Buried in the recently enacted Patient Protection and Affordable Care Act of 2010 is a significant benefit for small- and mid-sized biotech, pharmaceutical, and medical device companies. The legislation provides a 50% tax credit for investments in qualified therapeutic discoveries for tax years 2009 and 2010, or a grant for the same amount tax-free. The latter feature will be of particular benefit to biotech start-ups that are not yet profitable and do not have to pay income taxes. The cash grant option will allow more companies to receive an immediate return.
The tax credit/grant program covers research and development costs from 2009 and 2010 for all qualified “therapeutic discovery projects.” To qualify, a company must not have more than 250 employees in all businesses of the taxpayer (e.g., a small biotech project at a large pharmaceutical company would not qualify). These tax credits/grants are available to pass-through entities, such as partnerships or S corporations, as well as traditional C corporations.
A qualifying therapeutic discovery project is a project designed to either treat or prevent diseases or conditions by conducting preclinical studies or clinical trials or carrying out research protocols for the purpose of securing approval from the Food and Drug Administration; or diagnose diseases or conditions or to determine molecular factors relating to diseases or conditions by developing molecular diagnostics to guide therapeutic decisions.
The new legislation provides that “qualified investments” include “the aggregate amount of costs paid or incurred in the taxable year for expenses necessary for and directly related to the conduct of a qualifying therapeutic discovery project.” Excluded from the definition of “qualified expenses” are the salaries of certain employees identified in Section 162(m)(3) of the Tax Code (e.g., highly compensated chief executive officers). Other expenses that will not qualify include interest costs; facility maintenance, such as mortgage or rent, insurance, utilities; and certain indirect costs, like general and administrative expenses.
So what’s the catch? True to the adage that “there’s no such thing as a free lunch,” the new benefit has a substantial limitation. Unlike most programs establishing tax credits for qualified taxpayers, the tax credit/grant program will not be available in unlimited amounts to all eligible taxpayers. Instead, the new law creates a set pot of money—$1 billion for the 2009 and 2010 tax years. Moreover, companies will have to apply and compete for access to the tax credits/grants, and the money is expected to go quickly.
Consequently, applicants for the program should move rapidly to prepare; the government issued regulations implementing the program on May 21. It will be imperative that applicants demonstrate they have met the key requirements for accuracy, documentation, and justification of their expenses. The law provides that the Department of Treasury will assess applicants’ projects in consultation with the Department of Health and Human Services with emphasis on a number of criteria. Although a better picture of what should be included in an application will be forthcoming when the implementing regulations are completed, the new law suggests that successful applicants will demonstrate that their qualifying projects combine both a medical benefit and a job and economic advantage.
The medical benefit criteria are grounded on a showing that the project will result in new therapies to treat unmet medical needs or prevent, detect or treat chronic or acute diseases or conditions; reduce long-term healthcare costs in the U.S.; or significantly advance the goal of curing cancer within the next 30 years.
The jobs and economic criteria can be met by demonstrating that the therapeutic project will create and sustain high-quality, high-paying jobs in the United States. or advance U.S. competitiveness in the fields of life sciences, biological sciences, and medical science.
There is no bar against research expenses outside the U.S., but the strong sentiment of Congress in including this program as a part of healthcare reform was that the focus of the tax credit/grant should foster domestic jobs.
The program has generated significant interest, and undoubtedly the $ 1 billion earmarked to fund the program will not be sufficient to cover all qualifying projects. Left unanswered at this time is whether applications will be reviewed on a “first to file” basis, or whether the implementing ground rules for applications will instead establish a designated time period for all applications to be submitted, which arguably will facilitate more qualitative reviews by the government regarding the projects that should be given priority for the tax credit/grant. Likewise, the law itself establishes no upper limit on the total expenses per project that will qualify for the tax credit/grant. Given the tremendous costs associated with developing breakthrough therapies, this leaves open the possibility that the $1 billion could be taken up by the research expenses of a small number of qualified projects.
The take-away for the moment is companies should not delay in assessing whether their research and development activities qualify for the tax credit/grant. Likewise, now is the time to determine whether you have the required documentation to tie expenditures to a specific therapeutic project and whether you need to hire experts to assist with the application process. With the race to qualify fast approaching, companies with qualifying projects should take steps to ensure they will be able to file their applications as soon as possible after the final regulations are published.
Additional Information (PDF)
1. US Treasury Fact Sheet on Therapeutic Discovery Tax Credit
2. Internal Revenue Service Notice on Tax Credit
About the Author
William H. Kitchens is a partner at the Atlanta law firm Arnall Golden Gregory LLP, where he practices in the areas of food and drug law, environmental law and trade association law. He advises clients on matters related to litigation, compliance and enforcement, product approvals, advertising and labeling, and regulatory, licensing and permitting strategies. Mr. Kitchens was the firm's managing partner from 1996 to 2008.
