Expert Report on the Indiana Research and Development Sales Tax Exemption: Legal Structure, DOR Guidance, and Strategic Context

I. Executive Summary: Bridging Innovation and State Tax Compliance

1.1 The R&D Sales Tax Exemption: Simple Meaning

The Indiana Research and Development Sales Tax Exemption provides a 100 percent sales and use tax exemption for qualified research equipment and tangible personal property purchased for use directly in experimental or laboratory R&D activities within the state.1 This state incentive allows businesses to acquire necessary scientific equipment tax-free at the time of purchase or, if the tax was paid, to subsequently reclaim the paid tax via a refund claim.3

1.2 The Dual Incentive System: Strategic Utilization

Indiana employs a comprehensive, dual R&D incentive structure designed to stimulate technological advancement across different phases of business investment.4 This structure comprises the Sales Tax Exemption (governed by IC 6-2.5-5-40), which focuses on capital asset acquisition, and the Research Expense Income Tax Credit (governed by IC 6-3.1-4), which targets operational expenditures.5

These two regimes are governed by separate statutory criteria, meaning qualification for the sales tax exemption does not guarantee qualification for the income tax credit, and vice versa.1 This separation necessitates a highly strategic approach to compliance, requiring precise segregation of capital expenditures from operational costs for tax optimization.

The state’s policy structure demonstrates a coordinated legislative objective to foster economic growth by promoting two distinct drivers: net new capital formation and the employment of specialized R&D talent. The Sales Tax Exemption’s requirement that qualified equipment must be new and not previously used in Indiana 7 directly incentivizes new infrastructure investment and the modernization of research facilities. Conversely, the Income Tax Credit, tied to federal Qualified Research Expenses (QREs), heavily favors labor costs (wages) and contract research.8 This combined approach ensures that the state rewards both the purchase of advanced facilities and the employment of the personnel required to drive innovation.

1.3 Key Compliance Takeaways

Businesses claiming the Sales Tax Exemption must be rigorously vigilant regarding two core requirements: first, the property must demonstrate “no prior use in Indiana,” which impacts internal asset transfers and pre-installation handling 6; and second, the “direct use” requirement, which mandates strict functional segregation of R&D activities from administrative, quality control, or production-related uses.6

II. The Indiana R&D Sales Tax Exemption: Legal Framework (IC 6-2.5-5-40)

2.1 Detailed Analysis: Statutory Purpose and Strict Construction

The statutory authority for the exemption is Indiana Code (IC) § 6-2.5-5-40. The legislation aims to lower the initial cost barrier for businesses investing in cutting-edge research infrastructure. However, as with all Indiana tax exemptions, the provision is subject to a doctrine of strict construction, requiring taxpayers to present sufficient evidence that their claims fall “clearly within the exact letter of the law”.10 This principle places a high burden on the taxpayer, demanding meticulous documentation and adherence to explicit statutory definitions.

2.2 Statutory Definition of Exempt Property: The Three Prerequisites

The tangible personal property qualifying for the exemption, defined as “research and development property” or “research and development equipment,” must meet three concurrent prerequisites 6:

2.2.1 Constituent Property Type

The property must specifically consist of, or be a combination of: laboratory equipment, computers, computer software, telecommunications equipment, or testing equipment.7 The statutory inclusion of computer software recognizes the modern shift toward digital R&D methodologies. However, this inclusion is typically interpreted to apply to highly specialized, purpose-built software used in modeling, analysis, or design refinement, rather than general enterprise resource planning (ERP) or administrative software, which would likely fail subsequent use tests.

2.2.2 The “No Prior Use in Indiana” Constraint

This is arguably the most critical and limiting requirement. The property must not have previously been used in Indiana for any purpose.6

This rule is strictly focused on encouraging the acquisition of net new capital investment within Indiana. If a piece of equipment was originally purchased for manufacturing, inventory storage, or any other non-R&D function within the state, its subsequent conversion to R&D use makes the original purchase taxable.6 Furthermore, the rigidity of this clause affects corporate financial planning related to asset movement. If a company with R&D operations in multiple states decides to relocate specialized equipment from a facility outside Indiana (e.g., Illinois or Ohio) to an expanding lab in Indiana, the exemption can be utilized because the equipment was not previously used in Indiana. However, if that same equipment were briefly stored in an Indiana logistics center or used temporarily for an unrelated internal demonstration before installation in the lab, that prior non-R&D use in Indiana could be cited by the Department of Revenue (DOR) as grounds for disallowance. This risk mandates rigorous logistics and utilization documentation from the moment of asset acquisition.

2.2.3 Specific Purpose of Acquisition

The property must be acquired by the purchaser explicitly for R&D activities devoted to experimental or laboratory research directed toward: (A) new products; (B) new uses of existing products; or (C) improving or testing existing products.7

2.3 Statutory Definition of Qualified Activities (IC 6-2.5-5-40(a))

Qualified research activities are statutorily defined primarily as pre-commercialization efforts 7:

• Scope: Activities include the design, refinement, and testing of prototypes of new or improved commercial products conducted before sales have begun.
• Objective: The activity must aim to determine facts, theories, or principles, or to increase scientific knowledge that may lead to new or enhanced products.

2.4 The Direct Use Requirement: Essential and Integral to Laboratory Research

Indiana Department of Revenue (DOR) guidance, particularly Sales Tax Information Bulletin 75 (SIB 75), further clarifies that the property must be used directly in the R&D activity and be considered essential and integral to the experimental or laboratory research.6

Items that may be exempt when directly used include office supplies, consumables, hand-powered tools, and repair parts, provided their functional use is strictly segregated and essential to the experimental purpose.1 Conversely, items purchased for functions deemed incidental to research, such as management services, janitorial work, or general heating/illumination of office buildings, do not qualify for the exemption.6

III. Navigating Exclusions and Administrative Interpretation

3.1 Activities Explicitly Excluded by Statute (IC 6-2.5-5-40(a))

The statute provides a comprehensive list of activities for which property purchases are explicitly taxable, emphasizing that the exemption is restricted to purely experimental and laboratory research 6:

1. Surveys and Studies: Efficiency surveys, management studies, consumer surveys, and economic surveys.
2. Marketing and Sales: Advertising or promotions, market and sales research, and product market testing (including consumer surveys).
3. Non-Technical Research: Research in connection with literary, historical, social sciences, economics, humanities, psychology, or similar non-technical projects.
4. Testing for Quality Control (QC): Testing conducted specifically for purposes of quality control.
5. Investment Evaluation: The acquisition, investigation, or evaluation of another’s patent, model, process, or product for the purpose of assessing potential investment value. This exclusion limits the exemption’s applicability for companies specializing in technology licensing or acquisition, ensuring the state subsidizes internal innovation efforts that align with broad economic knowledge creation.4
6. Services: The providing of sales services or any other service, whether technical or nontechnical in nature.

3.2 Incidental Functions Deemed Taxable by SIB 75

DOR SIB 75 reinforces the “direct use” requirement by listing functions considered incidental to experimental or laboratory research, thereby rendering property purchased for these purposes taxable 6:

• Heating, cooling, or illumination of office buildings.
• Capital improvements to real property.
• Janitorial services.
• Personnel services or accommodations.
• Inventory control functions.
• Management or supervisory functions.
• Marketing or training.
• Accounting or similar administrative functions.

3.3 The Quality Control vs. Research Dichotomy and the Use of Exclusive Dedication

The statute creates a significant area of compliance risk by exempting testing equipment 7 while simultaneously excluding quality control testing.6 This distinction demands a complete functional separation.

If a piece of sophisticated equipment, such as a specialized material analyzer, is used both for checking the quality of commercial production lots (QC) and for iteratively testing new prototype designs (R&D), the exemption claim is highly vulnerable. DOR guidance does not recognize a “predominant use” exemption provision for general research and development property.10 This signifies that auditors will look for evidence of exclusive or near-exclusive use for qualifying experimental R&D activities. Any failure to demonstrate clear segregation and dedication of the property solely to exempt R&D functions, particularly given the state’s standard of strict construction, means that the entire purchase may be deemed taxable. This rigorous standard contrasts with many other state exemptions, such as those for manufacturing equipment, where a simple threshold of 51% productive use often suffices.

The following table summarizes the administrative and statutory distinction points:

Table Title

IV. Indiana Department of Revenue (DOR) Compliance Procedures

4.1 Exemption at the Time of Purchase: Form ST-105

Taxpayers seeking to realize the exemption benefit immediately, thereby improving cash flow, must furnish the seller with a completed Form ST-105, the Indiana General Sales Tax Exemption Certificate, at the time of the retail transaction.1

The ST-105 requires the purchaser to accurately complete all sections, specifying the nature of the exemption. The exemption for R&D property falls under the “Other” category on the form.13 A purchaser unable to provide all required information must pay the sales tax at the point of sale and pursue a refund later.13

4.2 Post-Transaction Recovery: Filing a Claim for Refund (Form GA-110L)

If sales or use tax was paid on qualified R&D property—either inadvertently or due to administrative necessity (such as an out-of-state vendor not accepting the ST-105)—the purchaser may file a claim for refund.1 This claim must be filed using Form GA-110L, the general claim for refund form.6

Filing a refund claim using GA-110L is generally an administratively heavier process than utilizing Form ST-105 proactively. Refund claims are often directed to the Tax Policy Division 6 for comprehensive review, ensuring that expensive R&D purchases meet the high statutory bar for exemption. Utilizing the ST-105 exemption certificate, when possible, is the preferred strategy as it prevents the taxpayer from effectively providing an interest-free loan to the state and eliminates the subsequent administrative delay inherent in the refund process.3

4.3 Documentation and Recordkeeping Requirements

Indiana law requires businesses claiming the exemption to maintain records adequate to substantiate the purchase price and the eligibility of the products used in qualified research.1 Auditable records must clearly demonstrate:

1. The property’s lack of previous use in Indiana.
2. The direct, essential, and integral use of the property in experimental or laboratory R&D.
3. Strict functional segregation of qualifying R&D use from non-qualifying administrative, quality control, or production activities.1

V. The Contextual Relationship: Sales Tax Exemption vs. R&D Income Tax Credit

Indiana’s strategic incentivization of innovation relies on two non-identical, but complementary, tax benefits. It is crucial for taxpayers to understand where the criteria for the Sales Tax Exemption (IC 6-2.5-5-40) and the Research Expense Income Tax Credit (IC 6-3.1-4) overlap and where they diverge.1

5.1 Key Strategic Difference: Capital Assets vs. Operational Expenses

The fundamental distinction lies in the target of the subsidy. The Sales Tax Exemption provides relief on the cost of purchasing capital assets (depreciable equipment and software).6 In contrast, the Income Tax Credit is based on operational costs required to conduct the research, specifically focusing on labor and supplies.1

5.2 The Income Tax Credit Mechanism (IC 6-3.1-4)

The state income tax credit calculation is directly linked to the federal R&D tax credit framework outlined in Section 41 of the Internal Revenue Code (IRC §41), utilizing federal definitions of Qualified Research Expenses (QREs) as modified for state application.14 The credit provides a tiered incentive: 15% on the first $1 million of incremental QREs over a statutorily defined base amount, and 10% on the excess QREs above $1 million.5 Taxpayers may carry forward unused credit amounts for up to 10 years.5

Federal QREs (IRC §41(b)) include 8:

• Wages paid for qualified research services (including direct supervision or direct support).
• Costs of supplies used in the conduct of qualified research.
• 65% of contract research expenses.

For Indiana purposes, QREs are specifically modified to include only expenses for qualified research conducted within Indiana.1 The cumulative impact of this incentive is substantial, with total state R&D tax credit claims reaching $31 million in 2022, demonstrating strong utilization of the operational expense component of the incentive structure.15

5.3 The Critical Discrepancy: Capital Assets are Mutually Exclusive

The rules for the two incentives are intentionally non-identical, particularly concerning the treatment of capital expenditures.1 The primary reason for this necessary difference stems from the federal definition of QREs:

• Income Tax Credit Exclusion: IRC §41(b)(2)(C) defines “supplies” eligible for the income tax credit as tangible property other than land or improvements to land, and, crucially, other than property of a character subject to the allowance for depreciation.8
• Sales Tax Exemption Focus: The Sales Tax Exemption applies precisely to the purchase of equipment that is depreciable tangible property.7

This structural difference means that the costs associated with purchasing capital equipment (the subject of the Sales Tax Exemption) are explicitly excluded from the QRE base used to calculate the Income Tax Credit. This design effectively ensures that the Sales Tax Exemption fills a structural gap left by federal law, providing a crucial subsidy for expensive upfront R&D infrastructure costs that cannot be capitalized within the QRE base.

The only major expense category that potentially qualifies for benefits under both regimes is consumable supplies (e.g., chemicals, raw materials consumed or destroyed during experimental testing). These are eligible supplies under IRC §41(b) and also qualify as R&D property used directly under IC 6-2.5-5-40.1

The rules’ non-identical nature also means that certain R&D activities that might meet the federal four-part test for qualified research and generate QREs for the income tax credit could still be ineligible for the sales tax exemption due to specific state exclusions. For instance, equipment purchased for internal-use software development or specialized engineering efforts, even if generating QREs, may not qualify for the sales tax exemption if the use is deemed incidental or not exclusively experimental in nature.

Table Title

VI. Practical Application and Case Study

6.1 Scenario Overview: Precision Automation Solutions (PAS)

Precision Automation Solutions (PAS), an Indianapolis-based firm, is expanding its testing capabilities to develop new robotics control software. The company requires new testing infrastructure for two projects: refining a new commercial product prototype and enhancing internal quality control procedures. The Indiana state sales tax rate is 7%.

6.2 Example 1: Exempt Purchase—Specialized Robotics Testing Rig

PAS purchases a specialized robotic testing rig ($200,000) from a Michigan supplier. This rig is custom-built and has never been used previously in Indiana. It is installed in the R&D laboratory and is dedicated 100% to running experimental stress tests and simulations for a new, unreleased commercial product prototype. The activity includes the design, refinement, and testing of the prototype before sales have begun.7

• Eligibility Analysis:

• Property Type: Testing equipment/laboratory equipment (Meets IC 6-2.5-5-40(b)(1)).7
• Prior Use: Never previously used in Indiana for any purpose (Meets “no prior use” constraint).6
• Activity: Devoted entirely to experimental testing of a new product prototype (Qualifies as R&D activity).7
• Direct Use: Essential and integral to the experimental phase (Meets SIB 75 requirement).6

• Result: Fully Exempt. PAS should provide Form ST-105 to the vendor at the time of purchase.

• Tax Saved: $\$200,000 \times 0.07 = \$14,000$

6.3 Example 2: Taxable Purchase—Combined QC and R&D Data Storage

PAS purchases a high-capacity data acquisition system ($80,000) for the R&D center. This system is used 70% for collecting data during the refinement of the new prototype (R&D activity) and 30% for routine quality control testing of existing commercial automation products before shipment (Excluded activity).7 The use is functionally commingled and not fully segregated.

• Eligibility Analysis:

• Property Type: Computers/Testing equipment (Meets statutory definition).7
• Prior Use: New in Indiana (Passes prior use test).6
• Activity Test (Direct Use): Fails. Although 70% of the use supports R&D, 30% supports quality control, an activity explicitly excluded by IC 6-2.5-5-40(a)(7).6 Given the strict construction applied to exemptions and the lack of a “predominant use” rule, the property is not used directly and exclusively for the essential, integral R&D function.

• Result: Fully Taxable. The use of the property is not dedicated solely to qualifying experimental activity. PAS must pay the sales tax and cannot claim a refund on the $80,000 purchase.

• Tax Paid: $\$80,000 \times 0.07 = \$5,600$

VII. Conclusion and Strategic Recommendations

The Indiana R&D Sales Tax Exemption is an essential financial tool for companies focused on technological advancement, directly subsidizing the acquisition of new capital infrastructure. However, the rigor of its statutory requirements demands comprehensive due diligence and robust internal control systems.

7.1 Nuanced Conclusions on Legislative Intent

Indiana’s incentive system reflects a sophisticated industrial policy designed to target both capital investment (via the Sales Tax Exemption) and human capital development (via the Income Tax Credit). By strictly defining qualifying assets as property not previously used in Indiana, the exemption directly promotes net new capital formation within the state. Furthermore, the explicit exclusion of activities such as investment evaluation and advertising ensures that the state’s financial support is channeled solely into genuine, experimental, in-house efforts that generate transferable knowledge for the broader economy.4

7.2 Strategic Compliance and Actionable Recommendations

Taxpayers must adopt a multi-faceted compliance strategy that specifically addresses the functional requirements of the Sales Tax Exemption:

1. Pre-Purchase Vetting and Certification: A proactive tax review must be performed prior to any purchase order for R&D equipment, confirming the asset’s “new in Indiana” status and its 100% dedicated, intended use for qualifying experimental or laboratory R&D.6 Utilization of Form ST-105 at the point of sale is the recommended approach for immediate cash flow benefit.1
2. Physical and Functional Segregation: Because the state does not recognize a “predominant use” doctrine for R&D property, any equipment claimed exempt must be functionally segregated and dedicated solely to exempt R&D activities. Auditors require explicit documentation demonstrating that the asset is not involved in excluded activities, particularly quality control, general administration, or production processes.6
3. Unified Record Management: Although the two primary incentives (Sales Tax Exemption and Income Tax Credit) target mutually exclusive expenditure categories (capital equipment vs. operational QREs), the underlying research projects must be consistently documented. Comprehensive records are necessary to substantiate both the exempt capital asset purchases and the calculation of QREs for the income tax credit, ensuring a coherent and defensible overall tax position.

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