Transferable Credit

Transferable credit within the North Dakota Research and Development framework represents a statutory mechanism that allows eligible primary sector small businesses to sell their non-refundable tax credits to third-party taxpayers for immediate liquidity. This instrument effectively converts potential future tax offsets into current operational capital, providing a critical non-dilutive funding source for early-stage innovation.

The North Dakota Research and Development (R&D) Tax Credit, formalized under North Dakota Century Code (N.D.C.C.) § 57-38-30.5, serves as a cornerstone of the state’s economic development strategy, particularly for industries that fall within the “primary sector.” Unlike traditional tax credits which require the earning entity to have an existing tax liability to realize value, the transferability provision acknowledges the unique financial lifecycle of research-intensive startups. These companies often incur significant qualified research expenses (QREs) years before reaching profitability and, consequently, years before they would otherwise be able to utilize a standard carryforward. By permitting the sale of these credits, North Dakota has created a secondary market for tax benefits that rewards technological risk-taking and encourages the retention of high-value intellectual property within the state’s borders.

Historical Evolution and Legislative Intent

The journey of the North Dakota Research Expense Tax Credit began with the passage of House Bill No. 1645 in 1987. At its inception, the credit was designed primarily as a corporate incentive, offering a credit equal to 8 percent of the first $1.5 million of qualified research expenses in excess of a base period, and 4 percent thereafter. The legislative assembly’s intent was clear: to diversify the state’s economy beyond its traditional reliance on raw commodity exports by incentivizing value-added activities. Over the following decades, the statute underwent several rounds of modernization to align more closely with federal standards and to enhance its utility for small businesses.

A pivotal shift occurred in 2007, when the legislature introduced tiered rates and specifically targeted “new” research conducted after December 31, 2006. This era marked the birth of the modern transferability clause, which was refined in subsequent sessions to include specific revenue caps and primary sector requirements. The introduction of the Alternative Simplified Method (ASC) in 2019 further demonstrated the state’s commitment to flexibility, allowing taxpayers to bypass the often-cumbersome gross receipts calculations inherent in the regular federal method. The current framework represents a sophisticated balance between fiscal responsibility—evidenced by the $100,000 lifetime transfer cap—and aggressive economic promotion.

The Statutory Definition of Qualified Research in North Dakota

To qualify for the North Dakota R&D credit, whether for internal use or transfer, the activities must satisfy both federal qualitative standards and state-specific geographic mandates. N.D.C.C. § 57-38-30.5 explicitly incorporates the definitions of “qualified research” and “qualified research expenses” as found in Section 41 of the Internal Revenue Code (IRC).

The Geographic Nexus Requirement

The primary divergence from the federal credit is the requirement of a strict North Dakota nexus. While the federal credit applies to research conducted anywhere within the United States, the North Dakota credit is limited to expenses “attributable to North Dakota activity.” This means that even if a North Dakota-based company conducts groundbreaking research in a laboratory in Minnesota, those specific expenses are excluded from the state credit calculation. This geographic boundary ensures that the state’s tax expenditure directly supports local payroll, supplies purchased from local vendors, and the use of local research facilities.

The Four-Part Test of IRC § 41

The state adheres to the federal “Four-Part Test” to determine the eligibility of research activities. For an activity to be considered qualified research, the taxpayer must demonstrate that it meets all of the following criteria:

• Permitted Purpose: The activity must relate to a new or improved function, performance, reliability, or quality of a “business component.” A business component can be a product, process, software, technique, formula, or invention.
• Elimination of Uncertainty: The taxpayer must have intended to discover information to eliminate uncertainty concerning the capability or method for developing or improving a business component, or the appropriateness of the component’s design.
• Process of Experimentation: Substantially all of the activities must constitute a process of experimentation. This involves the identification of a hypothesis, the evaluation of alternatives, and the systematic testing and refinement of the design.
• Technological in Nature: The process of experimentation must fundamentally rely on the principles of hard science, such as physical or biological sciences, engineering, or computer science.

Activities such as routine data collection, market research, or aesthetic changes do not qualify. In the context of North Dakota’s primary sectors, this often excludes pure agricultural production but includes the development of new hybridized seeds, the creation of proprietary software for precision agriculture, or the engineering of more efficient carbon sequestration equipment for energy plants.

Calculation Methodologies: Regular vs. Alternative Simplified Credit

The North Dakota Office of State Tax Commissioner provides taxpayers with two distinct pathways to calculate the research expense credit. Choosing the correct method is a critical strategic decision, as the election is made on a year-by-year basis and can significantly impact the final credit amount available for transfer.

The Regular Calculation Method

The regular method is tiered to favor smaller expenditures, offering a robust 25% credit on the first $100,000 of excess research expenses. This structure is specifically intended to provide a heavy incentive for early-stage R&D.

Level of Excess QREs	Credit Percentage
First $100,000 of Excess	25%
Excess above $100,000	8%

The term “excess” refers to the amount of qualified research expenses (QREs) for the tax year that exceeds a calculated “base amount.” For most taxpayers, the base amount mirrors the federal calculation, utilizing a fixed-base percentage of North Dakota gross receipts. However, the law stipulates that the qualified research expenses may not exceed 50% of the base amount in certain configurations, and for companies with no North Dakota gross receipts, the base is generally set at 50% of the current year’s QREs.

The Alternative Simplified Credit (ASC) Method

Recognizing that many modern startups may have fluctuating revenues or may not have the historical data required for the regular method, the state introduced the ASC method for tax years beginning after 2018. The ASC method ignores gross receipts and instead looks at the taxpayer’s research spending history over the preceding three years.

ASC Tiers	Credit Percentage
First $100,000 of Alternative Excess	17.5%
Alternative Excess above $100,000	5.6%

The “Alternative Excess” is the amount by which current-year QREs exceed 50% of the average QREs from the prior three tax years. If the taxpayer had zero research expenses in any of those three years, the credit is calculated as 7.5% of the first $100,000 of current-year QREs and 2.4% of the remainder.

Comparative Calculation Example

Consider a biotechnology company that has consistently spent $200,000 per year on research in North Dakota over the last three years. In the current year, their spending increases to $400,000.

ASC Method Calculation:

• Average of prior 3 years: $200,000.
• Base (50% of average): $100,000.
• Alternative Excess ($400,000 – $100,000): $300,000.
• Credit on first $100,000: $100,000 \times 17.5\% = \$17,500$.
• Credit on remaining $200,000: $200,000 \times 5.6\% = \$11,200$.
• Total ASC Credit: $28,700.

If this same company had no North Dakota gross receipts and used the regular method (assuming the 50% base rule for startups), their credit might be significantly higher ($25,000 on the first $100,000 of excess plus 8% thereafter). Thus, a detailed multi-year projection is often necessary to determine the optimal election.

Deep Dive: The Meaning of Transferable Credit

In the North Dakota context, “transferable” is a term of art with specific legal boundaries. It is distinct from “refundable.” While a refundable credit results in a direct check from the government to the taxpayer, a transferable credit must find a buyer in the private sector. This distinction shifts the administrative burden of valuation and liquidity from the state to the marketplace, albeit within a highly regulated framework.

The Lifecycle of a Transferable Credit

The lifecycle begins with a “Qualified Research and Development Company” earning an unused credit. Because the credit is non-refundable, if the company has no tax liability, the credit would normally sit on the balance sheet as a deferred tax asset, subject to a 15-year carryforward. The transferability provision allows the company to accelerate this future value. By selling the credit, the company receives immediate cash, which is typically used for payroll or further R&D equipment, effectively creating a “self-funding” mechanism for innovation.

The purchaser of the credit (the transferee) is usually a profitable corporation or an individual with a high state tax liability. The purchaser buys the credit at a discount—for example, paying $90,000 for $100,000 of tax credit. When the purchaser files their North Dakota income tax return, they apply the full $100,000 credit against their liability, realizing a $10,000 net benefit.

Eligibility Requirements for Credit Transfer

The North Dakota legislature has placed narrow guardrails around who can sell their tax credits. These restrictions ensure that the benefit targets small, emerging businesses in high-value sectors rather than serving as a tax-avoidance tool for larger entities or shell companies.

Entity-Level Restrictions

Only certain legal entities are permitted to sell, transfer, or assign the credit. The law explicitly limits this to:

• Individuals (Sole Proprietorships)
• C-Corporations
• Estates
• Trusts

Notably, passthrough entities such as Partnerships, S-Corporations, and LLCs (that have not elected C-Corp status) are excluded from the transfer provision. In these entities, the credit is passed through to the owners’ individual returns. If the owners have no liability, they cannot sell the credit at the entity level. This creates a strategic decision for startups: if the primary goal is credit transferability for liquidity, a C-Corporation structure may be preferable despite the potential for double taxation on future dividends.

Qualifying Criteria for the Seller (Transferor)

To be certified as a “Qualified Research and Development Company” capable of selling its credits, a taxpayer must meet all of the following requirements:

• Primary Sector Certification: The business must be certified by the Department of Commerce as a “primary sector business.” This means the business adds value to a product or service through the employment of knowledge or labor and results in the creation of new wealth.
• Revenue Cap: The company must have annual gross revenues of less than $750,000. This cap is strictly enforced; exceeding it in the year of transfer can disqualify the transaction.
• Post-2006 Research: The company must have conducted qualified research in North Dakota for the first time after December 31, 2006. Entities that were already conducting research in the state before this date are ineligible for the transfer provision.
• $100,000 Lifetime Limit: A qualified company may only sell, assign, or transfer up to a lifetime total of $100,000 of unused research credits. Once this threshold is reached, any additional credits earned must be used internally or carried forward.

Revenue Office Guidance: The Compliance Roadmap

The process of transferring a credit involves a multi-step interaction with two different state agencies: the North Dakota Department of Commerce and the Office of State Tax Commissioner. Precision in documentation is paramount.

Phase 1: Obtaining Certification (SFN 58638)

Before a sale can be negotiated, the taxpayer must be certified. This is accomplished by filing Form SFN 58638 with the Department of Commerce’s Division of Economic Development and Finance. The application package must include:

• A formal request for certification as a Qualified R&D Company.
• A one-page technical description of the research being performed.
• Federal income tax returns from the preceding three years (or proforma returns if part of a consolidated group).
• Proof of Primary Sector Business status.

If the company is a startup with less than one year of operation, it must provide projected revenue figures to demonstrate it will likely remain under the $750,000 cap. Upon approval, the Department of Commerce issues a certification letter to the taxpayer and a copy to the Tax Commissioner.

Phase 2: Executing the Transfer (Form CTS)

Once a buyer is found and a price is agreed upon, the transferor and transferee must jointly complete Form CTS, “Credit Transfer Statement.” This form is the legal nexus of the transaction and must be filed with the Tax Commissioner within 30 days of the date the purchase agreement is executed.

Key Data on Form CTS	Purpose
Tax Year Earned	Ensures the credit is within the 15-year window.
Credit Amount Transferred	Sets the face value of the tax offset for the buyer.
Gross Proceeds Received	Used to calculate the seller’s North Dakota income tax liability.
Confidentiality Waiver	Allows the Tax Dept to verify the underlying QREs with both parties.

Phase 3: Verification (Form 500)

Both parties are also required to file Form 500, a disclosure authorization that permits the Tax Department to share specific tax information between the buyer and seller. This is crucial for the “verification of the correctness” of the transferred credit. If the Tax Department audits the seller and determines that the research expenses were overstated, the buyer’s credit may be reduced, and the buyer will need to know why to seek recourse under their private purchase agreement.

Taxation of the Transfer: Implications for the Seller

One of the most frequent misconceptions regarding credit transfers is that the proceeds are “tax-free” grants. In reality, the sale of a state tax credit is treated as a taxable sale of property.

Federal Treatment

For federal purposes, the gross proceeds from the sale of the credit are generally includable in gross income. The basis in the tax credit is typically zero, meaning the entire sale price is recognized as a gain. Depending on the holding period and the nature of the company’s business, this may be treated as ordinary income or capital gain.

North Dakota Treatment

North Dakota law is even more specific. Under N.D.C.C. § 57-38-30.5, the entire amount of the gross proceeds received by the transferor must be assigned to North Dakota for taxation purposes. This means:

• The income cannot be apportioned to other states using the standard three-factor formula.
• The proceeds may not be reduced by any loss or deduction otherwise allowed for North Dakota income tax purposes.

Individuals who sell credits must use Schedule ND-1CS to calculate the tax on these proceeds. This schedule ensures the gain is isolated and taxed at the appropriate state rates, preventing the transferor from “washing” the gain against unrelated out-of-state losses.

The Transferee’s Perspective: Risks and Rewards

For the purchaser (transferee), the R&D credit represents an opportunity to reduce their effective tax rate. However, the law imposes strict limitations on the use of purchased credits compared to earned credits.

Usage Restrictions

A purchaser of a tax credit is bound by the same general rules that would have applied to the transferor, with two major exceptions:

• No Carryback: While the original earner of the credit can carry it back three years to get a refund of past taxes, the purchaser is prohibited from carrying back any portion of a purchased credit.
• No Re-sale: The credit can only be transferred once. The “original purchaser” is the end-user. They may not sell, assign, or further transfer the credit to a third party.

Audit Risk and the Purchase Agreement

Because the value of the credit depends on the validity of the seller’s research activities, the purchaser faces a unique “recapture” risk. If the Tax Commissioner conducts an audit of the transferor and determines the credit was improperly calculated, the amount of the credit available to the purchaser is adjusted.

To mitigate this, sophisticated purchasers typically require:

• Indemnification Clauses: The seller agrees to repay the buyer if the credit is invalidated.
• Escrow Accounts: A portion of the purchase price is held until the statute of limitations for an audit (typically 3-4 years) has passed.
• Property Tax Clearance: The buyer must ensure the seller has a valid “Property Tax Clearance Record” at the time of transfer, as state law requires this document for any major tax incentive claim.

Detailed Example: From Lab Bench to Liquid Capital

To visualize the practical application of these rules, let us follow a fictional North Dakota startup, Bismarck Bio-Refinery, Inc. (BBR), a certified primary sector C-Corporation.

Step 1: The Research Phase

In 2023, BBR spends $300,000 on “new” research aimed at converting wheat straw into a proprietary biodegradable plastic. All research is conducted at a facility in Grand Forks.

• 2023 QREs: $300,000
• Base Amount (Startup Method): $150,000 (50% of QREs)
• Excess QREs: $150,000

Credit Calculation (Regular Method):

• 25% of first $100,000 = $25,000
• 8% of remaining $50,000 = $4,000
• Total Credit Earned: $29,000

Step 2: Certification and Market Search

BBR has zero tax liability and only $100,000 in gross revenue from initial sample sales. They apply for and receive certification as a Qualified R&D Company via SFN 58638. They find a buyer, Red River Construction, which has a $50,000 North Dakota tax liability.

Step 3: The Transaction

Red River Construction agrees to buy the $29,000 credit at 85 cents on the dollar.

• Purchase Price: $24,650
• Execution Date: May 1, 2024
• Form CTS Filing: Jointly filed with the Tax Commissioner on May 15, 2024.

Step 4: Tax Reporting

• BBR (Seller): Receives $24,650 in cash. On their 2024 tax return, they report the full $24,650 as North Dakota income and pay the applicable tax.
• Red River (Buyer): On their 2024 North Dakota return, they apply the $29,000 credit against their $50,000 liability. They pay only $21,000 to the state. Their total cash outlay for that $29,000 tax “chunk” was only $24,650, resulting in a $4,350 net savings.

Economic Statistics and Impact Analysis

The North Dakota Research Expense Tax Credit is not merely a line item in the tax code; it is a measurable driver of the state’s economy. Legislative reviews conducted by the state provide a quantitative look at the program’s efficacy.

Claimant Demographics and Fiscal Outlay

During a ten-year review period (2007–2016), the program saw broad participation across different taxpayer types.

Taxpayer Category	Approximate Claims (2016 Tax Year)	Total Claim Value (2016)
Individuals	~1,700	$4,500,000
Corporations	~100	$500,000

The high number of individual claims is reflective of the “pass-through” nature of most North Dakota businesses. While only C-Corps and individuals can transfer the credit, thousands of owners of S-Corps and Partnerships utilize the credit directly on their individual returns.

GDP and Job Growth

Longitudinal economic modeling suggests the R&D credit provides a significant multiplier effect for the state. At the program’s peak, it was credited with the following impacts:

• Employment: 1,100 new jobs created.
• Population: 1,000 additional residents attracted to the state.
• GDP: Approximately $80 million in annual contributions to the state’s Gross Domestic Product.

From a purely fiscal perspective, the state projected that over 20 years, the credit would generate $213 million in new tax revenue from the increased economic activity, while the direct cost to the treasury in “foregone” tax revenue would be approximately $66 million. This positive ROI is a primary reason the credit remains a permanent fixture of North Dakota law.

Compliance Traps: Why Credits Are Disallowed

Despite the clear benefits, many taxpayers fail to successfully claim or transfer the credit due to administrative oversights. The Office of State Tax Commissioner is rigorous in its enforcement of the following “red flag” areas.

Failure to Obtain Property Tax Clearance

N.D.C.C. § 57-01-15.1 is an absolute barrier to incentive claims. If a taxpayer owns 50% or more of a property in any North Dakota county, they must attach a Property Tax Clearance Record to their return. This form proves the taxpayer is in good standing. Without it, the R&D credit is often automatically disallowed upon initial review, forcing the taxpayer into a lengthy and costly appeals process.

Misinterpreting “Primary Sector”

Many businesses believe they are primary sector companies because they provide services to the oil or agriculture industries. However, a “Primary Sector Business” must be the entity actually creating the value or wealth. A consulting firm that advises oil companies on how to be more efficient is generally a service provider, not a primary sector business. Conversely, a company that develops a proprietary chemical agent to enhance oil recovery is a primary sector business. Mis-categorizing the business on Form SFN 58638 will lead to an immediate rejection of the transfer certification.

The 30-Day Form CTS Deadline

The 30-day window to file Form CTS after executing a purchase agreement is strictly enforced. If the parties sign a contract on January 1st but wait until February 15th to file the statement, the Tax Department can refuse to recognize the transfer. This often requires the parties to “cancel” the original agreement and execute a new one, which can have cascading legal and tax-year implications.

Case Study: The “Valley of Death” Scenario

A common usage of the transferable credit is to bridge the gap between initial funding and commercialization—often called the “Valley of Death” in the startup world.

Basin Electric Power Cooperative provided testimony regarding a related issue: they had accumulated $10.3 million in research credits but had $1.6 million expire because they could not use them within the carryforward window due to massive depreciation deductions. This illustrates why transferability is so crucial for smaller players. If Basin Electric had been a small, qualified R&D company, they could have sold those expiring credits to another North Dakota taxpayer, recovering at least 80–90% of the value rather than letting it vanish.

Future Outlook: Legislative and Federal Changes

The landscape for R&D credits is currently shifting due to changes at the federal level. The “One Big Beautiful Bill Act” (OBBBA), signed into law in 2025, made several adjustments to federal tax law. While North Dakota’s income tax calculation begins with federal taxable income, the state’s R&D credit is calculated independently based on state-sourced expenses.

However, federal changes to “bonus depreciation” and the expensing of R&D costs (vs. amortization) can influence a company’s North Dakota taxable income, which in turn influences whether they need to sell their credits or can use them internally. As the federal environment becomes more favorable for capital investment, the “market price” for state tax credits may fluctuate as more companies find themselves with significant tax liabilities and a desire to purchase offsets.

Final Thoughts: Strategic Recommendations for Business Leaders

The North Dakota transferable research and development tax credit is a powerful, yet technically demanding, financial instrument. For primary sector startups, it represents one of the few ways to turn “tax math” into “bankable cash.”

To maximize the value of this provision, business leaders should adopt the following posture:

• Structure for Transferability: If a company is in its research phase, the C-Corporation model should be evaluated not just for its legal protections, but for its unique ability to sell R&D credits under N.D.C.C. § 57-38-30.5.
• Audit-Ready Documentation: Since the buyer’s value is contingent on the seller’s data, companies should maintain contemporaneous records that satisfy the federal “Four-Part Test” for every dollar spent.
• Strategic Market Timing: With a $100,000 lifetime cap, companies should time their sales for years when their cash-on-hand is lowest or when the market price for credits is highest.

By expertly navigating the guidance provided by the Department of Commerce and the Office of State Tax Commissioner, North Dakota businesses can ensure that their commitment to innovation is supported by the full weight of the state’s fiscal incentives, turning technical risks into enduring economic rewards.