Latest Federal Court Ruling in Favor of Taxpayers Claiming the Research and Development Tax Credit
February, 2010
Latest Federal Court Ruling in Favor of Taxpayers Claiming the Research and Development Tax Credit
By
Karim Solanji, J.D. and Saqib Dhanani, J.D.
Trinity Industries Federal Court Ruling Creates Clarity and Predictability for Taxpayers
Trinity Industries, Inc. v. United States,[1] is the latest Federal Court ruling in favor of taxpayers claiming the Research and Development Tax Credit. Following a string of favorable decisions, taxpayers considering the research and development tax credit now have increased clarity and predictability for their claims.[2] Trinity reaffirmed the reliability of the “substantially all” rule, increased clarity regarding what constitutes a “business component” and paved the road for manufacturers that design or build customized deliverables.
The “Substantially All” Rule
The Court renewed the reliability and predictability of the “substantially all” rule, under which taxpayers are able to qualify an entire component as long as 80% of the research activities qualify. In doing so, the Court rejected the Government’s long held requirement that taxpayers “break out every expense” to determine qualified expenses. In Trinity, even routine painting of hulls and insurance premiums for the ships qualified under the “substantially all” rule. Under Trinity, if the taxpayer satisfies the 80% rule on any project or component, all expenses incurred qualify irrespective of how routine or innovative they are.
Business Components Held for Sale, Lease or License
The Court rejected the Government’s argument that custom built ships were not business components “held for sale, lease or license” by the taxpayer. The Court made it emphatically clear that it did not matter whether the ships were custom built for a particular client. After completion, but prior to delivery, the Court held that the taxpayer’s ships were “held for sale” within the meaning of I.R.C. § 41 (d)(2)(B)(i). It is also worth noting that the Court did not even have to rely on the much broader alternative provision of the business component requirement, which is satisfied if the business component is “used by the taxpayer in a trade or business.”[3]
Customized Integration
The Trinity decision provides newfound clarity for those manufacturers and businesses that design or build customized deliverables. The Government has long held that assembling existing parts into a larger product or process does not qualify because it does not exemplify a “process of experimentation.” The Court rejected the Government’s stance as an oversimplification of the law and stated that “the simple fact that a new [component] incorporates existing systems does not resolve the QRE issue.” In Trinity, the Court focused on the complexities of ship building and stated that changes in electronics, power generation, power distribution or a change in engine plant could all change “weight distribution and performance” as a whole. The Court’s focus on the complexities of integration and overall performance of the finished product open the door to manufacturers and businesses that rely on customized design, construction or assembly.
Summary
Trinity provides manufacturers with a fresh opportunity to examine the potential of the R&D Tax Credit. By creating increased clarity and predictability in an otherwise challenging regulatory environment, Trinity enables the manufacturing core of the U.S. economy to recoup some of the costs spent on innovation at a time when capital is at a premium. Especially for those manufacturers specializing in customized development, assembly or construction of products, Trinity affords a new opportunity to utilize the R&D Tax Credit.
[1] Trinity Ind. Inc. v. United States, 105 ATFR 2d 2010 (N.D. Tex. 2010).
[2] See United States v. McFerrin, 570 F.3d 672 (5th Cir. 2009), reversing 492 F.Supp 2d 695 (S.D. Tex. 2007); FedEx Corp. v. United States, 2009 WL 2032905 (W.D. Tenn. 2009); TG Missouri Corp. v. Comm’r, 133 T.C. 13 (2009); Union Carbide Corp. v. Comm’r, T.C. Memo 2009-50 (2009).
[3] I.R.C. § 41 (d)(2)(B)(ii).