Federal Register, Volume 70 Issue 99 (Tuesday, May 24, 2005)

[Federal Register Volume 70, Number 99 (Tuesday, May 24, 2005)]
[Rules and Regulations]
[Pages 29596-29607]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10247]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9205]
RIN 1545-BE17

Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations relating to the
computation and allocation of the credit for increasing research
activities for members of a controlled group of corporations or a group
of trades or businesses under common control. These temporary
regulations reflect changes made to section 41 by the Revenue
Reconciliation Act of 1989 (1989 Act), which introduced the current
computational regime for the credit, and the Small Business Job
Protection Act of 1996, which introduced the alternative incremental
research credit. The text of the temporary regulations also serves as
the text of the proposed regulations set forth in the notice of
proposed rulemaking on this subject in the Proposed Rules section in
this issue of the Federal Register.

DATES: Effective Date: These regulations are effective May 24, 2005.
Applicability Dates: For dates of applicability see Sec. Sec.
1.41-6T(j) and 1.41-8T(b)(5).

FOR FURTHER INFORMATION CONTACT: Nicole R. Cimino (202) 622-3120 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On July 29, 2003, the Treasury Department and the IRS published in
the Federal Register (68 FR 44499) proposed amendments to the
regulations under section 41(f) (REG-133791-02) (the 2003 proposed
regulations) relating to the computation and allocation of the credit
for increasing research activities (research credit) under section 41
for members of a controlled group of corporations or a group of trades
or businesses under common control (controlled groups). The 2003
proposed regulations withdrew the proposed regulations published in the
Federal Register on January 4, 2000 (65 FR 258) (REG-105606-99) (the
2000 proposed regulations). In general, the 2000 proposed regulations
required

[[Page 29597]]

controlled groups to compute a group credit and then to allocate that
group credit among the members of the controlled group. The allocation
of the group credit under the 2000 proposed regulations was based on
the relative increases of each member's qualified research expenses
(QREs) over a base amount that was computed by multiplying that
member's most recent average annual gross receipts by the controlled
group's fixed-base percentage.
Although the 2003 proposed regulations did not modify the rules
relating to the computation of the group credit, the 2003 proposed
regulations did modify the rules relating to the allocation of the
group credit among the members of the controlled group. In particular,
the 2003 proposed regulations allocated the group credit in proportion
to the credit, if any, that a member of a controlled group would be
entitled to claim if it were not a member of a controlled group (the
stand-alone entity credit). In addition, based on the comments to the
2000 proposed regulations, the 2003 proposed regulations did not
propose special rules that would apply to consolidated groups that were
members of a controlled group. A public hearing on the 2003 proposed
regulations was held on November 13, 2003. After considering the
written comments and the statements at the public hearing, the Treasury
Department and the IRS are withdrawing the 2003 proposed regulations
and are issuing temporary regulations and proposed regulations cross-
referencing the temporary regulations. In substantial part, the
temporary regulations retain the rules contained in the 2003 proposed
regulations with certain modifications discussed below.

Summary of Comments and Explanation of Provisions

Computation of the Group Credit

Section 41(f)(1)(A)(i) provides that ``all members of the same
controlled group of corporations shall be treated as a single
taxpayer'' in determining the amount of the research credit under
section 41. Section 41(f)(1)(B)(i) provides a similar rule for a group
of trades or businesses under common control. The 2003 proposed
regulations applied the section 41 computational rules on an aggregate
basis for purposes of determining the amount of the group credit.
Additionally, a controlled group would have been treated as a start-up
company for purposes of determining the group's fixed-base percentage
only if each member of the group qualified as a start-up company.
Therefore, a controlled group with only two members would have been
subject to the start-up rules if one member of the group had QREs but
no gross receipts in 1983 and the other member had gross receipts but
no QREs in 1983.
Commentators generally agreed with the proposed rules for computing
the group credit. Commentators were concerned, however, with perceived
ambiguities related to the application of the start-up company rules to
a controlled group. For example, commentators asked that the
regulations clarify what a controlled group's start-up date is if all
the members of the group are start-up companies with different start-up
dates.
These temporary regulations retain the rules in the 2003 proposed
regulations for the computation of the group credit, except for the
start-up company rules. The temporary regulations state that a
controlled group is treated as a start-up company for purposes of
computing the group credit if (A) the first taxable year in which at
least one member of the group had gross receipts and at least one
member of the group had QREs begins after December 31, 1983, or (B)
there were fewer than three taxable years beginning after December 31,
1983, and before January 1, 1989, in which at least one member of the
group had gross receipts and at least one member of the group had QREs.
Consistent with this approach, the first taxable year in which a
controlled group has gross receipts for purposes of the start-up
company rules is the first year in which at least one member of the
group has gross receipts. Likewise, the first taxable year in which a
controlled group has QREs for purposes of the start-up company rules is
the first year in which at least one member of the group has QREs. The
Treasury Department and the IRS believe that this approach is more
consistent with treating a controlled group as a single taxpayer
because a controlled group with two members is not subject to the
start-up rules if one member of the group had QREs but no gross
receipts in 1983 and the other member had gross receipts but no QREs in
1983. Additionally, the temporary regulations specifically state that
for purposes of determining the fixed-base percentage, the first
taxable year after December 31, 1993, for which a controlled group has
QREs is the first taxable year in which at least one member of the
group has QREs.

Allocation of the Group Credit

Section 41(f)(1)(A)(ii) provides that ``the [portion of the group]
credit (if any) allowable by this section to each such member shall be
its proportionate shares of the qualified research expenses and basic
research payments giving rise to the credit.'' Section 41(f)(1)(B)(ii)
provides a similar rule for a group of trades or businesses under
common control. The 2003 proposed regulations apply these provisions by
allocating the group credit based on the relative amounts of each
individual member's stand-alone entity credit.
A number of commentators requested changes to the method of
allocating the group credit contained in the 2003 proposed regulations.
In general, these comments reflected dissatisfaction either with the
stand-alone entity credit method in the 2003 proposed regulations or
with any single, prescribed method. Consequently, commentators either
proposed specific alternatives or stated that final regulations should
allow members to allocate the group credit using any reasonable method.
One commentator advocated that a method that allocates the group credit
based on the relative amounts of each member's total QREs (gross QREs
method) is the only allocation method permitted under the statute.
Another commentator urged the Treasury Department and the IRS to adopt
an allocation method that, based on techniques of differential
calculus, allocates the group credit based on the marginal contribution
to the group credit of each member's QREs for the current year, QREs
for the base years, and gross-receipts for the base years, as well as
the controlled group's fixed-base percentage and the growth in gross
receipts for the controlled group (marginal contribution method). Other
commentators suggested that no single allocation method can
appropriately allocate the group credit in all cases; therefore,
members of a controlled group should be permitted to use any reasonable
method to allocate the group credit. For the reasons discussed below,
these temporary regulations generally retain the stand-alone entity
credit method of the 2003 proposed regulations with some modifications.
The preamble to the 2003 proposed regulations sets out at length
the reasons why the Treasury Department and the IRS believe that the
allocation method under section 41(f) should be based on a group
member's QREs in excess of a base amount. The stand-alone entity credit
method reflects the incremental nature of the credit and also is
consistent with the Treasury Department and the IRS' view of the
purpose of section 41(f). As stated in the preamble to the 2003
proposed regulations:

[[Page 29598]]

The legislative history to the research credit, as originally
enacted in 1981, indicates that the group credit computation and
aggregation rules were enacted to ensure that the research credit
would be allowed only for actual increases in research expenditures.
These aggregation rules were intended to prevent taxpayers from
creating 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. In effect, the group credit computation
rule serves as a cap on the maximum amount of credit that the
members of the group, in the aggregate, may claim.

Prior to the 1989 Act, the research credit was computed by
multiplying the credit rate by the excess of the taxpayer's current
year QREs over the taxpayer's average QREs for the preceding three
years. Final regulations issued in 1989, prescribing rules for the
allocation of the group credit prior to the 1989 Act, allocated the
group credit based on what effectively would have been each member's
stand-alone entity credit (without giving effect to the minimum base
period amount in computing each member's stand-alone entity credit).
The 1989 Act significantly modified the computation of the credit while
retaining the incremental approach of the pre-1989 Act credit. Congress
did not indicate in either the statute or the legislative history that
either the purpose or the application of section 41(f) was being
changed. Although the phrase ``increase in'' in sections
41(f)(1)(A)(ii) and 41(f)(1)(B)(ii) was deleted by the 1989 Act, for
the reasons set out in the preamble to the 2003 proposed regulations,
the Treasury Department and the IRS concluded that this change to the
statute was intended to reflect only the fact that a taxpayer's
entitlement to the research credit after the 1989 Act no longer
depended on whether the taxpayer had increased its current year QREs
over its average QREs for the preceding three years.
With respect to the alternative allocation methods suggested by the
commentators, the Treasury Department and the IRS conclude that these
methods are inconsistent with the purpose of section 41 generally and
section 41(f) specifically. A gross QREs method is at odds
fundamentally with the incremental nature of the research credit, and
the Treasury Department and the IRS continue to believe that neither
the statute nor the legislative history suggests that Congress intended
that the allocation of the group credit be based solely on a member's
total QREs without reference to whether those QREs exceed a base
amount.
Similarly, the Treasury Department and the IRS do not believe that
the suggested marginal contribution method is consistent with section
41(f). The Treasury Department and the IRS recognize the potential for
that method to more closely associate the amount of group credit
allocated to a particular member to the contributions of that member's
QREs for the current year, gross receipts for the current year, QREs
for the base years, and gross receipts for the base years to the amount
of the group credit. The marginal contribution method proposed,
however, has significant flaws that would change the function of the
aggregation rules in section 41(f) in a manner that the Treasury
Department and the IRS do not believe was intended by Congress. First,
the method would allow allocations of credit to members that have no
QREs, a result the Treasury Department and the IRS believe is contrary
to the statutory directive to allocate the group credit in proportion
to a member's share of QREs giving rise to the credit. Second, the
method uses different formulas for groups that are affected by special
rules, such as the maximum fixed-base percentage rule. As a result, it
is possible that a member of a group that increases its QREs by a
relatively small amount, that is enough to make the group subject to a
special rule, could be allocated proportionately less credit than if
the member had not increased its QREs. Finally, by relying on the
group's gross receipts and the group's fixed-base percentage, the
marginal contribution method appears to encourage planning and shifting
among group members, a result that is inconsistent with the purpose of
section 41(f). The Treasury Department and the IRS believe that an
appropriate allocation method should encourage a member to focus on
incrementally increasing its own research efforts.
The Treasury Department and the IRS also decline to adopt an
allocation rule that would permit the members of a controlled group to
use any reasonable method to allocate the group credit. Neither the
statute nor the legislative history indicates that Congress intended
the allocation of the group credit to be based on any reasonable method
selected by a member individually or the controlled group collectively.
Furthermore, a rule permitting the use of any reasonable method to
allocate the credit could result in continuing controversy. As
discussed in the preamble to the 2003 proposed regulations, the
Treasury Department and the IRS believe that the purpose of section
41(f) is undermined if the members of a controlled group use different
allocation methods to claim more than 100 percent of the group credit.
The Treasury Department and the IRS believe that a single, prescribed
method is necessary to preclude such potential for abuse.
Accordingly, the Treasury Department and the IRS continue to
believe that the purposes of the research credit statute generally and
the provisions of section 41(f) specifically are best furthered by an
allocation method that allocates the group credit based on each
member's stand-alone entity credit.

Special Allocation Rule for Excess Group Credit Situations

Under the 2003 proposed regulations, if the group credit exceeded
the sum of the stand-alone entity credits of the members of a
controlled group, the members with stand-alone entity credits would be
entitled to the entire group credit. In addition, if no member of the
controlled group had a stand-alone entity credit, none of the group
credit would be allocated to the members of the controlled group.
To address these situations, these temporary regulations modify the
allocation method of the 2003 proposed regulations in cases in which
the group credit exceeds the sum of the members' stand-alone entity
credits, including cases in which no member has a stand-alone entity
credit. If the group credit exceeds the sum of the members' stand-alone
entity credits, each member is allocated an amount of group credit
equal to that member's stand-alone entity credit. The remaining, or
excess, amount of group credit is then allocated among all the members
of the controlled group based on the ratio of an individual member's
QREs to the sum of all the members' QREs.

Computation of Stand-Alone Entity Credits

Commentators questioned whether members must use the same method,
i.e., the method described in section 41(a) (regular credit method) or
the alternative incremental research credit (AIRC) method described in
section 41(c)(4), in computing the stand-alone entity credit as that
used to compute the group credit. The Treasury Department and the IRS
do not believe that requiring taxpayers to be consistent in the method
used to compute the group credit and the stand-alone entity credit
would serve the purpose of section 41. Section 41(f) was intended to
encourage taxpayers to increase their individual research efforts to
maximize the group credit and thus their share of the group credit. The
Treasury Department and

[[Page 29599]]

the IRS believe that allowing the members to compute their stand-alone
entity credits without regard to the method used to compute the group
credit will encourage increasing research efforts. Thus, the temporary
regulations provide that a member's stand-alone entity credit must be
computed using whichever method results in the greater stand-alone
entity credit for that member, without regard to the method used to
compute the group credit.
Commentators also pointed out that the computation of the stand-
alone entity credits under the 2003 proposed regulations would no
longer require the intra-group transaction rules of Sec. 1.41-6(e)
(re-designated in these temporary regulations as Sec. 1.41-6(i)) to
apply. Although the intent of the stand-alone entity credit rule is to
compute a credit that is similar to that to which a member would be
entitled if there were no research credit aggregation rules for
controlled groups, the intent was not to render the intra-group
transaction rules or the acquisition/disposition rules of section
41(f)(3) inapplicable. Therefore, these temporary regulations
specifically provide that taxpayers must apply the intra-group
transaction rules and the acquisition/disposition rules when computing
the stand-alone entity credits. For example, to the extent that a
member's gross receipts and QREs have been reduced for purposes of
computing the group credit as a result of the application of the
acquisition/disposition rules, the member's stand-alone entity credit
must be computed using the same gross receipts and QREs.

Special Allocation Rule for Consolidated Groups

The preamble to the 2003 proposed regulations states that the
Treasury Department and the IRS considered comments requesting a
special allocation rule for consolidated groups, but decided not to
adopt such a rule. Several commentators further commented on that
issue. One commentator suggested that if the group credit were
allocated in proportion to QREs, no special consolidated group rule
would be necessary. Given that this commentator's proposed allocation
method is not the one adopted in these temporary regulations, the
Treasury Department and the IRS are not persuaded that a special
consolidated group rule is unnecessary. Another commentator suggested
that a consolidated group should be treated as a single member of a
controlled group for purposes of allocating the group credit and that
the failure to treat the consolidated group in such a manner would
result in abuse.
The Treasury Department and the IRS believe that treating a
consolidated group as a single member of a controlled group for
purposes of allocating the group credit is consistent with the
treatment of a consolidated group as a single taxpayer under a number
of the consolidated return regulations. Therefore, these temporary
regulations provide that, for purposes of allocating the group credit,
a consolidated group whose members are members of a controlled group is
treated as a single member of the controlled group. Accordingly, a
consolidated group whose members are members of a controlled group is
treated as a single member of the controlled group and a single stand-
alone entity credit is computed for the consolidated group. If the
consolidated group is the only member of the controlled group, the
stand-alone entity credit computed for the consolidated group is equal
to the group credit.
The portion of the group credit allocated to a consolidated group
must be allocated among the members of the consolidated group. The
Treasury Department and the IRS believe that the method of allocating
among the members of the consolidated group the portion of the group
credit allocated to the consolidated group should be no different than
the method of allocating the group credit among members of the
controlled group. Therefore, a stand-alone entity credit is computed
for each member of the consolidated group, and the portion of the group
credit allocated to the consolidated group is allocated among the
members of the consolidated group in proportion to the stand-alone
entity credits of the members of the consolidated group. One
commentator argued that separately computing the stand-alone credit for
each member of a consolidated group would be prohibitively burdensome.
The Treasury Department and the IRS, however, do not believe that
computing a stand-alone entity credit for each member of a consolidated
group imposes a greater burden than computing a stand-alone entity
credit for a corporation that is not a member of a consolidated group.
Moreover, providing a rule for allocating the portion of the group
credit allocated to a consolidated group among its members that is
different than the method used for allocating the controlled group
credit would create additional administrative complexity that seems
unwarranted.

Alternative Incremental Research Credit

Section 41(c)(4) provides an election to determine the research
credit using the AIRC computation. Section 41(c)(4)(B) provides that
the election to use the AIRC applies to all succeeding taxable years
unless revoked with the consent of the Secretary. Many issues have
arisen regarding how the AIRC election is made in the case of a
consolidated group and in the case of a controlled group, all members
of which are not included on a single consolidated federal income tax
return. These issues include: (1) How is an AIRC election made by
members of a controlled group for purposes of computing the group
credit under section 41(f)(1); (2) what happens when a controlled group
has made an AIRC election and a member leaves the group or a member
that has not made an AIRC election enters the group; (3) what happens
if a member that has made an AIRC election joins a controlled group
that has not made an AIRC election; and (4) when will a request to
revoke an AIRC election be granted.
Generally, the Treasury Department and the IRS assume that
taxpayers will elect to use the AIRC method if the AIRC method provides
more credit than the regular method, or if a taxpayer does not have the
books and records necessary to compute the base amount under the
regular method. Once a taxpayer elects the AIRC method, the Treasury
Department and the IRS believe that the AIRC method will continue to be
the better method in the future as well, unless the taxpayer has a
substantial change in its trade or business, such as the acquisition or
disposition of an entire trade or business. If such a substantial
change occurs, the Treasury Department and the IRS believe that it is
appropriate to allow the taxpayer to revoke its AIRC election. The IRS
has received many requests for consent to revoke AIRC elections from
taxpayers in such situations. To reduce the burden on taxpayers,
provide simplification, and ease administrative burden, the Treasury
Department and the IRS have determined that it is appropriate to grant
automatic consent to revoke an AIRC election on a prospective basis in
situations in which a taxpayer makes the revocation on an original
return. The Treasury Department and the IRS do not believe, however,
that allowing an AIRC election or revocation on an amended return
furthers the goal of simplification and ease of administration.
Therefore, these temporary regulations provide that a taxpayer that
has made an AIRC election is deemed to

[[Page 29600]]

have requested and been granted consent to revoke the election if the
taxpayer completes the portion of Form 6765, ``Credit for Increasing
Research Activities,'' relating to the regular credit and attaches the
completed form to the taxpayer's timely filed original return for the
year to which the revocation applies. This provision is similar to the
provisions in the existing regulations for making an AIRC election,
which require the taxpayer to complete the portion of Form 6765
relating to the AIRC and attach the completed form to the taxpayer's
timely filed original return for the year to which the election
applies. Once an election/revocation is made for a taxable year, the
taxpayer may not change the election/revocation on an amended return.
The temporary regulations provide special rules for controlled
groups under section 41(f)(1) (in which one or more of the members do
not join in filing a consolidated return). As discussed above, in this
situation many questions have arisen regarding which members of a
controlled group must make (or revoke) an AIRC election to have a valid
election (or revocation) for the controlled group. Attempting to track
elections across members of a controlled group, in which one or more of
the members do not join in filing a consolidated return would create
additional administrative complexity and increase the potential for
controversy. Thus, to reduce the additional administrative complexity
created by the additional computation, these temporary regulations
provide that in the case of a controlled group, all the members of
which are not included on a single consolidated return, the designated
member must make (or revoke) an AIRC election on behalf of the members
of the group. The election (or revocation) by the designated member is
binding on all of the members of the group for the taxable year to
which the election (or revocation) relates. The temporary regulations
provide that the designated member is that member of the group that is
allocated the greatest amount of the group credit. In the event the
members of a group compute the group credit using different methods
(either the regular method or the AIRC method) and at least two members
of the group qualify as the designated member, the designated member is
the member that computes the group credit using the method that yields
the greater group credit. The Treasury Department and the IRS believe
that these rules will simplify the election and revocation of the AIRC
method. Furthermore, granting automatic consent to revoke an AIRC
election also simplifies acquisitions and dispositions of members of
controlled groups. For example, when a new member joins a group, the
member must use the method used by the controlled group. In the taxable
year after a member leaves a group, the member is free to use either
method, assuming the member has not joined another controlled group. If
all members of a controlled group are members of a single consolidated
group, the AIRC election is made by the agent of the consolidated
group, determined pursuant to the rules of Sec. 1.1502-77.

Effective Date

The preamble to the 2003 proposed regulations stated that the
Treasury Department and the IRS intended to make those regulations
effective for taxable years beginning on or after the date that final
regulations are published in the Federal Register. The preamble to the
2003 proposed regulations also addressed the limited application of
final regulations to taxable years prior to that effective date to
prevent abuse. Because the Treasury Department and the IRS have decided
to retain the general rules for the computation and allocation of the
group credit contained in the 2003 proposed regulations, with the
modifications described above, these regulations are being issued in
temporary form and will be effective for taxable years ending on or
after May 24, 2005.
For taxable years prior to those covered by these temporary
regulations, a taxpayer generally may use any reasonable method of
computing and allocating the group credit. For the reasons set out in
the preamble to the 2003 proposed regulations, the Treasury Department
and the IRS believe that these temporary regulations should be
retroactive in limited circumstances to prevent abuse. Accordingly,
paragraph (b) of these temporary regulations, relating to the
computation of the group credit, and paragraph (c) of these temporary
regulations, relating to the allocation of the group credit, apply to
taxable years ending on or after December 29, 1999, if the members of a
controlled group, as a whole, claimed more than 100 percent of the
amount that would be allowable under paragraph (b). In the case of a
controlled group whose members have different taxable years and whose
members use inconsistent methods of allocation, the members of the
controlled group are deemed to have, as a whole, claimed more than 100
percent of the amount that would be allowable under paragraph (b).
Since the issuance of the 2003 proposed regulations, questions have
arisen regarding what constitutes a reasonable method of allocating the
group credit. Any allocation method used by a member of a controlled
group that is consistent with either the 2000 proposed regulations, the
2003 proposed regulations, these temporary regulations, or subsequent
final regulations will be accepted by the IRS as reasonable if the same
allocation method was used by all members of the controlled group. In
addition, for taxable years ending before December 29, 1999, any such
method will be accepted by the IRS as reasonable regardless of the
allocation method or methods used by other members of the controlled
group and regardless of whether the members of the controlled group, in
the aggregate, claimed more than 100 percent of the group credit.
Although the reasonableness of any other allocation method may depend
on the particular facts and circumstance of that taxpayer, in general,
the IRS, solely for purposes of what constitutes a reasonable method of
allocating the group credit for taxable years ending before December
29, 1999, will treat as reasonable a gross QREs method even if the
members of the controlled group use inconsistent allocation methods to
claim, in the aggregate, more than 100 percent of the group credit.
Such treatment of a gross QREs method as reasonable for such years is
for administrative convenience only.

Special Analyses

It has been determined that this Treasury Department decision 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. For the
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6)
refer to the Special Analyses section of the preamble to the cross-
reference notice of the proposed rulemaking published in the Proposed
Rules section in this issue of the Federal Register. Pursuant to
section 7805(f) of the Code, these temporary regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Nicole R. Cimino,
Office of Associate Chief Counsel (Passthroughs and Special
Industries).

[[Page 29601]]

However, personnel from the IRS and Treasury Department participated in
their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an
entry in numerical order to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *
Section 1.41-6T also issued under 26 U.S.C. 1502. * * *

0
Par. 2. In Sec. 1.41-0, the table of contents is amended by removing
the entries for Sec. 1.41-6 and Sec. 1.41-8 and adding entries for
Sec. 1.41-6T and Sec. 1.41-8T to read as follows:

Sec. 1.41-0 Table of contents.

* * * * *

Sec. 1.41-6T Aggregation of expenditures (temporary).

(a) Controlled groups of corporations; trades or businesses
under common control.
(1) In general.
(2) Consolidated groups.
(3) Definitions.
(b) Computation of the group credit.
(1) In general.
(2) Start-up companies.
(c) Allocation of the group credit.
(1) In general.
(2) Stand-alone entity credit.
(d) Special rules for consolidated groups.
(1) In general.
(2) Start-up company status.
(3) Special rule for allocation of group credit among
consolidated group members.
(e) Examples.
(f) For taxable years beginning before January 1, 1990.
(g) Tax accounting periods used.
(1) In general.
(2) Special rule when timing of research is manipulated.
(h) Membership during taxable year in more than one group.
(i) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease payments.
(5) Payment for supplies.
(j) Effective date.
* * * * *

Sec. 1.41-8T Special rules for taxable years ending on or after
January 3, 2001 (temporary).

(a) Alternative incremental credit.
(b) Election.
(1) In general.
(2) Time and manner of election.
(3) Revocation.
(4) Special rules for controlled groups.
(5) Effective date.

Sec. 1.41-6 [Removed]

0
Par. 3. Section 1.41-6 is removed.

0
Par. 4. Section 1.41-6T is added to read as follows:

Sec. 1.41-6T Aggregation of expenditures (temporary).

(a) Controlled group of corporations; trades or businesses under
common control--(1) In general. To determine the amount of research
credit (if any) allowable to a trade or business that at the end of its
taxable year is a member of a controlled group, a taxpayer must--
(i) Compute the group credit in the manner described in paragraph
(b) of this section; and
(ii) Allocate the group credit among the members of the group in
the manner described in paragraph (c) of this section.
(2) Consolidated groups. For special rules relating to consolidated
groups, see paragraph (d) of this section.
(3) Definitions. For purposes of this section:
(i) Trade or business. A trade or business is a sole
proprietorship, a partnership, a trust, an estate, or a corporation
that is carrying on a trade or business (within the meaning of section
162). Any member of a commonly controlled group shall be deemed to be
carrying on a trade or business if any other member of that group is
carrying on any trade or business.
(ii) Controlled group. The terms group and controlled group mean a
controlled group of corporations, as defined in section 41(f)(5), or a
group of trades or businesses under common control. For rules for
determining whether trades or businesses are under common control, see
Sec. 1.52-1 (b) through (g).
(iii) Group credit. The term group credit means the research credit
(if any) allowable to a controlled group.
(iv) Consolidated group. The term consolidated group has the
meaning set forth in Sec. 1.1502-1(h).
(v) Credit year. The term credit year means the taxable year for
which the member is computing the credit.
(b) Computation of the group credit--(1) In general. All members of
a controlled group are treated as a single taxpayer for purposes of
computing the research credit. The group credit is computed by applying
all of the section 41 computational rules on an aggregate basis. All
members of a controlled group must use the same method of computation,
either the method described in section 41(a) or the alternative
incremental research credit (AIRC) method described in section
41(c)(4), in computing the group credit for a credit year.
(2) Start-up companies--(i) In general. For purposes of computing
the group credit, a controlled group is treated as a start-up company
for purposes of section 41(c)(3)(B)(i) if--
(A) The first taxable year in which at least one member of the
group had gross receipts and at least one member of the group had
qualified research expenditures (QREs) begins after December 31, 1983;
or
(B) There were fewer than 3 taxable years beginning after December
31, 1983, and before January 1, 1989, in which at least one member of
the group had gross receipts and at least one member of the group had
QREs.
(ii) Example. The following example illustrates the principles of
paragraph (b)(2)(i) of this section:

Example. A, B, and C, all of which are calendar year taxpayers,
are members of a controlled group. During the 1983 taxable year, A
had QREs, but no gross receipts; B had gross receipts, but no QREs;
and C had no QREs or gross receipts. The 1984 taxable year was the
first taxable year for which each of A, B, and C had both QREs and
gross receipts. Because the first taxable year for which each of A,
B, and C had both QREs and gross receipts began after December 31,
1983, each of A, B, and C is a start-up company under section
41(c)(3)(B)(i) and each is a start-up company for purposes of
computing the stand-alone entity credit. During the 1983 taxable
year, at least one member of the group, A, had QREs and at least one
member of the group, B, had gross receipts, thus, the group had both
QREs and gross receipts in 1983. Therefore, the controlled group is
not a start-up company because the first taxable year for which the
group had both QREs and gross receipts did not begin after December
31, 1983.

(iii) First taxable year after December 31, 1993, for which the
controlled group had QREs. In the case of a controlled group that is
treated as a start-up company under section 41(c)(3)(B)(i) and
paragraph (b)(2)(i) of this section, for purposes of determining the
group's fixed-base percentage under section 41(c)(3)(B)(ii), the first
taxable year after December 31, 1993, for which the group has QREs is
the first taxable year in which at least one member of the group has
QREs.
(iv) Example. The following example illustrates the principles of
paragraph (b)(2)(iii) of this section:

Example. D, E, and F, all of which are calendar year taxpayers,
are members of a controlled group. The group is treated as a start-
up company under section 41(c)(3)(B)(i) and paragraph (b)(2)(i) of
this section. The

[[Page 29602]]

first taxable year after December 31, 1993, for which D had QREs was
1994. The first taxable year after December 31, 1993, for which E
had QREs was 1995. The first taxable year after December 31, 1993,
for which F had QREs was 1996. Because the 1994 taxable year was the
first taxable year after December 31, 1993, for which at least one
member of the group, D, had QREs, for purposes of determining the
group's fixed-based percentage under section 41(c)(3)(B)(ii), the
1994 taxable year was the first taxable year after December 31,
1993, for which the group had QREs.

(c) Allocation of the group credit--(1) In general. (i) To the
extent the group credit (if any) computed under paragraph (b) of this
section does not exceed the sum of the stand-alone entity credits of
all of the members of a controlled group, computed under paragraph
(c)(2) of this section, such group credit shall be allocated among the
members of the controlled group in proportion to the stand-alone entity
credits of the members of the controlled group, computed under
paragraph (c)(2) of this section:
[GRAPHIC] [TIFF OMITTED] TR24MY05.002

(ii) To the extent that the group credit (if any) computed under
paragraph (b) of this section exceeds the sum of the stand-alone entity
credits of all of the members of the controlled group, computed under
paragraph (c)(2) of this section, such excess shall be allocated among
the members of a controlled group in proportion to the QREs of the
members of the controlled group:
[GRAPHIC] [TIFF OMITTED] TR24MY05.003

(2) Stand-alone entity credit. The term stand-alone entity credit
means the research credit (if any) that would be allowable to a member
of a controlled group if the credit were computed as if section
41(f)(1) did not apply, except that the member must apply the rules
provided in paragraphs (d)(1) (relating to consolidated groups) and (i)
(relating to intra-group transactions) of this section. Each member's
stand-alone entity credit for any credit year must be computed under
whichever method (the method described in section 41(a) or the method
described in section 41(c)(4)) results in the greater stand-alone
entity credit for that member, without regard to the method used to
compute the group credit.
(d) Special rules for consolidated groups--(1) In general. For
purposes of applying paragraph (c) of this section, a consolidated
group whose members are members of a controlled group is treated as a
single member of the controlled group and a single stand-alone entity
credit is computed for the consolidated group.
(2) Start-up company status. A consolidated group's status as a
start-up company and the first taxable year after December 31, 1993,
for which a consolidated group has QREs are determined in accordance
with the principles of paragraph (b)(2) of this section.
(3) Special rule for allocation of group credit among consolidated
group members. The portion of the group credit that is allocated to a
consolidated group is allocated to the members of the consolidated
group in accordance with the principles of paragraph (c) of this
section. However, for this purpose, the stand-alone entity credit of a
member of a consolidated group is computed without regard to section
41(f)(1), but with regard to paragraph (i) of this section.
(e) Examples. The following examples illustrate the provisions of
this section. Unless otherwise stated, no members of a controlled group
are members of a consolidated group, and except as provided in Example
6, the group has not made an AIRC election:

Example 1. Group credit is less than sum of members' stand-alone
entity credits--(i) Facts. A, B, and C, all of which are calendar-
year taxpayers, are members of a controlled group. Neither A, B, nor
C made any basic research payments for their taxable year ending
December 31, 2004. For purposes of computing the group credit for
the 2004 taxable year (the credit year), A, B, and C had the
following:

----------------------------------------------------------------------------------------------------------------
A B C Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................... $200x $20x $110x $330x
1984-1988 QREs..................... $40x $10x $100x $150x
1984-1988 Gross Receipts........... $1,000x $350x $150x $1,500x
Average Annual Gross Receipts for 4 $1,200x $200x $300x $1,700x
Years Preceding the Credit Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit--(A) In general. The
research credit allowable to the group is computed as if A, B, and C
were one taxpayer. The group credit is equal to 20 percent of the
excess of the group's aggregate credit year QREs ($330x) over the
group's base amount ($170x). The group credit is 0.20 x ($330-
$170x), which equals $32x.
(B) Group's base amount--(1) Computation. The group's base
amount equals the greater of: The group's fixed-base percentage (10
percent) multiplied by the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year
($1,700x), or the group's minimum base amount ($165x). The group's
base amount, therefore, is $170x, which is the greater of: 0.10 x
$1,700x, which equals $170x, or $165x.
(2) Group's minimum base amount. The group's minimum base amount
is 50 percent of the group's aggregate credit year QREs. The group's
minimum base amount is 0.50 x $330x, which equals $165x.
(3) Group's fixed-base percentage. The group's fixed-base
percentage is the lesser of: the ratio that the group's aggregate
QREs for the taxable years beginning after December 31, 1983, and
before January 1, 1989, bear to

[[Page 29603]]

the group's aggregate gross receipts for the same period, or 16
percent (the statutory maximum). The group's fixed-base percentage,
therefore, is 10 percent, which is the lesser of: $150x/$1,500x,
which equals 10 percent, or 16 percent.
(iii) Allocation of the group credit. Under paragraph (c)(2) of
this section, each member's stand-alone entity credit must be
computed using the method that results in the greater stand-alone
entity credit for that member. The stand-alone entity credit for
each of A, B, and C is greater using the method described in section
41(a). Therefore, the stand-alone entity credit for each of A, B,
and C must be computed using the method described in section 41(a).
A's stand-alone entity credit is $20x. B's stand-alone entity credit
is $2x. C's stand-alone entity credit is $11x. The sum of the
members' stand-alone entity credits is $33x. Because the group
credit of $32x is less than the sum of the stand-alone entity
credits of all the members of the group ($33x), the group credit is
allocated among the members of the group based on the ratio that
each member's stand-alone entity credit bears to the sum of the
stand-alone entity credits of all the members of the group. The $32x
group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......... $20x $2x $11x $33x
Allocation Ratio (Stand-Alone 20/33 2/33 11/33
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit........ $32x $32x $32x
Equals: Credit Allocated to Member. $19.39x $1.94x $10.67x $32x
----------------------------------------------------------------------------------------------------------------

Example 2. Group credit exceeds sum of members' stand-alone
entity credits--(i) Facts. D, E, F, and G, all of which are
calendar-year taxpayers, are members of a controlled group. Neither
D, E, F, nor G made any basic research payments for their taxable
year ending December 31, 2004. For purposes of computing the group
credit for the 2004 taxable year (the credit year), D, E, F, and G
had the following:

----------------------------------------------------------------------------------------------------------------
Group
D E F G Aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year Qualified Research $580x $10x $70x $15x $675x
Expenses (QREs).
1984-1988 QREs.................. $500x $25x $100x $25 $650x
1984-1988 Gross Receipts........ $4,000x $5,000x $2000x $10,000x $21,000x
Average Annual Gross Receipts $5,000x $5,000x $2,000x $5,000x $17,000x
for 4 Years Preceding the
Credit Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit--(A) In general. The
research credit allowable to the group is computed as if D, E, F,
and G were one taxpayer. The group credit is equal to 20 percent of
the excess of the group's aggregate credit year QREs ($675x) over
the group's base amount ($526.19x). The group credit is 0.20 x
($675x-$526.19x), which equals $29.76x.
(B) Group's base amount--(1) Computation. The group's base
amount equals the greater of: the group's fixed-base percentage (3.1
percent) multiplied by the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year
($17,000x), or the group's minimum base amount ($337.50x). The
group's base amount, therefore, is $526.19x, which is the greater
of: 0.031 x $17,000x, which equals $526.19x, or $337.50x.
(2) Group's minimum base amount. The group's minimum base amount
is 50 percent of the group's aggregate credit year QREs. The group's
minimum base amount is 0.50 x $675x, which equals $337.50x.
(3) Group's fixed-base percentage. The group's fixed-base
percentage is the lesser of: the ratio that the group's aggregate
QREs for the taxable years beginning after December 31, 1983, and
before January 1, 1989, bear to the group's aggregate gross receipts
for the same period, or 16 percent (the statutory maximum). The
group's fixed-base percentage, therefore, is 3.10 percent, which is
the lesser of: $650x/$21,000x, which equals 3.10 percent, or 16
percent.
(iii) Allocation of the group credit. Under paragraph (c)(2) of
this section, each member's stand-alone entity credit must be
computed using the method that results in the greater stand-alone
entity credit for that member. The stand-alone entity credits for D
($19.46x) and F ($1.71x) are greater using the AIRC method.
Therefore, the stand-alone entity credits for D and F must be
computed using the AIRC method. The stand-alone entity credit for G
($0.50x) is greater using the method described in section 41(a).
Therefore, the stand-alone entity credit for G must be computed
using the method described in section 41(a). E's stand-alone entity
credit computed under either method is zero. The sum of the members'
stand-alone entity credits is $21.67x. Because the group credit of
$29.76x is greater than the sum of the stand-alone entity credits of
all the members of the group ($21.67), each member of the group is
allocated an amount of the group credit equal to that member's
stand-alone entity credit. The excess of the group credit over the
sum of the members' stand alone entity credits ($8.09) is allocated
among the members of the group based on the ratio that each member's
QREs bear to the sum of the QREs of all the members of the group.
The $29.76x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
D E F G Total
----------------------------------------------------------------------------------------------------------------
Group Credit.................... $29.76x
Minus: Sum of Stand-Alone Entity $19.467x $0.00x $1.71x $0.50x $21.67x
Credits.
Equals: Excess Group Credit..... $8.09x
Excess Group Credit............. 8.09x 8.09x 8.09x 8.09x ..............
Multiplied By Allocation Ratio: 580/675 10/675 70/675 15/675 ..............
QREs/Sum of QREs.
Excess Group Credit Allocated... $6.95x $0.12x $0.84x $0.18x ..............
Plus: Stand-Alone Entity Credit. $19.46x $0.00x $1.71x $0.50x ..............
Equals: Credit Allocated to $26.41x $0.12x $2.55x $0.68x $29.76x
Member.
----------------------------------------------------------------------------------------------------------------

Example 3. Consolidated group within a controlled group--(i)
Facts. The facts are the same as in Example 2, except that D and E
file a consolidated return.
(ii) Allocation of the group credit--(A) In general. For
purposes of allocating the controlled group's research credit of
$29.76x among the members of the controlled group, D and E are
treated as a single member of the controlled group.
(B) Computation of stand-alone entity credits. The stand-alone
entity credit for the

[[Page 29604]]

consolidated group is computed by treating D and E as a single
entity. Under paragraph (c)(2) of this section, the stand-alone
entity credit for each member must be computed using the method that
results in the greater stand-alone entity credit for that member.
The stand-alone entity credit for each of the DE consolidated group
($17.55x) and F ($1.71x) is greater using the AIRC method.
Therefore, the stand-alone entity credit for each of the DE
consolidated group and F must be computed using the AIRC method. The
stand-alone entity credit for G ($0.50x) is greater using the method
described in section 41(a). Therefore, the stand-alone entity credit
for G must be computed using the method described in section 41(a).
The sum of the members' stand-alone entity credits is $19.76x.
(C) Allocation of controlled group credit. Because the group
credit of $29.76x is greater than the sum of the stand-alone entity
credits of all the members of the group ($19.76x), each member of
the group is allocated an amount of the group credit equal to that
member's stand-alone entity credit. The excess of the group credit
over the sum of the members' stand alone entity credits ($10.00x) is
allocated among the members of the group based on the ratio that
each member's QREs bear to the sum of the QREs of all the members of
the group. The group credit of $29.76x is allocated as follows:

----------------------------------------------------------------------------------------------------------------
DE F G Total
----------------------------------------------------------------------------------------------------------------
Group Credit....................... $29.76x
Minus: Sum of Stand-Alone Entity $17.55x $1.71x $0.50x $19.76x
Credits.
Equals: Excess Group Credit........ $10.00x
Excess Group Credit................ 10.00x 10.00x 10.00x .................
Multiplied By Allocation Ratio: 590/675 70/675 15/675 .................
QREs/Sum of QREs.
Excess Group Credit Allocated...... $8.74x $1.04x $0.22x .................
Plus: Stand-Alone Entity Credit.... $17.55x $1.71x $0.50x .................
Equals: Credit Allocated to Member. $26.29x $2.75x $0.72x $29.76x
----------------------------------------------------------------------------------------------------------------

(iii) Allocation of the group credit allocated to consolidated
group--(A) In general. The group credit that is allocated to a
consolidated group is allocated among the members of the
consolidated group in accordance with the principles of paragraph
(c) of this section.
(B) Computation of stand-alone entity credits. Under paragraph
(c)(2) of this section, the stand-alone entity credit for each
member of the consolidated group must be computed using the method
that results in the greater stand-alone entity credit for that
member. The stand-alone entity credit for D ($19.46x) is greater
using the AIRC method. Therefore, the stand-alone entity credit for
D must be computed using the AIRC method. The stand-alone entity
credit for E is zero under either method. The sum of the stand-alone
entity credits of the members of the consolidated group is $19.46x.
(C) Allocation among members of consolidated group. Because the
amount of the group credit allocated to the consolidated group
($26.29x) is greater than $19.46x, the sum of the stand-alone entity
credits of all the members of the consolidated group, the amount of
the group credit allocated to the consolidated group is allocated to
each member of the consolidated group in an amount equal to the
member's stand-alone entity credit. The excess of the group credit
allocated to the consolidated group over the sum of the consolidated
group members' stand alone entity credits ($6.83x) is allocated
among the members of the consolidated group based on the ratio that
each member's QREs bear to the sum of the QREs of all the members of
the consolidated group. The group credit of $26.29x allocated to the
DE consolidated group is allocated between D and E as follows:

----------------------------------------------------------------------------------------------------------------
D E Total
----------------------------------------------------------------------------------------------------------------
Group Credit......................... $26.29x
Minus: Sum of Stand-Alone Entity $19.46x $0.00x $19.46x
Credits.
Excess Group Credit.................. $6.83x
Excess Group Credit.................. 6.83x 6.83x
Multiplied By Allocation Ratio: QREs/ 580/590 10/590
Sum of QREs.
Excess Group Credit Allocated........ $6.71x $0.12x
Plus: Stand-Alone Entity Credit...... $19.46x $0.00x
Equals: Credit Allocated to Member... $26.17x $0.12x $26.29x
----------------------------------------------------------------------------------------------------------------

Example 4. Member is a start-up company--(i) Facts. H, I, and J,
all of which are calendar-year taxpayers, are members of a
controlled group. The first taxable year for which J has both QREs
and gross receipts begins after December 31, 1983, therefore, J is a
start-up company under section 41(c)(3)(B)(i). The first taxable
year for which H and I had both QREs and gross receipts began before
December 31, 1983, therefore, H and I are not start-up companies
under section 41(c)(3)(B)(i). Neither H, I, nor J made any basic
research payments during the 2004 taxable year. For purposes of
computing the group credit for the 2004 taxable year (the credit
year), H, I, and J had the following:

----------------------------------------------------------------------------------------------------------------
H I J Group Aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................... $200x $20x $50x $270x
1984-1988 QREs..................... $55x $15x $0x $70x
1984-1988 Gross Receipts........... $1,000x $400x $0x $1,400x
Average Annual Gross Receipts for 4 $1,200x $200x $0x $1,400x
Years Preceding the Credit Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit--(A) In general. The
research credit allowable to the group is computed as if H, I, and J
were one taxpayer. The group credit is equal to 20 percent of the
excess of the group's aggregate credit year QREs ($270x) over the
group's base amount ($135x). The group credit is 0.20 x ($270x-
$135x), which equals $27x.
(B) Group's base amount--(1) Computation. The group's base
amount equals the greater of: The group's fixed-base percentage (5
percent) multiplied by the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year
($1,400x), or the group's minimum base amount ($135x). The group's
base amount, therefore, is $135x, which is

[[Page 29605]]

the greater of: 0.05 x $1,400x, which equals $70x, or $135x.
(2) Group's minimum base amount. The group's minimum base amount
is 50 percent of the group's aggregate credit year QREs. The group's
minimum base amount is 0.50 x $270x, which equals $135x.
(3) Group's fixed-base percentage. Because the first taxable
year in which at least one member of the group has QREs and at least
one member of the group has gross receipts does not begin after
December 31, 1983, the group is not a start-up company. Therefore,
the group's fixed-base percentage is the lesser of: the ratio that
the group's aggregate QREs for the taxable years beginning after
December 31, 1983, and before January 1, 1989, bear to the group's
aggregate gross receipts for the same period, or 16 percent (the
statutory maximum). The group's fixed-base percentage, therefore, is
5 percent, which is the lesser of: $70x/$1,400x, which equals 5
percent, or 16 percent.
(iii) Allocation of the group credit. Under paragraph (c)(2) of
this section, the stand-alone entity credit for each member of the
group must be computed using the method that results in the greater
stand-alone entity credit for that member. The stand-alone entity
credits for H ($20x), I ($2x), and J ($5x) are greater using the
method described in section 41(a). Therefore, the stand-alone entity
credits for each of H, I, and J must be computed using the method
described in section 41(a). The sum of the stand-alone entity
credits of the members of the group is $27x. Because the group
credit of $27x is equal to the sum of the stand-alone entity credits
of all the members of the group ($27x), the group credit is
allocated among the members of the group based on the ratio that
each member's stand-alone entity credit bears to the sum of the
stand-alone entity credits of all the members of the group. The
group credit of $27x is allocated as follows:

----------------------------------------------------------------------------------------------------------------
H I J Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......... $20x $2x $5x $27x
Allocation Ratio (Stand-Alone 20/27 2/27 5/27
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit........ $27x $27x $27x
Equals: Credit Allocated to Member. $20x $2x $5x $27x
----------------------------------------------------------------------------------------------------------------

Example 5. Group is a start-up company--(i) Facts. K, L, and M,
all of which are calendar-year taxpayers, are members of a
controlled group. The taxable year ending on December 31, 1999, is
the first taxable year in which each of K, L, and M had both QREs
and gross receipts. Therefore, the taxable year ending on December
31, 1999, is the first taxable year in which at least one member of
the group had QREs and at least one member of the group had gross
receipts. The 2004 taxable year is the fifth taxable year beginning
after December 31, 1993, for which at least one member of the group
had QREs. Neither K, L, nor M made any basic research payments
during the 2004 taxable year. For purposes of computing the group
credit for the 2004 taxable year (the credit year), K, L, and M had
the following:

----------------------------------------------------------------------------------------------------------------
K L M Group Aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................... $255x $25x $100x $380x
1984-1988 QREs..................... $0x $0x $0x $0x
1984-1988 Gross Receipts........... $0x $0x $0x $0x
Average Annual Gross Receipts for 4 $1,600x $340x $300x $2,240x
Years Preceding the Credit Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit--(A) In general. The
research credit allowable to the group is computed as if K, L, and M
were one taxpayer. The group credit is equal to 20 percent of the
excess of the group's aggregate credit year QREs ($380x) over the
group's base amount ($190x). The group credit is 0.20 x ($380x-
$190x), which equals $38x.
(B) Group's base amount--(1) Computation. The group's base
amount equals the greater of: the group's fixed-base percentage (3
percent) multiplied by the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year
($2,240x), or the group's minimum base amount ($190x). The group's
base amount, therefore, is $190x, which is the greater of: 0.03 ``
$2,240x, which equals $67.20x, or $190x.
(2) Group's minimum base amount. The group's minimum base amount
is 50 percent of the group's aggregate credit year QREs. The group's
minimum base amount is 0.50 `` $380x, which equals $190x.
(3) Group's fixed-base percentage. Because the first taxable
year in which at least one member of the group has QREs and at least
one member of the group has gross receipts begins after December 31,
1983, the group is treated as a start-up company under section
41(c)(3)(B)(i) and paragraph (b)(2)(i) of this section. Because the
2004 taxable year is the fifth taxable year beginning after December
31, 1993, for which at least one member of the group had QREs, under
section 41(c)(3)(B)(ii)(I), the group's fixed-base percentage is 3
percent.
(iii) Allocation of the group credit. Under paragraph (c)(2) of
this section, the stand-alone entity credit for each member of the
consolidated group must be computed using the method that results in
the greater stand-alone entity credit for that member. The stand-
alone entity credit for each of K ($25.5x), L ($2.5x), and M ($10x)
is greater using the method described in section 41(a). Therefore
the stand-alone entity credits for each of K, L, and M must be
computed using the method described in section 41(a). The sum of the
stand-alone entity credits of all the members of the group is $38x.
Because the group credit of $38x is equal to sum of the stand-alone
entity credits of all the members of the group ($38x), the group
credit is allocated among the members of the group based on the
ratio that each member's stand-alone entity credit bears to the sum
of the stand-alone entity credits of all the members of the group.
The $38x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
K L M Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......... $25.5x $2.5x $10x $38x
Allocation Ratio (Stand-Alone 25.5/38 2.5/38 10/38
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit........ $38x $38x $38x
Equals: Credit Allocated to Member. $25.5x $2.5x $10x $38x
----------------------------------------------------------------------------------------------------------------

Example 6. Group alternative incremental research credit--(i)
Facts. N, O, and P, all of which are calendar-year taxpayers, are
members of a controlled group. The research credit under section
41(a) is not allowable to the group for the 2004 taxable year
because

[[Page 29606]]

the group's aggregate QREs for the 2004 taxable year are less than
the group's base amount. The group credit is computed using the AIRC
rules of section 41(c)(4). For purposes of computing the group
credit for the 2004 taxable year (the credit year), N, O, and P had
the following:

----------------------------------------------------------------------------------------------------------------
N O P Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................... $0x $20x $110x $130x
Average Annual Gross Receipts for 4 $1,200x $200x $300x $1,700x
Years Preceding the Credit Year.
----------------------------------------------------------------------------------------------------------------

(ii) Computation of the group credit. The research credit
allowable to the group is computed as if N, O, and P were one
taxpayer. The group credit is equal to the sum of: 2.65 percent of
so much of the group's aggregate QREs for the taxable year as
exceeds 1 percent of the group's aggregate average annual gross
receipts for the 4 taxable years preceding the credit year, but does
not exceed 1.5 percent of such average; 3.2 percent of so much of
the group's aggregate QREs as exceeds 1.5 percent of such average
but does not exceed 2 percent of such average; and 3.75 percent of
so much of such QREs as exceeds 2 percent of such average. The group
credit is [0.0265 - [($1,700x x 0.015)-($1,700x x 0.01)]] + [0.032 -
[($1,700x x 0.02)--($1,700x x 0.015)]] + [0.0375 - [$130x-($1,700x -
0.02)]], which equals $4.10x.
(iii) Allocation of the group credit. Under paragraph (c)(2) of
this section, the stand-alone entity credit for each member of the
group must be computed using the method that results in the greater
stand-alone entity credit for that member. The stand-alone entity
credit for N is zero under either method. The stand-alone entity
credit for each of O ($0.66x) and P ($3.99x) is greater using the
AIRC method. Therefore, the stand-alone entity credits for each of O
and P must be computed using the AIRC method. The sum of the stand-
alone entity credits of the members of the group is $4.65x. Because
the group credit of $4.10x is less than the sum of the stand-alone
entity credits of all the members of the group ($4.65x), the group
credit is allocated among the members of the group based on the
ratio that each member's stand-alone entity credit bears to the sum
of the stand-alone entity credits of all the members of the group.
The $4.10x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
N O P Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......... $0.00x $0.66x $3.99x $4.65x
Allocation Ratio (Stand-Alone 0/4.65 0.66/4.65 3.99/4.65
Entity Credit/Sum of Stand-Alone
Entity Credits).
Multiplied by: Group Credit........ $4.10x $4.10x $4.10x
Equals: Credit Allocated to Member $0.00x $0.58x $3.52x $4.10x
----------------------------------------------------------------------------------------------------------------

(f) For taxable years beginning before January 1, 1990. For taxable
years beginning before January 1, 1990, see Sec. 1.41-6 as contained
in 26 CFR part 1, revised April 1, 2005.
(g) Tax accounting periods used--(1) In general. The credit
allowable to a member of a controlled group is that member's share of
the group credit computed as of the end of that member's taxable year.
In computing the group credit for a group whose members have different
taxable years, a member generally should treat the taxable year of
another member that ends with or within the credit year of the
computing member as the credit year of that other member. For example,
Q, R, and S are members of a controlled group of corporations. Both Q
and R are calendar year taxpayers. S files a return using a fiscal year
ending June 30. For purposes of computing the group credit at the end
of Q's and R's taxable year on December 31, S's fiscal year ending June
30, which ends within Q's and R's taxable year, is treated as S's
credit year.
(2) Special rule when timing of research is manipulated. If the
timing of research by members using different tax accounting periods is
manipulated to generate a credit in excess of the amount that would be
allowable if all members of the group used the same tax accounting
period, then the appropriate Internal Revenue Service official in the
operating division that has examination jurisdiction of the return may
require each member of the group to calculate the credit in the current
taxable year and all future years as if all members of the group had
the same taxable year and base period as the computing member.
(h) Membership during taxable year in more than one group. A trade
or business may be a member of only one group for a taxable year. If,
without application of this paragraph, a business would be a member of
more than one group at the end of its taxable year, the business shall
be treated as a member of the group in which it was included for its
preceding taxable year. If the business was not included for its
preceding taxable year in any group in which it could be included as of
the end of its taxable year, the business shall designate in its timely
filed (including extensions) return the group in which it is being
included. If the return for a taxable year is due before July 1, 1983,
the business may designate its group membership through an amended
return for that year filed on or before June 30, 1983. If the business
does not so designate, then the appropriate Internal Revenue Service
official in the operating division that has examination jurisdiction of
the return will determine the group in which the business is to be
included.
(i) Intra-group transactions--(1) In general. Because all members
of a group under common control are treated as a single taxpayer for
purposes of determining the research credit, transfers between members
of the group are generally disregarded.
(2) In-house research expenses. If one member of a group performs
qualified research on behalf of another member, the member performing
the research shall include in its QREs any in-house research expenses
for that work and shall not treat any amount received or accrued as
funding the research. Conversely, the member for whom the research is
performed shall not treat any part of any amount paid or incurred as a
contract research expense. For purposes of determining whether the in-
house research for that work is qualified research, the member
performing the research shall be treated as carrying on any trade or
business carried on by the member on whose behalf the research is
performed.
(3) Contract research expenses. If a member of a group pays or
incurs contract research expenses to a person outside the group in
carrying on the member's trade or business, that member shall include
those expenses as QREs. However, if the expenses are not

[[Page 29607]]

paid or incurred in carrying on any trade or business of that member,
those expenses may be taken into account as contract research expenses
by another member of the group provided that the other member--
(i) Reimburses the member paying or incurring the expenses; and
(ii) Carries on a trade or business to which the research relates.
(4) Lease payments. The amount paid or incurred to another member
of the group for the lease of personal property owned by a member of
the group is not taken into account for purposes of section 41. Amounts
paid or incurred to another member of the group for the lease of
personal property owned by a person outside the group shall be taken
into account as in-house research expenses for purposes of section 41
only to the extent of the lesser of--
(i) The amount paid or incurred to the other member; or
(ii) The amount of the lease expenses paid to the person outside
the group.
(5) Payment for supplies. Amounts paid or incurred to another
member of the group for supplies shall be taken into account as in-
house research expenses for purposes of section 41 only to the extent
of the lesser of--
(i) The amount paid or incurred to the other member; or
(ii) The amount of the other member's basis in the supplies.
(j) Effective date. These temporary regulations are applicable for
taxable years ending on or after May 24, 2005. Generally, a taxpayer
may use any reasonable method of computing and allocating the credit
for taxable years beginning before the date these regulations are
published in the Federal Register as final regulations. However,
paragraph (b), relating to the computation of the group credit, and
paragraph (c), relating to the allocation of the group credit, will
apply to taxable years ending on or after December 29, 1999, if the
members of a controlled group, as a whole, claimed more than 100
percent of the amount that would be allowable under paragraph (b). In
the case of a controlled group whose members have different taxable
years and whose members use inconsistent methods of allocation, the
members of the controlled group shall be deemed to have, as a whole,
claimed more than 100 percent of the amount that would be allowable
under paragraph (b).

Sec. 1.41-8 [Removed]

0
Par. 5. Section 1.41-8 is removed.

0
Par. 6. Section 1.41-8T is added to read as follows:

Sec. 1.41-8T Special rules for taxable years ending on or after
January 3, 2001 (temporary).

(a) Alternative incremental credit. At the election of the
taxpayer, the credit determined under section 41(a)(1) equals the
amount determined under section 41(c)(4).
(b) Election--(1) In general. A taxpayer may elect to apply the
provisions of the alternative incremental research credit (AIRC) in
section 41(c)(4) for any taxable year of the taxpayer beginning after
June 30, 1996. If a taxpayer makes an election under section 41(c)(4),
the election applies to the taxable year for which made and all
subsequent taxable years unless revoked in the manner prescribed in
paragraph (b)(3) of this section.
(2) Time and manner of election. An election under section 41(c)(4)
is made by completing the portion of Form 6765, ``Credit for Increasing
Research Activities,'' relating to the election of the AIRC, and
attaching the completed form to the taxpayer's timely filed (including
extensions) original return for the taxable year to which the election
applies. An election under section 41(c)(4) may not be made on an
amended return.
(3) Revocation. An election under this section may not be revoked
except with the consent of the Commissioner. A taxpayer is deemed to
have requested, and to have been granted, the consent of the
Commissioner to revoke an election under section 41(c)(4) if the
taxpayer completes the portion of Form 6765 relating to the regular
credit and attaches the completed form to the taxpayer's timely filed
(including extensions) original return for the year to which the
revocation applies. An election under section 41(c)(4) may not be
revoked on an amended return.
(4) Special rules for controlled groups--(i) In general. In the
case of a controlled group of corporations, all the members of which
are not included on a single consolidated return, the designated member
must make (or revoke) an election under section 41(c)(4) on behalf of
the members of the group. An election (or revocation) by the designated
member under this paragraph (b)(4) of this section shall be binding on
all the members of the group for the credit year to which the election
(or revocation) relates.
(ii) Designated member. For purposes of this paragraph (b)(4) of
this section, for any credit year, the term designated member means
that member of the group that is allocated the greatest amount of the
group credit under paragraph (c) of Sec. 1.41-6T. If the members of a
group compute the group credit using different methods (either the
method described in section 41(a) or the AIRC method of section
41(c)(4)) and at least two members of the group qualify as the
designated member, then the term designated member means that member
that computes the group credit using the method that yields the greater
group credit. For example, A, B, C, and D are members of a controlled
group but are not members of a consolidated group. For the 2005 taxable
year, the group credit using the method described in section 41(a) is
$10x. Under this method, A would be allocated $5x of the group credit,
which would be the largest share of the group credit under this method.
For the 2005 taxable year, the group credit using the AIRC method is
$15x. Under the AIRC method, C would be allocated $5x of the group
credit, which is the largest share of the group credit computed using
the AIRC method. Because the group credit is greater using the AIRC
method and C is allocated the greatest amount of credit under that
method, C is the designated member. Therefore, C's section 41(c)(4)
election is binding on all the members of the group for the 2005
taxable year.
(5) Effective date. These temporary regulations are applicable for
taxable years ending on or after May 24, 2005.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.

Approved: May 16, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-10247 Filed 5-23-05; 8:45 am]
BILLING CODE 4830-01-P