R&D Tax Credits Energize Startup Tech Companies

When it comes to research and development, Arkansas believes in giving credit where credit is due.

In the last few years, state agencies have given credit to about 20 startup tech companies to the tune of roughly $3 million.

Among other incentives, Arkansas Act 182 of 2003 – the Consolidated Incentive Act – authorized the Arkansas Science and Technology Authority to partner with the Arkansas Economic Development Commission to issue tax credits to companies to help offset R&D expenditures.

Once approved, a business can receive a tax credit equal to 33 percent of the amount it spent that year on R&D. For example, if a company spent $1 million on R&D, it could receive a tax credit for up to $333,000.

Of course, many of these companies aren’t even profitable yet, to say nothing of owing the state tens or hundreds of thousands of dollars. So the credits are transferable.

So far, most companies that have received R&D tax credits have sold them to banks.

Typically, the credits are sold at a discount of 8 percent to 10 percent.

Officials from several Northwest Arkansas startup companies and banks said the tax credit program works well for all parties involved. The banks get a tax break and the startups get some cash.

The credits are “a heck of an incentive” for tech companies, said Chuck Chalfant, president of Space Photonics Inc. in Fayetteville.

Since starting the program, the company has received about $500,000 in R&D tax credits, Chalfant said.

Space Photonics hasn’t spent any of the money generated from tax credits so far, but has set it aside as a contingency fund for future marketing and commercialization efforts, he said.

The tax credits can also mean new jobs.

“What it effectively means is that if you’ve got $1 million to spend on R&D, you’re going to get $300,000 back and you’re going to employ two engineers,” said Tim McFarland, owner of Grayrock Advisory Services.

McFarland is also a member of Accelerate Arkansas, an economic development organization dedicated to fostering higher paying jobs in the state.

The legislation that created the R&D tax credits is aimed at younger companies and is “aggressive” in terms of incentives, McFarland said.

Many of the companies that have received the credits have performed well and have created jobs that pay well, he said.

Doubling Up

The R&D tax credits have helped beef up the staff at BioBased Technologies. The company has received about $200,000 worth of credits, said Tom Muccio, CEO of the BioBased Family of Companies.

“We’ve probably doubled the size of our R&D staff” as a result of the credits, Muccio said.

BioBased “certainly wouldn’t have had as many scientists on staff without [the credits],” he said.

As a tech company, BioBased – which moved to Arkansas in 2004 – was courted by several states. Arkansas didn’t have the best incentive package “by a long shot,” Muccio said.

But the company’s leaders wanted to be in Arkansas.

“It’s certainly a good package, though, and we all wanted to be here,” he said.

Muccio thinks the tax credits, along with other incentives for tech companies, will “pay the state back very handsomely in the form of jobs and economic development,” he said.

At the 20 companies that have received the credits, about 190 employees earn an average of $30 an hour, said Brad Henry, senior policy analyst with the AEDC.

“The legislation around the targeted business tax credit was passed during 2003 legislative session, so we’re looking at the fifth year of the program,” Henry said. “It really took a while for it to get on its feet.”

Although the program wasn’t widely used for the first couple of years of its existence, the last few years have seen a substantial increase in applications for the credits, he said.

Qualifying Companies

Not just any business can qualify for R&D tax credits, and not all work done at companies that have received the credits is eligible either.

“We work on this program in conjunction with the ASTA, so basically we’ll get referred to a company or a company will call us with interest in the program and we’ll have that initial meeting and then conduct the due diligence,” Henry said.

“If the company meets the initial qualifications for the program, we’ll talk with ASTA and they’ll help us verify the company’s research.”

To qualify, according to the AEDC Web site, a company’s work must be undertaken for the purpose of discovering information which is technological in nature; the application of technological information must be intended to be useful in the new or improved business component; and all the activities related to the research effort must constitute elements of a process of experimentation relating to a new or improved function, performance, reliability or quality.

Some examples of work that would not qualify for tax credits would be research conducted after the beginning of commercial production; research adapting an existing product or process to a particular customer’s need; duplication of an existing product or process; surveys or studies; research related to certain internal-use computer software; research conducted outside of Arkansas; and research in the social sciences, arts or humanities, according to the Web site.

Other qualifications pertain to how long the company has existed, payroll amounts, pay levels and equity investment.

Interested Parties

One issue some recipients had with the program is that it comes in the form of a tax credit and not a research grant.

Right off the top, the tech companies typically lose 8 percent to 10 percent of the value of the credit, though Henry of the AEDC and The Bank of Fayetteville CFO Sam Stricklin said some banks have purchased the tax credits on a dollar-for-dollar basis.

Since 2005, BOF has purchased about $600,000 worth of credits, Stricklin said.

The credits have been good for both the bank and tech startups, because they “give them immediate cash and we can use the credits to pay off taxes,” Stricklin said.

Bank of the Ozarks has purchased about $2 million in tax credits since 2005, said Dan Rollet, executive vice president with the bank.

The bank will often offer to purchase the credits from tech startups at a rate that is more favorable for the companies when the amount of the credit is more than $100,000, Rollet said.

One advantage to the program being a tax credit as opposed to a grant is that with a credit, state money doesn’t have to be set aside to cover the cost, said Tom Chilton, technology development manager with AEDC.

There is no cap on the amount of tax credits that can be issued in a single year, but the qualifications are very restrictive about which companies can participate, because it’s targeted at a small segment of businesses, Chilton said.

“It’s almost self-limiting because there can only be so many companies that qualify,” he said.

The AEDC provides an annual program audit to the state Legislative Council for review.

Overall, the credits have been a “win-win situation for both parties,” said Sharmilla Mounce, business operations manager for Arkansas Power Electronics International Inc. in Fayetteville.

The company has received about $1 million in credits since 2005, she said.