PART 1 – How Controlled Group Rules Apply To Today’s Research and COVID-19 Employee Retention Credits

Peter Mehta

Peter Mehta, J.D., LL.M, is TCC’s Managing Director and National Service Leader for our R&D Tax Credit practice. With over 20 years of tax experience with the Big 4 and a law firm, Peter has significant expertise with R&D tax credit matters and federal and state practice and procedure issues.


In recent months we have fielded an increased number of inquiries regarding applying the aggregation and controlled group rules for both the Research Credit (RC) and the new Employee Retention Credit (ERC).   

Application of these rules is relatively straightforward…usually.  However, since different controlled group rules apply to the RC and ERC, we thought it would be useful and timely to summarize the controlled group rules, explain differences in application of the rules between the RC and the ERC and provide recent examples regarding their application.

Controlled Group Rules were Established in the Revenue Act of 1964

As part of the Revenue Act, I.R.C. § 1563(a) provides mechanical ownership tests to determine if a controlled group exists and also defines a controlled group of corporations as a parent-subsidiary controlled group, a brother-sister controlled group, or a combined group.

Additionally, the Revenue Act extends similar rules for other business entities (whether they be incorporated or not), providing that all trades or businesses under common control shall be treated as a single taxpayer.[1]  Two or more trades or businesses are under common control if the group of businesses is a parent-subsidiary group,   a brother-sister group or a combined group under common control.[2] 

Research Credits Determined Using the Single-Taxpayer Concept

Controlled group rules state that all members of the same group of corporations shall be treated as a single taxpayer.[3] The term “controlled group of corporations” has the same meaning given to such term by I.R.C. § 1563(a), except that “more than 50 percent” shall be substituted for “at least 80 percent” each place it appears in I.R.C. § 1563(a)(1).[4] 

Similarly, all trades or businesses (whether they be incorporated or not) under common control, shall be treated as a single taxpayer.[5]  The same “more than 50 percent” ownership requirement applies.[6]

Utilizing the “single taxpayer” concept to aggregate research expenses among the controlled group members is intended to prevent artificial increases in research expenditures by shifting expenditures among commonly controlled or otherwise related persons.

The members of a controlled group must compute a credit as if the members were a single taxpayer and then allocate the credit among the members, based upon the members’ proportionate share of qualified research expenses (“QREs”). 

Because all members of a group under common control are treated as a single taxpayer to determine the research credit, transfers between members of the group are ‘‘generally disregarded,’’ as stated in Treas. Regs. § 1.41-6(i)(1).

Disregarding intra-company transactions potentially leads to some interesting results. For example, we were recently asked by a U.S.-based company to opine on the impact that a Foreign Parent (FP) would have on the U.S. Company claiming an R&D credit, where the foreign parent essentially reimbursed the U.S. subsidiary for its research.

The threshold issue is: Should the FP be included as part of the controlled group? This consideration is surprisingly a source of some confusion.  Without wading through the convoluted analysis under I.R.C. § 1563, the short answer is “yes”.  In PLR 8914026, the IRS agreed that a foreign corporation is a member of a controlled group within the meaning of §1563(a).  Therefore, all foreign corporations with greater than 50% ownership are members of the controlled group.

Since they are part of the same controlled group, FP’s reimbursements would not be treated as funded research because inter-company transactions are disregarded. Therefore, the U.S. subsidiary may claim QREs despite the reimbursement.

Consider the same facts, except that FP sends employees to the U.S. to perform the work. Under these facts, how the employees were paid would determine if the U.S. subsidiary could claim an R&D credit. If the U.S. subsidiary paid the loaned workers directly and issued them a W-2, reporting wages paid, these could be claimed as wage QREs.

If, however, the FP pays the employees, and the U.S. subsidiary simply reimburses the FP, the payment would be disregarded.  Here, FP incurs the cost of the research, and the U.S. subsidiary could not claim the research costs even though the work was performed in the U.S. on behalf of the U.S. subsidiary.

Learn more about the Research Tax Credit.

[1] I.R.C. § 41(f)(1)(B)(i).
[2] Treas. Regs. §1.52-1(b).
[3] I.R.C. § 41(f)(1)(A)(i).
[4] I.R.C. § 41(f)(5)(A).
[5] I.R.C. § 41(f)(1)(B)(i).
[6] I.R.C. § 52(b).

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