Manufacturer Seeks Redetermination of Tax Deficiencies, Refund

a. By asserting a deficiency in any amount for tax year 2012.

b. On information and belief, by taking in the Notice the arbitrary and erroneous position with respect to tax year 2012 that certain costs related to tooling supplies were not “qualified research expenses” within the meaning of section 41(b)(1) of the Internal Revenue Code of 1986, as amended and in effect in the relevant years (hereinafter, the “Code”), and therefore that the amount of the Code section 41 credit for increasing research activities (the “Research Credit”) claimed by Petitioner should be reduced.

c. By failing to allow Petitioner's claim for additional Research Credit in the amount of at least $841,325, contained in an amended income tax return, Form 1120-X, filed on August 11, 2014, with respect to tax year 2012.

d. By adjusting Petitioner's Research Credit base amounts related to tax year 2012, including amounts paid or incurred for tool supplies used in the conduct of research for Petitioner's base years, even though disallowing such amounts paid or incurred for tool supplies used in the conduct of research in tax year 2012, thus arbitrarily failing to apply properly the consistency rule of Code section 41(c)(6).

e. By recomputing Petitioner's income, deductions, and credits for tax year 2012 on the basis of the erroneous assertions set forth above as well as the additional arbitrary and erroneous assertions in the Notice.

f. By asserting a deficiency in any amount for tax year 2013.

g. On information and belief, by basing $1,110,621 of the adjustments included in the Notice with respect to tax year 2013 on Respondent's arbitrary and erroneous position that certain costs related to tooling supplies were not “qualified research expenses” within the meaning of Code section 41(b)(1), and therefore that the amount of the Research Credit claimed by Petitioner should be reduced.

h. By arbitrarily and erroneously disallowing a net operating loss (“NOL”) carryback from tax year 2015 to tax year 2013, without any discussion or justification, which erroneous disallowance had the effect of improperly increasing Petitioner's tax for 2013 by the amount of $1,975,217.

i. By erroneously stating that Petitioner reported qualified research expenses in the amount of $18,832,355 on its tax year 2013 Form 1120 federal income tax return, although Petitioner in fact reported qualified research expenses in the amount of $20,256,966 on that return.

j. By recomputing Petitioner's income, deductions, and credits for tax year 2013 on the basis of the arbitrary and erroneous assertions set forth above as well as the additional erroneous assertions in the Notice.

a. Petitioner designs and manufactures components in body, chassis and powertrain systems with expertise in precision blanks, ShilohCore acoustic laminates, aluminum and steel laser welded blanks, complex stampings, modular assemblies, aluminum and magnesium die casting, as well as precision machined components, for use in the automotive manufacturing industry. Petitioner has over 4,200 employees with operations, sales and technical centers in Asia, Europe and North America.

b. Petitioner is both a supplier of automotive parts and a designer and engineer of precision tools and dies, welding, and assembly equipment.

c. The precision tools and dies referred to in subparagraph b above are used in Petitioner's own manufacturing operations, and are also sold to original equipment manufacturers (“OEMs”) and Tier I automotive part manufacturers who in turn supply OEMs. Thus, in addition to manufacturing and selling parts used in the automotive industry, Petitioner also designs and sells to customers tooling products that can be used to make parts.

d. The Research Credits disallowed by Respondent relate to Petitioner's design, engineering, experimentation, and development with respect to tools and dies for sale to its customers, not to the manufacturing and sale of parts by Petitioner.

e. Typically, a tooling customer's engineers design and develop a part the customer wants to manufacture. The customer communicates to Petitioner its general specifications and requirements for the part. These specifications relate to the part the customer wants to produce, not the tool that will be used to make that part.

f. Petitioner then must design a tool that can produce those parts. Such tools are (i) dies and stamps that convert a “blank,” that is, a flat sheet of metal, to the precise shape and specifications required by the customer; or (ii) high pressure die casting tools with a precision-shaped cavity into which molten aluminum (or magnesium) can be injected in order to produce a near net shape part.

g. To design the tool Petitioner's engineers create a conceptual or virtual model of the tool using computer design simulations, and repeatedly test the design with further computer simulations and analyses.

h. At this point, during the initial concept phase, Petitioner encounters uncertainty regarding many aspects of the tool design, including appropriate cavity shape and dimensions, tensile and compressive strength, ductility, force, geometry and draw radius, heating and cooling, the impact of physical properties of material handled including thermal and electrical conductivity, rate of thermal expansion and contraction, and combination of operations within the tool design. To cope with these uncertainties Petitioner must take many different types of design considerations into account, including size and shape of the part, accuracy and tolerances required, as well as the number and sequence of operations.

i. To resolve such uncertainties Petitioner tests the conceptual tool model using computer design and simulation tools, in an effort to eliminate uncertainty regarding positioning, stress, thinning, strain and deflection, process flow, tool/die structure, shrinkage, tool integrity, and other issues.

j. The computer design and simulation process referred to in subparagraph i above eliminates some but not all of the uncertainties, and often the simulation introduces new uncertainties that Petitioner's designers did not anticipate at the beginning of the process. Petitioner thus typically goes through multiple iterations of design, simulation, design modification and further simulation during this phase.

k. Eventually Petitioner reaches a point where further computer simulation cannot eliminate the remaining uncertainties concerning design and suitability.

l. At this point. Petitioner either (i) engages a third-party tooling manufacturer to build a prototype or “pilot model” of the tool, or (ii) builds the prototype or “pilot model” tool itself, based on the design specifications derived by Petitioner from the processes described in subparagraphs g through i above. In the case of tools built by third-party toolmakers, Petitioner provides such design specifications to the toolmaker.

m. Although the toolmaker utilizes its general knowledge and know-how in manufacturing a tool, the toolmaker is not engaged to perform research, but instead is a vendor engaged to manufacture a tool that meets the design specifications provided by Petitioner.

n. Once the toolmaker produces the tool to Petitioner's specifications, Petitioner's engineers and tooling experts conduct multiple tests on the prototype tool to resolve remaining uncertainties.

o. Examples of such uncertainties, among others, include shrinkage, porosity, hot spots, gas porosity in the part or casting, and inclusions.

p. Petitioner cannot eliminate uncertainties such as those referred to in subparagraph o above without physical testing and analysis of the tools produced by the third-party toolmakers.

q. Employees of Petitioner perform such testing and analysis and, depending on the outcome of such tests, Petitioner may have to make substantial modifications to the tool, or even scrap the model and redesign the tool, before a tool that can produce parts to the customer's specifications is developed.

r. If a tool purchased from the third-party toolmaker fails, Petitioner will either make engineering modifications to the tool itself, or require the toolmaker to make engineering modifications to the tool.

s. Once Petitioner believes that the tool will work as desired, Petitioner typically conducts one or more small-scale experimental sample part runs (i.e., not yet commercial production), in an effort to further eliminate uncertainty and produce a saleable/acceptable tool for the customer.

t. Although the tool itself may be manufactured by the toolmaker in a foreign jurisdiction, all of Petitioner's research, experimentation, testing and modification activities referred to in subparagraphs n through s above are conducted within the United States, either at Petitioner's facilities or locations of the tool vendors located within the United States.

u. Petitioner is bound by the purchase order terms to pay the vendor for any finished work or work in process and raw material regardless of cancellation or termination and irrespective of ultimate delivery and acceptance of the tool by the customer, and as such tools are built in accordance with Petitioner's agreement with the vendors, such vendors do not warrant that the tools will meet the performance requirements of Petitioner's customers.

v. Petitioner's design, testing, research, experimentation, and development activities as described above were technological in nature and relied on principles of mechanical engineering, manufacturing engineering, materials science, and computer science.

w. Petitioner's design, testing, research, experimentation, and development activities as described above were all undertaken to discover information and to be, and in fact were, useful in the development of new products, the tools which are the subject of those activities, for sale to customers in Petitioner's business of designing and selling tools to manufacturers in the automotive business.

X. Petitioner's design, testing, research, experimentation, and development activities as described above were undertaken for the purpose of developing a new or improved function, i.e., a new tool that produced a new part, or a new tool that produced a part more efficiently.

y. Petitioner's design, testing, research, experimentation, and development activities as described above did not relate to style, taste, cosmetic, or seasonal design factors, did not take place after commercial production began, did not relate to the adaptation or duplication of existing products, surveys or studies, computer software, or social sciences, and were not conducted outside the United States or funded by any other person.

z. Petitioner's design, testing, research, experimentation, and development activities as described above are undertaken to satisfy the customer's requirements. Under Petitioner's production parts approval process (“PPAP”) Petitioner must prove, through engineering trial runs, that the tool in question meets the customer's requirements. If those requirements are not met and approved by the customer. Petitioner must make further modifications to the tool or its design. The tools in question will not be accepted by a customer, cannot be sold to a customer, and are not available for use in commercial production by the customer, until the testing and modification process described above is completed.

aa. Petitioner conducted the research, development, testing and modification process described above with respect to the tools at issue.

bb. Petitioner sold all of the tools at issue to customers and did not retain ownership of such tools, nor did it claim depreciation with respect to such tools.

cc. For the tax years at issue Petitioner determined the total amounts paid or incurred for the tool supplies used in its conduct of qualified research through application of a valid statistical sampling method, and use of the statistical sampling method was accepted by Respondent.

dd. Petitioner's timely filed Form 1120 federal income tax return for tax year 2012 reported qualified research expenses of $2,615,804, resulting in a Research Credit of $156,107. Respondent has not challenged the amount of such qualified research expenses as originally reported on Petitioner's 2012 return.

ee. On August 11, 2014, Petitioner filed a Form 1120X amended federal income tax return for tax year 2012 that claimed a refund in the total amount of $839,484 (the “Claim for Refund”).

ff. The Claim for Refund properly reported an increase of $841,325 of Research Credit over the amount reported on the original return, for a total Research Credit of $997,432. The difference between the increased amount of the Research Credit and the total refund claimed as stated in subparagraph ee is due to the interaction of other adjustments not at issue here.

gg. The increase in the amount of the 2012 tax year Research Credit as shown on the Claim for Refund resulted from an increase in the amount reported as wages paid or incurred to employees for qualified services performed by such employees by the amount of $1,678,348, and an increase in the amount reported as paid or incurred for tool supplies used in qualified research by the amount of $10,515,039.

hh. All of the additional wages referred to in subparagraph gg above were incurred with respect to the conduct of Petitioner's design, testing, research and development activities as described above.

ii. On examination, Respondent erroneously took the position that none of the $10,515,039 claimed as additional tool supplies expenses on the Claim for Refund were amounts paid or incurred for supplies used in qualified research under Code section 41(b)(2)(A)(ii), and thus took the position that such amounts did not constitute a qualified research expense.

jj. On examination, Respondent purported to allow the $1,678,348 claimed as additional qualified wage expenses on the Claim for Refund, but nevertheless arbitrarily failed to allow any of the additional resulting Research Credit claimed by Petitioner.

kk. On information and belief, Respondent denied the entire amount of additional Research Credit shown on the Claim for Refund, notwithstanding his allowance of the additional wage expense reported on the Claim for Refund, due to a computational error: although Respondent rejected Petitioner's position that the cost of tools acquired from third-party vendors was a supply expense under Code section 41(b)(2)(A)(ii), and thus not a qualified research expense within the meaning of Code section 41(b), Respondent inconsistently added such tool supply expenses to the qualified research expenses Petitioner incurred in prior base years.

11. The addition of tool supply expenses to the base years had the effect of increasing qualified research expenses for the base years for purposes of computing the Research Credit for the 2012 tax year.

mm. Based on this arbitrary, inconsistent, and erroneous computation of the base years. Respondent not only failed to allow any of the claimed refund, but created an artificial purported deficiency by reducing the amount of Research Credit allowed for the 2012 tax year by $115,544 less than reported on Petitioner's tax year 2012 original return.

nn. In tax year 2013, Petitioner reported qualified research expenses in the amount of $20,256,966 on its timely-filed Form 1120 federal income tax return, including $14,016,670 as the amount paid or incurred for tool supplies acquired from third-party vendors for use in the conduct of qualified research under Code section 41(b)(2)(A)(ii). The Notice, however, claims that Petitioner reported only $18,832,355 of qualified research expenses.

oo. On examination. Respondent took the position that none of the $14,016,670 reported as tool supplies expense was eligible to be treated as qualified research expenses, and therefore reduced Petitioner's qualified research expenses by that amount; as a result Respondent reduced the amount of Research Credit allowable to Petitioner by $1,110,621.

pp. On information and belief, the Research Credit-related deficiencies in question, and the failure to allow Petitioner's Claim for Refund, are based in part on Respondent's arbitrary and erroneous position that the tools Petitioner purchased from third-party vendors do not qualify as “supplies used in the conduct of qualified research” within the meaning of Code section 41 (b)(2)(A)(ii).

qq. In preparing this Petition it has come to Petitioner's attention that the qualified research expenses Petitioner reported for the 2012 and 2013 tax years were understated, due to omission of expenses related to certain casting tools from inclusion in the statistical sample, and therefore that the amount of Research Credits reported and claimed by Petitioner was understated.

rr. Without explanation or even discussion the Notice also arbitrarily disallowed an NOL carryback from the 2015 tax year to the tax year 2013, which had the effect of erroneously increasing Petitioner's tax for 2013 by $1,975,217.

ss. The NOL carryback referred to in subparagraph rr above was unrelated to Research Credits, and was not a subject of the Respondent's examination of the years at issue; nor has Respondent completed examination of Petitioner's 2015 tax year, and Respondent has proposed no adjustment with respect to such 2015 tax year that would affect the amount of the NOL.

(i) this Court determine that there is no deficiency in tax for Petitioner's 2012 tax year;

(ii) this Court determine that there is no deficiency in tax for Petitioner's 2013 tax year;

(iii) this Court determine that Petitioner is entitled to a refund of tax in the amount of at least $839,484, together with interest as provided by law, for Petitioner's 2012 tax year, as well as an additional refund of tax in a currently unknown amount for tax years 2012 and 2013;

(iv) this Court determine that Respondent bears the burden of proof as to all matters; and

(v) this Court grant such other and further relief to which Petitioner may be entitled.