Meyer, Borgman & Johnson, Inc. v. Commissioner— What’s in the Four Corners of the Contract?

Written by Corporate Tax Incentives. Updated May 11, 2022.

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A new court opinion issued by the U.S. Tax Court emphasizes the importance of contract review for the analysis and substantiation of an R&D tax credit claim. The opinion alludes to additional requirements to demonstrate a taxpayer's economic risk when conducting research. Moreover, the court points to precedence to emphasize that terms and conditions within any contract agreement are most important, and no implications or assumptions should be needed or considered to substantiate a credit claim.

On November 19, 2020, the tax court issued a summary judgment opinion in Meyer, Borgman & Johnson, Inc. (MBJ) v. Commissioner. In this case, the taxpayer – a structural engineering services firm – was denied its R&D credit claim, with the court stating that the taxpayer’s research was funded, and therefore not eligible for the credit. After receiving a notice of deficiency for its credit claim, which was based on custom engineering and design work completed on complex building projects, MBJ filed a petition with the court for reconsideration. At issue within this case was whether or not MBJ’s services were “funded” as defined within Sec. 41(d), its associated treasury regulations, and supporting caselaw. After a period of discovery, both parties agreed to focus on a sampling of 14 project contracts, to provide resolution for the case.

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Sec. 41 expressly excludes a list of activities from the definition of qualified research, including funded research, which is defined in the treasury regulations Sec. 1.41-4A(d). The court went on to cite Sec. 1.41-4A(d)(1), indicating what would be considered unfunded research, in part cited here “…Amounts payable under any agreement that are contingent on the success of the research and thus considered to be paid for the product or the result of the research are not treated as funding.”

The taxpayer presented an argument that if there is a sale on a product (i.e., a business component as required by Sec. 41), then either the taxpayer or its client would be eligible to claim the credit that resulted from that research. However, the court pointed out situations in which neither the taxpayer performing the research nor the client paying for the research were entitled to a credit. Thereby, the court focused its analysis and ruling on answering the question of “whether or not the taxpayer bears the risk of financial loss of unsuccessful research.” If the answer to this is ‘no,’ the court stated that in those circumstances, there would be no identifiable credit to be claimed.

After review of the 14 contracts at issue in this case, the Commissioner concluded that there were no existing provisions within the four corners of the contract document that made payment contingent on the success of the taxpayer’s research, thereby making MBJ’s research funded.

Conversely, MBJ counterargued that for each of the 14 projects, the company would only be paid if the project work was successfully completed and met the predetermined local, industry, and client standards of quality. Specifically, the taxpayer stated that in business practice and application, MBJ was never paid the price of any contract until the work was fulfilled based on a client’s expectations. Beyond that, each of the taxpayer’s contract agreements were structured as fixed-price or lump-sum payments, which per the Geosyntec Consultants, Inc. v. United States cases, have inherent economic risk and, barring any substantial rights issues, are considered unfunded research. According to MBJ, each project’s contract agreement was ‘inherently risky’ because if they did not effectively perform the engineering work within the set price of the contract, they would be forced to take a loss on the work, because they could not bill beyond the set price, but would still have to provide labor and services until the engineering and design work was perfected.

Also citing the Geosyntec case, the court distinguished two types of economic risk – 1) financial risk based on cost-of-performance, and 2) financial risk of failure. Therefore, for the court, it was not an issue that MBJ might take a financial loss on projects for not being able to timely complete them with the expected quality of work. At issue was whether or not it was expressly written or clearly implied that payment on each of the contracts is contingent upon MBJ’s research. More clearly stated, if MBJ did not meet all the requirements, specifications, and codes of the project, the client would not pay. Further, MBJ argued that without meeting local and federal building code compliance requirements, the project would not conclude, and therefore, the taxpayer would not be paid. The court implied that in business practice, MBJ may be only getting paid when the client received properly designed and engineered structures. However, based on provisions in each of the Geosyntec, Dynetics, and Fairchild cases, the court analyzed that an express clause, term, or condition, that places economic risk of failure back onto the taxpayer must be present within the four corners of the contract document. The court unequivocally stated that:

…we will not read into the contract language that is not actually present.

Because MBJ failed to identify specific provisions, references, or examples of such contractual terms or building code requirements for each of the 14 projects, the court concluded that:

MBJ’s contracts here lack any of these express terms that courts have identified in this caselaw as important.

Further, Judge Holmes expanded on the need for express terms and conditions by stating:

Contract provisions like quality assurance procedures, specific barometers for success, and mechanisms for inspection, evaluation, and acceptance show that payments made under the contracts were contingent on the success of the research required under the contract. (Citations omitted). MBJ’s contracts don’t have such provisions.

Throughout the summary judgment opinion, the court both expressly and implicitly accepted that the taxpayer did in fact have to meet the client’s specifications and expectations, as well as local building code standards. Therefore, with the right contract analysis, MBJ may still have been entitled to a research credit.

Court rulings such as this one further signify that R&D credit claims continue to be scrutinized to ensure they measure up to what the code and corresponding caselaw have prescribed. Hiring subject matter experts who specialize in this niche area of tax law can ensure that your company’s R&D credit claim has the required accuracy and supporting documentation necessary to substantiate the credit. Contact CTI and our team of consultants today to allow us to analyze your company’s activities and maximize the credit opportunities available based on current caselaw and any applicable regulatory updates.


Research & Development Tax Credit Guide

Topics: R&D Tax Credit, Legal News

Corporate Tax Incentives

Written by Corporate Tax Incentives

CTI is a tax incentives specialty firm that secures greater tax credits for businesses with our proven project methodology and unparalleled personalized service. For almost 20 years, our elite tax professionals have proactively engaged clients to deliver unmatched value with transparency and efficiency thorough secure in-house software, comprehensive audit-ready deliverables, and 24x7 access to real-time dashboards. We are tax consultancy experts passionate about maximizing credits and incentives for powering the success of your business.