Direct conduct of research denotes the hands-on performance of activities intended to discover technological information that eliminates technical uncertainty regarding the development or improvement of a semiconductor business component. Within the Oregon Research and Development Tax Credit for Semiconductors, this term identifies the primary tier of qualified services performed by employees physically engaged in the technical process of experimentation.

The technical meaning of direct conduct of research is derived from a complex intersection of federal standards and state-specific statutory mandates. At its core, direct conduct involves the actual performance of the scientific method or engineering development required to resolve a technical challenge. This is distinct from the mere management of a project or the administrative support of a laboratory. Under the federal framework of Internal Revenue Code (IRC) § 41, which Oregon adopts by reference, direct conduct is the “Tier 1” of qualified services. It requires that the individual be the one physically or logically interacting with the subject of the research—whether that be a circuit design, a chemical etching process, or a software algorithm—to evaluate alternatives through a systematic process of trial and error. This classification is pivotal because it forms the baseline for calculating qualified research expenses (QREs), which are the expenditures eligible for the 15 percent Oregon tax credit.

The implementation of this definition in Oregon is uniquely tailored to the semiconductor industry following the passage of Enrolled House Bill 2009 in 2023. For an activity to constitute direct conduct in this context, it must not only meet the general federal criteria for research but must also support a trade or business directly related to semiconductors, conducted by a qualified semiconductor company within the geographic boundaries of the state. The detailed analysis of this term necessitates an exploration of the legislative evolution, the administrative rules promulgated by Business Oregon and the Department of Revenue, and the rigorous substantiation requirements established by both state and federal precedents.

Legislative Evolution and the Semiconductor Mandate

The current regulatory environment for research and development in Oregon is the result of a deliberate policy shift toward sector-specific incentivization. From 1989 until 2017, Oregon maintained a general corporate tax credit for qualified research activities, commonly referred to as the Oregon R&D credit. This legacy credit was based on the federal standards of IRC § 41 but was limited to a 5 percent rate on excess research expenses, capped at $1 million per taxpayer per year. The primary function of the legacy credit was to promote a higher level of research activity across all industries within the state than would have occurred without the incentive. However, the legacy credit was allowed to sunset in 2018, leaving a multi-year gap where no state-level R&D credit was available to Oregon businesses.

The introduction of the Research and Development Tax Credit for Semiconductors (codified in ORS 315.518 to 315.522) marked a significant departure from the prior broad-based approach. The 2023 Oregon Legislature recognized the specific economic contributions of the semiconductor industry and enacted House Bill 2009 to bolster the state’s competitiveness in this global market. This new credit increased the applicable percentage from 5 percent to 15 percent, while also expanding eligibility to include personal income taxpayers, thereby encompassing pass-through entities such as S corporations and partnerships that were previously excluded.

The shift toward a semiconductor-specific credit reflects a strategic use of state resources to target design, fabrication, and intellectual property creation. While other legislative proposals sought to reinstate a general R&D credit for all advanced manufacturers, budgetary considerations led the legislature to prioritize the semiconductor supply chain. This prioritization is underscored by the substantial increase in the annual maximum credit per taxpayer, which rose from the legacy limit of $1 million to the current $4 million.

Statutory Framework of ORS 315.518

The core of the semiconductor research incentive is established in ORS 315.518, which provides a credit against taxes due under ORS chapter 316 (personal income) or ORS chapter 317 (corporate excise). The statute dictates that the credit shall be determined in accordance with Section 41 of the Internal Revenue Code, but it introduces several critical modifications that define the scope of direct conduct of research for Oregon purposes.

The Qualified Semiconductor Company Requirement

The first statutory gatekeeper is the definition of a “qualified semiconductor company.” Under ORS 315.518(1), this is restricted to entities whose “primary business” involves the research, design, development, fabrication, assembly, testing, packaging, or validation of semiconductors. The statute also explicitly includes entities primarily focused on the creation of semiconductor manufacturing equipment, semiconductor core intellectual property, or electronic design automation (EDA) software.

The “primary business” test is a rigorous standard that requires the taxpayer to prove that their semiconductor-related activities are not merely ancillary to other operations. For example, a company that manufactures finished consumer electronics but designs its own chips may face challenges in qualifying if the bulk of its revenue and operations are tied to assembly and retail rather than the fundamental semiconductor supply chain. This requirement ensures that the state’s investment is concentrated in the foundational layers of semiconductor technology.

Geographic and Sector Limitations

ORS 315.518(2)(b) mandates that “qualified research” and “basic research” must consist only of research conducted in Oregon by a qualified semiconductor company. Furthermore, the research must be performed “in support of a trade or business directly related to semiconductors.” This geographic limitation means that even if a multi-state company conducts significant R&D elsewhere, only the portion of the direct conduct that physically occurs within Oregon’s borders can be included in the QRE calculation.

This requirement creates a distinct “Oregon-only” pool of expenses. If an engineer splits their time between a laboratory in Hillsboro, Oregon, and a facility in Santa Clara, California, the taxpayer must meticulously track the hours spent in Oregon to substantiate the claim. The nexus between the research activity and the semiconductor business must be direct; research into general corporate software or tangential electronic components that are not semiconductors or their direct manufacturing precursors would likely be excluded upon audit.

The Jurisprudence of Direct Conduct: Tier 1 vs. Tier 2 and 3

To understand the meaning of direct conduct of research, one must look to the federal classification of “qualified services” under Treasury Regulation § 1.41-2, which Oregon administrative rules incorporate. Qualified research expenses for in-house research primarily consist of wages paid to employees for these services. These services are traditionally categorized into three tiers, with direct conduct representing the most immediate involvement in the research process.

Tier 1: The Actual Conduct of Research

The actual or direct conduct of research involves the technical work performed by the individual who is personally conducting the experimentation. In the semiconductor industry, this typically involves the application of engineering, materials science, or physics to develop a new circuit architecture or a more efficient manufacturing process. An engineer who is running simulations to determine the thermal properties of a new 3D transistor design is engaged in the direct conduct of research.

This tier is characterized by the resolution of technical uncertainty through a hands-on approach. It is not limited to high-level scientists; it includes any employee who is performing the tasks that constitute the process of experimentation. For example, a software developer writing original code to optimize the placement of logic gates in a semiconductor design is performing direct conduct, as they are evaluating different algorithmic alternatives to achieve a functional result where the optimal design was not known at the outset.

Tier 2: Direct Supervision

Direct supervision involves the immediate, first-line management of the employees engaged in the actual conduct of research. This service is qualified because the supervisor’s technical oversight is integral to the direction of the experimentation. However, the “direct” qualifier is strictly enforced. It excludes general or executive-level supervision that is removed from the technical day-to-day work.

A qualifying supervisor in a semiconductor fabrication plant would be a technical lead who reviews experimental wafer batches with the lab engineers and decides which chemical mixtures to test next based on the observed results. In contrast, a Vice President of Operations who reviews the overall production schedule or a Human Resources manager who handles the hiring of lab staff is not engaged in direct supervision for the purposes of the R&D credit.

Tier 3: Direct Support

Direct support consists of services that provide an immediate and tangible aid to the research process, even if the individual is not performing the experimentation themselves. These services must be essential to the research activity. Within a semiconductor environment, examples of direct support include:

• A machinist who fabricates a specialized component for a prototype semiconductor manufacturing tool.
• A laboratory technician whose primary responsibility is the cleaning and calibration of high-precision equipment used exclusively in the research process.
• A data entry clerk whose role is limited to compiling the raw experimental data generated from chip testing to be analyzed by the research engineers.

Indirect services, such as general accounting, security for the research facility, or payroll processing for the R&D team, are specifically excluded. The distinction is whether the service is “directly” aiding the technical research or merely supporting the business as a whole.

The Four-Part Test in Semiconductor Research

For an activity to be considered the direct conduct of research, it must satisfy the federal “Four-Part Test” as established under IRC § 41(d). Oregon adopts these standards to determine if the activities for which the credit is claimed are truly “qualified research.”

1. The Technological in Nature Test

The research must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science. In the semiconductor industry, this is almost always satisfied through electrical engineering, materials science, or advanced physics. An activity that relies on social sciences, economics, or marketing does not qualify.

2. The Permitted Purpose Test

The objective of the research must be to discover information that will be used to develop a new or improved business component. For a qualified semiconductor company, the business component could be a product (such as a new microprocessor), a manufacturing process (such as a new lithography technique), a technique, or a formula. The research must be aimed at improving the functionality, performance, reliability, or quality of the component.

3. The Elimination of Uncertainty Test

At the outset of the research, there must be a genuine technical uncertainty regarding the capability or method for developing the business component, or the appropriate design of that component. This means that the information already available to the company does not provide a clear path to the desired result. In semiconductor development, this often relates to whether a new material can withstand specific electrical loads or if a new design can be fabricated at a certain scale.

4. The Process of Experimentation Test

The direct conduct of the research must involve a systematic process of experimentation. This requires the evaluation of one or more alternatives to achieve the desired result through methods such as modeling, simulation, or systematic trial and error. Routine engineering or quality control testing of existing products does not constitute a process of experimentation.

The federal courts have emphasized that the “substantially all” requirement—often called the 80 percent rule—applies here. For a business component to qualify, at least 80 percent of the activities associated with its development must constitute elements of a process of experimentation. This includes time spent in direct conduct, as well as the immediate supervision and support that aids that experimentation.

Administrative Rules and Guidance from Business Oregon

While the Department of Revenue handles the final tax returns, the Oregon Business Development Department (Business Oregon) is the primary gateway for the semiconductor R&D credit. Under Division 401 of the Oregon Administrative Rules (OAR 123-401), Business Oregon has established the procedures for certification that are a prerequisite to claiming any credit.

The Certification Lifecycle

A taxpayer seeking the credit must navigate a specific annual schedule. For the inaugural tax year (2024), a one-time registration form was required by December 1, 2023. For subsequent years, including 2025 through 2029, taxpayers must file a written application for certification by October 15 of each calendar year.

The certification application is a comprehensive document that must include:

1. Company Definition Narrative: A detailed description of how the taxpayer meets the definition of a qualified semiconductor company under ORS 315.518.
2. R&D Activity Description: A description of how the proposed research and development activities support a trade or business directly related to semiconductors.
3. Expected Expenditure Attestation: An attestation of the taxpayer’s expected QREs and basic research payments in Oregon for the tax year, based on internal financial projections.
4. Historical Expense Report: A report of QREs and basic research payments from the three preceding tax years to establish the baseline for the credit calculation.
5. Application Fee: A fee of $3,000 per application (as of 2025).

Statewide Caps and Allocation

One of the most critical functions of Business Oregon is the management of the statewide annual credit caps. The legislature established specific limits on the total amount of potential tax credits that can be certified each year to manage the impact on the state’s general fund.

If the total amount of potential tax credits sought by all applicants exceeds the annual cap, Business Oregon is authorized to reduce the certified amounts. The rules specify that the department will reduce certified credit amounts that exceed $200,000 by a ratio necessary to keep the total within the limits. This mechanism ensures that small businesses—those claiming $200,000 or less—receive their full requested credit, while larger claims are prorated.

The actual amount of credit a taxpayer is eligible to claim on their tax return depends on the actual QREs incurred during the year, but the claim can never exceed the amount certified by Business Oregon. If a company projects $10 million in QREs and is certified for a $1.5 million credit, but only spends $8 million, they must recalculate the credit on their return based on the actual $8 million. If they spend $12 million, they are capped at the certified $1.5 million.

Oregon Department of Revenue Filing and Audit Guidance

Once a taxpayer has obtained certification from Business Oregon, the focus shifts to the Department of Revenue (DOR). The DOR has promulgated OAR 150-315-0195 to provide specific guidance on how the credit is claimed and calculated on Oregon tax returns.

Calculating Oregon QREs and Gross Receipts

A fundamental piece of DOR guidance is the definition of “Oregon sales” for the purposes of the credit. Under the federal regular method, the “base amount” is influenced by the taxpayer’s gross receipts. OAR 150-315-0195(5) specifies that “gross receipts” in IRC § 41(c) means the total sales of the taxpayer in Oregon as calculated under ORS 314.665. For multi-state companies, this means using the Oregon sales factor from their apportionment formula.

Similarly, “qualified research expenses” for the Oregon credit are strictly limited to the sum of in-house research expenses and contract research expenses for research conducted in Oregon and paid or incurred by a qualified semiconductor company during the taxable year. This necessitates a precise geographical allocation of employee wages based on where the work was physically performed.

Election of the Alternative Simplified Credit (ASC) Method

The administrative rules clarify a point of initial confusion regarding the ASC method. While ORS 315.518 originally noted that IRC § 41(c)(4) (the Alternative Incremental Credit) did not apply, the DOR has explicitly allowed the use of the Alternative Simplified Credit (ASC) method.

A taxpayer who elects the ASC method for Oregon purposes must use the percentages specified in IRC § 41(c)(4)(A) or (B), which are modified by the DOR to be 14 percent of the excess QREs over the base, or 6 percent if the company has no prior QREs. The election of the ASC method is made on Oregon Schedule OR-RESEARCH (Form 150-102-130) and is generally irrevocable for that tax year without department approval.

The Modification (Add-Back) Requirement

To prevent a double benefit, both the federal and state governments require a modification to taxable income. Under ORS 315.518(8), a deduction may not be taken for the portion of expenses that is equal to the amount of the credit claimed. This means that if a corporation claims $100,000 in semiconductor R&D credits, it must add $100,000 back to its federal taxable income on its Oregon return (Form OR-20). This “Oregon modification” ensures that the state does not provide both a full expense deduction and a tax credit for the same dollar of research spending.

Audit and Substantiation Standards

All credits claimed under ORS 315.518 are subject to audit by the DOR. The standard for these audits is high, and the burden of proof rests entirely on the taxpayer to demonstrate that the activities constituted the direct conduct of research. The DOR guidance suggests that taxpayers should maintain all documentation used to support the certification application and the final tax return for at least four years.

Failure to provide adequate documentation can lead to the suspension or revocation of the credit under ORS 315.061. If a credit is revoked, the taxpayer may be liable for the unpaid tax plus interest and penalties. This makes the role of the “preparer” critical; state rules (OAR 800-010-0017) hold tax preparers to a standard of knowledge and skill, requiring them to engage in sufficient research to competently apply the tax code in this specialized area.

Refundability and the Small Business Advantage

A distinctive feature of the Oregon semiconductor credit is its partial refundability. This mechanism is specifically intended to provide cash flow to smaller research firms and startups that are investing heavily in innovation but may not yet have a positive tax liability.

The refundability is calculated based on the taxpayer’s Oregon employee count at the close of the tax year. For the purposes of this calculation, the credit is first applied against the taxpayer’s regular tax liability. If the credit exceeds the liability, the refundable portion is determined by a tiered percentage.

The refundable portion of the credit can be used to satisfy the Oregon corporate minimum tax (ORS 317.090), effectively reducing a corporation’s state tax bill to zero. Any remaining refundable amount is then issued as a check to the taxpayer, though the DOR may first offset the refund against any other outstanding state debts.

The non-refundable portion of the credit, as well as any credits claimed by companies with 3,000 or more employees, can be carried forward for up to five succeeding tax years. This tiered approach provides a significant advantage to smaller “Silicon Forest” companies, allowing them to reinvest the cash refund directly into further R&D activities.

Substantiation and Judicial Precedents in Research Credits

Because Oregon’s credit follows the federal IRC § 41 definition of qualified research, federal tax court rulings provide essential guidance on how “direct conduct” must be documented. Two recent cases, Moore v. Commissioner and Little Sandy Coal Co. v. Commissioner, underscore the necessity of granular recordkeeping.

The Burden of Production and Persuasion

In Moore v. Commissioner (2024), the 7th Circuit Court of Appeals affirmed a Tax Court ruling that denied R&D credits for an S corporation owner. The court noted that although the taxpayer undoubtedly performed research, they failed to maintain written records of how much time was dedicated specifically to “qualified” research versus general business management. The court’s conclusion was eloquent: “To do math, one needs accurate details.” In the absence of contemporaneous time logs or project-specific documentation, the taxpayer cannot meet the burden of proof required to claim the credit.

The “Substantially All” Rule and Supervision

The case of Little Sandy Coal Co. v. Commissioner (2023) provided critical clarification on the role of direct supervision and support. The Tax Court had originally held that providing services in direct supervision or support was not “engaged in research” and therefore could not be counted toward the “substantially all” (80 percent) requirement for a process of experimentation.

However, the Appeals Court disagreed, ruling that direct support and supervision activities should be considered in both the numerator and the denominator when determining if substantially all of the activities constitute a process of experimentation. This is a favorable ruling for semiconductor companies, where technical managers often spend significant time directing experimentation. Nevertheless, the court still denied the credit because the taxpayer provided no “principled way” to determine the exact portion of employee time spent on these tasks.

These cases demonstrate that for Oregon semiconductor companies, the “meaning” of direct conduct is only as good as the documentation that supports it. A company must be able to link every dollar of wage expense directly to a specific technical project and a specific technical uncertainty.

Comprehensive Example: Cascade Semiconductor Design, LLC

To illustrate the practical application of the direct conduct of research and the associated regulatory requirements, consider the case of Cascade Semiconductor Design, LLC (CSD), a hypothetical firm based in Tigard, Oregon.

Corporate Profile and Eligibility

CSD is a specialized firm that creates core intellectual property for power-efficient microcontrollers. The firm has 85 employees, all of whom are based in Oregon. Because its primary business is the creation of semiconductor core IP, it meets the definition of a “qualified semiconductor company” under ORS 315.518.

Project Identification: The “Low-Power 5” Project

In 2024, CSD initiates the “Low-Power 5” project. The goal is to design a new circuit architecture that reduces power leakage in 5nm process chips by 20 percent. This project satisfies the Four-Part Test:

1. Technological in Nature: It relies on advanced electrical engineering and silicon physics.
2. Permitted Purpose: The goal is to improve the performance and quality of a semiconductor IP component.
3. Elimination of Uncertainty: At the project’s start, it is uncertain if the proposed gate-all-around (GAA) architecture can be realized at 5nm without excessive manufacturing defects.
4. Process of Experimentation: CSD engineers will use EDA software to simulate thousands of different gate layouts and conduct systematic trial and error with different material thicknesses.

Calculating Qualified Research Expenses (QREs)

CSD identifies the following expenses directly related to the “Low-Power 5” project in 2024:

• Design Engineer Wages (Direct Conduct): 10 engineers spend 100 percent of their time on simulation and layout. Total wages: $1,500,000.
• Technical Lead Wages (Direct Supervision): 1 manager spends 80 percent of his time reviewing simulations and making design decisions. Total wages: $160,000 ($200,000 total salary).
• Technician Wages (Direct Support): 2 staff members spend 100 percent of their time maintaining the high-performance computing servers used exclusively for the simulations. Total wages: $140,000.
• Supplies: CSD pays $50,000 for specialized software licenses used directly in the experimentation.
• Contract Research: CSD pays a local university $100,000 to perform fundamental research on the new gate materials. Under state and federal rules, 65 percent of this is qualified. Total: $65,000.

Total 2024 Oregon QREs = $1,915,000.

The Certification Process with Business Oregon

By October 15, 2024, CSD submits its certification application to Business Oregon. It includes its historical QREs for 2021, 2022, and 2023, which averaged $1,200,000. It pays the $3,000 application fee. Business Oregon reviews the application and issues a certification for a potential credit of $207,900, assuming no proration is required due to the statewide cap.

Tax Filing and Calculation (ASC Method)

On its 2024 tax return, CSD elects the Alternative Simplified Credit (ASC) method.

1. Base Amount: 50 percent of the average of the 3 preceding years’ QREs. $1,200,000 × 0.50 = $600,000.
2. Excess QREs: $1,915,000 (Current QRE) – $600,000 (Base) = $1,315,000.
3. Credit Calculation: $1,315,000 × 14 percent (ASC Rate) = $184,100.

Refundability Application

Because CSD has 85 employees (fewer than 150), its credit is 75 percent refundable.

• CSD’s Oregon corporate excise tax liability for 2024 is $50,000.
• The credit is first applied to the $50,000 liability, reducing it to zero.
• The remaining credit is $134,100.
• Refundable Portion: 75 percent of the total credit ($184,100 × 0.75 = $138,075). Since $50,000 was already used to offset tax, the remaining refundable amount is $88,075.
• Carryforward Portion: The non-refundable 25 percent ($46,025) remains available to carry forward for five years.

Finally, CSD must add back the $184,100 credit amount to its federal taxable income on its Oregon return as a modification.

Strategic Compliance and the Future of the Silicon Forest

The Oregon Research and Development Tax Credit for Semiconductors represents a sophisticated, if targeted, effort to anchor the high-technology economy. The “Direct Conduct of Research” is the engine of this incentive, but it is an engine that requires precise calibration and constant maintenance.

The shift toward partial refundability and the inclusion of pass-through entities significantly lowers the barrier to entry for early-stage semiconductor firms. This is a critical development for the “Silicon Forest,” as it incentivizes the entire lifecycle of a semiconductor company, from the initial “hands-on” design phase (Direct Conduct) to the scaling of manufacturing operations.

However, the administrative hurdles—specifically the October 15 certification deadline and the $3,000 application fee—require companies to have robust internal tax and accounting functions. The confidentiality of the application process (exempt from public disclosure under ORS 192.311) provides a safe harbor for companies to share their technical secrets with Business Oregon without fear of exposing their IP to competitors.

As the program progresses toward its 2029 sunset, the data gathered by the Department of Revenue and the Legislative Revenue Office will be essential in determining its success. If the credit proves effective in driving semiconductor innovation, it may serve as a blueprint for future Oregon tax policy in other high-growth sectors. For now, the successful claim of the credit rests on the ability of Oregon’s semiconductor companies to meticulously define and document the direct conduct of their research, ensuring that every hour spent at the lab bench or the simulation terminal is accurately reflected in their tax filings.