Section 24365-24368(b) - Definition of Research and Experimental Expenditures(1) In General. (A) The term "research or experimental expenditures," as used in Sections 24365 to 24368, inclusive, means expenditures incurred in connection with the taxpayer's trade or business which represent research and development costs in the experimental or laboratory sense. The term includes generally all such costs incident to the development of an experimental or pilot model, a plant process, a product, a formula, an invention, or similar property, and the improvement of already existing property of the type mentioned. The term does not include expenditures such as those for the ordinary testing or inspection of materials or products for quality control or those for efficiency surveys, management studies, consumer surveys, advertising, or promotions. However, the term includes the costs of obtaining a patent, such as attorneys' fees expended in making and perfecting a patent application. On the other hand, the term does not include the costs of acquiring another's patent, model, production or process, nor does it include expenditures paid or incurred for research in connection with literary, historical, or similar projects.(B) The provisions of this regulation apply not only to costs paid or incurred by the taxpayer for research or experimentation undertaken directly by it but also to expenditures paid or incurred for research or experimentation carried on in its behalf by another person or organization (such as a research institute, foundation, engineering company, or similar contract). However, any expenditures for research or experimentation carried on in the taxpayer's behalf by another person are not expenditures to which Sections 24365 to 24368, inclusive, relate, to the extent that they represent expenditures for the acquisition or improvement of land or depreciable property, used in connection with the research or experimentation, to which the taxpayer acquires rights of ownership.(C) The application of paragraph (B) of this subsection may be illustrated by the following examples: EXAMPLE (1).
A Corporation engages B, to undertake research and experimental work in order to create a particular product. B will be paid annually a fixed sum plus an amount equivalent to his actual expenditures. In 1961, A pays to B in respect of the project the sum of $150,000 of which $25,000 represents an addition to B's laboratory and the balance represents charges for research and experimentation on the project. It is agreed between the parties that A will absorb the entire cost of this addition to B's laboratory which will be retained by B. A may treat the entire $150,000 as expenditures under Sections 24365 to 24368, inclusive.
EXAMPLE (2).
X Corporation, a manufacturer of explosives, contracts with the Y research organization to attempt through research and experimentation the creation of a new process for making certain explosives. Because of the danger involved in such an undertaking, Y is compelled to acquire an isolated tract of land on which to conduct the research and experimentation. It is agreed that upon completion of the project Y will transfer this tract, including any improvements thereon, to X. Sections 24365 to 24368, inclusive, do not apply to the amount paid to Y representing the costs of the tract of land and improvements.
(2) Certain Expenditures With Respect to Land and Other Property. (A) Expenditures by the taxpayer for the acquisition or improvement of land, or for the acquisition or improvement of property which is subject to an allowance for depreciation under Sections 24349 to 24354, inclusive, or depletion under Section 24831 to 24835, inclusive, are not deductible under Sections 24365 to 24368, inclusive, irrespective of the fact that the property or improvements may be used by the taxpayer in connection with research or experimentation. However, allowances for depreciation or depletion of property are considered as research or experimental expenditures, for purposes of Sections 24365 to 24368, inclusive, to the extent that the property to which the allowances relate is used in connection with research or experimentation. If any part of the cost of acquisition or improvement of depreciable property is attributable to research or experimentation (whether made by the taxpayer or another), see paragraphs (B), (C), and (D) of this subsection.(B) Expenditures for research or experimentation which result, as an end product of the research or experimentation, in depreciable property to be used in the taxpayer's trade or business may, subject to the limitations of paragraph (D) of this subsection, be allowable as a current expense deduction under Section 24365. Such expenditures cannot be amortized under Section 24366 except to the extent provided in subsection (1) (D) of Reg. 24365-24368(d).(C) If expenditures for research or experimentation are incurred in connection with the construction or manufacture of depreciable property by another, they are deductible under Section 24365 only if made upon the taxpayer's order and at its risk. No deduction will be allowed (i) if the taxpayer purchases another product under a performance guarantee (whether express, implied, or imposed by local law) unless the guarantee is limited, to engineering specifications or otherwise, in such a way that economic utility is not taken into account; or (ii) for any part of the purchase price of a product in regular production. For example, if a taxpayer orders a specially-built automatic milling machine under a guarantee that the machine will be capable of producing a given number of units per hour, no portion of the expenditure is deductible since none of it is made at the taxpayer's risk. Similarly, no deductible expense is incurred if a taxpayer enters into a contract for the construction of a new type of chemical processing plant under a turnkey contract guaranteeing a given annual production and a given consumption of raw material and fuel per unit. On the other hand, if the contract contained no guarantee of quality of production and of quantity of units in relation to consumption of raw material and fuel, and if real doubt existed as to the capabilities of the process, expenses for research or experimentation under the contract are at the taxpayer's risk and are deductible under Section 24365. However, see paragraph (D) of this subsection.(D) The deductions referred to in paragraphs (B) and (C) of this subsection for expenditures in connection with the acquisition or production of depreciable property to be used in the taxpayer's trade or business are limited to amounts expended for research or experimentation. For the purpose of the preceding sentence, amounts expended for research or experimentation do not include the costs of the component materials of the depreciable property, the costs of labor or other elements involved in its construction and installation, or costs attributable to the acquisition or improvement of the property. For example, a taxpayer undertakes to develop a new machine for use in its business. It expends $30,000 on the project of which $10,000 represents the actual costs of material, labor, etc., to construct the machine, and $20,000 represents research costs which are not attributable to the machine itself. Under Section 24365 the taxpayer would be permitted to deduct the $20,000 as expenses not chargeable to capital account, but the $10,000 must be charged to the asset account (the machine).(3) Exploration Expenditures. The provisions of Sections 24365 to 24368, inclusive, are not applicable to any expenditures paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore, oil, gas or other mineral. See Sections 24422 and 24837.Cal. Code Regs. Tit. 18, § 24365-24368(b)
1. New section filed 1-6-69; effective thirtieth day thereafter (Register 69, No. 2).[FN**]
This regulation is substantially the same as Section 26 CFR 1.174-2.1. New section filed 1-6-69; effective thirtieth day thereafter (Register 69, No. 2).