Earlier this year, the Eighth Circuit Court of Appeals upheld a lower tax court decision denying research and development credits on the basis that a taxpayer’s contracts were considered “funded.” The case in question, Meyer, Borgman & Johnson, Inc. v. Comm'r of Internal Revenue, No. 7805-16 (U.S.T.C. Nov. 19, 2020), centered on whether specific contracts contained the necessary risk of financial loss language, where payment would be contingent on the success of Meyer, Borgman & Johnson, Inc.’s (MBJ) research. Having financial risk is a crucial element to claim a research and development tax credit, as noted in Section 41 of the Internal Revenue Code and the associated Treasury Regulations. This tenet has been noted in a number of cases throughout the years.
The tax court made an important risk distinction, which was ultimately upheld by the Eighth Circuit. MBJ argued that, as a structural engineering firm, MBJ was required to create bespoke engineering designs that complied with all code requirements and structural regulations, but also met client requirements. Additionally, MBJ stated that payment was contingent on the success of the research and, further, that its contracts were inherently risky due to the fixed fee/lump sum nature of MBJ’s contractual arrangements. However, both the tax court and ultimately the Eighth Circuit held that while MBJ’s contracts had general economic risk, an express clause, term, condition or other language must be present within the four corners of the document to shift the economic risk of failure back onto the taxpayer. As MBJ was unable to point to such a clause within its contracts, MBJ did not meet the necessary risk element. It is important to note that the courts clearly distinguish that while a financial loss or contractual arrangement might imply financial loss, language must be expressly written and/or clearly imply that financial loss is contingent on a taxpayer’s research.
How does MBJ affect you?
Many taxpayers considering, or already claiming, research and development tax credits might be wondering how this might affect their claims. While the critical foundations of a tax credit analysis have not changed, it is important to review the terms and conditions within the four corners of client contracts and ensure the necessary language relating to payment contingent upon research success is evident. For taxpayers who are continuing to utilize fixed fee or lump sum contracts, a review of existing language would be appropriate to make the relationship of payment to research success explicitly clear, and/or lay out technical requirements that must be met, to unequivocally show conditions of success.
Our team at CTI is comprised of tax and legal professionals who are ready to consult on appropriate language, and to assist on ensuring all tax credits are compliant with the most up-to-date guidance. Contact our team today to see how our team of experts can best maximize your credit potential with minimal risk to your business!
