Tax Court denies restrictive interpretation of business component test


The Tax Court has denied an IRS motion for summary judgment in Harper v. Commissioner (T.C. Memo. 2023-57) because the IRS’ restrictive interpretation of the business component test was inconsistent with the statutory language and prior case law.


The taxpayers bringing the case were engaged in the business of design building and general contracting for residential, commercial, and industrial projects, and also specialized in military construction projects. The taxpayers claimed a Section 41 research credit for 2012 and 2013 related to construction designs. The taxpayers filed a petition in response to a notice of deficiency, and the IRS subsequently filed a motion for Summary Judgment.


The IRS motion contended that the construction designs underlying the taxpayer claims failed to meet the business component test as defined in Section 41(d), asserting the following arguments:

  • The buildings and facilities constructed by the taxpayers never belonged to them, yet only these structures (and not the designs) were “new or improved”
  • The taxpayer designs were not “products” as that word is intended in the statute, but rather “tangible manifestations of construction services”
  • Neither the taxpayer designs nor the facilities constructed were ever held for sale by the taxpayer
  • The taxpayers did not “use” its designs in the sense intended by the statute because Congress meant for taxpayer use of business components to be “meaningful” and so “affect the way a business operates to some degree,” as well as requiring an element habitual sale, lease or license


The Tax Court denied all four arguments asserted by the IRS. First, the Tax Court noted that the taxpayers were engaged in a multi-step conceptual design and development process for each construction project, and this process was indicative of the functional improvement per each project, which was the minimum level Congress intended to require under Union Carbide Corp. & Subs. (97 T.C.M. (CCH) at 1255). Secondly, while the Tax Court agreed that the designs were not “products,” the designs could fall within processes, techniques, or inventions, which are all included in the definitional list of business components under Section 41(d)(2)(B). In regard to the ownership issue, the Tax Court could not establish the ownership status from court record but stated that this issue did not require resolution for the purpose of summary judgment. Lastly, the Tax Court stated that it was indisputable that the taxpayers used the designs daily during the construction process to ensure completion of the projects and that the IRS interpretation that “use” require a transactional element is labored at best because neither the statutory language nor prior case law have required habitual sale of the product to satisfy the test, citing Trinity Indus., Inc. v. United States (691 F. Supp. 2d 688, 691).


The Tax Court noted other arguments were made by the parties, but found them to be irrelevant, moot, or without merit for purposes of the summary judgement. Taxpayers should watch for the Tax Court’s final opinion on this case, as it could highlight some of the alternative arguments or more complex issues. Taxpayers should also be aware that, as illustrated by the arguments asserted in Harper, the IRS continues to focus on evaluating research credit claims at the business component level. The motion may be helpful for taxpayers developing designs within the engineering industry because the Tax Court clarified that the designs satisfy the definition of business component under Section 41(d)(2)(B).




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