R&D Diagnostics Flashcards

Question

Two ways that software is not IUS?

Answer 1

1. Developed for third party use: software that is developed to enable the TP to interact with third parties, or to allow third parties to initiate function and review data on a TP system. 2. Developed for commercial sale: software that is to be sold, leased or licensed, or otherwise marketed to third parties.

Answer 2

1. Highly innovative: measurable improvement in speed, efficiency, or cost in business; 2. Significant economic risk: higher uncertainty--dedicate significant resources (time and money); 3. Not commercially available

Answer 3

Facts: Awarded 7 different contracts to develop missiles (U.S. government agencies, Boeing, University of Alabama). Contract with air force included both fixed-fee and cost-plus-fixed fee line items. Other contracts were all time & materials, cost-plus-fixed-fee contracts, and fixed-price level of effort contracts. TP arguments: 6 contracts at issue in this case. TP argues that a course of dealing existed between it and its contracting partner in which regardless of the plan terms of each contract, TP was expected to produce a successful result in order to receive payment. TP also argues that each of the contracts included either an inspection clause or a warranty clause or termination clause that put TP at financial risk if results were not successful. Government argument: Under each sample contract, TP would be paid regardless of whether research was successful. TP also fails to retain substantial rights in two of the contracts. Holding: Contracts were funded. Course of dealing argument is parol evidence--the court may only consider such evidence if the contracts are ambiguous. Court found that contracts were not ambiguous and so was limited to the language within the four corners of the contract. Inspection and warranty clauses within the contracts were also not enough. Clauses included language stating that payment was contingent on level of effort rather than success or outcome. Warranty clauses also did not put TP at financial risk--TP was paid to correct or replace nonconforming services. With regards to rights, Dynetics tried to argue similarly to Lockheed--but Court said that rights retained were incidental benefits and industry know-how.

Answer 4

Facts: TP is an architectural firm. 5 contracts sampled--all fixed-price--established that economic risk prong was satisfied using Geosyntec since fixed-price contracts are inherently risky. Issue: Did TP retain substantial rights? Government argument: No substantial rights because ownership of documents clause. Client owned project-related documents and contract prohibited TP from using or recreating any distinctive original, material exterior features without client's consent. Holding: TP retains substantial rights. Ownership of documents does not mean clients had exclusive right to TP's research. No provision in K that prohibits petitioner from using related researched technology in its business. No provision in K that prohibited use of research performed or required TP to pay client for use of its research. Both parties here have rights which is okay.

Answer 5

Facts: Edwards was a controls engineer. Contracted with hospital to design control system for hospital. Issues: 1. Primary designer a. Edwards had a maintenance K that did not specific design. Edwards produced design documents and sequence of operations to show they created technical specifications. Court says just because K doesn't say design doesn't mean you weren't the designer. Three ways to test if you were a designer: - Analyze existing conditions to prior specifications; - Modified to better operate; - Tested with simulations 2. Allocation letter a. Person that signed was not valid. Court said there is no one specific person that must sign it from the government building. b. Spot on letter that says amount of deduction. Designer put in 100% deduction. IRS argued that percentages weren't allowed and that a numeral amount is required. Court said it doesn’t matter--it's the same thing. 3. Modeling a. IRS took issue with the modeling methodology used to see if it was energy efficient. IRS said if you only designed controls and taking deduction for controls you should only model that and make sure that the control system is meeting that efficiency – court said you should model the entire building and compare to reference building. 4. Placement service date was incorrect IRS argued that Edwards was still working on the building in 2014 so they can't claim for 2013. Court said it was correct—does not need to be the date it was fully operational just when it was functionally in use 5. Deduction cannot exceed the cost of property.

Answer 6

Facts: TP was in the business of manufacturing chemicals and plastics. TP requested an R&D 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. UCC was turning crude oil into petroleum—had coking building up in the pipes. Testing the process of adding the additive into the petroleum to see if it had an impact. UCC took everything as a supply expense including the petroleum. 1. Whether the cost for supplies used during these projects would have been used in TP’s manufacturing process regardless of any research performed? Yes. The cost for supplies used during these projects would have been used in TP’s manufacturing process regardless of any research performed and therefore, 2. Whether they qualify as “an amount paid or incurred for supplies used in the conduct of qualified research?" No. They do not qualify as “an amount paid or incurred for supplies used in the conduct of qualified research” and should properly be excluded.

Answer 7

Company develops production molds to manufacture automotive parts. TG Missouri would sometimes construct the tool themselves or consult with a 3rd party. After the 3rd party toolmaker finished constructing the production mold, TP purchases the mold. TP owned some molds, some of them owned by customer but kept at TG facility. Issue: Whether production molds TP then sold to its customers are assets subject to depreciation. Hold: No. TA: The molds that were sold to its customers are not subject to depreciation allowances because the petitioner does not have any economic interest in the production molds it has sold. MUST BE DEPRECIABLE IN THE HANDS OF THE TP.

Answer 8

Issues: 1. POE * IRS says methodical plan involving a series of trials to test a hypothesis is required. TP evaluates software products--not qualified research because not experimentation. * Information must rely on the principles of the physical or biological sciences, engineering, or computer science. TP may not use conclusory statements to state work is technological in nature. * IRS states that the TP cannot face the same uncertainties for more than one year. The court says that is not a requirement for TP to face a different uncertainty each year. * IRS argues that TP does not employ anyone with the title of engineer or anyone with an engineering degree and therefore could not have performed research that relied on principles of engineering. Court says no specific degrees are required. No penalties were imposed since TP had a reasonable reliance on a competent tax advisor when claiming R&D credit and relied on tax advisor in good faith.

Answer 9

Facts: Makes ships ii. Three main issues: a. Didn’t meet sub all. Sub all rule stating at least 80% of TP's research must constitute elements of a POE applies to activities, not to physical components of the product being developed or improved. TP did not satisfy this requirement. b. 2021 case--court held that one who provides direct supervision or support of research is not "engaged" in research. i. Supplies are not activities, when the faction is described in 1.41-4(a)(6), it is computed using costs as a measure of activities, the costs of supplies used in the development of the product are not taken into account. First court said this is a K therefore you can’t be using it for uncertainty—appellate court said you can be doing it for both. c. Novelty approach i. Court uses trinity—appellate court agreed d. No documentation proving shrink back i. First court denied supply QREs 2. Explain the equation for sub all a. Original court b. Appellate court The taxpayer, a shipbuilding company, claimed the R&D tax credit for qualified research expenses attributable to the design and construction of 11 new vessel types that it had never built before. After reviewing documentation for two of the 11 vessels, the IRS asserted, and the tax court upheld, that the taxpayer failed to meet the “substantially all” test, it failed to properly apply the “shrink back” provisions, and it failed to provide contemporaneous documentation to sufficiently substantiate its R&D credits. Ultimately, the appellate court upheld the rejection of Little Sandy’s claim for the R&D tax credit just as the IRS and lower court did, but primarily due to a failure to properly document the activities that it claimed qualified for the credit. “Substantially all” and the process of experimentation for R&D tax credit While the appellate court upheld the denial of the credit, it went on to reject the tax court’s conclusion that direct support and direct supervision of qualified research are categorically excluded from the process of experimentation, a position widely asserted by the IRS during recent examinations of R&D credits. Instead, the opinion indicates that these activities must be analyzed and — if they constitute elements of a process of experimentation — then direct support and direct supervision of qualified research should be included in both the numerator and denominator of the fraction used to apply the “substantially all” test. One component of qualifying for the credit, according to IRC Section 41(d)(1)(C), is that “substantially all of the research activities must constitute elements of a process of experimentation,” and Section 1.41-4(a)(6) further explains that taxpayers must show that “research activities that constitute elements of a process of experimentation” (the numerator) constitute at least 80% of “research activities” (the denominator). In the Little Sandy Coal case, the taxpayer claimed that wages and costs associated with activities performed in direct support and direct supervision of qualified research activities should be counted in both the numerator and denominator of the fraction when calculating if the 80% test was met. The tax court ruled that these amounts should be considered “research activities” and included in the denominator, but that direct support and direct supervision lacked sufficient connection to a process of experimentation to be included in the numerator. The Court of Appeals noted that this would make a taxpayer’s ability to pass the “substantially all” test dependent on how expensive a pilot model would be. The higher court ruled that costs associated with direct support and direct supervision of research activities qualify for inclusion in both the numerator and denominator of the 80% calculation, as long as the costs in question qualify as “research expenses” deductible under Section 174 of the Internal Revenue Code. The higher court ruled that costs associated with direct support and direct supervision of research activities qualify for inclusion in both the numerator and denominator. Documentation and the R&D tax credit An important lesson to be learned from the Little Sandy Coal case is the significance of documentation when presenting an R&D tax credit claim to the IRS. The taxpayer in this case made numerous claims about test procedures, pilot models, subcomponents, and time allocations but failed to retain sufficient records to show how it met the criteria of IRC Section 41. For instance, Little Sandy claimed that certain components of the pilot models would improve the function, performance, reliability, and quality of the boats, such as a stern notch and towing bridle on a tanker and an outboard side plate on the dry dock. But the company’s documentation failed to break out the specific costs of the research expenses directly allocable to these improvements, as is required by the shrink back provision in Sec. 1.41-4(b)(2). They took what observers have termed an “all-or-nothing” approach in saying that the overall improvements to the vessels met the requirements of the credit claim. Had Little Sandy documented costs more carefully and tracked them to different subcomponents of the vessels developed, it seems they might have been able to salvage at least some of the R&D tax credit claim. Getting the most for R&D spending As the Little Sandy Coal case demonstrates, taxpayers that claim the R&D tax credit need to meet both the requirements of the law and the exacting standards of documentation expected by the IRS. A system of contemporaneous recordkeeping, including notes, test results, time-tracking data, cost data, and evidence of technological uncertainty or scientific experimentation, is a critical component to substantiating a claim for the credit.