What Gross Receipts are Used in R&D Credit?

For the research tax credit, what gross receipts do you include in computing its tax credit?  Despite the credit being on the books for several decades, this is an open question.  The court addressed this in Hewlett-Packard Co. v. Commissioner, 139 T.C. 8.

Facts & Procedural History

Hewlett-Packard Co. (“Hewlett-Packard”) is a global technology and service company that manufactured and distributed a broad range of technology-based business products, including printers, scanners, ink and laser supplies, desktop personal computers, notebooks, workstations, high-end servers, total disk storage systems, and software technology, including system management software.

Hewlett-Packard computed its research tax credits for tax years 1999 through 2003 using the alternative incremental credit or AIRC, which required Hewlett-Packard to compute its average annual gross receipts or AAGRs for the four taxable years preceding each of these tax years.

Gross Receipts for the R&D Credit

Hewlett-Packard used the amounts reported on line 1(c) of its Forms 1120, U.S. Corporation Income Tax Return, as the base for its AAGR calculation for each year.

Line 1(a) was for “gross receipt or sales,” Line 1(b) was for “returns and allowances,” and Line 1(c) was the difference between line 1(a) and line 1(b).

Lines 4, 5, 6, 7, and 10 were for “Dividends,” “Interest,” “Gross rents,” “Gross royalties,” and “Other income,” respectively. Hewlett-Packard excluded amounts reported on these lines in computing its AAGR.

The IRS did not agree that the amounts on Lines 4, 5, 6, 7, and 10 should be excluded in computing AAGR.

The issue for the court was whether Hewlett-Packard was required to include nonsales income, including dividends, interest, rent, and other income in its AAGR when calculating its research tax credits.

The court concluded that Hewlett-Packard was required to include nonsales income, including dividends, interest, rent, and other income, in its AAGR when calculating its research tax credits.

CFC Inter-Compnay Revenues

Hewlett-Packard included intercompany revenues from sales to its controlled foreign corporations or CFCs in Line 1(a) for each of the relevant years.

Hewlett-Packard did not believe it had to include intercompany revenues from sales to its CFCs in its AAGR.

Thus the court had to consider whether Hewlett-Packard was required to include intercompany gross receipts received from controlled foreign corporations (CFCs), within the meaning of Section 41(f)(5), in its “average annual gross receipts” (AAGR) when calculating its research credits and

The court concluded that Hewlett-Packard could exclude intercompany gross receipts received from CFCs from its AAGR when calculating its research tax credits.