For Companies Retooling to Fight COVID-19, R&D Tax Credits Are Important Weapons

Corporations in diverse sectors are responding to the exceptional challenges posed by the COVID-19 pandemic by optimizing their supply chains and transitioning to alternative processes to maintain essential operations in times of great uncertainty. Across industries, companies also are repurposing production and research competencies to support the war on COVID-19 and are offsetting disruption by transforming idle resources to deliver relevant and advanced medical solutions. They are doing so in response to urgent needs to help the public. 

New York City, currently the national epicenter of the virus, sent an urgent plea for aid from “businesses with the ability to source and/or make products to support the City’s COVID-19 response work,” including “businesses able to make new products from scratch.” Across the nation, other state and local governments are putting out similar calls for companies to support COVID-19 relief efforts through the production of a range of medical supplies, tests and equipment.

Credit for Innovation

These redirected activities and efforts are of great benefit to individuals and communities, and also may potentially qualify for the Research and Development tax credit, thus maximizing companies’ liquidity and catalyzing new product development and ideation. Businesses that have not taken advantage of this powerful incentive may have missed a huge opportunity for improved financial performance, and would be wise to put mechanisms in place that ensure they are capturing all of the expenses that could contribute to helping them qualify.

According to the tax code, US-based scientific, manufacturing and R&D repurposing can potentially qualify a company for the R&D tax credit. If businesses undertake innovations, repurposing, optimizations, ideation, or research into alternative methods that entail overcoming uncertainty in producing COVID-19 solutions, they may benefit from this tax incentive. This requires having an R&D tax credit study completed to quantify and qualify relevant expenditures. There are two standard methods of calculating the tax credit: A traditional ‘‘regular credit’’ and the Alternative Simplified Credit (ASC) methodology. These costs and calculations are then summarized on Form 6765 and included as part of the company’s tax return.

For many companies, catalyzing successful innovation is already critical to long-term strategy and success. Companies recognize the importance of tax credits and incentives as critical weapons in remaining competitive and harnessing innovation. This R&D tax credit may be increasingly attractive for companies that are redesigning their business processes and/or product innovation in the face of the pandemic.

A War Footing

The last time something similar occurred in the US was during World War II, when countless corporations producing cars, clothes or other items altered their manufacturing processes to aid in a collective effort. In the current situation, there is a higher level of regulation and more complex production of medical products than those made for the war effort. Government leaders around the globe have placed their economies on a war footing by offering assistance in the form of immense capital injections and crisis loan packages. In that context, it is unavoidable that many more firms will see the need to change their production from goods not needed in a time of crisis to those desperately needed, if it is possible for them to do so. Desperately needed items include hand sanitizer, gowns, goggles, gloves, surgical masks, face shields, respirators, and N95 masks, which protect health care professionals from contracting the disease.

During World War II, automakers were more easily able to shift to making tanks and planes because those are close relatives to cars and trucks. Because auto factory equipment such as robots and assembly lines aren’t really compatible with smaller items such as ventilators, other industries may be better equipped to help with the virus.

Rum producer Bacardi, for example, said its distillery in Puerto Rico has shifted to making ethanol needed to produce hand sanitizer. Pernod Ricard SA instituted a full repurposing of a distillery to produce high-quality products and offset the sanitizer shortages. Versare Solutions, a Minneapolis maker of cubicles and room dividers, has switched to making plexiglass screens for checkout lanes and reception areas after receiving a request from a California pharmacy. Luxury fashion designers are joining the mask production forces. High-end swimwear brand Karla Colletto is reopening its factory in Virginia to produce masks and gowns after it receives medical-grade materials from 3M this week.

The real challenge with this sort of operational shift lies in the scale-up of processes and procedures. For example, how does a whiskey manufacturer optimize the required environment to produce high-order batches of a brand new product in great volume for the entire nation?

Viability and Engineering Challenges

Changing entire production lines to make unfamiliar items is no simple task. It is crucial to understand that there are different levels of challenges in repurposing. These include: timing and supply chain constraints, quality assurance, and reliability of the product or manufacturing processes and relevant engineering, scientific and managerial know-how.

Building up capacity and capabilities to produce hygiene and protection products such as masks and disinfectants can be achieved relatively quickly. We have seen manufacturing and R&D companies transforming, for example, research and development sites into dust-free plants – as well as customizing related equipment, completing required R&D, and obtaining certification to produce face masks – within days. The challenges reside in the speed of production and in the ability to quickly find and qualify suppliers, and the quality and reliability of product are non-negotiable in this circumstance. In many cases, the existing supplier base can be leveraged to avoid lengthy qualifications and onboarding processes.

Trends in manufacturing, such as advanced robotics, data analytics, and 3D printing, have made it easier for companies to switch gears to make even complex products. What companies need now is to be more flexible, have agile factories that can adapt to make different types of products, be faster to market, and customize products based on pandemic-dictated demands. For example, companies using 3D printing to make respirator valves only need the designs to make them.

The Greater Good

Every business must assess how it will adapt during this global crisis. Despite the complex business challenges, repurposing not only helps companies protect their own workforce, but serves the greater good. It helps keep production lines up and running in times of low demand, generates moderate revenues, and positively impacts their reputation.

While it may take time and a monumental effort to switch automotive factories to produce medical products, it may be inevitable if the virus outbreak lasts for several months or longer. Beyond addressing the immediate crisis, companies have plenty of incentive to participate in combating the coronavirus pandemic: prudence, charity, and responsibility.

A valuable tangential benefit is that the research and development tax credits can be utilized to offset some of the risk associated with these dollars and can be recouped by the company.

Anchin’s R&D tax credit practice is particularly skilled and experienced at identifying qualifying projects and initiatives in each area of your business, and we are experts at examining, quantifying, and documenting all allowable expenses towards each company’s research credit.

To discuss these and other matters of importance related to the R&D tax credit, contact Yair Holtzman, Leader of Anchin’s R&D Tax Credit Group at 212.536.6933 or [email protected].