Overview of Section 48D

The Patient Protection and Affordable Care Act (enacted on March 23, 2010) created the qualifying therapeutic discovery project tax credit under Section 48D of the Internal Revenue Code (IRC) to subsidize expenses related to certain “qualifying therapeutic discovery projects.” This program provides a 50 percent investment tax credit¹ for certain expenditures incurred during 2009 or 2010. Companies with eligible projects (as defined in Section 48D) were required
to apply and compete for the tax credits and were therefore not guaranteed to receive a credit or grant under IRC
Section 48D.

Expenditures for which a credit is awarded under Section 48D may not be treated as credit-eligible expenses when the taxpayer computes its research credit or orphan drug credit. In addition, such expenditures may not be depreciated (if they are capital expenditures) or deducted (if they otherwise would be deductible); therefore, in such cases, companies are restricted from receiving a “double benefit.”

Companies are able to elect to receive a cash grant in lieu of the investment tax credit. For tax years beginning in 2009, companies that elected to receive a cash grant were required to do so as part of their application to have a project certified as a “qualifying therapeutic discovery project,” as this term is defined in IRC Section 48D. For tax years beginning in 2010, a separate application is required, which is due by the due date (including extensions) for filing the income tax return for such years. For taxpayers electing to receive a grant rather than the credit, the grant is not includable in the taxpayer’s gross income; however, the same rules that prevent taxpayers from obtaining a double benefit are applicable to grantees.

Once a company has been awarded a credit under IRC Section 48D, two issues arise:

• Which accounting guidance should be applied (i.e., an income tax model or a pretax recognition model).
• If a pretax recognition model applies, which pretax model should be used.

Existing Guidance Under ASC 740

The IRC Section 48D benefit, when elected to be received as a cash grant, indicates that benefits that do not depend on taxable income (or a company’s tax status or position) are not considered an element of income taxes accounted for under ASC 740.² However, benefits whose realization depends on the existence of taxable income are accounted for as a reduction of income taxes under ASC 740. One exception to this general rule is a tax benefit that previously depended on future taxable income for realization but that, because of a change in tax law, is now realizable as a cash grant (e.g., see IRC Section 168(k)(4), which allows a research and development (R&D) credit to be refunded in lieu of claiming bonus depreciation); such a benefit would generally continue to be accounted for under
ASC 740.

Realization of the IRC Section 48D benefit, when elected to be received as a cash grant, does not depend on the existence of future taxable income. However, to the extent that the benefit results in the realization or monetization of prior-period tax attributes (specifically from 2009) that previously depended on taxable income, it may be acceptable to treat the IRC Section 48D benefit similarly to the exception described above. The following examples illustrate this concept:

• A company generates a research or orphan drug credit in 2009, which is not fully used to reduce taxes in 2009 and is therefore carried forward to the 2010 tax year. The amount carried forward is subsequently reduced when the 2009 tax return is amended to claim certain expenses as refundable under IRC Section 48D, because these amounts are no longer usable in the computation of the research or orphan drug credit.
• A company generates a net operating loss in 2009, which cannot be carried back and is therefore carried forward to reduce taxable income in future years. The amount carried forward is subsequently reduced when the 2009 tax return is amended to claim certain expenses as refundable under IRC Section 48D, because these amounts are no longer deductible in the determination of taxable income.

In both examples, amounts carried forward as deferred tax assets are converted to refundable grants (i.e., “monetized”). Accordingly, they are treated similarly to the monetization of research tax credits under IRC Section 168(k)(4). It would thus be acceptable to view the grant as monetization of a preexisting deferred tax asset. Therefore, according to this view, only the portion of the grant amounts in excess of the monetized deferred tax asset should be recognized as a grant (see grant discussion below).

If a company had previously established a valuation allowance against a deferred tax asset, and the valuation allowance is subsequently reduced as a result of a the monetization of the deferred tax asset as described above, the release of the valuation allowance is reflected as an income tax benefit.

Grant Accounting

Because of the nature of the IRC Section 48D credit, an analogy to IAS 20³ may be appropriate if the credit is viewed as a government grant. A company is not eligible to receive the IRC Section 48D benefit until it receives notification from the government that its application for the credit is approved. Accordingly, the credit would be recognized in the income statement once all the recognition requirements are met, which would generally be upon receipt of government approval of the company’s application for any expenditure incurred in 2009. The portion of the credit received for 2010 expenditures that have not been incurred should be deferred and recognized as such costs are incurred. (Note that for any credit received in connection with capital expenditures, a company should analogize to IAS 20 and evaluate the recognition in the income statement in relation to the timing of recording the associated cost of the capital assets.)

Under IAS 20, there are two alternatives for grants of this nature. They can be recorded as either (1) other income, in a separate line item under operating income, or (2) a reduction in the related expense account (R&D or other). The recording of such a grant as other income or as an offset to the related expense is a policy election. In evaluating these options, a company should consider (1) whether it has a preexisting accounting policy for similar credits and (2) the nature of its business.

Conclusion

On the basis of the guidance described above, there are two acceptable views on recording a benefit received under IRC Section 48D:

1. The benefit provided by IRC Section 48D is a refundable grant that does not depend on taxable income for realization and should therefore be excluded from the tax provision calculation under existing guidance. Under this approach, the full amount of the IRC Section 48D benefit would be recognized outside of the tax provision calculation and any changes to the income tax position as a result of amending 2009 tax returns would be reflected separately in the tax provision.
2. The portion of the grant that a company receives in connection with 2009 expenses that results in an impact to the company’s tax position upon amendment of its 2009 tax return (as required) would be accounted for as part of the tax provision. Under this approach, the company may reflect a portion of the IRC Section 48D benefit in the tax provision calculation in an amount equal to the amount that is part of the amendment to its 2009 tax return. The remaining benefit would be recognized outside of the tax provision calculation.

For the portion of the grant that is not determined to be included in a company’s tax provision, such amounts generally will be recorded on the date of receipt of the government approval of the company’s application for this grant and should be recorded as either other income or an offset to the related expenditure that gave rise to the credit. As noted above, if the credit is offset against the related expenditure, and that expenditure was capital, the company should recognize the benefit over the life of the related asset..

[1] The term “investment tax credit” used herein refers only to IRC Section 48D and does not have the same meaning as used in ASC 740-10-25-46 regarding the deferral and flow-through methods of recognizing investment tax credits related to depreciable property.

[2] FASB Accounting Standards Codification Topic 740, Income Taxes.

[3] IAS 20, Accounting for Government Grants and Disclosure of Government Assistance.