In a recent opinion, the US Tax Court rebuffed another attempt by the IRS to deny the R&D credits credit to taxpayers. By granting summary judgment to the taxpayer, the Court upheld the string of cases that define what funded research means.
The Case: Populous Holdings, Inc. v. IRS
The taxpayer, Populous Holdings, Inc. (Populous), an architectural design service company, claimed a research credit for two years; the claim included qualified research expenses associated with more than 100 client contracts. The IRS denied the credit asserting another party funded the taxpayer’s research activities in each instance. The Court reviewed a representative sample of the contracts and ultimately determined that the research was not funded, and Populous was entitled to the credit.
In determining if the research performed was funded, the court followed the guidance of previous cases. In general, the courts have held that fixed-price contracts should be considered unfunded. Those cases considered contract research to be funded unless:
- The payment was contingent on the success of the research, AND
- The contractor retained substantial rights in the research.
The contracts that the court reviewed were all fixed priced contracts, and all gave the client a right to review and approve design documents and dispute invoices (i.e., payment was shown to be contingent on the success of the research).
Additionally, the contracts did not contain provisions prohibiting Populous from using the research it performed, or require payment to the client for the use of the research (i.e., the contractor retained substantial rights in the research).
As a result, the court held that the research performed by Populous was not funded.
This case is significant in that it reinforces the current law surrounding the definition of funded research. As the IRS continues to look for new ways to limit the research credit, changing the requirements of funded research will not be one of them.