The U.S. Court of Appeals for the Eighth Circuit has affirmed the Tax Court’s decision in Meyer, Borgman & Johnson, Inc. v. Commissioner (No. 23-1523), ruling that the structural engineering firm was not entitled to a Section 41 research credit claim because its research was funded.
The taxpayer addressed by the decision contracted with customers to create structural designs for building projects and claimed research credits associated with creating the designs for its September 2010, 2011 and 2013 tax years. On summary judgement, the Tax Court ruled in favor of the IRS, finding that the taxpayer’s research constituted funded research under Section 41(d)(4)(H) because, under the contract terms, payment was not contingent upon the success of the research. The Tax Court reasoned that, although the contract terms addressed conformity with building and design codes and expressed customer requirements, the contracts lacked the level of specificity regarding the results of the research required to comply with these requirements. The taxpayer filed an appeal, claiming that its right to payment was contingent on the success of its research and its contracts included inspection, acceptance, and quality assurance provisions.
The Eighth Circuit rejected the taxpayer’s claims, citing precedential case law that examined the funded research exclusion. Due to the lack of specificity in the taxpayer’s contracts, the Eighth Circuit reasoned that the taxpayer’s contracts were comparable to those in Dynetics, Inc. & Subsidiaries v. United States, 121 Fed. Cl. 492 (2015) and Geosyntec Consultants, Inc. v. United States, 776 F.3d 1330, 1341 (11th Cir. 2015), in which the courts ruled that the research was funded. It distinguished the taxpayer’s contracts from those in Fairchild Industries, Inc. v. United States, 71 F.3d 868 (Fed. Cir. 1996), in which the Federal Circuit held that the research was not funded. The Eighth Circuit found that none of the taxpayer’s contracts expressly (or by clear implication) require payment to be contingent on the success of the research, stating that the taxpayer agreed to adhere to professional standards and that requirements to comply with pertinent codes and regulations or perform pursuant to a general standard of care does “not mandate success.”
Further, the Eighth Circuit explained that the taxpayer’s contracts do not include the specificity of Fairchild, where the taxpayer “had to succeed at each step,” in part because the contracts do not include provisions that require a refund of payments already received if specific benchmarks are not met.
Grant Thornton Insight:
The Eighth Circuit’s decision reinforces the importance for taxpayers that perform research pursuant to customer contracts to adequately document specific provisions in the contracts that may be used to substantiate their research credit claim. Contracts with express provisions such as detailed technical specifications and acceptance criteria, including any requirements that the research must be successful for the taxpayer to receive payment, may better substantiate that the research being performed is not funded.
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