IRS drops intercompany gross receipts issue in research credit case

Despite a weak economic environment, U.S pharmaceutical and biotech companies continue to invest significantly in research and development in the pursuit of new life-saving and life-enhancing medicines. As such, the industry stands to benefit greatly from a recent IRS "Notice of No Objection and Objection to the Motion for Partial Summary Judgement on Research Credit Issues" filing with respect to the exclusion of intercompany transaction receipts from foreign members of a controlled group as part of the calculation of its section 41 research credit, as further described below. Hopefully, such filing is an indication that the IRS will no longer pursue this issue. The IRS, however, has not to date issued general guidance on this issue.

An illustration of a potential benefit from such action is that the uncertainty surrounding the interplay of the research credit with the repatriation provision under Internal Revenue Code section 965, based on inconsistent IRS guidance, would effectively be removed. During 2005, many pharmaceutical and life sciences companies repatriated billions of dollars (so-called homeland dividends) from their CFCs under section 965, which had been enacted as part of the American Jobs Creation Act of 2004. Under the reasoning of an IRS Chief Counsel Advice issued in 2002, such section 965 dividends could be excluded from the gross receipts calculation, which had a beneficial effect on the overall calculation of the credit. However, another IRS Chief Counsel Advice issued several years later appeared to reach an opposite conclusion, and as a result, had the effect of severely reducing or in some cases eliminating a taxpayer's credit.

In light of the many other existing complexities with respect to the calculation and documentation of the credit, the new IRS filing on this issue, which has a tortured history, is certainly welcome news for pharmaceutical and life sciences companies, who should immediately assess the potential impact of such action on their existing calculations, as well as on any decisions made to choose the alternative simplified method (ASC) in lieu of the regular credit.

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