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Florida Tax Review

Abstract

The decline of U.S. research and development efforts in recent years dominates political, scientific and academic discourse. It is attributed, in part, to military research cutbacks after the end of the cold war and, in part, to the U.S. economic recession. Many fear that the research and development slowdown portends the demise of the United States as a significant factor in the global market for goods and services. Others believe the decline is only one of many indicators of the diminished competitive position of the United States in the global economy. In a pre-election proposal to stimulate technological growth and to strengthen industry for anticipated "international trade wars of the 1990's and beyond," President Clinton advocated a shift of at least thirty billion dollars from military research activities to the private sector over a four year period. The Clinton proposal envisioned cost sharing technology joint ventures between the federal government and private industry.

Increased government spending is one way to stimulate research and development activity. International tax policy also may provide research incentives. One example of important tax rules for U.S. businesses is the rules governing the allocation and apportionment of research and development expenses to domestic or foreign source income. Research cost allocation is a crucial determinant of the allowable foreign tax credit for multinational businesses. Designed to mitigate the double taxation hazard to U.S. businesses that operate in other countries, the foreign tax credit permits a taxpayer to offset against its U.S. tax liability certain income taxes paid to foreign countries. Because the credit against U.S. tax liability is limited to a tax computed at U.S. rates on foreign source taxable income, the Internal Revenue Code rewards the allocation of research expenses to domestic source income, which results in a corresponding increase in foreign source taxable income as a proportionate part of worldwide taxable income. In the past, Congress has employed international tax policy to stimulate U.S.-based research by enacting rules that favor U.S.-based research. Those rules were promulgated in response to complaints by the U.S. business community that the 1977 regulations resulted in an inappropriate allocation of research expenses to foreign source income, which resulted in an inability to obtain full credit against U.S. tax liability for taxes paid abroad. President Clinton's most recent initiative, which is part of his new economic plan, proposes allocation of all U.S.-based research costs to domestic source income. This article contends that tax rules should not provide an incentive for U.S.-based research. Accordingly, this article supports neutral tax rules that apportion research costs on the basis of income expected to be derived from those activities.

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