research as research (1) with respect to which expenditures
may be treated as expenses under section 174, (2) which is
undertaken for the purposes of discovering information (a)
which is technological in nature, and (b) the application of
which is intended to be useful in the development of a new or
improved business component of the taxpayer, and (3)
substantially all of the activities of which constitute
elements of a process of experimentation for (a) a new or
improved function, (b) performance, or (c) reliability or
quality (sec. 41(d)(1)). Section 41(d) (4) (c) specifically
provides that the term qualified research does not include

lalny research related to the reproduction of an existing
business component (in whole or in part) from a physical
examination of the business component itself or from plans,
blueprints, detailed specifications, or publicly available
information with respect to such business component. 3
Applying the language of section 41(d) (4) (C), the IRS
concluded in a private letter ruling that expenses incurred
to develop generic drugs for approval by the Food and Drug
Administration (FDA) through a process known as an
abbreviated new drug application ( ANDA ) are not eligible
for the research tax credit.‘

The research tax credit is not available for
expenditures attributable to research that is conducted
outside the United States (sec. 41(d) (4) (F)). In addition,
the credit is not available for research in the social
sciences, arts, or humanities, nor is it available for
research to the extent funded by any grant, contract, or
otherwise by another person (or governmental entity) (secs.
41 (d) (4) (G) and (H)).

3 In 1986, Congress amended section 41(d) to provide an
express, narrower definition of qualified research for purposes
of the credit. Prior to that time, qualified research had the
same meaning as the term research and experimental under
section 174 (except that research conducted outside the United
States, social sciences or humanities research, and research
funded by any grant, contract, or otherwise by a third party were
not eligible for the credit).

4 LTR 9346006 (August 13, 1993). Under the ANDA procedure,
a generic drug manufacturer must demonstrate that the generic
drug is bioequivalent to the listed (i.e., brand name ) drug and
that the active ingredient, route of administration, dosage form,
strength, and conditions of use are the same as the listed drug.
The ANDA for a generic drug need not contain data demonstrating
the safety or effectiveness of the drug (which was previously
demonstrated by clinical testing of the listed drug). Id.



State taxes would be implemented third, and the present-law
offset for past due support owed to the family (that has not
been assigned to a State) would be implemented last.

The bill would permit disclosure of the following
otherwise confidential tax information to the States,
relating to the refund offset for State tax obligations:
whether or not a reduction has been made, the amount of the
reduction, and identifying information regarding the person
against whom a reduction was or was not made.

Effective Date

The bill would be effective for Federal tax refunds
payable after December 31, 1994.



DESCRIPTION OF PROPOSALS

1. Allow Research Tax Credit for Expenses of Developing
Generic Alternatives to Brand-Name Products

res:

The research and experimentation tax credit ( research
tax credit ) provides a credit equal to 20 percent of the
amount by which a taxpayer s qualified research expenditures
for a taxable year exceed its base amount for that year. The
credit is scheduled to expire and (absent extension by
Congress) will not apply to amounts paid or incurred after
June 30, 1995.

The base amount for the current year generally is
computed by multiplying the taxpayer s fixed-base
percentage by the average amount of the taxpayer s gross
receipts for the four preceding years. If a taxpayer both
incurred qualified research expenditures and had gross
receipts during each of at least three years from 1984
through 1988, then its fixed-base percentage is the ratio
that its total qualified research expenditures for the
1984-1988 period bear to its total gross receipts for that
period (subject to a maximum ratio of 16 percent). All other
taxpayers (such as start-up firms) are assigned a
fixed-base percentage of three percent for a five-year,
start-up period, after which such firms must compute their
fixed-base percentage on the basis of their actual research
experience. In computing the credit, a taxpayer s base
amount may not be less than 50 percent of its current-year
qualified research expenditures .?

Research expenditures eligible for the credit consist
of: (1) in-house expenses of the taxpayer for research
wages and supplies used in qualified research ; (2) certain
time-sharing costs for computer use in qualified research;
and (3) 65 percent of amounts paid by the taxpayer to a third
party (other than an employee) for qualified research
conducted on the taxpayer s behalf.

Only expenses attributable to qualified research are
eligible for the credit. . Section 41(d) defines qualified

2 Deductions for qualified research expenditures allowed to
a taxpayer under section 174 are reduced by an amount equal to
100 percent of the taxpayer s research credit determined for that
year. Taxpayers alternatively may elect to claim a reduced
research credit amount in lieu of reducing deductions otherwise
allowed (sec. 280C(c)).



In addition, the 20-percent research tax credit also
applies to the excess of (1) 100 percent of cash expenditures
(including grants or contributions) paid by a corporation to
a universities (or certain other tax-exempt scientific
research organizations) for basic research over (2) the sum
of (a) the greater of two fixed research floors plus (b) an
amount reflecting any decrease in nonresearch giving to
universities by the corporation as compared to such giving
during a fixed-base period, as adjusted for inflation (sec.
41(e)). This separate credit computation for certain basic
research payments is commonly referred to as the university
basic research credit.

Description of Proposal

The proposal would amend section 41(d) (4) (C) to provide
that the ineligibility for the research tax credit for
research expenses related to duplication of an existing
business component shall not apply to research related to the
development of a business component of the taxpayer that is
an original alternative to achieve the equivalent result of a
competitor s product. The legislative history would state
that the proposal clarifies that duplication for purposes of
section 41(d) (4) (C) consists of reproduction of a
competitor s product by imitation, but does not include
duplication of performance by the development of alternative
products to achieve similar results. For example, research
to develop a generic drug product would be qualified if it
seeks to test an alternative unique formulation of excipients
to achieve the bioequivalent delivery of a known active
ingredient contained in a listed drug in order to satisfy
procedures for an FDA abbreviated new drug application
(ANDA) .

Effective D.

The proposal would be effective for expenditures paid or
incurred in taxable years beginning after December 31, 1994.
No inference would be intended with respect to the proper
interpretation of section 41 for expenses paid or incurred in
taxable years beginning prior to 1995.



DESCRIPTION OF PROPOSALS
RELATING TO
ALLOWING RESEARCH TAX CREDIT FOR EXPENSES
OF DEVELOPING GENERIC ALTERNATIVES
AND
OFFSETTING OF FEDERAL TAX REFUNDS
FOR PAST-DUE STATE TAX OBLIGATIONS (H.R. 4138)

Scheduled for a Hearing
by the
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
HOUSE COMMITTEE ON WAYS AND MEANS

on October 6, 1994

Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
October 4, 1994

JCX-24-94



2. H.R. 4138 (Messrs. Jacobs, Rangel, Stark, Grandy,
McCrery, and Others)

Refund Offset for Past-Due, Legally Enforceable State Tax
Obligations

es: aw

Federal tax refunds must be offset against past due
child support payments (Code sec. 6402). In the case of
families receiving specified public assistance payments
(primarily AFDC payments), these past due support payments
are assigned to the State that makes the public assistance
payments. Federal tax refunds must also be offset for the
amount of any past due, legally enforceable debt to a Federal
agency. Federal tax refunds may not be offset against past-
due, legally enforceable State tax obligations.

If a refund is subject to offset both under the Federal
agency provision and because of past due child support, the
offset for past due child support that has been assigned to a
State is to be implemented first, the offset for past due
debts owed to Federal agencies second, and the offset for
past due child support not assigned to a State (but owed to
the family) last. No court of the United States has
jurisdiction to hear any action brought to restrain or review
a refund offset made because of either past due child support
or a nontax Federal debt.

Description of Bill

The bill would require that the Internal Revenue Service
(IRS) reduce the amount of an overpayment of Federal tax
otherwise payable to a person by the amount of past-due,
legally enforceable State tax obligations of such person and
pay those amounts to the State. The bill would impose
several procedural requirements on the States before the IRS
could offset a refund. These procedural requirements are
generally parallel to present-law procedural requirements
imposed on the Federal Government prior to offsetting a
refund for nontax Federal debts. The bill would apply to all
types of State taxes and to any local tax that is
administered by the chief tax administration agency of the
State.

If a refund were subject to offset under multiple
provisions, the present-law offset for past due child support
that has been assigned to a State would be implemented first,
the present-law offset for other past due debts to Federal
agencies would be implemented second, the proposed offset for



CONTENTS

INTRODUCTION . . . 2... ee eee eee eee

DESCRIPTION OF PROPOSALS ..........4.4..

1.

Allow Research Tax Credit for Expenses of
Developing Generic Alternatives to Brand-
Name Products .............

H.R. 4138 (Messrs. Jacobs, Rangel, Stark,
McCrery, and Others): Refund Offset for
Past-Due, Legally Enforceable State Tax
Obligations ........ wee eee



INTRODUCTION

The Subcommittee on Select Revenue Measures of the House
Committee on Ways and Means has scheduled a public hearing on
October 6, 1994, on two miscellaneous tax proposals: (1) modify
the research tax credit to allow the credit for expenses of
developing generic alternatives to brand-name products; and (2)
H.R. 4138 (Messrs. Jacobs, Rangel, Stark, Grandy, McCrery, and
others), to provide a Federal tax refund offset for past-due,
legally enforceable State tax obligations.

This document,’ prepared by the staff of the Joint Committee
on Taxation, provides a description of present law and the
proposals.

1 This document may be cited as follows: Joint Committee
on Taxation, Description of Proposals Relating to Allowing the
R rch redit £ S_of vi in neri
Al nativ an ffs i ‘ed. Te ef for St-Due

State Tax Obligations (JCX-24-94), October 4, 1994.