Internal Revenue Code (“IRC”) section 41 provides for a federal research and development credit for certain qualified research expenses, basic research payments, and other enumerated expenses. California allows a similar, but not identical, research and development credit (“R&D Credit”) for the amounts paid or incurred for research and development in California. Generally, the California credit is allowed in accordance with IRC section 41, as modified by California Revenue and Taxation Code sections 17052.12 (personal income tax) and 23609 (corporation tax).

Less than a year ago, the FTB issued Legal Division Guidance 2011-06-01, which addressed two questions regarding the California R&D Credit. First, it explained California does not conform to the definition of “gross receipts” set forth in IRC section 41(c)(7) because California excludes from the definition receipts that are not “sales of property….” Accordingly, the FTB stated that such items as throwback sales, as well as receipts from services, rents, operating leases and interest are excluded from the California definition of “gross receipts.” Second, that guidance stated that pure service companies cannot claim the California R&D Credit. The FTB took the position that a pure service company with only service receipts has no “gross receipts” as defined under section 23609. Consequently, such a company cannot establish that it correctly calculated its California base amount and fixed-base percentage – the figures used to compute the R&D Credit.