Allocation and apportionment of research and experimental expenditures

Allocation and apportionment of research and experimental expenditures

On April 30, 1992, Tax Executives Institute filed the following comments with Assistant Treasury Secretary Fred T Goldberg, Jr., requesting the Treasury Department to amend the allocation and apportionment regulations under Treas. Reg. [subsection] 1.861-8(e)(3), which govern the treatment of research experimental expenditures. The comments were prepared under the aegis of the Institute’s International Tax Committee whose chair is Raymond G. Rossi of Intel Corporation.

Senator Bentsen and Representative Rostenkowski have written to Secretary Nicholas F. Brady urging the Department of the Treasury to amend the income tax regulations concerning the allocation and apportionment of research and experimental expenditures under section 861(b) of the Internal Revenue Code. The current regulations, promulgated in 1977, have been in effect intermittently for fewer than 5 of the past 15 years because of various congressional moratoria on its enforcement. The latest temporary legislative approach set forth in section 864(f) of the Code is set to expire on June 30, 1992. Tax Executives Institute supports the effort to resolve this issue administratively on a basis consistent with the extant legislation.


Tax Executives Institute (TEI) is the principal association of corporate tax executives in North America. Our approximately 4,800 members are employed by more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and the government alike.

As a professional association, TEI is firmly committed to maintaining a tax system that works – one that is consistent with sound tax policy, one that taxpayers can comply with, and one in which the Internal Revenue Service can effectively perform its examination function. Many of TEI’s members work for multinational enterprises for which the allocation and apportionment rules of Treas. Reg. [subsection] 1.861-8 have a substantial impact. For example, they know first-hand the counterproductive effect of the on-again, off-again legislative moratorium. They know first-hand of the need for certainty in an area where the tax rules are intended, at least in part, as an incentive to U.S.-based research. And, they know first-hand of the need to resolve this issue on a permanent basis. Thus, TEI brings an informed and balanced perspective to the debate over the appropriate allocation of research and experimental expenditures.


The current regulatory rule is set forth in Treas. Reg. [subsection] 1.861-8(e)(3). After allowing allocation of research expenditures for research performed to meet certain limited legal requirements, the rule permits allocation of 30 percent of total expenditures based on the geographic source where the research is conducted. The balance of the research expenditures is apportioned to various categories of income based on sales. The 30-percent exclusive apportionment is justified on two grounds:

First, research and development

often benefits a broad

product category, consisting of

many individual products, all

of which may be sold in the

nearest market but only some

of which may be sold in foreign

markets. Second, research and

development often is utilized in

the nearest market before it is

used in other markets, and in

such cases, has a lower value

per unit of sales when used in

foreign markets. Treas. Reg. [subsection]


TEI does not here dispute the underlying premise of the section 861 regulations that expenses should be allocated and apportioned to the income generated based on factual relationships. Nonetheless, we believe that the development of a theoretically and conceptually correct allocation of research expense to the income attributable to U.S.-developed intangibles would prove unadministrable for both taxpayers and the IRS. Thus, we understand the thinking that led to the development of the sales and gross income methods of apportioning research expenses as tenuous proxies for identifying the income attributable to the intangible. Those methods, however, were developed by the Treasury Department without exposure to public comment before the section 861 regulations were adopted as final. Furthermore, those methods understate the problem of developing the rational connection between the performance of research and the production of income attributable to intangibles developed by the research effort. Consequently, TEI echoes the statements of those congressional leaders and other commentators who argue that the 30-percent exclusive apportionment rule and its rationale should be re-examined by the Treasury Department – especially in light of the desire to keep research and development programs in the United States.

As you well know, enforcement of the current regulation has been delayed through periodic intervention by Congress. The most recent expression of public policy concerning the proper allocation of research expenditures is embodied in section 864(f), which treats 64 percent of U.S. incurred expense as exclusively allocable to U.S. source income and the same portion of foreign situs research expense as exclusively allocable to foreign source income. TEI believes that the “64-percent solution” reflects an equitable and administratively feasible resolution of this longstanding issue.

As to the Treasury’s authority to resolve this matter administratively, we respectfully submit that the same regulatory grant that empowered the Treasury to issue the 30-percent exclusive apportionment rule clearly extends to a revised 64-percent regulation that embodies the public policy compromise tacitly reached among the President, the Congress, and the affected taxpayers. Even before Senator Bentsen and Representative Rostenkowski wrote Secretary Brady, the Conference Agreement to H.R. 4210 exhorted Treasury to rewrite the research expense regulations, based on the congressional understanding that Treasury has broad authority under current law to modify the regulations. Although President Bush vetoed H.R. 4210 (for reasons unrelated to the section 861 issue), the consensus view of the President, the Congress, and the private sector remains that research and development should be encouraged to remain in the United States and that a 64-percent exclusive apportionment rule would serve that goal. Impediments and disincentives to that agreed public policy goal should be removed.


For the foregoing reasons, Tax Executives Institute encourages the Treasury to withdraw the current regulation [subsection] 1.861-8(e)(3), announce that it intends to modify the current regulations consistent with section 864(f), and permit taxpayers to rely upon the method prescribed there as a temporary administrative approach, pending issuance of revised regulations.

The Institute would be pleased to discuss this matter with you. If you should have any questions please contact Jeffery P Rasmussen of the Institute’s professional tax staff at (202) 638-5601.

Less taxing matters …

During the past three or four years, TEI Headquarters has received many requests that it send business cards to a small boy in England. These letters closely resembled chain letters, albeit without the promise of riches if you comply and the threat of famine and plague if you break the chain. As recited in the letters, the young boy’s name is Craig Shergold, he is seven years old, he lives in England, and he has a brain tumor that has shortened his life expectancy to only a few months. The letters state that Master Shergold’s only wish is to be listed in the Guinness Book of World Records for receiving the most business cards and that the Make-a-Wish Foundation had undertaken to make Craig’s wish come true.

As Wayne and Garth would say: NOT.

It is true that several years ago Craig Shergold – who at the time was seven years old – was diagnosed as having a brain tumor and that he did express a desire to have his name in the Guinness Book of World Records as the boy with the most Get-well cards. Soon this wish was taken up by the Children’s Make-a-wish Foundation (which incidentally has been sued for trademark infringement by the Make-a-wish Foundation – isn’t it nice to know that eleemosynary organizations have not escaped the general litigiousness of society?).

Somewhere along the line, however, the wish got skewed. The request for get-well cards was transmuted into one for business cards. No one stopped to ask why a young boy would want business cards. (“I’ll trade you one John Akers for a Lee Iaccocca and a Katherine Graham.” “No, in light of the United Way scandal, I’ll trade you straight up your Akers for my Iaccocca.”) And soon, Master Shergold was deluged with scads and scads of business cards … which he did not want.

That is not all. More than two years ago, the medical – as opposed to the postal – plight of Craig came to the attention of philanthropist John Kluge, who flew the boy to the University of Virginia for brain surgery. Voila! 95 percent of the tumor was removed and the remaining portion was pronounced benign. Master Shergold returned to England physically cured, but besieged by a cancer of cards that had grown uncontrollably.

Craig, through his parents, asked that the practice cease. The Postal Services in the United States and England seconded the motion. As did the Guinness Book of World Records and the Children’s Make-a-wish Foundation. As did Ann Landers. As does TEI Headquarters.

As Geraldo would say, now it can be told.

COPYRIGHT 1992 Tax Executives Institute, Inc.

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