Section 24365-24368(d) - Treatment as Deferred Expenses[FN*]
(1) In General. (A) If a taxpayer has not adopted the method provided in Section 24365 of treating research or experimental expenditures paid or incurred by it in connection with its trade or business as currently deductible expenses, it may, for any income year beginning after December 31, 1960, elect to treat such expenditures as deferred expenses under Section 24366, subject to the limitations of paragraph (B) of this subsection. If a taxpayer has adopted the method of treating such expenditures as expenses under Section 24365, it may not elect to defer and amortize any such expenditures unless permission to do so is granted under Section 24365(c). See subsection (2) of this regulation.(B) The election to treat research or experimental expenditures as deferred expenses under Section 24366 applies only to those expenditures which are chargeable to capital account but which are not chargeable to property of a character subject to an allowance for depreciation or depletion under Sections 24349 to 24354, inclusive, or Sections 24831 to 24835, inclusive, respectively. Thus, the election under Section 24366 applies only if the property resulting from the research or experimental expenditures has no determinable useful life. If the property resulting from the expenditures has a determinable useful life, Section 24366 is not applicable, and the capitalized expenditures must be amortized or depreciated over the determinable useful life. Amounts treated as deferred expenses are properly chargeable to capital account for purposes of Section 24916(a), relating to adjustments to basis of property. See Section 24916(g). See Section 24367 and subsection (2)(A) of Reg. 24365-24368(b) for treatment of expenditures for the acquisition or improvement of land or of depreciable or depletable property to be used in connection with the research or experimentation.(C) Expenditures which are treated as deferred expenses under Section 24366 are allowable as a deduction ratably over a period of not less than 60 consecutive months beginning with the month in which the taxpayer first realizes benefits from the expenditures. The length of the period shall be selected by the taxpayer at the time it makes the election to defer the expenditures. If a taxpayer has two or more separate projects, it may select a different amortization period for each project. In the absence of a showing to the contrary, the taxpayer will be deemed to have begun to realize benefits from the deferred expenditures in the month in which the taxpayer first puts the process, formula, invention, or similar property to which the expenditures relate to an income-producing use. See Section 24916(g) for adjustments to basis of property for amounts allowed as deductions under Section 24366 and this regulation. See Section 24347 and the regulations thereunder for rules relating to the treatment of losses resulting from abandonment.(D) If expenditures which the taxpayer has elected to defer and deduct ratably over a period of time in accordance with Section 24366 result in the development of depreciable property, deductions for the unrecovered expenditures, beginning with the time the asset becomes depreciable in character, shall be determined under Sections 24349 to 24354, inclusive (relating to depreciation) and the regulations thereunder. For example, for the income year 1961, A Corporation, who reports its income on the basis of a calendar year, elects to defer and deduct ratably over a period of 60 months research and experimental expenditures made in connection with a particular project. In 1963, the total of the deferred expenditures amounts to $60,000. At that time, A has developed a process which it seeks to patent. On July 1, 1963, A first realized benefits from the marketing of products resulting from this process. Therefore, the expenditures deferred are deductible ratably over the 60-month period beginning with July 1, 1963 (when A first realized benefits from the project). In its return for the year 1963, A deducted $6,000; in 1964, A deducted $12,000 ($1,000 per month). On July 1, 1965, a patent protecting its process is obtained by A. In its return for 1965, A is entitled to a deduction of $6,000, representing the amortizable portion of the deferred expenses attributable to the period prior to July 1, 1965. The balance of the unrecovered expenditures ($60,000 minus $24,000, or $36,000) is to be recovered as a depreciation deduction over the life of the patent commencing with July 1, 1965. Thus, one-half of the annual depreciation deduction based upon the useful life of the patent is also deductible for 1965 (from July 1 to December 31.)(E) The election shall be applicable to all research and experimental expenditures paid or incurred by the taxpayer or, if so limited by the taxpayer's election, to all such expenditures with respect to the particular project, subject to the limitations of paragraph (B) of this subsection. The election shall apply for the income year for which the election is made and for all subsequent income years, unless a change to a different treatment is authorized by the Franchise Tax Board under Section 24366(b). See subsection (2)(B)of this regulation. Likewise, the taxpayer shall adhere to the amortization period selected at the time of the election unless a different period of amortization with respect to a part or all of the expenditures is similarly authorized. However, no change in method will be permitted with respect to expenditures paid or incurred before the income year to which the change is to apply. In no event will the taxpayer be permitted to treat part of the expenditures with respect to a particular project as deferred expenses under Section 24366 and to adopt a different method of treating the balance of the expenditures relating to the same project for the same income year. The election under this regulation shall not apply to any expenditures paid or incurred before the income year for which the taxpayer makes the election.(2) Election and Change of Method. (A) Election. The election under Section 24366 shall be made not later than the time (including extensions) prescribed by law for filing the return for the income year for which the method is to be adopted. The election shall be made by attaching a statement to the taxpayer's return for the first income year to which the election is applicable. The statement shall be signed by a principal officer of the corporation or its duly authorized representative, and shall-- (i) Set forth the name and address of the taxpayer;(ii) Designate the first income year to which the election is to apply;(iii) State whether the election is intended to apply to all expenditures within the permissible scope of the election, or only to a particular project or projects, and, if the latter, include such information as will identify the project or projects as to which the election is to apply;(iv) Set forth the amount of all research or experimental expenditures paid or incurred during the income year for which the election is made;(v) Indicate the number of months (not less than 60) selected for amortization of the deferred expenses for each project; and(vi) State that the taxpayer will make an accounting segregation in its books and records of the expenditures to which the election relates.(B) Change to a Different Method or Period. Application for permission to change to a different method of treating research or experimental expenditures or to a different period of amortization for deferred expenses shall be in writing and shall be addressed to the Franchise Tax Board, P.O. Box 1468, Sacramento, CA 95812-1468. The application shall include the name and address of the taxpayer, shall be signed by a principal officer of the corporation or its duly authorized representative, and shall be filed not later than the end of the first income year in which the different method or different amortization period is to be used. The application shall set forth the following information with regard to the research or experimental expenditures which are being treated under Section 24366 as deferred expenses: (i) Total amount of research or experimental expenditures attributable to each project;(ii) Amortization period applicable to each project; and(iii) Unamortized expenditures attributable to each project at the beginning of the income year in which the application is filed. In addition, the application shall set forth the length of the new period or periods proposed, or the new method of treatment proposed, the reasons for the proposed change, and such information as will identify the project or projects to which the expenditures affected by the change relate. If permission is granted to make the change, the taxpayer shall attach a copy of the letter granting the permission to its tax return for the first income year in which the different method or period is to be effective.
(3) Example. The application of this regulation is illustrated by the following example: EXAMPLE.
N Corporation is engaged in the business of manufacturing chemical products. On January 1, 1961, work is begun on a special research project. N Corporation elects, pursuant to Section 24366, to defer the expenditures relating to the special project and to amortize the expenditures over a period of 72 months beginning with the month in which benefits from the expenditures are first realized. On January 1, 1961, N Corporation also purchased for $57,600 a building having a remaining useful life of 12 years as of the date of purchase and no salvage value at the end of the period. Fifty percent of the building's facilities are to be used in connection with the special research project. During 1961, N Corporation pays or incurs the following expenditures relating to the special research project:
| Salaries.......................................................................................................................................................................... | ..........................$15,000 |
| Heat, light and power.................................................................................................................................................... | ..........................700 |
| Drawings........................................................................................................................................................................ | ..........................2,000 |
| Models............................................................................................................................................................................ | ..........................6,500 |
| Laboratory materials..................................................................................................................................................... | ..........................8,000 |
| Attorney's fees............................................................................................................................................................... | ..........................1,400 |
| Depreciation on building attributable to project (50 percent of $4,800 allowable depreciation).......................... | .......................... 2,400 |
| Total research and development expenditures.......................................................................................................... | ..........................$36,000 |
The above expenditures result in a process which is marketable but not patentable and which has no determinable useful life. N Corporation first realizes benefits from the process in January 1962. N Corporation is entitled to deduct the amount of
6,000 (($36,000 x 12 months)/72 months) as deferred expenses under Section
24366 in computing net income for 1962.
Cal. Code Regs. Tit. 18, § 24365-24368(d)
1. New section filed 1-6-69; effective thirtieth day thereafter (Register 69, No. 2).
2. Change without regulatory effect pursuant to Section 100, Title 1, California Code of Regulations filed 12-8-89 (Register 90, No. 3).[FN*]
This regulation is substantially the same as Section 26 CFR 1.174-4. Note: Authority cited: Section 26422, Revenue and Taxation Code. Reference: Sections 24365- 24368, Revenue and Taxation Code.
1. New section filed 1-6-69; effective thirtieth day thereafter (Register 69, No. 2).
2. Change without regulatory effect pursuant to Section 100, Title 1, California Code of Regulations filed 12-8-89 (Register 90, No. 3).