[ad_1]
A change in the tax treatment of research and experimental expenditures under Section 174 of the Internal Revenue Code, effective for tax years beginning January 1, 2022, may have an additional impact on U.S. taxpayers who incur research expenditures abroad. Under previous rules, businesses had the option of deducting these expenses in the year they opened or capitalizing the expense and amortizing it over five or 10 years. Starting in 2022, businesses will lose the option to deduct these expenses in the year they opened.
Under the new law, taxpayers must recoup and recoup Section 174 costs over a five-year period for research conducted in the U.S. or 15 years for research conducted abroad. Many businesses must assess their expenses to determine whether annual deductible expenses are now capitalized and disallowed as “research and testing expenses” for tax years beginning in 2022.
Taxpayers paying for research outside the US have some additional concerns. On the face of it, the new law imposes a longer time limit on spending on foreign research. Therefore, some expenses that are fully deductible by businesses in 2021 will generate only one-third of the deduction in the year in which the expense was incurred using the half-year convention in 2022.
The change will have some secondary effects on the tax return in calculating other items such as international intangible low-tax income, foreign-sourced intangible income, foreign tax credit and erosion and abuse.
International Section 174 Capitalization of Expenses
Many businesses incur expenses that meet the definition of Section 174 research and testing expenses. Until now, there was little need to track those expenses separately because they were treated like other deductible expenses for tax purposes. Fees such as maintenance and research costs and wages for engineering and laboratory expenses are not separated from the general building maintenance and payroll account.
Businesses that track expenses to qualify for the research and experimentation tax credit may have a system in place to control certain Section 174 expenses, but the interpretation of Section 174 covers many more types of expenses than the list of expenses that qualify for the R&E credit. .
Businesses that pay service providers outside the United States should determine whether the activities performed qualify as “research” within the meaning of section 174. For example, if a business purchases raw materials or finished goods from a foreign supplier, that cost probably does not include a research component. But if it pays for engineering services or software development from overseas providers, some expenses that are fully deductible when incurred can now be phased out more than 15 years.
Any business that relies on a global network of contractors and suppliers to produce products and provide services will need a more detailed system for tracking expenses that qualify for Section 174 expenses and their spending authority.
Special risk for related parties residing abroad
Businesses with global networks that include related foreign affiliates may see additional effects of this change. When Section 174 is applied to foreign R&D expenses incurred by controlled foreign corporations, taxpayers may see a significant increase in the amount of tested income included in the GILTI calculation in the first year the rules apply. This leads to additional GLT inclusion and may result in residual GILTI taxation.
In certain circumstances, subject to the new section 174 regulations, taxpayers who previously qualified for the high tax exception under the GLTI regulations may be subject to tax when calculating foreign taxable income for GLTI purposes. In most cases, the tax paid in the foreign jurisdiction will not change because the foreign jurisdiction applies its own tax principles to calculate taxable income without regard to US tax principles.
Double-blindness concerns arise when a U.S. taxpayer contracts a foreign firm to perform R&D-related services. Payments to foreign branches are amortized over 15 years by U.S. businesses, and related expenses are amortized over 15 years for CFCs and foreign affiliates whose activities are included in U.S. income.
When such a transaction occurs between multiple national related entities, it may result in multiple reversals that amplify the effect on the U.S. parent’s taxable income in the year in which the payment is made. This situation causes the foreign party contractor to receive the contract income for tax purposes in the year related to the smaller fractional benefit less related expenses.
The Section 174 amendment adjusts the taxable income number that provides the basis for tax calculations such as FDII, BEAT and the foreign tax credit. In some cases, the result of these calculations may be a little misleading for the taxpayer, but the overall effect of this change will be a reduction in the current year’s deductions and a significant increase in the current year’s taxable income.
Many questions are still unanswered.
Taxpayers applying the international aspects of the Section 174 expense reimbursement rules may benefit from guidance from the IRS. For example, when unrelated and related foreign parties conduct research on behalf of the taxpayer, should both parties treat the underlying expenses as capitalized research? Or might the rights-and-risk model view payment as a large study for one party and a deductible operating expense for the other? Additional guidance in this area can help reduce the risk of double exposure.
Because there is no timely way to delay this change, taxpayers should review their potential expenses for five or 15 years to estimate the tax impact of these new provisions on current tax liabilities. Consult your tax advisor to learn more about how Section 174 expensing and related international aspects may affect your business.
Authors information
Robert Pwonsky He is a senior manager of international tax at Plante Moran. He advises companies on global compliance and effective tax rates, as well as cross-border transactions, provides international tax due diligence, and provides consistent strategies to minimize global financial taxes.
Caitlin Slezak He is a senior manager in Plant Moran’s national tax office. She advises colleagues and clients on emerging tax issues, focusing on technical tax accounting methods related to tax revenue, expense recognition and tax inventory accounting.
Jay Woods He is an international tax manager at Plante Moran. As a member of the firm’s Global Tax Services practice group, he works with globally active clients with a focus on outbound and inbound services.
Take your smart, original:Write to us
[ad_2]
Source link
