Qualifying R&D Activities

Qualifying Research Activities

Qualifying Research Activities relate to efforts undertaken to develop new products, enhance existing products, and to develop or improve manufacturing processes. In order to qualify for the R&D tax credit, the qualifying research activities must satisfy the Four Tests ascribed by the Internal Revenue Service. In addition, the company carrying out the work must bear the financial risk.

The Four Tests

The activity was undertaken for the purpose of discovering information that is technological in nature and fundamentally relies on principles of physical or biological sciences, engineering or computer science. The activity was intended to exceed, expand or refine the common knowledge of the skilled professionals in a particular field of science or engineering.

The activity related to the performance, quality or reliability of a product, process, software, technique, formula or invention to be held for sale, lease or license by the company or for carrying out the company’s trade or business.

The activity was undertaken to resolve uncertainty concerning the configuration, performance or methodology of the intended product, process, software, technique, formula or invention. It must be demonstrated the company did not know:

  • if it could achieve the desired result, or
  • how to achieve the desired result, or
  • the appropriate design, process or systematic configuration to achieve the desired result of the product, process, software, technique, formula or invention being developed.

The activity involved a process of experimentation in which more than one hypothesis was evaluated attempting to achieve the desired result. The process of experimentation included the design of an experiment to test and analyze the hypothesis, conducting the experiment, refining or discarding the hypotheses as part of a sequential design process to develop or improve a product, process, software, technique, formula or invention.

It has been found that there are three types of R&D situations in which qualifying research activities occur:

Classic R&D – resulting from a deliberate decision to develop a new or improved product or process.

Contingent R&D – planned to be contingent on receiving an order, where the bid was made knowing that existing technology is insufficient to fill the order without some development effort.

Unplanned R&D – arising from the sudden discovery, part way through filling an order, that existing technology is inadequate and must be advanced by an emergency development effort to complete the order.

Qualifying Research Activities typically include one or more of the following:

  • Development of products or processes using specific know-how that is treated as a trade secret or is patentable.
  • Development of new or improved products in which the state of the art is advanced and that required one or more design iterations to achieve.
  • Development or incorporation of a new technology in order to catch up to a competitor.
  • An attempt to develop a new or improved product or process that was eventually abandoned.
  • Implementation of a new process or improvements to an existing process relating to manufacturing, testing or quality control.
  • Development of new products in which technical uncertainties must be overcome in order to satisfy the requirements of a customer specification or performance requirement.

Qualifying Research Activities are performed by employees who conduct, directly supervise or support the development effort.

Conduct R&D Activities

Employees who conduct research activities are generally involved in hands-on efforts and engaged in identifying and resolving technical problems. Examples of employees conducting research activities are:

  • A design engineer developing new products.
  • A manufacturing engineering devising new process systems.
  • An electrical engineering developing new computer circuitry.
  • A process engineer improving the performance of fabrication systems.
  • A chemist formulating new chemical compounds.
  • An environmental engineer deriving methodologies for resolving ground contamination.
  • A civil engineer developing components for infrastructure systems.
  • An agricultural engineering evaluating soil samples.
  • A scientist performing laboratory experiments.
  • A computer programmer developing software code.
  • A mechanical engineering improving power systems.
  • An architectural engineer developing building fabrication systems.
  • A bio-engineer developing new bacteria for waste water systems.
  • A materials science engineer evaluating plastic polymers.

Direct R&D Supervision

Direct supervision of research activities concerns immediate supervision (first-line management) of qualified research activities, as in the case of an engineering manager who directly supervises a team of engineers and technicians, but who does not perform hand-on development work. Direct Supervision does not include supervision by a higher level manager of a first-line manager who directly supervises but does not conduct hands-on research activities. Examples include:

  • Attending technical meetings in which specifications, concepts or results are discussed;
  • Meeting directly with engineers involved in resolving technical issues;
  • Defining technical challenges needing to be addressed;
  • Project planning;
  • Reviewing proposed design configurations or process methodologies;
  • Managing the development process;
  • Providing feedback to senior management regarding the ongoing research activities.

Support R&D Activities

Support of research activities refers to activities performed that support those employees conducting or supervising the qualified research activities. Examples of such activities include:

  • A technician calibrating research equipment;
  • A machine operator fabricating a prototype component;
  • A system operator assisting engineers with process trials;
  • A shop foreman providing technical feedback to the research team;
  • A salesperson providing conceptual or technical information to the development team;
  • A clerk typing technical reports;
  • A maintenance worker cleaning up following an experimental process test;
  • A quality assurance worker performing analysis and compiling information relating to prototype products;
  • A purchasing agent investigating sources and procuring materials for use in a prototype product or new process system.