An election to treat research and experimental expenses as deferred expenses is made where a deduction for a portion of such expenses is claimed on a tax return even though an election statement was not filed with the return; the election also applies to subsequent expenditures.
Rev. Rul. 71-136
Advice has been requested regard¬≠ing the proper application of section 174 of the Internal Revenue Code of 1954 under the circumstances de¬≠scribed below.
The taxpayer expended 20x dollars for research and experimental expenses in connection with product X dur¬≠ing the taxable year ended Decem¬≠ber 31, 1964, its first year of operation. The taxpayer’s books and financial statements for 1964 reflected a deduc¬≠tion of one-fifth of the amount so ex¬≠pended as amortization for the year. A deduction of one-fifth of the amount expended was claimed as a deduction on the taxpayer’s Federal income tax return for 1964 and each of the four succeeding years. The return for 1964 did not contain a written statement in the form required by section 1.174-(b)(1) of the Income Tax Regulations regarding an election to amortize the expenditures.
During the taxable year ended December 31, 1968, the taxpayer expended 30x dollars for research and experimental expenses in connection with a new product Y. Such amount was deferred by the taxpayer on its books and one-fifth of this amount was amortized and claimed as a deduction on the taxpayer’s Federal income tax return for 1968.
In 1969 the taxpayer expended an additional 10x dollars for research and experimental expenditures in connec¬≠tion with product Y. Part of such expenditure was expensed and part was deferred by the taxpayer for Fed¬≠eral income tax purposes in 1969.
The taxpayer did not request per¬≠mission to change his method of treat¬≠ment of research and experimental expenditures for 1968 with respect to a new product Y.
The question presented is whether a valid election to defer research and experimental expenses was made by the taxpayer in 1964, pursuant to section 1.174-4 of the regulations, and further, whether, under the circum¬≠stances described, section 174 of the Code was properly applied in 1968 and 1969 with respect to the research and experimental expenditures made in 1968 and 1969.
Section 1.174-1 of the regulations provides, in part, that research and experimental expenditures may be treated as expenses not chargeable to capital account and deducted in the year in which they are paid or incurred (section 1.174-3), or they may be deferred and amortized (section 1.174-4). Such expenditures which are neither treated as expenses nor deferred and amortized under section 174 of the Code must be charged to capital account.
Section 1.174-4(a)(1) of the regu¬≠lations provides, in general, that if a taxpayer has not adopted the method provided in section 174(a) of the Code of treating research or experimental expenditures paid or incurred by him in connection with his trade or business as currently deductible expenses, he may elect to treat such expenditures as deferred expenses under section 174(b) of the Code.
Section 1.174-4(a)(5) of the regu¬≠lations provides, in part, that the elec¬≠tion shall apply for the taxable year for which the election is made and for all subsequent taxable years, unless a change to a different treatment is authorized by the Commissioner of Internal Revenue under section 174(b)(2) of the Code. In no event will the taxpayer be permitted to treat part of the expenditures with respect to a particular project as deferred ex¬≠penses under section 174(b) and to adopt a different method of treating the balance of the expenditures relat¬≠ing to the same project for the same taxable year.
Section 1.174-4(b)(1) of the regu¬≠lations provides, in part, that the elec¬≠tion under section 174(b) of the Code shall be made by attaching a statement to the taxpayer’s return for the first taxable year to which the election is applicable. The statement shall be signed by the taxpayer and shall contain six enumerated items of information.
Section 1.174-4(b)(2) of the regu¬≠lations provides, in effect, that permis¬≠sion to change to a different method of treating research and experimental expenditures or to a different period of amortization for deferred expenses shall be obtained from the Commis¬≠sioner of Internal Revenue by filing certain enumerated information in a written application no later than the end of the first taxable year in which the different method or different amortization period is to be used.
Although the taxpayer in the instant case did not file a formal statement with his Federal income tax return for the year 1964, electing to treat research and experimental expenses as deferred expenses under section 174(b) of the Code, as required by section 1.174-4(b)(1) of the regulations, he treated such expenditures on the tax return that he filed as if he had elected to defer such expenses by deducting only one-fifth of the amount expended. Therefore, this amounted to a suffi¬≠cient election to defer such expendi¬≠tures. Kentucky Utilities Co. v. Glenn, 394 F.2d 631 (1968). The cited case involved a similar election, under sec¬≠tion 266 of the Code (relating to taxes and carrying charges.) The court held that the treatment of certain taxes on the tax return filed as if an election to capitalize had been made amounted to a sufficient election to capitalize rather than to expense the taxes in question.
Similarly, it is held that in the instant case the taxpayer made a valid election to defer research and experimental expenses in 1964. Since the taxpayer did not receive permission to change to a different method for 1968, the year in which research and experimental expenditures were made in connection with a new product Y, the election made in 1964 by the taxpayer applies to the expenditures made in 1968 and 1969 with respect to product Y. The taxpayer properly deferred and amor¬≠tized such expenditures made in 1968 and part of such expenditures made in 1969, but improperly expensed a part of such expenditures made in 1969. The part expensed should also have been deferred and amortized.