Technological in Nature (Qualified Research Test)

Technological in Nature refers to the requirement that qualifying research must fundamentally rely on the principles of the physical, biological, or computer sciences or engineering. This standard ensures that tax incentives target hard-science innovation rather than aesthetic design, social science research, or routine business improvements.

The Statutory Foundation of Utah’s Research and Development Tax Credit

The Utah Research and Development (R&D) tax credit is established as a robust mechanism to incentivize high-tech growth and scientific exploration within the state. Governed by Utah Code § 59-7-612 for corporations and § 59-10-1012 for individual claimants, estates, trusts, and pass-through entities, the credit serves as a strategic offset against Utah income tax liabilities. The legislative intent is clear: to foster a localized innovation ecosystem by providing a nonrefundable credit for qualified research activities (QRAs) conducted specifically within Utah’s borders.

The Utah framework is structurally distinct from the federal credit provided under Internal Revenue Code (IRC) § 41, yet it is inextricably linked to it. Utah employs a unique three-component structure to calculate the credit amount. This multifaceted approach rewards both incremental growth in research spending and the maintenance of a baseline level of innovation investment.

The Three-Component Credit Formula

The total Utah R&D tax credit is the aggregate of three separate calculations, each addressing a different aspect of the taxpayer’s research investment.

Credit Component	Statutory Rate	Description	Carryforward Period
Incremental Research Credit	5%	Applied to qualified research expenses (QREs) for the current year that exceed a calculated base amount.	14 Years
Basic Research Credit	5%	Applied to payments made to qualified Utah organizations for basic research that exceed a base amount.	14 Years
Volume-Based Credit	7.5%	Applied to the total current-year QREs incurred in Utah, regardless of historical spending.	None (Current Year Only)

The inclusion of the 7.5% volume-based credit is a notable departure from the purely incremental federal model, providing significant relief to firms that maintain high levels of R&D without necessarily increasing their spending year-over-year. However, the 14-year carryforward is reserved exclusively for the 5% incremental and basic research components; the volume-based portion is a "use it or lose it" incentive.

Deconstructing the Qualified Research Test

To claim the Utah credit, an activity must meet the definition of "qualified research" as set forth in IRC § 41(d), as adopted by Utah statute. The Utah Code explicitly incorporates the federal definitions, meaning that the four-part test established by the Internal Revenue Service (IRS) is the governing standard for Utah taxpayers. At the center of this test lies the "Technological in Nature" requirement, which serves as the primary filter for the types of scientific and technical disciplines that qualify for the credit.

The Four-Part Test of Qualification

Prong	Test Name	Objective and Requirement
1	Permitted Purpose Test	The activity must be intended to improve the functionality, performance, reliability, or quality of a new or existing business component.
2	Technological in Nature Test	The process of experimentation must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science.
3	Elimination of Uncertainty Test	The activity must aim to discover information that would eliminate uncertainty concerning the development or improvement of a business component, specifically regarding capability, methodology, or design.
4	Process of Experimentation Test	Substantially all (80% or more) of the activities must involve a process of experimentation, such as modeling, simulation, or systematic trial and error.

The "Technological in Nature" prong is the most critical boundary between general business innovation and "qualified research." While a company might innovate in marketing, management, or the social sciences, such activities are ineligible because they do not rely on the "hard sciences".

Detailed Analysis of the Technological in Nature Requirement

The requirement that research be technological in nature dictates that the information discovered must be based on the fundamental principles of the physical sciences, biological sciences, engineering, or computer science. This standard is not satisfied merely by the use of high-tech equipment or sophisticated software; rather, it is the nature of the inquiry and the principles applied during the process of experimentation that determine eligibility.

The Definition of "Hard Sciences"

The term "hard sciences" is used in administrative guidance and case law to distinguish qualifying disciplines from the "soft sciences" like psychology, sociology, or economics.

• Physical Sciences: This includes physics and chemistry. Research in the physical sciences often involves exploring the atomic or molecular structure of materials, chemical reactions, thermodynamics, or the mechanics of physical systems. In Utah's manufacturing and aerospace sectors, this frequently manifests as materials science research—testing the tensile strength, thermal resistance, or chemical stability of new alloys or composites.
• Biological Sciences: This encompasses molecular biology, genetics, biochemistry, and microbiology. Utah’s life sciences corridor, particularly in the Salt Lake and Utah Valleys, produces significant QREs in the biological sciences through the development of new pharmaceuticals, medical devices, and diagnostic tools.
• Engineering: Perhaps the broadest qualifying discipline, engineering involves the application of scientific and mathematical principles to design and build structures, machines, and systems. This includes mechanical, electrical, civil, chemical, and aerospace engineering.
• Computer Science: Not to be confused with routine IT or software application, computer science for R&D purposes focuses on advances in algorithm design, database architecture, network protocols, or the fundamental technical capabilities of software.

Exclusion of the Soft Sciences and Humanities

Federal law, as adopted by Utah Code § 59-7-612(4)(c) and § 59-10-1012(3)(c), explicitly excludes research in the social sciences, arts, or humanities. Consequently, an activity that uses experimental methods to test a new marketing strategy or an organizational management technique fails the technological in nature test. Even if the goal is to improve the "performance" of a business component, the underlying principles must be rooted in the physical world or mathematics, not human behavior or aesthetic preference.

Local Revenue Office Guidance and Application of Law

The Utah State Tax Commission (USTC) provides administrative guidance through administrative rules and official publications. These sources clarify the state’s stance on federal conformity and provide local interpretations of how the technological standard is applied to Utah-specific tax situations.

Rule R865-6F-14: The Policy of Federal Conformity

The most foundational guidance regarding the interpretation of the R&D credit in Utah is Administrative Rule R865-6F-14, which outlines the extent to which federal income tax provisions are followed for corporation franchise tax purposes.

The rule establishes a clear policy: the USTC follows federal requirements as closely as possible in matters involving the determination of income. Since the Utah R&D credit statute refers directly to IRC § 41, the federal regulations (Treasury Reg. § 1.41-4) and relevant federal court decisions (such as those defining the "hard science" requirement) are considered controlling authority in Utah. However, the rule notes that the Commission may diverge from federal determinations if the state statutes differ or if the Commission specifically disagrees with a federal interpretation. In the context of the R&D credit, the primary divergence is not in the definition of research, but in the localization of the expenses (QREs must be incurred in Utah) and the calculation method (Utah’s three-component formula vs. the federal incremental method).

Publication 25 and 64: Sales Tax Interactions

While the R&D tax credit is an income tax incentive, the USTC’s guidance on sales and use tax (Publication 25 and Publication 64) provides insight into how the state categorizes technology and services.

Publication 64, specifically addressing "Sales Tax Information for Computer Service Providers," defines "custom computer software" and "remotely accessed software" (SaaS). In Utah, the taxability of software often hinges on whether it is "prewritten" or "custom". This distinction can sometimes bleed into R&D credit audits. If a taxpayer claims that their software development is "technological in nature" because it involves the creation of unique, specialized algorithms, the USTC may look at whether that same software was treated as "custom programming services" (nontaxable for sales tax) or "prewritten software" (taxable). While the standards for sales tax and the R&D credit are legally distinct, the state’s characterization of an activity as a "service" vs. a "product" can influence an auditor's perception of whether a "business component" was being developed.

Private Letter Rulings and State Interpretations

Private Letter Rulings (PLRs) issued by the USTC, while not binding policy for all taxpayers, illustrate the state’s analytical approach. For instance, in rulings involving video streaming and data processing platforms, the Commission has had to determine whether the core of the service was "prewritten software" or an "information service".

One PLR involving a streaming provider clarified that sales of subscriptions for "enhanced features" were not subject to sales tax because the primary object was an information service. In an R&D context, the development of the "proprietary platform" that enables such features would likely be scrutinized under the technological in nature test to ensure that the work involved solving technical latency or data-architecture challenges rather than just designing a new user interface.

The "Substantially All" Requirement and the Shrink-Back Rule

A critical procedural aspect of the technological test is the "substantially all" requirement. For an activity to qualify, at least 80% of the research must satisfy the process of experimentation test. If a project in its entirety fails this threshold, the "Shrink-Back Rule" allows the taxpayer to apply the test to a smaller subset of elements within the business component.

The rule dictates that if the 80% threshold is not met at the product level, the analysis "shrinks back" to the next most significant subset of elements (e.g., a subsystem or a component). This process continues until either a subset satisfies the tests or the most basic element is reached and fails.

For a Utah engineering firm developing a new medical device, the overall project might include industrial design and market analysis (non-qualified). If these non-technical activities exceed 20% of the project's costs, the project fails as a whole. However, the firm can shrink back to the development of the internal sensor and the microfluidic chip. Because the research on the chip and sensor fundamentally relies on biology and electrical engineering and is 100% focused on technical experimentation, those specific costs (wages of the engineers, supplies for the prototypes) would qualify for the Utah credit.

Software Development: Internal Use vs. Commercial Application

Software development is a significant driver of the Utah economy, but it faces a higher bar for qualification under the technological in nature test, particularly when the software is intended for "internal use".

Commercial Software and SaaS

Software that is developed to be sold, leased, licensed, or otherwise marketed to third parties (including SaaS models) is treated under the general four-part test. To be technological in nature, the development must go beyond "routine" coding. It must involve technical challenges such as:

• Developing new or more efficient algorithms for data processing.
• Integrating disparate systems through complex middleware architecture.
• Optimizing software for specialized hardware or extreme scale.

The Internal Use Software (IUS) High Threshold Test

If a Utah taxpayer develops software primarily for internal administrative functions (e.g., HR systems, accounting, or internal project management), it must satisfy an additional "high threshold" test beyond being technological in nature.

IUS Requirement	Description
Innovation	The software must result in a reduction in cost or improvement in speed that is substantial and economically significant.
Significant Economic Risk	The taxpayer must commit substantial resources and face technical uncertainty regarding the ability to complete the project.
Not Commercially Available	The software must not be available for purchase or lease from a third party without substantial modification.

The IRS and USTC view software as IUS if it facilitates general and administrative functions. However, software that is developed for use in an activity that itself constitutes qualified research, or software that is part of a production process, is not subject to the IUS high threshold test.

Impact of the Tax Cuts and Jobs Act (TCJA) and Section 174

Recent federal changes to IRC § 174 have fundamentally altered the landscape for R&D tax planning in Utah. Effective for tax years beginning after December 31, 2021, taxpayers are required to capitalize and amortize research and experimentation (R&E) costs over five years for domestic research and fifteen years for foreign research.

Because the Utah R&D credit is calculated using QREs—which are a subset of Section 174 expenses—this amortization requirement has a cascading effect. While Section 174 covers a broader range of costs (including foreign R&D and patent legal fees), only those that are domestic and meet the four-part test can generate the credit. In Utah, this means that while all "technological" research must now be capitalized for tax purposes, only the portion conducted in Utah will yield the state credit.

Interaction Table: Section 174 vs. Section 41 (Utah Application)

Expense Category	Section 174 (Amortization)	Section 41 (Utah Credit)
Utah-Based R&D (Hard Science)	Capitalize & Amortize (5 Years)	Eligible for 5% & 7.5% Credits
U.S.-Based R&D (Non-Utah)	Capitalize & Amortize (5 Years)	Ineligible for Utah Credit
Foreign-Based R&D	Capitalize & Amortize (15 Years)	Ineligible for Utah Credit
Patent Acquisition Costs	Capitalize & Amortize	Ineligible for Utah Credit
Market Research	Deductible under Sec. 162	Ineligible for both

The requirement to capitalize these costs can significantly increase a company’s taxable income in the short term, making the R&D credit an essential tool for managing cash flow. However, the reduction in Section 174 deductions mandated by Section 280C (or the election to reduce the credit instead) must be carefully accounted for on Utah returns.

Local Application and Calculation: Startup Provisions

Utah provides a specific election for startup companies to simplify the calculation of the "base amount" for the 5% incremental credit. Under IRC § 41, a startup is generally defined by the year in which it first had both gross receipts and QREs. Utah, however, allows a taxpayer to elect to be treated as a startup for Utah purposes even if they do not meet the federal definition.

The Startup Fixed-Base Percentage

Startups in Utah use a fixed-base percentage of 3% for the first five taxable years in which they have QREs. This percentage is then phased into the actual historical ratio of QREs to gross receipts over the subsequent five years.

For a Utah-based biotech startup, this election is often beneficial because it prevents "federal data bleed"—where high national gross receipts might dilute the credit for a smaller Utah operation. By electing Utah startup status, the company can establish a base amount that is more reflective of its localized, early-stage research activities. This election is irrevocable, requiring careful long-term modeling of Utah-sourced income and expenses.

Comprehensive Example: Sporting Goods Manufacturing in Salt Lake City

To demonstrate the application of the technological in nature test and the calculation of the credit, consider a sporting goods manufacturer located in Salt Lake City.

Project: Development of Advanced Protective Gear

The Company, which employs approximately 100 people, initiates a project to develop a new line of high-impact protective wear for winter sports.

Activities and Technical Analysis:

• Material Discovery: Engineers experiment with non-Newtonian fluids integrated into textile fibers to create armor that is flexible but hardens on impact.
  • Technological Test: This relies on the physical sciences (chemistry and materials science).
  • Qualification: Passes.
• Prototype Testing: The team builds a pneumatic impact-testing rig to simulate high-velocity collisions and measures force dissipation.
  • Technological Test: This relies on mechanical engineering and physics.
  • Qualification: Passes.
• Aesthetic Design: Graphic designers create various color schemes and logo placements for the new gear.
  • Technological Test: This relies on the arts and marketing.
  • Qualification: Fails.
• Field Surveys: The company sends prototypes to 50 skiers to gather feedback on comfort and "style."
  • Technological Test: This is market research/social science.
  • Qualification: Fails.

Application of the Shrink-Back Rule

The company finds that the "Aesthetic Design" and "Field Surveys" account for 25% of the total project costs. Because this exceeds the 20% threshold for non-qualified activities, the project fails the "substantially all" test at the product level. The company "shrinks back" to the "Material Discovery" and "Prototype Testing" phases. These phases represent 75% of the costs and are 100% technological. The wages of the engineers and the supplies used for the impact rig are captured as Utah QREs.

Calculation of the Utah Credit

The company determines its Utah QREs for the year are $1,100,000. For the 5% incremental credit, their base amount is calculated as $900,000.

Component	Formula	Credit
Incremental Credit	($1,100,000 - $900,000) * 0.05	$10,000
Volume-Based Credit	$1,100,000 * 0.075	$82,500
Total Utah Credit	Sum of Components	$92,500

The company can claim the full $92,500 on its Utah return. If the company’s tax liability is only $50,000, it can use the $50,000 to reduce its tax to zero. The $10,000 incremental portion can be carried forward, while the remaining volume credit is lost.

Documentation and Substantiation Requirements

The USTC does not require a formal certification process for the R&D credit (except for basic research payments), but it expects taxpayers to maintain contemporaneous records in a "sufficiently usable form" to substantiate the claim.

Required Documentation Categories

Type of Record	Purpose
Technical Reports	To prove the research was technological and involved experimentation.
Project Accounting	To link specific wages and supply costs to the qualified activities.
Personnel Qualifications	To show that researchers have the background (e.g., engineering degrees) to perform hard-science research.
Test Results/Logs	To document the elimination of technical uncertainty.

Following IRS FAA 20214101F, which Utah auditors often reference for specificity, refund claims should identify all business components, the specific research activities performed for each, and the individuals involved in those activities.

Synthesis and Forward-Looking Considerations

The technological in nature requirement is the pivot point upon which the validity of a Utah R&D tax credit claim turns. By anchoring its state credit to federal IRC § 41, Utah provides a stable and predictable environment for businesses that operate across state lines. However, the local requirement that research be conducted in Utah places a premium on accurate labor and cost tracking.

For businesses in the state, the 7.5% volume-based credit represents one of the most aggressive non-incremental incentives in the country, particularly as the state continues to lower its corporate income tax rate—most recently to 4.5%. This environment encourages sustained investment in the "hard sciences," ensuring that Utah remains a hub for aerospace, life sciences, and advanced manufacturing.

As the IRS continues to refine its guidance on software experimentation and the capitalization of R&E costs under Section 174, Utah taxpayers must remain agile. The USTC’s policy of federal conformity through Rule R865-6F-14 suggests that any future clarifications from the Treasury Department will likely be adopted by the state, further solidifying the need for robust, technology-focused documentation. Ultimately, the Utah R&D tax credit rewards those who push the boundaries of human knowledge through the rigorous application of scientific and engineering principles, provided they do so within the borders of the Beehive State.