U.S. Tax Court Reaffirms Architecture, Engineering and Construction Industry’s Right to Claim R&D Tax CreditsAnchin AlertJuly 7, 2020
Taxpayers within the Architecture, Engineering and Construction (AEC) industry received a big win from the U.S. Tax Court this past December. The Tax Court’s decision reaffirmed that AEC industry companies contracted by developers or other clients are indeed eligible to claim R&D tax credits for research activities they perform. This has long been a contentious issue between the IRS and AEC Industry taxpayers. Populous Holdings, an architectural design services company, had claimed R&D tax credits on its 2010 and 2011 tax returns totaling nearly $300,000. The IRS disallowed these claims, arguing that the research activities were funded by Populous clients who contracted with the company for its services.
Contracted research is considered funded and ineligible for R&D credits unless: 1) payment to the contractor is contingent on the success of the research, and 2) the contractor retains substantial rights in the research. Similar to the Geosyntec case of 2015, Populous and the IRS agreed to limit their analysis to the funding issue, stipulating the qualifying nature of the underlying research activities. The parties agreed to review five of the more than 100 contracts during the timeframe of the claimed credits. All five contracts selected for review were fixed-price type arrangements, where Populous was obligated to meet all client requirements for a lump sum or fixed fee. Any additional cost overruns necessary to meet project requirements would have to be absorbed by Populous.
In his decision, Judge Goeke referred to the earlier Geosyntec ruling which concluded in general that fixed-price contracts are inherently risky to the contractor, and are therefore not considered funded. The Tax Court found that in each of the five fixed-price contracts, payments to Populous were indeed contingent on the success of the research. Other clauses from these contracts also favored Populous, such as the client having the right to review and approve Populous’ designs, client having the right to dispute invoices, and Populous bearing the cost of design revisions.
On the rights issue, the Tax Court relied on the decades old Lockheed Martin case, which established that a contractor retains substantial rights in the research performed for a third party, so long as the contractor retains the rights to use the research results in his or her trade or business, even if such rights are not exclusive. None of the contracts under review by the parties included provisions prohibiting Populous from using the results of its research, nor did they include provisions requiring Populous to pay for the right to use the results of its research. Thus, it was held by the Tax Court that Populous retained significant intellectual property rights to the research performed.
This Tax Court decision will now be applicable to other similar cases, providing clarity and relief to AEC – and potentially other – companies claiming R&D tax credits under fixed-price arrangements.