Maximizing Tax Benefits from R&D Expenditures: A Guide
School
Polytechnic University of the Philippines**We aren't endorsed by this school
Course
ACCOUNTING 101
Subject
Accounting
Date
Dec 11, 2024
Pages
29
Uploaded by HighnessStingrayPerson1253
Typical Process
Research and DevelopmentThetaxpayermayelecttoclaimResearchanddevelopmentexpenditures as•ordinary and necessary expenses;•as deferred expenses.
Ordinary and Necessary expensesOrdinary and necessary expenses which are not chargeable to thecapital account require that it must be•Paid or incurred by the taxpayer during the taxable year•In connection with his trade, business, or profession and•The expenditures so treated shall be allowed as deduction duringthe taxable year when paid or incurred
Deferred ExpensesResearch anddevelopment expensesmay be treated as deferredexpenses or expenses chargeable to capital account (optional on thepart of the taxpayer) and requires that it must be•Paid or incurred by the taxpayer in connection with his trade,business, or profession•Not treated as expenses•Chargeable to capital account but not chargeable to property of acharacter which is subject to depreciation or depletion.
Tax BenefitA Corp. spent P1,000,000 in R&D in 2020. The R&D cost can beamortized over 5 years. If the corporation is subject to 25% corporateincome tax rate for the next 5 years, how much is the tax benefit?Treatment of R&D Cost20202021202220232024Deducted in Full250,000Tax benefit= P1,000,000 x 25% = P250,000
Tax BenefitA Corp. spent P1,000,000 in R&D in 2020. The R&D cost can beamortized over 5 years. If the corporation is subject to 25% corporateincome tax rate for the next 5 years, how much is the tax benefit?Treatment of R&D Cost20202021202220232024Deducted in Full250,000Deferred Charges50,00050,00050,00050,00050,000Tax benefit= P1,000,000 / 5 x 25% = P50,000 (per year)
In Full or DeferredThe full deduction could be an advantage if the company is paying theregular corporate income tax.But if the company is in a net operating loss (NOL) carryforwardsituation, it would still pay the minimum corporate income tax. If thecorporation will remain in several years as such, a better option is tospread out the allowed deduction to stretch out the tax benefits sinceNOLCO and excess MCIT can only be carried over three years.
AnticipationTax rate and rule changes also should be considered in the planningprocess.Ifthegovernmentplanstodecreasecorporateincometax,thecompanymaydecidetoincurtaxdeductible,new-productdevelopment costs this year but not next year. Just the opposite mightoccur if the tax rate is expected to go up.
Value-AddingA Corp. has corresponding tax benefits arising from R&D in 2020. If thecompany has a 10% cost of capital, compute the present value of theR&D.Treatment of R&D Cost20202021202220232024Deducted in Full250,000Deferred Charges50,00050,00050,00050,00050,000
Present Value of Tax BenefitsA Corp. has corresponding tax benefits arising from R&D in 2020. If thecompany has a 10% cost of capital, compute the present value of theR&D.Deducted in FullDeferred Charges+ P50,000 x 1.1^-1+ P50,000 x 1.1^-2+ P50,000 x 1.1^-3+ P50,000 x 1.1^-4+ P50,000 x 1.1^-5= P250,000= 189,539.34
Present Value of Tax BenefitsA Corp. has corresponding tax benefits arising from R&D in 2020. If thecompany has a 10% cost of capital, compute the present value of theR&D.Deducted in FullDeferred Charges= P250,000= P50,000 x (1 - 1.1^-5)/10%= 189,539.34
Present Value of the ProjectThe board of directors approves the P2 million fund for the researchand development of a new product that will compete withOurPhone.The Board expects that the new product will generate P1,000,000additional pre-tax profits for five years;The company is subject to an income tax rate of 25% and has a cost ofcapital of 10%. Assuming the company claims the R&D in full in theyear incurred, what is the net present value of the project?
R&D on New Product DevelopmentYear 1Year 2Year 3Year 4Year 5Additional Pre-tax income 500,000500,000500,000500,000500,000Additional Tax on operating income (25% of additional profit)(125,000)(125,000)(125,000)(125,000)(125,000)Tax Benefit on R&D Cost (1M x 25%)250,000Net Cash Flow625,000375,000375,000375,000375,000PV Factor 1.1^-11.1^-21.1^-31.1^-41.1^-5Present Value of Cash Flows568,182309,917281,743256,130232,845R&D Cost (1,000,000)NPV648,818
New MachineYear 1Year 2Year 3Year 4Year 5Cost Reduction500,000500,000500,000500,000500,000Additional Tax on operating income (25% of additional profit)(125,000)(125,000)(125,000)(125,000)(125,000)Tax Benefit on Depreciation (1M /5 x 25%)50,00050,00050,00050,00050,000Net Cash Flow425,000425,000425,000425,000425,000PV Factor 1.1^-11.1^-21.1^-31.1^-41.1^-5Present Value of Cash Flows386,364351,240319,309290,281263,892Cost of Machine(1,000,000)NPV611,084
NegotiatingBy engineering tax benefits, the firm implicitly changes aproduct’sprice. By promoting theproduct’stax advantages, the firm can segmentthe market.
Lease vs. PurchaseCompany A can negotiate either to buy or lease a machinery fromCompany B. Assume that the cost of the machinery is P1 million. Themachinery has an expected life of five years. Company A can either buythe machinery outright or lease them over five years for 250,000 peryear. In case of lease, the Company need to spend additional P80,000for installation costs for easy dismantling at the end of the lease term.The cost of capital is 10%. The tax rate is 25%.
PurchaseYearCash Flow ItemAt 25%NOL0Purchase Price(1,000,000)(1,000,000)1Present Value of Tax Benefit on Depreciation per year45,454.55-241,322.31-337,565.74-434,150.67-531,046.07-Net Present Value(810,460.66)(1,000,000)
LeaseYearCash Flow ItemAt 25%NOL0(80,000)(80,000)1Present Value of Tax Benefit on lease payment per year(170,454.55)(227,272.73)2(154,958.68)(206,611.57)3(140,871.53)(187,828.70)4(128,065.02)(170,753.36)5(116,422.75)(155,230.33)Net Present Value(790,772.52)(1,027,696.69)
Lease vs. PurchaseAt 25%NOLPurchase(810,460.66)(1,000,000)Lease(790,772.52)(1,027,696.69)Based on the foregoing, Company A may negotiate to lease the property ratherthan buying it if the company is in the tax-paying position. But if it is in NOLCO-position, Company A is better off buying.
Other Negotiating Deals•Negotiating a delay in the sale or purchase•Bundling
Shifting of R&DSuppose a high-tech firm wants to spend P5 million of R&D but is in anNOL situation. In the case, the company cannot utilize the allowabledeductions for the year.
Shifting of R&DIf Company P can shift the R&D cost to its profitable subsidiary, sayCompany S, then the subsidiary can claim tax savings of P1,250,000(5,000,000 x 25%) in the year the cost was incurred.
Shifting of R&DParentSubsidiaryGross Income 50,000,00050,000,000Profit (loss) before R&D020,000,000R&D Costs (5,000,000)-Taxable Income (Net Loss) (5,000,000)20,000,000Corporate Income Tax 25%25%Regular Corporate Income Tax-5,000,000Minimum Corporate Income Tax (5,000,000 x 1%)500,000Tax Savings
Shifting to a Pass Through Entity To the extent that tax benefits can flow through the entity to be usedby other taxpayers (such as the other partners or LLC owners), thebenefits generate value that the firm can negotiate for.
TransformingIf a new product turns out to be unsellable, all costs of unsoldinventory, supplies, and equipment can be written off as ordinarylosses.
Collapsible Corporation TechniqueInstead of selling products individually, a product is developed in anentity and the entity is sold.Classicexamplesarehavingacorporationmakeafilm,developsoftware, or purchase a cellar of newly bottled wine. When the film isfinished, the software works, or the wine is sufficiently aged, it is notsold directly. Instead, the common stock of the corporation is sold.
Collapsible Corporation TechniqueThis will be treated as sale of capital asset. The sale of shares of stocknot treaded in local stock exchange is subject to capital gains tax of 15%on net capital gain.