Amounts Paid for Right to Use Computers

Amounts paid for the right to use computers refer to expenditures incurred for the leasing of computational power or hosting infrastructure, such as cloud-based server environments, utilized specifically for conducting qualified research activities. In the South Carolina regulatory environment, these costs represent a distinct category of qualified research expenses that allow taxpayers to claim a 5% credit against state income tax and corporate license fees, provided the underlying research is performed within the borders of the state.

This classification of expenditure serves as a critical bridge between legacy mainframe time-sharing models and contemporary cloud computing paradigms. While the statutory language traces its origins to the Internal Revenue Code of 1981, its modern application by the South Carolina Department of Revenue (SCDOR) requires a sophisticated understanding of the distinction between intangible communication services and the functional leasing of computational capacity. The South Carolina Research Expenses Credit is fundamentally anchored in federal law through South Carolina Code Section 12-6-3415, which provides a nonrefundable credit equal to 5% of a taxpayer’s qualified research expenses (QREs) made in South Carolina during the taxable year. The state’s reliance on federal definitions creates a system of substantial conformity, whereby the eligibility of an expense at the state level is largely contingent upon its qualification under Internal Revenue Code (IRC) Section 41. Under IRC Section 41(b)(2)(A)(iii), in-house research expenses include any amount paid or incurred to another person for the right to use computers in the conduct of qualified research. South Carolina explicitly adopts this definition but attaches a rigorous geographical nexus requirement: the research must be conducted, and the expenses must be made, within South Carolina.

The Statutory Architecture of Section 12-6-3415

The South Carolina Research Expenses Credit is not an independent creation of the state’s tax code but is rather an elective incentive that mirrors the federal credit for increasing research activities. To grasp the meaning of computer usage expenses, one must first navigate the layered statutory framework that governs the state’s tax incentive programs. South Carolina Code Section 12-6-3415 serves as the primary authority, authorizing a credit against the taxes imposed under Chapter 6 of Title 12 (income tax) or Section 12-20-50 (corporate license fees). This dual application is a unique feature of South Carolina law, allowing businesses to offset both their operating income tax and the license fees based on their capital stock and paid-in surplus.

The state’s approach to R&D incentives is designed to be straightforward yet deeply integrated with federal compliance. Unlike many states that require a complex “base amount” calculation involving historical spending averages, South Carolina applies its 5% rate directly to the total qualified research expenses incurred in the state during the current tax year. This simplicity, however, is offset by the requirement that the taxpayer must also claim the federal R&D credit for the same taxable year. This federal claim requirement acts as a prerequisite; if a taxpayer cannot substantiate their research activities or their computer usage costs under the federal IRC Section 41 standards, they are effectively barred from the state-level credit.

The interaction between the Research Expenses Credit and other state incentives is governed by strict ordering and limitation rules. For instance, the credit is limited to 50% of the taxpayer’s remaining tax liability after all other credits have been applied. This necessitates a strategic evaluation of the taxpayer’s entire credit portfolio, including the Jobs Tax Credit (§12-6-3360) and the Corporate Headquarters Credit (§12-6-3410). While the Headquarters Credit may cover the costs of tangible personal property such as servers and networking equipment, the Research Expenses Credit specifically addresses the recurring operational costs of leasing that same equipment for experimental purposes. This distinction between capital investment and operational experimentation is the foundation upon which the “right to use computers” provision is built.

Federal Conformity and the Definition of Qualified Research Expenses

South Carolina’s tax code is built upon the principle of conformity to the Internal Revenue Code. Code Section 12-6-40 applies the federal IRC to state tax laws, ensuring that the definitions of income, deductions, and credits remain largely consistent between the state and federal governments. This conformity is particularly vital for the R&D credit, as Section 12-6-3415 explicitly defines “qualified research expenses” as having the same meaning as defined in IRC Section 41(b).

The federal definition of QREs is bifurcated into in-house research expenses and contract research expenses. In-house research expenses comprise three categories: wages paid to employees performing qualified services, amounts paid for supplies used in research, and amounts paid for the right to use computers. The inclusion of computer usage in the “in-house” category, despite the payment being made to a third party (the computer owner), is a historical artifact of the early computer industry. In the 1980s, high-performance computing was often accessed through time-sharing arrangements rather than direct ownership. The legislature sought to incentivize this high-tech exploration by allowing the rental costs of these massive systems to be treated as a direct research expense.

In the modern South Carolina context, this federal definition has been interpreted to encompass cloud computing. Because cloud providers such as Amazon Web Services (AWS) or Microsoft Azure provide virtualized access to hardware, the payments made for “instances” or “processing time” are functionally identical to the mainframe time-sharing models of the past. However, the conformity is not absolute. South Carolina periodically decouples from certain federal provisions through Code Section 12-6-50. While the state has historically followed the federal lead on R&D definitions, the annual conformity process means that taxpayers must remain vigilant for any legislative changes that might diverge from federal standards, particularly regarding the capitalization of research expenses.

Feature	Federal IRC § 41	South Carolina § 12-6-3415
Credit Rate	Varies (e.g., 20% of excess)	5% of total SC QREs
Base Amount	Required (Regular or ASC)	No base amount required
Geography	United States & Territories	South Carolina only
Entity Types	C-Corp, S-Corp, Individuals	C-Corp, S-Corp, Individuals, LLCs
Liability Limit	General Business Credit limits	50% of SC tax liability
Carryforward	20 Years	10 Years

The comparison above highlights the unique positioning of the South Carolina credit. While the rate is lower than the federal statutory rate, the absence of a base amount hurdle makes the “right to use computers” expense significantly more valuable at the state level for companies with consistent spending patterns.

Theoretical Interpretation of “Right to Use Computers”

The meaning of “amounts paid for the right to use computers” hinges on the legal distinction between a service and a lease. For an expenditure to qualify under Section 12-6-3415, the taxpayer must demonstrate that they are paying for the use of the computer hardware itself, rather than for a service performed by the computer or its owner. This distinction is increasingly complex in an era dominated by Software as a Service (SaaS).

At the core of this interpretation is the “True Object Test.” This test, frequently cited in SCDOR advisory opinions, seeks to identify the fundamental nature of a transaction. If the “true object” of a contract is to obtain the output or the functionality of a software program (such as using a payroll processing application), the transaction is classified as a service. Conversely, if the “true object” is to obtain the computational “ways and means” to execute the taxpayer’s own code or conduct their own simulations, the transaction is classified as a “right to use” the computer.

In the realm of research and development, this interpretation mandates that computer usage be “integral and necessary” to the experimental process. This language, often borrowed from sales tax machine exemptions, suggests that the computer must be a tool for discovery. For a South Carolina software developer, this means that the costs associated with “staging servers” or “testing environments” in the cloud are generally qualified, as these environments are used to break code, run iterations, and eliminate technical uncertainty. However, costs for “production servers”—those hosting the final software for customers—do not qualify, as the research phase has concluded.

The SCDOR policy manuals, specifically the South Carolina Tax Incentives for Economic Development (TIED) 2025 edition, emphasize that research must be conducted “in the experimental or laboratory sense.” This implies that the computer usage must be part of a systematic trial and error process. The “right to use” does not extend to routine data entry or administrative functions. It is the “discovery” of information that fundamentally relies on computer science which validates the expense.

SCDOR Guidance and the Local Revenue Office Perspective

The South Carolina Department of Revenue provides administrative clarity through revenue rulings, revenue procedures, and the instructions for Schedule TC-18. The SCDOR’s role is to ensure that the legislative intent of Section 12-6-3415 is realized while protecting the state’s revenue from overreaching claims.

The TC-18 Filing Process

A taxpayer claiming the credit must complete Form TC-18 and attach it to their income tax return (e.g., SC1120 for corporations or SC1040 for individuals). The form requires a simple entry of “Qualified research expenses made in South Carolina” on Line 1. However, the simplicity of the form belies the depth of documentation required in the event of an audit. The SCDOR mandates that any taxpayer claiming the credit “must clearly demonstrate entitlement.” For computer usage, this involves maintaining detailed records of cloud service invoices, hosting agreements, and logs that link specific server usage to research projects.

Revenue Ruling #16-11 and Nexus

A critical piece of local guidance is Revenue Ruling #16-11, which addresses corporate income tax nexus in the context of cloud computing. While nexus determines whether a company is subject to South Carolina tax at all, it also informs the “made in South Carolina” requirement for the R&D credit. The Department’s position is that the physical location of the computer server is less important than the location where the “right to use” is exercised. If a South Carolina-based engineer accesses a virtual server located in another state to conduct research, the expense is generally viewed as being “made in South Carolina” because the research activity—the intellectual labor and the exercise of the “right to use”—occurs within the state.

Interaction with the 50% Liability Limit

The SCDOR provides specific examples of how the 50% liability limitation operates. Because the Research Expenses Credit is often applied after other credits, it is crucial for taxpayers to follow the “ordering rules” set forth in Section 12-6-3415. If a taxpayer has multiple credits, some with limits and some without, they must compute the remaining liability step-by-step. The R&D credit is always calculated based on the remaining liability after all other credits have been deducted. This prevents a taxpayer from using the R&D credit to reduce their tax below zero in a way that would bypass the nonrefundable nature of the credit.

Sales and Use Tax Interplay with R&D Tax Policy

One of the most nuanced aspects of South Carolina tax law is the relationship between the sales and use tax treatment of computers and the income tax R&D credit. The SCDOR has issued several key rulings that define the taxability of software and cloud services, which in turn influences whether an expense is classified as a “right to use computers.”

Revenue Ruling #12-1 and Electronic Delivery

Revenue Ruling #12-1 confirms that prewritten computer software delivered electronically is not subject to South Carolina sales and use tax because it is considered an intangible. However, the ruling notes that if the software is delivered via a tangible medium (like a disk), it is taxable. For R&D purposes, this creates a parallel: if the software is an intangible service, it is unlikely to qualify as a computer rental. But if the payment is for the infrastructure (IaaS), which allows the user to operate their own software on the provider’s hardware, it is more likely to be seen as a “right to use computers.”

The ASP Exception (Revenue Ruling #05-13)

A significant hurdle for cloud-based R&D claims is Revenue Ruling #05-13, which classifies charges from Application Service Providers (ASPs) as “communication services” subject to sales tax. The Department views these as taxable transmissions of data or messages. If the SCDOR classifies a cloud expenditure as a “communication service” for sales tax purposes, they may concurrently argue that it is not a “computer rental” for R&D credit purposes. Taxpayers must therefore be careful to distinguish their IaaS costs (the right to use raw computing power) from their SaaS/ASP costs (the right to access a specific software application).

Data Center Exemptions

For very large research facilities, South Carolina Code Section 12-36-2120(79) provides a sales tax exemption for computers and computer equipment used in a “datacenter.” To qualify, the facility must meet specific investment ($50 million) and job creation requirements. While this exemption addresses the purchase of hardware, it complements the R&D credit by reducing the initial capital outlay for a research facility. A taxpayer may theoretically utilize the sales tax exemption for the hardware they own while simultaneously claiming the R&D credit for the “right to use” additional computational capacity leased from third parties.

The Four-Part Test and Computer Usage

The qualification of computer usage as a research expense is contingent upon satisfying the federal “Four-Part Test” incorporated into South Carolina law. Every dollar claimed for “right to use computers” must be tied to an activity that passes these four benchmarks.

Permitted Purpose Test

The usage must be for the development or improvement of a business component’s functionality, performance, reliability, or quality. In the context of computer rentals, this means the processing power must be used to refine a product. For example, a South Carolina-based aerospace firm using leased high-performance computing (HPC) clusters to conduct wind-tunnel simulations is using the computer for a permitted purpose: improving the aerodynamic quality of a wing design.

Elimination of Uncertainty Test

The taxpayer must intend to discover information that would eliminate technical uncertainty. Computer usage often plays a primary role here by allowing for “what-if” scenarios that would be impossible or too expensive to test physically. If a biotech company uses cloud servers to run millions of molecular combinations to identify a potential drug candidate, they are using the computer to eliminate the uncertainty of which molecule will bind to a specific protein.

Process of Experimentation Test

Substantially all of the activities must constitute a process of experimentation. This requires a systematic trial-and-error approach. In the digital realm, this is evidenced by the “iterative” nature of code deployment and testing. SCDOR auditors often look for “sprint” logs or version control history to confirm that the “right to use computers” was indeed for experimentation and not for the maintenance of a static system.

Technological in Nature Test

The research must fundamentally rely on principles of physical or biological science, engineering, or computer science. This is a crucial distinction for computer usage. Simply using a computer to perform market research or social science analysis does not qualify. The “right to use” must be aimed at advancing computer science itself (e.g., developing a new database algorithm) or using computer science to solve an engineering or biological problem.

Computational Analysis of Credit Calculation and Limitations

The South Carolina Research Expenses Credit is a nonrefundable incentive with specific mathematical constraints. The calculation of the credit is the first step, but the “allowable” credit in a given year is subject to a 50% liability cap.

Calculation of the Earned Credit

The earned credit is simply 5% of the qualified research expenses incurred in South Carolina. For a company with $1,000,000 in QREs (including computer usage), the credit earned is $50,000. Unlike the federal credit, there is no “fixed-base percentage” or “average annual gross receipts” requirement for the state portion. This makes the credit more predictable for South Carolina businesses.

The 50% Limitation Logic

The most complex part of the South Carolina R&D credit is the limitation found on Line 8 of the TC-18 form. The credit “taken in any one taxable year may not exceed fifty percent of the taxpayer’s remaining tax liability after all other credits have been applied.” This means the taxpayer must determine their tax liability before the R&D credit and after all other non-limited credits.

Tax Component	Value	Source/Reference
Gross SC Income Tax Liability	$100,000	Baseline Assumption
Other Credits (e.g., Conservation)	($20,000)	No percentage limit
Remaining Tax Liability	$80,000	Intermediate Step
50% Limitation Cap	$40,000	50% of Remaining
Available R&D Credit (Earned + CF)	$50,000	From TC-18 Line 4
Credit Allowed for Current Year	$40,000	Lesser of Available or Cap
Credit Carryforward to Future Year	$10,000	10-year period

The logic here is to ensure that the taxpayer pays at least 50% of their adjusted tax liability to the state, even if they have substantial R&D credits. However, the 10-year carryforward provides a safety net, allowing the remaining 50% of the credit to be harvested in subsequent years.

Procedural Compliance and Documentation Standards

The SCDOR maintains high standards for the documentation of R&D credits. Because the credit is “a matter of legislative grace,” the burden of proof rests entirely on the taxpayer. This is particularly challenging for the “right to use computers” expense, which is inherently intangible.

Recordkeeping for Cloud Environments

Taxpayers using cloud infrastructure must maintain a clear “nexus of usage” between the expenditure and the research project.

• Invoices and Contracts: Detailed invoices from providers (AWS, Azure, etc.) should ideally be segmented by “Account” or “Tag” to separate research environments from production environments.
• Project Logs: Developers should maintain logs within their project management tools (Jira, GitHub) that detail the technical problems being solved and the computational resources required.
• Nexus Documentation: Since the credit is for expenses “made in South Carolina,” the taxpayer must be able to prove that the individuals exercising the “right to use” the computer were physically located in the state. This can be achieved through payroll records showing South Carolina withholding for the engineers performing the research.

Common Audit Pitfalls

SCDOR audits often focus on the “True Object” of computer usage. A common pitfall is the failure to distinguish between “computer usage” and “software subscriptions.” If an invoice shows a “per-user license fee” for a cloud-based CRM tool, the SCDOR will likely disqualify it as a service rather than a right to use hardware. Another pitfall is the “80% Rule” for wages, which does not apply to computer rentals. While a developer who spends 80% of their time on research may have 100% of their wages qualified, the computer rental must be strictly pro-rated based on actual research usage versus production usage.

Legislative Outlook: The One Big Beautiful Bill Act (OBBBA)

The regulatory landscape for South Carolina R&D credits underwent a massive shift in 2025 with the passage of the federal “One Big Beautiful Bill Act.” This legislation directly impacted how “amounts paid for the right to use computers” are treated for both deduction and credit purposes.

The Return of Immediate Expensing

From 2022 to 2024, the Tax Cuts and Jobs Act (TCJA) required businesses to capitalize and amortize R&D expenses (including computer rentals) over five years. This created a significant cash-flow burden, as companies could only deduct 10% or 20% of their annual R&D spend in the first year. The OBBBA of 2025 introduced IRC Section 174A, which permanently restored the ability for businesses to immediately deduct domestic research and experimental expenditures.

For South Carolina taxpayers, this federal restoration of immediate expensing is a transformative event. Because South Carolina conforms to the federal definition of taxable income, the shift back to expensing under Section 174A significantly reduces the state-level tax base for R&D-intensive firms. This “double benefit”—the immediate deduction plus the 5% credit—restores South Carolina’s competitive position as a top-tier state for technology investment.

Retroactive Relief for Small Businesses

The OBBBA also provided a “look-back” provision for small businesses (those with $31 million or less in average annual gross receipts). These companies can amend their 2022, 2023, and 2024 returns to reverse the amortization requirement and claim immediate deductions. The SCDOR guidance suggests that South Carolina will follow this federal lead, potentially leading to significant refund opportunities for small South Carolina startups that were forced to capitalize their cloud-hosting and server costs over the last three years.

Economic Implications and Sector Analysis

The “right to use computers” provision is not merely a technical tax rule; it is a primary driver of South Carolina’s modern industrial strategy. The state has pivoted toward sectors that are inherently computation-heavy, making this specific category of the R&D credit more relevant than ever.

The Automotive and Aerospace Nexus

South Carolina is home to global manufacturing leaders like BMW, Boeing, and Volvo. These companies use “right to use” computers for advanced Finite Element Analysis (FEA) and Computational Fluid Dynamics (CFD). These simulations allow engineers to test structural integrity and aerodynamics in a virtual environment. By allowing a 5% credit on the fees paid to supercomputing centers or cloud platforms for these simulations, South Carolina effectively subsidizes the “digital twins” that power modern aerospace and automotive engineering.

Software as an Independent Industrial Component

The SCDOR’s TIED manual identifies “software development” as a qualified business for several incentives. For these firms, the R&D credit is often their most valuable asset. As South Carolina attracts more fintech and cybersecurity firms, the interpretation of cloud usage as a qualified expense becomes a critical factor in “location decisions.” The state’s 5% credit, combined with the lack of a “base amount” requirement, makes it significantly more attractive than neighboring states with more complex R&D regimes.

Detailed Practical Example: Greenville Aerospace Analytics

To illustrate the comprehensive application of the “right to use computers” in the South Carolina R&D credit framework, consider “Greenville Aerospace Analytics” (GAA), a mid-sized firm specializing in drone stabilization software. In the 2024 tax year, GAA engaged in a project to develop an AI-based navigation system that eliminates signal latency during high-speed flight.

Identifying the Qualified Research Expenses (QREs)

GAA conducted all research in Greenville, South Carolina. Their expenditures for the navigation project included:

• Qualified Wages: $1,200,000 paid to software engineers and data scientists.
• Cloud Computing (IaaS): $300,000 paid to AWS for GPU-intensive “instances” used to train the AI model.
• Supplies: $50,000 in prototype drone components consumed during flight testing.
• Contract Research: $200,000 paid to a Clemson University lab for specialized sensor testing.

Calculating Total SC QREs:

• Wages: $1,200,000 (100% qualified)
• Computer Usage: $300,000 (100% qualified as the “right to use” virtual GPUs for experimentation)
• Supplies: $50,000 (100% qualified)
• Contract Research: $130,000 (Only 65% of the $200,000 qualifies under IRC §41 standards)

Total SC QREs = $1,680,000

Calculating the Earned Research Expenses Credit

Under Section 12-6-3415, the credit is 5% of the total SC QREs.

Earned Credit = $1,680,000 x 0.05 = $84,000

Applying the 50% Liability Limitation

GAA must first calculate its South Carolina tax liability. Assume the following:

• SC Corporate Income Tax: $120,000
• SC Corporate License Fee: $30,000
• Total Tax Liability: $150,000

GAA also earned a Jobs Tax Credit (§12-6-3360) of $40,000. Under SCDOR ordering rules, the Jobs Tax Credit is applied before the R&D credit.

Calculation of Remaining Liability:

• Total Tax: $150,000
• Minus Jobs Tax Credit: ($40,000)
• Remaining Tax Liability: $110,000

Calculation of the 50% Limitation:

• $110,000 x 0.50 = $55,000

Determination of Allowable Credit and Carryforward

GAA earned an $84,000 R&D credit, but its limitation for the 2024 tax year is $55,000.

• Credit Taken This Year: $55,000 (Lesser of $84,000 or $55,000)
• Credit Carryforward: $29,000 ($84,000 – $55,000)

The $29,000 carryforward can be used to offset up to 50% of GAA’s liability in any of the next 10 taxable years.

Interaction with the OBBBA of 2025

If GAA is a small business, they would also look at their 2022 and 2023 returns. During those years, they were forced to amortize the $300,000 computer usage costs over five years. With the passage of the OBBBA, GAA can file amended returns to deduct the unamortized portion immediately, significantly lowering their taxable income for those years and potentially generating refunds of taxes already paid.

Final Thoughts: Synthesizing Policy and Practice

The definition of “amounts paid for the right to use computers” in the South Carolina R&D credit context is a dynamic intersection of legacy federal code and modern cloud technology. By conforming to IRC Section 41 while providing a simplified 5% calculation, South Carolina has created a robust environment for technological investment. However, the state’s rigorous 50% liability limitation and strict documentation standards for cloud environments require taxpayers to maintain high levels of administrative discipline.

For the modern South Carolina business, success in claiming this credit depends on the ability to distinguish between “software services” and “hardware usage” and to link every computational dollar to a project that passes the rigorous Four-Part Test. As the 2025 OBBBA restores immediate expensing, the “right to use computers” provision will once again become a primary catalyst for innovation in the Palmetto State, ensuring that South Carolina remains a competitive destination for the high-tech industries of the future.