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R&D: Reward the Result as Well as the Effort
Posted by David M. Katz | CFO.com | US
August 1, 2011 5:26 PM ET

Now may not be the best time to recommend an added tax break for corporations. Then again, it just might be.

With the credit-limit fiasco apparently headed toward resolution, Congress might have some inclination to turn their toward job creation. And with stimulus packages off the table and tax reform very much in the air, part of the jobs effort should include rewarding U.S. companies with effective research and development programs.

"R&D?" you might ask, perhaps with a raised eyebrow. "Don't we already reward it with a tax credit and a tax deduction?" We do. But before Congress had disappeared into its current maelstrom, it was contemplating President Obama's proposed budget for 2012. In that budget was a proposal to tax intangible assets produced abroad by U.S. companies--thereby removing some of the sweetener from the R&D tax break.

The plan, known as the "excess returns" proposal, would tax part of the income of companies that transfer patents, licenses, and the like to subsidiaries in countries with much lower tax rates than here. The Obama administration believes the plan "may reduce the incentive for taxpayers to engage in these transactions" and thus ultimately return revenues to Treasury, according to report published in June by the Joint Committee on Taxation.

That, however, is a stick. And corporations, like the humans who construct them, respond much better to a carrot, says Jim Shanahan, a leader of the research tax credit consulting practice for PricewaterhouseCoopers in Washington, D.C.

In exchange for a bit of added tax revenue, the plan could have the diasastrous effect of spurring U.S. companies to site their R&D offshore from the outset. Instead of taxing foreign-source income related to intangibles, why not reward the generation of such income on these shores?

Besides providing the current tax credit companies get for investing in the effort and people needed to research such things as new drugs and new technologies, this country should provide tax breaks to companies that actually produce successful processes from all that R&D, Shanahan told me in an recent interview for an article on the tax credit that will appear in the October issue of CFO.

The PwC consultant urges finance chiefs to push for a credit similar to ones being contemplated in the United Kingdom and other European countries. In June, the U.K. Treasury released what's known as its "patent box regime proposal" for public debate. Likely to be enacted, the bill envisions a whopping cut in the corporate tax rate for profit generated in the United Kingdom that stems from patents.

Indeed, says Shanahan, a proposal here should include more than just patents. Preferring the more-inclusive term "innovation box" to "patent box," he'd include trade secrets, knowhow, copyrights, and other intellectual property not protected by patents. To further spark innovation--and maybe add fuel to an economic recovery--the incentive could be applied to domestic manufacturing of products spawned by successful R&D.

Overall, such incentives could make the nation a very attractive place to not only perform R&D, but also to keep the intellectual property here, contends Shanahan. In the upcoming Congressional debate on tax reform, the innovation box should be a keeper.

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