Court Finds Some of Corporation's Research Expenses Eligible for Tax Credit

As a starting point, both sides agree on three key points. First, under 26 U.S.C. § 41(d)(4)(H), Plaintiff cannot claim the research credit if another party or the government has "funded" the otherwise qualifying research. Second, existing contracts govern the determination of § 41(d)(4)(H)'s "funded research" exclusion, with no factual disputes between the parties and no need for expert testimony. Third, if the Court finds that Plaintiff's research is funded, judgment should be entered in Defendant's favor. Conversely, a finding that the research is not funded would result in further litigation on more fact-intensive issues about Plaintiff's entitlement to the research tax credit.

In light of these agreements and in the interest of efficiency, the Court authorized summary judgment briefing on the threshold "funded research" exclusion before setting a trial in this matter. Briefing limited to this potentially dispositive matter ensued.

Cross-motions for summary judgment do not change the standard. Ernie Haire Ford, Inc. v. Universal Underwriters Insurance Co., 541 F.Supp.2d 1295, 1297-98 (M.D. Fla. 2008). A court is to treat each such motion separately, determining, for each side, whether a judgment may be entered under the Rule 56 Standard. Id.; see also American Bankers Ins. Group v. U.S., 408 F.3d 1328, 1331 (11th Cir. 2005) ("This court reviews the district court's disposition of cross-motions for summary judgment de novo, applying the same legal standards used by the district court, viewing the evidence and all factual inferences therefrom in the light most favorable to the non-movant, and resolving all reasonable doubts about the facts in favor of the non-moving party.").

The research credit was created as part of the Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, § 221, 95 Stat. 172, 241.¹ Congress has continually extended the credit since its inception, emphasizing that "research is the lifeblood of our economic progress [and] effective tax incentives for research and development must be a fundamental element of America's competitiveness strategy." H.R. Rep. No. 100-1104, pt. 2, at 88 (1988). Even so, as with all income tax deductions and credits, the research credit is "a matter of legislative grace [and] the taxpayer bears the burden of proving entitlement to any . . . credit claimed." MedChem (P.R.), Inc. v. Comm'r of Internal Revenue, 295 F.3d 118, 123 (1st Cir. 2002) (collecting cases).

A series of tax code provisions and treasury regulations govern whether research expenses are credit-eligible. Generally, a taxpayer may claim a credit of 20% of increased "qualified research expenses" for a tax year over a statutorily defined base amount. I.R.C. § 41(a)(1). Qualified research expenses can be either in-house research expenses or contract research expenses. I.R.C. § 41(b). Research is "qualified" if it (1) is a business expense under I.R.C. § 174; (2) is undertaken to discover technological information; (3) is useful in the development of a new or improved business component; and (4) includes activities that constitute elements of an experimentation process. I.R.C. § 41(d)(1).

B. The Funded Research Exclusion

Seven categories of research are expressly excluded from the tax code's definition of "qualified research. " I.R.C. § 41(d)(4)(A)-(H). Presently at issue is the seventh category, excluding "[a]ny research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity)." I.R.C. § 41(d)(4)(H). The tax code does not define the term "funded," but implementing treasury regulations do.

Treasury Regulation § 1.41-4, governing qualified research expenses paid or incurred in tax year 2003 to the present, repeats the tax code's language excluding funded research and adds that "[t]o determine the extent to which research is so funded, § 1.41-4A(d) applies." 26 C.F.R. § 1.41-4(c)(9). In turn, Treasury Regulation § 1.41-4A(d) provides in relevant part:

Treasury Regulation § 1.41-2(e) governs a taxpayer's ability to claim payments to third parties for qualified research as credit-eligible contract research expenses. This regulation provides in relevant part:

As explained in the seminal Federal Circuit case addressing the funded research exclusion, § 1.41-4A(d)(1) and § 1.41-2(e)(2) are "mirror image" rules for determining if a researcher, rather than the researcher's client, is entitled to claim the tax credit. Fairchild Industries, Inc. v. U.S., 71 F.3d 868, 870 (Fed. Cir. 1995). Together, these "regulations implement allocation of the tax credit to the person that bears the financial risk of failure of the research to produce the desired product or result." Id. The contractual arrangement is the factor that determines who is entitled to the tax credit. Id. The client may claim the credit only if the agreement requires the client to pay for the research even if it is unsuccessful. Id. For the researcher to claim the credit, the amounts payable under the agreement must be "contingent on success." Id. at 873. "The inquiry turns on who bears the research costs upon failure, not on whether the researcher is likely to succeed in performing the project." Id.

C. Fairchild Industries v. US.³

In Fairchild, an aircraft manufacturer entered into a fixed-price incentive contract with the U.S. Air Force to design and produce a new training aircraft. Id. at 870. The contract had two phases. Id. In the first development phase, the manufacturer was to develop two prototype aircraft and necessary support systems. Id. In the second production phase, the manufacturer was to produce fifteen additional aircraft. Id.

The contract included over 1,000 pages of technical specifications requiring the manufacturer to meet specific design, construction, quality, and performance standards. Id. The Air Force was contractually obligated to pay for research only if the manufacturer produced results that met the contract specifications. Id. at 871. If the Air Force deemed any work unacceptable, it could reject the work, require the manufacturer to correct the work at its own expense, or accept the work subject to a price reduction. Id.

Each project phase was broken down into contract line items, each separately priced. Id. The contract allowed for bi-monthly, refundable progress payments for specific line items, but the manufacturer could retain such payments only if the associated line item was accepted by the Air Force. Id. After formal acceptance by the Air Force, each progress payment was "liquidated" by crediting it against the total fixed price. Id. After the manufacturer successfully completed 90% of the first phase, the parties terminated the contract for convenience. Id.

In federal income tax returns, the manufacturer sought tax credits for qualified research expenses it incurred. Id. The IRS disallowed $5.8 million in claimed tax credits after concluding that the Air Force had "funded" the underlying research expenses. Id. at 871-72. A lower court agreed with the disallowance, finding that the manufacturer "did not itself incur" the research expenses because the progress payments made it such that the manufacturer "was spending the government's money to conduct the [aircraft] research, not its own." Id. at 872. Thus, the lower court held, the research expenses were "funded" and the manufacturer ineligible to receive any research tax credits. Id.

The Federal Circuit reversed, holding that the manufacturer 's research work was not "funded " by the Air Force because payment was contingent on success. Id. at 873. The contingent on success "inquiry turns on who bears the research costs upon failure, not on whether the researcher is likely to succeed in performing the project." Id. "When payment is contingent on performance, such as the successful research and development of a new product or process, the researcher bears the risk of failure." Id. Applying this test, the Federal Circuit found that the manufacturer plainly bore the risk of failure under the contract "for the Air Force was liable for payment only when the work, line item by item, succeeded and was accepted." Id. It mattered not that the Air Force made progress payments because the manufacturer had no right to retain such payments until each project phase was successfully completed and the manufacturer was contractually obligated to return any progress payments made for unsuccessful performance. Id. As a result, the research was not "funded" and the manufacturer was entitled to the research tax credits. Id.

A. Plaintiff's Business Activities

Plaintiff is a consulting and engineering firm, headquartered in Boca Raton, Florida, that specializes in matters involving the environment, natural resources, and geologic infrastructure. Since its founding in 1983, Plaintiff has completed thousands of projects for private businesses and government agencies. Its core business is to develop innovative and sustainable solutions to environmental problems that are less expensive and disruptive than conventional remediation approaches. Plaintiff has offices worldwide and employs over 800 engineers, scientists, and other professionals with expertise in environmental engineering, geochemistry, hydrogeology, biology, and other earth-related sciences.

Plaintiff enters many different types of contracts with clients in three primary areas: (1) environmental studies and cleanup, (2) infrastructure engineering and design, and (3) natural resources assessment and restoration. Of these different contracts, the parties identify three contract types. The first type is a "lump sum" or "fixed-price" contract under which Plaintiff agrees to perform contracted work for a fixed total price that is specified at contract formation. Under this first contract type, Plaintiff submits invoices based upon completing particular milestones or percentages of work. The second type is a "cost-plus subject to a maximum " or "capped" contract under which Plaintiff is paid for labor and other expenses, plus a mark-up, subject to an agreed upon maximum price. Under this second contract type, Plaintiff bills its clients for labor and other expenses incurred up until the maximum amount is reached. The third type is a "cost-plus" contract under which Plaintiff is paid for all time and material costs incurred for the project.

Presently at Issue are only two of the three contract types, fixed-price and capped. Plaintiff concedes that cost-plus contracts do not qualify for the research tax credit because the client, and not Plaintiff, assumes the salient risk under such contracts.

B. Six Representative Contracts

During the tax period in question, Plaintiff performed over 4,500 projects. Plaintiff's tax refund claims in this suit stem from roughly 8%, or approximately 370, of these projects.⁴ Rather than litigate the details of these hundreds of projects, the parties have agreed to present the Court with six contracts for review in determining if Plaintiff's research activities are funded. Of the six contracts, discussed below, three are fixed-price and three are capped.

Under an incorporated subcontract, dated May 29, 2003, Plaintiff's subsidiary agreed to pay Plaintiff a fixed price of $9.5 million "to provide highly specialized technical expertise and experience" for the project. (DE 37-1 at 51). The subcontract included a five-point scope of work: (1) technical support in terms of the design and construction of radioactive waste disposal facilities, (2) serve as a liaison with Malaysian and international regulatory authorities, (3) provide technical personnel to direct construction, assure worker safety, and conduct lab testing of contaminated materials, (4) monitor for minimal environmental impact as required by permit, and (5) provide project management services. The subsidiary agreed to pay Plaintiff for its work by making periodic lump sum deposits into a designated bank account. An initial $2.25 million deposit was due within 120 days of the signing of the subcontract "as a deposit from which future payments to [Plaintiff] will be made." (Id. at 52). Subsequent deposits were to be made according to an attached deposit schedule, with payments from the account being made to Plaintiff "for undisputed invoice amounts . . . within [60] days of [Plaintiff's subsidiary's] receipt and approval of [Plaintiff's] invoices." (Id.) Plaintiff's claimed tax credits pertain solely to its work under the subcontract.

The total fixed price for both phases was $1,291,689. Under the contract, Plaintiff submitted monthly invoices to the Naval Facilities Engineering Command for work completed. The contract required the Navy to inspect and accept or dispute the items on each invoice within 14 days of receipt. The Navy would then pay the invoices, except for any disputed portions.

The total fixed price for both phases was $535,000. Under the contract, Plaintiff would submit monthly invoices. The contract required Woods Hole to pay each invoice within 30 days, except for any disputed amounts. The parties agreed to settle the disputed amounts within 15 days thereafter.

The contract price was capped at $9,991,578. Under the contract, DSWA was to reimburse Plaintiff according to a detailed project budget broken down by subtask. Plaintiff would submit monthly invoices to DSWA. In sum, DSWA was required to pay only for invoiced work that it approved for payment. DSWA's payment for each subtask was not to exceed the amount budgeted for each subtask. For the contract as a whole, Plaintiff was required to submit a notice of completion to DSWA. DSWA then had 30 days to provide a list of any incomplete services.

The contract price was capped at $18,781. Under the contract, WMI was to pay Plaintiff according to an estimated budget broken down by work task. WMI' s payment for each task was not to exceed the separate price budgeted for each task. Plaintiff would submit monthly invoices to WMI, and WMI agreed to pay all undisputed amounts within 45 days of receiving an invoice. For any disputed amounts, WMI was required to notify Plaintiff of the dispute and request clarification or remedial action.

The contracting parties treated the cost estimates in Plaintiff's LOE proposals as not-to-exceed caps on Plaintiff's compensation. Pursuant to the contract, Plaintiff periodically submitted invoices to Pneumo Abex, and Pneumo Abex agreed to pay the invoice amount within 30 days of receipt. If Pneumo Abex objected to any portion of the invoice, it was required to give Plaintiff written notice of its objections but still timely pay all undisputed amounts.

With respect to the two trios of contracts, the parties advance the same arguments. Plaintiff relies chiefly on contract principles of risk allocation, contending that the payment mechanisms, conditional acceptance terms, and warranty provisions of each contract placed the financial risk of research failures squarely on Plaintiff such that the research expenses at issue were unfunded. Plaintiff argues further that the client payment procedures under the contracts satisfy the "contingent on success" inquiry because the payments are for the product or result of successful research, not for the performance of the research itself.

Defendant counters that the determination of whether research is funded does not turn on routine business risks or the potential for financial loss. Rather, Defendant continues, the regulations contemplate only excess research costs, i.e. costs above the funding received, as being unfunded. In addition, Defendants contend, Plaintiff's reliance on client payments for the product of research and not research itself is misplaced. According to Defendant, the ultimate goal of the contract is irrelevant. What matters is that Plaintiff did not guarantee success under any contract and would be paid for its work irrespective of any such success.

To resolve the parties' dispute, this Court must determine if payment to Plaintiff under each contract was "contingent upon development of a specified 'product or result,' to be paid 'contingent on the success of the research."' Fairchild, 71 F.3d at 872 (citing predecessor regulation to 26 C.P.R. § 1.41-4A(d)(1)). If so, Plaintiff remains eligible to claim research credits. If not, such eligibility vanishes. The key inquiry in the "contingent on success" analysis "turns on who bears the research costs upon failure, not on whether the researcher is likely to succeed in performing the project." Fairchild, 71 F.3d at 873. If "payment is contingent on performance, such as the successful research and development of a new product or process, the researcher bears the risk of failure." Id.

The foregoing analysis requires the Court to review the specific mechanics of each representative contract and differentiate them to determine which is eligible for a tax credit. As an analogy, let us contemplate the horse and the elephant. Both are large mammals who consume vegetation and have four legs and a tail. The horse has hooves. The elephant has a trunk. If we consider unfunded research as an elephant, the Court must determine what are the characteristics of the "trunk" of a contract that identifies it as an unfunded research contract. Under the tax code and implementing regulations, risk of failed research is the trunk. The risk is that the contractor will only be compensated if its research succeeds, i.e. payment to the contractor is contingent on the success of its research. Success here is defined by the client deeming the research satisfactory. The most salient characteristics of the unfunded research contract are payment conditioned on client satisfaction and a dispute mechanism to resolve payment issues. As necessary, the Court has carefully reviewed the specific mechanics of each representative contract and will address each trio of fixed-price and capped contracts in tum.

A. Fixed-Price Contracts

In the fixed-price contract context, the Court agrees with Plaintiff. As a general matter, contractors like Plaintiff who engage in a variety of complex commercial endeavors for clients distribute the risks associated with such endeavors via contracts and insurance. The nature of fixed-price contracts makes them inherently risky to contractors. Under these types of contracts, to the extent a contractor's performance is unsuccessful, the contractor must remedy the performance without additional compensation. Thus, these contracts generally place maximum economic risk on contractors who ultimately bear responsibility for all costs and resulting profit or loss. Indeed, the IRS acknowledges as much in an audit technique guide designed for use in examining the tax credit-eligibility of aerospace industry research activities. The guide, which discusses the Fairchild "contingent on success" test, defines a fixed-price contract like the one in Fairchild as "one where the price for performance is fixed by the contract at the inception of the contract. The price is not subject to adjustment solely by reason of the cost of performance. The contractor is obligated to perform and is at risk in the event of a cost overrun." IRS Aerospace Industry Research Credit Audit Technique Guide, 2005 WL 5207270, at * 15-16 (Jan. 28, 2005). The guide acknowledges that firm-fixed price contracts providing "for a price not subject to any adjustment on the basis of the contractor's cost experience in performing the contract . . . place[] upon the contractor maximum risk and full responsibility for all costs and resulting profit or loss." Id. at *5. Such contracts provide "maximum incentive for the contractor to control costs, and impose[] a minimum administrative burden on the customer." Id.

Defendant seemingly argues that the payment mechanism is irrelevant to the requisite analysis of risk, and that Plaintiff is attempting to craft a rule making contractors governed by a fixed-price contract per se entitled to the research credit. Financial risk is the primary -- if not the only -- motivation behind parties' willingness or unwillingness to contract for services, and the fact that a party may be entitled to a tax credit in a specific circumstance based on a general risk does not vitiate its entitlement. Indeed, the Court notes that Defendant's rebuttal to Plaintiff's contention in this regard refers the Court to a tax regulation that is specifically not at issue by agreement of the parties. See, e.g., (DE 50 at 11)(citing Treas. Reg. 1.41-4A(d)(3)(i), which governs research in which the taxpayer retains substantial rights despite the parties' stipulation not to address substantial rights "[b]ecause of the several variances in the contracts with respect to the rights, if any, that [Plaintiff] retained in the research." (DE 38 at 2)).

Moreover, this characterization of Plaintiff's argument ignores another risk Plaintiff urges the Court to consider in its calculus. As illustrated by Fairchild, an additional risk surfaces for contractors in fixed-price contracts involving provisions making payment conditional on a client's affirmative acceptance of satisfactory research performance. Under such provisions, the contractor bears all the risk of research failure because the client remains "liable for payment only when the work, line item by line item, succeed[s] and [is] accepted." Fairchild, 71 F.3d at 873. Where a contract's specific terms governing the client's acceptance of services and payment of monies owed are structured in such a way that the risk already facing a contractor -- that the expense of the contracted-for services will exceed the amount owed them under the contract -- will expand to include additional risk. This additional risk, that the client's dissatisfaction with services and refusal to accept might put a researcher even further in the red -- Defendant might characterize this as even further minimizing the contractor's profit -- is created by the terms of the contract.

In evaluating the allocation of risk, warranty and default provisions also play a role, albeit a relatively minor one. A warranty is an "express or implied promise that something in furtherance of the contract is guaranteed by one of the contracting parties." Black's Law Dictionary (9th ed. 2009), warranty. A contract default provision states what will happen if one of the parties fails to perform as required under the agreement. In general, warranty provisions tend to evenly distribute economic risks by providing the client some level of assurance that project work will comply with applicable standards, while allowing a contractor to restrict liability by disclaiming warranties or limiting remedies in exchange for a client's lower payment. See generally, East River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 872-73 (1986). Similarly, default provisions evenly distribute risk by giving a non-breaching party the right to terminate the contract or take another specified course of action in the event of default by the other party.

Applying the above principles, the Court concludes that Plaintiff bore the risk of failed research under each representative fixed-price contract. Turning first to the Asian Rare Earth Contract, similarities to Fairchild abound. The five-page fixed-price subcontract between Plaintiff and its Malaysian-based subsidiary was inextricably tied to a larger primary fixed-price contract between its subsidiary and a Malaysian corporation. As in Fairchild, when the contracts were entered, it was not known whether Plaintiff's work under the contract would be successful or accepted. As Jon Dickinson avers, the overall project "was the first-ever radioactive cleanup and storage project of this type in Southeast Asia." (DE 40, Ex. 1, ¶ 20). As in Fairchild, payment to Plaintiff was contingent on Plaintiff's performance. Specifically, under the primary contract, Plaintiff's subsidiary was required to submit "every month an application for payment" to the Malaysian corporation "based on the Work [Plaintiff's subsidiary] expects to complete within each succeeding month" with reference to certain milestones in Exhibit A. (DE 37-1 at 18, 40). In turn, Exhibit A identified the costs for a series of individualized tasks, ranging from airfare and site security to surveying and testing. (Id. at 40-49). Under the subcontract, Plaintiff's subsidiary was to pay Plaintiff the fixed price of $9.5 million in installments according to an attached deposit schedule, "but only to the extent that [Plaintiff's subsidiary's] payments from [the Malaysian corporation] are sufficient to maintain such deposit schedule." (Id. at 52).

Importantly, under the primary contract, the Malaysian corporation had the right to dispute the completion of a project milestone and withhold payment until the dispute was settled. (Id. at 18). This conditional payment provision made the Malaysian corporation, and Plaintiff's subsidiary by association, liable for payment to Plaintiff only when and if each milestone was completed and accepted. This right of the client to withhold payment until particular milestones are achieved and accepted is the functional equivalent of the Air Force's right in Fairchild to make unliquidated progress payments that were to be liquidated only upon the Air Force's acceptance of each contract line item as successful.

Also of import in the Asian Rare Earth Contract are the warranty provisions. The primary contract expressly warranted against defects in workmanship and materials for the two-year period after project completion. (Id. at 25-26). The warranty required Plaintiff's subsidiary to repair or replace any such defects at its expense. (Id.). The subcontract, by comparison, expressly released Plaintiff's subsidiary and the Malaysian corporation from any claims and liability to Plaintiff once final payment to Plaintiff was made, however stated explicitly that such "final payment shall in no way relieve [Plaintiff] of liability for its obligations or for faulty or defective work discovered after final payment." (Id. at 53). These provisions, together with the other provisions noted above, demonstrate that Plaintiff bore the risk of any research failure during the course of its contractually-obligated performance. To be sure, payments to Plaintiff were directly tied to and contingent upon the success of such performance.

The Court next turns to the Seal Beach Contract. For this project, Plaintiff contracted with the U.S. Navy to remediate a groundwater plume beneath a former NASA rocket engine R&D and test facility in California known as Seal Beach. The firm fixed-price contract consisted of two parts. (DE 40 at 54). The total fixed amount of the Phase I Contract was $170,320. (DE 59-2 at 65). The Phase II Contract increased the total price of the contract to $1,291,689. (Id. at 67).

Notably, a number of Seal Beach Contract terms combine to shift the risk of research onto Plaintiff. First, Section E -- Inspection and Acceptance, mandated that the Navy had the right to inspect and accept all supplies and services provided by Plaintiff after delivery (Id. at 69). Second, FAR 52.246-9 "Inspection of Research and Development," incorporated by reference and reinforcing the earlier provision, reserves the Navy's right to "inspect and evaluate the work performed . . . under the contract." (Id. at 70). Section E-1, under which the Navy has fourteen working days after receipt of the invoice to inspect and accept the supplies and services, serves a similar purpose (Id. at 69). Section E-2, which provides that the "performance and quality of the work delivered by the contractor including services rendered and any documentation or written material compiled . . . [are] subject to inspection, review, and acceptance by [the Navy]," and Section E-3, under which services rendered are "subject to [the Navy's] inspection during both the contractor's operations and after the completion of the tasks," do likewise. (Id.) Finally, FAR 52.232-2 "Payments Under Fixed-Price Research and Development Contracts," also incorporated by reference, which obligates the Navy to pay Plaintiff only after submitted invoices are "delivered or rendered and accepted," shifts risk further onto Plaintiff (Id. at 72).

There were no warranty provisions in the contract. The Court acknowledges that certain default provisions shift some of the risk onto the Navy: In the event of termination, the Navy was obligated to pay Plaintiff "the contract price, if separately stated, for completed work it has accepted and the amount agreed upon . . . for (1) completed work for which no separate price is stated, (2) partially completed work, (3) other property described above that it accepts, and (4) the protection and preservation of the property." (Id.). However, under FAR 52.249-9, "Default (Fixed-Price Research and Development)," the Navy reserved the right to terminate the contract in whole or in part, at which time if the Navy acquired work "similar to the work terminated," Plaintiff would be "liable to [the Navy] for any excess costs for the similar work" (Id. at 78). Ultimately, as with Asian Rare Earth, the Seal Beach Contract was not funded because the totality of the above provisions demonstrate that Plaintiff ultimately bore the risk of any research failure during the course of its contractually-obligated performance.

Lastly, turning to the Saudi Arabia Coastline Contract, the essence of this contract involved research Plaintiff was performing for Woods Hole Group. Woods Hole Group, Plaintiff's client, contracted with the Kingdom of Saudi Arabia to monitor and assess environmental damage which occurred along the coastline as a result of military operations during the First Gulf War (DE 37-3 at 2). Pursuant to a fixed-price contract, Woods Hole hired Plaintiff to assess the environmental damage and develop a treatment plan. (Id. at 11, 16). Work was to be done "in accordance with professional standards and to the satisfaction of the client." (Id. at 38). Billing was to be made on a monthly basis for work completed proportionately on each task. Payment was to be within 30 days of receipt of the electronic invoice. A dispute resolution mechanism called for a resolution within 15 days of the electronic invoice. (Id. at 12). Thus, this last representative contract features research for a fixed price, payment conditioned on client satisfaction with the research, and a price dispute mechanism. As with the others, and without belaboring points already made, the Saudi Arabia Coastline Contract is not funded.

B. Capped Contracts

In the capped contract context, the Court agrees with Defendant. Plaintiff concedes that cost-plus contracts without a cap do not qualify for the research tax credit because the client, and not Plaintiff, assumes the salient risk under such contracts. As the similarity in their names suggest, capped or "cost-plus subject to a maximum" contracts operate much the same as cost-plus contracts without a cap. Both provide for reimbursement to the contractor of allowable time and material costs incurred in the performance of the contract. Both establish detailed cost estimates at the outset for the purpose of determining the amounts to be reimbursed. The only difference is that capped contracts incorporate a not-to-exceed ceiling price which the contract may not exceed. Despite Plaintiff's contrary contention, this difference is not enough to move Plaintiff's expenses incurred under capped contracts into the realm of unfunded research.

The IRS audit guide discussed above distinguishes firm-fixed-price contracts from cost-plus fixed-fee contracts, describing the latter as those "in which the contractor has minimal responsibility for the performance cost and the negotiated fee is fixed." IRS Aerospace Industry Research Credit Audit Technique Guide, at *5. While no further explanation is provided, a review of the representative capped contracts helps to illustrate the point. A distinctive feature of the capped contracts at issue is that each one obligates the client to reimburse Plaintiff for pre-defined tasks at pre-defined rates in accordance with a detailed project budget. This reimbursement process is in contrast to the fixed-price contracts, which generally required Plaintiff to apply for payments conditioned on the client 's acceptance of the tasks performed.

For instance, under the capped Cherry Island Contract, Plaintiff was hired to design a method for expanding the disposal capacity of an existing landfill in Delaware. An incorporated scope of work statement and project schedule describe seven general tasks with multiple subtasks and establishes over 300 deliverables, all in a great level of detail. (DE 37-4 at 62-117).

The contract required the client to pay Plaintiff "on a cost reimbursement basis as set forth in [attached exhibits C and D] in an amount not to exceed $9,991,578." (Id. at 56). Exhibit D, entitled "Manner and Time of Payment," obligated Plaintiff to submit no more than one "approvable" invoice each month to the client with a full itemization of costs, subcontractor expenses, labor rates, hours expended, and other expenses per subtask in accordance with Exhibit C, together with a progress report that "reflects the items of work performed and justifies all expenses during the invoice period." (Id. at 200). The client was required to pay Plaintiff all undisputed amounts each month, but could withhold payment for any disputed amounts. (Id.). While at first blush, this right to withhold payment appears to condition payment on successful performance by Plaintiff, the totality of the contract makes it such that payment to Plaintiff was not "contingent on success" as is required to make the contract unfunded.

Significantly, all invoices were to be verified by designated project managers of both Plaintiff and the client. (Id.). Including Plaintiff in the invoice verification process is a feature not present in any of the fixed-price contracts and demonstrates that the payment was not conditioned entirely on client satisfaction. More importantly, under Article XI entitled "Compensation," the client was obligated to reimburse Plaintiff for "a sum up to but not exceeding the total listed in Exhibit C" for each individual subtask. (Id.). In turn, Exhibit C is a detailed project budget with hourly and per unit rates, together with a detailed breakdown of all labor, expense, and subcontractor costs per individual subtask. (Id. at 117-199). Having agreed to such a detailed project budget at the outset, it cannot be said that Plaintiff bore the entire risk of any failed research. Quite the contrary, as with cost-plus contracts without a cap, the parties contracted for and agreed that the client would reimburse Plaintiff for each task-related expenditure, thus placing the risk of failed research on the client and making this contract funded.

The Court next turns to the Waste Management Contract, a capped contract with a not-to-exceed price of $18,781. (DE 59-5 at 12). Plaintiff contracted with CWM Chemical Services, Inc., a subsidiary of Waste Management, Inc., to remediate the TCE-contaminated groundwater beneath a warehouse in Niagara County, New York, that had been used for roughly 30 years to manufacture and store weapons and radioactive material. (Id. at 3). Despite a complex Master Agreement with various provisions involving the client's payment and acceptance approval rights, the crux of the Waste Management contract is outlined in a simple Addendum. This Addendum identifies the contract pricing mechanism as a "guaranteed not to exceed price contract," which contemplates a means by which Plaintiff could receive more money, if necessary: Plaintiff could submit change orders if need arose to address price or work adjustments (DE 59-5 at 12). Plaintiff and client agreed at the outset that certain research necessary to complete the overall goal of the contract would be paid for. This agreement, coupled with the proviso allowing Plaintiff to apply for more funds in the event of cost overruns, minimizes the risk prevalent in fixed-price contracts. Indeed, it makes this capped contract more akin to a cost-plus contract. While the payment and acceptance provisions might require hoop-jumping by Plaintiff, the ultimate availability of additional payment to complete research makes this contract funded.

The final contract, the capped Pneumo-Abex Contract, has one particular factor that obviates the need for a full analysis. Uniquely, among the six contracts submitted, this Professional Services Agreement, in "Part 4 Recognition of Risk," specifically states that Plaintiff does not guarantee results, only compliance with professional standards of care is required (DE 37-6 at 3). Risk to Plaintiff of failed research is gone; no further analysis is required.

² This regulation contemplates a second scenario where research is "funded," i.e. when a taxpayer agrees to perform research for another person without retaining "substantial rights" to its research. 26 C.F.R. § 1.41-4A(d)(2)-(3). By stipulation, the parties agreed not to address this second scenario "[b]ecause of the several variances in the contracts with respect to the rights, if any, that [Plaintiff] retained in the research." (DE 38 at 2). The parties agree that "[i]f the Court determines that the research is funded, regardless of whether [Plaintiff] retained substantial rights to the underlying research, judgment will be entered in favor of [Defendant]." (Id.) In view of this concession, the Court need not address the "substantial rights" scenario in deciding the present motions.

³ The Court requested that the parties submit the contract at issue in Fairchild as part of their post-argument supplemental briefing. The parties complied by retrieving the available portions of the contract submitted to the Federal Circuit in a joint appendix. The entire contract could not be located. As Defendant notes, reviewing only excerpted pages of an entire contract may lead to inaccurate contrasts and comparisons. More importantly, upon further reflection and following a thorough review of the extensive record materials in this case, the Court finds it unnecessary to rely upon the Fairchild contract beyond what is discussed in the Federal Circuit's opinion itself.

⁴ Though immaterial for present purposes, the Court notes that the precise number of projects at issue is unknown. Initially, Geosyntec claimed credit-eligible expenses for its work on 370 projects (DE 30 at 1). Geosyntec later conceded that "a small number of projects " included in its refund claims are cost-plus contracts that are not credit-eligible such that "the total number of projects at issue is less than 370" (DE 49 at 2).

⁵ The contract does not define the term "EISB." Scholarly articles describe the term as Enhanced In Situ Bioremediation, generally meaning a controlled technology or process designed to create a favorable environment for mitigating or eliminating contaminants. See generally Liesbet van Cauwenberghe & Diane S. Roote, P.G., In Situ Bioremediation, Ground-Water Remediation Technologies Analysis Center (Oct. 1998), http://www.environmental-expert.com/Files/0/articles/817/insbio_o.pdf.