Minnesota Tax Court addresses key R&D credit computation issues

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September 2018

UPDATE: The proposed regulation was published in the Texas Register on August 30, 2019, and effective September 4, 2019. The final regulation contained the language summarized below.

UPDATE: On July 31, 2019, the Minnesota Supreme Court affirmed the Tax Court decision below, which held that the Minnesota Research & Development Credit (Minnesota R&D Credit) incorporates the federal minimum base amount limitation in IRC Section 41(c)(2). Thus, the 50% current year R&D expense limitation applies in Minnesota.

The Court further upheld the Tax Court’s conclusion that the fixed-base percentage used to compute the Minnesota R&D Credit base amount is calculated using federal vs. Minnesota aggregate gross receipts in the denominator. An increased denominator results in a decreased base amount, which results in an increased credit, subject to the minimum base amount limitation discussed above.

In regard to the incorporation of the federal minimum base amount, unlike the Tax Court, the Minnesota Supreme Court found the Taxpayers' interpretation was reasonable. However, the Court found the Commissioner's interpretation reasonable as well, thus the statute was found to be ambiguous. The Court resorted to legislative intent, and determined that the better interpretation of the statute was that the legislature intended to incorporate the federal minimum base amount.

The takeaway

It is unknown whether IBM, General Mills, or the Commissioner will appeal the rulings in these cases.  If the decision stands, it provides guidance regarding the computation of the Minnesota R&D Credit.  Importantly, it means that the tax form used to calculate the credit through the 2016 tax year (Minnesota Schedule RD) is not correct, in part.  Federal aggregate gross receipts must be used to compute the fixed-base percentage, not Minnesota aggregate gross receipts, as the form suggests.  Taxpayers with Minnesota QREs should consider whether to recompute their Minnesota R&D Credit for all open periods through tax year 2016 to determine if they qualify for an increased credit.

In 2017, the Minnesota Legislature amended Minn. Stat. § 290.068 to modify the definition of aggregate gross receipts.  Minn. Stat. § 290.068, subd. 2(c) now reads:

(c) “Base amount” means base amount as defined in section 41 (c) of the Internal Revenue Code, except that the average annual gross receipts and aggregate gross receipts must be calculated using Minnesota sales or receipts under section 290.191 and the definitions contained in paragraphs (a) and (b) shall apply.  (Emphasis added.)

Effective for tax years beginning after December 31, 2016, taxpayers must use Minnesota gross receipts to compute the Minnesota fixed-base percentage.

All parties to these cases have a right to appeal to the Minnesota Supreme Court within 60 days of a final order for judgment from the Minnesota Tax Court.  The reasoning and conclusions of the Tax Court as outlined in this Insight could be subject to review on appeal.

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Peter Michalowski

Peter Michalowski

State and Local Tax Leader, PwC US

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