R&D tax credit cases – favorable

Multiple court cases settled in 2009 are likely to affect IRS examinations of prior- and future-year claims. The good news is that the rulings in these cases were favorable to taxpayers and sought to clear up long-standing issues regarding credit qualification and documentation.

The following are brief comments about significant rulings:

  • In TG Missouri v. Commissioner, the Tax Court ruled the cost of production molds designed, modified and ultimately sold to the customer but retained by TG Missouri for production may be considered a qualified supply expense because they were tangible property used in the research activity and not excluded because they were “property of a character subject to depreciation.”
  • In Union Carbide v. Commissioner, the Tax Court described the “primary purpose” of experimental trials as an indicator of qualified research activity, e.g., to eliminate uncertainty in developing a new product or process. It also accepted—over IRS objections—various forms of oral testimony and information substantiation.
  • In FedEx Corp. v. U.S., a U.S. District Court said the IRS may not apply two criteria (requiring new knowledge and “unique or novel” product) the IRS had used to limit Internal Use Software claims. This had been known as the “discovery test” when it was excluded in the 2003 final regulations.
  • In U.S. v. McFerrin, the U.S. Fifth Circuit Court reversed a federal district court’s denial of a credit based on failing to meet the “discovery test” (noted above) and lack of contemporaneous evidence of research activities and expenses. Most significantly for the taxpayer, the court allowed reliance on the taxpayer’s oral testimony and estimates (under the Cohan rule), which the IRS had rejected.