Development costs; specially-built manufacturing systems. The taxpayer’s costs to develop and de­sign a specially-built automated manufacturing system for a cus­tomer’s specific order at the tax­payer’s risk are deductible as re­search and experimental expendi­tures, even though each product design results in the production of only one machine system.

Rev. Rul. 73-275

Advice has been requested concern­ing the treatment, for Federal income tax purposes, of certain expenditures under the circumstances described below.


A corporation is engaged in the de­sign, manufacture, and sale for fixed prices of specially-built automated manufacturing systems that will pro­duce, or perform certain operations on, a customer-designed metal part in accordance with the customer’s speci­fications as to its rate of production, tolerances and efficiency.

Each automated system is custom designed, developed and produced for a customer’s specific order at the cor­poration’s risk. A system comprises the integration into one continuous opera­tion of known machines, precision ma­chine tools, transfer mechanisms, and related equipment.

The sole function of the product en­gineering department of the corpora­tion is to develop and design, through research and experimentation, the concept of the products manufactured and sold by the corporation. The de­partment produces blueprints that it turns over to the manufacturing de­partment.

The question presented is whether the expenditures connected with the product engineering department, in­cluding salaries and overhead, are re­search and development expenditures within the meaning of section 174 of the Internal Revenue Code of 1954.

Section 174 of the Code provides, in general, that a taxpayer may treat re­search or experimental expenditures in connection with his trade or business as expenses that are not chargeable to his capital account. Such expenditures are allowable as a deduction in the taxable year paid or incurred or, under certain circumstances, they may be deferred and amortized.

Section 1.174-2(a)(1) of the Income Tax Regulations provides that the term “research or experimen­tal expenditures” as used in section 174 of the Code means expenditures that represent research and develop­ment costs in the experimental or lab­oratory sense and that the term in­cludes generally all such costs incident to the development of an experimental or pilot model, a plant process, a product, a formula, an invention or similar property. Section 174 covers costs incurred in developing the concept of a product as opposed to the product itself. Martin Mayrath , 41 T.C. 582 (1964), aff’d , 357 F.2d 209 (566 cr. 1966).

In the instant case, the product en­gineering department develops and de­signs, through research and experi­mentation, the plan or model from which the corporation produces each machine system. Such development and design is undertaken at the corpo­ration’s risk.

Accordingly, in the instant case the costs of the product engineering de­partment are expenditures for re­search and development within the meaning of section 174 of the Code, even though each product design re­sults in the production of only one machine system.

Any change in the taxpayer’s pres­ent method of accounting for research and experimental expenditures is a change in method of accounting to which the provisions of section 1.174-3(b)(3) of the regulations apply.

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