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U.S. moves to expand business R&D tax break

By Patrick Temple-West

WASHINGTON (Reuters) - Think you have a new way of making wine? There could be research tax breaks for that.

The U.S. government on Thursday called for a wider array of business activities to be made eligible for research tax breaks, including more manufacturing process-oriented costs, giving a preliminary tax law win to manufacturers and food processors.

The Treasury Department has proposed new rules that would make the research tax deduction and, in more limited cases, the research tax credit applicable to supply and production costs.

For instance, Treasury and the Internal Revenue Service said a wine producer could claim research tax breaks for production costs associated with "a different method of crushing the wine grapes" as it tests a new manufacturing process. These testing costs could be deductible as experimental research.

Agriculture and food processors might benefit from these rules if they could claim the tax breaks as they developed new products, tax lawyers said.

The new rules also would allow a company to claim the costs of a prototype, such as an experimental aircraft, even if it later sells a completed airplane.

The hazy line between research for final products and research for production methods and equipment has been a frequent source of legal conflict between companies and the IRS.

If approved, the rules would apply to future tax filings and could not be enforced until finalized. But the IRS often changes enforcement policies to reflect proposed rules, tax lawyers said on Thursday.

The new rules "are going to make a lot of taxpayers happy ... It eliminates a huge area of dispute," said Patricia Sweeney, a tax lawyer for Miller & Chevalier.

In one court case, Lockheed Martin Corp claimed $13.6 million of research tax credits. The aerospace group filed a lawsuit against the IRS in December, saying the agency wrongly rejected the research tax credits Lockheed claimed for making prototypes resulting from research.

Lockheed said in its court filing that some of the credits were claimed for prototypes, but argued the designs were new and unproven and should qualify as research.

No court date has been set in this case before the U.S. District Court for the District of Maryland in Greenbelt.

In September 2012, Dow Chemical Co lost a case in U.S. appeals court involving $8 million in research tax credits. Dow unit Union Carbide wanted to apply the credits retroactively to cover the costs of supplies, even though it ended up selling the finished goods.

Trinity Industries Inc and Bayer AG are also fighting the IRS in court over research credits.

The proposed rules would clarify "a gray area" in the taxpayers' favor and limit arguments available to the government, said Alex Sadler, a partner at law firm Ivins, Phillips & Barker.

The proposed rules are open for public comment and the IRS has scheduled a January 8, 2014 hearing.

(Editing by Kevin Drawbaugh and Andre Grenon)

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