The Therapeutic Discovery Project Credit and Financial Statement Disclosure

Many life science-focused companies are eagerly awaiting response from the Internal Revenue Service on applications related to the Qualifying Therapeutic Discovery Project Credit.

The credit was provided under new section 48D of the Internal Revenue Code, as enacted as part of the Patient Protection and Affordable Care Act of 2010.

The credit was included as part of the landmark health care reform legislation enacted into law on March 23, 2010. Modeled after existing tax credits for investments in Qualifying Advanced Energy Projects, the new program created a credit (or for certain taxpayers, a grant) to encourage investments in new therapies to prevent, diagnose and treat acute and chronic diseases.

IRS Notice 2010-45 outlined the procedures for which eligible taxpayers could apply for certification from the IRS of a qualified investment with respect to a qualifying therapeutic discovery project as eligible for a credit or grant. This notice specifically stated that the IRS would approve or deny taxpayer applications for Section 48D certification no later than Oct. 29, 2010, and would notify taxpayers by letter of the agency’s decision.

With many of the companies that applied for the credit now in the middle of their third quarter financial close, one of the questions that we have been receiving from our clients is: “How should the potential credit or grant be accounted for in our third quarter financial statements?”

For calendar year companies that have a third quarter which ended Sept. 30, 2010, and will not know if they received a credit or grant by the time they file their third quarter financial statements, it is recommended that a mention of the company’s application is appropriate within the financial statement footnotes.

Calendar year companies that have a third quarter which ended Sept. 30, 2010, and are advised by the IRS that they have been approved to receive a credit or grant prior to the filing of their third quarter financial statements, may address this positive notification as a subsequent event. Adjustment to the third quarter financial statements is not appropriate in this situation, which is akin to a gain contingency.

For the purpose of ASC 450 (formerly FAS 5), a contingency is defined as an existing condition, situation or set of circumstances involving uncertainty as to possible gain or loss to an entity that will ultimately be resolved when one or more future events occur, or fail to occur. ASC 450 prohibits gain contingencies, following similar language in FAS 5, stating in ASC 450-30-25, "A contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization."

As the result of the guidance in ASC 450 related to gain contingencies, it would not be appropriate for the entity to adjust its third quarter financial statements. However, if the credit is significant to the company’s financial statements, robust disclosure within the subsequent events section of the financial statements would be appropriate and provide adequate information to readers of the financial statements.

For more information, please contact McGladrey Life Sciences Practice leader John Lanza at 212.372.1307.