Court Denies R&D Credit For Lack Of Success-Based Fee And Rights To Research

The Court of Federal Claims has ruled in Dynetics Inc. v. United States (No. 12-576T) that Dynetics didn't qualify for an R&D credit because its research was funded by another party. The court took an expansive view of the 1995 Federal Claims decision in Fairchild Industries Inc. v. United States (71 F.3d 868) in holding that the payments to Dynetics weren't contingent on the success of the research and that Dynetics didn't retain substantial rights to the research.

The decision was based on a sample of seven contracts, and the IRS and Dynetics asked the court to determine if under the regulations the contract language indicated the research was considered "funded." The regulations under Section 41 generally bar any R&D credit from qualified research "funded by any grant, contract, or otherwise by another person." Any payments contingent on the success of the research aren't treated as funded under the rules, but research is considered funded if the taxpayer doesn't retain any substantial rights to the research.

Dynetics argued that it was under substantial financial risk of not being paid unless its research was successful. It based its argument on termination and inspection clauses, and a general expectation under "a course of dealing" that it would need to be successful to be paid. The court ruled that a course of dealing can be considered only if the contract language is ambiguous and that the contract itself was unambiguous. Dynetics then cited the finding in Fairchild that an inspection clause shifted the risk to the contractor. The court...