TIR 04-15: Amendments To Massachusetts Corporate Excise Governing Domestic and Foreign Manufacturing Corporations and Research and Development Corporations
The Massachusetts Legislature recently amended chapter 63, §§ 38C and 42B of the Massachusetts General Laws. See St. 2003, c. 141, §§ 27, 29, (An Act Relative to Investments in Emerging Technologies to Promote Job Creation, Economic Stability and Competitiveness in the Massachusetts Economy), effective November 26, 2003, as amended by St. 2004, c. 65, §12. Those provisions apply to both domestic and foreign manufacturing corporations and research and development (R&D) corporations, respectively. The purpose of this Technical Information Release is to explain the effect of the new legislation on these corporations. To the extent that this TIR is inconsistent with public written statements applying prior law, including the Research and Development regulation, 830 CMR 64H.6.4, this TIR supersedes those documents.
B. SUMMARY OF CHANGES
The amendments to G.L. c. 63, §§ 38C and 42B clarified prior law in a number of ways. First, a corporation organized under or subject to G.L. c. 156D, ( c.156B until July 1, 2004) and a limited liability company (LLC) organized or chartered under G.L. c. 156C (or an entity organized under laws other than those of the Commonwealth as a foreign corporation or LLC) which is not classified as a partnership and has elected to be taxed as a corporation separate from its members for federal income tax purposes and which is engaged in manufacturing in Massachusetts or research and development in Massachusetts may now qualify as a manufacturing corporation or R&D corporation, for purposes of chapter 63, provided it meets other requirements for qualification set forth in this TIR.
Second, the Legislature amended G.L. c. 63, § 38C to clarify that a domestic manufacturing corporation be engaged in manufacturing in Massachusetts. Similarly, a domestic research and development corporation must be engaged in research and development in Massachusetts. This clarification conforms to the existing requirement in G.L. c. 63, § 42B that foreign manufacturing corporations and research and development corporations be engaged in such activities in Massachusetts.
Third, the requirements for qualification as an R&D corporation have significantly changed. A corporation may now qualify if it has a sufficient level of either receipts or expenditures attributable to R&D activity in Massachusetts. With respect to receipts, the Legislature repealed one of the two former tests. That test required a corporation to derive 1/3 of its receipts from research and development of property capable of being manufactured in Massachusetts. The remaining “receipts” test under former law (i.e., requiring an entity to derive more than 2/3 of its receipts attributable to Massachusetts from research and development) remains in force.
With respect to expenditures, the Legislature added a new test for qualification. This test will allow certain entities (e.g., start-up corporations) to qualify without regard to receipts. However, unlike entities qualifying on the basis of their receipts from R&D, entities qualifying solely by virtue of meeting the “expenditures” test may not claim the investment tax credit (ITC) under G.L. c. 63, § 31A.
C. RESEARCH AND DEVELOPMENT QUALIFICATION REQUIREMENTS
1. Domestic research and development corporations: G.L. c. 63, § 38C as amended by St. 2003, c. 141, § 27
In order to qualify as a domestic R&D corporation, the following requirements must be met:
a) the corporation must be organized under or subject to G.L. c. 156B (c. 156D, effective July 1, 2004) or c. 156C (for LLCs);
b) the corporation must be engaged in research and development in Massachusetts;
c) its principal activity in Massachusetts must be research and development;
d) during the taxable year, one of the following tests must be met:
1) the corporation must derive more than 2/3 of its receipts attributable to Massachusetts from research and development; or
2) it must incur more than 2/3 of its expenditures attributable to Massachusetts for research and development.
2. Foreign research and development corporations: G.L. c. 63, § 42B as amended by St. 2003, c. 141, § 29
In order to qualify as a foreign R&D corporation, the following requirements must be met:
a) the entity must be established, organized or chartered under laws other than those of Massachusetts;
b) the entity must have a usual place of business in Massachusetts;
c) it must be engaged in research and development in Massachusetts;
d) its principal activity in Massachusetts must be research and development;
e) during the taxable year, one of the following tests must be met:
1) the entity must derive more than 2/3 of its receipts attributable to Massachusetts from research and development, or
2) it must incur more than 2/3 of its expenditures attributable to Massachusetts for research and development.
D. EXPLANATION OF TERMS AND PHRASES
1. “Research and development”
Research and development is experimental or laboratory activity having as its ultimate goal the development of new products, the improvement of existing products, the development of new uses for existing products or the development or improvement of methods for producing products. Research and development does not include testing or inspection for quality control purposes, efficiency surveys, management studies, consumer surveys or other market research, advertising or promotional activities, or research in connection with literary, historical or similar projects. G.L. c. 63, §§ 38C, 42B. Research and development may include activities conducted by contract research organizations (CROs) that perform certain stages of research and development necessary to bring a product to market even if another entity performs other stages of research and development.
2. “Principal activity”
Massachusetts statutes, regulations and rulings pertaining to research and development corporations do not define the term “principal activity.” For purposes of meeting this requirement, the Department will treat a corporation having a clear majority of Massachusetts-based employees engaged in R&D activity in Massachusetts as qualifying for “principal activity” status. See, e.g., Department Letter Ruling 02-12. Also relevant are the corporation’s purpose and overall operations in Massachusetts.
Receipts from research and development include receipts from the provision of research and development services and from royalties or fees derived from the licensing of patents, know-how or other technology developed from research and development. Under the amendments, such receipts must be attributable to activity in Massachusetts and allocable to research and development activity performed in Massachusetts. See G.L. c. 63, §§ 38C, 42B.
Corporations may now qualify as R&D corporations if more than 2/3 of their expenditures attributable to Massachusetts are allocable to research and development, whether or not they derive more than 2/3 of their receipts from R&D activity. Thus, a corporation such as a start-up corporation may now qualify as an R&D corporation under this test even if it has no receipts for the taxable year. A corporation that is engaged in research and development and that also conducts manufacturing activities must exclude expenditures relating to manufacturing from total expenditures for the purposes of the expenditures test regardless of whether the manufacturing activities of the corporation are substantial.
5. “Attributable to the Commonwealth”; “allocable to research and development”
The amendments to G.L. c. 63, §§ 38C and 42B define a research and development corporation as one which, in pertinent part, “[d]erives more than 2/3 of its receipts attributable to the commonwealth from [research and development] or incurs more than 2/3 of its expenditures attributable to the commonwealth allocable to [research and development] . . . .”
Neither the amendments nor Massachusetts case law expressly defines the phrases “attributable to the Commonwealth” or “allocable to research and development” for purposes of G.L. c. 63, §§ 38C or 42B. The Legislative intent of the amendments, as evidenced by the title of the Act, is to promote investment in research and development activities in Massachusetts. Accordingly, these terms may be interpreted according to their common sense and ordinary meaning in determining whether a corporation meets this statutory test. In any event, the research and development activity pertaining to a corporation’s receipts and expenditures must be performed in Massachusetts.
E. ELIGIBILITY FOR TAX BENEFITS
and foreign manufacturing corporations and R&D corporations may be
eligible for certain tax benefits discussed below:
1. Investment Tax Credit (ITC) under G.L. c. 63, § 31A
The new amendments did not change the rules allowing corporations classified as manufacturing corporations and R&D corporations qualifying under the receipts test above to claim the ITC against the Massachusetts corporate excise for qualifying property allowed by G.L. c. 63, § 31A. Such corporations should continue to refer to that section for rules that apply to claiming the ITC. However, R&D corporations qualifying solely on the basis of expenditures are expressly precluded from claiming the ITC under the new law.
2. Sales tax exemptions under G.L. c. 64H, §§ 6(r), (s)
In general, the sales tax applies to purchases of materials and machinery to be used in research and development by a business that does not qualify as a manufacturing corporation or an R&D corporation. However, section 6(r) of chapter 64H exempts, in relevant part, “[s]ales of materials, tools and fuel, or any substitute, therefore, which . . . are consumed and used directly and exclusively in . . . research and development by a manufacturing corporation or a research and development corporation within the meaning of [G.L. c. 63, § 38C or 42B]” Section 6(s) of chapter 64H exempts, in relevant part, “[s]ales of machinery, or replacement parts thereof, used directly and exclusively in . . . research and development by a manufacturing corporation or a research and development corporation within the meaning of [G.L. c. 63, § 38C or 42B].” A corporation must qualify as a research and development corporation by meeting the receipts or expenditures tests of those provisions as a prerequisite to claiming the §§ 6(r), (s) exemptions.
For purposes of meeting the “directly and exclusively” requirement of these provisions, CROs otherwise meeting the tests for qualification as R&D corporations may qualify for these sales tax exemptions on their purchases of tangible personal property used directly and exclusively in R&D, even if another entity performs other stages of R&D necessary to bring a product to market.
For R&D corporations qualifying under the newly-added expenditures test, the sales tax exemptions apply only to purchases made on or after November 26, 2003, the effective date of the amendments. For R&D corporations qualifying under the “receipts” test, or for manufacturing corporations, the sales tax exemptions apply to any purchases made on or after the date the corporation qualifies for exemptions.
3. Local property tax exemption for machinery; effect on liability for corporate excise
Corporations that are properly classified by the Commissioner as manufacturing corporations are eligible for the exemption from local property tax under G.L. c. 59, § 5(16)(3) on their machinery. See G.L. c. 58, § 2; 830 CMR 58.2.1(4)(a). The new amendments do not change the unavailability of this exemption for those corporations that are not classified as manufacturing corporations. G.L. c. 59, § 5(16)(3). Accordingly, a research and development corporation that is not also classified as a manufacturing corporation may not claim this exemption.
For purposes of computing the Massachusetts corporate excise on tangible property under G.L. c. 63, § 30, machinery exempt from local property tax under G.L. c. 59, § 5(16) is generally included in the non-income measure of the corporate excise.
/s/ Alan LeBovidge
Commissioner of Revenue
June 9, 2004
 Section 12 is effective on July 1, 2004, (see St. 2004, c. 65, § 65) to the extent it refers to chapter 156D, the recently enacted successor to the Massachusetts business corporations statute, currently codified at G.L. c. 156B.
 The amendments have no effect on the requirements for classification as a manufacturing corporation under G.L. c. 58, § 2. See Department of Revenue Manufacturing Corporations regulation 830 CMR 58.2.1 for these requirements.