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Checkpoint Contents Federal Library Federal Source Materials IRS Rulings & Releases Private Letter Rulings & TAMs, FSAs, SCAs, CCAs, GCMs, AODs & Other FOIA Documents Private Letter Rulings & Technical Advice Memoranda (1950 to Present) 1995 PLR/TAM 9522057 - 9522001 TAM 9522001 -- IRC Sec(s). 41, 6/02/1995

Technical Advice Memoranda

Te chnical Adv ice Me m orandum 9522001, 6/02/1995, IRC Se c(s). 41

UIL No. 0041.51-03

He adnote :
Reference(s): Code Sec. 41; The Service has ruled in technical advice that firm's activities relating to developing and improving food products and food manufacturing techniques may constitute qualified research under section 41. Copyright 1995, Tax Analysts.

Full Te x t:
Date: December 21, 1994 Control No.: TR-32-222-94 Taxpayer's Name : *** Taxpayer's Address : *** Taxpayer's Identification No. : *** Years Involved : *** Date of Conference : *** LEGEND: Taxpayer = ***
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x = *** y = *** z = ***

ISSUE
Are Taxpayer's research activities related to the development of new food products and manufacturing techniques, and the improvement of existing food products and manufacturing techniques excluded from qualifying for the credit for increasing research activities because research relating to style, taste, cosmetic, or seasonal design factors is ineligible for the credit under section 41(d)(3)(B)?

FACTS
Taxpayer develops and manufactures food products. During the tax years x, y, and z, Taxpayer's research and development department engaged in various activities aimed at developing new food products and manufacturing techniques, and improving existing food products and manufacturing techniques. The goal of Taxpayer's various research activities was to develop finished food products, with acceptable taste and nutritional value, for use as a source of energy. Taxpayer provided an example of its research activities to develop a product. In the example, Taxpayer had an idea for a target product but did not know how the various components of the product would interact when Taxpayer tried to produce the product on a large scale. The objectives of the project were to develop the functional design specifications of the target food product and to develop the manufacturing processes for the target food product. In order to develop the functional design specifications and the manufacturing process for the target food product, Taxpayer conducted various experiments to determine the proper processing conditions for the product and its various components, and to determine how the various product ingredients interacted. Taxpayer used food chemistry principles to determine the order that the ingredients must be added together. Taxpayer made formulation modifications in order to use some existing equipment to manufacture the target product. However, Taxpayer also developed some new equipment to use in the manufacturing process. In addition, Taxpayer conducted various experiments to determine a proper heat transfer rate for the product and built a customized oven to be used in the product manufacturing process. In assembling the target product, Taxpayer developed new equipment and techniques. Taxpayer built some prototype units and tested the prototypes in a pilot plant. After acceptable equipment designs were developed, full-scale production units were built. On its tax returns for x, y, and z, Taxpayer treated these activities as qualified research and claimed the credit for increasing research activities. On examination, the Internal Revenue Service (Service) proposed to disallow some of the Taxpayer's credit for increasing research activities on the theory that any research related to sensory taste does not qualify for the research credit under section 41(d)(3)(B). The Service has not yet completed its examination of whether the activities that the Taxpayer treated as qualified research activities satisfied the other components of the definition of qualified research in section 41(d)(1). Thus, for purposes of this technical advice
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request, we assume Taxpayer's research activities satisfy the other components of the section 41(d)(1) definition of qualified research. In addition, market research, consumer surveys, or other types of costs described in section 41(d)(4)(D) are not at issue in this technical advice request because Taxpayer apparently did not include those types of costs in its qualified research expenses.

LAW
Section 41 provides a credit against tax for increasing research activities. The credit is an incremental credit equal to the sum of 20 percent of the excess of the taxpayer's qualified research expenses for the taxable year, over a base amount, and 20 percent of the taxpayer's basic research payments. The term qualified research expenses is defined in section 41(b). Qualified research expenses include in-house expenses and contract research expenses which are paid or incurred by the taxpayer during the taxable year in carrying on any trade or business of the taxpayer. The term in-house research expenses means any wages paid or incurred to an employee in the conduct of qualified research or in the direct support or supervision of qualified research and any supplies used in the conduct of qualified research. The term contract research expenses means 65 percent of any amount paid or incurred by the taxpayer to another person (other than an employee of the taxpayer) for qualified research. Section 41(d)(1) defines the term qualified research as research (A) with respect to which expenditures may be treated as expenses under section 174, (B) which is undertaken for the purpose of discovering information which is technological in nature and the application of which is intended to be useful in the development of a new or improved business component of the taxpayer, and (C) Substantially all of the activities of which constitute elements of a process of experimentation for a purpose described in section 41(d)(3). Under section 41(d)(3)(A), research is conducted for a purpose described in this paragraph if it relates to a new or improved function, performance, or reliability or quality. However, section 41(d)(3)(B) provides that research shall in no event be treated as conducted for an eligible purpose if it relates to style, taste, cosmetic, or seasonal design factors. The tests under section 41(d)(1) are to be applied separately to each business component. Section 41(d)(2)(A). The term business component includes any product, process, computer software, technique, formula, or invention which is to be used by the taxpayer in a trade or business of the taxpayer. Section 41(d)(2)(B).

ANALYSIS
The issue in this technical advice request is whether Taxpayer's research activities related to the development of new food products and manufacturing techniques, and the improvement of existing food products and manufacturing techniques are excluded from qualifying for the credit for increasing research activities because research relating to style, taste, cosmetic, or seasonal design factors is ineligible for the credit under section 41(d)(3)(B). It is our view that the term taste as used in section 41(d)(3)(B) means individual or consumer preference not sensory taste. Thus, Taxpayer's research activities in developing new food products and manufacturing techniques, and improving existing food products and manufacturing techniques may not be excluded from the definition of the term qualified research under section 41(d)(3)(B). To be entitled to the credit for increasing research activities under section 41, Taxpayer must be engaged in
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qualified research as defined in section 41(d)(1) and Taxpayer's activities must not be excluded from the definition of the term qualified research under section 41(d)(4). The tests under section 41(d)(1) are applied separately to each business component. Section 41(d)(2). Therefore, a plant process, machinery, or technique for commercial production is treated as a different business component than the product being produced. H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. 11-73 (1986), 1986-3 (Vol. 4) C.B. 73. As defined in section 41(d)(1), the term qualified research means research: (A) with respect to which expenditures may be treated as research and experimental expenditures under section 174, (B) which is undertaken for the purpose of discovering information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component of the taxpayer, and (C) substantially all of the activities of the research constitute a process of experimentation for an eligible purpose. Under section 41(d)(3)(A), research is conducted for an eligible purpose if it relates to a new or improved function, performance, or reliability or quality. However, under section 41(d)(3)(B), research is not conducted for an eligible purpose if it relates to style, taste, cosmetic, or seasonal design factors. The term taste has several different meanings depending on the context in which it is used. Webster's Ninth New Collegiate Dictionary provides the following definition of the term taste: 1 obs : test 2 a obs : the act of tasting b : a small amount tasted c : a small amount : BIT; esp : a sample of experience (her first taste of success) 3 : the one of the special senses that perceives and distinguishes the sweet, sour, bitter, or salty quality of a dissolved substance and is mediated by the taste buds on the tongue 4 : the objective sweet, sour, bitter, or salty quality of a dissolved substance as perceived by the sense of taste 5 a : a sensation obtained from a substance in the mouth that is typically produced by the stimulation of the sense of taste combined with those of touch and smell : FLAVOR b : the distinctive quality of an experience (the attempt to cheat left a bad taste in my mouth) 6 : individual preference : INCLINATION 7 a : critical judgement, discernment, or appreciation b : manner or aesthetic quality indicative of such discernment or appreciation. As used in section 41(d)(3)(B), we believe that the term taste is intended to mean individual preference or critical judgement, discernment, or appreciation. This interpretation is consistent with the meanings of the other ineligible purposes enumerated in section 41(d)(3)(B). When read together, we believe that the exclusions for research related to style, taste, cosmetic, and seasonal design factors exclude research activities that relate to matters of individual and consumer preference rather than functional aspects, including flavor or sensory taste, of a business component. In the case of food products, new product development and improvements to existing products may relate to texture, smell, and flavor. These characteristics affect taste in the sensory context. To the extent that a food product developer tries to develop products with a new or improved function, performance, or reliability or quality including new or improved textures, smells, or flavors, the research activities to develop the products may relate to functional aspects of a business component as required in section 41(d)(1) and (3)(A). Thus, the research activities conducted for purposes described in section 41(d)(3)(A) and otherwise satisfying the definition of qualified research in section 41(d)(1) would not be treated as conducted for an ineligible purpose under section 41(d)(3)(B).

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In developing its new products, Taxpayer conducted research into the physical properties of the target products' component parts and the composite products. In addition, Taxpayer conducted research to develop and improve manufacturing techniques and equipment. Because the tests under section 41(d)(1) are to be applied separately to each business component which is to be used by the taxpayer in its trade or business, Taxpayer's research activities related to new or improved manufacturing techniques and equipment should be considered independently from Taxpayer's research activities related to the target product for purposes of section 41(d)(1). Research activities related to new or improved manufacturing techniques and equipment are not treated as being conducted for an ineligible purpose under section 41(d)(3)(B) and excluded from qualifying for the credit for increasing research activities merely because the techniques and equipment are intended to be used in food production. These techniques and equipment may be developed for purposes described in section 41(d)(3)(A). If the research activities are performed for an eligible purpose in section 41(d)(3)(A) and otherwise meet the requirements in section 41(d)(1), the research activities may constitute qualified research for section 41.

CONCLUSION
Although Taxpayer is in the business of developing and manufacturing food products, all of Taxpayer's research activities are not excluded from the definition of the term qualified research because section 41(d)(3)(B) of the Internal Revenue Code excludes research that relates to taste. We believe that the word taste as used in section 41(d)(3)(B) means individual or consumer preference. Therefore, Taxpayer's activities related to the development and improvement of the functional aspects of a target product may constitute qualified research. In addition, research in developing or improving manufacturing techniques and equipment may constitute qualified research. Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the Code. Except as to the application of section 41(d)(3)(B), no opinion is expressed as to whether Taxpayer's activities constitute qualified research under section 41(d). A copy of this technical advice memorandum is to be given to the Taxpayer. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent. Temporary or final regulations pertaining to one or more of the issues addressed in this memorandum have not yet been adopted. Therefore, this memorandum will be modified or revoked by the adoption of temporary or final regulations to the extent the regulations are inconsistent with any conclusion in the memorandum. See section 16.03 of Rev. Proc. 94-2, 1994-1 C.B. 428, 442. However, a technical advice memorandum involving a continuing transaction generally is not revoked or modified retroactively if the taxpayer can demonstrate that the criteria in section 16.04 of Rev. Proc. 94-2 are satisfied.

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