The Research and Development Equipment Sales Tax Exemption in Indiana: A Strategic Guide to Compliance and Maximizing Innovation Incentives

Executive Summary: The Dual Incentive Strategy

The Indiana Research and Development Equipment Sales Tax Exemption, codified under IC 6-2.5-5-40, provides a 100% waiver of state gross retail tax on the purchase of qualifying tangible personal property. This incentive targets specialized capital assets, such as laboratory instruments and dedicated computer software, provided they are demonstrably new to the state and are used directly for experimental or laboratory research activities.1

This exemption operates in tandem with the Indiana Research Expense Income Tax Credit (IC 6-3.1-4), which targets operational expenditures—qualified research expenses (QREs) such as wages and supplies. Together, these two incentives form Indiana’s core strategy to encourage technology-driven investment by reducing both the fixed costs (equipment) and variable costs (operations) associated with innovation within the state.1

Rationale and Economic Impact of the Exemption

The fundamental purpose of Indiana’s R&D tax incentives is to encourage companies to conduct research and development activities within its borders.1 This policy is strategically rooted in economic theory, recognizing that technological progress is a potent driver of output and economic growth, often surpassing the impact of traditional labor and capital inputs.4

Indiana offers a comprehensive suite of R&D incentives, which include the Research Expense Credit (income tax reduction), the Patent-Derived Income Exemption, and the 100% Sales Tax Exemption for R&D equipment.4 The sales tax exemption holds a distinct and highly valuable role: it directly subsidizes capital investment. Unlike the income tax credit, which is calculated against expenses incurred over time (QREs, excluding capital depreciation), the sales tax exemption provides an immediate, dollar-for-dollar reduction in the cost of assets essential for building a research infrastructure. This strategic segmentation ensures that incentives are provided for both the establishment of R&D facilities and the ongoing operations necessary to staff them, resulting in a cohesive policy aimed at lowering both fixed and variable innovation costs simultaneously. This structure necessitates that taxpayers adopt an integrated compliance approach, aligning their capital expenditure documentation with their operational QRE tracking.1

II. Definitive Analysis of Qualifying Research and Development Equipment

A. Statutory Basis: IC 6-2.5-5-40 and the 100% Exemption

The Indiana Code grants a full 100 percent sales tax exemption for qualified research and development equipment and property purchased for use in Indiana.1 The statute, IC 6-2.5-5-40, defines the eligible property and sets forth the stringent conditions for its acquisition and use.

B. Defining “Research and Development Equipment”

Statutorily, “research and development equipment” is defined as tangible personal property acquired by the purchaser for the designated purpose of experimental or laboratory research.2 The property must consist of, or be a combination of, one or more of the following five categories, reflecting the essential tools of modern R&D 2:

1. Laboratory equipment.
2. Computers.
3. Computer software.
4. Telecommunications equipment.
5. Testing equipment.

C. The Critical Eligibility Conditions (Non-Negotiable Requirements)

Compliance with the sales tax exemption is highly dependent upon satisfying two fundamental criteria at the time of purchase, as defined by the Indiana Code.

1. The “New to Indiana” Requirement (IC 6-2.5-5-40(b)(2))

The equipment must not have been previously used in Indiana for any purpose whatsoever.2 This is arguably the most stringent and frequently audited aspect of the exemption. The rule is absolute: whether the prior use was by the taxpayer, an affiliated company, or an unrelated third party, if the property was previously employed within Indiana’s borders, the exemption is disallowed.7

This strict requirement places a significant audit burden on taxpayers, particularly large, multi-state enterprises. The law is focused on attracting and incentivizing the importation of new capital into the state, not merely subsidizing the use of existing, pre-owned assets. Therefore, any taxpayer attempting to claim the exemption on equipment relocated from an affiliated or liquidated entity within Indiana, or equipment that has been previously used for any non-R&D function in Indiana, will face denial. Maintaining meticulous documentation confirming the asset’s entire operational history outside Indiana, or proving it is newly manufactured and immediately imported, is essential to protect the claim.

2. Acquisition Purpose and Use Requirement

The property must be acquired by the purchaser for the purpose of research and development activities.7 This use must be devoted directly to experimental or laboratory R&D aimed at developing new products, new uses of existing products, or improving or testing existing products.2

If an item is initially acquired for a purpose unrelated to R&D—such as general inventory, resale, or standard manufacturing production—and is subsequently diverted to R&D use, the purchase does not qualify for the sales tax exemption because the initial acquisition purpose was taxable.7 This is a critical distinction, requiring the taxpayer to establish the intent of use at the time of purchase.

III. Indiana Department of Revenue (IDOR) Guidance on Qualifying Activities (Information Bulletin #75)

The operational interpretation of what constitutes qualifying research and development activities is further clarified by the Indiana Department of Revenue (IDOR) through Sales Tax Information Bulletin #75 (SIB #75).7

A. The Mandate for Experimental or Laboratory Research

To qualify, the activity must be considered essential and integral to experimental or laboratory research and development.7 SIB #75 explicitly defines “research and development activities” to include the design, refinement, and testing of prototypes of new or improved commercial products.7 Crucially, these activities must be conducted before commercial sales have begun and must aim to determine facts, theories, or principles, or to increase scientific knowledge that could lead to new or enhanced products.7

B. The “Direct Use” Requirement vs. Incidental Functions

The property must be used directly in the R&D activities. This means the equipment must have an immediate effect on the tangible personal property being researched or refined, analogous to the “direct use” standard applied to manufacturing exemptions.7

Examples of tangible personal property that may be exempt when directly used in R&D activities include office supplies, consumables, hand-powered tools, and necessary repair parts.7 However, items that support the research environment but are not integral to the experimental phase are specifically excluded.

C. Detailed Analysis of Excluded Activities and Non-Qualifying Functions

The IDOR guidance, combined with statutory exclusions, clearly delineates a list of functions that are not considered research and development. Equipment purchased primarily for these purposes will not qualify for the exemption 2:

1. Administrative and Managerial Functions: This includes accounting or similar administrative functions, management or supervisory functions, inventory control functions, personnel services, and training.7
2. Sales and Marketing Research: Activities such as consumer surveys, advertising or promotions, market and sales research, and product market testing by consumers are excluded.2
3. Routine Business Efficiency: Efficiency surveys, economic surveys, and management studies are not deemed R&D.2
4. Non-Technical Research: Research activities tied to literary, historical, social sciences, economics, humanities, or similar nontechnical projects are excluded.2
5. Quality Control: Testing performed solely for purposes of quality control is non-qualifying.2
6. Real Property and Overheads: The exemption does not cover capital improvements to real property, office furniture, furnishings, storage equipment, or general environmental controls (e.g., heating, cooling, or illumination of office buildings).7

The exclusion of Quality Control (QC) represents a particularly nuanced compliance challenge. Equipment utilized for routine, post-production QC testing is explicitly taxable.7 Conversely, the exact same piece of equipment used for experimental testing to eliminate technological uncertainty, refine a prototype, or discover a new technical capability is exempt.3 Taxpayers must institute rigorous time-tracking and documentation protocols to clearly differentiate between exempt pre-production R&D testing and non-exempt routine verification or post-commercialization activities. The equipment’s functional use must consistently align with the principles of the federal IRC §41 Four-Part Test to substantiate the sales tax exemption claim.

IV. Compliance and Procedures for Claiming the Exemption

Taxpayers claiming the R&D equipment exemption must follow established Indiana Department of Revenue procedures, choosing between obtaining the exemption at the point of sale or filing a subsequent claim for refund.1

A. Procedural Mechanisms for Exemption

1. Point-of-Sale Exemption: Using the ST-105

The preferred method is to secure the exemption at the time of purchase by presenting the vendor with a properly executed Indiana General Exemption Certificate (Form ST-105).11

To be valid, the certificate must be fully completed. This includes providing the purchaser’s Indiana Registered Retail Merchant’s Certificate TID and LOC Number, or if the purchaser is located out-of-state but registered to collect tax, their State Tax ID Number from another state.11 Vendors are required to keep this certificate on file to support the exempt sale.12

A critical compliance detail is that if the purchaser fails to provide all the required information, the vendor is mandated to charge the sales tax, and the purchaser must then file a claim for refund directly with the IDOR.11 Furthermore, the ST-105 certificate cannot be issued for the purchase of Utilities, Vehicles, Watercraft, Aircraft, or Gasoline.11

2. The Refund Process: Filing Form GA-110L

If sales tax was paid on an exempt R&D equipment purchase, the taxpayer retains the option to file a timely claim for refund with the IDOR using Form GA-110L.1

For high-value, complex, or custom equipment purchases—such as the creation of one-off prototypes or highly customized software—it can be a proactive risk management strategy to intentionally pay the sales tax upfront and immediately file the refund claim via Form GA-110L. This procedural choice effectively compels the taxpayer to compile the complete, robust, and audit-ready R&D nexus documentation prior to receiving the tax benefit. This preparation significantly mitigates the risk of a future audit failure and reduces exposure to potential penalties and interest compared to relying solely on a vendor-accepted ST-105, which typically involves minimal regulatory review at the point of transaction.11

B. Record-Keeping and Misuse Liability

The burden of proof rests entirely with the purchaser to demonstrate that the property met both the “new to Indiana” and the “direct use in R&D” criteria at the time of acquisition.7 Taxpayers must be cognizant that negligent or fraudulent misuse of the exemption certificate can subject both the individual signatory and the business entity to the imposition of tax, interest, and civil and/or criminal penalties.12

V. The R&D Equipment Exemption in Context with the Indiana Research Expense Income Tax Credit

The efficacy of the R&D equipment sales tax exemption is maximized when integrated into a comprehensive tax strategy that also utilizes the Indiana Research Expense Income Tax Credit (IC 6-3.1-4).

A. Overview of the Income Tax Credit

The Research Expense Credit is nonrefundable but permits unused credits to be carried forward for up to ten taxable years.5 It is designed to reduce Indiana state income tax liability based on qualified research expenses (QREs) incurred within the state.1 Qualified research expense is defined by reference to Section 41(b) of the Internal Revenue Code (IRC).1

The core linkage between the sales tax exemption and the income tax credit lies in the common definition of qualified research activity. If the research activity supported by the equipment fails the federal IRC §41 Four-Part Test (specifically lacking elimination of uncertainty or process of experimentation), the QREs claimed for the income tax credit are jeopardized.3 Correspondingly, the sales tax exemption claimed on the capital equipment used in that non-qualifying activity is also highly susceptible to disallowance. Compliance documentation must consistently prove both technological risk (for the credit) and direct use (for the exemption).

B. Calculation Methods for the Income Tax Credit

Indiana provides taxpayers with an annual election between two primary calculation methodologies to determine the value of the income tax credit: the Traditional Method and the Alternative Simplified Credit (ASC).3

C. Strategic Planning: Maximizing the Combined Benefit

The sales tax exemption acts as a key catalyst in a broader R&D incentive strategy. The immediate cash flow benefit derived from avoiding sales tax on a large capital purchase lowers the initial investment barrier.1 Successful utilization of this exemption often leads to the funding of new, high-tech research facilities, which necessarily requires the hiring of specialized personnel and the purchase of consumables. These operational costs, in turn, become Qualified Research Expenses (QREs) that feed the Research Expense Income Tax Credit.5

Tax directors should strategically view capital expenditure data related to the sales tax exemption as a leading indicator for future income tax credit growth. A substantial claim on R&D equipment signals a planned increase in research staff and activities. Ensuring the newly hired personnel are performing qualified research and that the associated expenses are rigorously tracked allows the company to maximize the income tax benefit derived from the initial, exempt capital investment.

VI. Practical Application: Detailed Case Study Example

This example demonstrates the calculation of the sales tax exemption alongside the income tax credit, highlighting critical compliance distinctions.

A. Scenario Setup: Quantum Dynamics, LLC

Quantum Dynamics is an Indiana-based manufacturing company specializing in new sensor technology. The company is embarking on a major R&D expansion and plans to purchase $1,200,000 in specialized equipment. The Indiana state sales tax rate is 7%.

Relevant Financial Data for the Tax Year:

• Current Year Indiana QREs: $1,500,000
• Prior 3-Year Average Indiana QREs: $800,000 (used for ASC calculation)

B. Step-by-Step Exemption Analysis for Equipment Purchases

The company analyzes four major assets intended for the expansion:

• Total Sales Tax Exemption Savings: $42,000 + $14,000 = $56,000.
• Total Sales Tax Liability (Use Tax Assessment Required): $7,000 + $21,000 = $28,000.

C. Quantification of Income Tax Credit (Using ASC)

Quantum Dynamics elects the Alternative Simplified Credit (ASC) method.

1. Determine Base Amount: 50% of the Prior 3-Year Average QREs.
   
   $$\text{Base Amount} = \$800,000 \times 50\% = \$400,000 \quad \text{[3, 13]}$$
2. Determine Excess QREs: Current QREs minus the Base Amount.
   
   $$\text{Excess QREs} = \$1,500,000 – \$400,000 = \$1,100,000$$
3. Calculate Income Tax Credit: 10% of the Excess QREs.
   
   $$\text{Income Tax Credit} = \$1,100,000 \times 10\% = \$110,000 \quad \text{[3, 13]}$$

D. Summary of Combined Tax Savings

The combined incentives provide a substantial reduction in both capital and operational costs for Quantum Dynamics, LLC.

Combined R&D Incentive Quantification for Quantum Dynamics, LLC

The purchases of the Inventory Control Robot and the Used Telecom Switch, despite representing only a fraction of the total expenditure, introduce significant compliance complexity and audit risk. If Quantum Dynamics had improperly claimed the full $1.2 million purchase as exempt, the resulting audit would focus heavily on these non-qualifying assets, exposing the company to liability for the $28,000 in sales tax, plus penalties and interest. This illustrates that rigorous upfront screening against the IDOR’s strict exclusion list and the “new to Indiana” rule is crucial to ensure the security of the entire incentive claim.

Conclusion: Ensuring Rigorous Compliance and Maximizing Innovation Investment

The Indiana R&D Equipment Sales Tax Exemption is a substantial 100 percent capital expenditure subsidy vital to the state’s strategy of fostering economic growth through innovation. It operates as a distinct yet complementary incentive to the Research Expense Income Tax Credit, reducing the fixed costs of establishing or expanding research facilities while the income credit addresses ongoing operational expenses.

To successfully utilize this exemption, taxpayers must maintain strict compliance with two core, auditable requirements: First, the equipment must be demonstrably new to Indiana, possessing no prior use history within the state’s borders.2 Second, the equipment must be used directly in experimental or laboratory research, strictly excluding a defined list of ancillary or administrative functions, such as quality control, marketing, management, and inventory tracking, as detailed in IDOR guidance.2

Strategic planning requires the synchronization of capital investments with operational spending forecasts. By securing the upfront cash flow benefit of the sales tax exemption, taxpayers often drive increased QREs (wages and supplies) for the subsequent income tax credit claim. This integrated approach, paired with the proactive use of refund claims (Form GA-110L) for high-risk purchases, provides the necessary audit defensibility to maximize the total combined incentive value and securely leverage Indiana’s robust research ecosystem.

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/