Accounting for the Qualified Therapeutic Discovery Tax Credit
I have been notified that I have been awarded the Therapeutic Discovery Tax Credit. What do I need to consider from a financial accounting perspective?
The first key issue that arises is whether companies should record the receipt of the grant as revenue, other income or an offset (reduction) to research and development expense (“R&D”). Prior to companies making the decision on how to record the grant, they should look to any pre-existing accounting policies for similar transactions. If their accounting policy is silent with respect to similar grants, then we believe that companies should not record the grant as revenue unless they can demonstrate that the grant arrangement is part of its ongoing central operations. We also believe that netting the grant received with the R&D expense is not appropriate since the grant funds received do not directly correlate on a $1 for $1 basis with expense. Under most circumstances, we believe that the receipt of the grant should be recorded as other income, with appropriate footnote disclosure.
Secondly, companies will need to determine for which accounting period the grant award applies. Companies should look to the guidance for “Subsequent Events” when evaluating which period to record the transaction. This issue relates to the fact that many companies were notified that they were approved for the grant subsequent to September 30, 2010, but prior to the release of their quarterly financial statements. However, the issue becomes more complicated because the award may cover both 2009 and 2010 expenditures. We are of the position that the companies would record the grant in the period in which it was received, not granted (or notified of approval) for 2009 expenditures (which would generally be a 4th quarter adjustment for calendar year companies). The notification that they were approved for the grant would not be sufficient to record the transaction in that period, as the earnings process was not complete due to the lack of the dollar amount being known. For 2010 expenditures, the IRS will require a “reconciliation” of actual qualified expenditures compared to the amounts indicated on the QTDP application, which will be a separate tax form (once published) filed 30 days after the end of the 2010 tax year. This amount would be calculable as part of the fiscal 2010 closing process, (and the earnings process complete) and therefore we believe it should be recorded as an “other accounts receivable” in the 2010 books. Subsequent collection of the cash in early fiscal 2011 should be further evidence that the process was complete.
We have not seen too many of our clients and friends electing to treat the award as a tax “credit,” as substantially all of the recipients elected to treat it as a grant. However, if tax “credit” was elected then the basic rules of recognizing other tax credit should be followed, which is part of the tax provision calculation process.
For federal income tax purposes, the IRS indicated that if the 2009 tax return has already been filed and the award relates to those periods, the tax return should be amended in order to decrease the expenses taken or fixed assets basis (dollar for dollar for the award received) and also reduce any R&D tax credit associated with these specific expenses.
For the 2010 tax returns the above rule should be followed as well; however, this time applied with the original tax return.
Please be aware that various states follow the federal rules and usually begin with the federal taxable income so those may need to be amended as well for the 2009 tax period. In addition, some states may issue their own rules about the taxability of this item, so check the rules of the states in which you operate. Please remember that the filing of the amended tax returns for 2009 will change the components of the deferred taxes, and will need to be reflected in the 2010 accounts.
If you would like to understand more about the Qualified Therapeutic Discovery Tax Credit, our professionals are ready to assist you.