LOCKHEED MARTIN ENTITLED TO CREDIT FOR INCREASING RESEARCH ACTIVITIES.

       UNITED STATES COURT OF APPEALS FOR THE FEDERAL CIRCUIT

BACKGROUND

[2] Lockheed Martin was a party to numerous fixed-price contracts with the United States during the 1982 through 1988 tax years. ¹ In 1991 Lockheed Martin filed refund claims for tax years 1984 through 1988. The tax refund claims asserted entitlement to research credits under the "credit for increasing research activities" provision of the Internal Revenue Code, I.R.C. section 44F (1982) ² and I.R.C. section 41(d) (1988), ³ based on certain research expenses that it incurred from 1982 to 1988 in performance of those contracts. Each 1120X tax form filed by Lockheed Martin stated as follows:

     The credit for increasing research activities has been increased

[3] The IRS disallowed the refund claims on the ground that the research expenses did not qualify for the tax credit. The IRS stated that the research performed under the contracts was not "qualified research" under sections 44F(d) and 41(d) because, under Treasury Reg. section 1.41-5(d) (1989), the research was "funded" by the government. The IRS concluded that the research was "funded" because payment was not contingent on the success of the research and Lockheed Martin did not retain "substantial rights" in the research.

[4] Lockheed Martin appealed this decision to the Court of Federal Claims. During the course of discovery on the Low Altitude Navigation and Targeting InfraRed for Night ("LANTIRN") contract, Lockheed Martin learned of additional research expenses that it had not included in its Green Books. It filed a "motion for pretrial order clarifying the scope of complaint" asking the court to order the government to consider evidence regarding these expenses and any other expenses uncovered during discovery.

[5] The Court of Federal Claims denied the motion, reasoning that the submission to the IRS of a tax refund claim stating detailed legal and factual grounds for the refund is a prerequisite to bringing a tax refund suit, and that Lockheed Martin could not substantially vary either the legal or factual bases for its refund claim at trial. See Lockheed Martin, 39 Fed. Cl. at 200-02. The court held that Lockheed Martin's introduction of additional expenses would constitute a substantial variance of the factual basis for its refund claims because those expenses could have constituted a separate basis for recovery had they been timely filed. See id. at 202-03.

[6] The parties both subsequently moved for summary judgment on the question whether, under Treasury Reg. section 1.41, Lockheed Martin retained "substantial rights" in the research for which it claimed qualified research expense tax credits. The parties agreed to have the issue resolved by reference to the contracts governing four programs that represented approximately 65% of the expenses claimed, and to extend the court's determination whether Lockheed Martin retained substantial rights under those contracts, pro rata, to all of the contracts in the suit. The four programs were the LANTIRN, Small Intercontinental Ballistic Missile ("SICBM" or "Midgetman"), Supersonic Low Altitude Target ("SLAT"), and Titan IV programs. The parties refer to these as the "Major Programs."

[7] The contract provisions setting forth the parties' rights in the results of Lockheed Martin's research were substantially the same for each of the Major Programs. The SICBM, Titan IV, and SLAT programs were governed by a single contract. The LANTIRN program was governed by both Full Scale Engineering Development (FSED) and Production contracts. Except for the LANTIRN Production contract, each contract incorporated by reference substantially similar standard regulatory clauses regarding patent rights. Each of the Major Program contracts also (1) incorporated by reference standard regulatory clauses regarding rights in technical data and computer software; (2) contained security classification guidelines for certain information; and (3) incorporated by reference substantially similar regulatory clauses regarding the government's recovery of nonrecurring costs on commercial sales.

[8] The Court of Federal Claims held that Lockheed Martin did not retain substantial rights in its research under any of the Major Program contracts. See Lockheed Martin, 42 Fed. Cl. at 500. The court so concluded because (1) the government had an unlimited right to use Lockheed Martin's technical data and disclose it to third parties, which "considerably diminished, if not destroyed" the value of Lockheed Martin's right to use its research results and hence its competitive advantage; (2) Lockheed Martin had to seek prior approval from the State Department before entering into licensing agreements or discussing with other customers technical information not in the public domain; (3) the government had veto power over Lockheed Martin's right to file patent applications and could require Lockheed Martin to transfer title to a subject invention if Lockheed Martin failed to file a patent application within a specific period of time; and (4) the recoupment provision required Lockheed Martin to pay the government for the right to use its research results. See id. at 498- 500. The court also held that Lockheed Martin lacked substantial rights in its research for the further reason that particular statutory provisions restricted Lockheed Martin's exports. See id. at 498. The court characterized the profits that Lockheed Martin received on private sales of related technology as "incidental benefits." See id. at 499.

[9] Lockheed Martin timely appealed to this court. We have jurisdiction pursuant to 28 U.S.C. section 1295(a)(5) (1994).

DISCUSSION

A. CLAIM VARIANCE

[10] The first issue that Lockheed Martin raises in its appeal is whether the court erred in denying its motion to order the government to consider additional research expenses not discovered until trial. Specifically, Lockheed Martin argues that the introduction of additional expenses would not substantially vary its tax refund claims because the legal basis, the class of contract, and the categories of expenses underlying the claims remained unchanged. Lockheed Martin argues that since its claims were written broadly and put the government on notice that it was claiming research credits for wages, supplies, contract research, and rent expenses made pursuant to its fixed-price contracts, it should be able to introduce any such expenses without varying the claims' factual basis. Lockheed Martin submits that the court improperly narrowed its claim to the expenses listed in the Green Books, which simply constituted evidence for proving its tax claims and did not constitute the claims.

[11] The government responds that the court correctly rejected Lockheed Martin's introduction of additional expenses because those expenses would substantially vary the factual basis for its tax claims. The government argues that even though Lockheed Martin wrote its refund claims broadly, there is no dispute that it predicated its refund claims on specific expenses which together formed the factual basis for the claims. The government contends that, by definition, later-discovered expenses cannot constitute the factual predicate for an earlier tax claim. Thus, the government reasons, Lockheed Martin cannot introduce additional expenses without varying the factual basis for the claims. The government also points out that when Lockheed Martin submitted the Green Books to the government for auditing, it represented to the government that, with respect to thirteen of the contracts, those books contained all of the expenses upon which its research credit claims were predicated. Thus, the government argues, the expenses listed in the Green Books constitute the factual basis underlying Lockheed Martin's refund claims for those contracts and Lockheed Martin cannot now add expenses without varying that basis.

[12] The operative facts are not in dispute. The proper application of the tax laws to an undisputed set of operative facts is a question of law, over which we exercise plenary review. See Washington Energy Co. v. United States, 94 F.3d 1557, 1560 (Fed. Cir. 1996); Kane v. United States, 43 F.3d 1446, 1448 (Fed. Cir. 1994).

[13] We agree with the government that the court correctly rejected Lockheed Martin's attempt to introduce research expenses that it did not discover until after it filed suit in the Court of Federal Claims. A taxpayer may not sue the United States for the recovery of income taxes unless it has timely filed a refund claim at the Internal Revenue Service in the manner prescribed by regulation. See I.R.C. section 7422(a) (1994). The regulations require that the taxpayer submit with its tax refund claim the supporting evidence necessary to prove its claim. See Treasury Reg. section 301.6402-2(a) (as amended in 1977). The regulations further provide that:

     No refund or credit will be allowed after the expiration of the

[14] We agree with the government that the introduction of additional expenses would constitute a substantial variance of the factual basis of Lockheed Martin's claims. Lockheed Martin's claims were written broadly, but there can be no dispute that each of its tax refund claims was based on a finite group of expenses. Lockheed Martin predicated its claims on particular research expenses that it believed entitled it to a tax credit. To arrive at a research credit total for each year, Lockheed Martin summed those expenses. Even though the details of the expenses were not provided to the IRS, they constituted the factual basis for its claims. There is no dispute that the expenses that Lockheed Martin attempted to introduce were not discovered until after it filed suit in the Court of Federal Claims, several years after the claims were filed with the IRS. They were not among the expenses upon which Lockheed Martin predicated its claim. The substantial variance rule prohibits Lockheed Martin from now introducing those expenses. The court therefore did not err by denying Lockheed Martin's request that the court consider expenses discovered after the refund claims were filed.

[15] For these reasons we affirm the Court of Federal Claims' denial of Lockheed Martin's "motion for pretrial order clarifying the scope of complaint."

B. SUBSTANTIAL RIGHTS

[16] The second issue that Lockheed Martin raises is whether the court erred in holding on summary judgment that Lockheed Martin was not entitled to a research expense tax credit because it did not retain "substantial rights in its research" under the four Major Programs as required under Treasury Reg. section 1.41.

[17] Summary judgment is appropriate if "there is no genuine issue as to any material fact and . . . the moving party is entitled to a judgment as a matter of law." United States Court of Federal Claims Rule 56. We review a grant of summary judgment by the Court of Federal Claims de novo to determine whether the summary judgment standard has been correctly applied. See Winstar Corp. v. United States, 64 F.3d 1531, 1539 (Fed. Cir. 1995) (en banc), Aff'd 518 U.S. 839 (1996). Summary judgment is particularly appropriate here. There are no material facts in dispute. The only issues are legal -- whether the Court of Federal Claims properly construed the relevant provisions of the Internal Revenue Code, Treasury regulations, and Major Program contracts, and applied the correct law.

[18] Lockheed Martin argues that the proper test for determining whether a researcher retains "substantial rights" in its research is whether the research contract gives the researcher the right to use the results of its research in its business without paying for that right, irrespective of whether it retains the right to control the use of the research by others. Lockheed Martin submits that it meets this test because, under the Major Program contract provisions, it retained the right to use the research results in its business. Lockheed Martin argues that the court gave undue weight to the government's nonexclusive rights in Lockheed Martin's research, improperly speculated on Lockheed Martin's competitive advantage, incorrectly analogized the concept of " substantial rights" to patent rights, and erroneously characterized Lockheed Martin's rights in its research as "incidental benefits." Lockheed Martin further contends that the court erroneously considered the government's power to withhold the grant of a patent for national security reasons, and its power to restrict foreign technology and software sales by refusing an export license, because those powers exist outside of the contracts. Lockheed Martin also asserts that the court erroneously construed the recoupment clause as a payment for use. Lastly, Lockheed Martin contends that if the treasury regulation were interpreted to require the researcher to obtain exclusive rights to its research in order to have substantial rights, then the regulation would be an invalid construction of the statute because the statute does not contemplate that the researcher would obtain exclusive rights to its research.

[19] The government responds that the court correctly held that Lockheed Martin did not retain substantial rights in its research. The government concedes that Lockheed Martin retained the right to use and disclose the results of its research, but contends that that right does not rise to the level of a "substantial" right. The government primarily argues that Lockheed Martin's right to use its research is not a "substantial right" because it had to pay to use the research under the contracts' recoupment provision. The government also argues that Lockheed Martin's right to use its research was not a substantial right because the government had the right to use Lockheed Martin's technical data and computer software, and to disclose that information to third parties, and Lockheed Martin did not have the right to prevent the government from doing so. It also asserts that the government had the right to use or sell any patented invention resulting from the research. The government also argues that top secret security provisions and export control laws further restricted sales of products resulting from Lockheed Martin's research. The government contends that because of all of these restrictions, Lockheed Martin's rights to use and disclose its research had "no practical value."

[20] We agree with Lockheed Martin that it retained substantial rights in its research results and that it is entitled to the tax credit. We start first with the statute. While the definition of qualified research in the I.R.C. does not refer to the concept of "substantial rights in research," it excludes from its definition research that is "funded . . . by another person." I.R.C. sections 44F(d), 41(d).

[21] The "credit for increasing research activities" was originally numbered section 44F in the I.R.C. The Tax Reform Act of 1984, Pub. L. No. 98-369, sections 471(c), 474(i)(1), 98 Stat. 494, 826, 831-32, renumbered section 44F as section 30. The Tax Reform Act of 1986, Pub. L. No. 99-514, section 231, 100 Stat. 2085, 2173-80, renumbered section 30 as section 41 and substantially amended the provision. Since the credit provision was amended during the tax period at issue in this case (1982-88), we must interpret both the original (section 44F) and the amended (section 41) provision. The relevant aspects of section 41 are substantially similar to section 44F, however, and we reach the same conclusions with respect to both sections.

[22] The original "credit for increasing research activities" provision, section 44F, provided as follows:

     General rule

[23] Sections 44F and 41F both define "qualified research." Section 44F defines "qualified research" as follows:

     Qualified research

[24] These regulations imply two scenarios in which the taxpayer's research will be considered "funded" by another person. The first is when the parties agree that payment shall not be contingent ⁴ on the success of the research. If the taxpayer's research will be paid for by another person whether or not the research succeeds, the research is funded and the expenditures are not entitled to the tax credit. In contrast, if the taxpayer will be paid only if it succeeds in its research for the other party, the taxpayer's research will not be considered funded. See Fairchild Indus., Inc. v. United States, 71 F.3d 868, 873 (Fed. Cir. 1995). "The statute is designed so that those who will bear the risk of financial loss can include the tax credit in their calculation of investment risk." Id. at 874.

[25] The second scenario in which a taxpayer's research can be considered "funded" or "paid for" is when the taxpayer agrees to perform research for another person without retaining "substantial rights" to its research -- when the person for whom the research is performed has "the exclusive right to exploit the results of the research" and the taxpayer "must pay for the right to use the results of the research." See Treasury Reg. section 1.41(5)(d)(2) and -(3). If the taxpayer does not have the right to use or exploit the results of the research, its expenditures are not entitled to the tax credit regardless whether there is an agreement that the research will be paid for only if successful, and regardless whether the taxpayer receives some "incidental benefit" such as increased experience. On the other hand, it follows that as long as exclusive rights are not vested in "another person," the taxpayer may retain substantial rights. Treasury Reg. section 1.41-5(d) thus implements the statute's purpose of giving a tax credit only to those taxpayers who themselves take on the financial burden of research and experimentation to develop new techniques, equipment, and products that they can use in their businesses.

[26] This interpretation is supported by Treasury Reg. section 1.41-2(a), which ties the concept of "substantial rights" to use. That subsection states in relevant part as follows:

         (a) Trade or business requirement -- (1) In general. An in-

[27] We therefore must reject the government's argument that "substantial rights" only includes the scenario in which the taxpayer retains the right to exclude others (including the government) from its research and in which other parties do not also have the right to use or disclose the taxpayer's research, including patented inventions. Nothing in the statute or the regulations supports such an interpretation. The right to use the research results, even without the exclusive right, is a substantial right.

[28] The trial court relied in part on an analogy to patent cases. However, that analysis is unsound. The patent cases deal with the concept of "all substantial rights," and whether any agreement transferring such rights amounts to an assignment, as opposed to a license. See, e.g., Vaupel Textilmaschinen KG v. Meccanica Euro Italia S.P.A., 944 F.2d 870 (Fed. Cir. 1991). We are not dealing here with a patent license, but with a tax statute, with different language and different concepts. The language of the statute and regulations do not require the retention of ALL substantial rights. The issue is only what "substantial rights" means for purposes of the "credit for increasing research activities" provision.

[29] We similarly reject the argument that the determination whether Lockheed Martin retained "substantial rights" to its research can be found by reference to export control laws and top secret classifications; they are also irrelevant because they are outside of the research agreements. The determination whether Lockheed Martin retained "substantial rights" must be made by reference to the Major Program contracts alone. The regulation's focus on the taxpayer's right under the research agreements makes it clear that the determination whether the taxpayer had the right to use the results of its research without paying for that right must be determined by reference to the research agreements. The government concedes that the contract provisions give Lockheed Martin the right to use its research in its business. Such a right is clearly substantial. It permits Lockheed Martin to manufacture and sell up-to-date products meeting the needs of its customers. We do not agree with the trial court's conclusion that Lockheed Martin's rights were "considerably diminished, if not destroyed." The relevant inquiry is whether, under the terms of the contracts, Lockheed Martin's right to use its research without paying for it is a substantial right. It clearly is.

[30] The government's final argument that Lockheed Martin did not retain substantial rights in its research under Treasury Reg. 1.41-5(d)(3) is that the contracts' recoupment provision, entitled "Recovery of Nonrecurring Costs on Commercial Sales," ⁵ requires Lockheed Martin to pay for that right.

[31] We agree with Lockheed Martin that, under this provision, it retained the right to use its research results in its business without paying for that right. That contract provision reads in pertinent part as follows:

     Recovery of Nonrecurring Costs on Commercial Sales

[33] This recoupment provision, by its own terms, only applies when the contractor intends to sell items or sell or license technology developed for the government to third parties. It does not otherwise restrict the contractor's use of the items or technology. We therefore disagree with the government that, under the recoupment provisions of the Major Program contracts, Lockheed Martin agreed to pay for the right to use the results of its research. Only Lockheed Martin's obligation to reimburse costs when it commercially sells items or sells or licenses "related technology" is involved. Lockheed Martin's right to make the subject products, essentially similar products, or related technology, and to use them in its own business, is not restricted. Even the right to sell is not precluded if reimbursement is made.

[34] The recoupment clause also does not affect Lockheed Martin's right to make and use patented inventions or to exclude unauthorized third parties from making, using, or selling such inventions. The Titan IV, LANTIRN FSED, and SLAT contracts' "Patent Rights Clause -- Retention by the Contractor" reads in relevant part as follows:

          (a) Definitions

[35] The recoupment clause similarly does not restrict Lockheed Martin's right to make and use technical data and computer software. The contracts' "Rights in Technical Data and Computer Software" provision, like the patent provision, gives the government broad rights, but not all rights. It gives the government the unlimited right to use, duplicate, and disclose to others a wide range of technical data, computer software, computer databases, and other information developed by Lockheed Martin in the course of the contract, and the right to permit others to do so. ⁸ This provision does not restrict Lockheed Martin's right to use this information itself or disclose it to others. Read in conjunction with the recoupment provision, the only restriction imposed on Lockheed Martin relates to its obligation of reimbursement when it wishes to sell or license some of this information if the information constitutes a contract item, an "essentially similar item" or "related technology." The fact that others may have access to the data and software does not mean that Lockheed Martin loses its rights therein. The right to use is not a zero-sum game. Lockheed Martin still retains substantial rights in the subject matter even when others do as well.

[36] In sum, under the Major Program contracts, Lockheed Martin retained the right to use the results of its research in its business without paying for that right and therefore retained "substantial rights" in its research under Treasury Reg. sections 1.41-2(a) and 1.41-5(d). Because Lockheed retained "substantial rights" to its research, the research performed under the Major Program contracts did not fall under the "funded" exclusion of the "credit for increasing research activities" statute, sections 44(d) and 41(d). The Court of Federal Claims thus erred in concluding otherwise.

CONCLUSION

[37] The Court of Federal Claims correctly denied Lockheed Martin's "motion for pretrial order clarifying the scope of the complaint"; that decision is affirmed. However, the court erroneously granted the government's motion for summary judgment that Lockheed Martin did not fall within the "funded" exclusion of the "credit for increasing research activities" statute. The court should have granted summary judgment in Lockheed Martin's favor. That decision is therefore reversed. The case is remanded for further proceedings consistent with this opinion.

[38] AFFIRMED-IN-PART, REVERSED-IN-PART, and REMANDED.

² All references to section 44F are to the 1982 I.R.C.

³ All references to section 41 are to the 1988 I.R.C.

⁴ Whether or not the research was funded because payment was contingent on the success of the research has not been raised as an issue in this appeal. It is unclear from the briefs whether the government has conceded that payment was contingent on the success of the research or whether it has withdrawn this ground for the claims' disallowance.

⁵ The Titan IV and SLAT contracts incorporate 32 C.F.R. section 7-104.64 (Feb. 1980). The LANTIRN FSED contract incorporates 32 C.F.R. section 7-104-64 (Sept. 1979). The LANTIRN Production and SICBM contracts incorporate 48 C.F.R. section 252.235-7002 (Feb. 1980). The relevant language of these regulations is identical.

⁶ The Titan contract incorporates 32 C.F.R. section 7- 302.23(b) (Jan. 1984). The LANTIRN FSED contract incorporates 32 C.F.R. section 7-302.23(b) (Aug. 1977). The SLAT contract incorporates 32 C.F.R. section 7-302.23(b) (July 1981). The relevant language of these provisions is identical.

⁷ The SICBM contract incorporates 48 C.F.R. section 52.227-12 (Apr. 1984).

⁸ The Titan IV and SLAT contracts incorporate 32 C.F.R. section 7-104.9(a) (May 1981). The LANTIRN FSED contract incorporates 32 C.F.R. section 7-104.9(a) (Mar. 1979). The LANTIRN and SICBM contracts incorporate 48 C.F.R. section 52.227-7013 (May 1981). The relevant language of these provisions is substantially similar.