Politics and the R&D Credit

Companies are still waiting for Congress to extend the R&D tax credit.

Lobbyists representing American industry are keeping busy this fall. Representatives from a variety of technology and manufacturing associations are pushing to convince senators to extend the expired Research & Experimentation Tax Credit, also known as the R&D credit.

On July 31, the House voted in favor of extending the credit for two years, retroactive to January 1, 2006, but the Senate adjourned on August 4 without passing a bill that included the credit’s extension. Believing that the extension was so popular that it could help sway legislators on other matters, House Ways and Means Committee chairman Bill Thomas (R-Calif.) and Senate Majority Leader Bill Frist (R-Tenn.) attached it to a bill to reduce estate taxes and raise the minimum wage. The bill failed to get the support of Democrats, who oppose the estate-tax reduction.

Although the credit is without controversy, says Clint Stretch, managing principal, tax policy, for Deloitte Tax LLP, it’s had a rocky history. Congress has allowed it to expire a dozen times since it was established in 1981, most recently on December 31, 2005. Although Congress has never extended it for more than five years at a time, legislators have always reinstated it retroactively (with a single exception).

The tax credit is worth approximately $7 billion a year to the 16,000 American companies that qualify for it. Rockwell Collins, a $3.8 billion defense contractor, expects to spend about $725 million this year on research and development. The company will see its 2006 effective tax rate increase 1 to 2 percent (or about 2 cents per share) if the credit is not extended retroactively.

The failure to extend the credit has infuriated the bill’s backers, who warn that it could drive R&D spending overseas. “At least 10 competitor nations offer more-generous and permanent R&D incentives,” says Monica McGuire of the National Association of Manufacturers. According to the R&D Credit Coalition, in 2003 U.S. firms invested $22.3 billion in R&D conducted abroad.

In August, Deloitte’s Stretch gave the credit only a 25 percent chance of passing before the November elections. “There’s a very good chance that it will pass after the elections and before the first of the year,” he says. “But there’s some chance they won’t get around to passing it until next year. And that has everything to do with politics and nothing to do with substance.”

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