If your business has purchased equipment for research and development, you could get a valuable break under the tax law. Lawmakers broadened the definition of industrial machinery back in 2015, opening the door for a much wider array of businesses to qualify.

The industrial machinery tax credit that has been in the law for years has traditionally benefited only manufacturers because it applied to the purchase of machinery used in the “fabrication or processing of tangible personal property” or certain related manufacturing activities.

It’s valuable because it can offset as much as 50 percent of a company’s franchise and excise taxes, and can carry forward for as many 15 years.

State Expands Definition for Industrial Machinery

An expanded definition of “industrial machinery” adds eligibility for the industrial machinery tax credit and sales and use tax exemption for a much wider array of companies who make purchases for research and development.

Previously, these industrial machinery tax credits and sales and use tax exemptions were reserved for the purchase of machinery used in the “fabrication or processing of tangible personal property” or some other related manufacturing activities, and therefore were only available to a narrow segment of businesses.

Under the new definition that went into effect July 1, 2015, eligible industrial machinery is extended to include “machinery, apparatus, and equipment,” including parts, repairs and installation “that is necessary to, and primarily for, the purpose of research and development.” This expanded definition is not just limited to those businesses engaged in traditional manufacturing activities; it applies broadly to any business conducting research and development.

These credits can offset as much as 50 percent of a company’s franchise and excise tax obligation, with a carry-forward for as long as 15 years. The sales and use tax exemption covers the entire sales and use tax obligation. Companies that have already paid sales and use tax on those purchases could qualify for a refund.

The net effect of the new definition is that nearly any business engaged in product development or improvement should now qualify for these credits and exemptions.

State Expands Research and Development Tax Credits for Machinery Purchases

The change expands the credit for manufacturers, but also for companies not considered manufacturers who make equipment purchases for research and development.

For example, a company that develops software might buy equipment, pay for installation, or incur repair costs as part of its research and development. Or a pharmaceutical company developing new drugs might have equipment costs related to its research.

Those costs will need to be segregated, but any purchases after July 1 this year that fall into the new category could be eligible for the credit.

What’s more, additional savings accrue since purchases for “industrial machinery” are also exempt from sales and use taxes. If sales and use was already paid, the company could qualify for a refund.

The state offers several credits as a way to encourage investment and business in Tennessee, and a few other changes this year might also bring significant savings to your business.

For example, new credits have become available related to the cost of moving back-office functions to Tennessee. Previously, the “Headquarters Tax Credit” limited such credits to construction and relocation costs associated with moving a headquarters to Tennessee. But now, you may have your headquarters somewhere else, move your call center or accounting center to Tennessee, and still qualify.

With changes in law with the Revenue Modernization Act last year, it could be beneficial for businesses to check with their accountant about what new credits might help them.

Research and Development Exemption Could Benefit Your Company

Tennessee has long had an exemption from sales tax for qualifying manufacturing machinery purchased and used in the state.  As of July 1, 2015, Tennessee also exempts qualifying research and development machinery and equipment (including repair parts and labor, similar to the industrial machinery exemption). To qualify for the exemption, the company must apply on form RV-F1325101 and state whether the equipment will be used for one of the following:

  1. basic research in a scientific field of endeavor;
  2. advancing knowledge or technology in a scientific or technical field of endeavor;
  3. the development of a new product, whether or not the new product is offered for sale;
  4. the improvement of an existing product, whether or not the improved product is offered for sale;
  5. the development of new uses of an existing product, whether or not a new use is offered as a rationale to purchase the product; or
  6. the design and development of prototypes, whether or not a resulting product is offered for sale.

Per the application, research and development does not include ordinary testing or inspection of materials or products used for quality control (other than that occurring during the activities listed above), market research, efficiency surveys, consumer surveys, advertising and promotions, management studies, or research in connection with literary, historical, social science, psychological, or other similar nontechnical activities.

The application requires a description of the research and development conducted at the facility, a list of the machinery and equipment to be purchased, and other information.  It is important to note that the exemption may apply to other industries outside of fabricating or processing goods for resale (“manufacturing”).  Also, research and development equipment that is eligible for sales tax exemption is also eligible for the franchise/excise tax industrial machinery tax credit.

These are some complicated issues but could result in some substantial tax benefits for your business. Make sure you consult a state and local tax expert to ensure you are not leaving any money on the table. For more information check out State and Local Tax services.