Credit for Increasing Research Activities, 29596-29607 [05-10247]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 70, Number 99 (Tuesday, May 24, 2005)]
[Rules and Regulations]
[Pages 29596-29607]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-10247]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9205]
RIN 1545-BE17


Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations relating to the 
computation and allocation of the credit for increasing research 
activities for members of a controlled group of corporations or a group 
of trades or businesses under common control. These temporary 
regulations reflect changes made to section 41 by the Revenue 
Reconciliation Act of 1989 (1989 Act), which introduced the current 
computational regime for the credit, and the Small Business Job 
Protection Act of 1996, which introduced the alternative incremental 
research credit. The text of the temporary regulations also serves as 
the text of the proposed regulations set forth in the notice of 
proposed rulemaking on this subject in the Proposed Rules section in 
this issue of the Federal Register.

DATES: Effective Date: These regulations are effective May 24, 2005.
    Applicability Dates: For dates of applicability see Sec. Sec.  
1.41-6T(j) and 1.41-8T(b)(5).

FOR FURTHER INFORMATION CONTACT: Nicole R. Cimino (202) 622-3120 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On July 29, 2003, the Treasury Department and the IRS published in 
the Federal Register (68 FR 44499) proposed amendments to the 
regulations under section 41(f) (REG-133791-02) (the 2003 proposed 
regulations) relating to the computation and allocation of the credit 
for increasing research activities (research credit) under section 41 
for members of a controlled group of corporations or a group of trades 
or businesses under common control (controlled groups). The 2003 
proposed regulations withdrew the proposed regulations published in the 
Federal Register on January 4, 2000 (65 FR 258) (REG-105606-99) (the 
2000 proposed regulations). In general, the 2000 proposed regulations 
required

[[Page 29597]]

controlled groups to compute a group credit and then to allocate that 
group credit among the members of the controlled group. The allocation 
of the group credit under the 2000 proposed regulations was based on 
the relative increases of each member's qualified research expenses 
(QREs) over a base amount that was computed by multiplying that 
member's most recent average annual gross receipts by the controlled 
group's fixed-base percentage.
    Although the 2003 proposed regulations did not modify the rules 
relating to the computation of the group credit, the 2003 proposed 
regulations did modify the rules relating to the allocation of the 
group credit among the members of the controlled group. In particular, 
the 2003 proposed regulations allocated the group credit in proportion 
to the credit, if any, that a member of a controlled group would be 
entitled to claim if it were not a member of a controlled group (the 
stand-alone entity credit). In addition, based on the comments to the 
2000 proposed regulations, the 2003 proposed regulations did not 
propose special rules that would apply to consolidated groups that were 
members of a controlled group. A public hearing on the 2003 proposed 
regulations was held on November 13, 2003. After considering the 
written comments and the statements at the public hearing, the Treasury 
Department and the IRS are withdrawing the 2003 proposed regulations 
and are issuing temporary regulations and proposed regulations cross-
referencing the temporary regulations. In substantial part, the 
temporary regulations retain the rules contained in the 2003 proposed 
regulations with certain modifications discussed below.

Summary of Comments and Explanation of Provisions

Computation of the Group Credit

    Section 41(f)(1)(A)(i) provides that ``all members of the same 
controlled group of corporations shall be treated as a single 
taxpayer'' in determining the amount of the research credit under 
section 41. Section 41(f)(1)(B)(i) provides a similar rule for a group 
of trades or businesses under common control. The 2003 proposed 
regulations applied the section 41 computational rules on an aggregate 
basis for purposes of determining the amount of the group credit. 
Additionally, a controlled group would have been treated as a start-up 
company for purposes of determining the group's fixed-base percentage 
only if each member of the group qualified as a start-up company. 
Therefore, a controlled group with only two members would have been 
subject to the start-up rules if one member of the group had QREs but 
no gross receipts in 1983 and the other member had gross receipts but 
no QREs in 1983.
    Commentators generally agreed with the proposed rules for computing 
the group credit. Commentators were concerned, however, with perceived 
ambiguities related to the application of the start-up company rules to 
a controlled group. For example, commentators asked that the 
regulations clarify what a controlled group's start-up date is if all 
the members of the group are start-up companies with different start-up 
dates.
    These temporary regulations retain the rules in the 2003 proposed 
regulations for the computation of the group credit, except for the 
start-up company rules. The temporary regulations state that a 
controlled group is treated as a start-up company for purposes of 
computing the group credit if (A) the first taxable year in which at 
least one member of the group had gross receipts and at least one 
member of the group had QREs begins after December 31, 1983, or (B) 
there were fewer than three taxable years beginning after December 31, 
1983, and before January 1, 1989, in which at least one member of the 
group had gross receipts and at least one member of the group had QREs. 
Consistent with this approach, the first taxable year in which a 
controlled group has gross receipts for purposes of the start-up 
company rules is the first year in which at least one member of the 
group has gross receipts. Likewise, the first taxable year in which a 
controlled group has QREs for purposes of the start-up company rules is 
the first year in which at least one member of the group has QREs. The 
Treasury Department and the IRS believe that this approach is more 
consistent with treating a controlled group as a single taxpayer 
because a controlled group with two members is not subject to the 
start-up rules if one member of the group had QREs but no gross 
receipts in 1983 and the other member had gross receipts but no QREs in 
1983. Additionally, the temporary regulations specifically state that 
for purposes of determining the fixed-base percentage, the first 
taxable year after December 31, 1993, for which a controlled group has 
QREs is the first taxable year in which at least one member of the 
group has QREs.

Allocation of the Group Credit

    Section 41(f)(1)(A)(ii) provides that ``the [portion of the group] 
credit (if any) allowable by this section to each such member shall be 
its proportionate shares of the qualified research expenses and basic 
research payments giving rise to the credit.'' Section 41(f)(1)(B)(ii) 
provides a similar rule for a group of trades or businesses under 
common control. The 2003 proposed regulations apply these provisions by 
allocating the group credit based on the relative amounts of each 
individual member's stand-alone entity credit.
    A number of commentators requested changes to the method of 
allocating the group credit contained in the 2003 proposed regulations. 
In general, these comments reflected dissatisfaction either with the 
stand-alone entity credit method in the 2003 proposed regulations or 
with any single, prescribed method. Consequently, commentators either 
proposed specific alternatives or stated that final regulations should 
allow members to allocate the group credit using any reasonable method. 
One commentator advocated that a method that allocates the group credit 
based on the relative amounts of each member's total QREs (gross QREs 
method) is the only allocation method permitted under the statute. 
Another commentator urged the Treasury Department and the IRS to adopt 
an allocation method that, based on techniques of differential 
calculus, allocates the group credit based on the marginal contribution 
to the group credit of each member's QREs for the current year, QREs 
for the base years, and gross-receipts for the base years, as well as 
the controlled group's fixed-base percentage and the growth in gross 
receipts for the controlled group (marginal contribution method). Other 
commentators suggested that no single allocation method can 
appropriately allocate the group credit in all cases; therefore, 
members of a controlled group should be permitted to use any reasonable 
method to allocate the group credit. For the reasons discussed below, 
these temporary regulations generally retain the stand-alone entity 
credit method of the 2003 proposed regulations with some modifications.
    The preamble to the 2003 proposed regulations sets out at length 
the reasons why the Treasury Department and the IRS believe that the 
allocation method under section 41(f) should be based on a group 
member's QREs in excess of a base amount. The stand-alone entity credit 
method reflects the incremental nature of the credit and also is 
consistent with the Treasury Department and the IRS' view of the 
purpose of section 41(f). As stated in the preamble to the 2003 
proposed regulations:


[[Page 29598]]


    The legislative history to the research credit, as originally 
enacted in 1981, indicates that the group credit computation and 
aggregation rules were enacted to ensure that the research credit 
would be allowed only for actual increases in research expenditures. 
These aggregation rules were intended to prevent taxpayers from 
creating artificial increases in research expenditures by shifting 
expenditures among commonly controlled or otherwise related persons. 
H. Rep. No. 97-201, 1981-3 C.B. (Vol. 2) 364, and Sen. Rep. 97-144, 
1981-3 C.B. (Vol. 2) 442. In effect, the group credit computation 
rule serves as a cap on the maximum amount of credit that the 
members of the group, in the aggregate, may claim.

    Prior to the 1989 Act, the research credit was computed by 
multiplying the credit rate by the excess of the taxpayer's current 
year QREs over the taxpayer's average QREs for the preceding three 
years. Final regulations issued in 1989, prescribing rules for the 
allocation of the group credit prior to the 1989 Act, allocated the 
group credit based on what effectively would have been each member's 
stand-alone entity credit (without giving effect to the minimum base 
period amount in computing each member's stand-alone entity credit). 
The 1989 Act significantly modified the computation of the credit while 
retaining the incremental approach of the pre-1989 Act credit. Congress 
did not indicate in either the statute or the legislative history that 
either the purpose or the application of section 41(f) was being 
changed. Although the phrase ``increase in'' in sections 
41(f)(1)(A)(ii) and 41(f)(1)(B)(ii) was deleted by the 1989 Act, for 
the reasons set out in the preamble to the 2003 proposed regulations, 
the Treasury Department and the IRS concluded that this change to the 
statute was intended to reflect only the fact that a taxpayer's 
entitlement to the research credit after the 1989 Act no longer 
depended on whether the taxpayer had increased its current year QREs 
over its average QREs for the preceding three years.
    With respect to the alternative allocation methods suggested by the 
commentators, the Treasury Department and the IRS conclude that these 
methods are inconsistent with the purpose of section 41 generally and 
section 41(f) specifically. A gross QREs method is at odds 
fundamentally with the incremental nature of the research credit, and 
the Treasury Department and the IRS continue to believe that neither 
the statute nor the legislative history suggests that Congress intended 
that the allocation of the group credit be based solely on a member's 
total QREs without reference to whether those QREs exceed a base 
amount.
    Similarly, the Treasury Department and the IRS do not believe that 
the suggested marginal contribution method is consistent with section 
41(f). The Treasury Department and the IRS recognize the potential for 
that method to more closely associate the amount of group credit 
allocated to a particular member to the contributions of that member's 
QREs for the current year, gross receipts for the current year, QREs 
for the base years, and gross receipts for the base years to the amount 
of the group credit. The marginal contribution method proposed, 
however, has significant flaws that would change the function of the 
aggregation rules in section 41(f) in a manner that the Treasury 
Department and the IRS do not believe was intended by Congress. First, 
the method would allow allocations of credit to members that have no 
QREs, a result the Treasury Department and the IRS believe is contrary 
to the statutory directive to allocate the group credit in proportion 
to a member's share of QREs giving rise to the credit. Second, the 
method uses different formulas for groups that are affected by special 
rules, such as the maximum fixed-base percentage rule. As a result, it 
is possible that a member of a group that increases its QREs by a 
relatively small amount, that is enough to make the group subject to a 
special rule, could be allocated proportionately less credit than if 
the member had not increased its QREs. Finally, by relying on the 
group's gross receipts and the group's fixed-base percentage, the 
marginal contribution method appears to encourage planning and shifting 
among group members, a result that is inconsistent with the purpose of 
section 41(f). The Treasury Department and the IRS believe that an 
appropriate allocation method should encourage a member to focus on 
incrementally increasing its own research efforts.
    The Treasury Department and the IRS also decline to adopt an 
allocation rule that would permit the members of a controlled group to 
use any reasonable method to allocate the group credit. Neither the 
statute nor the legislative history indicates that Congress intended 
the allocation of the group credit to be based on any reasonable method 
selected by a member individually or the controlled group collectively. 
Furthermore, a rule permitting the use of any reasonable method to 
allocate the credit could result in continuing controversy. As 
discussed in the preamble to the 2003 proposed regulations, the 
Treasury Department and the IRS believe that the purpose of section 
41(f) is undermined if the members of a controlled group use different 
allocation methods to claim more than 100 percent of the group credit. 
The Treasury Department and the IRS believe that a single, prescribed 
method is necessary to preclude such potential for abuse.
    Accordingly, the Treasury Department and the IRS continue to 
believe that the purposes of the research credit statute generally and 
the provisions of section 41(f) specifically are best furthered by an 
allocation method that allocates the group credit based on each 
member's stand-alone entity credit.

Special Allocation Rule for Excess Group Credit Situations

    Under the 2003 proposed regulations, if the group credit exceeded 
the sum of the stand-alone entity credits of the members of a 
controlled group, the members with stand-alone entity credits would be 
entitled to the entire group credit. In addition, if no member of the 
controlled group had a stand-alone entity credit, none of the group 
credit would be allocated to the members of the controlled group.
    To address these situations, these temporary regulations modify the 
allocation method of the 2003 proposed regulations in cases in which 
the group credit exceeds the sum of the members' stand-alone entity 
credits, including cases in which no member has a stand-alone entity 
credit. If the group credit exceeds the sum of the members' stand-alone 
entity credits, each member is allocated an amount of group credit 
equal to that member's stand-alone entity credit. The remaining, or 
excess, amount of group credit is then allocated among all the members 
of the controlled group based on the ratio of an individual member's 
QREs to the sum of all the members' QREs.

Computation of Stand-Alone Entity Credits

    Commentators questioned whether members must use the same method, 
i.e., the method described in section 41(a) (regular credit method) or 
the alternative incremental research credit (AIRC) method described in 
section 41(c)(4), in computing the stand-alone entity credit as that 
used to compute the group credit. The Treasury Department and the IRS 
do not believe that requiring taxpayers to be consistent in the method 
used to compute the group credit and the stand-alone entity credit 
would serve the purpose of section 41. Section 41(f) was intended to 
encourage taxpayers to increase their individual research efforts to 
maximize the group credit and thus their share of the group credit. The 
Treasury Department and

[[Page 29599]]

the IRS believe that allowing the members to compute their stand-alone 
entity credits without regard to the method used to compute the group 
credit will encourage increasing research efforts. Thus, the temporary 
regulations provide that a member's stand-alone entity credit must be 
computed using whichever method results in the greater stand-alone 
entity credit for that member, without regard to the method used to 
compute the group credit.
    Commentators also pointed out that the computation of the stand-
alone entity credits under the 2003 proposed regulations would no 
longer require the intra-group transaction rules of Sec.  1.41-6(e) 
(re-designated in these temporary regulations as Sec.  1.41-6(i)) to 
apply. Although the intent of the stand-alone entity credit rule is to 
compute a credit that is similar to that to which a member would be 
entitled if there were no research credit aggregation rules for 
controlled groups, the intent was not to render the intra-group 
transaction rules or the acquisition/disposition rules of section 
41(f)(3) inapplicable. Therefore, these temporary regulations 
specifically provide that taxpayers must apply the intra-group 
transaction rules and the acquisition/disposition rules when computing 
the stand-alone entity credits. For example, to the extent that a 
member's gross receipts and QREs have been reduced for purposes of 
computing the group credit as a result of the application of the 
acquisition/disposition rules, the member's stand-alone entity credit 
must be computed using the same gross receipts and QREs.

Special Allocation Rule for Consolidated Groups

    The preamble to the 2003 proposed regulations states that the 
Treasury Department and the IRS considered comments requesting a 
special allocation rule for consolidated groups, but decided not to 
adopt such a rule. Several commentators further commented on that 
issue. One commentator suggested that if the group credit were 
allocated in proportion to QREs, no special consolidated group rule 
would be necessary. Given that this commentator's proposed allocation 
method is not the one adopted in these temporary regulations, the 
Treasury Department and the IRS are not persuaded that a special 
consolidated group rule is unnecessary. Another commentator suggested 
that a consolidated group should be treated as a single member of a 
controlled group for purposes of allocating the group credit and that 
the failure to treat the consolidated group in such a manner would 
result in abuse.
    The Treasury Department and the IRS believe that treating a 
consolidated group as a single member of a controlled group for 
purposes of allocating the group credit is consistent with the 
treatment of a consolidated group as a single taxpayer under a number 
of the consolidated return regulations. Therefore, these temporary 
regulations provide that, for purposes of allocating the group credit, 
a consolidated group whose members are members of a controlled group is 
treated as a single member of the controlled group. Accordingly, a 
consolidated group whose members are members of a controlled group is 
treated as a single member of the controlled group and a single stand-
alone entity credit is computed for the consolidated group. If the 
consolidated group is the only member of the controlled group, the 
stand-alone entity credit computed for the consolidated group is equal 
to the group credit.
    The portion of the group credit allocated to a consolidated group 
must be allocated among the members of the consolidated group. The 
Treasury Department and the IRS believe that the method of allocating 
among the members of the consolidated group the portion of the group 
credit allocated to the consolidated group should be no different than 
the method of allocating the group credit among members of the 
controlled group. Therefore, a stand-alone entity credit is computed 
for each member of the consolidated group, and the portion of the group 
credit allocated to the consolidated group is allocated among the 
members of the consolidated group in proportion to the stand-alone 
entity credits of the members of the consolidated group. One 
commentator argued that separately computing the stand-alone credit for 
each member of a consolidated group would be prohibitively burdensome. 
The Treasury Department and the IRS, however, do not believe that 
computing a stand-alone entity credit for each member of a consolidated 
group imposes a greater burden than computing a stand-alone entity 
credit for a corporation that is not a member of a consolidated group. 
Moreover, providing a rule for allocating the portion of the group 
credit allocated to a consolidated group among its members that is 
different than the method used for allocating the controlled group 
credit would create additional administrative complexity that seems 
unwarranted.

Alternative Incremental Research Credit

    Section 41(c)(4) provides an election to determine the research 
credit using the AIRC computation. Section 41(c)(4)(B) provides that 
the election to use the AIRC applies to all succeeding taxable years 
unless revoked with the consent of the Secretary. Many issues have 
arisen regarding how the AIRC election is made in the case of a 
consolidated group and in the case of a controlled group, all members 
of which are not included on a single consolidated federal income tax 
return. These issues include: (1) How is an AIRC election made by 
members of a controlled group for purposes of computing the group 
credit under section 41(f)(1); (2) what happens when a controlled group 
has made an AIRC election and a member leaves the group or a member 
that has not made an AIRC election enters the group; (3) what happens 
if a member that has made an AIRC election joins a controlled group 
that has not made an AIRC election; and (4) when will a request to 
revoke an AIRC election be granted.
    Generally, the Treasury Department and the IRS assume that 
taxpayers will elect to use the AIRC method if the AIRC method provides 
more credit than the regular method, or if a taxpayer does not have the 
books and records necessary to compute the base amount under the 
regular method. Once a taxpayer elects the AIRC method, the Treasury 
Department and the IRS believe that the AIRC method will continue to be 
the better method in the future as well, unless the taxpayer has a 
substantial change in its trade or business, such as the acquisition or 
disposition of an entire trade or business. If such a substantial 
change occurs, the Treasury Department and the IRS believe that it is 
appropriate to allow the taxpayer to revoke its AIRC election. The IRS 
has received many requests for consent to revoke AIRC elections from 
taxpayers in such situations. To reduce the burden on taxpayers, 
provide simplification, and ease administrative burden, the Treasury 
Department and the IRS have determined that it is appropriate to grant 
automatic consent to revoke an AIRC election on a prospective basis in 
situations in which a taxpayer makes the revocation on an original 
return. The Treasury Department and the IRS do not believe, however, 
that allowing an AIRC election or revocation on an amended return 
furthers the goal of simplification and ease of administration.
    Therefore, these temporary regulations provide that a taxpayer that 
has made an AIRC election is deemed to

[[Page 29600]]

have requested and been granted consent to revoke the election if the 
taxpayer completes the portion of Form 6765, ``Credit for Increasing 
Research Activities,'' relating to the regular credit and attaches the 
completed form to the taxpayer's timely filed original return for the 
year to which the revocation applies. This provision is similar to the 
provisions in the existing regulations for making an AIRC election, 
which require the taxpayer to complete the portion of Form 6765 
relating to the AIRC and attach the completed form to the taxpayer's 
timely filed original return for the year to which the election 
applies. Once an election/revocation is made for a taxable year, the 
taxpayer may not change the election/revocation on an amended return.
    The temporary regulations provide special rules for controlled 
groups under section 41(f)(1) (in which one or more of the members do 
not join in filing a consolidated return). As discussed above, in this 
situation many questions have arisen regarding which members of a 
controlled group must make (or revoke) an AIRC election to have a valid 
election (or revocation) for the controlled group. Attempting to track 
elections across members of a controlled group, in which one or more of 
the members do not join in filing a consolidated return would create 
additional administrative complexity and increase the potential for 
controversy. Thus, to reduce the additional administrative complexity 
created by the additional computation, these temporary regulations 
provide that in the case of a controlled group, all the members of 
which are not included on a single consolidated return, the designated 
member must make (or revoke) an AIRC election on behalf of the members 
of the group. The election (or revocation) by the designated member is 
binding on all of the members of the group for the taxable year to 
which the election (or revocation) relates. The temporary regulations 
provide that the designated member is that member of the group that is 
allocated the greatest amount of the group credit. In the event the 
members of a group compute the group credit using different methods 
(either the regular method or the AIRC method) and at least two members 
of the group qualify as the designated member, the designated member is 
the member that computes the group credit using the method that yields 
the greater group credit. The Treasury Department and the IRS believe 
that these rules will simplify the election and revocation of the AIRC 
method. Furthermore, granting automatic consent to revoke an AIRC 
election also simplifies acquisitions and dispositions of members of 
controlled groups. For example, when a new member joins a group, the 
member must use the method used by the controlled group. In the taxable 
year after a member leaves a group, the member is free to use either 
method, assuming the member has not joined another controlled group. If 
all members of a controlled group are members of a single consolidated 
group, the AIRC election is made by the agent of the consolidated 
group, determined pursuant to the rules of Sec.  1.1502-77.

Effective Date

    The preamble to the 2003 proposed regulations stated that the 
Treasury Department and the IRS intended to make those regulations 
effective for taxable years beginning on or after the date that final 
regulations are published in the Federal Register. The preamble to the 
2003 proposed regulations also addressed the limited application of 
final regulations to taxable years prior to that effective date to 
prevent abuse. Because the Treasury Department and the IRS have decided 
to retain the general rules for the computation and allocation of the 
group credit contained in the 2003 proposed regulations, with the 
modifications described above, these regulations are being issued in 
temporary form and will be effective for taxable years ending on or 
after May 24, 2005.
    For taxable years prior to those covered by these temporary 
regulations, a taxpayer generally may use any reasonable method of 
computing and allocating the group credit. For the reasons set out in 
the preamble to the 2003 proposed regulations, the Treasury Department 
and the IRS believe that these temporary regulations should be 
retroactive in limited circumstances to prevent abuse. Accordingly, 
paragraph (b) of these temporary regulations, relating to the 
computation of the group credit, and paragraph (c) of these temporary 
regulations, relating to the allocation of the group credit, apply to 
taxable years ending on or after December 29, 1999, if the members of a 
controlled group, as a whole, claimed more than 100 percent of the 
amount that would be allowable under paragraph (b). In the case of a 
controlled group whose members have different taxable years and whose 
members use inconsistent methods of allocation, the members of the 
controlled group are deemed to have, as a whole, claimed more than 100 
percent of the amount that would be allowable under paragraph (b).
    Since the issuance of the 2003 proposed regulations, questions have 
arisen regarding what constitutes a reasonable method of allocating the 
group credit. Any allocation method used by a member of a controlled 
group that is consistent with either the 2000 proposed regulations, the 
2003 proposed regulations, these temporary regulations, or subsequent 
final regulations will be accepted by the IRS as reasonable if the same 
allocation method was used by all members of the controlled group. In 
addition, for taxable years ending before December 29, 1999, any such 
method will be accepted by the IRS as reasonable regardless of the 
allocation method or methods used by other members of the controlled 
group and regardless of whether the members of the controlled group, in 
the aggregate, claimed more than 100 percent of the group credit. 
Although the reasonableness of any other allocation method may depend 
on the particular facts and circumstance of that taxpayer, in general, 
the IRS, solely for purposes of what constitutes a reasonable method of 
allocating the group credit for taxable years ending before December 
29, 1999, will treat as reasonable a gross QREs method even if the 
members of the controlled group use inconsistent allocation methods to 
claim, in the aggregate, more than 100 percent of the group credit. 
Such treatment of a gross QREs method as reasonable for such years is 
for administrative convenience only.

Special Analyses

    It has been determined that this Treasury Department decision is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
refer to the Special Analyses section of the preamble to the cross-
reference notice of the proposed rulemaking published in the Proposed 
Rules section in this issue of the Federal Register. Pursuant to 
section 7805(f) of the Code, these temporary regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Nicole R. Cimino, 
Office of Associate Chief Counsel (Passthroughs and Special 
Industries).

[[Page 29601]]

However, personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.41-6T also issued under 26 U.S.C. 1502. * * *


0
Par. 2. In Sec.  1.41-0, the table of contents is amended by removing 
the entries for Sec.  1.41-6 and Sec.  1.41-8 and adding entries for 
Sec.  1.41-6T and Sec.  1.41-8T to read as follows:


Sec.  1.41-0  Table of contents.

* * * * *


Sec.  1.41-6T  Aggregation of expenditures (temporary).

    (a) Controlled groups of corporations; trades or businesses 
under common control.
    (1) In general.
    (2) Consolidated groups.
    (3) Definitions.
    (b) Computation of the group credit.
    (1) In general.
    (2) Start-up companies.
    (c) Allocation of the group credit.
    (1) In general.
    (2) Stand-alone entity credit.
    (d) Special rules for consolidated groups.
    (1) In general.
    (2) Start-up company status.
    (3) Special rule for allocation of group credit among 
consolidated group members.
    (e) Examples.
    (f) For taxable years beginning before January 1, 1990.
    (g) Tax accounting periods used.
    (1) In general.
    (2) Special rule when timing of research is manipulated.
    (h) Membership during taxable year in more than one group.
    (i) Intra-group transactions.
    (1) In general.
    (2) In-house research expenses.
    (3) Contract research expenses.
    (4) Lease payments.
    (5) Payment for supplies.
    (j) Effective date.
* * * * *


Sec.  1.41-8T  Special rules for taxable years ending on or after 
January 3, 2001 (temporary).

    (a) Alternative incremental credit.
    (b) Election.
    (1) In general.
    (2) Time and manner of election.
    (3) Revocation.
    (4) Special rules for controlled groups.
    (5) Effective date.


Sec.  1.41-6  [Removed]

0
Par. 3. Section 1.41-6 is removed.

0
Par. 4. Section 1.41-6T is added to read as follows:


Sec.  1.41-6T  Aggregation of expenditures (temporary).

    (a) Controlled group of corporations; trades or businesses under 
common control--(1) In general. To determine the amount of research 
credit (if any) allowable to a trade or business that at the end of its 
taxable year is a member of a controlled group, a taxpayer must--
    (i) Compute the group credit in the manner described in paragraph 
(b) of this section; and
    (ii) Allocate the group credit among the members of the group in 
the manner described in paragraph (c) of this section.
    (2) Consolidated groups. For special rules relating to consolidated 
groups, see paragraph (d) of this section.
    (3) Definitions. For purposes of this section:
    (i) Trade or business. A trade or business is a sole 
proprietorship, a partnership, a trust, an estate, or a corporation 
that is carrying on a trade or business (within the meaning of section 
162). Any member of a commonly controlled group shall be deemed to be 
carrying on a trade or business if any other member of that group is 
carrying on any trade or business.
    (ii) Controlled group. The terms group and controlled group mean a 
controlled group of corporations, as defined in section 41(f)(5), or a 
group of trades or businesses under common control. For rules for 
determining whether trades or businesses are under common control, see 
Sec.  1.52-1 (b) through (g).
    (iii) Group credit. The term group credit means the research credit 
(if any) allowable to a controlled group.
    (iv) Consolidated group. The term consolidated group has the 
meaning set forth in Sec.  1.1502-1(h).
    (v) Credit year. The term credit year means the taxable year for 
which the member is computing the credit.
    (b) Computation of the group credit--(1) In general. All members of 
a controlled group are treated as a single taxpayer for purposes of 
computing the research credit. The group credit is computed by applying 
all of the section 41 computational rules on an aggregate basis. All 
members of a controlled group must use the same method of computation, 
either the method described in section 41(a) or the alternative 
incremental research credit (AIRC) method described in section 
41(c)(4), in computing the group credit for a credit year.
    (2) Start-up companies--(i) In general. For purposes of computing 
the group credit, a controlled group is treated as a start-up company 
for purposes of section 41(c)(3)(B)(i) if--
    (A) The first taxable year in which at least one member of the 
group had gross receipts and at least one member of the group had 
qualified research expenditures (QREs) begins after December 31, 1983; 
or
    (B) There were fewer than 3 taxable years beginning after December 
31, 1983, and before January 1, 1989, in which at least one member of 
the group had gross receipts and at least one member of the group had 
QREs.
    (ii) Example. The following example illustrates the principles of 
paragraph (b)(2)(i) of this section:

    Example. A, B, and C, all of which are calendar year taxpayers, 
are members of a controlled group. During the 1983 taxable year, A 
had QREs, but no gross receipts; B had gross receipts, but no QREs; 
and C had no QREs or gross receipts. The 1984 taxable year was the 
first taxable year for which each of A, B, and C had both QREs and 
gross receipts. Because the first taxable year for which each of A, 
B, and C had both QREs and gross receipts began after December 31, 
1983, each of A, B, and C is a start-up company under section 
41(c)(3)(B)(i) and each is a start-up company for purposes of 
computing the stand-alone entity credit. During the 1983 taxable 
year, at least one member of the group, A, had QREs and at least one 
member of the group, B, had gross receipts, thus, the group had both 
QREs and gross receipts in 1983. Therefore, the controlled group is 
not a start-up company because the first taxable year for which the 
group had both QREs and gross receipts did not begin after December 
31, 1983.

    (iii) First taxable year after December 31, 1993, for which the 
controlled group had QREs. In the case of a controlled group that is 
treated as a start-up company under section 41(c)(3)(B)(i) and 
paragraph (b)(2)(i) of this section, for purposes of determining the 
group's fixed-base percentage under section 41(c)(3)(B)(ii), the first 
taxable year after December 31, 1993, for which the group has QREs is 
the first taxable year in which at least one member of the group has 
QREs.
    (iv) Example. The following example illustrates the principles of 
paragraph (b)(2)(iii) of this section:

    Example. D, E, and F, all of which are calendar year taxpayers, 
are members of a controlled group. The group is treated as a start-
up company under section 41(c)(3)(B)(i) and paragraph (b)(2)(i) of 
this section. The

[[Page 29602]]

first taxable year after December 31, 1993, for which D had QREs was 
1994. The first taxable year after December 31, 1993, for which E 
had QREs was 1995. The first taxable year after December 31, 1993, 
for which F had QREs was 1996. Because the 1994 taxable year was the 
first taxable year after December 31, 1993, for which at least one 
member of the group, D, had QREs, for purposes of determining the 
group's fixed-based percentage under section 41(c)(3)(B)(ii), the 
1994 taxable year was the first taxable year after December 31, 
1993, for which the group had QREs.

    (c) Allocation of the group credit--(1) In general. (i) To the 
extent the group credit (if any) computed under paragraph (b) of this 
section does not exceed the sum of the stand-alone entity credits of 
all of the members of a controlled group, computed under paragraph 
(c)(2) of this section, such group credit shall be allocated among the 
members of the controlled group in proportion to the stand-alone entity 
credits of the members of the controlled group, computed under 
paragraph (c)(2) of this section:
[GRAPHIC] [TIFF OMITTED] TR24MY05.002

    (ii) To the extent that the group credit (if any) computed under 
paragraph (b) of this section exceeds the sum of the stand-alone entity 
credits of all of the members of the controlled group, computed under 
paragraph (c)(2) of this section, such excess shall be allocated among 
the members of a controlled group in proportion to the QREs of the 
members of the controlled group:
[GRAPHIC] [TIFF OMITTED] TR24MY05.003

    (2) Stand-alone entity credit. The term stand-alone entity credit 
means the research credit (if any) that would be allowable to a member 
of a controlled group if the credit were computed as if section 
41(f)(1) did not apply, except that the member must apply the rules 
provided in paragraphs (d)(1) (relating to consolidated groups) and (i) 
(relating to intra-group transactions) of this section. Each member's 
stand-alone entity credit for any credit year must be computed under 
whichever method (the method described in section 41(a) or the method 
described in section 41(c)(4)) results in the greater stand-alone 
entity credit for that member, without regard to the method used to 
compute the group credit.
    (d) Special rules for consolidated groups--(1) In general. For 
purposes of applying paragraph (c) of this section, a consolidated 
group whose members are members of a controlled group is treated as a 
single member of the controlled group and a single stand-alone entity 
credit is computed for the consolidated group.
    (2) Start-up company status. A consolidated group's status as a 
start-up company and the first taxable year after December 31, 1993, 
for which a consolidated group has QREs are determined in accordance 
with the principles of paragraph (b)(2) of this section.
    (3) Special rule for allocation of group credit among consolidated 
group members. The portion of the group credit that is allocated to a 
consolidated group is allocated to the members of the consolidated 
group in accordance with the principles of paragraph (c) of this 
section. However, for this purpose, the stand-alone entity credit of a 
member of a consolidated group is computed without regard to section 
41(f)(1), but with regard to paragraph (i) of this section.
    (e) Examples. The following examples illustrate the provisions of 
this section. Unless otherwise stated, no members of a controlled group 
are members of a consolidated group, and except as provided in Example 
6, the group has not made an AIRC election:

    Example 1. Group credit is less than sum of members' stand-alone 
entity credits--(i) Facts. A, B, and C, all of which are calendar-
year taxpayers, are members of a controlled group. Neither A, B, nor 
C made any basic research payments for their taxable year ending 
December 31, 2004. For purposes of computing the group credit for 
the 2004 taxable year (the credit year), A, B, and C had the 
following:

----------------------------------------------------------------------------------------------------------------
                                              A                  B                  C           Group aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs...................  $200x               $20x               $110x              $330x
1984-1988 QREs.....................  $40x                $10x               $100x              $150x
1984-1988 Gross Receipts...........  $1,000x             $350x              $150x              $1,500x
Average Annual Gross Receipts for 4  $1,200x             $200x              $300x              $1,700x
 Years Preceding the Credit Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if A, B, and C 
were one taxpayer. The group credit is equal to 20 percent of the 
excess of the group's aggregate credit year QREs ($330x) over the 
group's base amount ($170x). The group credit is 0.20 x ($330-
$170x), which equals $32x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: The group's fixed-base percentage (10 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($1,700x), or the group's minimum base amount ($165x). The group's 
base amount, therefore, is $170x, which is the greater of: 0.10 x 
$1,700x, which equals $170x, or $165x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $330x, which equals $165x.
    (3) Group's fixed-base percentage. The group's fixed-base 
percentage is the lesser of: the ratio that the group's aggregate 
QREs for the taxable years beginning after December 31, 1983, and 
before January 1, 1989, bear to

[[Page 29603]]

the group's aggregate gross receipts for the same period, or 16 
percent (the statutory maximum). The group's fixed-base percentage, 
therefore, is 10 percent, which is the lesser of: $150x/$1,500x, 
which equals 10 percent, or 16 percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, each member's stand-alone entity credit must be 
computed using the method that results in the greater stand-alone 
entity credit for that member. The stand-alone entity credit for 
each of A, B, and C is greater using the method described in section 
41(a). Therefore, the stand-alone entity credit for each of A, B, 
and C must be computed using the method described in section 41(a). 
A's stand-alone entity credit is $20x. B's stand-alone entity credit 
is $2x. C's stand-alone entity credit is $11x. The sum of the 
members' stand-alone entity credits is $33x. Because the group 
credit of $32x is less than the sum of the stand-alone entity 
credits of all the members of the group ($33x), the group credit is 
allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of the 
stand-alone entity credits of all the members of the group. The $32x 
group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                              A                  B                  C                Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit..........  $20x                $2x                $11x               $33x
Allocation Ratio (Stand-Alone        20/33               2/33               11/33
 Entity Credit/Sum of Stand-Alone
 Entity Credits).
Multiplied by: Group Credit........  $32x                $32x               $32x
Equals: Credit Allocated to Member.  $19.39x             $1.94x             $10.67x            $32x
----------------------------------------------------------------------------------------------------------------

    Example 2. Group credit exceeds sum of members' stand-alone 
entity credits--(i) Facts. D, E, F, and G, all of which are 
calendar-year taxpayers, are members of a controlled group. Neither 
D, E, F, nor G made any basic research payments for their taxable 
year ending December 31, 2004. For purposes of computing the group 
credit for the 2004 taxable year (the credit year), D, E, F, and G 
had the following:

----------------------------------------------------------------------------------------------------------------
                                                                                                       Group
                                         D               E               F               G           Aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year Qualified Research    $580x           $10x            $70x            $15x            $675x
 Expenses (QREs).
1984-1988 QREs..................  $500x           $25x            $100x           $25             $650x
1984-1988 Gross Receipts........  $4,000x         $5,000x         $2000x          $10,000x        $21,000x
Average Annual Gross Receipts     $5,000x         $5,000x         $2,000x         $5,000x         $17,000x
 for 4 Years Preceding the
 Credit Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if D, E, F, 
and G were one taxpayer. The group credit is equal to 20 percent of 
the excess of the group's aggregate credit year QREs ($675x) over 
the group's base amount ($526.19x). The group credit is 0.20 x 
($675x-$526.19x), which equals $29.76x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: the group's fixed-base percentage (3.1 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($17,000x), or the group's minimum base amount ($337.50x). The 
group's base amount, therefore, is $526.19x, which is the greater 
of: 0.031 x $17,000x, which equals $526.19x, or $337.50x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $675x, which equals $337.50x.
    (3) Group's fixed-base percentage. The group's fixed-base 
percentage is the lesser of: the ratio that the group's aggregate 
QREs for the taxable years beginning after December 31, 1983, and 
before January 1, 1989, bear to the group's aggregate gross receipts 
for the same period, or 16 percent (the statutory maximum). The 
group's fixed-base percentage, therefore, is 3.10 percent, which is 
the lesser of: $650x/$21,000x, which equals 3.10 percent, or 16 
percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, each member's stand-alone entity credit must be 
computed using the method that results in the greater stand-alone 
entity credit for that member. The stand-alone entity credits for D 
($19.46x) and F ($1.71x) are greater using the AIRC method. 
Therefore, the stand-alone entity credits for D and F must be 
computed using the AIRC method. The stand-alone entity credit for G 
($0.50x) is greater using the method described in section 41(a). 
Therefore, the stand-alone entity credit for G must be computed 
using the method described in section 41(a). E's stand-alone entity 
credit computed under either method is zero. The sum of the members' 
stand-alone entity credits is $21.67x. Because the group credit of 
$29.76x is greater than the sum of the stand-alone entity credits of 
all the members of the group ($21.67), each member of the group is 
allocated an amount of the group credit equal to that member's 
stand-alone entity credit. The excess of the group credit over the 
sum of the members' stand alone entity credits ($8.09) is allocated 
among the members of the group based on the ratio that each member's 
QREs bear to the sum of the QREs of all the members of the group. 
The $29.76x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                         D               E               F               G             Total
----------------------------------------------------------------------------------------------------------------
Group Credit....................                                                                  $29.76x
Minus: Sum of Stand-Alone Entity  $19.467x        $0.00x          $1.71x          $0.50x          $21.67x
 Credits.
Equals: Excess Group Credit.....                                                                  $8.09x
Excess Group Credit.............  8.09x           8.09x           8.09x           8.09x           ..............
Multiplied By Allocation Ratio:   580/675         10/675          70/675          15/675          ..............
 QREs/Sum of QREs.
Excess Group Credit Allocated...  $6.95x          $0.12x          $0.84x          $0.18x          ..............
Plus: Stand-Alone Entity Credit.  $19.46x         $0.00x          $1.71x          $0.50x          ..............
Equals: Credit Allocated to       $26.41x         $0.12x          $2.55x          $0.68x          $29.76x
 Member.
----------------------------------------------------------------------------------------------------------------

    Example 3. Consolidated group within a controlled group--(i) 
Facts. The facts are the same as in Example 2, except that D and E 
file a consolidated return.
    (ii) Allocation of the group credit--(A) In general. For 
purposes of allocating the controlled group's research credit of 
$29.76x among the members of the controlled group, D and E are 
treated as a single member of the controlled group.
    (B) Computation of stand-alone entity credits. The stand-alone 
entity credit for the

[[Page 29604]]

consolidated group is computed by treating D and E as a single 
entity. Under paragraph (c)(2) of this section, the stand-alone 
entity credit for each member must be computed using the method that 
results in the greater stand-alone entity credit for that member. 
The stand-alone entity credit for each of the DE consolidated group 
($17.55x) and F ($1.71x) is greater using the AIRC method. 
Therefore, the stand-alone entity credit for each of the DE 
consolidated group and F must be computed using the AIRC method. The 
stand-alone entity credit for G ($0.50x) is greater using the method 
described in section 41(a). Therefore, the stand-alone entity credit 
for G must be computed using the method described in section 41(a). 
The sum of the members' stand-alone entity credits is $19.76x.
    (C) Allocation of controlled group credit. Because the group 
credit of $29.76x is greater than the sum of the stand-alone entity 
credits of all the members of the group ($19.76x), each member of 
the group is allocated an amount of the group credit equal to that 
member's stand-alone entity credit. The excess of the group credit 
over the sum of the members' stand alone entity credits ($10.00x) is 
allocated among the members of the group based on the ratio that 
each member's QREs bear to the sum of the QREs of all the members of 
the group. The group credit of $29.76x is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                             DE                  F                  G                Total
----------------------------------------------------------------------------------------------------------------
Group Credit.......................                                                            $29.76x
Minus: Sum of Stand-Alone Entity     $17.55x             $1.71x             $0.50x             $19.76x
 Credits.
Equals: Excess Group Credit........                                                            $10.00x
Excess Group Credit................  10.00x              10.00x             10.00x             .................
Multiplied By Allocation Ratio:      590/675             70/675             15/675             .................
 QREs/Sum of QREs.
Excess Group Credit Allocated......  $8.74x              $1.04x             $0.22x             .................
Plus: Stand-Alone Entity Credit....  $17.55x             $1.71x             $0.50x             .................
Equals: Credit Allocated to Member.  $26.29x             $2.75x             $0.72x             $29.76x
----------------------------------------------------------------------------------------------------------------

    (iii) Allocation of the group credit allocated to consolidated 
group--(A) In general. The group credit that is allocated to a 
consolidated group is allocated among the members of the 
consolidated group in accordance with the principles of paragraph 
(c) of this section.
    (B) Computation of stand-alone entity credits. Under paragraph 
(c)(2) of this section, the stand-alone entity credit for each 
member of the consolidated group must be computed using the method 
that results in the greater stand-alone entity credit for that 
member. The stand-alone entity credit for D ($19.46x) is greater 
using the AIRC method. Therefore, the stand-alone entity credit for 
D must be computed using the AIRC method. The stand-alone entity 
credit for E is zero under either method. The sum of the stand-alone 
entity credits of the members of the consolidated group is $19.46x.
    (C) Allocation among members of consolidated group. Because the 
amount of the group credit allocated to the consolidated group 
($26.29x) is greater than $19.46x, the sum of the stand-alone entity 
credits of all the members of the consolidated group, the amount of 
the group credit allocated to the consolidated group is allocated to 
each member of the consolidated group in an amount equal to the 
member's stand-alone entity credit. The excess of the group credit 
allocated to the consolidated group over the sum of the consolidated 
group members' stand alone entity credits ($6.83x) is allocated 
among the members of the consolidated group based on the ratio that 
each member's QREs bear to the sum of the QREs of all the members of 
the consolidated group. The group credit of $26.29x allocated to the 
DE consolidated group is allocated between D and E as follows:

----------------------------------------------------------------------------------------------------------------
                                                 D                     E                       Total
----------------------------------------------------------------------------------------------------------------
Group Credit.........................                                              $26.29x
Minus: Sum of Stand-Alone Entity       $19.46x               $0.00x                $19.46x
 Credits.
Excess Group Credit..................                                              $6.83x
Excess Group Credit..................  6.83x                  6.83x
Multiplied By Allocation Ratio: QREs/  580/590               10/590
 Sum of QREs.
Excess Group Credit Allocated........  $6.71x                $0.12x
Plus: Stand-Alone Entity Credit......  $19.46x               $0.00x
Equals: Credit Allocated to Member...  $26.17x               $0.12x                $26.29x
----------------------------------------------------------------------------------------------------------------

    Example 4. Member is a start-up company--(i) Facts. H, I, and J, 
all of which are calendar-year taxpayers, are members of a 
controlled group. The first taxable year for which J has both QREs 
and gross receipts begins after December 31, 1983, therefore, J is a 
start-up company under section 41(c)(3)(B)(i). The first taxable 
year for which H and I had both QREs and gross receipts began before 
December 31, 1983, therefore, H and I are not start-up companies 
under section 41(c)(3)(B)(i). Neither H, I, nor J made any basic 
research payments during the 2004 taxable year. For purposes of 
computing the group credit for the 2004 taxable year (the credit 
year), H, I, and J had the following:

----------------------------------------------------------------------------------------------------------------
                                              H                  I                  J           Group Aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs...................  $200x               $20x               $50x               $270x
1984-1988 QREs.....................  $55x                $15x               $0x                $70x
1984-1988 Gross Receipts...........  $1,000x             $400x              $0x                $1,400x
Average Annual Gross Receipts for 4  $1,200x             $200x              $0x                $1,400x
 Years Preceding the Credit Year.
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if H, I, and J 
were one taxpayer. The group credit is equal to 20 percent of the 
excess of the group's aggregate credit year QREs ($270x) over the 
group's base amount ($135x). The group credit is 0.20 x ($270x-
$135x), which equals $27x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: The group's fixed-base percentage (5 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($1,400x), or the group's minimum base amount ($135x). The group's 
base amount, therefore, is $135x, which is

[[Page 29605]]

the greater of: 0.05 x $1,400x, which equals $70x, or $135x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $270x, which equals $135x.
    (3) Group's fixed-base percentage. Because the first taxable 
year in which at least one member of the group has QREs and at least 
one member of the group has gross receipts does not begin after 
December 31, 1983, the group is not a start-up company. Therefore, 
the group's fixed-base percentage is the lesser of: the ratio that 
the group's aggregate QREs for the taxable years beginning after 
December 31, 1983, and before January 1, 1989, bear to the group's 
aggregate gross receipts for the same period, or 16 percent (the 
statutory maximum). The group's fixed-base percentage, therefore, is 
5 percent, which is the lesser of: $70x/$1,400x, which equals 5 
percent, or 16 percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, the stand-alone entity credit for each member of the 
group must be computed using the method that results in the greater 
stand-alone entity credit for that member. The stand-alone entity 
credits for H ($20x), I ($2x), and J ($5x) are greater using the 
method described in section 41(a). Therefore, the stand-alone entity 
credits for each of H, I, and J must be computed using the method 
described in section 41(a). The sum of the stand-alone entity 
credits of the members of the group is $27x. Because the group 
credit of $27x is equal to the sum of the stand-alone entity credits 
of all the members of the group ($27x), the group credit is 
allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of the 
stand-alone entity credits of all the members of the group. The 
group credit of $27x is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                              H                  I                  J                Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit..........  $20x                $2x                $5x                $27x
Allocation Ratio (Stand-Alone        20/27               2/27               5/27
 Entity Credit/Sum of Stand-Alone
 Entity Credits).
Multiplied by: Group Credit........  $27x                $27x               $27x
Equals: Credit Allocated to Member.  $20x                $2x                $5x                $27x
----------------------------------------------------------------------------------------------------------------

    Example 5. Group is a start-up company--(i) Facts. K, L, and M, 
all of which are calendar-year taxpayers, are members of a 
controlled group. The taxable year ending on December 31, 1999, is 
the first taxable year in which each of K, L, and M had both QREs 
and g