The long-term future of Gov. Dannel P. Malloy’s most ambitious economic development program — the $1 billion Bioscience Connecticut initiative — could be undercut by the governor’s own hand, if lawmakers approve his proposed cap on research and development tax credits, a move that would encourage larger, more mature R&D companies to seek out other states with more favorable incentives, industry officials warn.
Although Malloy’s proposed $40 billion budget left untouched an R&D tax credit cash refund program vital to the survival of small bioscience startups, his proposal to cut in half the ability of larger companies to offset their tax liability with R&D tax credits would diminish Connecticut’s attraction to the bioscience industry.
It would also bolster the competitive edge of New England’s other major bioscience research hub: Massachusetts.
“Serious high-end biotech investors will tell small companies to go to more attractive states,” said Susan Froshauer, president and CEO of CURE, Connecticut’s bioscience industry group.
In his two-year budget plan, which aims to close a multi-billion dollar deficit, Malloy proposed cutting the amount of tax credits a company can use to offset its annual tax liability from 70 percent to 35 percent for fiscal year 2016. His proposal increases that offset to 45 percent for fiscal 2017 and 60 percent thereafter.
Even though the cap applies to all businesses it would be a blow to bioscience in particular because it isn’t as established as other industries and is heavily involved in research activities, said Bonnie Stewart, a lobbyist for the Connecticut Business & Industry Association.
“To change policies midstream has a devastating impact on those companies in Connecticut,” Stewart said. “It discourages investment in Connecticut when you mess around with policies like that.”
In Connecticut, companies can earn a tax credit equal to up to 6 percent of their annual R&D spending, and they can hold onto those credits until they’re used up. Businesses also can earn additional R&D tax credits each year by increasing the amount they spend annually on research; these incremental R&D tax credits are equal to 20 percent of the increase in spending, and they have to be used within 15 years.
Connecticut businesses claimed $26.1 million in R&D tax credits in 2012, the most recent year available, according to the Department of Revenue Services (DRS).
A big issue with Connecticut’s R&D program, however, is that companies earn more credits each year than they can actually use. That’s because the state currently allows companies to offset only 70 percent of their tax liability. By tightening that cap even further, Malloy’s budget will make it even harder for companies to cash in their R&D tax credits, Stewart said.
A 2010 study from the Connecticut Center for Economic Analysis estimated Connecticut companies held more than $1 billion in unused R&D tax credits.
Meanwhile, Massachusetts, with its bioscience hub in Cambridge around MIT, would gain a further competitive edge over Connecticut. The Bay State allows companies to use their R&D tax credits to offset nearly all of their tax liability, down to a $456 minimum tax.
“Why would companies stay here if they can get a better deal in Massachusetts?” Stewart said.
Neither Malloy’s office nor the Office of Policy & Management, which developed the proposed budget, offered comment for this story.
While advanced manufacturing would be impacted as well, a major user of the R&D program would be exempt from the tax credit cap, softening the blow.
Hartford conglomerate United Technologies Corp. — with subsidiaries like East Hartford jet engine manufacturer Pratt & Whitney and Farmington heating and cooling system manufacturer Carrier Corp. — reached an agreement with Malloy last year to use $400 million in unused tax credits in exchange for UTC investing $500 million in new Connecticut facilities. That deal is not impacted by Malloy’s budget.
Companies supporting UTC operations don’t do much R&D themselves, so as long as UTC’s subsidiaries keep sending them work, the state’s suppliers shouldn’t feel much of an impact from the cap either, said Al Samuel, executive director of the trade group Aerospace Component Manufacturers.
Smaller companies not impacted
The one bright spot, bioscience officials say, is that the R&D cap won’t have much of an impact on startups because they will still have access to an R&D cash refund program created in 2000.
Under the program, which Malloy’s budget left untouched, businesses with less than $70 million in gross income but no tax liability can receive a cash refund from DRS equal to 65 percent of their R&D credits’ value.
This cash refund program is especially important for bioscience startups because it is typically one of their few — if not only — revenue sources, Froshauer said. Bioscience startups can spend up to $1 billion in research and 15 years before a product hits the market, so having even the smallest of revenues is key to attracting investors.
“The ability to get credits back that can be used as cash is very important for the [profit and loss statement] for the company, and it is important to the investors to offset the incredible expense of developing a drug and getting it out there,” Froshauer said.
The bigger issue is that a more stringent tax credit cap will make Connecticut less attractive for startups as they grow into larger companies, which is the ultimate goal of Malloy’s bioscience initiative.
The hope is that the $1 billion taxpayers have invested in the UConn Health Center and bringing Jackson Laboratory to Farmington, among other initiatives, eventually will lead to spin-off companies that grow into major job creators.
Malloy’s initiative assumes those companies will stay in the state because they were founded here, but a less competitive R&D tax credit program would undermine that, Stewart said.
Jackson Laboratory won’t be impacted by the R&D credit cap because it is a nonprofit and doesn’t pay taxes, said Michael Hyde, the genomics research organization’s vice president for external affairs.
The impact on Jackson spinoffs probably will be minimal as well, Hyde said, because they can take advantage of the R&D credit cash refund program.
“A larger company, though, that has tax liability would feel the pain,” Hyde said.
