Best Practices: Could the capital expenditures for the lab and pilot-scale productions qualify as QREs?

Our R&D team does more than evaluate new products. We also develop the manufacturing process for the products. We research the type of equipment we think we can use and then improve the machines accordingly.

• The first stage in our development is lab-scale production.
• Once we can successfully produce the product, we attempt a pilot scale, which is a midsize production line.

Moving from the lab scale to pilot scale, we often modify the equipment or try new equipment altogether.

Could the capital expenditures for the lab and pilot scale productions qualify as QREs?

Jason Massie answers:

The Union Carbide case is the best process improvement case to review. Section 41(d)(2)(C) provides a special rule for production processes and explains that taxpayers should treat the production process as a separate business component. So, the underlying product development is a business component, and the development of the production process is a business component. Each must meet the Four-Part Test and documentation requirements.

The expert in the UCC case made it clear that he does not believe making process improvements directly in the manufacturing facility precludes UCC from claiming those costs as QREs.

‘In Mr. Spitz’s opinion, experiments conducted in laboratories or pilot plants cannot simply be “scaled-up” to full-sized plants without additional testing because of the differences in size, dimensions, and fluid dynamics of plant equipment and the inherent unpredictability of chemical reactions and chemical plant operations.’

Based on the above, lab-scale and even pilot-scale activities differ from production activities based on the UCC court analysis.

Whether capital expenditures related to lab scale or pilot scale are supplies expenses for research credits depends on whether the equipment is subject to depreciation.

If lab-scale production requires the team to purchase equipment solely used for R&D purposes, and the equipment has more than a one-time use, then the equipment will likely be subject to depreciation.

Time spent by engineers during lab scale and pilot scale would certainly seem to qualify as QREs.

If you purchase new equipment for pilot scale, it would be prudent to conduct the same analysis. Equipment purchased for one specific use and then discarded seems to be more of a supply expense. You will want to review the facts and circumstances to determine whether these expenses are includable as QREs.

Please contact the MASSIE team if you want to discuss this topic further or require assistance with your calculations.

Disclaimer: The information on this website is for general information purposes only. Nothing on this site should be taken as legal advice for any individual case or situation.

Jason Massie, CPA, Esq.

As the Founder and President of MASSIE R&D Tax Credits, Jason is responsible for the quality, consistency, and integrity of our services. His strategic vision and leadership drive innovation within the company, encouraging collaboration and ne...