Pure Research

Pure research in the Ohio regulatory framework refers to scientific or technological inquiry and experimentation in the physical sciences aimed at expanding fundamental knowledge without immediate commercial application. Within the state’s tax code, this definition serves to distinguish foundational scientific exploration from direct product development, qualifying specific investments for both high-value sales tax exemptions and incremental commercial activity tax credits.

The concept of pure research occupies a unique and often misunderstood position within the Ohio Revised Code (ORC). While many taxpayers view research and development (R&D) through the lens of tangible product creation—frequently referred to as “direct research”—Ohio law acknowledges that the precursor to such innovation is often the theoretical and experimental work conducted in the “hard” sciences. By providing a statutory home for pure research, Ohio creates an incentive structure that supports the entire innovation lifecycle, from the laboratory bench to the assembly line. This report explores the definition of pure research, its interaction with the Ohio Research and Development Investment Tax Credit and Sales Tax Exemption, the rigorous guidance provided by the Ohio Department of Taxation, and the strategic application of these laws in a professional corporate environment.

Defining Pure Research in the Ohio Statutory Context

The definition of “pure research” in Ohio is primarily derived from the administrative and statutory language governing the Research and Development Sales Tax Exemption, though its principles permeate the broader R&D tax credit landscape. Pure research is defined as scientific or technological inquiry and experimentation in the physical sciences. This is distinct from “direct research,” which Ohio defines as research conducted to design, create, or formulate new or better products, equipment, or processes.

The limitation to the “physical sciences” is a critical jurisdictional boundary. In the eyes of the Ohio Department of Taxation and the Ohio Revised Code, pure research does not encompass the social sciences, arts, or humanities. Instead, it focuses on the fundamental principles of biology, chemistry, physics, and engineering. This mirrors the federal requirement that research be “technological in nature,” relying on the hard sciences to resolve technical uncertainties.

Term	Statutory Definition	Practical Application
Pure Research	Scientific or technological inquiry and experimentation in the physical sciences.	Fundamental discovery, testing of theoretical hypotheses, basic science.
Direct Research	Research conducted to design, create, or formulate new or better products or processes.	Prototyping, engineering, process improvement, software development.

The relevance of pure research is most evident when analyzing the Research and Development Sales Tax Exemption under ORC Section 5739.011. This exemption applies to machinery and equipment used primarily for research and development activities in both direct and pure research. By including pure research, the state ensures that a biotech firm purchasing a high-resolution electron microscope for fundamental cellular inquiry receives the same tax relief as a manufacturer purchasing a 3D printer for prototyping.

The Ohio R&D Investment Tax Credit: Structural Mechanics

While the term “pure research” is a staple of the sales tax exemption, the primary mechanism for corporate tax relief in Ohio is the Research and Development Investment Tax Credit, authorized under ORC Section 5751.51 for the Commercial Activity Tax (CAT) and ORC Section 5726.56 for the Financial Institutions Tax (FIT).

The Federal Piggyback: IRC Section 41

The Ohio R&D investment credit is fundamentally tied to the federal definition of “qualified research expenses” (QREs) as set forth in Section 41 of the Internal Revenue Code (IRC). To receive the Ohio credit, a taxpayer must generally be allowed a federal research credit for the same taxable year. This “piggyback” structure simplifies the identification of qualifying activities but subjects the taxpayer to the rigorous “Four-Part Test” established by the IRS and adopted by Ohio.

Under IRC Section 41, pure research often manifests as “basic research,” which is defined as any original investigation for the advancement of scientific knowledge not having a specific commercial objective. Ohio’s reliance on IRC Section 41 implicitly includes these basic research payments within the scope of the CAT and FIT credits, provided the research is conducted in Ohio.

Incremental Calculation and the 7% Rate

The Ohio credit is not a flat percentage of all R&D spending. Instead, it is an incremental credit designed to reward companies for increasing their investment in Ohio-based innovation.

The credit is equal to 7% of the amount by which the taxpayer’s current-year qualified research expenses exceed their average annual QREs for the three preceding years.

The mathematical representation of the credit calculation is expressed as follows:

Where n is the current calendar year. If the taxpayer has no prior history of QREs in Ohio, the average is considered $0, making the entire amount of current-year QREs eligible for the 7% credit. This structure is particularly beneficial for startups or companies relocating their R&D operations to Ohio.

State Revenue Office Guidance: The Ohio Department of Taxation

The Ohio Department of Taxation (ODT) provides the administrative “rails” upon which these statutory credits run. Their guidance, issued through Information Releases, Administrative Rules, and Final Determinations, is the definitive source for how the law is applied during audits and compliance reviews.

Administrative Rules and the Calendar Year Requirement

A critical piece of guidance is found in Ohio Administrative Code (OAC) Rule 5703-29-22, which explains the commercial activity tax credits. A fundamental requirement highlighted in this rule is that the credit must be computed based on expenses incurred during the calendar year, regardless of the taxpayer’s federal taxable year. This can create significant reconciliation work for fiscal-year taxpayers who must “carve out” their Ohio expenses to align with the January-to-December reporting period of the CAT.

Information Release CAT 2007-03

This release, which has been updated over the years, clarifies the mechanics of claiming the credit and the order in which credits must be applied. The CAT R&D credit is nonrefundable, meaning it can only be used to reduce tax liability to zero; it cannot result in a refund check from the state.

If the credit exceeds the tax due for a particular year, the unused portion may be carried forward for up to seven years. Information Release CAT 2007-03 emphasizes that the order of credits is strictly defined by ORC Section 5751.98 to prevent taxpayers from losing credits with shorter carryforward periods first.

Credit Priority	Credit Name	Carryforward Period
Nonrefundable	Jobs Retention Credit	3 Years
Nonrefundable	Qualified Research Expenses Credit	7 Years
Nonrefundable	R&D Loan Payment Credit	No Limit (up to loan term)
Refundable	Jobs Creation Credit	N/A (Refundable)

The “Incurred in Ohio” Geographical Limitation

A recurrent theme in ODT guidance and Board of Tax Appeals cases is the strict geographical limitation of the credit. Unlike the federal credit, which allows expenses incurred throughout the U.S., the Ohio credit requires that the qualified research expenses be “incurred in this state”.

In Cristal USA, Inc. v. McClain (2020), the Tax Commissioner issued a final determination reinforcing that even if a taxpayer receives a federal QRE credit, they are not automatically entitled to the Ohio credit. The taxpayer must affirmatively demonstrate that the specific activities giving rise to those expenses occurred within the borders of Ohio. This is particularly challenging for companies with multi-state research teams, as payroll must be meticulously apportioned based on where the work was actually performed, not where the employee is domiciled.

Pure Research vs. Direct Research: Application of the Law

To understand how pure research applies to the law, one must look at the interplay between the hard sciences and the “Four-Part Test.” Ohio Law, through its adoption of federal standards, requires research to meet four criteria to be considered “qualified.”

1. The Section 174 Test (Uncertainty)

The research must involve activities where the expenditures may be treated as expenses under IRC Section 174. This requires that the research be intended to eliminate uncertainty concerning the development or improvement of a “business component”.

In the context of Pure Research, this uncertainty often relates to the capability or method of achieving a result in the physical sciences. For example, a company studying the properties of a new composite material at a molecular level is conducting pure research. The uncertainty lies in how those molecules will behave under stress—a fundamental scientific question that precedes any product design.

2. The Technological Information Test (Hard Sciences)

The research must be undertaken for the purpose of discovering information that is “technological in nature”. This means the process of experimentation must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science.

Pure research, by its very definition in Ohio law (inquiry in the physical sciences), satisfies this test inherently. It is the quintessence of technological information, as it seeks to expand the knowledge of the physical world through the scientific method.

3. The Business Component Test

The taxpayer must intend to apply the information discovered to develop a new or improved business component (product, process, software, formula, or invention).

This is where pure research and the tax credit can sometimes clash. Pure research, if conducted purely for the sake of knowledge with no intent to ever apply it to a business component, would not qualify for the investment tax credit. However, most industrial pure research is conducted with the intent of eventually applying those scientific discoveries to a product or process. As long as that intent exists at the outset, the work qualifies.

4. The Process of Experimentation Test

Substantially all of the research activities must constitute elements of a process of experimentation. This involves the systematic evaluation of alternatives through modeling, simulation, or trial-and-error testing.

Pure research is almost by definition a process of experimentation. Whether it is titration in a chemistry lab or stress-testing a new alloy, these activities involve identifying a hypothesis, testing it against alternatives, and refining the result.

The Sales Tax Exemption: A Deeper Dive into ODT Guidance

For many Ohio businesses, the Research and Development Sales Tax Exemption is more valuable than the investment credit because it provides an immediate 100% exemption on capital expenditures.

Definition of Qualified Equipment

ODT guidance, specifically in the context of the manufacturing and R&D exemptions, clarifies that “qualified research and development equipment” includes capitalized tangible personal property used by the consumer “primarily” in a research and development activity. “Primarily” is defined as more than 50% of the time.

This creates a high bar for “dual-use” equipment. If a computer is used 40% of the time for R&D (pure or direct) and 60% of the time for general administrative work, it is 100% taxable. Conversely, if it is used 60% for pure research and 40% for admin, it is 100% exempt.

The “Testing” Distinction

A common pitfall in ODT audits involves the distinction between R&D and quality control testing. Under OAC Rule 5703-9-21, equipment used for “testing” is generally taxable unless that testing is performed on a product, equipment, or manufacturing process that is currently being created or designed.

Pure research activities often involve testing to discover fundamental properties. ODT guidance clarifies that if the testing is part of the “inquiry and experimentation in the physical sciences,” it is exempt as pure research. However, if the testing is performed on finished products to ensure they meet customer specifications (quality control), it is taxable.

Audit and Compliance: The Evolving Landscape

The 135th General Assembly significantly amended ORC Section 5751.51 through House Bill 33, primarily to strengthen the ODT’s audit capabilities.

Audit Sampling and Good Faith Efforts

The ODT is now statutory authorized to “audit a sample of the taxpayer’s qualified research expenses over a representative period”. While the Commissioner is required to make a “good faith effort” to reach an agreement with the taxpayer on what constitutes a representative sample, the Commissioner is not precluded from proceeding even if no agreement is reached. This shift places a premium on contemporaneous documentation, as a single poorly documented project in a sample can be extrapolated to disqualify a much larger portion of the credit.

Record Retention Requirements

Both the CAT and FIT statutes impose strict record retention requirements for R&D credits.

Record Type	Retention Period	Content Required
Current Year QREs	4 Years from Filing Date	Payroll records, supply invoices, project descriptions, time logs.
Base Period QREs	4 Years from Filing Date	Documentation for the 3 preceding years used to calculate the average.
Exemption Certs	4 Years	Copies of all Blanket Exemption Certificates provided to vendors.

Failure to maintain these records is often cited in Final Determinations as the primary reason for credit denial, even if the research activities were legitimate.

The Role of Combined and Consolidated Groups

Ohio’s Commercial Activity Tax allows for two types of group filings: Combined and Consolidated. The R&D credit application differs slightly between them.

In a Consolidated Elected Taxpayer group, all members (including those with less than 50% common ownership if elected) are treated as a single taxpayer. However, ORC Section 5751.51(C) requires that “each person in the taxpayer’s group shall separately calculate the credit” using the QREs incurred by that specific person. This means the 3-year average base must be calculated at the entity level before being aggregated into the group credit.

In a Combined Taxpayer group (mandatory for members with >50% common ownership who do not elect to consolidate), the same entity-level calculation applies. The distinction is that combined groups only report receipts from outside the group, whereas consolidated groups exclude all inter-company receipts. Because the R&D credit is based on expenses, not receipts, the choice between combined and consolidated filing rarely impacts the generation of the credit, but it significantly impacts the utilization of the credit against the group’s total tax liability.

Comprehensive Example: The “Physical Sciences” Laboratory Case Study

To clarify the intersection of pure research, investment credits, and sales tax exemptions, consider the following comprehensive example involving a fictional Ohio company, Novus Chemia, LLC.

The Entity and Context

Novus Chemia is a mid-sized chemical manufacturer based in Columbus, Ohio. The company is a C-Corporation subject to the Commercial Activity Tax. In 2024, Novus Chemia embarks on a multi-year project to develop a new class of fire-retardant polymers.

Phase 1: Pure Research (Laboratory Inquiry)

In the first half of 2024, Novus Chemia’s scientists conduct fundamental inquiry into the molecular interaction between bromine-free compounds and synthetic fibers. They are not building a product yet; they are testing scientific theories in the physical sciences to see if fire suppression is even possible without traditional halogens.

• Sales Tax Application: Novus Chemia purchases a $250,000 mass spectrometer to analyze chemical bonds during this phase. Because the spectrometer is used >50% of the time for this “scientific inquiry in the physical sciences,” the purchase is 100% exempt from Ohio sales tax.
• Credit Application: The wages paid to the PhD chemists conducting these tests are qualified in-house research expenses. Even though this is “pure research,” it meets the Four-Part Test because there is technical uncertainty and the intent is to eventually use the knowledge for a fire-retardant product.

Phase 2: Direct Research (Prototyping)

In the second half of 2024, having discovered a viable compound, the team begins formulating a specific spray-on coating for aircraft seats. This is “direct research” as it involves creating a new product.

• Sales Tax Application: The company buys a pilot-scale application booth for $100,000 to test the coating. This equipment is also exempt, as direct research is a qualifying activity.
• Credit Application: Supply costs for the prototype chemicals and the fabrics consumed during testing are included as QREs.

Phase 3: The Credit Calculation

At the end of 2024, Novus Chemia tallies its Ohio QREs:

• Wages (Chemists & Lab Assistants): $800,000
• Supplies (Chemicals & Fabrics): $150,000
• Contract Research (65% of $100,000 paid to Ohio State University for specialized testing): $65,000
• Total 2024 Ohio QREs: $1,015,000

Novus Chemia’s historical Ohio QREs are:

• 2021: $700,000
• 2022: $750,000
• 2023: $800,000
• 3-Year Average Base: $750,000

Calculation:

Novus Chemia will report $18,550 on its CAT return. If the company’s total CAT liability for the year is $15,000, it will use $15,000 of the credit to eliminate its tax and carry forward the remaining $3,550 for up to seven years.

Inter-Program Synergies: JobsOhio and R&D Loans

Strategic tax planning in Ohio often involves more than just claiming the R&D investment credit. The state offers a unique synergy between tax credits and low-interest financing through the Research and Development Investment Loan Fund, administered in partnership with JobsOhio.

The R&D Investment Loan

This fund provides loans between $1 million and $5 million for projects primarily engaging in R&D activity. While the interest rates are market-competitive, the true value lies in the Borrower’s Qualified Research and Development Loan Payment Credit.

Under ORC Section 5751.52, a taxpayer can claim a dollar-for-dollar, non-refundable CAT credit for all principal and interest payments made during the year on a qualified R&D loan. This credit effectively makes the loan “interest-free” and subsidizes the principal repayment, provided the company has sufficient CAT liability to offset.

This loan repayment credit is separate from, and can be claimed in addition to, the standard 7% incremental R&D investment credit. For a company investing $5 million in a new “pure research” facility, the combined impact of the 7% credit, the sales tax exemption, and the loan repayment credit can represent a recovery of 30-40% of the project’s total cost over the loan term.

Future Outlook: Legislative and Administrative Trends

The Ohio R&D landscape is currently being shaped by two divergent forces: the expansion of audit authorities and the significant reduction in the number of businesses subject to the CAT.

The Impact of House Bill 33 (2023)

As discussed, HB 33 increased the exclusion threshold for the CAT to $3 million in 2024 and $6 million in 2025. This change is a “double-edged sword” for R&D tax planning. On one hand, it eliminates the CAT liability for thousands of small and mid-sized businesses, rendering the nonrefundable R&D credit moot for those entities. On the other hand, for companies that do exceed these thresholds, the ODT has been given more powerful tools to audit those who remain.

Practitioners expect the ODT to focus its audit resources on high-value R&D claims from the state’s largest manufacturers and technology firms. This means that “pure research” claims—which often involve high equipment costs and specialized labor—will likely receive increased scrutiny. Companies must be prepared to defend the “scientific inquiry” nature of their work and provide proof that the inquiry fundamentally relied on the physical sciences.

Convergence with Federal Changes (IRC Section 174 Amortization)

A significant shadow over the R&D landscape is the federal requirement, effective for tax years beginning after December 31, 2021, that R&D expenses (including pure research costs) be capitalized and amortized over 5 years (for domestic research) or 15 years (for foreign research) rather than being immediately expensed.

While this is a federal income tax change, it has ripple effects in Ohio. Because Ohio’s QRE definition is tied to IRC Section 41—which in turn relies on IRC Section 174—the federal reclassification of certain costs may impact how ODT views those same costs during an audit. Some practitioners argue that “pure research” contracts, where the contractor gains only “mere know-how” rather than a commercial product, might be a way to navigate the new Section 174 amortization burdens, provided the contract is structured correctly.

Final Thoughts and Tactical Recommendations

Pure research in Ohio is more than a theoretical concept; it is a statutory pillar that supports the earliest, riskiest stages of the innovation cycle. By providing explicit definitions and high-value exemptions, the Ohio Revised Code incentivizes businesses to anchor their fundamental scientific inquiry within the state.

To maximize the benefits of these laws while minimizing audit risk, professional taxpayers should adopt the following tactical measures:

1. Segment Pure and Direct Research: In project management systems, explicitly flag activities that qualify as “inquiry in the physical sciences” to streamline sales tax exemption claims.
2. Verify the “Physical Sciences” Nexus: Ensure that laboratory work is anchored in biology, chemistry, or physics, and be prepared to defend this nexus if the research has a high degree of abstraction.
3. Contemporaneous Documentation: Maintain project descriptions that explicitly identify the “technical uncertainty” being addressed, the “physical science” principles relied upon, and the “process of experimentation” used.
4. Audit Sample Readiness: Given ODT’s new sampling authority, ensure that every project claimed as a QRE is documented as if it were the primary subject of an audit.
5. Strategic Financing: For large-scale R&D capital investments, prioritize JobsOhio R&D loans to capture the dollar-for-dollar CAT repayment credit, which can significantly enhance the net present value of the project.

In summary, the Ohio R&D tax ecosystem is a sophisticated machine with many moving parts. By mastering the nuanced meaning of pure research and its application within the CAT, FIT, and sales tax frameworks, Ohio businesses can secure a substantial competitive advantage in an increasingly complex global innovation market.