Fifth Circuit upholds denial of construction firm’s R&D credit


The U.S. Court of Appeals for the Fifth Circuit recently upheld a Louisiana district court’s decision in Leonard L. Grigsby et al. v. The United States (No. 22-30764) disallowing a taxpayer’s research tax credit because the taxpayer did not clearly define its business components and the research activities were funded research under Section 41(d)(4)(H).


The taxpayer appealing the district court’s decision is a shareholder of Cajun Industries LLC (“Cajun”), a construction company organized as an S corporation that claimed the research credit for work it performed under contractual agreements with its clients. During the legal proceedings, four sample projects were evaluated.


The taxpayer argued that the district court’s grant of summary judgment in favor of the government improperly placed the burden on the taxpayer, in part because the taxpayer could not produce evidence establishing its business components. The Fifth Circuit disagreed, finding that the IRS assessment of tax liability was entitled to a presumption of correctness because it specified the amount of the deficiency or otherwise provided the information necessary to compute the deficiency. Once the presumption of correctness was established, the burden then shifted to the taxpayer to rebut the presumption. Further, the Fifth Circuit found that even if the IRS assessment was not entitled to the presumption of correctness, the government met its burden of production by submitting approximately 40 exhibits at summary judgment and demonstrating that there was no genuine dispute as to any material fact.


Regarding its establishment of business components, the taxpayer asserted that sufficient evidence was produced that Cajun developed four business component products, citing responses provided during the district court proceedings. The Fifth Circuit held that the taxpayer did not offer sufficient evidence to create a genuine dispute as to whether the products constituted business components. In its ruling, the Fifth Circuit indicated that the cited responses described Cajun’s “means and methods” (i.e., processes) rather than products and stated that taxpayers must evaluate process business components separate from product business components in accordance with Section 41(d)(2)(C).


Further, the taxpayer argued that the district court erred in excluding its claim that its business components were construction processes. The Fifth Circuit held that the district court’s ruling was not an abuse of discretion because the construction processes argument was raised by the taxpayer for the first time at summary judgment and the omission of such an argument during earlier proceedings was “highly prejudicial for the government.” Additionally, the taxpayer failed to explain the change in their argument that their business components were processes rather than products.


The taxpayer also disputed the district court’s findings that its research projects were funded, claiming that Cajun retained substantial rights in its research and that the projects were “contingent” upon delivery of a product. After reviewing the contractual terms associated with Cajun’s four sample projects, the Fifth Circuit agreed with the district court’s findings that three of Cajun’s four sample projects did not meet the Substantial Rights Standard under Treas. Reg. Sec. 1.41-4A(d). Citing Fairchild Industries, Inc. v. United States (71 F.3d at 870) and Geosyntec Consultants, Inc. v. United States (776 F.3d 1330, 11th Circ. 2015), the Fifth Circuit concluded that the fourth sample project was funded, in part because the terms of the contract were such that Cajun was compensated for all expenditures incurred notwithstanding that the contract was a “firm, fixed-price contract.”  


Grant Thornton Insight:

This ruling by the Circuit Court reinforces that research credit claims for taxpayers in the construction industry may be at higher risk due to the nature of contractual terms and the types of development activities that are generally undertaken. Further, the Grigsby decision is consistent with developments in recent case law that demonstrate a trend of research credit claims being challenged on the basis of substantiation. It is important for taxpayers to retain adequate documentation to substantiate their research tax credit claims, including the clear establishment of business components.



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