January 1, 1989 bear to its aggregate

gross receipts for the same period. Section 41(c)(3)(B) provides rules

for computing the fixed-base percentage for start-up companies. Section

41(c)(3)(C) provides that the maximum fixed-base percentage is 16%.

Section 41(f)(1), as amended by the 1989 Act, continues to provide

rules for computing the research credit for members of a controlled

group. As under prior law, all members of a controlled group are

treated as a single taxpayer for purposes of computing the credit.

However, the allocation rule was amended to eliminate any reference to

an ``increase'' in qualified research expenses. Under the amended

allocation rule, the group credit is allocated among the members of the

group based on each member's ``proportionate share of the qualified

research expenses and basic research payments giving rise to the

credit.''

In explaining the 1989 Act revisions to the research credit, the

House Report simply states that the rules relating to the aggregation

of related persons and changes in ownership are the same as under

present law with the modification that when a business changes hands,

qualified research expenses and gross receipts for periods prior to the

change of ownership are treated as transferred with the trade or

business which gave rise to those expenditures and receipts for

purposes of recomputing a taxpayer's fixed-base percentage. H. Rep. No.

101-247 at 1202. The legislative history to the 1989 Act does not refer

to the elimination of the word ``increase'' from the allocation rule.

In the light of the statutory changes enacted in 1989, taxpayers

have questioned the proper method for computing the research credit for

members of a controlled group and the proper method for allocating the

group credit to members of the group under the new rules.

The proposed regulations provide that, for purposes of computing

the group credit, all of the computational rules of section 41 are

applied on an aggregate basis. This is consistent with the statutory

prescription that the controlled group be treated as a single taxpayer

and is necessary to preclude taxpayers from creating artificial

increases in the credit by shifting qualified research expenses and

gross receipts among commonly controlled or otherwise related persons.

In proposing rules for the allocation of the credit, Treasury and

the IRS considered, but were not persuaded by, certain taxpayers'

argument that the elimination of the word ``increase'' from the

allocation rule in the statute requires that the credit be allocated on

the basis of the gross amount of qualified research expenses incurred

by the various members of the controlled group. Treasury and the IRS

believe that elimination of the word ``increase'' was necessitated by

the 1989 statutory amendments to the computation of the research

credit, which afford a credit in certain circumstances even where the

taxpayer (or each member of a controlled group) is decreasing its gross

amount of qualified research expenses (e.g., because the taxpayer's

gross receipts also are decreasing). However,

[[Page 260]]

there is no indication that the elimination of the word ``increase''

was intended to suggest that the credit be allocated without regard to

its incremental nature. To the contrary, the statutory prescription

that the credit be allocated according to each member's proportionate

share of the qualified research expenses ``giving rise to'' the credit

supports a rule that allocates the credit to those members whose share

of current year qualified research expenses exceeds their share of the

base amount. Thus, the proposed regulation provides that the group

research credit is allocated to each member based on the ratio that the

member's increase in its qualified research expenses over its base

amount bears to the sum of each member's increase in qualified research

expenses over its base amount. The member's base amount is computed by

multiplying the group fixed-base percentage by the member's average

annual gross receipts for the four preceding tax years.

In order to prevent manipulation of the amount of credit allocated

to a consolidated group of corporations that is a member of a

controlled group with other taxpayers, Treasury and the IRS considered

a special rule for allocating the research credit that would treat all

members of a consolidated group as a single taxpayer for purposes of

allocating the research credit among members of the controlled group.

Treasury and the IRS request comments on special rules for allocating

the research credit among members of a controlled group that contains a

consolidated group of corporations.

Allocation of the Credit for Basic Research Payments and the

Alternative Incremental Research Credit

The proposed regulations also address the computation and

allocation of the group credit for basic research payments (certain

amounts paid to qualified organizations for basic research) and for the

alternative incremental research credit (an elective alternative method

of computing the research credit, under which taxpayers are assigned a

lower three-tiered fixed base percentage, and the credit rate is

reduced).

As in the case of the regular credit for qualified research

expenses, the proposed regulations provide that all computations with

respect to the group credit for basic research payments and the

alternative incremental research group credit are undertaken on an

aggregate basis. Similarly, these group credits are allocated to the

various group members on an incremental basis.

Proposed Effective Date

The regulations generally are proposed to be applicable for taxable

years ending on or after the date proposed regulations are filed with

the Federal Register, but are also proposed to be retroactive in

certain limited circumstances to prevent abuse. To prevent taxpayers

that are members of a controlled group from together claiming in excess

of 100% of the credit with respect to prior taxable years, the rules

for allocating the group credit would apply to any taxable year

beginning after December 31, 1989, in which, as a result of

inconsistent methods of allocation, the members of a controlled group

as a whole claimed more than 100% of the allowable group credit. In the

case of a group whose members have different taxable years and whose

members used inconsistent methods of allocation, the members of the

group as a whole shall be deemed to have claimed more than 100% of the

allowable group credit.

No claim for refund (1) Attributable to a change in method of

allocation; (2) Pertaining to a taxable year ending before the date the

proposed regulations are filed with the Federal Register; and (3) Filed

after the date these proposed regulations are filed with the Federal

identifying all members of the controlled group for the taxable year at

issue. The statement must contain a declaration signed by the taxpayer

under penalties of perjury that states: ``To the best of my knowledge

and belief, taking into account prior claims, this amended claim and

any related adjustments, no more than the total amount of the group

credit will be allocated to the members of the controlled group.''

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It also has

been determined that section 553(b) of the Administrative Procedure Act

(5 U.S.C. chapter 5) does not apply to these regulations. It is hereby

certified that the collection of information contained in these

regulations will not have a significant economic impact on a

substantial number of small entities. This certification is based on

the expectation that few, if any, small entities will file claims for

refund attributable to a change in method of allocating the research

credit among members of its controlled group. Accordingly, a Regulatory

Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.

chapter 6) is not required. Pursuant to section 7805(f) of the Internal

Revenue Code, this notice of proposed rulemaking will be submitted to

the Chief Counsel for Advocacy of the Small Business Administration for

comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (preferably a

signed original and eight (8) copies) or electronic comments are

submitted timely to the IRS. Treasury and the IRS request comments on

the clarity of the proposed regulations and how they may be made easier

to understand. All comments will be available for public inspection and

copying.

A public hearing has been scheduled for April 26, 2000 at 10 a.m.

in room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW.,

Washington, DC. Due to building security procedures, visitors must

enter at the 10th Street entrance, located between Constitution and

Pennsylvania Avenues, NW. In addition, all visitors must present photo

identification to enter the building. Because of access restrictions,

visitors will not be admitted beyond the immediate entrance area more

than 15 minutes before the hearing starts. For information about having

your name placed on the building access list to attend the hearing, see

the FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who

wish to present oral comments at the hearing must submit written or

electronic comments and an outline of the topics to be discussed and

the time to be devoted to each topic (preferably a signed original and

eight (8) copies by April 5, 2000). A period of 10 minutes will be

allotted to each person making comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these proposed regulations is Lisa J.

Shuman of the Office of the Assistant Chief Counsel (Passthroughs and

Special Industries). However, personnel from other offices of the IRS

and the Treasury Department participated in their development.

[[Page 261]]

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. In Sec. 1.41-0, the table of contents is amended by

revising the entries for Sec. 1.41-8(a), (a)(1), (a)(4), and (b) and

adding entries for Sec. 1.41-8(a)(5) and (a)(6) to read as follows:

Sec. 1.41-0 Table of contents.

* * * * *

1.41-8 Aggregation of expenditures.

(a) Controlled group of corporations; trades or businesses under

common control.

(1) In general.

* * * * *

(4) Allocation of credit for basic research payments.

(5) Allocation of alternative incremental research credit.

(6) Examples.

(b) For taxable years beginning before January 1, 1990.

* * * * *

Par. 3. In Sec. 1.41-8, paragraphs (a)(1), (a)(4), (b), and (c)(1)

are revised and paragraphs (a)(5) and (a)(6) are added to read as

follows:

Sec. 1.41-8 Aggregation of expenditures.

(a) Controlled group of corporations; trades or businesses under

common control--(1) In general. In determining the amount of the credit

for increasing research activities allowed with respect to a trade or

business that at the end of its taxable year is a member of a

controlled group of corporations or a member of a group of trades or

businesses under common control, all members of the group are treated

as a single taxpayer. Thus, for purposes of determining the amount of

the credit, all of the rules in section 41, including, for example, the

rules in section 41(c)(2) (pertaining to the minimum base amount),

section 41(c)(3)(B) (pertaining to the fixed-base percentage for start-

up companies), and section 41(c)(3)(C) (pertaining to maximum base

amount) are applied only to the aggregate computation of the base

amount. The credit (if any) allowed to any member is determined on the

basis of the ratio that its increase (if any) in its qualified research

expenses over its base amount bears to the aggregate increases in

qualified research expenses over the base amount of all members of the

group. For purposes of the preceding sentence, a member computes its

base amount by multiplying the group fixed-base percentage by the

member's average annual gross receipts for the four preceding tax

years.

* * * * *

(4) Allocation of credit for basic research payments. The credit

(if any) attributable to basic research payments allowed to a member is

determined on the basis of the ratio that its excess (if any) of basic

research payments over its qualified organization base period amount

bears to the aggregate excess of basic research payments over the

qualified organization base period amount of all members in the group.

For purposes of the preceding sentence, a member computes its qualified

organization base period amount using similar principles to those used

in paragraph (a)(1) to determine the member's base amount.

(5) Allocation of alternative incremental research credit. If the

credit is computed under the alternative incremental research credit

rules, the credit (if any) allowed to the member is determined on the

basis of the ratio that its excess (if any) of qualified research

expenses over 1% of its average annual gross receipts for the four

taxable years preceding the taxable year for which the credit is being

determined bears to the aggregate excess of qualified research expenses

over 1% of the average annual gross receipts of all members of the

group for the four taxable years preceding the taxable year for which

the credit is being determined.

(6) Examples. The following examples illustrate the provisions of

this paragraph (a):

Example 1. (i) Facts. A controlled group of three corporations

(all of which are calendar-year taxpayers) had qualified research

expenses for the credit year 1999, qualified research expenses for

the period 1984 through 1988, gross receipts for the period 1984

through 1988, and average annual gross receipts for the four years

preceding the credit year as follows:

----------------------------------------------------------------------------------------------------------------

A B C Total

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Credit year qualified research $200x............. $20x.............. $110x............. $330x

expenses.

1984-1988 qualified research 40x.............. 10x.............. 100x............. 150x

expenses.

1984-1988 gross receipts......... 1,000x........... 350x............. 150x............. 1500x

Average annual gross receipts for 1,200x........... 200x............. 300x............. 1700x

4 years preceding credit year.

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(ii) Computation of the group credit. (A) The group research

credit is computed as if the three corporations are one taxpayer.

The research credit is equal to 20 percent of the excess of the

group's aggregate credit year qualified research expenses over the

group's base amount.

(B) The group's base amount equals the greater of fifty percent

of the group's credit year qualified research expenses (the minimum

base amount); or, the group's fixed-base percentage times the

group's average annual gross receipts for the four taxable years

preceding the credit year. The group's fixed-base percentage is the

ratio that the group's aggregate qualified research expenses for the

taxable years beginning after December 31, 1983, and before January

1, 1989 bear to its aggregate gross receipts for the same period.

Therefore, the group's fixed-base percentage is 150x/1500x or 10%

and the group's base amount is $170x, the greater of 50% of $330 or

10% of $1,700x.

excess of the group's aggregate credit year qualified research

expenses over the group's base amount. That is 20% of ($330x--$170x)

or $32x.

(iii) Allocation of the group credit. The group research credit

of $32x is allocated to the members of the group based on the ratio

that the member's increase in its qualified research expenses over

the member's base amount bears to the sum of the member increases in

qualified research expenses over their base amounts. The member's

base amount is computed by multiplying the group fixed-base

percentage of 10% by the member's average annual gross receipts for

the four preceding tax years. The $32x credit is allocated as

follows:

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Credit year qualified

Member research expenses Member base amount Increase Ratio Credit

--------------------------------------------------------------------------------------------------------------------------------------------------------

A.................................. $200x................. $120x................. $80x................. 80/160............... $16x

[[Page 262]]

B.................................. 20x.................. 20x.................. ..................... 0...................

C.................................. 110x................. 30x.................. 80x................. 80/160.............. 16x

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Example 2. (i) Facts. The facts are the same as in Example 1

except that A had no qualified research expenses during the credit

year. The following table shows the group's qualified research

expenses for the credit year, qualified research expenses for the

period 1984 through 1988, gross receipts for the period 1984 through

1988, and average annual gross receipts for the four years preceding

the credit year:

----------------------------------------------------------------------------------------------------------------

A B C Total

----------------------------------------------------------------------------------------------------------------

Credit year qualified research 0................. $20x.............. $110x............. $130x

expenses.

1984-1988 qualified research $40x.............. 10x.............. 100x............. 150x

expenses.

1984-1988 gross receipts......... 1,000x........... 350x............. 150x............. 1500x

Average annual gross receipts for 1,200x........... 200x............. 300x............. 1700x

4 years preceding credit year.

----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit. Under these facts, the

controlled group's credit year qualified research expenses are less

than the group's base amount of $170x, and no credit is allowed to

the group unless the group elects to use the alternative incremental

research credit under section 41(c)(4). If the group elects to use

the alternative incremental credit under section 41(c)(4), the group

is allowed a credit equal to .0165($25.5x-$17x) + .022($34x-$25.5x)

+ .0275($130x-$34x) or $2.96725x.

(iii) Allocation of the group credit. Assuming that the group

elects to use the alternative incremental research credit under

section 41(c)(4), the group research credit of $2.96725x is

allocated to the members of the group based on the ratio that the

member's qualified research expenses over one percent of the

member's average annual gross receipts for the four preceding years

bears to the sum of the member increases in qualified research

expenses over one percent of their average annual gross receipts for

the four preceding years. The $2.96725x credit is allocated as

follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------

1 percent of member

Credit year qualified average annual gross

Member research expenses receipts for 4 Increase Ratio Credit

preceding tax years

--------------------------------------------------------------------------------------------------------------------------------------------------------

A.................................. 0..................... $12x.................. 0.................... 0....................

B.................................. $20x.................. 2x................... $18x................. 18/125............... .427284x

C.................................. 110x................. 3x................... 107x................ 107/125.............. 2.539966x

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Example 3. (i) Facts. A controlled group of three corporations

(all of which are calendar-year taxpayers) had qualified research

expenses for the credit year 1999, qualified research expenses for

the period 1984 through 1988, gross receipts for the period 1984

through 1988, and average annual gross receipts for the four years

preceding the credit year as follows:

----------------------------------------------------------------------------------------------------------------

A B C \1\ Total

----------------------------------------------------------------------------------------------------------------

Credit year qualified research $200x............. $20x.............. $50x.............. $270x

expenses.

1984-1988 qualified research 55x.............. 15x.............. 0................ 70x

expenses.

1984-1988 gross receipts......... 1000x............ 400x............. 0................ 1400x

Average annual gross receipts for 1200x............ 200x............. 0................ 1400x

4 years preceding credit year.

----------------------------------------------------------------------------------------------------------------

\1\ C began business in 1999.

(ii) Computation of the group credit. (A) The group research

credit is computed as if the three corporations are one taxpayer.

The research credit is equal to 20 percent of the excess of the

group's aggregate credit year qualified research expenses over the

group's base amount.

(B) The group's base amount equals the greater of: fifty percent

of the group's credit year qualified research expenses (the minimum

base amount), or, the group's fixed-base percentage times the

group's average annual gross receipts for the four taxable years

preceding the credit year. The group's fixed-base percentage is the

ratio that the group's aggregate qualified research expenses for the

taxable years beginning after December 31, 1983, and before January

1, 1989 bear to its aggregate gross receipts for the same period.

Therefore, the group's fixed-base percentage is 70x/1400x or 5% and

the group's base amount is $135x, the greater of 50% of $270x or 5%

of $1,400x.

excess of the group's aggregate credit year qualified research

expenses over the group's base amount. That is 20% of ($270x-$135x)

or $27x.

(iii) Allocation of the group credit. The group research credit

of $27x is allocated to the members of the group based on the ratio

that the member's increase in its qualified research expenses over

the member's base amount bears to the sum of the member increases in

qualified research expenses over their base amounts. The member's

base amount is computed by multiplying the group fixed-base

percentage of 5% by the member's average annual gross receipts for

the four preceding tax years. The $27x credit is allocated as

follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------

Credit year qualified

Member research expenses Member base amount Increase Ratio Credit

--------------------------------------------------------------------------------------------------------------------------------------------------------

A.................................. $200x................. $60x.................. $140x................ 14/20................ $18.9x

B.................................. 20x.................. 10x.................. 10x................. 1/20................. 1.35x

C.................................. 50x.................. 0.................... 50x................. 5/20................. 6.75x

--------------------------------------------------------------------------------------------------------------------------------------------------------

[[Page 263]]

Example 4. (i) Facts. The facts are the same as in Example 3

except that C began business in 1989. A, B, and C had qualified

research expenses for the credit year 1999, qualified research

expenses for the period 1984 through 1988, gross receipts for the

period 1984 through 1988, and average annual gross receipts for the

four years preceding the credit year as follows:

----------------------------------------------------------------------------------------------------------------

A B C Total

----------------------------------------------------------------------------------------------------------------

Credit year qualified research $200x............. $20x.............. $50x.............. $270x

expenses.

1984-1988 qualified research 55x.............. 15x.............. 0................ 70x

expenses.

1984-1988 gross receipts......... 1,000x........... 400x............. 0................ 1,400x

Average annual gross receipts for 1,200x........... 200x............. 1,000x........... 2,400x