Technological in nature refers to research activities that fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science to discover information intended for a new or improved business component. This standard ensures that tax incentives are reserved for hard-science innovation, excluding activities based on soft sciences, aesthetic design, or routine business management.
The North Dakota Research Expense Tax Credit, codified under North Dakota Century Code (N.D.C.C.) § 57-38-30.5, represents a sophisticated legislative mechanism designed to foster a high-technology industrial base within the state. By tethering state definitions to Section 41 of the Internal Revenue Code (IRC), the North Dakota Legislative Assembly has created a framework that is both familiar to national tax practitioners and specifically tailored to the state’s economic priorities, such as agriculture, energy, and unmanned aircraft systems. The “technological in nature” requirement serves as the qualitative anchor of this credit, functioning as a gatekeeper to ensure that the “process of experimentation” conducted by a taxpayer is rooted in rigorous scientific inquiry rather than subjective or purely commercial pursuits. For a North Dakota business to successfully navigate an audit of its research activities, it must demonstrate that the challenges it overcame were not merely business obstacles, but technical uncertainties that required the application of hard-science principles. This standard distinguishes the state’s research credit from other economic development incentives, such as the automation credit or the seed capital investment credit, by focusing specifically on the intellectual labor of discovery and technical improvement.
Historical and Statutory Evolution of N.D.C.C. § 57-38-30.5
The legal architecture of the North Dakota research credit has undergone significant transformation since its inception in 1987. Understanding this evolution is critical for practitioners, as the “technological in nature” standard has been interpreted through varying legislative lenses over nearly four decades. The credit was originally established through House Bill No. 1645, which sought to replicate the successful economic stimulation observed in Minnesota’s technology sector. At that time, the credit was relatively modest and focused primarily on corporate entities.
The Original Framework and Early Adjustments
The 1987 legislation introduced a corporate income tax credit equal to 8 percent of the first $1.5 million of North Dakota qualified research expenses (QREs) in excess of a base amount, and 4 percent of any amount exceeding that threshold. While the fundamental definition of “qualified research” was already linked to the federal IRC, the state’s administrative infrastructure for verifying the “technological in nature” status of claims was in its infancy. Subsequent amendments in 1993 through Senate Bill Nos. 2222 and 2223 further refined the application of the credit, but it remained a primarily corporate tool until the landmark changes of 2007.
The 2007 Restructuring and the Expansion of Eligibility
The passage of House Bill Nos. 1412 and 1018 in 2007 marked the most significant restructuring in the credit’s history. These bills expanded the credit’s availability to passthrough entities—such as S corporations, partnerships, and limited liability companies—and individual income taxpayers. This expansion was driven by a legislative realization that much of North Dakota’s innovation was occurring within smaller, entrepreneurial firms rather than large, established corporations. By allowing individual owners to claim their proportional share of the credit, the state incentivized a broader range of technical activities, particularly in emerging sectors like software development and ag-tech.
| Legislative Milestone | Key Change Introduced | Economic Policy Goal |
|---|---|---|
| 1987 HB 1645 | Established credit at 8% and 4% tiers | Encourage corporate R&D and diversification |
| 2007 HB 1412/1018 | Expanded to passthrough entities and individuals | Support startups and entrepreneurial innovation |
| 2009 HB 2207 | Safeguarded federal definitions from expiration | Maintain stability regardless of federal changes |
| 2017 Uniformity | Created uniform “primary sector business” definition | Streamline certification for transfers |
| 2019 ASC Method | Introduced Alternative Simplified Computation | Simplify filing for companies without long histories |
The 2007 amendments also introduced the concept of “transferability” for qualified research and development companies. This provision allowed certified small businesses to sell their unused credits to other taxpayers, providing essential cash flow for firms that were “technological in nature” but not yet profitable enough to have a significant tax liability.
The Four-Part Test: The Structural Context of Technology
The North Dakota Office of State Tax Commissioner utilizes the federal “four-part test” as the definitive rubric for evaluating research activity. For any project to qualify, it must satisfy all four criteria concurrently. The “technological in nature” requirement functions as the second prong, but its validity is often dependent on the context established by the other three prongs.
The Permitted Purpose Requirement
The research must be directed toward a “business component,” which includes any product, process, software, technique, formula, or invention that the taxpayer intends to hold for sale, lease, or license, or use in its own trade or business. The purpose of the activity must be to improve the functionality, performance, reliability, or quality of that component. In North Dakota, this often manifests in the energy sector, where a company might attempt to improve the “reliability” of a carbon capture system. If the purpose of the activity is purely aesthetic or related to market feasibility, it fails this first test and, by extension, renders the “technological in nature” inquiry moot.
The Technological in Nature Requirement
As the focus of this analysis, this prong requires that the research discovery process fundamentally rely on the “hard sciences”. The Office of State Tax Commissioner follows federal treasury regulations which specify that the process of experimentation must be based on engineering, physics, chemistry, biology, or computer science.
A critical nuance in this standard is the “discovery” of information. Historically, the “Discovery Test” required that the information be “new to the world”. However, modern standards applied in North Dakota only require that the information be “new to the taxpayer”. This allows a North Dakota manufacturer to qualify for the credit by developing a proprietary technical process that is new to their specific operations, even if a similar process is used by a competitor, provided that the taxpayer had to engage in their own technological experimentation to achieve it.
The Elimination of Uncertainty
The taxpayer must demonstrate that they faced “technological uncertainty” at the project’s inception. Uncertainty exists if the information available to the taxpayer does not establish either the capability or method for developing the business component, or the appropriate design of that component. For a claim to be robust, this uncertainty must be technical rather than economic. For example, a North Dakota ag-tech firm might be uncertain if a specific drone sensor can accurately measure soil moisture through dense crop canopies—this is a technical uncertainty. Uncertainty about whether farmers will buy the sensor is an economic uncertainty and does not support an R&D claim.
The Process of Experimentation
Finally, the taxpayer must engage in a “process of experimentation” designed to evaluate one or more alternatives to achieve a result where the capability, method, or design was initially uncertain. This process typically involves modeling, simulation, systematic trial and error, or other scientific methods. The “technological in nature” standard is the lens through which this experimentation is viewed; the trial and error must be based on the hard sciences. If a company tests different colors for a product’s user interface to see which one “looks better,” they are engaging in a process of experimentation, but it is not technological in nature because it relies on aesthetic preference rather than computer science or physics.
Deep Dive: Hard Science vs. Soft Science in State Audits
The distinction between hard and soft sciences is the primary battleground in state revenue office audits of research credits. The North Dakota Tax Commissioner provides clear, though often rigorous, boundaries on what constitutes a hard science.
The Domain of Engineering and Physical Sciences
Engineering is the most common foundation for research credit claims in North Dakota’s manufacturing and energy sectors. This includes mechanical, electrical, chemical, and civil engineering. When a company in the Bakken oil fields develops a new drill bit alloy or a proprietary fracking fluid, the underlying science is metallurgy (physics) or fluid dynamics (physics/engineering). These are quintessentially technological in nature. Similarly, chemical engineering plays a vital role in North Dakota’s biodiesel and ethanol industries, where the development of new catalyst processes for fuel refining is a primary driver of R&D expenditures.
The Domain of Computer Science
In the digital era, computer science has become a leading “hard science” for North Dakota R&D claims, particularly in Fargo’s growing tech corridor. However, the state distinguishes between “software engineering” and “routine programming”. To be technological in nature, software development must involve the creation of new algorithms, the improvement of system architecture, or the resolution of complex integration challenges that are not solvable through standard, commercially available coding practices. The use of standard web development tools to build a basic e-commerce site is not considered technological in nature because it does not involve a process of experimentation based on computer science principles; it is merely the application of existing technology.
Explicit Exclusions: The Soft Science Barrier
North Dakota law and guidance explicitly exclude several categories of research because they fail the technological in nature test:
- Social Sciences: Research rooted in psychology, sociology, or human behavior is disqualified. For instance, a fintech company studying how user behavior changes with different notification sounds is performing social science research, not hard science.
- Management Studies: Activities aimed at improving office efficiency or organizational structure are non-technological.
- Market Research: Any study related to consumer preference, market size, or economic feasibility is excluded.
- Aesthetic and Style Design: Research focused on the look, feel, or taste of a product (e.g., the flavor profile of a new food product or the silhouette of a piece of furniture) is considered a non-technological activity.
| Qualifying Hard Science | Non-Qualifying Soft Science / Activity |
|---|---|
| Mechanical Engineering | Aesthetic Product Design |
| Molecular Biology | Consumer Taste Testing |
| Software Architecture | Market Feasibility Studies |
| Chemical Synthesis | Management Efficiency Training |
| Physics/Thermodynamics | Routine Quality Control |
Administrative Guidance and Filing Procedures
The North Dakota Office of State Tax Commissioner is the primary authority for administering the credit, while the North Dakota Department of Commerce manages the certification processes required for specific enhanced benefits. For a business to successfully claim the credit, it must adhere to a strict set of filing requirements and maintain contemporaneous documentation that supports the “technological in nature” status of its projects.
Standard Filing Requirements
The credit is claimed when filing the North Dakota income tax return. Taxpayers are required to attach a schedule or worksheet that details the computation of the credit. While the state does not have a single dedicated form that mirrors federal Form 6765 for all taxpayers, it requires specific schedules based on filing status.
| Taxpayer Type | Form to be Filed |
|---|---|
| Individual / Sole Proprietor | Schedule ND-1TC |
| C Corporation | Form 40, Schedule TC or CR |
| S Corporation | Form 60, Schedule K |
| Partnership | Form 58, Schedule K |
| Estate or Trust (Fiduciary) | Form 38, Schedule 38-TC |
The Certification Process for Primary Sector Businesses
For businesses seeking to transfer or sell their credits, the administrative burden increases significantly. This process involves the Department of Commerce and is designed to ensure that only “primary sector” businesses—those that add value to a product or process through technical innovation—receive these benefits.
- Primary Sector Certification: The business must first be certified as a primary sector business by the Department of Commerce.
- R&D Company Certification: The business must then apply for certification as a “Qualified Research and Development Company”. This requires proving that the company has annual gross revenues of less than $750,000 and has not conducted R&D in the state prior to 2007.
- Form CTS (Credit Transfer Statement): Once certified, the seller and the purchaser must jointly file Form CTS within 30 days of the execution of a transfer agreement. This form allows the Tax Commissioner to disclose specific tax information between the parties to verify the correctness of the transfer.
Audit Defense and Documentation Standards
In the event of an audit, the North Dakota Tax Commissioner requires “adequate documentation” to substantiate that the activities were technological in nature. The revenue office follows federal standards, which prioritize contemporaneous records over retrospective testimony. Key documentation includes:
- Project Lists and Descriptions: A comprehensive list of every project claimed, with a detailed technical summary of the scientific principles applied and the uncertainties encountered.
- Technical Documents: Blueprints, CAD models, lab reports, testing logs, and research protocols that prove a systematic process of experimentation took place.
- Personnel Records: Time-tracking data or “nexus” documentation that links specific employee hours to qualified research activities.
- Supply Invoices: Proof that materials were used specifically in the experimental phase of a project.
Calculation Methodologies: Determining the Value of Technology
The North Dakota research credit offers two primary methods for calculation: the Regular Method and the Alternative Simplified Computation (ASC). A taxpayer may choose on a year-to-year basis which method to use, providing flexibility for companies with fluctuating research budgets.
The Regular Method
The Regular Method is based on the excess of qualified research expenses over a “base amount”. The base amount is calculated using historical North Dakota gross receipts and research spending patterns.
- 25 percent of the first $100,000 in excess QREs.
- 8 percent of any excess QREs above $100,000.
This tiered structure is particularly advantageous for small to mid-sized innovation projects, as the 25 percent rate is one of the highest initial rates in the United States.
The Alternative Simplified Computation (ASC) Method
Introduced for tax years beginning after 2018, the ASC method mirrors the federal ASC and is often used by companies that lack the historical data required for the regular method.
- The credit is based on the amount by which current-year QREs exceed 50 percent of the average QREs from the preceding three years.
- 17.5 percent of the first $100,000 of “alternative excess”.
- 5.6 percent of alternative excess over $100,000.
If a company has zero research expenses in any of the three preceding years, a special “new researcher” rate applies: 7.5 percent of the first $100,000 and 2.4 percent of the remainder.
| Calculation Method | Tier 1 Rate (First $100k) | Tier 2 Rate (Excess) | Base Definition |
|---|---|---|---|
| Regular Method | 25% | 8% | Fixed-base % x avg. receipts |
| ASC Method | 17.5% | 5.6% | 50% of 3-yr avg. QREs |
| ASC (New Researcher) | 7.5% | 2.4% | N/A – applied to total QREs |
The Industry Context: Applying the Standard in North Dakota
The application of the “technological in nature” standard varies significantly across North Dakota’s key economic sectors. The state’s revenue office and Department of Commerce have developed nuanced understandings of how research manifests in these specific domains.
Agricultural Innovation and “Field Research”
Agriculture is the backbone of North Dakota’s economy, and much of the state’s innovation occurs in the field or the barn. For a farmer or ag-tech company to claim the credit, their work must go beyond standard crop management.
Qualifying Example: Drought-Resistant Seed Development. A North Dakota seed company develops a new variety of durum wheat specifically designed for the arid soil of the western part of the state. The project involves cross-breeding based on genetic markers (Biology) and controlled testing of water uptake rates (Physics/Biology). This is clearly technological in nature.
Non-Qualifying Example: New Equipment Purchase. A farmer buys a new combine with advanced GPS and auto-steer capabilities. While the machine is “technological,” the farmer did not conduct the research; they are the end-user of someone else’s R&D. Furthermore, the purchase of depreciable equipment is generally excluded from qualified research expenses.
Energy Sector: Carbon Capture and Efficiency
North Dakota’s energy industry—including oil, gas, and lignite coal—is a heavy user of the R&D credit. Much of this work is focused on reducing environmental impact or improving extraction efficiency in the Bakken formation.
Qualifying Example: Carbon Solvent Research. A power cooperative in North Dakota experiments with a new chemical solvent intended to capture CO2 emissions from coal-fired plants more efficiently. The team evaluates different chemical concentrations and thermal profiles to see which captures the most gas with the least energy input (Chemical Engineering/Thermodynamics). This project satisfies the “technological in nature” standard because the experimentation is rooted in chemistry and mechanical engineering.
Unmanned Aircraft Systems (UAS): The Drone Frontier
North Dakota is a national leader in UAS technology, hosting major test sites and business parks. Research in this sector is almost always technological in nature.
Qualifying Example: Autonomous Navigation Algorithms. A Fargo-based drone company develops a new software system that allows drones to navigate safely in high-wind conditions without GPS. The process involves developing complex flight-logic algorithms (Computer Science) and testing how the drone’s sensors react to different wind vectors (Physics/Aeronautical Engineering). This project meets all prongs of the four-part test, with a heavy emphasis on computer science as the “hard science” foundation.
Economic and Fiscal Impact: Measuring the Policy’s Success
The North Dakota research credit is more than just a tax benefit; it is a measured economic policy with documented outcomes. The state periodically reviews the fiscal impact of these incentives to ensure they are providing a positive return on investment for taxpayers.
GDP and Job Creation Statistics
A comprehensive review conducted by the interim Taxation Committee in 2017-2018 provided significant data on the credit’s performance:
- Annual GDP Contribution: The credit is estimated to contribute approximately $80 million per year to North Dakota’s gross domestic product.
- Job Creation: The incentive has been credited with adding roughly 1,100 high-paying jobs to the state’s economy, primarily in professional, scientific, and technical services.
- Population Growth: The credit was estimated to have added approximately 1,000 individuals to the state’s population through the recruitment of engineers, scientists, and software developers.
Fiscal Cost and Revenue Generation
Over a 20-year period, the state analyzed the direct and indirect costs of the research credit:
- Direct Cost: The state issued approximately $66 million in credits over two decades.
- Revenue Generation: During the same period, the economic activity stimulated by the credit resulted in approximately $213 million in new state revenue.
- Net Impact: While the credit resulted in a net liability of roughly $30 million for the state budget when accounting for the increased costs of a larger population (schools, infrastructure), it was deemed to have a significantly positive impact on the overall private-sector economy.
| Economic Indicator | Estimated Impact (Historical Review) |
|---|---|
| Annual GDP Contribution | $80,000,000 |
| Total Jobs Created | 1,100 |
| Direct State Credit Cost (20-yr) | $66,000,000 |
| Total Revenue Resulting (20-yr) | $213,000,000 |
| 2016 Individual Claims | $4,500,000 |
| 2016 Corporate Claims | $500,000 |
These statistics demonstrate that the “technological in nature” standard, while a hurdle for taxpayers, ensures that state funds are effectively targeted toward activities that produce real economic growth and high-value employment.
Contemporary Challenges: Section 174 Amortization and the 2024 Outlook
The most pressing issue facing North Dakota research credit claimants today is the change to IRC Section 174 amortization rules. Because North Dakota law is closely tied to the IRC, federal changes have a direct “ripple effect” on state filings.
The Shift from Expensing to Amortization
Beginning in tax year 2022, the Tax Cuts and Jobs Act (TCJA) mandate required that research and experimental (R&E) expenditures no longer be fully deducted in the year they are incurred. Instead, taxpayers must now capitalize and amortize these costs over five years for domestic research and 15 years for foreign research.
This change has significant implications for the “technological in nature” standard:
- Increased Documentation: Because costs must now be tracked and amortized over multiple years, the importance of documenting the “technological” start and end dates of a project has increased.
- Cash Flow Pressure: For North Dakota startups, the inability to immediately expense research costs creates a higher tax burden in the short term, making the research credit—and especially its transferability—even more critical for survival.
The 2024 Legislative Environment
The “One Big Beautiful Bill Act” (OBBBA) and other proposed federal legislation seek to restore the full expensing of research costs. North Dakota practitioners must monitor these changes, as the state legislature has historically moved to safeguard state definitions from federal turbulence. The 2024 North Dakota “Red Book” indicates that while corporate income tax collections remain a stable part of the state’s revenue mix (accounting for approximately 5.5% of net collections in the 2023-2025 biennium), the state remains committed to using tax incentives to maintain its competitive edge in the regional economy.
Final Thoughts
The North Dakota Research Expense Tax Credit, through its rigorous “technological in nature” standard, provides a robust framework for incentivizing high-value innovation. This standard ensures that the state’s financial resources are directed toward activities that fundamentally advance the physical and biological sciences, engineering, and computer science. By requiring a process of experimentation rooted in these hard sciences, North Dakota maintains a credit that is both defensible and economically impactful.
For businesses operating in the state, the credit represents a significant opportunity to offset the high costs of technical discovery. The tiered rate structure, combined with the innovative transferability provisions for small primary sector businesses, makes North Dakota one of the most attractive states for technological entrepreneurship. However, the path to successfully claiming and defending these credits requires a deep understanding of both state and federal laws, a commitment to contemporaneous documentation, and a clear distinction between routine business improvements and genuine scientific inquiry.
As the state’s economy continues to evolve, the “technological in nature” standard will serve as the enduring benchmark for progress. Whether it is a new carbon capture method in the western coal fields, a drought-resistant crop in the Red River Valley, or an autonomous flight system in Grand Forks, the ingenuity of North Dakota’s businesses is the true driver of the state’s future. By adhering to the principles of the hard sciences, these innovators not only secure their own financial viability but also contribute to the long-term prosperity and technical sophistication of the entire state.
