The research and development (R&D) credit provides a tax incentive to taxpayers for performing qualified research in the US to develop new or improved business component. Its aim is to encourage tax payers to increase their qualified R&D activities by making the R&D credit available for incremental qualified research expenditures in excess of a base amount.

For the purposes of the R&D credit, qualified research is defined as research that satisfies all four parts of a four-part test.

Qualified research is research that is:

  • Technological in nature: relying on the physical or biological sciences, computer science, or engineering;
  • Undertaken to eliminate uncertainty: relating to capability, methodology or product/process design;
  • Undertaken for a permitted purpose: relating to function, performance, reliability or quality, as opposed to a cosmetic or aesthetic purpose;
  • Consists of a process of experimentation: evaluating one or more alternatives.

A further three tests must be satisfied for the development of internal-use software to be considered as qualified research:

  • Innovation test: the software must be innovative in that it is intended to result in an improvement that is substantial and economically significant;
  • Significant economic risk test: the software development must involve significant economic risk and uncertainty due to technical risk;
  • Commercially available test: the software must not already be commercially available for use by the taxpayer without modifications.

In addition, the research must be conducted in the US, Puerto Rico or a US territory to qualify.

R&D expense deductions:

The expenses that may be claimed as Qualified Research Expenditures (QRE) for the R&D credit are limited to:

  • (Taxable) wages: incurred in the performance, direct supervision or direct support of qualified research activities;
  • Supplies: non-depreciable personal property used or consumed in conducting the qualified research activities;
  • Contract research: for contract research conducted on behalf of the taxpayer in instances where the taxpayer is at financial risk, claimable at 65 percent (or 75 percent or 100 percent in certain situations).