Expert Tax Memorandum: The Indiana Research and Development Property Sales Tax Exemption (IC 6-2.5-5-40) and Its Context with the R&D Income Tax Credit

I. Executive Summary: The Dual Incentives for Research and Development in Indiana

The Research and Development Property Sales Tax Exemption is a 100 percent exclusion from Indiana sales and use tax for qualified equipment and property purchased for direct use in experimental activities within the state.1 This benefit applies specifically to tangible personal property acquired solely for direct and integral involvement in laboratory research and development (R&D) activities, complementing the state’s R&D income tax credit structure.1

1.1. Strategic Context: Indiana’s Innovation Investment Framework

The State of Indiana employs a critical dual incentive mechanism designed to encourage significant investments in innovation. This framework consists of two separate, yet complementary, statutory provisions: the Research Expense Income Tax Credit (governed by IC 6-3.1-4) and the Research and Development Property Sales Tax Exemption (governed by IC 6-2.5-5-40).1

The Income Tax Credit targets operational expenditures, known as Qualified Research Expenses (QREs), which are defined by Section 41(b) of the Internal Revenue Code (IRC) and generally include wages, supplies, and contract research costs incurred in Indiana.1 In contrast, the Sales Tax Exemption specifically targets capital investment, providing a total exemption from the state’s gross retail and use tax liability for the acquisition of qualified R&D equipment and property.1

A fundamental distinction in compliance strategy arises from this dual structure. Taxpayers cannot assume that eligibility for the federal R&D tax credit (IRC §41) or Indiana’s state income tax credit (IC 6-3.1-4) automatically confers eligibility for the sales tax exemption. The sales tax benefit is governed by strict, separate state-level “direct use” standards articulated by the Indiana Department of Revenue (DOR) through administrative guidance, primarily Sales Tax Information Bulletin (SIB) 75.2 This requires that every asset purchase intended for R&D must undergo an independent, rigorous analysis against state-specific criteria for “direct use” and “no prior use in Indiana.” The primary challenge for corporate tax departments lies in the DOR’s rigorous interpretation of “direct use,” which necessitates stringent documentation proving that the asset is essential and integral to experimental research, distinguishing it from general support or administrative property.2

1.2. Summary of Key Findings and Recommendations

The legal and administrative interpretation by the DOR, particularly regarding the concept of “direct use,” dictates that property must be tangibly and functionally integrated into the research activity itself, leading to a strict delineation between exempt laboratory property and taxable incidental property (such as generic office equipment or general storage units).2 To successfully claim and defend this exemption under audit scrutiny, taxpayers must satisfy two concurrent, high-threshold requirements: first, proving the property has had “no prior use in Indiana” 2, and second, demonstrating that the property is “essential and integral” to the research process itself.3

II. Statutory Foundation and Contextual Linkage

2.1. Legislative Mandate: The R&D Property Sales Tax Exemption (IC 6-2.5-5-40)

The authority for the sales tax exemption is established under Indiana Code § 6-2.5-5-40. This statute provides for a 100 percent sales tax exemption for qualified research and development equipment and property purchased for use within Indiana.1 The legislative intent behind this provision is clear: to remove the state sales and use tax burden on the acquisition of capital assets that are critical to fostering experimental innovation and product improvement within the state. This immediate reduction in the cost basis of qualifying capital expenditures is designed to encourage corporate investment in new R&D facilities and technologies.

The mechanics of this exemption mean that, upon a qualifying purchase, the taxpayer can either purchase the item without paying sales tax by issuing an exemption certificate (Form ST-105) 1, or, if sales tax is paid at the time of the transaction, the purchaser retains the right to file a timely claim for a full refund of the sales tax paid.1

2.2. The Companion Incentive: The Research Expense Income Tax Credit (IC 6-3.1-4)

The state’s other primary R&D incentive is the Research Expense Income Tax Credit, established under IC 6-3.1-4.1 This credit offers a benefit against a taxpayer’s Indiana state income tax liability based on qualified research expenses (QREs) incurred within Indiana.5

The credit is calculated based on the excess of current-year QREs over a defined base period amount. Specifically, the potential value of the credit is equal to the taxpayer’s qualified research expense for the taxable year, minus the base period amount up to $1 million, multiplied by 15 percent.1 For any excess of Indiana QREs over the base period amount that exceeds $1 million, a reduced credit percentage of up to 10 percent is applied.1 An alternative calculation method may also be utilized.1

The interplay between these two statutes highlights a significant financial dynamic. While the income tax credit provides a benefit that offsets net liability and is realized only after the percentage-based calculation, the sales tax exemption serves as a direct capital cost reducer, immediately decreasing the upfront expense of the asset.8 Therefore, the immediate financial impact of properly utilizing the sales tax exemption can often be more substantial for current cash flow and capital budgeting than the delayed and formulaic income tax credit. Compliance with the exemption is thus critical not only for tax savings but also for optimized cash flow management during periods of high capital expenditure.

Table 1: Indiana R&D Tax Incentives: Sales Tax Exemption vs. Income Tax Credit

III. Definitional Prerequisites for Qualified R&D Property (The Threshold Test)

3.1. Defining “Research and Development Property”

To qualify for the 100% sales tax exemption, the purchased item must meet the stringent definition of “Research and development property.” This is defined as tangible personal property, which often includes depreciable assets such as specialized laboratory equipment.8 The definition is predicated upon two primary requirements that must be satisfied simultaneously at the time of purchase:

The “No Prior Use in Indiana” Restriction

The property must not have been previously used in Indiana for any purpose whatsoever before its acquisition by the purchaser for R&D activities.2 This provision is strictly interpreted by the DOR to prevent the retroactive exemption of existing assets. The regulatory environment enforces a clean, auditable line of intent at the time of purchase.

If an item is originally acquired for an unrelated purpose—such as inventory held for resale, or manufacturing machinery used in general production—and is subsequently repurposed for R&D activities, the use of that item in the R&D context remains taxable.2 This restriction effectively denies the exemption for any assets that a company attempts to repurpose from existing manufacturing operations or general corporate functions into a new R&D role. The regulation ensures that the exemption incentivizes new capital investment dedicated explicitly to experimental research from the outset.

3.2. Defining “Research and Development Activities”

The second fundamental requirement is that the property must be acquired by the purchaser for the specific purpose of research and development activities devoted to experimental or laboratory research.4 These activities must be focused on three specific outcomes: the development of new products, finding new uses for existing products, or improving or testing existing products.4

“Research and development activities” include the design, refinement, and testing of prototypes of new or improved commercial products. Crucially, this work must be conducted before sales have commenced, with the purpose of determining facts, theories, or principles, or for the purpose of increasing scientific knowledge that may lead to new or enhanced products.2

IV. The “Direct Use” Test: Indiana Department of Revenue Guidance (SIB 75)

The most complex and heavily audited aspect of this exemption is the application of the “direct use” standard, primarily detailed in Sales Tax Information Bulletin (SIB) 75.2

4.1. The “Essential and Integral” Standard: Legal Precedent and Interpretation

The statute requires that to qualify for the exemption, the property must be used directly in R&D activities.2 The DOR interprets this “direct use” requirement by drawing upon standards historically applied to the manufacturing exemption (IC 6-2.5-5-3 and 45 IAC 2.2-5-10). To qualify, the property must be devoted to a research and development activity that is considered essential and integral to the experimental or laboratory process.2

An asset is considered “essential and integral” if it has an immediate effect on the tangible personal property being researched or processed, or if it constitutes a necessary part of an integrated process that generates the experimental data or knowledge.9 An administrative decision confirmed this standard, noting that sales tax refunds were granted for purchases of “specialized equipment essential and integral” to a company’s research, while denying refunds for generic, non-essential items.3

4.2. The Mandatory Exclusionary List: Activities Not Considered R&D

SIB 75 is the authoritative administrative document that explicitly details activities that are not considered qualifying R&D, thereby rendering property purchased for these functions taxable, even if those functions occur within a dedicated R&D facility.2

Specific activities that will not qualify for the exemption include:

• Administrative and Support Functions: Heating, cooling, or illumination of office buildings; janitorial services; personnel services or accommodations; inventory control functions; management or supervisory functions; accounting or similar administrative functions.2
• Non-Experimental Research: Efficiency surveys, management studies, consumer surveys, economic surveys, advertising or promotions, and research in connection with literary, historical, or similar projects.2
• Excluded Commercial Functions: Marketing and sales research, the providing of sales services, or the acquisition or evaluation of another’s patent or product for investment purposes.2

A critical area of exclusion is the segregation of routine commercial activities from pure experimental work. The DOR specifically excludes “testing for purposes of quality control” (QC) and product market testing (including product testing by consumers).2 This exclusion is highly significant because it limits the exemption to the pure exploratory and experimental phases of product development. If R&D property is used in a hybrid capacity—for both exempt experimental testing and routine, post-production QC—the taxpayer must accurately document the apportionment of use. Failure to clearly delineate and document the percentage of exempt use, or demonstrating a failure to functionally separate the experimental activity from routine QC, risks losing the entire exemption for that specific asset. This regulatory strictness underscores the intent to limit the benefit solely to activities that advance scientific knowledge or develop new applications, rather than routine business maintenance.

4.3. Delineating Direct Use vs. Incidental Use

The theme across all DOR rulings is functional proximity to the experiment. If the property touches the experimental subject, generates experimental data, or critically processes that experimental data, it is typically deemed directly used and thus exempt. If the property supports the personnel or the general environment of the facility, it is considered incidental and taxable.

Exempt Examples: Items that may be exempt include office supplies, specialized consumables (e.g., chemical reagents or specialized raw materials), hand-powered tools, and repair parts, but only when these items are used directly in the R&D activities.2

Taxable Examples: Items that are consistently deemed taxable because they are not used directly in R&D include office furniture, furnishings, general storage equipment, and other items necessary for the business but incidental to the actual experiment.2 This distinction was affirmed in an administrative decision where the DOR explicitly denied refunds for the purchase of generic office furniture, household extension cords, and routine office supplies, emphasizing the contrast with specialized, essential, and integral equipment.3

Table 2: Indiana DOR Guidance on R&D Property: Direct Use Criteria

V. Compliance and Administrative Procedures

Compliance involves specific documentation and procedural requirements, depending on whether the exemption is claimed at the point of sale or via a post-purchase refund.

5.1. Claiming the Exemption at the Time of Purchase (Form ST-105)

The most efficient and preferred method for utilizing the sales tax exemption is for the purchaser to complete and provide the seller with Form ST-105, the Indiana Sales and Use Tax Exemption Certificate, at the time of the retail transaction.1

The purchaser must ensure the following details are accurately completed on Form ST-105 10:

1. Enter the seller’s name and address.
2. Indicate whether the certificate covers a single purchase or serves as a blanket exemption for ongoing qualifying purchases.
3. Provide a clear description of the product being purchased.
4. Check the relevant box indicating the reason for the exemption (R&D Property Exemption).
5. Provide the purchaser’s signature, date, printed name, and title. The Indiana Taxpayer Identification Number (TID) must also be accurately provided.10

5.2. Mechanism for Refund of Sales Tax Paid (Form GA-110L)

If the purchaser inadvertently or necessarily pays Indiana sales or use tax on the purchase of exempt R&D property, the law allows the purchaser to file a timely claim for a refund.1 This refund claim must be submitted to the DOR using Form GA-110L (Claim for Refund).2 Taxpayers who have questions concerning the application of the exemption or the refund process are advised to contact the Tax Policy Division of the Indiana Department of Revenue for guidance.2

5.3. Required Recordkeeping for Audit Defense

A business claiming the exemption is statutorily required to maintain records adequate to substantiate the purchase price of the products and, most critically, to document that the property was used exclusively in qualified research.1

Effective audit defense hinges on establishing a complete and defensible link between financial records and scientific or engineering documentation. The records must be sufficient to substantiate:

1. Original Intent and Status: Proof of purchase date and location, verifying the “no prior use in Indiana” status of the asset.
2. Exemption Mechanism: The issuance of Form ST-105 or the filing of Form GA-110L.
3. Direct Use: Equipment utilization logs, project initiation documents, lab notebooks, or engineering specifications that demonstrate the asset’s “essential and integral” involvement in the specific experimental R&D activity.

The ability of an auditor to trace an item from the moment of purchase directly into the exempt R&D activity, substantiating the “direct use” standard throughout its service life, is paramount to sustaining the exemption.

Table 3: Procedures for Claiming the R&D Property Sales Tax Exemption

VI. Case Study and Practical Application Example

6.1. Scenario: Advanced Materials Testing Center, Inc.

Advanced Materials Testing Center, Inc. (AMTC) establishes a new laboratory in Indianapolis dedicated to materials science research, specifically focused on improving concrete tensile strength using novel additives. AMTC purchases a range of new equipment for this facility.

6.2. Analysis of Expenditures Against Qualification Criteria

The following expenditures are analyzed against Indiana’s R&D Property Sales Tax Exemption requirements:

A. New, High-Compression Fatigue Testing Machine

AMTC purchases a specialized hydraulic machine designed exclusively to apply extreme pressure cycles to test newly formulated concrete prototypes until failure. This machine has never been used previously in Indiana.

• Analysis: This machine meets the “no prior use” criterion.4 Its function is to generate critical experimental data (fatigue limits) on new product formulations, making it an essential and integral part of the experimental process required for new product development.2
• Result: Exempt. AMTC should issue Form ST-105 to the vendor at the time of purchase.

B. Consumables (Chemical Catalysts and Sensors)

AMTC purchases bulk quantities of proprietary chemical catalysts that are mixed into the concrete batches, along with disposable, specialized strain sensors embedded in the test blocks.

• Analysis: Both the catalysts and the sensors are tangible personal property consumed directly within the experimental process and are necessary for the testing and data collection phases of the R&D activity.2 They are used directly to facilitate the experimentation.
• Result: Exempt.

C. Managerial Office Workstations and Document Storage Cabinets

AMTC purchases standard desks, chairs, and locked storage cabinets for the R&D Director’s office and for the administrative assistant responsible for scheduling and budget tracking.

• Analysis: These items are used for supervisory and general administrative functions, which are explicitly excluded as incidental and not direct R&D activities under SIB 75.2 The property does not have an immediate or essential effect on the tangible personal property (concrete) being researched. The DOR has specifically ruled that generic office furniture and storage are taxable.3
• Result: Taxable. Sales tax must be paid.

D. Dedicated High-Performance Computing Cluster (HPC)

AMTC purchases a server cluster used exclusively by R&D staff to run complex Finite Element Modeling (FEM) simulations of material stresses. These simulations are a necessary substitute for lengthy physical testing and are used to refine and narrow down potential prototype formulas before expensive, large-scale lab runs.

• Analysis: Although the HPC cluster is physically separated from the actual concrete mixing area, its function is the essential and integral creation and analysis of experimental data that drives the research outcome. In modern engineering disciplines, computational modeling that substitutes for or directs physical experimentation is generally treated as functionally equivalent to laboratory activity. To defend this exemption, AMTC must establish clear documentation proving that the cluster is used exclusively for modeling related to experimental design and validation, and is functionally separated from general business computing operations.
• Result: Highly Defensible Exempt, provided usage logs and project documents substantiate its essential and integral role in the experimental process.

VII. Conclusion and Strategic Recommendations

The Indiana R&D Property Sales Tax Exemption provides a highly valuable, immediate tax benefit for companies engaging in qualified research. However, its benefit is contingent upon strict adherence to administrative guidance that imposes a much narrower focus on “direct use” than the criteria applied for the companion income tax credit.

7.1. Key Compliance Pitfalls to Avoid

The most common causes for denial upon DOR audit stem from two core areas:

1. Failure to Prove “Virgin” Status: Taxpayers must meticulously track the procurement and installation of exempt assets to demonstrate that they had “no prior use in Indiana.” The repurposing of existing equipment, even if fully dedicated to a new R&D project, constitutes a taxable use upon its entry into the research activity.
2. Commingling Activities: The inclusion of property used for excluded functions, such as routine quality control (QC), management, or marketing research, jeopardizes the exemption.2 If an asset is used for both exempt R&D and taxable QC, the taxpayer must be prepared to prove apportionment based on documented usage; otherwise, the entire purchase price may be deemed taxable.

7.2. Recommendations for Integrated Tax Planning

To maximize the utilization and defensibility of the R&D Property Sales Tax Exemption, corporate tax and R&D departments must implement coordinated strategies:

1. Establish Detailed Internal Protocols: Create standard operating procedures that mandate the linking of all capital expenditure requests for R&D purposes to specific, documented experimental projects. This allows for immediate verification of the asset’s role as “essential and integral” at the time of purchase.
2. Mandate ST-105 Utilization: Ensure that the issuance of Form ST-105 is the default and mandatory procedure for all qualifying purchases. Relying on the subsequent refund process (Form GA-110L) is administratively burdensome and can draw greater audit scrutiny.2
3. Cross-Functional Documentation: Tax teams must collaborate directly with R&D engineers and scientists to ensure that technical documentation (such as laboratory utilization logs and project definitions) clearly supports the financial claim. This documentation must explicitly differentiate between exempt experimental activities and non-exempt support functions, demonstrating the functional proximity required by the DOR’s direct use standard.
4. Track Asset Life Cycle: Maintain rigorous records to track the functional deployment of exempt assets. If an asset is later repurposed from experimental R&D to routine production or quality control, the taxpayer may incur subsequent use tax obligations, requiring proactive planning to manage this transition.

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