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IRS Issues Guidelines for $1B Tax Credit-or-Cash Program Aimed at Startups

By Alex Philippidis

NEW YORK (GenomeWeb News) — The federal government today issued its long-awaited guidelines for startup companies seeking tax credits under the new Therapeutic Discovery Project tax credit program, created as part of the controversial healthcare reform legislation signed into law in March.

Startups looking to use the program can begin submitting applications for certification starting June 21. Those applications must be postmarked no later than July 21, according to the guidelines released by the US Internal Revenue Service for awarding the two-year program's $1 billion in available tax credits.

The IRS will issue certifications to winning companies following review by the US Department of Health and Human Services, the Treasury Department said in a statement. Applicants are supposed to hear back from the agency by Oct. 29, and decisions cannot be appealed.

The credit covers up to 50 percent of the cost of qualifying biomedical research, up to a maximum credit of $5 million per firm. However, startups can elect to receive their award as cash if they have yet to produce a profit. That aspect of the program is likely to be especially attractive to startups, since most tax credit programs on both the national and local levels do not offer such flexibility, an intellectual property lawyer who works with startup biotech companies told GenomeWeb Daily News.

"The grant feature is expected to be especially attractive to companies that are in early stages," William Kitchens, a lawyer with the Atlanta law firm Arnall Golden Gregory whose clients include life sciences startups, said. "Everybody who has looked at this believes that it will clearly be oversubscribed, and that there will be more people applying than the set-aside billion dollars."

Once the program ends, he said, "either Congress is going to have to consider some kind of extension like with 'Cash for Clunkers,' or if they stay with this, then clearly they're going to have to not make grants to certain projects that otherwise qualify based upon the criteria, simply because they've run out of money," Kitchens said.

Companies electing the tax credit can use it immediately, while those that take the benefit as a cash grant must wait to use the money the following year, and must have already spent the capital. But since most such companies have yet to produce a profit, they don't have the tax liability that a credit is intended to reduce. "And therefore, a tax credit, even if they carry it over to the next year, is not worth anything for them," Kitchens added.

Chuck McOsker, founder of Airway Therapeutics, which has an option to license a technology developed at Cincinnati Children's Hospital Medical Center designed to fight several forms of respiratory disease, told GWDN he found attractive a provision allowing applicants to estimate their expenses to be incurred through 2010, and not have to certify those until the tax year is over and the actual figures are available, allowing for adjustment if expenses are less than the amount certified.

"For smaller companies that are just ramping up spending, I think that's going to be a big advantage," McOsker said.

The program applies tax credits or grants to research and development costs incurred in the 2009 and 2010 tax years by traditional C corporations, as well as partnerships or S corporations, with total workforces of up to 250 employees.

A biotech unit of a pharmaceutical giant could not qualify for the benefits. Also ineligible are government agencies, tax-exempt organizations, and even partnerships whose partners include government or tax-exempt entities.

Companies developing a technology licensed from a university or research institute qualify for the program as long as the institutions are not equity partners. "If the interest of the university was spun off into a traditional pass-through type entity that was not a not-for-profit entity, then that might work," Kitchens said.

According to the law, startups qualify for the program if their projects are designed to:

• "Treat or prevent diseases through pre-clinical activities, clinical trials, and clinical studies";

• Carry out research toward securing approval of products from the US Food and Drug Administration.

• "Diagnose diseases or conditions or to determine molecular factors related to diseases or conditions by developing molecular diagnostics to guide therapeutic decisions."

• "Develop a product, process, or technology to further the delivery or administration of therapeutics."

The law defines "qualified investments" as aggregate costs "for expenses necessary for, and directly related to, the conduct of a qualifying therapeutic discovery project. However, those costs exclude the salaries of top executives, interest costs, indirect costs such as general and administrative expenses, and "facility maintenance" costs such as insurance, mortgage or rent payments, and utility expenses.

Under the program, the IRS is supposed to award tax credits or grants to projects that "show reasonable potential" of resulting in new therapies that treat areas of unmet medical need; that prevent, detect, or treat chronic or acute diseases and conditions; reduce long-term health costs in the US; or "significantly advance" the goal of curing cancer within 30 years.

"HHS will make this determination [of reasonable potential] based on an analysis of the scientific rationale for the project (question 9), the current stage of development of the project (question 10), and the evidence that the applicant has the capacity to bring the project to fruition (question 11)," according to the IRS guidance, a summary of which is here.

Some 1,200 "businesses or other for-profit entities" are expected to apply for benefits under the program, according to the guidance.

The law creating the tax credit program — officially a new Section 48D of the Internal Revenue Code — takes up 6-1/2 pages of the 906-page healthcare act, known as the Patient Protection and Affordable Care Act, or HR 3590. According to Section 48D, projects will also be assessed based on their ability to create and sustain, directly and indirectly, "high quality, high-paying" US jobs, and to advance US competitiveness in the biological, life, and medical sciences.

The program's inclusion in the healthcare measure followed more than a year of lobbying by the Biotechnology Industry Organization for a life-science equivalent to the Advanced Energy Manufacturing Tax Credit, also known as 48C after its section of the internal revenue code. BIO originally sought to include the tax credit program within the $862 billion American Recovery & Reinvestment Act, then in a second stimulus measure that was never passed.

"This had given us some time to vet this with members of Congress who care about biotechnology and small life science companies," especially US Sen. Robert Menendez (D-NJ), who came to champion the program, BIO spokeswoman Ellen Dadisman told GWDN.

She said no tax credit for life-science companies similar to the Therapeutic Discovery Project program exists in any state.

"This program brings a much-needed shot in the arm to small life science companies for whom the capital markets have been frozen," BIO President and CEO Jim Greenwood said in a statement.

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