During the recently ended legislative session, the Indiana General Assembly significantly expanded the state’s sales tax exemption for property purchased for use in R&D activities. Although certainly well-intentioned, the R&D exemption has been the source of much consternation for taxpayers since it became law in 2005. The exemption historically contained challenging language that led to difficult audits and uneven application of the exemption.
The Indiana General Assembly has sought to remedy these problems with its new amendments to the R&D exemption. Effective for purchases made after June 30, 2013, all purchases of “research and development property” devoted to experimental or laboratory research and development activities are exempt from tax. See P.L. 288. This is a significant, and welcome, departure from the existing statutory language that provides an exemption for “research and development equipment” that was “devoted directly” to experimental or laboratory research and development activities. See IC 6-2.5-5-40 (a)-(b). (emphasis added).
The General Assembly has also clarified that the revised exemption applies “regardless of whether the person that acquires the research and development property is a manufacturer or seller of the new or existing products,” meaning that third party or contract researchers are eligible for the expanded benefit.
With the amendments, the General Assembly has made two very taxpayer favorable changes to the exemption: changing from R&D “equipment” to the much broader R&D “property” and requiring only that the property be “devoted” to R&D activities instead of “devoted directly” to R&D activities.
The statutory language limiting the exemption to R&D equipment has always been problematic. Although R&D equipment is defined in the statute as laboratory equipment, computers, computer software, telecommunications equipment, and testing equipment, Indiana has no other formal guidance on what constitutes equipment and what does not. The Indiana Department of Revenue chose to go the informal route, issuing only a non-binding information bulletin with its interpretations. See Sales Tax Info. Bulletin No. 75 (Oct. 2008). The new language does away with the equipment issue by broadening the exemption to include all research and development property.
For example, the Department’s existing information bulletin provides that research and development equipment does not include “hand powered tools or property with a useful life of less than one year.” Id. With the statutory change to research and development property, one might expect that these types of purchases are no longer at issue.
The second change, from “devoted directly” to simply “devoted,” is more subtle but equally important. By comparison, consider Indiana’s manufacturing exemption which provides an exemption for purchases acquired for “direct” use in “direct” production of other tangible personal property, a so-called “double direct” test. See IC 6-2.5-5-3(b). The original R&D exemption required a qualifying purchase to be “devoted directly” to R&D activities, a single “direct” test. It seems then the legislature has now implemented “a zero direct” test by striking the word “direct” from the statute entirely. By omission the new language suggests that purchases used both directly and indirectly in R&D activities might qualify for the exemption. It certainly follows that a “zero direct” test must include a broader range of exempt purchases.
For example, might electricity used to light R&D labs or power testing equipment now qualify for the exemption? It is after all tangible personal property seemingly devoted to R&D activities. See IC 6-2.5-1-27. It’s an unanswered question, but it is one worth exploring.
Of course, all statutory language is open to interpretation and taxpayers will have to wait to see the Department’s view of the revised language. The Department is expected to issue an updated Sales Tax Information Bulletin No. 75 in the coming weeks. In the meantime, businesses should consider a review to determine if previously taxable purchases might now qualify for the expanded exemption.
This is a guest post by my former colleague Scott Novak, SALT Senior Manager with CliftonLarsonAllen, LLP in Indianapolis.