R&D Tax Credit Court Cases

Bayer Corporation - February 2012 (Statistical Sampling and Documentation)

A U.S. district court denied Bayer Corporation's motion to use a statistical sampling method to respond to a government interrogatory regarding the business components underlying the qualified research expenses it claimed in a refund suit stemming from the denial of section 41 tax credits for qualified research expenses.

McFerrin – June 2009 (Oral testimony)

Federal Court of Appeals extended the "Cohan rule" to hold that a taxpayer who establishes the existence of qualified research expenses, is entitled to rely on rough estimates, rather than contemporaneous documentation, to determine the amount of those expenditures. (In the original trial at the District Court, the court ruled against the taxpayer saying that McFerrin's evidence supporting its claim, which consisted primarily of employee testimony, was not sufficient. The Appeals Court remanded this case back to the District Court.) This court opinion is favorable to taxpayers in its application of the type of evidence needed to support a credit claim. For taxpayers without detailed time records, reasonable estimates based on the longstanding rule in Cohan v. Commissioner may be allowed.

Union Carbide – 2009 (Uncertainty / Base Period)

To qualify for the research credit, research is performed in order to resolve uncertainties in the development of a product or process. The Tax Court has ruled that a taxpayer does not have to be uncertain that the project would be successful. It noted that even if a taxpayer believed it was capable of completing a project, there was still uncertainty with the project because information available to the taxpayer did not establish the appropriate design of the product. Even if a taxpayer is capable of making a new product, research may still be needed to determine the appropriate design of the product.

The base period (1984 through1989) presents difficult documentation problems for any taxpayer. In a Tax Court case, a taxpayer used documented estimates of expenses in the base period to come up with a reasonable determination of its fixed base percentage. The IRS attacked the taxpayer's base period calculation as relying on legally impermissible estimates and assumptions on expenses and activities. The Court found the taxpayer did substantiate its base period with reliable documentation and estimates. The Court noted that the regulations do not "require that a taxpayer substantiate its research credit claim with any particular types of documents" and that the taxpayer provided a "close approximation" of its activities in the base period years.

FedEx – 2009 (Internal Use Software)

In a favorable court opinion, a U.S. District Court held that a taxpayer could rely on the guidance on internal use software found in 2001 Treasury regulations, but it was not bound by the restrictive "discovery test" that was also in the 2001 Treasury Regulations.

TG Missouri Corp – 2009 (Supplies)

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The Tax Court held that supplies are includible in the calculation of qualified research expenses, even if the supply may have a useful life of greater than one year as long as the property is not depreciable in the hands of the taxpayer. The issue was unclear as the IRS had taken the position that if a supply was of a property type capable of being depreciated, it could not qualify as a supply. This court opinion is especially favorable for mold makers and tool & die manufacturers since their supply costs can be substantial.