Everything You Need to Know About the R&D Tax Credit for Industrial Hemp Companies


By Jen Bolton

Many hemp companies are often not taking advantage the Research & Development (R&D) Tax Credit due to previous restrictions. However, with the passage of the 2018 Farm Bill and the effective legalization of low THC hemp as an agricultural commodity, hemp farmers and researchers are now free from the restrictions of IRC 280(e) and able to cultivate hemp broadly.

As a result, the US has already seen great steps into new and better techniques for cultivating hemp and creating hemp-derived products like CBD, as well as further technical research and expansion of cannabis process techniques. Now in 2020, and despite the global pandemic, the US has only seen the industrial hemp, CBD and cannabis industry continue to expand as the demand for these products grow.

These legislative and economic changes have also created the opportunity for companies in these industries to claim eligible Federal tax incentives, like the Research and Development Tax Credit.  Eligible farmers, researchers, manufacturers, and other businesses may be able to recapture some of their R&D expenditures and qualify them for the federal R&D Tax Credit and potentially a state R&D Tax Credit to offset federal and state income tax liability.

What is the R&D Tax Credit?

The R&D Tax Credit is a Federal tax incentive that is available to a wide range of companies in the industrial hemp, CBD, and cannabis industries. The R&D Tax Credit enables qualifying companies to reduce their income tax liability in the current tax year dollar-for-dollar,  and  potentially receive a refund for overpaid taxes on previously filed tax returns.

There’s no limit on the amount of R&D expenses that can be qualified in a given tax year. and the credit can be claimed by a qualifying company each tax year, making the credit an effective tax planning strategy for growing businesses.

The R&D Tax Credit can also be carried forward up to 20 years to offset future tax liability if it cannot be used immediately or completely. Startups and early stage businesses can also take advantage of the Payroll Tax Credit to reduce their FICA payroll tax liability, even if the company has minimal-to-no federal income tax liability. Many states also offer an R&D Credit which can be used in conjunction to offset state tax liability.

Qualifying R&D Activities

Companies can claim the R&D Tax Credit by qualifying their activities according the four-part test. Qualifying activities can found at each stage of the production lifecycle, but each activity must pass each of the elements of the four-part test to qualify. The four-part test asks:

  • Does the activity intend to make or improve a product or process that results in improved function, performance, reliability, quality or cost efficiency?
  • Does the activity intend to eliminate an uncertainty when developing or improving a product or process related to methodology, design, techniques, formulas or inventions?
  • Does the activity include a process of experimentation to eliminate or resolve an uncertainty by evaluating alternatives or approaches using trial and error, prototyping, modeling, or other methods?
  • Is the activity technical in nature by relying on a hard science, such as agronomy, botany, or engineering?

It’s also important to keep in mind that efforts to improve or create a product or process do not need to have been successful to qualify for the R&D Tax Credit. The new or improved product or process also does not need to be novel to the industry; it only needs to be new or improved to the business conducting the research and development.

Examples of potentially qualifying activities includes:

  • Cultivating new hemp varieties and characteristics
  • Developing new growing methods and procedures
  • Devising new or improved ways to process and harvest hemp
  • Experimenting to grow healthier, stronger, and better-quality plants
  • Developing and testing new filtration or irrigation systems
  • Testing new farming methods to increase crop yield
  • Investigating new ways to use industrial hemp fibers
  • Developing new hemp-related products
  • Formulating new topical creams and other absorption methods
  • Testing new CBD oil products and extraction techniques
  • Designing and integrating new or improved processing equipment or systems

Qualifying Costs:

Qualifying costs are the expenses incurred in performing the qualifying activities. Potentially qualifying R&D expenses include:

  1. Compensation paid to employees involved in the R&D activities, including employees with direct involvement, as well as employees that directly supervised or supported the R&D projects, such as managers, supervisors, and production teams.
  2. Raw materials & supplies consumed during the R&D process, such as seed, fertilizer, and pesticides; or solvents, testing materials, and materials consumed in processing methods and product development.
  3. Contractor expenses for R&D related services.
  4. In some cases, we may also be able to qualify custom designed and manufactured equipment involved in the R&D process, or substantially modified specialty equipment for the company’s R&D process.

Why work with Specialists?

Given the technical nature of the R&D Tax Credit and the quickly evolving legislation regarding the Hemp and Cannabis industries,  it is essential to work with a firm that has ample experience in both.

Our qualified experts in Leyton’s Hemp and Cannabis team will fully substantiate and safeguard your claim by working with you and your technical team to properly qualify the activities and expenses related to your research and development. Having the proper documentation to validate a claim is crucial, and Leyton safeguards your claim with a detailed Technical Report that outlines how your companies R&D qualifies for the R&D Tax Credit.

Blake Garvey, LL.M, J.D., B.Sc.

Senior Tax Attorney – Leyton USA

About Leyton:

Founded in 1997, Leyton is one of the world’s largest innovation funding specialist helping our clients improve their global performance. In the US, our specific expertise is in the optimization of Federal and State Research and Development (R&D) Tax Credits. Our dedicated industry teams are comprised of highly experienced scientists, engineers, tax accountants, and attorneys, all of whom are motivated to help your business robustly claim and realize the R&D credit to incentivize further innovation investment.