Background

T.C. Memo 2007-188

This is a case filed in the United States Tax Court.  The sole issue in this case is whether Tyson Foods Inc.  may depreciate approximately $2 million in expenditures for which complete and correct records were not maintained.

Basic Facts

Tyson Foods is a fully integrated producer, processor and marketer of poultry based foods with offices located in Springdale, Arkansas and Delaware.  In 1994, Tyson Foods purchased the stock of Culinary, a manufacturer of frozen food products, in a transaction that was treated as an asset purchase for federal income tax purposes. Tyson Foods did not credit a receivable for accounting for payments the City of Chicago made in connection with the subsidy. The Commissioner of Internal Revenue thinks that Tyson Food’s income should be reduced by $1,800,354 of the $5 million subsidy.

The IRS’ main criticism of the plaintiffs evidence is for the entire calender year of 1995 and cannot be allocated to the fsical years before the Court. Taxpayers are required to keep accounts or records, including inventories in order to establish gross income, credits, deductions and any other information that must be shown.  In order for an estimate to made by the Court, there must be sufficient evidence in the record and Tyson Foods failed to provide this.  The only evidence the plaintiffs had were recorded in the moving expenses account and no invoices were ever recorded or produced.

Findings

Tyson Foods has failed to satisfy its burden of proof in order to feel entitled to the deductions.

Click Here to view the full case: TG Missouri Corporation v. Commissioner, 133 T.C. 278 ( T.C. 2009).

Background

This is an appeal from the U.S. Tax Court denying Union Carbide Corporation (UCC) a credit for supplies used in the conduct of qualified research.  Judge Pooler agrees with this judgment and files a separate concurrence.

UCC conducted three research projects at two production plants in the 1994 and 1995 tax credit years.  UCC requested a research credit for the costs of all supplies used in these projects even though they would have been used if the research and projects hadn’t been carried out.  It was argued that UCC only is entitled to credits for the additional supplies that were used in these projects.

Basic Facts

The three projects are as follows:

1. Amoco anticoking project: UCC conducted research  and production on industrial furnaces to diminish the creation of coke in the furnace however they found their project did not result in lower productions of coke and they discontinued the research.
2. UCAT-J proejct: UCC attempted to lower costs in the production of polyethylene products.  They ran this project 19 times and this project was discontinued after it resulted in higher levels of off-grade polyethylene.
3. Sodium Borohydride: This project was used to find if sodium borohydride would reduce the presence of an unwanted byproduct.  The test ran for two weeks and they were successful.

At the bench trial in Tax Court, the costs for supplies used for the anticoking project were not credible as an “amount paid for supplies used in the conduct of qualified research”.  They acknowledged that if UCC had not purchased these materials, these woudl have been treated as inventory and costs of goods sold.  The sodium borohydride project did not fulfill the “process of experimentation test”.

The main issue in this case is whether the cost for supplies used during these projects would have been used in UCC’s manufacturing process regardless of any research performed and would they qualify as “an amount paid or incurred for supplies used in the conduct of qualified research.”

• UCC argues for the dictionary definition of qualified research however this kind of definition does not constitute the beginning and end of statutory construction.  The Court and this Opinion agree that these research costs claims are merely indirect research costs excluded from QREs.

Findings

The decision of the Tax Court is affirmed with response to the anticoking project and the UCAT-J project.  This Opinion is also in agreeance with the Tax Court’s decision in regards to the sodium borohydride project because it is not considered qualified research.

Click Here to view the full case: Union Carbide Corporation v. Commissioner of Internal Revenue, No. 11-2552 (2d circuit 2012).

 

Background

In 1996, FedEx Corporation found a need for a new computer based system to more easily track their billing records. They carried out this project until 2001 when it was abandoned.  In May 2001, they filed research credits for this project which required substantial expenditures for research and development for which the IRS denied.

In 2008, FedEx Corporation filed suit in federal district court in order to receive over $10 million in tax for those years they were not previously granted.

FedEx filed a motion in 2009 for partial summary judgment on the legal standards in regards to the judgment on the legal stand for the “discovery” test and the “internal use software” test.

Basic Facts

The two parties differ over what satisfied the discovery test and the internal use software test.  Research on computer or software by or for the benefit of the taxpayer primarily for internal use is not considered qualified research.  In 2001, a “discovery” test would be required to be undertaken to “obtain knowledge that exceeds, expands, or refines the common knowledge of skilled professionals in a particular field of science or engineering.”  The “discovery” test in the Proposed Regulations and in the 2003 Final Regulations differed from the 2001 Final Regulations.  The 2003 Regulations do not adopt the “internal use software” test and the “discovery” test  is satisfied by research that eliminates certain uncertainty and improves business components.

FedEx Corporation seeks summary judgment on the question of the tests the IRS should have applied to determine whether they were eligible for research tax credits in terms of QREs.  FedEx Corp argues that the 2001 Final Regulations apply to their project because the tax years in question occurred between 1997 and 2000.  Because the IRS has not issued a new “internal use software” test, they should rely on the test from 2001.  The IRS tried to amend the 2003 Final Regulations with an announcement when the Treasury could have issued temporary regulations instead.  This requirement from the IRS for FedEx to apply to the “discovery” test from 2001 is contrary to what the IRS stated in the 2003 Final Regulations.

 Court’s Decision

In June 2009, the U.S. District Court for the Western District of Tennessee granted the plaintiff’s motion for partial summary judgment. The taxpayer may rely on the “internal use software” test from the 2001 Final Regulations.

Click Here to view the full case: FedEx Corporation v. U.S. – 103 AFTR 2d 2009-2722 (W.D. Tenn. June 9, 2009).

 

 

Background

United States (“The Government”) claims that Procter and Gamble (P&G) and its subsidiaries improperly excluded receipts from intercompany transfers with the foreign members of its controlled group when determining “Gross Receipts” for the purpose of calculating its research tax credit.

During IRS’ Audit, they issued a notice of proposed adjustment which reversed its prior position that all receipts from intercompany transfers be excluded.  Because of this, the IRS states that P&G’s calculate are incorrect because foreign member s of controlled groups should be included in Gross Receipts.  Procter and Gamble argue that this revision contracts the IRS’ own regulations.

The sole issue in this case is a legal one: whether a taxpayer must include the results of its intercompany transactions within its “Gross Receipts” for the purposes of determining the amount of its research credit.

Basic Facts

• P&G and its affiliates are in the manufacture and and sale of consumer products in the US and throughout the  world operating under a variety of brand names including Charmin, Crest, Pringles, Pantene, Pampers and Bounty
• P&G’s subsidiaries regularly engage in intercompany transactions with one another.  These subsidiaries regularly engaged in in the manufacture and sale of specific P&G products
• P&G also owned additional subsidiaries who sold P&G products and belonged to P&G’s “controlled group of corporations”
• P&G engaged in extensive research activities throughout this time which consisted of activities related to the development and improvement of products and technologies.  P&G claimed research tax credits on its tax returns for the expenses incurred for this research.
• When calculating research, P&G treated all members of its “controlled group of corporations” as a single taxpayer, which was used in P&G’s previous tax returns.
• After the IRS requested P&G’s Gross Receipts and how they got there, the IRS issued a written determination which stated that P&G were correct.
• In 2006, the IRS Chief Counsel revised the agency’s position on Gross Receipts; however this rule only applies to receipts from foreign subsidiaries and not to receipts from domestic subsidiaries.
• In 2007, the IRS now claimed that intercompany transactions with foreign members should no longer be excluded from Gross Receipts and therefore P&G’s Gross Receipts and Base Amount were incorrect.
• The IRS said P&G’s domestic sales continued to be excluded from Gross Receipt as well.
• In turn, P&G’s research credit decreased as their Base Amount and Gross Receipts increased.
• P&G paid that additional tax that was owed and then filed a civil action seeking a refund on those aforementioned amounts.
• P&G’s decision to not include intercompany transfers with its international members is consistent with the credit’s intended effect.  The research credit is intended to reward research expenditures by measuring the expenditures against Gross Receipts.  By including international transactions, this would double count transactions and would create irrelevant measurements.

Court’s Decision

Based on the evidence provided on record, the Court finds that there is no material for trail and the Plaintiff (P&G) is entitled to judgment as a matter of law relating to the Gross Receipts research credit issue.  In turn, the Plaintiff’s motion for partial summary judgment is granted and the Defendant’s cross motion for partial summary judgment is denied.

Click here to view the full case: Procter & Gamble Co. v. United States, 733 F. Supp. 2d 857 (S.D. Ohio 2010).

Background

Apple Computer Incorporated treated incomes they earned from stock options as wages for increasing research activities in 1982, 1982 and 1983.

Basic Facts

The main question for this court case is whether the income generated from stock options is appropriate and constitutes wages paid for increasing research activities.

• Apple Computer Incorporated is a California corporation based in Cupertino, California who designs, produces markets and services computer related products.
• Apple has maintained three employee stock option plans and they have been publicly held and listed since first offering in December of 1980
• During this time, there was an increase in stock price and these spreads were not reported as costs or expenses.  Apple then deducted the spreads as wages and claimed these wages as increasing research activities.
• Qualified research expenses are defined as in-house research expenses and contract research expenses.  Apple and Commissioner dispute over whether the spreads constitute wages for qualified research.
• Apple Computer Incorporated used an accrual accounting method which means that the taxpayer deducts expenses in the year they are incurred regardless of whether or not they are actually paid in that year.  The Commissioner of Internal Revenue is arguing that Federal income tax laws should be controlled by financial accounting conventions.  The Supreme Court rejected this idea and stated that if this were to occur, innumerable difficulties would arise in tax administration.

Court’s Decision

1.  Wages for Qualified Services: Apple Computers Incorporated asked for the spreads from stock options to be excluded from the definition of wages but there is no language to support this.  The Court says that amounts of compensation are not subject to withholding, like certain fringe benefits, do not enter into the credit computation even if they are used in performing research.   The language and legislative history does not allow Apple Computer Inc. to exclude spreads from the definition of wages.
2. Expenses Paid or Incurred: The Respond states that Apple Computer Inc. did not pay or incur any costs when the employees excised their stock options.  There is no requirement that the expense be paid in cash and Apple Computer Inc. recorded a liability when each option occurred.  The Commissioner of Internal Revenue’s argument that Federal income tax laws should be controlled by financial accounting conventions.
3. Expenses Incurred After Services Performed: The Ninth Circuit held that the legislative history does not clearly explain that expenses do not qualify unless paid or incurred in the year the services are performed.  This circuit rejected the respondent’s argument of omitting expenses incurred after services performed.
4. Options Granted Before the Enactment of Section 44F: All the expenses were incurred after June 30, 1981 and before January 1, 1986 and therefore all expenses were incurred when the employees exercised options.

An appropriate order will be issued.

Click here to view the full case: Apple Computer Inc. v. Commissioner 98 T.C. 232 (1992) acq 1992-2 CB 1.

Background

Trinity Industries v. United States (N.D. Tex. 2010) involves Trinity Industries seeking a refund for certain qualified research expenditures (QREs) tax credits claiming they were wrongfully disallowed for the 1994 and 1995 tax year.  This suit was filed in March of 2009 in the U.S. District Court, Northern District of Texas, Dallas Division.

Trinity is involved in a variety of business and some of these expenditures discussed were incurred by a division of Trinity referred to as Trinity Marine Group (TMG).  TMG in the tax years discussed was in the business of shipbuilding.  The claimed QREs are in the nature of construction of “first in class” (new type of design) ships for clients and customers.

Because Trinity did not segregate costs in relation to each new aspect of design, an all or nothing approach to litigation was chosen.  The Court finds that Trinity must stand or fall on an “80% of the whole ship” basis meaning that if Trinity can show that 80% of a first class ship was part of  a process of experimentation, they can claim the entire cost .

There are two elements in dispute for this case:

1. Were the expenditures useful in the development of a new or improved business component?
2. Do the expenditures constitute elements of a process of experimentation?

1) Business Component – The Government argues that because the ships were special order and not “held for sale” they do not qualify as business components. The Court finds that each first class ship was a business component and TMG held the ships for sale.

2) Process of Experimentation – Because Trinity did not provide any evidence in regards to this issue the Court finds there is no evidence from which it can estimate QREs relating to any business component smaller than an entire vessel.

The Projects

The following 6 projects and their description and outcome are listed below:

A. The Mark V – This project was a highly innovative and special operations deployment craft which existed nowhere else in the world at the time of production.  In order to complete this project, TMG built two Mark V prototypes and they were both based on an entirely new design.  With these findings, the Court approves of QREs for TMG.

B. The Dirty Oil Barge – Although oil barges had previously been designed by TMG, double hull oil barges were new and changed the design and approach in its entirety.  The specific requirements and the stability necessary for the barges revealed this was an entirely fresh design.  The Court approves of QREs for this project.

C. XFBB – This project required a process of experimentation however the features and designs of the boat seemed to be too similar to previous projects.  Because of this, the Court had to ascertain whether 80% or more of these costs were dedicated to experimentation.  Due to this uncertainty, the Court finds that Trinity has failed to meet its burden of proof and therefore not entitled to any QRE credit for this project

D. T-AGS 60 – This project involved an oceanographic research ship designed for the US Navy.  Although this project included qualified research, most of the balance of the T-AGS was not new or different and the Court finds that Trinity is not entitled to any QRE credit.

E. Crew Rescue Boat – The Crew Rescue Boat was an offshore oil field service boat.  Much of the construction and development of this ship did not involve the process of experimentation, but rather integrated other capabilities into the single vessel.  The Court finds that Trinity is not entitled to the QRE credit due to having less than 80% of the costs devoted to experimentation.

F. Hurley Dredge – This involved the building of a dredge for the Corps of Engineers in the Mississippi River.  The changes that TMG made to design this boat were small and not in comparison to the general project.  Because of this, the Court found that Trinity is not entitled to any QRE credit for this project.

Court’s Decision

The Court directs both parties to attempt to reach an agreement in terms of the appropriate dollar amount of credit.  If they cannot agree, each party can file briefs based on current evidence no later than March 15, 2010.

Click Here to view the full case: Trinity Industries, Inc. v. United States, 691 F. Supp. 2d 688 (N.D. Tex. 2010).

Background

In 2009, the United States (“the Government”) filed an action to recover erroneously issued refunds to Morris and Cynthia Davenport and Myra Davenport for the 2003 tax year in upwards of $292,095 in total.  The Government claims they are entitled to 10% surcharge and interest for their efforts.  In 2011, the Davenports filed a similar action against the Government for a refund in regards to qualified research tax credits that think the IRS wrongfully disallowed for 2002’s tax year.

Basic Facts

David Davenport and Morris Davenport are 50% shareholders in Burly Corporation. Burly manufacture building parts for residential and stand alone metal buildings through its subsidiary Mueller Supply Incorporated, which the Davenports have owned since 1984.  In 2006 the Davenports amended their tax returns for 2002 and 2003 in conjunction with software developed to manage and integrate all of Mueller’s business aspects.  This device was know as the OneWorld Project and the developed software was known as OneWorld System.  The US refund is based on tax credits in regards to the OneWorld Project.

The Government rejected the research credits claimed by the Davenports for the 2002 tax year and contends that it erroneously refunded the amounts claimed by the Davenports for the 2003 tax year because no audit was performed in processing the Davenports’ 2003 claims. The Davenports contend that the Government’s refund claim as to David and Myra Davenport was badly timed.  The IRS mailed the refund check for the 2003 tax year to to David and Myra Davenports on December 28, 2007 and the refund check to Morris and Cynthia Davenport for the 2003 tax year was mailed on June 27, 2008.  In the instance of the OneWorld application, the Davenports argued that they redesigned and restructured the software whereas the Government claims it was only an adaptation of software instead of an entirely new composite and that is why the tax credits were rejected.

Mueller purchased a license from IBM in regards to an ERP Bridge, which is a collection software used by IBM to organize all of their clients’ data and customize to each customers’s needs.  After filing 1120S tax forms in 2002 and 2003, the Davenports were contracted with alliantgroup to determine if they were eligible for research and development tax credits.  The Government and Mueller agree that the tax credits are in reference to activities performed by Mueller employees including wages and outside employees who helped develop OneWorld software and has nothing to do with IBM or JD Edwards consultants.

Court’s Decision

The court could find no evidence that the Davenports and Mueller’s activities would pass the process of experimentation test.  The evidence to support the Davenports’ claim that the activities would pass the process test was only found in the Davenport’s amended tax returns filed in 2006.  Furthermore, these activities were concluded that they took place after the initial start up of they System by IBM.  Therefore, these aforementioned activities do not satisfy the experimentation test because they did not occur “as of the beginning of the taxpayer’s research activities” but rather in the middle of them.

In 2011 the Government moved for summary judgment for the 2003 refunds claim and the wrongful disallowance of the Davenports’ 2002 tax refund credits that were supposedly wrongfully disallowed.  The Davenports then moved for partial summary judgment in regards to the legal standards that apply to the parties’ claims. In 2012, the court:

• grants the United States’ Motion for Summary Judgment,
• denies Defendants’ Motion for Partial Summary Judgment,
• dismisses with prejudice the Davenports’ claims

The Davenports’ then seek for the reconsideration of the court’s 2012 memorandum opinion and order and judgment pursuant to Federal Rule of Civil Procedure 59(e).

In September 2012 after careful consideration and review of the evidence in both cases, the Court denied the Davenports’ Reconsideration of Summary Judgment on the basis that they have not established a manifest error of law.

Click here to read United States v. Davenport 897 F. Supp. 2d 496 (N.D. Tex. 2012).

 

Background

This case was filed on March 21, 2012 in the United States Tax Court.  The sole issue for decision in this case is whether or not certain wages from Farouk Systems, Inc. (FS) paid to petitioner Farouk Shami (Mr. Shami) for 2003, 2004 and 2005 and petitioner John McCall (Mr. McCall) for 2003 and 2004 qualify as research expenses for purposes of claiming credit and increasing research activities.

Basic Facts

FS was a hair, skin and nail company that sold and developed products.  FS employed hundreds of people who were in several departments like manufacturing, education and research, marketing and sales. Activities involving scientific research and experimentation were conducted by the research and development department, which employed 18-27 staff at any time, or the activities were outsourced.

Mr. Shami was FS’s chief executive officer, president and secretary for 2003 and 2004.  Mr. McCall was a principal for a company who distributed FS products and he was a shareholder in FS in the 1990s.

In order to conduct research and development tax studies, FS contracted with alliantgroup to cover the relevant years.  These studies claimed that FS was able to qualify for research and tax credits from the wages paid to Mr. Shami ($8.7-$9.5 million) and Mr. McCall ($1.8-$5.7 million) on an annual basis.

QREs (Qualified Research Expenses) can include wages paid to employees when performing qualified research activities.  All wages paid to an employee can constitute QREs if 80% of their wages are attributable to qualified services for the taxable year.  Taxpayers must retain records of this qualified research to prove these findings.

Findings

• Taxpayers (FS) must be prove they are entitled to claim tax credits.  Petitioners have not shown that they have provided adequate information to suffice this.
• Mr. Shami and Mr. McCall say that they spent 80% of their time dedicate to product search and development for 2003 and 2004 and Mr. McCall spent 30% of his time in 2005 for these services.  The Commissioner of Internal Revenue argues that they did not provide substantial evidence that these activities corresponded to their wages because Mr. Shami and Mr. McCall failed to provide any documentation that proves these services occurred during the relevant years.
• Several testimony petitioners offered to substantiate this time however they were seen as inadequate and sometimes contradictory to the Mr Shami’s and Mr. McCall’s statements.  Petitioners turned to United States v. McFerrin in saying the Court must make an estimate in regards to the amount of wages allocable to qualified services however, this case argued that the Court will make an estimate if the taxpayer provides adequate documentation to substantiate costs associate with their research activities.  The Court will not make an estimate for the allocation of wages because the plaintiff failed to provide sufficient evidence.
• The Court rejected the petitioners’ argument.

Click here to read the full Tax Court Memorandum: Basim Shami and Rania Ardah, et al. v. Commissioner of Internal Revenue (T.C. Memo 2012-78)