MASSIE says: The “Substantially All” tests determine if nonqualifying activities and hours should be included in the final credit calculation.
Under the “process of experimentation” test, the “substantially all” requirement is met “only if 80 percent or more of a taxpayer’s research activities measured on a cost or other consistently applied reasonable basis . . . constitute elements of a process of experimentation.” Treas. Reg. § 1.41-4(a)(6).
Section 41(d)(2)(A) requires the four tests be separately applied to each of the taxpayer’s business components. Treas. Reg. § 1.41-4(b)(1). Treas. Reg. Section 1.41-4(a)(6) further confirms the requirement under Section 41(d)(2)(A) by stating that the “substantially all” requirement under the “process of experimentation” test is “applied separately to each business component.”
There are two ways to apply the “Substantially All” tests.
First, we start by defining a business component at a high, overall-project level. If a business component’s non-qualifying activity percentage is 20 percent or less, then it passes the “Substantially All” test.
However, if a project’s non-qualifying activity percentage is greater than 20 percent, then the “shrink-back rule” applies. We can “shrink back” the scope of the business component to a smaller, more R&D-focused component or subset of elements of the product, process, computer software, technique, formula, or invention to be held for sale, lease, or license until it is able to meet the 80 percent threshold that provides a better possibility of tax-credit success.
Second, if an employee’s qualifying hours are 80 percent or greater, then 100 percent of that employee’s hours can be used toward the final credit calculation.
Disclaimer: The information on this website is for general information purposes only. Nothing on this site should be taken as legal advice for any individual case or situation.
