Enterprise Resource Planning (“ERP”) has become an integral component of the manufacturing process as it can provide insight on vendor management, product logistics and server integration. Taxpayers may be able to qualify time for the R&D tax credit associated with developing and integrating the ERP system depending on whether it is developed primarily for internal or external use. Internal use software is developed primarily for general and administrative functions, human resource management, and support services. When qualifying internal use software, it must meet the IRS 4-part test along with the high threshold of innovation test. However, if software is developed to interact with third parties or to allow third parties to review data or initiate functions on a taxpayer’s system, it is considered external use and only needs to meet the IRS 4-part test.
Further, whether a project is deemed internal use depends on the intent of the taxpayer at the beginning of the software development project.
- Permitted Purpose — The activity must be undertaken to develop a new or improved “business component” that relates to function, performance, reliability, quality or to realize a signiﬁcant cost reduction. A business component refers to any product, process, computer software, technique, formula or invention which is held for sale, lease or license or used by the taxpayer in its trade or business.
- Technological in Nature —An activity must be technological in nature such that the research must rely on a hard science, such as physical, biological, or computer sciences or engineering disciplines.
- Technical Uncertainty — The activities must be undertaken to discover information in an effort to eliminate uncertainty regarding the development or improvement of a business component. Uncertainty exists if at the outset of the project, the taxpayer is unsure of: 1) whether the business component could be developed; 2) how to develop the business component: or 3) the business component’s appropriate design.
- Process of Experimentation — A process of experimentation evaluates one or more alternative hypotheses/designs to achieve a result where the capability or the method of achieving that result is uncertain at the outset of the taxpayer’s research activities.
High Threshold of Innovation Test
Innovative — Unique or Novel — The regulations deem software innovative if the software is intended to be unique or novel and is intended to differ in a signiﬁcant or inventive way from prior software implementations or methods such that it would result in a reduction in cost or improvement in speed.
Significant Economic Risk — The software development must involve signiﬁcant economic risk in that the taxpayer commits substantial resources to the development and there is a “substantial uncertainty”, technical risk, that such resources would be recovered within a reasonable period.
Commercial Availability — The software cannot be purchased, leased or licensed and used for the intended purpose without modiﬁcations.
In general, the following activities are deemed not qualiﬁed in relation to the implementation of an ERP system:
- Evaluating technical requirements as well as business needs to conﬁgure the system
- System conﬁguration to match business processes
- Re-engineering business processes
- Transferring data through routine programming
- One-to-one mapping of data to be exchanged between systems
Examples that could be considered qualiﬁed include the following:
- Developing an interface between legacy software and the ERP software by experimenting with data exchange software applications
- Customizing certain features or modules
- Activities to develop specialized data caching and synchronization software
- Systematic trial and error testing of data caching algorithms
Qualifying time devoted to implementing an ERP system can be complex so it is important to reach out to your tax advisor to discuss speciﬁc qualiﬁcation related to your program. If you have any speciﬁc questions, please contact Betsi Barrett or Nina Desai.