On June 25, the U.S. District Court in Procter & Gamble Co. and Subsidiaries (P&G) v. United States (Case No. 1:08-cv-00608-TSB) granted partial summary judgment in favor of P&G in an important tax case involving the federal R&D Tax Credit. In the case, the court ruled on the issue of whether a taxpayer must include intercompany transactions as part of its Gross Receipts when calculating the R&D Credit’s base amount.
During the period in question (2001-2005), P&G conducted its business through various subsidiary corporations that regularly engaged in intercompany transactions with one another. In calculating its R&D Credit, P&G aggregated all of its subsidiaries’ research expenditures and gross receipts under one “controlled group”. In this calculation, P&G disregarded the gross receipts that were generated from intercompany transactions between its domestic and foreign subsidiaries.
The IRS originally accepted P&G's approach under audit. However, months later, the IRS reversed its position based on new advice from IRS Chief Counsel. By including the intercompany transactions in P&G’s gross receipts, the IRS’s calculation increased P&G’s base amount which decreased the company’s R&D Tax Credit for the years at issue. Under this new guidance, the IRS issued a notice of proposed adjustment and assessed P&G for the underpayment of tax.
In court, P&G argued that the plain language of Code Section 41(f) states that all members of a controlled group of corporations should be treated as a single taxpayer. Conversely, the IRS contended that the proper definition of gross receipts is defined in [now] Code Section 41(c)(7).
After reviewing both arguments, the court recognized that including intercompany transactions in a company’s gross receipts calculation could result in doubling (or more) of the R&D Credit’s base amount, which is contrary to the intent of the regulations. The court agreed with P&G that Code Section 41(f) controlled, and further that Code Section 41(c)(6) did not compel a different result. The Court further rejected the IRS’ argument that the aggregation rules only applied to the calculation of qualified research expenditures, and not to gross receipts. In addition, the court found no basis for the IRS’ distinguishing between domestic and foreign affiliate gross receipts.
Ultimately, the Court ruled in P&G’s favor and confirmed that all members of a controlled group should be treated as a single taxpayer when computing the base amount of the group’s R&D Credit calculation.
Published by: Brian Lefever is a Professional Engineer, and VP of Operations for Titan Armor, the R&D Tax Credit software designed to efficiently meet the current IRS documentation requirements for the research tax credit.