Geographic Nexus and the Consumption of Supplies: A Comprehensive Analysis of the Maryland Research and Development Tax Credit

The location where supplies are consumed refers to the specific physical site where materials, reagents, or prototypes are used up, worn out, or transformed during the qualified research process within the borders of Maryland. For the purposes of the Maryland Research and Development (R&D) tax credit, this geographic requirement ensures that the fiscal benefit is strictly tied to innovation activities physically occurring within the state, irrespective of where the supplies were originally procured or where the parent company is headquartered.

The Maryland Research and Development Tax Credit program, governed primarily by Tax-General Article § 10-721 of the Annotated Code of Maryland, represents a sophisticated effort by the state to foster an “innovation economy” by subsidizing the technical and scientific experimentation that occurs within its jurisdiction.1 At its core, the program distinguishes itself from the federal R&D tax credit by imposing a rigid geographic nexus requirement.2 While the federal credit, under Section 41 of the Internal Revenue Code (IRC), allows for expenses incurred anywhere in the United States, Maryland requires that qualified research and development (QRD) be “conducted in this State”.3 The determination of whether research is conducted in Maryland is not merely a question of corporate domicile but a technical analysis of where the work is performed and where the tangible materials essential to that work are exhausted—a concept codified as the “location where supplies are consumed”.1

The Statutory Framework: Maryland Tax-General § 10-721

The legislative intent behind the Maryland R&D tax credit is to encourage increased research activities and expenditures specifically within the state.1 The statute provides a framework for both a basic credit and a growth credit, although recent legislative changes have prioritized the latter.1 To navigate the legal requirements, one must first look to the statutory definitions that anchor the program. Maryland law defines “Maryland qualified research and development” as qualified research as defined in § 41(d) of the Internal Revenue Code that is conducted in the state.1 Similarly, “Maryland qualified research and development expenses” are defined as qualified research expenses (QREs) as defined in § 41(b) of the Internal Revenue Code incurred for research conducted in Maryland.1

Under Tax-General § 10-721(f), the Department of Commerce and the Comptroller are tasked with adopting regulations to administer the credit.1 Specifically, the law permits these agencies to consider a set of critical factors when determining the eligibility of expenses:

The explicit inclusion of the “location where supplies are consumed” as a factor in § 10-721(f)(2)(iii) signals that the state revenue offices view the physical depletion of materials as a primary indicator of Maryland-based innovation.1 This prevents “brass plate” R&D, where a company might claim a credit based on Maryland-based procurement or administrative staff while the actual physical laboratory work—and the associated consumption of materials—occurs in another jurisdiction.

Defining “Supplies” through the Federal and State Lens

Because Maryland adopts the federal definition of QREs under IRC § 41(b), the meaning of “supplies” in the Maryland context is inextricably linked to federal tax law.2 Under IRC § 41(b)(2)(C), a supply is defined as any tangible property other than land or improvements to land and property of a character subject to the allowance for depreciation.5 This creates a sharp distinction between “supplies” and “equipment.”

Consumables vs. Capital Assets

For an item to be considered a supply for the Maryland R&D credit, it must not be a depreciable asset.6 If a piece of laboratory machinery is expected to last more than a year and is subject to depreciation, it does not qualify for the income tax credit as a supply.6 However, it may qualify for the Maryland Sales and Use Tax exemption or the Personal Property Tax exemption, which use broader definitions of R&D property.7

Qualified supplies typically include:

• Chemical Reagents and Biologicals: Materials used in chemical reactions or biological assays that are “used up” during the process.
• Prototypes: Tangible models or test versions of a product. Even if a prototype is robust, the raw materials used to construct it are considered “consumed” in the R&D process if the prototype itself is used for testing and experimentation.10
• Single-Use Labware: Pipettes, petri dishes, and specialized filters that are discarded after an experiment.
• Utilities: Fuel, gas, and electricity consumed directly in the research process.8

The Requirement of Consumption “In the State”

The nuance of the Maryland law lies in the word “consumed.” While a company might purchase 1,000 gallons of a specialized solvent from a vendor in Ohio (the “purchase location”), the credit is only available for the portion of that solvent that is physically “consumed” (poured, reacted, or evaporated) in a Maryland laboratory.11

This requirement is mirrored in the regulations for the Cellulosic Ethanol Technology R&D Tax Credit (COMAR 24.05.12.09), which is often used by the Department of Commerce as an interpretative baseline for general R&D activities.11 COMAR 24.05.12.09(C) states explicitly that “all supplies used… must have been consumed in the State”.11 This regulatory guidance emphasizes that the physical presence and depletion of the supply within Maryland’s borders is a non-negotiable prerequisite for the credit.

Local Revenue Office Guidance and Administrative Interpretation

The Comptroller of Maryland and the Department of Commerce provide overlapping guidance that clarifies how the law applies to real-world business scenarios. While the Department of Commerce handles the certification of the credit, the Comptroller’s Office is responsible for processing the claims on tax returns and conducting audits.1

The Department of Commerce Certification Process

To receive the R&D tax credit, a business must submit a mandatory application to the Department of Commerce by November 15 of the calendar year following the tax year in which the expenses were incurred.3 The application requires the business to certify that “all eligible Maryland Qualified R&D Expenses… were incurred in Maryland”.14

For supplies, this certification implies that the business has a tracking mechanism to ensure the materials were physically used in a Maryland facility.14 The Department of Commerce’s instructions (Form RDTC) require the listing of the address of the Maryland facility where the research occurred.14 If a business has multiple facilities, it must attach a list, and the supply costs must be allocated specifically to those Maryland addresses.14

The Comptroller’s Audit Standards

The Comptroller’s Office typically aligns its audit standards for the R&D credit with the federal § 41 substantiation guidelines, but with the added layer of geographic verification.10 In practice, this means the Comptroller expects to see:

• Purchase Documentation: Invoices showing that supplies were ordered for or delivered to a Maryland site.10
• Usage Logs: Lab notebooks or innovation logs that tie the consumption of specific batches of material to Maryland-based experiments.16
• Inventory Records: Records showing the internal transfer of supplies from a central warehouse to a Maryland-based R&D team.10

If a business operates in multiple states, the Comptroller will scrutinize the allocation methodology. For example, if a company buys $500,000 in supplies for a project that has researchers in both Maryland and Virginia, the company cannot simply claim 100% of the cost for the Maryland credit.17 The burden of proof is on the taxpayer to demonstrate, via a “facts and circumstances analysis,” that the supplies were indeed consumed in Maryland.1

Recent Legislative Evolution: Chapter 114 (2021) and the Shift to Growth

The landscape of the Maryland R&D credit underwent a significant transformation with the passage of Chapter 114 of the Acts of 2021 (Senate Bill 196).1 This legislation sought to simplify the credit and focus the state’s limited resources on businesses that are actively expanding their R&D footprint.4

Repeal of the Basic Credit

Prior to 2021, Maryland offered two distinct credits:

1. The Basic R&D Credit: 3% of Maryland QREs that did not exceed the Maryland Base Amount.4
2. The Growth R&D Credit: 10% of Maryland QREs that exceeded the Maryland Base Amount.1

Chapter 114 repealed the 3% basic credit for tax years beginning after December 31, 2020.4 Consequently, the “location where supplies are consumed” now primarily impacts the calculation of the 10% growth credit.1 Because the growth credit is calculated against a “Maryland Base Amount,” the geographic consumption of supplies in prior years is just as important as current-year consumption.17

Understanding the Maryland Base Amount

The Maryland Base Amount is calculated by multiplying a company’s “fixed-base percentage” by its average Maryland gross receipts for the preceding four years.4 The fixed-base percentage itself is derived from the ratio of Maryland QREs to Maryland gross receipts in the prior four-year period.4

If a company fails to accurately track the location where supplies were consumed in previous years, they may inadvertently miscalculate their base amount, which could lead to a denial or over-calculation of the 10% growth credit.16

Small Business Refundability and the Asset Test

One of the most valuable aspects of the Maryland R&D tax credit is its refundability for “small businesses”.1 This feature is particularly crucial for startups in the biotechnology and software sectors where R&D supply consumption is high but taxable income is low or non-existent.6

The Net Book Value Asset Test

A small business is defined as a for-profit corporation, LLC, partnership, or sole proprietorship with “net book value assets” totaling less than $5 million at the beginning or end of the taxable year.1

“Net book value assets” means the total assets of the business (including intangible assets) as reported on the balance sheet, minus depreciation and amortization.10 Importantly, liabilities are not subtracted from this total; the test is based on the gross value of the assets after accounting for the loss in value due to time and use.10

For these qualified small businesses, if the certified R&D credit exceeds the state income tax liability for the year, the business may claim a refund for the excess amount.1 This provides immediate liquidity that can be reinvested into further research and the purchase of additional supplies.10

The $3.5 Million Set-Aside

To ensure that small businesses are not crowded out by large multinational corporations, the state mandates that $3.5 million of the $12 million annual credit cap be reserved specifically for small businesses.1 If the total credits applied for by small businesses exceed this set-aside, the Department of Commerce prorates the awards.1 Conversely, if small businesses do not use the full $3.5 million, the remainder is reallocated to the general pool.3

Practical Example: The Medical Device Prototype Scenario

To illustrate the meaning of “Location Where Supplies Are Consumed,” consider the case of “Chesapeake Surgical Solutions,” a hypothetical medical device company.

Scenario Background

In 2024, Chesapeake Surgical Solutions (CSS) is developing a new type of biodegradable surgical stent. CSS is headquartered in Baltimore, MD, but it also has a testing site in Arlington, VA. In 2024, CSS incurs the following supply-related expenses:

1. Specialized Polymer: $100,000 purchased from a chemical house in New Jersey.
2. 3D Printing Resin: $50,000 purchased from a vendor in Maryland.
3. Electricity and Inert Gases: $20,000 for the Baltimore lab’s specialized environmental chambers.
4. Sterile Packaging Samples: $10,000 used during testing.

Analysis of Geographic Consumption

The “purchase location” is largely irrelevant to the Maryland credit. Instead, CSS must determine where these items were physically “consumed”.1

• The Polymer: CSS used $80,000 of the polymer in the Baltimore lab to create test stents and $20,000 in the Arlington, VA lab for comparative testing. Only the $80,000 consumed in Baltimore is a Maryland QRE.11
• 3D Printing Resin: All $50,000 was used by the 3D printer in the Baltimore facility to create prototype stents. This is $50,000 in Maryland QREs.10
• Utilities: The $20,000 was consumed entirely at the Baltimore site. This is $20,000 in Maryland QREs.8
• Packaging: Half of the samples were used in Maryland and half in Virginia. Only $5,000 is a Maryland QRE.12

Outcome

Total Maryland QREs for supplies: $80,000 + $50,000 + $20,000 + $5,000 = $155,000. Even though the company may have spent $180,000 total on supplies, only the portion consumed “in the State” qualifies.1 If CSS qualifies as a small business and the growth over their base amount is $100,000, they would be eligible for a $10,000 credit (subject to proration).1

Economic Impact and Statistical Performance: The 2024 DLS Report

In December 2024, the Maryland Department of Legislative Services (DLS) published a comprehensive evaluation of the R&D tax credit program.18 This report provides a data-driven look at how the credit—and specifically the investment in Maryland-based R&D—has performed over the last decade.

Key Findings from the DLS Evaluation

The report highlights that while Maryland is a national leader in R&D intensity, the state tax credit is just one part of a complex incentive structure.18

The DLS noted that the program is frequently oversubscribed, meaning the effective credit rate for businesses is often significantly lower than the statutory 10%.18 In some years, larger firms may receive a prorated credit of only 2-3% of their excess expenses.3 This underscores the importance for businesses to meticulously document their supply consumption; in a prorated environment, every dollar of eligible expense counts toward the final certified award.1

Administrative Challenges Identified

The 2024 report also identified “unequal credit rates” as a side effect of the proration process.18 Because small businesses and larger businesses are in different proration pools, a small business might receive 60% of its applied-for credit while a large business might receive 10%, even if both companies had identical levels of supply consumption in Maryland.1 The DLS recommended that the General Assembly consider whether a unified pool or a different allocation method would be more equitable.18

Synergy with Maryland Sales and Use Tax Exemptions

A common point of confusion for Maryland businesses is the relationship between the R&D Income Tax Credit and the Sales and Use Tax exemption. While they are separate programs administered by different divisions, they share the same geographic nexus requirement: consumption in Maryland.8

The Sales and Use Tax Exemption (TG § 11-217)

Under Maryland Tax-General § 11-217(b), the sales and use tax does not apply to the sale of tangible personal property, digital codes, or digital products for “use or consumption in research and development”.8

This exemption is arguably more direct than the income tax credit. It applies at the point of sale, meaning a business does not pay the 6% sales tax on lab supplies.8 To claim this, the business provides the vendor with an “Exemption Certificate” (Form ST 206 for utilities or a general certification for other property).8

Direct and Predominant Use

To qualify for the sales tax exemption, the supply must be used “directly and predominantly” in R&D.8

1. Directly: The use must be integral to the research activity and occur where the activity is carried on.8
2. Predominantly: The supply must be used for R&D purposes at least 50% of the time.8

For the Income Tax Credit, the consumption rule is even stricter; only the actual amount consumed in the R&D process can be included in the QRE calculation.2 If a company buys a pallet of gloves and uses 60% in the R&D lab and 40% in the general administrative office, 100% might be exempt from sales tax (meeting the “predominant” 50% test), but only 60% of the cost can be claimed as a QRE for the R&D income tax credit.8

Personal Property Tax and R&D Equipment

While supplies are consumed, the machinery that facilitates the consumption is often eligible for a personal property tax exemption.7 State law authorizes local jurisdictions (counties and municipalities) to exempt personal property used in manufacturing or R&D from local taxation.7

The SDAT Application

To claim this exemption, a business must file a separate application with the State Department of Assessments and Taxation (SDAT) by September 1.7 The business must explain the R&D process in detail and provide a depreciation schedule for the equipment.22

This tiered approach means that a Maryland R&D facility can effectively eliminate sales tax on its supplies, property tax on its equipment, and receive a 10% income tax credit on the growth of its spending—provided all these activities occur “in the State”.9

Documentation and Audit Defense Strategies

The Comptroller’s Office has the authority to audit R&D tax credit claims for several years after the credit is certified.10 Because the credit is based on the “location where supplies are consumed,” documentation must go beyond simple receipts; it must prove the physical movement and depletion of the items.10

Essential Records for Supply Consumption

Tax professionals recommend that Maryland businesses maintain an “audit-ready” file that includes:

• Project Narratives: Descriptions of each R&D project that meet the federal “Four-Part Test” (Permitted Purpose, Elimination of Uncertainty, Process of Experimentation, and Technological in Nature).2
• Inventory Reconciliation: A system that tracks materials from the point of delivery in Maryland to the specific lab bench where they were used.16
• Utilities Invoices: For companies claiming utilities as a supply, documentation showing that the meters are dedicated to the R&D space and not the general office space.8
• Prototype Disposal Records: Records showing that a prototype was dismantled, destroyed, or otherwise “consumed” during testing, rather than being sold as a finished product.11

Dealing with “In-House” vs. “Contract” Research

If a Maryland company pays a third party to conduct research, the consumption of supplies is handled differently.5 Under federal rules (adopted by Maryland), “Contract Research Expenses” are generally limited to 65% of the amount paid to the contractor.10

For the Maryland credit, the contractor must also perform the work in Maryland.1 If a Maryland company pays a contractor in California to run a test, the California contractor’s supply consumption does not qualify for the Maryland credit, even though the Maryland company paid for it.1 The “Location Where Supplies Are Consumed” rule applies to the person performing the research, not the person funding it.1

Strategic Implications for Maryland Businesses

The geographic specificity of the Maryland R&D tax credit creates several strategic opportunities and risks for businesses.

Multi-State Allocation Risks

Businesses with laboratories in multiple states (e.g., Maryland and North Carolina) must be extremely cautious. A common error is using a “headcount” or “payroll” ratio to allocate supply costs across states.17 The Comptroller’s Office may reject such broad-based allocations, instead demanding direct evidence of “consumption” in Maryland.1 To mitigate this, companies should use “project codes” in their accounting software that are tied to specific physical locations.14

Leveraging the Small Business Advantage

Because of the $3.5 million set-aside and refundability, small businesses (under $5M in net book value assets) should prioritize Maryland consumption.1 If a startup has a choice between running a supply-intensive experiment in a Maryland incubator or an out-of-state facility, the 10% refundable Maryland credit (plus the 6% sales tax exemption) provides a powerful financial argument for staying in-state.8

The Sunset Provision and Future Planning

The Maryland R&D tax credit is currently set to expire on June 30, 2027.1 While the General Assembly has historically extended the program, businesses making long-term R&D investments should monitor the 2025 and 2026 legislative sessions closely.3 The 2024 DLS recommendation to potentially terminate the credit suggests that the program may undergo further changes, such as tighter definitions of “small business” or a shift toward “SBIR matching grants”.18

Conclusion: Geography as a Pillar of Innovation Policy

The Maryland Research and Development Tax Credit is more than a simple fiscal incentive; it is a meticulously localized policy that rewards the physical reality of scientific inquiry.1 By centering the credit on the “location where supplies are consumed,” Maryland ensures that its tax dollars are used to support the labs, technicians, and prototype shops physically operating within the state.1

For the business professional, this means that success in claiming the credit depends as much on geographic discipline as it does on scientific merit. Companies must not only prove that they are innovating but that they are doing so using Maryland’s infrastructure and materials.14 As the state continues to refine its R&D incentives—balancing the needs of small startups against the fiscal constraints of the $12 million annual cap—the principles of “consumption” and “in-state nexus” will remain the bedrock of the program.1 Businesses that master these geographic nuances, supported by robust documentation and a clear understanding of the interaction between income, sales, and property taxes, will be best positioned to turn Maryland’s commitment to innovation into a tangible competitive advantage.

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