U.S. manufacturers are pushing lawmakers to reverse a provision in the 2017 tax law that will force companies to write down research and development expenditures starting in 2022.
Businesses and experts are concerned that if the policy isn’t reversed soon, U.S. competitiveness in manufacturing will be further diminished, as tax incentives to keep factories stateside weaken. The fears are heightened now, as the coronavirus pandemic continues to pummel the U.S. economy.
As Congress prepares to begin negotiating another industry-focused aid package, lobbying groups and companies see now as their chance to get the tax law changed reversed.
“There’s a host of reasons why acting now and strengthening the R&D credit will have not just an immediate, but a long-term impact,” said former IRS Commissioner Mark Everson, now vice chairman of alliantgroup LP, which focuses most of its tax-consulting business on R&D. “It will be beneficial for the country.”
The 2017 tax law removed the option of expensing R&D costs in the same taxable year and will require companies to write down those deductions over five years, or 15 years for costs incurred outside the U.S. The change was part of lawmakers’ efforts to address revenue issues stemming from the law’s massive corporate tax cut.
An EY study commissioned by the R&D Coalition found that the provision would decrease R&D spending by $4.1 billion in the first five years. The coalition groups large companies like Intel Corp., Microsoft Corp., Raytheon, and Northrop Grumman Corp. to advocate for R&D issues.
Before the law was enacted, companies could write off any R&D expenses made in the same tax year, with certain limitations, to lower their tax liabilities or spread them out over five years. The perk was widely used by U.S. companies and provided incentive to keep factories on U.S. soil.
The pay-for was never intended to be permanent, Everson said, and the expectation was that lawmakers would address it later.
Hope for Congress
One possible route Congress could take is to wrap in an existing measure to its relief package: a bipartisan House bill from Reps. John Larson (D-Conn.) and Ron Estes (R-Kan.) introduced in 2019 (H.R. 4549) that would restore the tax treatment. The bill hasn’t gained widespread traction so far.
“We need to bring our manufacturing back to the United States through immediate R&D expensing that will result in years of economic growth,” Estes said July 10 in a statement to Bloomberg Tax.
The U.S. ranks 26th out of 36 nations in the value of its R&D tax incentives, he said.
Intel Corp. Chief Tax Officer and Treasurer Sharon Heck, chair of the R&D Coalition, recently told Bloomberg Tax that her group is pushing lawmakers to consider the issue.
In March, the group sent a letter to top congressional leaders expressing support for the Larson-Estes bill and arguing that if the policy is allowed to go into effect, “it will act as a disincentive to perform R&D in the U.S.”
Pain for Companies
According to the EY study, which was issued in October 2019, requiring R&D expenditures to be amortized may cut about 23,400 R&D jobs in each of the first five years, causing a ripple effect that affects suppliers and consumer spending.
With those job cuts on the horizon and broad effects on companies, the time to implement a fix is now, David Eiselsberg, senior director of tax policy at the National Association of Manufacturers, said.
Companies plan their R&D spending years in advance, and that planning window has already opened, Eiselberg said.
And if Congress fails to act, the policy will result in a significant hit to manufacturers’ earnings in the first year of implementation.
“We’re making the argument that not only would this prevent the cash hit or liquidity impact, but this would also help support recovery from the economic fallout from Covid-19,” Eiselberg said.
In Europe, more indirect government support for R&D has increasingly become the norm, potentially leaving the U.S. behind.
By 2019, all but five Organization for Economic Cooperation and Development (OECD) tax jurisdictions provided tax incentives to companies operating in them. In January, Germany introduced R&D tax credits, signifying a major shift in the way OECD countries approach to the issue.
Microsoft and other major U.S. companies transferred their R&D centers to Europe because of Europe’s tax incentives, and more companies could follow suit without further changes to U.S. tax incentives, said Georges Cavalier, a tax researcher at the European Institute of Law.
However, Congress established differences for the amortization times in its tax code to try to prevent businesses from fleeing to Europe. For R&D conducted outside in foreign countries, the time horizon for the amortization is 15 years, research in the U.S. only needs to be amortized for five years.
That could potentially keep research and development stateside, Elke Asen, tax policy researcher at the Tax Foundation.
“From a U.S. tax code perspective, this incentivizes U.S. businesses to conduct their R&D in the U.S. rather than outside of the U.S.,” Asen said. “So no advantage for Europe here.”
But Congress—like everyone else—did not foresee how the pandemic would cripple the U.S. economy and deeply affect the manufacturing sector.
“There’s an impact in terms of liquidity, there’s an impact in terms of jobs, innovation, and competitiveness,” NAM’s Eiselberg said.