The “major portion of a trade or business” denotes the acquisition or disposal of a viable, self-sustaining business segment that triggers mandatory adjustments to historical research expenses and gross receipts. Under North Dakota law, this rule ensures that taxpayers calculate their tax credits by comparing current research spending against the combined historical data of both the successor and the acquired business unit.

The North Dakota Research and Experimental Expenditure Tax Credit, codified under North Dakota Century Code (N.D.C.C.) § 57-38-30.5, represents a significant fiscal tool designed to stimulate technological innovation and economic diversification within the state. Central to the administration of this credit is the “major portion” rule, a regulatory mechanism that prevents the artificial inflation of tax benefits following corporate acquisitions or restructurings. By requiring an integrated historical baseline, the North Dakota Office of State Tax Commissioner (NDSTC) ensures that the credit remains a reward for incremental growth in research activity rather than a byproduct of legal entity changes. This report examines the statutory origins of this rule, its federal dependencies, administrative applications, and the strategic implications for taxpayers navigating the intersection of corporate law and tax compliance.

Statutory Origins and Legislative Evolution of the North Dakota R&D Credit

The genesis of the North Dakota research credit can be traced to the 1987 legislative session, specifically House Bill No. 1645. At its inception, the Legislative Assembly sought to replicate the success of similar incentives in Minnesota, viewing the tax credit as an essential instrument for encouraging both domestic and out-of-state corporations to establish research footprints in North Dakota. The original enactment provided for a corporate income tax credit equal to 8 percent of the first $1.5 million of North Dakota qualified research expenses in excess of base period expenses, with a 4 percent rate for amounts exceeding that threshold.

Subsequent decades saw several pivotal restructurings that expanded the credit’s reach and modified its calculation methodologies. In 2007, House Bill Nos. 1412 and 1018 significantly altered the landscape by extending eligibility to pass-through entities and individuals, thereby democratizing access to the incentive beyond the large corporate sector. These amendments also introduced tiered credit rates and caps that continue to influence contemporary tax planning.

The most significant contemporary development was the introduction of the Alternative Simplified Computation (ASC) method in 2019, which provided taxpayers with a more streamlined calculation option that mirrors federal law while maintaining the state’s geographic focus.

Conceptual Definition of a Major Portion of a Trade or Business

To understand the “major portion” rule, one must first analyze its definition within the context of federal and state tax jurisprudence. North Dakota law explicitly incorporates the definitions of “qualified research expenses” and “base amount” from Section 41 of the Internal Revenue Code (IRC). Consequently, the interpretation of what constitutes a “major portion” is governed by Treasury Regulation § 1.41-7 and § 1.52-2(b).

The Viability and Self-Sustenance Standard

A “major portion” or “separate unit” of a trade or business is not defined by a specific percentage of assets or a particular dollar value. Instead, the determination rests on whether the acquired or disposed assets constitute a viable trade or business capable of operating as a self-sustaining enterprise. Treasury Regulation § 1.52-2(b)(2)(i) clarifies that a separate unit is a segment of a trade or business that can function independently with only minor adjustments.

Key indicators used by the NDSTC and federal examiners to identify a major portion include:

• The transfer of operational goodwill specifically associated with the unit.
• The acquisition of a complete division, including its human capital, customer base, and intellectual property.
• The ability of the segment to generate revenue and incur expenses that are distinct from the parent organization.

This distinction is critical because the mere acquisition of physical assets, such as specialized laboratory equipment or computers, does not constitute the acquisition of a “major portion” and thus does not trigger the base amount adjustments required under IRC § 41(f)(3).

Application of the Separate Unit Rule

In the context of research activities, a separate unit often takes the form of a specific R&D laboratory or a specialized engineering department. If a taxpayer acquires such a unit from another entity, it is effectively stepping into the shoes of the predecessor regarding that unit’s research history. This ensures that the successor cannot claim a credit for research activity that was already being performed; rather, it must demonstrate that its spending has increased relative to the combined historical baseline of the predecessor’s unit and its own existing operations.

Mechanics of Base Amount Adjustments under IRC Section 41(f)(3)

When a “major portion” transition occurs, both the successor (acquirer) and the predecessor (disposer) must perform specific adjustments to their historical records to ensure the credit is calculated on an incremental basis.

The Successor Acquisition Adjustment

If a taxpayer acquires a major portion of a trade or business after December 31, 1983, it must increase its qualified research expenses (QREs) and gross receipts for all periods prior to the acquisition by the amounts attributable to the acquired business. For the year in which the acquisition occurs, the successor must use a pro-rata calculation known as the “acquisition year amount”.

The acquisition year amount is determined by the following formula:

$$QRE_{Adj} = QRE_{Pred} \times \frac{Days_{Owned}}{Days_{Total}}$$

Where:

• $QRE_{Adj}$ is the amount added to the successor’s base for the acquisition year.
• $QRE_{Pred}$ is the predecessor’s qualified research expenses for the measurement period.
• $Days_{Owned}$ is the number of days in the acquisition year that the successor owned the business.

For all subsequent taxable years, the successor must include the full amount of the predecessor’s historical North Dakota QREs and gross receipts in its base amount calculation.

The Predecessor Disposition Adjustment

The predecessor is generally allowed to decrease its QREs and gross receipts for the periods before the disposition, provided it can prove that the successor is making the corresponding upward adjustments. This prevents double-counting of research history and ensures that the predecessor’s remaining business is not unfairly penalized by a historical base that includes research activity no longer under its control.

In North Dakota, this disposition adjustment is strictly limited to research conducted within the state. If a multi-state corporation sells a North Dakota-based research unit, only the North Dakota-sourced expenses and receipts are removed from its state-level base calculation.

North Dakota State Revenue Office Guidance and Law Application

The North Dakota Office of State Tax Commissioner provides authoritative guidance on how these federal rules apply specifically to North Dakota filings. The commissioner mandates that whenever a taxpayer acquires or disposes of a major portion of a trade or business or a separate unit in a transaction with another taxpayer, the qualified research expenses and base period must be adjusted in the manner provided by IRC § 41(f)(3).

Geographic Limitations and “Carve-Out” Requirements

A unique challenge in North Dakota compliance is the geographic “carve-out.” While federal law looks at national QREs and gross receipts, North Dakota only considers expenses incurred for research conducted in the state and receipts attributable to North Dakota.

When a major portion is acquired, the successor must obtain records from the predecessor that specifically isolate the North Dakota components of the research history. If the predecessor did not track research by location, the taxpayer must work with the NDSTC to establish a reasonable allocation method, often based on payroll or specialized project records.

Filing Procedures for Consolidated Groups

For corporate taxpayers filing a consolidated combined return in North Dakota, the research credit may be applied against the aggregate tax liability of the group. However, the “major portion” rule still applies at the individual entity level when a new member is added to the group through acquisition. If a consolidated group acquires a target corporation that becomes a member, the group’s consolidated base must be adjusted to include the target’s pre-acquisition research history.

The NDSTC clarifies that this provision for consolidated returns does not apply to tax credits purchased or received from other taxpayers through the small business transfer program. Purchased credits are restricted to the liability of the purchasing entity alone.

Methodologies for Credit Calculation in North Dakota

North Dakota taxpayers have two primary methods to compute their R&D credit, both of which are impacted by the major portion rule due to their reliance on historical data.

The Regular Method Calculation

The Regular Method is the traditional approach, calculating the credit based on the excess of current-year QREs over a base amount. The base amount is typically the product of the taxpayer’s “fixed-base percentage” and its average annual gross receipts for the four preceding years.

The current tiered credit rates for the regular method in North Dakota are:

• 25% of the first $100,000 in excess qualified expenses.
• 8% of any excess qualified expenses exceeding $100,000.

For taxpayers who began research in North Dakota before January 1, 2007, a maximum annual credit of $2 million applies. Any credit earned in excess of this amount may not be carried forward or back.

The Alternative Simplified Computation (ASC) Method

The ASC method, introduced in North Dakota for tax years beginning after 2018, provides a simplified path for taxpayers who may have difficulty establishing a fixed-base percentage or who have fluctuating research spends.

Under the North Dakota ASC:

• The credit is 17.5% of the first $100,000 of “North Dakota alternative excess research and development expenses”.
• The credit is 5.6% of any excess over $100,000.

“Alternative excess research and development expenses” are defined as the amount by which current-year North Dakota QREs exceed 50% of the average North Dakota QREs for the three preceding tax years.

If a taxpayer acquires a major portion of a business, the three-year average used in the ASC calculation must be adjusted to include the predecessor’s North Dakota QREs for those same years. Failure to adjust the three-year lookback period in an ASC calculation following an acquisition is a common error identified during state audits.

Primary Sector Businesses and Small Business Credit Transfers

North Dakota provides a unique mechanism for small, primary sector businesses to monetize their R&D credits, adding another layer of complexity to acquisition planning.

Certification Requirements

A taxpayer can be certified by the North Dakota Department of Commerce as a “Qualified Research and Development Company” if it meets specific criteria:

1. It is a primary sector business (manufacturing, processing, or adding value through knowledge/labor).
2. It has annual gross revenues of less than $750,000.
3. It began conducting qualified research in the state after December 31, 2006.

The Monetization Mechanism

Once certified, these companies may elect to sell, transfer, or assign up to $100,000 of unused tax credits to another taxpayer. The transferor and transferee must jointly file Form CTS – Credit Transfer Statement within 30 days of the purchase agreement.

If a larger company acquires a “major portion” of a certified small business, the eligibility of those credits for transfer may be impacted. If the acquisition causes the entity to exceed the $750,000 revenue cap or if the unit is absorbed into a larger non-primary sector business, the ability to sell future credits may be lost. Furthermore, the “major portion” rule requires the acquirer to absorb the small business’s history, which may dilute the acquirer’s own credit position if the small business had high historical spending relative to its current activity.

Comprehensive Example: The Acquisition of a Research Unit

To demonstrate the application of the major portion rule and NDSTC guidance, consider a scenario involving the acquisition of a specialized biotechnology unit.

Transaction Profile

Acquirer Corp is a Fargo-based medical device manufacturer. In 2024, it has $800,000 in North Dakota QREs. Its average North Dakota gross receipts for the period 2020–2023 were $3,000,000. Its fixed-base percentage is 3%.

Target Unit Z is a research division of a company based in Minnesota. On October 1, 2024, Acquirer Corp purchases Unit Z, which operates a lab in Grand Forks. This constitutes a “major portion” because Unit Z is a self-sustaining enterprise with its own specialized staff and intellectual property.

Unit Z Historical Data (North Dakota Only)

Step 1: Adjusting Historical Gross Receipts

Acquirer Corp must add Unit Z’s historical North Dakota receipts to its own base period average.

$$Total Receipts_{Base} = (3,000,000 \times 4) + (800k + 850k + 900k + 950k) = 12,000,000 + 3,500,000 = 15,500,000$$

$$Avg Receipts_{Adj} = \frac{15,500,000}{4} = \$3,875,000$$

Step 2: Determining the Adjusted Base Amount

Using the 3% fixed-base percentage:

$$Base Amount = 3,875,000 \times 0.03 = \$116,250$$

However, the base amount cannot be less than 50% of the current year’s QREs. Acquirer Corp’s 2024 QREs will include its original $800,000 plus the portion of Unit Z’s expenses incurred post-acquisition (Oct–Dec). Assuming Unit Z’s spending remained constant, its QREs for the final quarter would be roughly $60,000.

$$Total QREs_{2024} = 800,000 + 60,000 = \$860,000$$

$$Min Base Amount = 860,000 \times 0.50 = \$430,000$$

Since $430,000 > $116,250, the adjusted base amount for the credit is $430,000.

Step 3: Final Credit Calculation

$$Excess QREs = 860,000 – 430,000 = \$430,000$$

The North Dakota Regular Method tiered calculation:

1. First $100,000 @ 25% = $25,000.
2. Remaining $330,000 @ 8% = $26,400.
3. Total North Dakota R&D Credit = $51,400.

Without the major portion adjustment, Acquirer Corp might have used a lower base amount, leading to an overstatement of the credit and potential audit exposure.

Audit Risks and State Enforcement Guidelines

The North Dakota Office of State Tax Commissioner, in conjunction with IRS coordination, treats research credit claims involving acquisitions with heightened scrutiny. Audit guidelines emphasize several key areas where taxpayers often fail to meet the “major portion” standards.

The Continuity and Consistency Requirement

A foundational principle of the R&D credit is that QREs in the credit year must be determined on a basis consistent with the base years. When a major portion is acquired, the successor must ensure that the predecessor categorized its expenses (wages, supplies, and contract research) using the same methodology the successor uses. If the predecessor did not include certain indirect labor in its QREs, the successor cannot include those same labor types in its current year QREs unless it also adjusts the predecessor’s historical data upward to compensate.

Common Audit Triggers

Examiners are instructed to identify and verify acquisitions and dispositions to confirm they are properly reflected in the computation. Common triggers for an in-depth review include:

• A significant spike in QREs relative to historical averages that cannot be explained by organic growth.
• Changes to the fixed-base percentage from prior years.
• Discrepancies between federal Form 6765 and North Dakota state filings regarding reported gross receipts.
• Failure to attach the required Property Tax Clearance Record, which is a certification that the taxpayer is in good standing with each county where they hold a significant interest in real property.

Documentation and Substantiation

Taxpayers must maintain robust records for at least four years, aligning with federal IRC § 41 standards. In an acquisition scenario, this documentation should include:

• The purchase agreement and any schedules detailing the R&D assets or personnel transferred.
• Project-level documentation showing that the research involves technological uncertainty and a process of experimentation.
• A breakdown of North Dakota-specific gross receipts, excluding capital gains, sales taxes, and other non-operational revenues as defined in Treasury Regulation § 1.41-3(c).

Future Outlook: The Impact of OBBBA 2025 and Section 174 Changes

The landscape of research and development tax policy is currently undergoing a massive shift due to the “One Big Beautiful Bill Act of 2025” (OBBBA), which restored the full deductibility of U.S.-based R&D expenditures. This change is particularly relevant for North Dakota taxpayers because state income tax starts with federal taxable income.

Retroactive Restoration and State Conformity

OBBBA allows eligible small businesses to retroactively expense R&D costs for 2022, 2023, and 2024, eliminating the five-year amortization requirement for domestic research. This creates a significant decision point for North Dakota taxpayers: whether to amend prior-year returns or take the remaining unamortized balance in 2025.

If a taxpayer chooses to amend, they must consider the “major portion” rule:

• Amended Credit Claims: Restating Section 174 expenses may increase QREs, which in turn necessitates an adjustment to the base period calculations of any acquired or disposed units.
• New Reporting Obligations: For the 2025 tax year, the IRS (and subsequently state authorities) will require expanded disclosures on Form 6765, including mandatory business-component level reporting (Section G). Section E of the new form specifically requires confirmation of any major portions acquired or disposed of during the year.

Strategic Considerations for High-Income Shareholders

In pass-through entities, which are common in North Dakota, the restoration of expensing under OBBBA can reduce Qualified Business Income (QBI), potentially shrinking the Section 199A deduction. Taxpayers must model the multi-year cash flow impact, balancing the immediate refund from R&D expensing against the increased shareholder-level tax liability from reduced QBI deductions.

Economic Impact and Statistical Overview of the Credit

The North Dakota Research Expense Tax Credit is not merely a theoretical construct; it has a profound and documented impact on the state’s economic vitality. Legislative studies provide a detailed statistical look at the credit’s performance over the past two decades.

Economic Participation and Job Creation

Data from the 2021-2022 Economic Development Tax Incentive Study highlights the credit’s role in attracting and retaining human capital in the state.

Fiscal Sustainability and Budgetary Implications

While the credit has been a net positive for the state’s economy, it represents a net liability for the state budget. Over a 20-year period, the credit generated an estimated $213 million in revenue through indirect economic activity but cost the state approximately $248 million in direct and indirect expenses, resulting in a $30 million net budgetary deficit.

Despite this, the North Dakota Legislative Assembly continues to support the credit, recognizing that its value as an economic development tool—particularly in sectors like agriculture and energy—far outweighs the direct fiscal cost. Testimonies from major state players, such as the Basin Electric Power Cooperative, emphasize that the credit is a vital incentive even for companies currently in a net operating loss position, as the 15-year carryforward provides a long-term offset for future profitability.

Final Thoughts and Recommendations for Taxpayers

The “major portion of a trade or business” rule serves as the essential guardrail for the North Dakota Research and Experimental Expenditure Tax Credit. By anchoring state adjustments to the rigorous standards of IRC § 41(f)(3), North Dakota ensures that its tax incentives are targeted toward genuine innovation rather than the shuffling of existing corporate assets.

For businesses navigating mergers, acquisitions, or restructuring within the state, the following recommendations are paramount:

• Prioritize Due Diligence: Acquirers must secure detailed North Dakota-specific research and gross receipts history from predecessors before closing a transaction.
• Evaluate Methodologies: Taxpayers should perform a comparative analysis between the Regular Method and the ASC method, keeping in mind how the “major portion” rule differently affects the lookback periods for each.
• Maintain Rigorous Records: Given the heightened audit risk for amended returns and acquisition-related claims, businesses must maintain project-level documentation that satisfies the four-part test for qualified research.
• Monitor Federal Changes: The OBBBA 2025 changes provide a significant opportunity for tax savings but require careful navigation of state conformity rules and shareholder-level impact.

By adhering to these principles and the guidance provided by the North Dakota Office of State Tax Commissioner, taxpayers can effectively leverage the R&D credit to drive growth while ensuring full compliance with the state’s sophisticated tax laws. The continued evolution of the credit highlights North Dakota’s commitment to being a premier destination for technological advancement and primary sector development.