A common question about the federal R&D tax credit is whether research conducted outside the United States can be taken into account. Under Section 41 of the Internal Revenue Code, the answer is generally no: research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States is excluded from qualified research. This page explains the exclusion and the questions it raises for multinational teams and foreign contractors. It is educational and is not individualized advice. For the cost framework, see our page on qualified research expenses.
Foreign Research in Plain English
Section 41(d)(4)(F) provides that the term "qualified research" does not include any research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States. This is a geographic exclusion: it turns on where the research is performed, not on the taxpayer's nationality or place of business. Research that qualifies in every other respect is still excluded if it is conducted outside the specified U.S. locations.
The Federal Foreign-Research Exclusion
The exclusion is statutory and is implemented through the qualified-research definition. Because the exclusion applies at the qualified-research stage, costs associated with excluded foreign research generally cannot be taken into account as qualified research expenses for the federal credit, even if the costs would otherwise fit a recognized category. The exclusion is one of several under Section 41(d)(4); others include research after commercial production, adaptation, duplication, certain internal-use software, and funded research. For more, see our page on qualified research.
Where the Research Is Performed
The exclusion turns on where the research is physically performed. Determining where particular activities occurred can be straightforward when all the work happens in one location, but it can be more difficult when a project spans multiple countries. The question is not where the taxpayer is headquartered or where the business component is sold, but where the research activities themselves take place.
Multinational Development Teams
Where a development team includes employees in the United States and employees abroad working on the same business component, the analysis generally requires separating the activities performed in the United States from those performed outside it. Only the activities (and associated costs) tied to research performed in the United States, Puerto Rico, or a U.S. possession may potentially be taken into account; the foreign portion is excluded. This can require a supportable allocation of activities and costs by location.
Foreign Contractors
Contract research performed by an outside party located outside the United States is also generally excluded, because the research is conducted outside the specified locations. The location of the contractor — not the location of the taxpayer that engages it — is what matters for the foreign-research exclusion. A U.S. taxpayer that engages a foreign firm to perform research abroad generally cannot take those costs into account as qualified research expenses for the federal credit. For more, see our page on R&D tax credit contractor costs.
U.S. and Foreign Work on the Same Project
A single project may involve both U.S. and foreign work. In that situation, the analysis generally requires identifying which activities were performed in the United States and which were performed abroad, and allocating the associated costs accordingly. The U.S. portion may potentially be taken into account if the other requirements are met; the foreign portion is excluded. A blanket allocation of an entire project's costs to the United States, without support for where the activities occurred, generally is not appropriate.
Allocating Costs and Activities
Where employees or contractors are in multiple locations, a supportable allocation of wages and contractor costs by where the qualified research was performed is generally needed. Payroll, time, and activity records that identify where employees performed their work, and contractor records that identify where the contracted research was performed, can help support the allocation. For more on the wage component, see our page on R&D tax credit employee wages.
Documentation That May Help
Records that show where research activities were performed — including employee work locations, contractor locations, and project activity records tied to geography — can help support which portion of a project may be taken into account and which is excluded. Because the exclusion is geographic, location evidence is particularly important for multinational projects. For more, see our page on R&D tax credit documentation.
State Credit Rules May Differ
The federal foreign-research exclusion does not necessarily govern state R&D credits. Some states may follow the federal approach, while others may have their own rules about the location of qualifying research. A taxpayer considering a state credit should check the current rules of the specific state. For more, see our page on state R&D tax credits.
Key Takeaway
Under Section 41, research conducted outside the United States, Puerto Rico, and U.S. possessions is excluded from qualified research for the federal credit. The exclusion turns on where the research is physically performed, which can require allocation for multinational teams and foreign contractors. Because the analysis can be fact-specific, professional review is appropriate. For the broader cost framework, see our page on qualified research expenses.