The Business Component: Navigating the Core Technical Requirement of the Arkansas R&D Tax Credit

The Business Component (BC) is the foundational subject of all qualified research under Arkansas statute, establishing the precise goal of the research and development (R&D) activity. Defined explicitly in Arkansas regulations as any product, process, computer software, technique, formula, or invention held for sale, lease, license, or used in the taxpayer’s trade or business 1, the BC serves as the essential objective criterion for claiming state R&D tax incentives. The state mandates that all R&D expenditures must be meticulously linked to the development or improvement of this BC through administrative pre-approval and strict adherence to the four-part federal qualification test.

I. The Statutory Framework of Arkansas R&D Incentives

Arkansas provides significant incentives for technological advancement, specifically targeting university-based research, in-house research, and R&D conducted by technology-based start-up enterprises.3 Understanding the definition and application of the Business Component begins with the legal structures underpinning these incentives.

I.A. Legal Foundation and Adoption of Federal Standards

The Arkansas R&D Tax Credit Program is governed by Arkansas Code Annotated (ACA) § 15-4-2708 and related provisions in Title 26.4 In structuring its incentives, Arkansas relies heavily on the framework established by Internal Revenue Code (IRC) Section 41 for defining “Qualified Research”.5 This federal linkage means that Arkansas taxpayers must satisfy the rigorous federal four-part test, a criterion in which the definition and nature of the BC are absolutely central.6

The incentive is designed to significantly reduce state income tax liability. Approved tax credits under these programs can offset up to 100% of a business’s annual state income tax liability.3 Furthermore, any unused credits may be carried forward for up to nine consecutive tax periods or until exhausted, whichever occurs first.3 This robust carryforward provision provides long-term value for companies undertaking multi-year R&D projects focused on developing a complex BC.

I.B. Differentiation of Arkansas R&D Credit Programs

While the technical requirement for a Business Component remains consistent, Arkansas segregates its R&D incentives into distinct programs based on the nature of the research, which dictates the credit rate and maximum annual benefit.

In-House R&D Tax Credit (20% Incremental)

This program is a discretionary incentive primarily utilized by mature companies performing ongoing in-house research.8 The credit offered is 20% of qualified research expenditures (QREs).8 A crucial element of this program is that the credit is based only on QREs that exceed the baseline expenditure established in the preceding year, thus functioning as an incremental credit.3 This structure rewards increasing levels of research investment, but QREs are narrowly defined, consisting primarily of qualified R&D salaries, excluding expenses such as supplies, equipment, and buildings.8

Strategic Value/Targeted Business R&D (33% Capped)

Targeted businesses, and research in fields identified as having long-term economic or commercial value to the state, may be offered a higher credit rate.3 This credit is equal to 33% of qualified research and development expenditures incurred each year for up to five years.3 Although the rate is higher, this program is subject to a strict annual maximum credit limitation of $50,000 per tax year.6 Applications for this program require a detailed project plan submitted to the Arkansas Economic Development Commission (AEDC).6

University-Based R&D (33% Capped)

An eligible business that contracts research with one or more Arkansas colleges or universities may also qualify for a 33% income tax credit for those qualified research expenditures.3 Like the Strategic Value program, this incentive is also subject to the maximum tax credit that may be claimed by a taxpayer, which is limited to $50,000 per tax year.9

I.C. Key Compliance Principle: Consistent BC Standard Across Tiers

A fundamental principle governing Arkansas R&D tax compliance is the requirement that the definition of the Business Component and the technical rigor required to prove its development remain identical across all credit programs.3 This consistency ensures that the state maintains its commitment to incentivizing technological progress regardless of the size or structure of the claimant.

The consistent application of the four-part test, centered on the BC, standardizes the technical compliance documentation required by the Arkansas Science & Technology Authority (ASTA) and the AEDC. By applying the same high standard to all incentivized research, the state assures that even the high-rate, capped programs (33%) meet the same level of technical justification as the uncapped 20% program. This standardization streamlines the technical review process but places a significant burden on the taxpayer to demonstrate precise adherence to the BC definition from the very first phase of the R&D project.

II. The Legal Interpretation of “Business Component” (BC) in Arkansas Regulations

The legal definition of the Business Component is found within the state’s regulatory guidance related to the Consolidated Incentive Act. This regulatory definition provides the necessary detail to move from a general concept of innovation to a precise, tax-qualifying activity.

II.A. The Definitional Breadth of the Business Component

The state definition classifies the Business Component as encompassing both tangible, physical deliverables and abstract, intangible improvements used within a business context.1

Specifically, the BC is defined as:

• Tangible Components: Any “product” or “invention.”
• Intangible Components: Any “process,” “computer software,” “technique,” or “formula”.1

The critical factor that transforms these items into a tax-qualifying BC is the element of intended use. The component must be either held for sale, lease or license (indicating external revenue generation) or used in trade or business of the taxpayer (indicating internal optimization or operation).1 This dual purpose accommodates businesses that commercialize their R&D output as well as those whose innovation focuses on proprietary, internal efficiencies.

II.B. Qualification of Internal Processes and Software

The explicit inclusion of “process” and “computer software” in the definition of the BC is particularly vital for modern manufacturing and technology firms.1

Research expenditures aimed at improving manufacturing processes, assembly sequences, or quality control techniques qualify as long as the improvement overcomes a defined technological uncertainty. Similarly, the development of custom, proprietary software intended solely for internal use—such as automation software for component storage and delivery systems, or custom-engineered fixtures required for precision manufacturing—constitutes a valid BC.10 To qualify, such software must involve the development of new or improved functionality and must go beyond routine maintenance, data entry, or customization of commercial off-the-shelf software. The emphasis is strictly on activities that resolve technical unknowns through systematic experimentation related to the software’s underlying technological design.

II.C. Trade or Business Linkage and Economic Purpose

The regulatory inclusion of the phrase “used in trade or business” ensures that the development of the BC has a genuine economic purpose directly related to the taxpayer’s core operations, thereby distinguishing qualifying R&D from purely non-commercial or academic pursuits.

The statute mandates that the BC must ultimately be applied to the company’s income-producing activities. This regulatory requirement establishes a strong link between the BC definition and the Permitted Purpose test (the first of the four qualification tests). The expenditure must aim to discover information intended to be useful in a new or improved business component.3 This linkage confirms that the R&D is directed toward a tangible economic asset. Consequently, administrative bodies like the AEDC require detailed documentation—via the mandatory Project Plan—outlining the intent to use the resultant BC, ensuring the research aligns with verifiable business goals.6

III. The Business Component as the Objective of the Four-Part Test

The Business Component is not merely a descriptive label; it is the definitive driver of the qualification process. The four-part test, adopted from the federal IRC Section 41, is essentially a technical validation process focused entirely on the development of the BC.

III.A. Permitted Purpose and Elimination of Uncertainty

The first two requirements of the four-part test establish the scope and technical complexity of the work related to the BC.

Test 1: Permitted Purpose

The BC sets the goal. The research activity must be undertaken for the purpose of creating a new BC or improving on an existing one, specifically concerning its functionality, performance, reliability, or quality.2 This test ensures that the research is focused on advancement rather than duplication or basic maintenance.

Test 2: Elimination of Uncertainty

This is the nexus of the BC analysis, and often the most scrutinized element during an audit. The taxpayer must intend to discover information that would eliminate technical uncertainty regarding the BC’s development, methodology, or appropriate design.2 Technical uncertainty exists if the company cannot know, based on readily available scientific or technical data, whether the BC can be developed or improved, or the best method to achieve that outcome.2 If the company already possesses the requisite scientific knowledge or engineering standards to achieve the BC’s desired improvement, the research fails the uncertainty test, regardless of how novel the BC may be to the company itself.

III.B. Process of Experimentation and Technological Basis

The remaining two tests define the required execution strategy for resolving the uncertainty inherent in the BC’s development.

Test 3: Process of Experimentation

The R&D activity must involve a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain.2 This systematic effort, focused entirely on the challenges presented by the BC development, requires thorough documentation of alternatives considered, trials conducted, and the conclusions drawn at each iteration.

Test 4: Technological in Nature

The systematic experimentation used to discover the necessary information must fundamentally rely on principles of the physical or biological sciences, chemistry, engineering, or computer science.2 This ensures that the BC improvement is rooted in the hard sciences, distinguishing true qualified research from non-qualifying activities such as market research, routine industrial engineering, or stylistic design changes.

III.C. The High Threshold of “Substantially All”

Arkansas law dictates that qualified research must satisfy all of the statutory tests.3 Certain regulations further emphasize that substantially all of the activities related to the research effort must meet these qualification criteria.3

This high standard for compliance demands precise allocation of Qualified Research Expenditures (QREs). Because the BC is the central objective, if a significant amount of time (and thus employee wages) is spent on non-technical, supporting activities—such as market analysis, administrative documentation, or general engineering tasks that do not involve resolving technical uncertainty—those QREs are ineligible. Taxpayers must implement granular time tracking systems that allocate employee wages directly to the specific experimental activities focused on resolving technological uncertainties within the BC development, thereby ensuring “substantially all” of the cost incurred relates to the qualifying activity.

The Four-Part Test: Integrating the Business Component

IV. Navigating Arkansas Administrative and Compliance Guidance (AEDC, ASTA, DFA)

Arkansas utilizes a distinctive, bifurcated administrative structure for approving R&D credits. This structure requires technical pre-approval by specialized agencies before the Department of Finance and Administration (DFA) will process the tax claim.

IV.A. The Role of AEDC and ASTA in Technical Qualification

The Arkansas Economic Development Commission (AEDC) and the Arkansas Science & Technology Authority (ASTA) are the primary technical gatekeepers for R&D tax credit approval.3 Taxpayers are required to apply to the AEDC/ASTA to qualify for the credit, particularly for programs managed under the ASTA.3

This application process mandates the submission of a detailed project plan.6 This plan must clearly identify the intent of the project, which explicitly details the Business Component objective, the expenditures planned, the start and end dates of the project, and an estimate of total project costs.6 This project plan serves as the taxpayer’s formal declaration that the planned activities will satisfy the four-part test and is focused on a qualified BC. ASTA approval of the research activity is mandatory before a taxpayer can seek the credit.7

IV.B. The Critical Certificate of Tax Credit

Following the approval of the Project Plan and verification of qualified research, the commission issues a Certificate of Tax Credit.6 The issuance of this certificate is non-negotiable for claiming the credit with the DFA. The business is legally required to file this Certificate of Tax Credit with its income tax return on which the credit is first claimed.6

This administrative step highlights the state’s bifurcated compliance model: the DFA effectively delegates the technical and scientific review of the R&D activity (and the BC qualification) to the specialized commission (AEDC/ASTA). If the Certificate is not issued, or if it is later revoked due to non-compliance with the approved project plan, the DFA will automatically deny the credit claim upon filing, irrespective of the quality of the taxpayer’s internal documentation. Therefore, technical compliance with AEDC/ASTA rules precedes and dictates financial compliance with the DFA.

IV.C. Contractual Compliance through the Financial Incentive Agreement

For discretionary credits, specifically those related to Targeted Businesses or R&D in an Area of Strategic Value, the qualification process is initiated by signing a “Financial Incentive Agreement” with the commission.1 This agreement contractually specifies the incentive, the term, and the investment and/or payroll threshold requirements necessary to qualify for eligibility.1

This contractual document establishes heightened compliance obligations. It serves as the primary source document utilized by the DFA when auditing the business to verify compliance.1 The development of the Business Component must be executed precisely as outlined in this agreement and the accompanying Project Plan. Failure to meet the agreement’s contractual terms—which include maintaining eligibility and adherence to specified reporting and threshold requirements—may result in the denial of future credit utilization or potential clawbacks of previously claimed credits. The administrative pre-approval process thus converts technical R&D compliance into a contractual performance risk.

V. Qualified Expenditures and BC Linkage

Arkansas maintains a narrower definition of Qualified Research Expenditures (QREs) than the federal definition, making precise allocation of costs to the BC development effort particularly important.

V.A. Strict Definition of QREs

Arkansas QREs are primarily limited to in-house labor costs. The qualified expenditures include:

1. In-house expenses for taxable wages paid (wages subject to withholding).6
2. Usual fringe benefits specific to the research activities of employees.6

These QREs must be attributable to employees performing qualified services related to the discovery of information intended to be useful in a new or improved Business Component.3 A notable distinction from the federal program is that for the In-House R&D Tax Credit (20%), expenses for supplies, equipment, and buildings generally do not qualify.8

V.B. The Role of Contractual Research

For certain programs, specifically the 33% credit programs (Targeted Business or Strategic Value), QREs can include wages and usual fringe benefits paid through contractual agreements.3 These contracts must be approved in writing by the director and must be with a state college, an Arkansas state university, or another Arkansas-based research organization performing research for the targeted business.6

Crucially, even when the research is outsourced, the ultimate accountability for the BC rests with the taxpayer. The contracted research must be directed toward developing a Business Component used in the taxpayer’s trade or business and must satisfy all four qualification tests. The taxpayer retains the legal responsibility for ensuring and documenting that the activities performed by the contractor meet the technical standards required for BC qualification.

V.C. Strategic Calculation: Maximizing the Incremental Credit

Taxpayers must perform a careful strategic comparison between the two main credit structures. The uncapped 20% incremental credit for In-House R&D is often fiscally superior for businesses with substantial R&D budgets compared to the 33% Strategic Value credit, which is strictly capped.

The maximum benefit attainable under the 33% capped program is $50,000.9 This cap implies that the credit ceases to provide an incremental return once QREs exceed approximately $151,515 ($50,000 / 0.33 = $151,515). However, due to the $50,000 limitation, the actual QRE threshold at which the 20% credit becomes equivalent to the 33% credit is higher. If a company has incremental QREs of $250,000, the 20% credit generates $50,000 ($250,000 * 0.20 = $50,000), equaling the maximum 33% credit.3

Therefore, businesses with incremental QREs exceeding $250,000 will find the 20% program to offer a greater return on their investment in the BC development. Taxpayers must model their BC development costs against this $250,000 QRE break-even point to choose the most advantageous program. Regardless of the choice, meticulous linkage of all expenditures to the activities that resolve the technical uncertainty of the BC is required.

VI. Documentation Requirements for Audit Readiness

Substantiation must satisfy the requirements of both the technical pre-approval agencies (AEDC/ASTA) and the financial auditors (DFA). The documentation must prove the technical uncertainty related to the BC and the systematic effort undertaken to resolve it.

VI.A. The Necessity of Detailed Technical Records

To demonstrate the application of the four-part test to the BC, the taxpayer must retain a comprehensive set of technical records.2 These records include:

1. Project Descriptions: Documents outlining the specific functional improvement sought in the BC, serving as proof of the Permitted Purpose.2
2. Experimentation Logs and Lab Notes: Records that detail the technical hurdles encountered, the hypothesis for resolution, and the systematic process used to overcome these hurdles. This demonstrates the Elimination of Uncertainty and the Process of Experimentation.2
3. Testing Protocols and Results: Detailed records of trial runs, quality assurance metrics, performance data, failed iterations, and successful outcomes, all explicitly linked to the BC’s specified performance goals.2
4. Prototypes and Design Iterations: Physical or virtual proof, such as photographs, videos, or design schematics, of the attempts made to develop or refine the BC.2

VI.B. Financial Linkage and Compliance Documents

Financial records must provide an auditable link between employee labor costs (QREs) and the approved BC development activities 2:

• Detailed Payroll Data and contemporaneous time sheets that allocate effort to specific R&D projects.2
• Contracts, invoices, and payment records for contractual research services.2
• The approved Project Plan and, if applicable, the Financial Incentive Agreement.1
• The final, issued Certificate of Tax Credit, which must accompany the income tax return filing.6

VI.C. Substantiation through Technical Failures

A common area of compliance misunderstanding relates to the quality of technical documentation. Documentation of unsuccessful attempts and technical failures often provides more convincing proof of the “Elimination of Uncertainty” test than records of successful final products.2

If the records show that every step in the BC development was immediately successful, it suggests the project was routine engineering and lacked genuine technical uncertainty, leading to the failure of Test 2. Effective compliance documentation must highlight the difficulties encountered—the discarded alternatives, the unforeseen technical hurdles, and the systematic means by which the design or methodology was adapted to resolve the inherent challenges of the BC’s development. This evidence demonstrates that the expenditures were necessary to discover information that was not readily available to the taxpayer.

VII. Case Study Analysis: Business Component Examples in Arkansas

Practical examples illustrate how the diverse definition of the Business Component applies across various Arkansas industries.

VII.A. Example 1: Intangible BC – Custom Logistics Software

• Industry: Distribution and Warehouse Facilities.12
• Scenario: A regional distribution center develops a proprietary Artificial Intelligence (AI) routine designed to optimize the sequence and execution path for automated guided vehicles (AGVs) transporting specific types of goods. The goal is to reduce inter-AGV traffic interference and maximize sorting throughput by 20% during peak hours.
• The Business Component (BC): The proprietary computer software and its underlying optimization algorithm (formula/technique).1
• Qualification Analysis:

• Uncertainty: The company faced significant uncertainty regarding whether a new, custom-developed, non-linear AI algorithm could reliably predict and execute optimal, collision-free paths in a dynamic, high-density environment without relying on standard, commercial off-the-shelf optimization packages, which failed to meet the necessary throughput metric.
• Technological Nature: The project relied fundamentally on principles of computer science, specifically machine learning and complex optimization algorithms.
• QREs: Wages paid to the in-house computer scientists, software architects, and specialized developers engaged in designing, coding, testing, and debugging the AI models.
• Potential Credit Impact: Assuming the company qualifies as a Targeted Business, incurring $150,000 in qualifying wages would result in a credit of $49,500 ($150,000 $\times$ 33%), effectively maximizing the benefit at the $50,000 annual cap.9

VII.B. Example 2: Tangible BC – Improved Manufacturing Process

• Industry: Electronics Manufacturing (NAICS 31-33).10
• Scenario: An electronics manufacturer specializing in Printed Circuit Board (PCB) assembly requires a new thermal welding process to bond two dissimilar, heat-sensitive components together. Standard industry processes result in unacceptable thermal distortion of Component A, leading to premature failure. The company undertakes R&D to develop a novel, multi-stage pulsed-laser thermal application process.
• The Business Component (BC): The new manufacturing process (pulsed-laser thermal application technique).1
• Qualification Analysis:

• Uncertainty/Experimentation: Uncertainty existed concerning the exact timing, temperature profile, and physical parameters necessary to achieve the desired bond strength without damaging the heat-sensitive component. This required systematic experimentation, including multiple design iterations and functionality tests of custom-engineered fixtures and control software.2
• Technological Nature: The experimentation relied on principles of material science, thermodynamics, and optical engineering to control the energy transfer accurately.
• QREs: Wages paid to manufacturing engineers, thermal analysts, and technicians involved in designing the custom fixtures, developing the laser control software, and executing rigorous temperature testing protocols.
• Compliance Note: The records must include detailed testing protocols and failure reports (e.g., thermal mapping data, structural analysis of failed welds) to definitively prove that the systematic process successfully resolved the technological uncertainty inherent in creating the new process BC.

Conclusion: Strategic Utilization and Planning

The definition and substantiation of the Business Component (BC) represent the core challenge and primary area of risk in claiming the Arkansas R&D tax credit. The state’s compliance structure is engineered to reward research that meets a high technical threshold, requiring pre-certification and adherence to a federally derived four-part test centered on the BC. Taxpayers cannot achieve successful compliance merely by summarizing high-level expenditures; they must provide auditable, contemporaneous documentation that proves the systematic effort resolved technical uncertainty related to a defined BC.

Actionable Compliance Recommendations

To fully capitalize on and successfully defend the Arkansas R&D tax credit, businesses must adopt the following three strategic recommendations:

1. Rigorously Define and Document the BC Objective: Prior to initiating research, ensure the BC is articulated as a clearly identifiable product, process, formula, or software aimed at achieving measurable new functionality, performance, or quality improvement. This definition must be formalized within the Project Plan submitted to the AEDC/ASTA, linking the technical effort directly to the economic utility within the business’s trade or business.
2. Embed Technical Uncertainty Resolution in Documentation: Establish internal record-keeping procedures that explicitly document the technological uncertainty related to the BC (Test 2) and the systematic attempts to eliminate that uncertainty (Test 3). Documentation should emphasize records of alternatives considered, tests performed, and especially technical failures, as these prove that the R&D was necessary and not routine.

Align QREs with Pre-Approved BC Activities: Ensure that wages and contract costs (QREs) are meticulously tracked and allocated solely to activities satisfying the four-part test related to the BC. Strategic planning should evaluate the company’s incremental QRE level against the $250,000 threshold to select the optimal tax program (20% uncapped vs. 33% capped). Finally, maintain the integrity of the compliance pathway by ensuring the Certificate of Tax Credit issued by the technical agencies is always used to validate the claim with the DFA.

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/