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Innovation Files: CSBI Tax Proposals Attempt to Bridge “Valley of Death”

March 26, 2015
Over at the Innovation Files, Joe Kennedy has posted an excellent summary of a set of tax reform proposals developed by the Coalition of Small Business Innovators (CSBI), of which BIO is a member. The proposals would increase investment and employment at small, research intensive companiesby allowing investors to take advantage of passive losses and research credits generated by the company. They would also allow companies to carry net operating losses forward to future years even when they raise new financing, and hence undergo a change in ownership structure. Since many of these companies often operate for years without profits, these proposals will help incentivize investors to provide them with much-needed capital to continue the critical R&D required to produce treatments and cures.

Smaller, research-intensive companies typically face high hurdles to raising investment capital, even when they are making regular progress in commercializing a product with promising science because of the long time horizon – and concomitant investment term – involved with researching, developing, and commercializing a new product. A new biotechnology treatment typically takes between 10-15 years to make its way from the lab to patient bedside. Many promising technologies are left undeveloped due to a lack of available investment capital for such lengthy R&D time horizons – a phenomenon known as the “Valley of Death.”

The CSBI proposals aim to help address that. If enacted, they could increase investment in small, research-intensive firms by $14.1 billion and create 72,000 jobs in eligible companies. Kennedy summarizes the two proposals:
The first proposal would amend Section 469 of the Tax Code to permit passive investors to take advantage of the net operating losses and research tax credits of companies in which they invest. The Tax Reform Act of 1986 severely limited this ability because it was seen as a way for high-income individuals to reduce their taxes by investing in operations that were never meant to be profitable. Under the reform, investors could immediately use their share of net operating losses, as well as any credits for research and development. The percentage of losses or credits that could be passed through would be limited to the portion of investment that was specifically targeted for qualified research activities as determined for purposes of the research and development tax credit. In order to qualify, the company would have to devote at least half of its expenses to research and development. The company would also have to have less than 250 employees and less than $150 million in assets. A recent study by Ernst & Young, Economic impact of tax proposals affecting research-intensive start-up businesses and qualified small business companies, estimates that this change would increase investment in these companies by $9.2 billion, allowing them to create 47,000 jobs. The proposal is currently contained in both the Start-up Jobs and Innovation Act (S. 341) and the COMPETE Act (S. 537).

The second change would make it easier for small companies to carry net operating losses forward even as they continue to attract new investors. Small, research-intensive companies often go through several rounds of financing as they rack up expenses while getting nearer to their goal of profitability. Unfortunately, Section 382 of the Tax Code prevents companies from carrying net operating losses forward if they undergo an ownership change. This eliminates one of their possible attractions to investors. It also means that the company will start paying taxes on its revenue long before its total revenues exceed it total expenses. Under the proposal, Section 382 would not apply to net operating losses that are generated by qualifying research and development conducted by a small business. The Ernst & Young analysis estimated that this change would increase direct investment in these companies by $4.9 billion and boost their employment by 25,000 jobs.

Read his full post here.