Covid-19 and the social distancing measures that followed upended the retail industry, heightening the need for stores to find liquidity and new ways to engage customers, and to strengthen supply chains. But what if the tax code could help retailers adapt to an e-commerce sector that grows 33% per year (as it did in 2020) in comparison to the more modest 12.5% in the previous five years, while also meeting new consumer demands, which increasingly favor connectivity through digital channels?
While online retailing has pushed retailers to make investments in digital transformation during the past 25 years, the past 16 months have accelerated the trend. Now, the most successful retailers take advantage of the rapid consumer and market dynamics and invest heavily in digital transformation to meet the demands. The return on investment for them can be significantly enhanced with efficient tax planning—like capitalizing on tax incentives offered to organizations that invest in innovation through research and experimentation (R&E) tax credits.
All too often, however, companies overlook the tax credits that can be claimed for their commitment to innovation. In a survey conducted by KPMG of approximately 1,000 tax professionals across industries, one in three reported that they had never claimed state-level R&E credits or incentives even though they were eligible to do so. Why is this? Because companies have historically focused on claiming the credit for highly innovative product and process improvements as opposed to somewhat less obvious areas of investments, including in information technology. Often the methodology to identify the qualifying expenses and supporting documentation may be considered to be more complex than it is in practice. That said, the benefits far outweigh the challenges, and numerous technologies are available to help automate the process.
Claiming R&E credits
The R&E tax credit is attracting attention outside of the accounting department—and with good reason. Chief technology officers, vice presidents, directors of engineering, and other technology leaders in the retail industry understand that the value of these credits goes beyond just improving the effective tax rate of the organization. They know that the investment in innovation is vital for remaining competitive, improving the “digital front door,” and increasing the overall efficiency of the business. They also know the R&E tax credits can strengthen the overall return on such investments.
Retailers need to evaluate whether and to what extent their investments qualify for federal and state R&E credits, namely they need to show that the projects are technological and entail a process of innovation among other factors. The costs that can be included in the credits include wages to employees, supply costs for research, contractor expenses, engineering and design fees, and costs tied to the project.
Examples of R&E initiatives that could apply to retailing include:
- automation of a delivery process
- development of sustainable and eco-friendly apparel using biodegradable material, and creating information technology systems to implement the concept of fast fashion
- creating an app for taking a brick-and-mortar store online
- drone-based delivery
- leveraging artificial intelligence-based software to optimize supply chains
- robotic warehouse management
- developing a blockchain-based product tracking system
- developing software to be used for internal functions by the organization, including financial management and performing day-to-day activities.
Expanding the credit
As our economy works its way out of the fallout from the pandemic, and social distancing requirements continue to alter the way business is conducted, the Biden administration and Congress are considering an expansion of the R&E tax credit, as well as possible other revisions to the tax code, which could help spur growth and create jobs.
For example, advance payments on the research credit and an increase in the amount of external research expenses that may qualify is actively being considered. Currently, taxpayers can qualify only 65% of expenses related to external applied research. In addition, multinational organizations that have software development and research footprints across multiple global jurisdictions can often take advantage of R&E tax incentives provided by advanced international economies.
We know that being a successful merchandiser means meeting the needs of the consumer in the most convenient fashion. Investing in digital transformation and leveraging the tax code—and the potentially lucrative credits that can accompany doing so—should be a no-brainer to retailers as they adapt to a new business normal that can uncover opportunities for new growth.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Gregory Bocchino is a KPMG partner and national leader of KPMG’s Accounting Methods and Credits Services Practice. Ajay Wanchoo is a managing director for KPMG’s Accounting Methods and Credit Services Practice, where he leads the qualitative effort for R&D studies to identify qualified research activities.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.