ASC Credit Rate (5.6%)

The 5.6% Alternative Simplified Credit (ASC) rate is the statutory percentage applied to North Dakota qualified research expenses that exceed the first $100,000 of a taxpayer’s “alternative excess research and development” base. This specific rate represents the marginal incentive provided to businesses that elect the simplified calculation method, which relies on a three-year rolling average of historical expenditures rather than complex historical gross receipts data.

The North Dakota Research Expense Tax Credit, codified under North Dakota Century Code (N.D.C.C.) § 57-38-30.5, represents one of the state’s most enduring and significant fiscal tools for fostering private-sector innovation. While the credit has existed since 1987, the introduction of the 5.6% rate in 2019 marked a pivotal shift toward administrative simplification and alignment with federal tax standards found in Internal Revenue Code (IRC) § 41. By offering a 5.6% rate on expenses exceeding a defined threshold, North Dakota provides a competitive incentive for high-volume research and development (R&D) activities, particularly for companies in the energy, agriculture, and manufacturing sectors that may have fluctuating revenues or complex historical financial structures. This rate is not an isolated figure but rather the upper tier of the Alternative Simplified Method, which also features a 17.5% rate for the first $100,000 of incremental research spending. The following analysis explores the legal, administrative, and economic dimensions of this rate, providing a comprehensive guide for corporate taxpayers and researchers navigating the North Dakota tax landscape.

Historical Context and the Legislative Evolution of the R&D Credit

The trajectory of North Dakota’s R&D tax policy reveals a consistent legislative effort to balance aggressive incentive structures with fiscal stability. The credit was originally established by House Bill No. 1645 during the 1987 legislative session, a move largely inspired by successful models in neighboring Minnesota. In its infancy, the credit utilized a tiered system of 8% for the first $1.5 million in excess expenses and 4% for additional expenditures, primarily targeting corporate entities.

Between 2007 and 2016, the legislature experimented with a variety of rates to stimulate the state’s burgeoning technical sector. During this period, the percentage allowed on amounts exceeding $100,000 varied based on when a taxpayer first began conducting research in the state. For those who began research prior to 2007, the rates escalated significantly: 7.5% in 2007, 11% in 2008, 14.5% in 2009, and reaching a peak of 18% from 2010 through 2016. This period of high rates reflected a strategy to reward established researchers. However, for tax years following 2016, the legislature unified the regular rate at 8% for all excess expenses over $100,000, regardless of when the research activities commenced.

The specific 5.6% ASC rate emerged from House Bill 1111 in the 2019 legislative session. This legislation recognized that the “Regular Method” of calculating the credit, which requires historical gross receipts dating back decades, was often an insurmountable hurdle for newer companies or those with complex mergers and acquisitions histories. By adopting the Alternative Simplified Method, North Dakota allowed taxpayers to look only at their previous three years of spending, applying a 17.5% rate to the first $100,000 of growth and the 5.6% rate to everything beyond that.

Statutory Definition and the ASC Calculation Mechanism

The application of the 5.6% rate is contingent upon a specific mathematical threshold known as “alternative excess research and development.” Under N.D.C.C. § 57-38-30.5, this is defined as the amount by which qualified research expenses (QREs) incurred in North Dakota for the current year exceed 50% of the average QREs for the three preceding taxable years.

The state’s adoption of this method mirrors the federal Alternative Simplified Credit (ASC) structure but applies a different set of percentages tailored to North Dakota’s fiscal objectives. Unlike the federal credit, which uses a flat rate, the North Dakota ASC is tiered to provide a steeper incentive for the initial portion of a firm’s research growth.

The logic behind the 5.6% rate is to maintain a level of benefit that is roughly comparable to the 8% rate used in the Regular Method while accounting for the fact that the ASC base (50% of a 3-year average) is often easier to exceed than the Regular Method’s fixed-base percentage. The state revenue office guidance clarifies that if a taxpayer has zero research expenses in any of the three preceding years, they cannot use the 5.6% rate. Instead, they must apply a secondary set of reduced rates—7.5% on the first $100,000 and 2.4% thereafter—to ensure the credit remains proportional to actual incremental investment.

Local State Revenue Office Guidance on Qualified Expenditures

The North Dakota Office of State Tax Commissioner provides rigorous guidance on what constitutes a “qualified research expense” eligible for the 5.6% rate. The state largely conforms to the federal definitions under IRC § 41, but with one critical and absolute caveat: the research activities and the associated expenses must be attributable exclusively to North Dakota-based operations.

The Four-Part Test in the North Dakota Context

To satisfy the state revenue office, research activities must meet the “Four-Part Test.” This is not a formal state filing but a standard of proof that taxpayers must be prepared to defend during an audit.

1. Technical Uncertainty: The research must be intended to discover information that would eliminate uncertainty concerning the development or improvement of a business component. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the component.

2. Process of Experimentation: Substantially all of the activities must constitute a process of experimentation, involving the evaluation of alternatives through modeling, simulation, or systematic trial and error.

3. Technological in Nature: The research must rely on principles of the physical or biological sciences, engineering, or computer science.

4. Qualified Purpose: The objective must be to create a new or improved function, performance, reliability, or quality for a product, process, software, or technique.

Eligible Expense Categories

The 5.6% rate is applied to the aggregate of three primary cost pools, provided they are incurred within the state:

• Wages: This includes the portion of salaries paid to employees directly involved in research, as well as those providing direct supervision or support. The tax commissioner emphasizes that only the time spent on qualified activities is eligible; therefore, detailed time-tracking is essential for compliance.
• Supplies: Costs for tangible property used in the conduct of qualified research are eligible. This typically excludes land, improvements to real property, and depreciable assets.
• Contract Research: Payments to third parties for research conducted on behalf of the taxpayer are eligible at 65% of the actual cost. The taxpayer must retain the substantial rights to the research and bear the economic risk of failure.
• Computer Costs: Modern interpretations by the North Dakota revenue office include the cost of cloud computing and server space utilized for research simulations and data testing.

Comprehensive Calculation Example: The 5.6% Rate in Practice

To illustrate the mechanics of the 5.6% rate, consider a hypothetical North Dakota technology firm, “Fargo Software Dynamics,” which is determining its research credit for the 2024 tax year using the Alternative Simplified Method.

Historical Expenditure Data

Fargo Software Dynamics has documented the following North Dakota-sourced QREs over the preceding three years:

• 2021 QREs: $800,000
• 2022 QREs: $950,000
• 2023 QREs: $1,250,000
• 2024 (Current Year) QREs: $1,800,000

Calculating the ASC Base

The first step is determining the average of the three prior years:

Average = (800,000 + 950,000 + 1,250,000) / 3 = 1,000,000

The ASC base is 50% of this average:

Base = 1,000,000 x 0.50 = 500,000

Determining Alternative Excess Research and Development

The firm must now determine how much of its 2024 spending qualifies as incremental growth over the base:

Alternative Excess = 1,800,000 – 500,000 = 1,300,000

Applying the 17.5% and 5.6% Rates

The credit is calculated across two tiers:

• Tier 1 (First $100,000): $100,000 x 17.5% = $17,500
• Tier 2 (The Balance over $100,000): (1,300,000 – 100,000) x 5.6% = 1,200,000 x 0.056 = $67,200

Total North Dakota Research Expense Credit for 2024:

$17,500 + $67,200 = $84,700

This example demonstrates how the 5.6% rate provides the bulk of the benefit for larger R&D programs, while the 17.5% rate acts as a significant “bonus” for the first $100,000 of incremental growth.

Administrative Guidance on Method Election and Filing

The Office of State Tax Commissioner provides specific procedural rules for electing the 5.6% ASC rate. One of the most critical rules is that the election to use the ASC method is made on an annual basis. A taxpayer can choose the Regular Method in one year and the ASC method the next, depending on which provides a more advantageous result. However, once a credit is claimed on an original return using a specific method, that election is binding for that taxable year and cannot be changed on an amended return.

Filing Requirements by Entity Type

North Dakota requires different forms and schedules for claiming the R&D credit, depending on the taxpayer’s legal structure:

• Individuals: Claims are made on Schedule ND-1TC, Line 9a. Taxpayers must attach documentation showing the step-by-step calculation.
• C Corporations: The credit is reported on Form 40, Schedule TC. If the credit is part of a consolidated return, it may be applied against the aggregate tax liability of the group, provided the expenses were North Dakota-sourced.
• Passthrough Entities (S-Corps, LLCs, Partnerships): The credit is calculated at the entity level but passed through to the owners in proportion to their ownership interests. Owners claim their share of the credit on their respective individual or corporate returns.

Audit Readiness and Documentation Standards

The state revenue office warns that “poor documentation can lead to audit risks”. Taxpayers utilizing the 5.6% rate should maintain a “Research Credit Defense File” containing:

• Employee payroll records and time tracking.
• Detailed general ledger reports for supply costs.
• Executed contracts for third-party research.
• Technical documentation such as white papers, prototypes, and test results that prove the “process of experimentation”.
• A property tax clearance record, which is often a prerequisite for certain corporate tax incentives in North Dakota.

Transferability of Unused Credits: Liquidity for Startups

For many emerging businesses, a non-refundable tax credit has limited immediate value if the company is not yet profitable. North Dakota addresses this through a unique transferability provision. A “qualified research and development company” may elect to sell, transfer, or assign up to $100,000 of its unused research credit to another taxpayer.

Eligibility for Credit Transfer

To qualify for this provision, the taxpayer must meet stringent criteria overseen by both the Department of Commerce and the Tax Commissioner:

1. Primary Sector Certification: The business must be certified as a “primary sector business,” meaning it adds value to a product or process through technology or manufacturing.

2. Revenue Limit: Annual gross revenues must be less than $750,000.

3. New Research: The research must have commenced in North Dakota for the first time after December 31, 2006.

Procedural Mechanics of the Transfer

The transfer process requires joint action by the seller (transferor) and the buyer (transferee):

• Form CTS: The parties must jointly file Form CTS (Credit Transfer Statement) within 30 days of the sale.
• Taxpayer Identification: The filing must include the names, addresses, and taxpayer identification numbers of both parties, along with the gross proceeds received by the seller.
• Purchaser Limitations: The buyer of the credit may carry any unused portion forward for up to 15 years but is prohibited from carrying the credit back to prior tax years. Furthermore, the buyer cannot re-sell or further assign the credit.

Economic Impact and Claimant Statistics

The North Dakota Legislative Council and the Taxation Committee periodically review the fiscal impact of the Research Expense Tax Credit to determine its effectiveness. A major review conducted by the 2017-18 interim committee provided significant insights into the usage of the credit.

The statistics suggest that while the credit results in a net loss to the state budget when accounting for the cost of servicing an increased population ($30 million projected loss over 20 years), it is a powerful driver of private-sector activity. The concentration of jobs in the professional services and technical industries indicates that the credit is successfully targeting high-value employment. Furthermore, case studies of large entities like the Basin Electric Power Cooperative show that massive R&D projects can generate millions in credits, demonstrating the importance of the 15-year carryforward period for capital-intensive industries.

Carryback and Carryforward Provisions

The flexibility of the North Dakota R&D credit is further enhanced by its generous carryover rules. If the credit calculated using the 5.6% rate exceeds a taxpayer’s current liability, the unused portion must first be carried back to the three preceding taxable years. This can result in immediate tax refunds for taxes paid in those prior years.

If the credit is not exhausted by the carryback, it may be carried forward for up to 15 years. It is important to note that for taxpayers who began research before 2007, there is an annual limit of $2 million in credits that can be claimed; any amount exceeding this cap is permanently lost and cannot be carried forward or back.

Interaction with Other North Dakota Business Incentives

The 5.6% R&D credit does not exist in a vacuum but is part of a broader suite of incentives managed by the Office of State Tax Commissioner. Understanding how these credits interact is vital for comprehensive tax planning.

• Automation Tax Credit: Businesses can earn a 15% credit for purchasing equipment to automate manufacturing or animal agricultural processes. However, the cost used for the automation credit cannot also be used as a basis for the research credit.
• Angel Fund Investor Credit: Individuals investing in early-stage North Dakota companies focused on R&D can receive a credit of up to 45%. This incentivizes the capital side of innovation, while the 5.6% credit incentivizes the expenditure side.
• Renaissance Zone Exemptions: Companies located in designated Renaissance Zones may qualify for income tax exemptions for up to five years, which might reduce the immediate need for R&D credits but increases the value of the 15-year carryforward.

Comparative Analysis: North Dakota vs. Regional Neighbors

When evaluating the competitiveness of North Dakota’s 5.6% ASC rate, it is helpful to look at how neighboring states structure their research incentives.

• Minnesota: Minnesota offers a 10% credit on the first $2 million of qualifying expenses and 4% on the excess. Notably, Minnesota does not conform to the federal Alternative Simplified Method, making North Dakota’s 5.6% ASC rate a more flexible option for firms that prefer the simplified base.
• Indiana: Indiana utilizes an Alternative Incremental Credit method with a 10% rate on the excess of expenses over 50% of the three-year average. While the rate is higher than North Dakota’s 5.6%, North Dakota’s initial 17.5% tier often provides a higher effective credit for small to mid-sized growth.
• Arizona: Arizona is significantly more aggressive, offering a 24% credit on the first $2.5 million of expenses. However, Arizona’s ASC method involves different base calculations and does not feature the same tiered structure as North Dakota.

Future Outlook and Legislative Stability

The 5.6% rate appears to be a stable fixture of North Dakota’s tax code. The 2021 and 2023 legislative sessions, while focusing on broad individual income tax cuts and property tax relief, left the R&D credit structure largely intact. This suggests a legislative consensus that the ASC method is functioning as intended—reducing administrative friction for businesses while encouraging incremental growth in high-tech spending.

The “Safety Net” provision in N.D.C.C. § 57-38-30.5 further underscores this stability. The law explicitly states that if the federal research credit under IRC § 41 were to expire or become ineffective, the North Dakota state provisions would remain in force, using the federal definitions as they existed in the most recent year of effectiveness. This ensures that North Dakota businesses can make long-term R&D investment decisions without fear of a sudden disappearance of state-level support.

Final Thoughts: Strategic Recommendations for Professionals

The 5.6% Alternative Simplified Credit rate is the cornerstone of North Dakota’s modern innovation policy. For businesses operating in the state, the election of the ASC method provides a predictable, calculation-friendly path to significant tax savings. However, the shift to the ASC method should be evaluated annually. While the 5.6% rate is lower than the 8% regular rate, the simplified base often makes the ASC method more lucrative for firms that are rapidly expanding their North Dakota footprint.

Tax professionals and business owners should prioritize the following actions to maximize the benefit of the 5.6% rate:

1. Quantitative Comparison: Perform a side-by-side calculation of the Regular Method versus the ASC Method every year. The ability to switch between methods annually is a powerful planning tool.

2. State-Specific Accounting: Ensure that accounting systems can isolate North Dakota-sourced QREs from global or national research budgets. The state revenue office is notoriously strict on the exclusion of any out-of-state activities.

3. Liquidity Planning: If the firm is in a pre-profit stage, engage with the Department of Commerce early to secure Primary Sector Certification. This is the only way to monetize the credit through the $100,000 transfer provision.

4. Audit Defense: Treat the “Four-Part Test” as a living document. Maintain technical narratives and experimental data for every project claimed under the 5.6% rate to ensure that the credit survives the four-year state audit window.

By integrating the 5.6% ASC rate into a broader multi-year tax strategy, North Dakota businesses can effectively subsidize their most innovative and risky endeavors, ensuring long-term growth and technical leadership in the region’s competitive economy.