By Patrick Temple-West and Ernest Scheyder
WASHINGTON/NEW YORK (Reuters) - Dow Chemical Co lost a 2nd Circuit Court of Appeals case to the U.S. Internal Revenue Service on Friday, with judge's ruling the company could not claim research and development tax credits for improving the way it makes an existing product.
In a test of how broadly the R&D tax credit can be claimed, the court's three judges unanimously upheld a U.S. Tax Court ruling that the Dow unit, Union Carbide Corp, could not claim the R&D credit retroactively for manufacturing process improvements.
The IRS commissioner's "interpretation is entirely consistent with the purpose of the research tax credit, which is to provide a credit for the cost that a taxpayer incurs in conducting qualified research that he would not otherwise incur," Judge Edward Korman wrote in the court's opinion.
The case could go to the U.S. Supreme Court.
It involves research conducted in 1994 and 1995 to improve the way existing products were made. Dow wanted to apply the credit retroactively to cover costs for supplies, even though it ended up selling the finished goods.
One improvement was an experimental, cost-cutting method to make polyethylene resin for dry cleaning bags with fewer materials. Using the new process, Dow sold enough resin to customers to make 125 million dry cleaning bags.
Giving Dow the credit to cover supply costs it would have incurred anyway in the normal course of doing business "simply creates an unintended windfall," Korman wrote.
In a concurring opinion, Judge Rosemary Pooler wrote that Congress may have intended the tax law to include supplies as qualifying for the research tax credit, but lawmakers did not write the law specifically enough.
The IRS and Dow Chemical did not immediately respond to a request for comment.
The U.S. Chamber of Commerce, the country's largest lobbying group for businesses, had backed Dow's case, which involves less than $8 million in disputed R&D claims, but has been seen as an important corporate tax law test, tax professionals said.
The case is: Union Carbide Corp & Subsidiaries vs. Commissioner of Internal Revenue in the 2nd Circuit U.S. Court of Appeals No. 11-2552.
(Editing by Kevin Drawbaugh and Leslie Gevirtz)