The research and development (R&D) tax credit continues to be a tremendous opportunity for businesses across virtually every industry—in all life-cycle stages—to lower the cost of innovation. Whether a business is in its infancy stages as a pre-revenue, early-stage, or startup business that can use the credit to offset payroll tax or a business in the growth or mature stage generating taxable income, significant opportunities exist to increase cash flow, increase return on innovation investments, and improve the bottom line annually through the R&D tax credit.
This article examines some significant trends in food and agriculture that are driving the need for sustained innovation efforts to develop new or improved products and new or improved processes and production methods, as well as invest in custom machinery and equipment and technology, creating opportunities for food and agriculture businesses to take advantage of the R&D tax credit.
Trends Driving Innovation in Food & Agriculture
The need for innovation has never been greater, with the ramifications of the COVID-19 pandemic continuing to be felt up and down the supply chain. This need for innovation also is driven by the ever-increasing volume of external market forces and ongoing trends, leading to fierce competition for the consumer dollar. Ever-evolving consumer tastes and the desire for functional foods, as well as the focus on environmental, social, and governance (ESG) requirements, are driving forces that continue to push the bounds of innovation, impact sustainability commitments, and have significantly accelerated the rise of plant-based products. To address these shifts as well as widespread labor shortages, businesses will continue to be driven to innovate from a product, process, technology, and automation perspective.
Sustainability continues to be a top industry and consumer trend as consumers have become more focused on how their decisions and those across the industry impact the global environment. This has been the driving force behind a number of trends across various sectors in food and agriculture, including the development of innovative packaging, e.g., recyclable, biodegradable; process improvements aimed at lowering costs; and improving reliability, quality, and efficiency while addressing ESG goals. Sustainability also has led to the introduction of new and reformulated products manufactured using ingredients that have been grown using more sustainable methods.
The increasing popularity of plant-based diets driving the exponential increase in plant-based retail sales has continued to fuel the rise of innovative plant-based products. As health and nutrition continue to drive consumer tastes and spending, production technologies, techniques, and methods will need to evolve. As new or improved products are developed, understanding consumer decision-making processes, the need for “clean” labels, and the process or method used to process a product are never more important. Over the last year, plant-based meat products have continued to grow in popularity and with the consumer shift to plant-based diets, there is a need for these products that go beyond the typical veggie burger. What’s more, the food industry continues to develop products that taste just as good as their real meat counterparts. The spectrum of plant-based products is certainly only going to increase with today’s plant-based food market projected by NielsenIQ to be a multibillion-dollar market, as noted by Good Food Institute.
The implementation of new digital technologies and the need for automation also continue to be significant trends. The continuing impacts of the COVID-19 pandemic, including labor shortages, supply chain disruptions, the inability to obtain inputs, and shifting workforce priorities, have placed immense stress on food and agriculture to develop technology solutions, machinery and equipment, and processes that will allow these businesses to meet heightened consumer demand with a smaller labor force. New and improved processes built on automation and robotics will play a key role in mitigating the shortage of human labor, optimizing workflow, removing production bottlenecks, improving margins, and enhancing process efficiency and quality of end products for producers. Manufacturers are looking to other emerging technologies to help them innovate and craft better products, including digital hubs used to help launch new food ideas to capture large market segments and the use of blockchain in propelling intelligent decision making for growers, manufacturers, and distributors. In addition, agricultural technology continues to see significant growth in investment, with major technological innovations in the space focused on vertical farming, farm automation or “smart” farming, automation and robotics, livestock technology, precision agriculture, and artificial intelligence.
As consumers become increasingly focused on protecting and preserving health—and more cautious about what they put in their mouths—functional foods have quickly become a growing segment of the consumer market. With the added purpose of enhancing nutrition, innovation in developing new and reformulating existing products with healthier ingredients in food categories such as packaged products, beverages, dried fruits, cereal, water, and more will continue to trend upward as consumers demand quick and healthy solutions with multiple health benefits.
Furthermore, businesses continue to deal with inconsistent quality of product ingredients coming from suppliers, supply chain disruptions, and the inability to obtain key ingredients in the quantities needed stemming from the pandemic. In some cases, businesses have needed to pivot to new suppliers and new raw ingredients, causing food manufacturers to reformulate existing formulas and develop new processes and methods to produce those products. In addition, manufacturers want to ensure consistent taste, product performance, and shelf life, as well as food safety.
Market saturation and the bombardment of products mean manufacturers and producers must rely on innovation to craft better food products. The reward for doing so will mean market differentiation and enabling their products to stand out from the pack.
Which Business Activities Qualify for the R&D Tax Credit?
Originally enacted as part of the Economic Recovery Tax Act of 1981, the R&D credit is an activity-based credit that rewards evolutionary development. Since 1981, the R&D credit has gradually evolved, with new legislation, taxpayer-favorable regulations, and judicial precedent greatly expanding the activities and costs that have the potential to qualify for the credit. Any business—regardless of industry—that is developing new or improved products, processes, designs, software, or methods can qualify for the credit and recoup seven to 11 cents for every dollar of credit-eligible spend. The R&D credit is a dollar-for-dollar reduction of income tax liability at the entity level (in the case of a C corporation) and the shareholder or member level (in the case of a S corp or partnership). Businesses can secure credits for the current year and all open tax years, subject to the statute of limitations. In addition, there are special rules for qualified early-stage businesses and startup companies to convert these income tax credits to up to $1.25 million in payroll tax credits, as well as allow the credit to offset alternative minimum tax at the shareholder or member level for qualified small businesses, which many businesses are not aware of. In the event the credit cannot be used immediately or completely, the unused credit can be carried back one year and forward up to 20 years, offsetting future tax liability. Lastly, in addition to the federal credit, nearly 40 states have R&D credits and incentives of which businesses can take advantage.
The federal R&D credit (and most state credits by virtue of conformance) is governed by Section 41 of the Internal Revenue Code, which outlines four basic tests that activities must meet to qualify for the credit. Qualified research activities must:
- Be intended to develop new or improved functionality, performance, reliability, or quality of a product, process, software, technique, formula, or invention or result in a significant cost reduction;
- Apply principles of a hard science, e.g., physical, biological, engineering, or computer science principles;
- Be intended to eliminate technical uncertainty regarding capability, methodology, or appropriateness of design, and;
- Be a part of a process of experimentation, meaning a systematic trial and error process capable of evaluating one or more alternatives to eliminate uncertainty.
It is important to note that the research need not be successful to qualify for the credit. The research also is not required to involve the discovery of information that is new to the world or the industry; it simply needs to be new to the business claiming the credit.
A wide variety of activities can qualify for the credit. Some examples include:
- Developing recipe formulations for new food products and flavorings in response to consumer preferences and demand, e.g., non-GMO, organic, gluten-free, etc., to reduce costs, improve shelf life, or evaluate alternative ingredients
- Improving existing food product formulations to extend product shelf life
- Developing new or improved agricultural or chemical materials that go into the food products
- Improving existing food product formulations to achieve certain nutritional and analytical requirements
- Developing new production processes and techniques for the production of new food products, including mixing times, batching sequences, and cooking temperatures and durations
- Improving existing production processes to improve efficiency or reduce workforce, lead time, and waste, or improve quality
- Developing custom machinery and equipment for the production and testing of food products
- Developing new packaging designs to provide enhanced functionality or increased product shelf life
- Producing prototype product samples for testing and validation of new recipe formulations
- Testing prototype samples for analytical and microbiological qualities
- Installing process automation, packaging equipment, or similar systems
- Customizing ERP software to integrate production, purchasing, and shipping systems; B2B or B2C functionality; vendor management and ordering; CRM; server integration; and product logistics
- Implementing new or improved sanitization or washing systems and methods for improved food safety and quality
- Developing new packaging materials and methods to increase shelf life or optimize storage space
- Developing new strains of crops, plants, or livestock
- Implementing precision-farming techniques in an attempt to increase yield and/or production efficiency
- Experimenting with new or different fertilizers
- Developing/implementing new ways to protect crops from disease
- Developing new/improved irrigation systems, cultivation techniques, disease-resistant crops, or harvesting techniques
- Implementing new equipment to improve harvest cycle times
- Developing new disease-resistant crops or livestock
- Developing new ways to prevent or control disease or insect pests
- Developing or experimenting with new feeds or feeding techniques for livestock
- Developing and experimenting with new breeding techniques
- Developing new gene-transfer technologies
- Optimizing treatment and management of farm waste in an energy-efficient manner
- Designing and implementing biosecurity practices
- Evaluating alternative feedstuffs
- Changing growth-promoting implant regiments
- Evaluating new genetic lines
- Improving animal husbandry techniques
- Experimenting with technology innovations, including vertical farming, automation and robotics, livestock technology, artificial intelligence, and drones
As customer trends continue to drive innovation in food manufacturing and agricultural processes, businesses must work to keep up. The R&D tax credit can be a tremendously valuable tool to help food and agricultural businesses immediately recoup the cost of their sustained innovation efforts and activities to develop new or improved products and new or improved processes and methods, as well as invest in custom machinery and equipment and technology.
The R&D tax credit is complex to analyze, calculate, and document. The national team of R&D tax credit professionals at FORVIS is here to help! FORVIS has helped businesses large and small across the U.S. secure the benefits they are entitled to and missing out on.
If you have any questions about whether your business qualifies for the R&D tax credit, want to begin the planning process to take advantage of the R&D credit, or are interested to learn more about the R&D credit services at FORVIS, please reach out to a professional on our R&D tax credit team or submit the Contact Us form below.