A common question is how government grants affect the R&D tax credit. The short answer is that government grants may affect the credit through the funded-research exclusion. Research performed under a grant is generally treated as funded. The analysis examines the grant terms, rights, and eligible expenses, and blanket statements should be avoided. This page explains the framework in general terms. It is educational and is not individualized advice. For the foundational framework, see our page on funded research.
The Funded-Research Exclusion
Under Section 41(d)(4)(H), research is excluded from qualified research to the extent it is funded by another person (or governmental entity). The Treasury Regulations provide that research performed under a grant is generally treated as funded. This means that research performed under a government grant may be excluded from the taxpayer's qualified research to the extent of the grant funding. For more, see our page on funded research.
Grant Terms Matter
The analysis examines the grant terms. Different grants have different terms regarding payment, rights, and eligible expenses. Some grants provide funding for specific research activities; others provide broader funding. Some grants allocate rights to the government; others leave rights with the taxpayer. The specific terms of the grant control the analysis.
Rights to Results
The taxpayer generally must retain substantial rights in the research results for the research to not be funded. Where the grant gives the government rights to the results, or where the taxpayer must pay for the right to use the results, the taxpayer may not retain substantial rights. The grant provisions allocating intellectual-property rights are relevant.
Eligible Expenses
The analysis may also examine which expenses are eligible for the grant and which are not. If only certain expenses are funded by the grant, the unfunded expenses may potentially be taken into account, provided the other requirements are met. The allocation of expenses between funded and unfunded portions may be required.
Avoid Blanket Statements
It is important to avoid blanket statements about government grants and the R&D tax credit. Some grant-funded research may be fully excluded; some may be partially excluded; and some may not be excluded at all, depending on the grant terms. The determination depends on the specific grant and facts. Professional review of the actual grant is appropriate.
Hypothetical Example
Consider a manufacturer that receives a government grant to perform research on a new technology. If the grant provides funding for the research, and the government retains rights to the results, the research may be funded and excluded from the manufacturer's qualified research to the extent of the grant funding.
By contrast, if the manufacturer uses its own funds (not grant funds) for a separate portion of the research, and retains exclusive rights to those results, the separately funded portion may warrant review as qualified research, provided the other requirements are met.
These examples are illustrative only and do not provide legal conclusions about any particular grant.
Documentation That May Help
Records that can help support the funded-research analysis for government grants include the grant agreement, funding terms, provisions allocating rights, expense records distinguishing funded and unfunded portions, and any project communications clarifying the scope of the grant. For more, see our page on R&D tax credit documentation.
Key Takeaway
Government grants may affect the R&D tax credit through the funded-research exclusion. Research performed under a grant is generally treated as funded. The analysis examines the grant terms, rights, and eligible expenses, and blanket statements should be avoided. Because the funded-research analysis is fact-specific, professional review is appropriate.