In Procter & Gamble Co. v. United States, No. 1:08-cv-00608-TSB (Jun. 25, 2010), the District Court for the Southern District of Ohio concluded that the taxpayer did not have to include gross receipts from sales to a controlled foreign corporation in computing its research tax credit. The implications of this conclusion require some further thought.
With the research tax credit, generally, a taxpayer will receive a larger research tax credit in the current tax year if its gross receipts are more in its base period tax years (usually 1984 thru 1989) and its gross receipts are less in more recent tax years (the four years prior to the year in which the research tax credit is claimed).
Many American companies have increased their foreign activities since the late 1980s. Thus, these taxpayers would have higher gross receipts in their recent tax years if sales to their controlled foreign corporations counted as gross receipts for purposes of the current tax year’s research tax credit. This would result in a lower research tax credit for the taxpayer in the current year. This is why the Procter & Gamble Co. case is important. It stands for the proposition that companies who have increased foreign activities will not have a reduced research tax credit as a result of their foreign activities (the result is different if the taxpayer operates as a foreign branch rather than a controlled foreign corporation per the Deere & Co. case).
The IRS had previously issued legal guidance that reached the opposite conclusion, and it has enforced this position in a number of audits and appeals. Taxpayers who have had their research tax credits adjusted on audit and in appeals should contact their tax advisers to see how this case impacts their current and past research tax credits.