As more and more companies use technology to improve products and increase efficiencies, the relevance and importance of reviewing expenditures for eligibility for the Research and Development Tax Credit becomes more critical. One industry where there has been tremendous growth in the research and development sector is the food and beverage industry.
The Federal Research & Development (R&D) Tax Credit permits a credit of up to 6.5 percent on qualified research expenditures such as employee wages, the cost of materials and supplies, patent development costs, and contract research expenses. Qualified research expenditures must meet the following four-part test:
- Permitted Purpose – The activity must intend to develop a new or improved product or process.
- Technological in Nature – The activity needs to rely on the sciences (engineering, biology, computer science, or physics).
- Technical Uncertainty – The purpose of the activity must be to eliminate uncertainty during development regarding the capability, methodology, or appropriateness of design.
- Process of Experimentation – The taxpayer must utilize a systematic approach of working through the technical uncertainty.
In addition to the federal credit, 41 states have their own R&D credit programs which largely follow the federal definition.
It is important to note that legislation enacted at the end of 2015 introduced groundbreaking changes to the R&D landscape going forward. Congress enacted a bill that makes the R&D credit permanent, which will provide businesses and taxpayers certainty as to the state of the credit moving forward. The bill also introduced the availability of a payroll tax credit for qualified small businesses. A qualified small business is defined as a Corporation, Partnership, LLC or Sole Proprietorship which is less than five years old with less than $5 million in annual gross receipts in each of the preceding five years. The Payroll Tax Credit will be refundable up to $250,000 in payroll taxes per year. This is especially favorable for many small, start-up food companies which typically do not have any income tax to offset in their first few years. In addition, the bill included provisions for the R&D credit to be able to offset Alternative Minimum Tax liability for qualified companies, which will result in the owners of many pass-through entities receiving a greater benefit.
Some examples of the areas in the food and beverage industry where the R&D credit could apply include the following:
- Gluten-free is one of the fastest growing food categories in the nation and often requires a vast amount of trial and error in the development process. There are two main challenges in gluten-free product development: physical composition and taste. There is often a great deal of research and development required to create a product that not only closely mimics the food item being modified and replaced, but also physically holds together without the gluten compound. Gluten gives elasticity to dough-based foods, helping them rise and keep shape. Therefore, it can be very challenging to remove gluten from the process and still maintain the physical composition of the product. There is also significant trial and error centered around taste, as removing the gluten protein can drastically change the taste of a product. All of the direct expenditures (materials, patent development) and some of the indirect expenditures (employee wages) incurred in developing products in order to meet certain taste and physical composition specifications are eligible for the R&D tax credit.
- Innovative packaging has become a key differentiator among competitors in the food and beverage industry. For example, Campbell introduced a Soup-on the-Go to make it possible for consumers to eat soup without a bowl and spoon. In addition, the demand for single-serving product packaging continues to increase industrywide. As manufacturers work to meet this demand, the experimentation involved with developing single-serve packaging to meet consumer performance standards, cost parameters and transport compatibility qualifies as research expenditures.
- Similarly, the beverage industry has seen also rapid growth in research and development. Some of the world's largest beverage companies have opened R&D facilities in the U.S. to further expand their research and development efforts. Coca-Cola, for example, is well known for customizing flavors to local tastes. These flavors are individually perfected recipes based on feedback from well-defined target markets. For multinational companies like Coca-Cola, new product formulation and testing can make up a large percentage of qualified research and development expenditures, as long as the research activities occur in the U.S.
- The rapid expansion of craft breweries has yielded them a unique role in the marketplace. While the bigger craft brewers are constantly fighting with the macro brewers for market share, they are also trying to stave off additional competition from up-and-coming micro craft breweries. In this highly competitive environment, the R&D tax credit can be a valuable incentive. For craft breweries and even wineries and other beverage industry companies, the development of new product recipes as well as the perfection of existing products are key project drivers of research and development expenditures for the purposes of the tax credit. For example, the development and testing of a new seasonal beer is a qualified research expenditure. However, enhancement and refinement of production processes, as well as innovation in product packaging, can be also be significant components of the R&D costs incurred.
For more information on how your food, beverage, or other qualified business can take advantage of the R&D credit and enhance the growth of your business, contact Marcum's Research and Development specialists.