With the high demand in housing and multi-use properties currently increasing in sometimes record amounts across the country, it may be a surprise to companies within the Design-Build industries, including Architecture, Engineering, and Construction, which provide the engineering, design and manufacturing processes related to new housing and real estate development that some of these activities can be qualified and claimed as part of the Research and Development Tax Credit. The difficulty with these types of activities – and which is commonly the case related to other manufacturing industries and activities – is the determination of where the design process ends, and production begins. For the Research and Development Tax Credit, the important activities to focus on are those that occur up to the point of when a product, business component or design is considered as “in production”.
For an example – some companies provide the engineering design necessary for the components of a home or other structure – i.e., the walls, the trusses and roof, and floors. The time spent by the engineers to design each component, as well as the time spent combining those components into overall building designs can likely be considered as qualified activities, as long as the four tests – technical uncertainty; process of experimentation; new or improved performance, function, quality or reliability; and based on “hard sciences” such as engineering – are met. In this example, these four tests might be met in the following manner:
- Technical uncertainty – the overall design for a wall is unknown – what the framing design will be; what the materials will entail and what impact those materials will have upon the structural integrity of the wall; what will be the ultimate load bearing capability of the wall and will it meet all necessary specifications?
- Process of experimentation – many design firms utilize advanced software such as CAD to analyze the overall structures of engineered items. Computer simulation is an allowable form of process of experimentation – a systematic, recordable, or observable manner in which to eliminate uncertainty from a design. Additional activities that might fall under process of experimentation in this example might include the fabrication of a prototype wall for actual physical testing of load bearing, or in finding the point of failure; or in analyzing the impact that moisture has on the performance of the wall.
- New or improved performance, function, quality or reliability – even though walls are common and have been around for centuries, the specific application and design needs of walls in new construction can be considered as a new design, especially if the whole of the design (the house or structure) is a new design. It may be perfectly suitable and successful to import a wall design used in other instances, but it is still unknown whether that wall will function as necessary according to specifications.
- Based on “hard sciences” – this test is to ensure that the activity being claimed is not related to sectors of activity considered as explicitly non-qualified – ie., accounting, marketing, human resources, etc. The majority of companies performing these design activities will be basing their work upon engineering and physics principles and knowledge, which are considered “hard sciences.” For example – the physics behind the development of a load bearing wall – evaluating the impact of wind and other natural forces on the structural integrity of a wall design, and what impact utilizing different materials might have on these forces.
Some items of concern other than identifying when the design process ends, and the production process begins including how companies performing these activities structure their agreements with clients and customers. The main items of concern in this area are who retains the rights to the design, and who inherits the risk of performing the activity?
Staying within the example of designing the components of a home or structure, if the company performing these design activities has an arrangement with a real estate development firm to provide designs, and will receive payment regardless of whether the designs are used or if the designs meet the specifications provided by the developer, then these design activities, no matter how complex, would be considered funded research – because the development firm has paid for the rights to the designs, and also inherits the financial risk regardless of the final design.
However, another agreement structure might entail the design firm receiving a portion or “good faith” deposit from the developer, the remaining amount being contingent upon the delivery of an acceptable final design. In this case, any costs for the design efforts that occur outside of the initial good faith deposit would be a risk of the design firm. And the contingency aspect of the acceptable final design also puts the risk inherently with the designer, and not the developer. Regardless of the structure of the agreement, it is very important that when claiming these types of activities for the Research and Development Tax Credit that the agreements be collected as part of the contemporaneous documentation required to successfully defend a claimed credit.
These are just a few ways that Design-Build industries can participate in and benefit from the Research and Development Tax Credit. The main issues to consider are:
- When does design end and production begin?
- If there was a design agreement with a third party, what is the structure of that agreement?
- Who holds the rights to the design and the risk of the design activity?
- What documentation has been collected to support the claim?
- Design documents – showing iterations, computer modeling, testing, test reports, photos of prototype testing, etc.
- Agreements between the Design Build firm and their client/customer
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