Government Asks Court to Vacate Judgment in R&D Tax Credit Case

AUDIO TECHNICA U.S., INC.,
Plaintiff-Appellee
v.
UNITED STATES OF AMERICA,
Defendant-Appellant

IN THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT

ON APPEAL FROM THE JUDGMENT OF THE
UNITED STATES DISTRICT COURT FOR THE
NORTHERN DISTRICT OF OHIO

BRIEF FOR THE APPELLANT

RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General

ELLEN PAGE DELSOLE
(202) 514-8128
RANDOLPH L. HUTTER
(202) 514-2647
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:
JUSTIN E. HERDMAN
United States Attorney

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TABLE OF CONTENTS

Table of contents

Table of authorities

Statement regarding oral argument

Jurisdictional statement

Statement of the issues

Statement of the case

Summary of argument

Argument:

Conclusion

Addendum

Certificate of compliance

TABLE OF AUTHORITIES

Cases:

Batchelor-Robjohns v. United States, 788 F.3d 1280 (11th Cir. 2015)

Commissioner v. Sunnen, 333 U.S. 591 (1948)

In re Commonwealth Institutional Securities, Inc., 394 F.3d 401 (6th Cir. 2005)

Davis v. Fiat Chrysler Automobiles U.S., LLC, 747 F. App'x 309 (6th Cir. 2018), cert. denied, 139 S. Ct. 1337 (2019)

Edwards v. Aetna Life Ins. Co., 690 F.2d 595 (6th Cir. 1982)

First Tech. Safety Sys. v. Depinet, 11 F.3d 641 (6th Cir. 1993)

In re Fordu, 201 F.3d 693 (6th Cir. 1999)

Estate of Gilford v. Commissioner, 88 T.C. 38 (1987)

Helvering v. Northwest Steel Rolling Mills, Inc., 311 U.S. 46 (1940)

Helvering v. Taylor, 293 U.S. 507 (1935)

Konstantinidis v. Chen, 626 F.2d 933 (D.C. Cir. 1980)

Logan v. Dayton Hudson Corp., 865 F.2d 789 (6th Cir. 1989)

Louzon v. Ford Motor Co., 718 F.3d 556 (6th Cir. 2013)

Mirando v. U.S. Dept. of Treasury, 766 F.3d 540 (6th Cir. 2014)

Morgan v. Union Metal Mfg., 757 F.2d 792 (6th Cir. 1985)

New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934)

New Hampshire v. Maine, 532 U.S. 742 (2001)

Paschal v. Flagstar Bank, 297 F.3d 431 (6th Cir. 2002)

Reed Elsevier, Inc. v. Muchnick, 559 U.S. 154 (2010)

Research, Inc. v. United States, Civ. No. 3-94-385, 1995 WL 560140 (D. Minn. June 21, 1995)

Reynolds v. Commissioner, 861 F.2d 469 (6th Cir. 1988)

Smith v. Rock-Tenn Servs., Inc., 813 F.3d 298 (6th Cir. 2016)

Southern Pac. R.R. v. United States, 168 U.S. 1 (1897)

Teledyne Indus., Inc. v. N.L.R.B., 911 F.2d 1214 (6th Cir. 1990)

Union Carbide Corp. v. Commissioner, 97 T.C.M. (CCH) 1207 (2009), aff'd, 697 F.3d 104 (2d Cir. 2012)

United States v. Brawner, 173 F.3d 966 (6th Cir. 1999)

United States v. International Bldg. Co., 345 U.S. 502 (1953)

United States v. McFerrin, 570 F.3d 672 (5th Cir. 2009)

United Stationers, Inc. v. United States, 163 F.3d 440 (7th Cir. 1998)

Welch v. Helvering, 290 U.S. 111 (1933)

White v. Wyndham Vacation Ownership, Inc., 617 F.3d 472 (6th Cir. 2010)

Internal Revenue Code (26 U.S.C.):

28 U.S.C.:

Regulations:

Treasury Regulations (26 C.F.R.):

Miscellaneous:

Fed. R. Evid. 103(b)

H. Conf. Rep. 97-215 (1981), reprinted in 1981 U.S.C.C.A.N. 285

H.R. Rep. 97-201 (1981), reprinted in 1981-2 C.B. 352

T.D. 9712, Alternative Simplified Credit Elections, 2015-11 I.R.B. 750 (Feb. 27, 2015)

Tax Court Rule:

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STATEMENT REGARDING ORAL ARGUMENT

Counsel for the appellant, the United States, request that oral argument be heard in this case in order to address any questions the Court may have regarding the merits of this appeal or the tax-law provisions it involves.

JURISDICTIONAL STATEMENT

A. District Court jurisdiction

On August 16, 2016, Audio Technica U.S., Inc. (taxpayer) filed its complaint seeking a refund of income taxes for the years ending March 31, 2006 through March 31, 2010. (RE 1, Complaint, PageID#1.)¹ The District Court had jurisdiction over taxpayer's claims for refunds for the years ended March 31, 2006, through March 31, 2009, under 28 U.S.C. § 1346(a)(1) and Internal Revenue Code (I.R.C.) § 7422 (26 U.S.C).²

B. Appellate jurisdiction

After the case was tried to a jury, the District Court entered a judgment on March 28, 2019, awarding taxpayer a refund of $40,432 for its tax year ended March 31, 2008. (RE 144, Judgment, PageID#2890.) The judgment also stated that taxpayer “has substantially prevailed on the primary issues in dispute, and is thereby awarded its reasonable court costs.” (Id., at PageID#2894.) The United States filed a timely notice of appeal on May 21, 2019. (RE 148, Notice of Appeal, PageID#2918.) See 28 U.S.C. 2107(b). That judgment was a final and appealable judgment, over which this Court has jurisdiction under 28 U.S.C. § 1291.

The award of “reasonable court costs” did not quantify the amount of costs, and it was vaguely worded, leaving it unclear whether the order was awarding costs under 28 U.S.C. § 1920 or under I.R.C. § 7430. As explained further below (pp. 33-36, infra), the Government believes the judgment is best construed as awarding only costs under 28 U.S.C. § 1920. The District Court later awarded costs in the amount of $9,941.36 under 28 U.S.C. § 1920 (RE 149, Order and decision, PageID#2920), and the Government does not challenge that award.

If, however, this Court views the judgment's award of “reasonable court costs” as a ruling under I.R.C. § 7430, it warrants this Court's review. Section 7430 imposes the same prerequisites for “reasonable court costs” and attorney's fees, creating the possibility that the judgment, if not appealed now, could be construed as a binding ruling that requirements for attorney's fees were met, if taxpayer later seeks attorneys' fees. If this Court does view the judgment's ruling regarding “reasonable court costs” as one under I.R.C. § 7430, this Court has jurisdiction to review it now, even though no quantifiable amount of costs or fees under I.R.C. § 7430 has yet been requested or awarded. See Morgan v. Union Metal Mfg., 757 F.2d 792, 795-96 (6th Cir. 1985) (when a party “timely appeals a judgment on the merits and wishes to consolidate it with an appeal from a determination of liability for attorneys' fees” even before the amount has been set, the court of appeals' jurisdiction “over the appeal on the merits carries with it the authority to determine liability for fees”).

STATEMENT OF THE ISSUES

1. Whether the District Court erred in granting taxpayer's motion in limine, ruling that judicial estoppel barred the United States from challenging taxpayer's application of a.92 fixed-base percentage to its 1984-1988 base period in this case, because the parties had stipulated to tax deficiencies or research credits for other tax years in cases settled in the Tax Court and had assumed a.92 fixed-base percentage in arriving at the settlement amounts.

2. Whether, if this Court finds that the District Court's ruling that taxpayer is entitled to “reasonable court costs” was a ruling under I.R.C. § 7430, that order was an abuse of the District Court's discretion. The Government acknowledges that, if this Court concludes that the judgment is not a ruling under I.R.C. § 7430, no ripe issue in this regard is presented for review.

STATEMENT OF THE CASE

A. Procedural overview

Taxpayer filed its complaint in this case seeking over $300,000 in federal income tax refunds on the basis of research credits under I.R.C. § 41 for tax years ending March 31, 2006, through March 31, 2010. (RE 1, Complaint, PageID#1; RE 23, Amended Complaint, PageID#204.) The case was tried to a jury. Taxpayer's claims for refunds for tax years ending March 31, 2006, and March 31, 2007, were unsuccessful because taxpayer lacked sufficient increases in qualified research expenses to qualify for the research credit. The jury awarded taxpayer research credits for its 2008 and 2009 tax years. Taxpayer had losses for its year ended March 31, 2009, so the credit it was awarded for that year was carried back to the prior year. Accordingly, the refund awarded taxpayer for the year ended March 31, 2008, included amounts based on the research credits to which taxpayer was entitled for both the years ended March 31, 2008, and March 31, 2009. The District Court entered a judgment awarding taxpayer a refund of $40,432 for the tax year ending March 31, 2008.

The court also ordered that taxpayer had overpaid its tax liability for its tax year ending March 31, 2010, by $156,919, but it did not award taxpayer a refund for that year because taxpayer had already “received the benefit [i.e., a complete refund] for the tax year ending March 31, 2010.” (RE 144 at 5, Final Judgment, PageID#2894.) The judgment also provided that taxpayer had “substantially prevailed on the primary issues in dispute” and awarded taxpayer “its reasonable court costs.” (Ibid.) The Government appeals from the judgment.

B. Factual background

1. Taxpayer's refund claims and its motion in limine

Taxpayer is a company that manufactures high-performance microphones, headphones, wireless systems, mixers, and electronic products for home and professional use. (RE 23 at 2, Amended Complaint, PageID#198.) Taxpayer filed this action seeking research credits, and income tax refunds based on those credits, for its tax years ended March 31, 2006 through March 31, 2010.³ (RE 23 at 8, Amended Complaint, PageID#204.) Taxpayer claimed that it was entitled to research credits under I.R.C. § 41 because of increased research spending during those tax years. (Id. at 4-5, PageID#200-201.) As explained in more detail in the Argument below, the § 41 research credit is allowed for 20 percent of the increase in “qualified research expenses” (“QREs”) over a “base amount.” I.R.C. § 41(a). Under the “general” rule, the “base amount” is the product of (1) the “fixed-base percentage,” and (2) the average annual gross receipts for the taxpayer for the four taxable years before the year for which the credit is being determined. I.R.C. § 41(c)(1). Section 41(c)(3)A) defines the “fixed-base percentage” as the percentage of a taxpayer's aggregate gross receipts for the years beginning after December 31, 1983, and ending before January 1, 1989 (the “base period”) that constituted QREs for such years. The research credit under I.R.C. § 41 is available only for the excess of the taxpayer's QREs over the “base amount.” I.R.C. § 41(a)(1).

It is the taxpayer's burden to show that it is entitled to research credits. See New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); United Stationers, Inc. v. United States, 163 F.3d 440, 443 (7th Cir. 1998); see also Tax Ct. Rule 142; Welch v. Helvering, 290 U.S. 111 (1933). It follows that it is the taxpayer's burden to demonstrate the fixed-base percentage to be used in calculating the research credit.

In addition to the instant case, taxpayer had research credit issues for other tax years that were the subject of Tax Court litigation. The IRS issued notices of deficiency to taxpayer with regard to taxpayer's tax years ended March 31, 2002 through 2005, asserting deficiencies in tax and penalties. Taxpayer challenged those determinations in a single Tax Court proceeding (Tax Ct. Case No. 17540-09), which was resolved by a settlement in which taxpayer agreed to deficiencies for each year but no penalties. (See RE 58-2 at 3, Exhibit 2, PageID#914-15.) A notice of deficiency also was issued to taxpayer for its tax year ended March 31, 2011, which taxpayer also challenged in Tax Court. (Tax Ct. Case No. 27948-14.) That case also settled pursuant to a stipulated decision in which taxpayer agreed to a deficiency but no penalties. (See RE 58-3; Exhibit 3, PageID#931-32.)

In the instant case, taxpayer filed a motion in limine regarding calculation of the fixed-base percentage to be used in calculating any research credit to which taxpayer was entitled. (RE 80, Motion in Limine, PageID#1122.) In its motion, taxpayer alleged that in the two Tax Court cases involving prior tax years, the IRS had agreed that, for the purpose of the stipulated decisions in those cases, a fixed-base percentage of.92 would be applied to taxpayer's 1984-1988 base period. (Id. at 3, PageID#1127.) Taxpayer argued that, because the Government had agreed to the.92 fixed-base percentage in the Tax Court cases, it was judicially estopped “from introducing any evidence or asserting a different position than it agreed to with regard to the Fixed Base Percentage in the instant matter.” (Ibid.) Taxpayer represented to the District Court that in the prior cases, the Government had “secured final judicial acceptance of that position,” i.e., of the applicability of the.92 fixed-base percentage. (Id. at 6, PageID#1130.)

The Government opposed taxpayer's motion, pointing out that in the Stipulation of Settled Issues in the Tax Court case involving the tax year ended March 31, 2011, on which taxpayer relied (see RE 58-3, Exhibit 3, PageID#931), there was no reference to any agreement regarding taxpayer's base amount or fixed-base percentage (RE 89, Response to Motion in Limine, PageID#1234). Rather, the prior stipulation was “merely a stipulation to settle the case for a particular dollar amount.” (Id. at 2, PageID#1235.) Accordingly, the Government maintained that judicial estoppel could not apply to bar it from challenging taxpayer's use in this case of the fixed-base percentage that taxpayer claimed had been used to arrive at settlement amounts in prior cases. (Ibid.)

The District Court, however, granted taxpayer's motion, thus holding that a.92 fixed-base percentage would apply. (RE 114, Order, PageID#1345-46.) The court noted that the parties had entered into stipulated settlements in the prior Tax Court cases, and the court stated that the “stipulated settlements were accepted and signed by the Tax Court.” (Id. at 1-2, PageID#1345-46.) The District Court further observed that the Government had “consistently allowed this same basis of.92% to be used to resolve similar tax issues in dispute here,” and that the Government had “repeatedly accepted this basis” and thus was “judicially estopped from arguing that another basis should be used.” (Id. at 2, PageID#1346.) Accordingly, taxpayer was not required to prove the applicable fixed-base percentage in the instant case.

2. The final judgment

The case was tried to a jury, which found that taxpayer had QREs for each of the tax years in issue. (RE 123-1, Jury Verdict, PageID#2214.) The District Court ordered taxpayer to “propose a supplemental final judgment entry stating its full relief” within 14 days, and also ordered the Government, if it did not agree with taxpayer's proposed judgment, to file a brief opposing taxpayer's proposed judgment within 14 days of taxpayer's submission. (RE 126, Judgment Entry, PageID#2259.)

Taxpayer submitted a proposed supplemental final judgment, which proposed that taxpayer was entitled to research tax credit of $12,614 for the tax year ended March 31, 2008, research tax credit of $32,107 for the tax year ended March 31, 2009, and a refund in the amount of $40,432 for the tax year ended March 31, 2008. (RE 129-1, Proposed Supplemental Final Judgment, Page ID#2501.)⁴ Taxpayer's proposed judgment also stated that taxpayer had overpaid taxes in the amount of $156,919 for the tax year ended March 31, 2010, but it acknowledged that taxpayer had already “received the benefit,” i.e., the refund, to which it was entitled for that year. (Ibid.) For the tax years ended March 31, 2006 and 2007, despite the jury's finding that taxpayer had QREs for those years, taxpayer lacked sufficient increases in QREs for those years to qualify for the research credit. It therefore was not entitled to any credit or refund for those years. In its proposed judgment, taxpayer also proposed that it had “substantially prevailed on the primary issues in the case” and that it should be awarded “its reasonable court costs.” (Ibid.)

The United States filed an objection to taxpayer's proposed judgment in which the Government objected to several aspects of the proposed judgment. (RE 132, Objection to Proposed Supplemental Final Judgment, PageID#2569.) The United States first objected to the entry of a judgment awarding taxpayer research credit for its tax year ended March 31, 2010, noting that the District Court lacked jurisdiction over that tax year because, as taxpayer conceded in its proposed judgment, taxpayer had “received the entire amount of claimed refund for the 2009 tax year [i.e., the tax year ended March 31, 2010] before this suit was filed.”⁵ (RE 132, Objection to Proposed Supplemental Final Judgment, PageID#2571-72.)

In its objection to the proposed judgment, the Government further noted that it was unclear from the proposed judgment whether taxpayer was seeking an award of costs under 28 U.S.C. § 1920 or under I.R.C. § 7430. (Id. at 5, PageID#2573.) If taxpayer's request was made under I.R.C. § 7430, that section imposes one set of requirements for an award of “litigation costs,” which may include both reasonable court costs and attorney's fees. But, the Government explained, taxpayer could not qualify for an award of attorney's fees for several reasons. Specifically, taxpayer had not substantially prevailed with respect to the amount in controversy or with respect to the issues presented, because the research credits to which taxpayer was entitled as a result of the suit was a small fraction of the $310,702 in credits taxpayer had requested in its complaint. (Id. at 4, PageID#2572.) The Government also contended that taxpayer did not qualify as a party entitled to attorney's fees § 7430(c)(4)(A) and, by reference, 28 U.S.C. § 2412(d)(2)(B), because it had not demonstrated that its net worth was below $7 million. (Id. at 5-6, PageID#2573-74.)

The District Court did not directly address the Government's objections. Rather, on March 28, 2019, the court simply entered taxpayer's proposed judgment as the final judgment, holding that taxpayer “substantially prevailed on the primary issues in dispute, and is thereby awarded its reasonable court costs.” (RE 144, Final Judgment, PageID#2890.) The court did not specify the statute under which it awarded costs.

On April 17, 2019, taxpayer filed a motion seeking $44,687.60 in costs under 28 U.S.C. § 1920. (RE 145, Motion for costs, PageID#2895.) The United States objected to that request to the extent that it sought $34,746.24 in travel expenses for out-of-district counsel. (RE 146, Opposition to motion for costs, PageID#2909.) The District Court agreed that those travel expenses were not recoverable under 28 U.S.C. § 1920, and thus granted the bill of costs under 28 U.S.C. § 1920 in the amount of $9,941.36, which included clerk and marshal fees, transcript fees, and printing fees — all costs authorized by 28 U.S.C. § 1920, which the Government did not contest. (RE 149, Order and Decision, PageID#2920.) The time has now expired in which taxpayer might have appealed the partial denial of the costs it sought, and the Government is not appealing the award of $9,941.36 in costs under 28 U.S.C. § 1920. Rather, the Government challenges on appeal only the award of reasonable costs in the final judgment to the extent the Court concludes it should be viewed as an award under I.R.C. § 7430. The Government does so protectively because, under § 7430, the same statutory requirements apply for both awards of costs and awards of attorney's fees, which can be requested up to 30 days after a final and nonappealable judgment is entered. See I.R.C. § 7430(c) (incorporating requirements of 28 U.S.C. § 2412(d)(1)(B), providing that an attorney's fees request can be filed with 30 days of final judgment, defined in 28 U.SC. § 2412(d)(2)(G) as a judgment that is final and not appealable).

The United States filed a timely notice of appeal on May 21, 2019. (RE 148, Notice of Appeal, PageID#2918.)

SUMMARY OF ARGUMENT

1. Taxpayer brought this suit seeking a tax refund based on research credits available under I.R.C. § 41. Under § 41, a taxpayer may be allowed research tax credits for an increase in qualified research expenses over a “base amount” of such expenses. The base amount generally is determined by using a calculation, one component of which is the “fixed-base percentage” of a taxpayer's gross receipts for a specified number of years. It is the taxpayer's burden to prove that it is entitled to research credits, and it is thus the taxpayer's burden to demonstrate the proper fixed-base percentage to be used in calculating the taxpayer's qualified research expenses.

In this case, taxpayer filed a motion in limine alleging that the Government had agreed to its use of a.92 fixed-base percentage in two prior Tax Court cases involving taxpayer's claim for research credits in other tax years. Taxpayer argued that the Government thus was judicially estopped from arguing that taxpayer was not entitled to use a .92 fixed-base percentage in the instant case. The District Court erred in granting taxpayer's motion.

Judicial estoppel precludes a party who has successfully and unequivocally asserted a position in a prior proceeding from asserting an inconsistent position in a subsequent proceeding. For the doctrine to apply, the first court must have “adopted the position urged by the party, either as a preliminary matter or as part of a final disposition.” Edwards v. Aetna Life Ins. Co., 690 F.2d 595, 599, n.5 (6th Cir. 1982). Generally, a party's decision to resolve a dispute by agreement does not warrant the application of judicial estoppel where there is nothing in the record showing that factual allegations were relied upon to induce settlement and the court made no findings of fact or conclusions of law.

The District Court misapplied the doctrine of judicial estoppel in this case. In the two prior Tax Court cases, the court did not expressly accept the parties' use of a.92 fixed-base percentage, and the Government neither advocated for that figure nor persuaded the Tax Court to adopt it as the court's own holding. Rather, the court only accepted the parties' overall settlement of the final tax deficiency amounts or, in one case, the amount of allowable research credit. The parties in those cases did not stipulate to the amount of the fixed-base percentage, and the court did not expressly accept or adopt the percentage used by the parties in arriving at the settlements. Accordingly, the District Court's granting of taxpayer's motion in limine should be reversed, the case should be remanded, and taxpayer should be required on remand to prove the correct fixed-base percentage that applies in this case.

2. In the final judgment, the District Court held that taxpayer had “substantially prevailed on the primary issues in dispute, and is thereby awarded reasonable court costs.” A finding that a party has “substantially prevailed,” however, is one of the prerequisites for an award of attorney's fees under I.R.C. § 7430, whereas it is not a required finding for an award of costs under 28 U.S.C. § 1920. The court, however, did not cite any statutory basis for the award, and it is thus unclear whether the award is limited to “costs” under 28 U.S.C. § 1920, which, under the terms of that statute, does not include attorney's fees, or whether the basis for the award is I.R.C. § 7430, under which an award of costs may include court costs as well as attorney's fees.

Because the court did not specify that it was awarding attorney's fees or that its award was one under I.R.C. § 7430, and because the court did not make the requisite findings for an award of attorney's fees under § 7430, the Government believes that the court did not, in fact, make an award under § 7430. If this Court agrees, then the issue is not ripe for review. If the Court determines that the judgment included a ruling under I.R.C. § 7430, however, then this Court has jurisdiction to review the award in this appeal, even though the District Court did not yet determine any amount of fees, and this Court should hold that the District Court abused its discretion in granting taxpayer an award under I.R.C. § 7430.

First, the District Court's finding that taxpayer had substantially prevailed was wrong. The final judgment in fact awarded taxpayer a small fraction of the relief it sought in its amended complaint. In addition, an award under § 7430 is authorized only if the taxpayer shows that the Government's position was not substantially justified. But here taxpayer did not present any argument that the Government's position was not substantially justified, and the District Court made no determination in that regard. Finally, for any award of attorney's fees under I.R.C. § 7430, a corporation, such as taxpayer, must show that its net worth does not exceed $7,000,000. Taxpayer did not attempt to make such a showing, and the District Court made no net-worth determination. Taxpayer thus did not carry its burden of showing that it was entitled to an award of attorney's fees under I.R.C. § 7430, and the District Court did not make the required determinations for such an award. Accordingly, if this Court finds that the final judgment contains a ruling under I.R.C. § 7430, the Court should also find that the District Court abused its discretion and reverse that determination.

ARGUMENT

I. The District Court erred in ruling that the United States was judicially estopped from challenging taxpayer's use of a.92 percent fixed-base percentage in calculating the research credit to which it was entitled for the tax year ended March 31, 2008

Standard of review

Although this Court generally reviews the District Court's ruling on a motion in limine for abuse of discretion (Louzon v. Ford Motor Co., 718 F.3d 556, 560 (6th Cir. 2013)), “ '[t]his court reviews de novo the district court's application of judicial estoppel.' ”⁶ Davis v. Fiat Chrysler Automobiles U.S., LLC, 747 F. App'x 309, 312-13 and n.2 (6th Cir. 2018), cert. denied, 139 S. Ct. 1337 (2019) (quoting White v. Wyndham Vacation Ownership, Inc., 617 F.3d 472, 476 (6th Cir. 2010) (alteration in original)), and citing, among other cases, Mirando v. U.S. Dept. of Treasury, 766 F.3d 540, 545 (6th Cir. 2014)).

A. Introduction: The research credit under I.R.C. § 41

Tax credits are a matter of legislative grace. New Colonial Ice, 292 U.S. at 440; United States v. McFerrin, 570 F.3d 672, 675 (5th Cir. 2009). They are allowed only “as clearly provided for by statute, and are narrowly construed.” McFerrin, 570 F.3d at 675; accord Helvering v. Northwest Steel Rolling Mills, Inc., 311 U.S. 46, 49 (1940). A taxpayer claiming the credit must clearly establish full satisfaction of all of the statutory requirements. New Colonial Ice, 292 U.S. at 440; see United Stationers, Inc., 163 F.3d at 443 (“In this case [regarding the research credit under §41], as with all claimed credits, the taxpayer bears the burden of showing entitlement to the credit.”); see also Tax Ct. Rule 142; Welch v. Helvering, 290 U.S. 111 (1933). Taxpayers must carry their burden of proof by a preponderance of the evidence. Estate of Gilford v. Commissioner, 88 T.C. 38, 51 (1987). Moreover, they are required to retain records necessary to substantiate a claimed credit. I.R.C. § 6001; Treas. Reg. (26 C.F.R.) §§ 1.6001-1(a), (e); 1.41-4(d).

Section 41 of the Internal Revenue Code provides an incremental tax credit designed to encourage taxpayers to increase their research spending beyond the level that they would spend absent any tax incentive. Congress believed that a “substantive tax credit for incremental research and experimental expenditures will overcome the resistance of many businesses to bear the significant costs of staffing, supplies, and certain computer charges which must be incurred in initiating or expanding research programs.” H.R. Rep. 97-201, at 111 (1981), reprinted in 1981-2 C.B. 352, 357; see also H. Conf. Rep. 97-215, at 223 (1981), reprinted in 1981 U.S.C.C.A.N. 285, 313. The credit is allowed for an increase in “qualified research expenses” over the “base amount” (I.R.C. § 41(a)), which is calculated under I.R.C. § 41(c). Thus, it is not sufficient for a taxpayer simply to demonstrate that it did research during the year(s) in issue or even that it had qualified research expenses during such year(s). Rather, the taxpayer must show that its “qualified research expenses,” as defined by the statute, increased.

“Qualified research expenses” include both the cost of qualified research conducted by a taxpayer in-house, and the cost of contract research paid by a taxpayer to another party for qualified research. I.R.C. § 41(b). “In-house research expenses” includes “any wages paid or incurred to an employee for qualified services,” i.e., the performance, direct supervision, or direct support of qualified research, and “any amount paid or incurred for supplies used in the conduct of qualified research.” I.R.C. § 41(b)(2)(A), (B). Congress intended to make the research credit available only for expenses incurred “in the actual conduct of research,” and not for indirect research expenses, or general and administrative costs. H.R. Rep. 97-201, at 117-18, reprinted in 1981-2 C.B. at 361.

Under I.R.C. § 41, as in effect during the years at issue here, “qualified research,” is research that satisfies each of four tests: (1) the expenses incurred must be of the type deductible under I.R.C. § 174 (“the Section 174 test”),⁷ which governs the tax accounting or research and experimental expenditures (§ 41(d)(1)(A)); (2) the research must have been undertaken for the purpose of discovering information that is “technological in nature” (§ 41(d)(1)(B)(i)); (3) the application of that information must be intended to be useful in the development of a new or improved business component of the taxpayer (the “business component test”) (§ 41(d)(1)(B)(ii)); and (4) substantially all of the research activities must have constituted elements of a “process of experimentation” (the “process of experimentation test”) (§ 41(d)(1)(C)). See McFerrin, 570 F.3d at 676. These tests apply separately with respect to each “business component” of the taxpayer, which is a “process” or “product” for sale, lease, or license to third parties, or is used by the taxpayer in its trade or business. § 41(d)(2)(A), (B). Excluded from the activities for which the credit is allowed are, inter alia, “research conducted after the beginning of commercial production of the business component,” and “[a]ny research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States.” I.R.C. § 41(d)(4)(A), (F).

The § 41 research credit is allowed for 20 percent of the increase in “qualified research expenses” (“QREs”) over a “base amount.” I.R.C. § 41(a). Under the “general” rule, the “base amount” is the product of (1) the “fixed-base percentage,” and (2) the average annual gross receipts for the taxpayer for the four taxable years before the year for which the credit is being determined. Section 41(c)(3)A) defines the “fixed-base percentage” as the ratio of the taxpayer's aggregate QREs for the years beginning December 31, 1983, and ending before January 1, 1989 (the “base period”) over the taxpayer's aggregate receipts for such years.⁸ The research credit under I.R.C. § 41 is available only for the excess of the taxpayer's QREs over the “base amount.” I.R.C. § 41(a)(1). Because this general rule governed taxpayer's claim to the credit for its tax year ended March 31, 2008, taxpayer had to establish the applicable fixed-base percentage in order to show its entitlement to the credit for that year.⁹ Research, Inc. v. United States, Civ. No. 3-94-385, 1995 WL 560140, at *4 (D. Minn. June 21, 1995) (“The taxpayer here bears the burden of proving its qualification for the credit.” (citing Helvering v. Taylor, 293 U.S. 507 (1935) and Welch v. Helvering, 290 U.S. 111 (1939))).

B. The District Court erred in ruling that the United States was estopped from challenging taxpayer's use of a.92 fixed-base percentage in calculating the research credit to which it was entitled for its tax year ended March 31, 2008

Judicial estoppel precludes a party who has successfully and unequivocally asserted a position in a prior proceeding from asserting an inconsistent position in a subsequent proceeding. See Reed Elsevier, Inc. v. Muchnick, 559 U.S. 154, 170 (2010). The doctrine “typically applies when, among other things, a 'party has succeeded in persuading a court to accept that party's earlier position, so that judicial acceptance of an inconsistent position in a later proceeding would create the perception that either the first or the second court was misled.'” Ibid. (quoting New Hampshire v. Maine, 532 U.S. 742, 750 (2001)); see also In re Commonwealth Institutional Securities, Inc., 394 F.3d 401, 406 (6th Cir. 2005). It is aimed at protecting litigants from opponents who reverse their positions to another litigant's detriment, such as by taking advantage of both sides of a factual issue at different times or before different courts. Teledyne Indus., Inc. v. N.L.R.B., 911 F.2d 1214, 1220 (6th Cir. 1990). For judicial estoppel to apply, it is not necessary that a party have finally prevailed on the merits in the first proceeding; the first court need only have “adopted the position urged by the party, either as a preliminary matter or as part of a final disposition.” Edwards v. Aetna Life Ins. Co., 690 F.2d 595, 599 n.5 (6th Cir. 1982).

In the instant case, taxpayer sought to bind the United States to the purported terms of settlements with taxpayer in Tax Court litigation involving research credits for other tax years. The District Court granted taxpayer's request to bar the United States from objecting to its use of a.92 fixed-base percentage in calculating the research credits for the tax years in issue, ruling that the United States was judicially estopped by its settlements in the Tax Court cases.

There is nothing in the record, however, to demonstrate that the Tax Court in the prior cases was persuaded or accepted that.92% was the proper fixed-base percentage to apply. Rather, in the two prior Tax Court cases the parties merely stipulated to the amount of tax deficiencies for which taxpayer was liable, or the research credit that taxpayer would be allowed, and that no penalties would apply; they did not stipulate to the amount of the fixed-base percentage, and taxpayer produced no evidence in the District Court to support its claim that the Government had secured final judicial acceptance of that percentage. The only evidence taxpayer produced regarding the stipulated decisions in the prior Tax Court cases was an unsigned copy of the stipulated decision in Tax Court case No. 17540-09, involving taxpayer's tax years ended March 31, 2002 through March 31, 2005, and a copy of the Stipulation of Settled Issues in Tax Court case No. 27948-14, involving taxpayer's tax year ending March 31, 2011. (RE 58-2, 58-3, Exhibits 2 and 3 to Response in Opposition to Motion to Compel Discovery, PageID#914-915, 931-934.) In the first document, the decision reflects only the amount of the tax deficiency for each tax year, and, in the second document, the parties stipulated only that taxpayer was entitled to a research credit of $78,495 for the tax year ended March 31, 2011. Nothing in either of these documents refers to the fixed-base percentage used to calculate the research credit. Indeed, it cannot reasonably be said that the Commissioner advanced a position that a.92 fixed-base percentage was correct in the prior Tax Court litigation, because taxpayer conceded in the instant case that it was taxpayer's position in the prior cases — not the Commissioner's — that the.92% figure should apply. (RE 80-1 at 3, n.2, Brief in Support of Motion in Limine, PageID#1127.)

Generally, a party's decision to resolve a dispute by agreement does not warrant applying judicial estoppel where there is nothing in the record showing that factual allegations were relied upon to induce settlement and the court made no findings of fact or conclusions of law. See Teledyne Indus., 911 F.2d at 1218-19 (declining to apply judicial estoppel where there was no judicial acceptance of allegations in the agreed orders); Edwards, 690 F.2d at 599-600 (denying judicial estoppel where administrative agency official decided to pay claim without resort to litigation); Konstantinidis v. Chen, 626 F.2d 933, 939 & n.10 (D.C. Cir. 1980) (denying judicial estoppel where settlement was reached without admissions or stipulations of fact, but distinguishing case where settlement expressly conveyed property rights and party receiving them was entitled to the benefit of the earlier bargain).

Under the reasoning of these cases, judicial estoppel should not have been applied here because, in taxpayer's prior cases, the Tax Court did not expressly accept the parties' use of a.92 fixed-base percentage, and the Commissioner neither advocated for that figure nor persuaded the Tax Court to adopt it as the court's own holding. Rather, the court accepted only the parties' overall settlement of the final tax deficiency amounts for the years in issue, or, in the case involving the tax year ended March 31, 2011, the amount of taxpayer's allowable research credit. Accordingly, because the Government did not persuade the Tax Court to accept a certain fixed-base percentage, and because the Tax Court did not expressly accept any percentage, the District Court erred in ruling that the United States was judicially estopped in this case from arguing that taxpayer was required to carry its burden of proving the fixed-base percentage to which was entitled for the tax year ended March 31, 2008.¹⁰

In its brief in support of its motion in limine (RE 80-1 at 5-6, Brief in Support of Motion in Limine, PageID#1129-30), taxpayer relied heavily on this Court's opinion in Reynolds v. Commissioner, 861 F.2d 469 (6th Cir. 1988), to support its position, but Reynolds is readily distinguishable. In that case, this Court held that the Commissioner was judicially estopped from taking a certain position because it was contrary to a settlement stipulation that the bankruptcy court “approved and so ordered.” As the Court there explained (861 F.2d at 473):

In contrast with the judicial approval of an asserted position regarding property ownership in Reynolds, this case is an “ordinary civil case” in which settlement does not reflect a successful assertion of, or acceptance of, either party's factual allegations by the court. See id. at 473. See also Teledyne Indus., 911 F.2d at 1219 (distinguishing Reynolds). Because the Government made no specific representations before the Tax Court regarding the fixed-base percentage, and merely settled for a specified deficiency amount, the District Court's holding that the United States is bound based by judicial estoppel to a.92 fixed-base percentage is wrong.

Moreover, the context here of a stipulated settlement in the Tax Court makes the application of judicial estoppel particularly inappropriate. Tax Court litigation differs from district court litigation in that its rules impose on the parties a duty to stipulate, “to the fullest extent to which complete or qualified agreement can or fairly should be reached, all matters not privileged which are relevant to the pending case, regardless of whether such matters involve fact or opinion or the application of law to fact.” Tax Ct. R. 91(a)(1). Because of this duty to stipulate to resolve Tax Court cases quickly and efficiently, Tax Court Rule 91(e) specifically provides that such “[a] stipulation and the admissions therein shall be binding and have effect only in the pending case and not for any other purpose, and cannot be used against any of the parties thereto in any other case or proceeding.” Thus, even if the parties had stipulated to a fixed-base percentage in the settled cases, binding the Government to such a stipulation in a suit regarding a different tax year conflicts with Tax Court Rule 91(e)'s specific prohibition against the use of the stipulation in any other case.

II. To the extent that the District Court ruled against the Government under I.R.C. § 7430, it abused its discretion

Standard of Review

This court reviews a district court's determination regarding the award of attorney fees and costs for abuse of discretion. Paschal v. Flagstar Bank, 297 F.3d 431, 433 (6th Cir. 2002). “ 'Abuse of discretion is defined as a definite and firm conviction that the trial court committed a clear error of judgment.' ” Id. at 433-34 (quoting Logan v. Dayton Hudson Corp., 865 F.2d 789, 790 (6th Cir. 1989)). “ 'An abuse of discretion exists when the district court applies the wrong legal standard, misapplies the correct legal standard, or relies on clearly erroneous findings of fact.' ” Paschal, 297 F.3d at 434 (quoting First Tech. Safety Sys. v. Depinet, 11 F.3d 641, 647 (6th Cir. 1993)).

A. It is not clear that the District Court has made a ruling under I.R.C. § 7430

At the outset, the Government acknowledges that it is not clear that the District Court has made a ruling under I.R.C. § 7430 that is ripe for review. In the final judgment, the District Court held that taxpayer had “substantially prevailed on the primary issues in dispute, and is thereby awarded its reasonable court costs.” (RE 144, Final Judgment, PageID#2894.) The judgment does not cite any statutory basis for the award. Thus, it is unclear whether the court's award is limited to “costs” under 28 U.S.C. § 1920, which, under the terms of that statute, does not include attorney's fees, or whether the basis for the award is Section 7430 of the Internal Revenue Code, under which an award of “reasonable litigation costs” may include “reasonable court costs” as well as “reasonable fees paid or incurred for the services of attorneys in connection with the court proceeding.” I.R.C. § 7340(c)(1). Adding to the confusion, the judgment states that taxpayer “substantially prevailed,” language that appears in I.R.C. § 7430(c)(4)(A) as part of the definition of “prevailing party.” The determination that one party is a “prevailing party” is part of the overall determination under § 7430 of whether another party is liable for litigation costs. The terms “substantially prevailed” and “prevailing party” do not appear in 28 U.S.C. § 1920. Accordingly, while the District Court did not expressly order an award of attorney's fees under I.R.C. § 7430, it appears that the court may have made the determination that taxpayer qualifies as a “prevailing party” under I.R.C. § 7430 — a statute under which the same prerequisites apply to awards of both “reasonable court costs” and attorney's fees.

Because the District Court did not specify that it was awarding taxpayer attorney's fees, or that its ruling was one under I.R.C. § 7430, the Government believes that the judgment does not in fact rule on whether the requirements for an attorney's fee award under § 7430 were met, and that before such an award could be made, taxpayer and the District Court would have to establish the statutory requirements have been met. If this Court agrees, then the issue is not ripe for review. If this Court determines that the judgment included a ruling under § 7430 that is ripe for review, however, it has jurisdiction to review the award in an appeal on the merits of the case, even though no amount of fees has been determined by the District Court. See Morgan v. Union Metal Mfg., 757 F.2d 792, 795-96 (6th Cir. 1985) (holding that, although a party is generally permitted to wait to appeal a fee award until the amount of fees is determined, “the court's jurisdiction over the appeal on the merits carries with it the authority to determine the liability for fees” even if the amount of fees has not yet been set). As we discuss below, any determination by the District Court that taxpayer qualifies for an award of fees under § 7430 is erroneous as a matter of fact and of law.

B. If the District Court did determine that the Government was liable for costs or attorney's fees under I.R.C. § 7430, it abused its discretion by not making the findings required under the statute

In order for the District Court to determine liability for costs or attorney's fees under I.R.C. § 7430, the court must first determine that the party seeking fees has exhausted the administrative remedies available to such party within the Internal Revenue Service. I.R.C. § 7430(b)(1). The court further must determine whether the party requesting fees is the “prevailing party,” because only a prevailing party can recover “litigation costs,” including attorney's fees, under § 7430. See I.R.C. § 7430(a). As the statute provides, “prevailing party” means any party in a court proceeding brought by or against the United States in connection with the collection or refund of any tax, interest, or penalty under the Internal Revenue Code

I.R.C. § 7430(c)(4)(A)(i). Additionally, under I.R.C. § 7430(c)(4)(B)(i), a party cannot be treated as a prevailing party if the Government's position was substantially justified.

Under 28 U.S.C. § 2412(d)(1)(B), as in effect on October 22, 1986, and today, a party seeking an award must file an itemized request for fees showing that the requirements for an award were met. Moreover, § 7430(c)(4)(A)(ii)'s incorporation of the requirements of 28 U.S.C. § 2412(d)(2)(B) in the definition of a prevailing party means the party requesting an award of cost or fees must meet the net-worth limitations under 28 U.S.C. § 2412(d)(2)(B). That section currently provides, as is relevant here, that a corporation must have a net worth of less than $7 million to qualify for an award of fees. None of these requirements was met, and if the District Court intended to hold that the Government was liable for attorney's fees, it abused its discretion in doing so.

First, the District Court erred in finding that taxpayer “substantially prevailed on the primary issues in dispute.” (RE 144, Final Judgment, PageID#2894.) In its amended complaint, taxpayer sought aggregate research credits for five tax years in the amount of $310,702. (RE 23 at 11, Amended Complaint, PageID#207.) This included a research credit of $60,603 for its tax year ended March 31, 2010. (Id. at 8, ¶ 9.iii, PageID#204.)

Prior to filing its complaint, however, taxpayer had already received a tax refund for its tax year ended March 31, 2010, which included its entire claimed research credit for that year. (RE 131-1 at 1-5, Memorandum In Support of Motion to Dismiss, PageID#2558-62.) As the District Court acknowledged in the judgment, taxpayer “has received the benefit for the tax year ending March 31, 2010,” and accordingly no credits or refund were awarded for that tax year in the final judgment. (Final Judgment, RE 144 at 5, PageID#2894.) In addition, the jury found that taxpayer was not entitled to any research credit or refunds for its tax years ended March 31, 2006 or 2007. (Ibid.) As a result, the final judgment effectively awarded taxpayer research credits totaling only $44,721 and refunds totaling $40,432, a small fraction of the amounts it requested in the amended complaint.¹¹ Taxpayer thus did not substantially prevail with regard to the amount in controversy or the significant issues before the court. Taxpayer is not entitled to attorney's fees for this reason alone.

In addition, taxpayer did not make an application for an award of fees under 28 U.S.C. § 2412(d)(1)(B), and the court made no determination regarding whether the Government's position was substantially justified. See I.R.C. § 7430(c)(4)(A)(ii) and (c)(4)(B)(i). It further made no finding regarding whether taxpayer had exhausted its administrative remedies. See I.R.C. § 7430(b)((1). Thus, if the court intended to award attorney's fees to taxpayer, its attempt to do so without requiring taxpayer to make the proper application and without addressing all the statutory requirements, was an abuse of discretion.

Finally, under 28 U.S.C. § 2412(d)(2)(B), a corporate party such as taxpayer must show that its net worth does not exceed $7,000,000. Taxpayer did not attempt to make such a showing, and the District Court did not determine that taxpayer met the net-worth requirement. Further, as the Government noted below, taxpayer's tax returns indicate that it has a net worth far in excess of the $7 million limit. (RE 132 at 6, Objection to Proposed Supplemental final Judgment, PageID#2574.)

For these reasons, taxpayer did not carry its burden of showing that it was entitled to an award of costs or attorney's fees under § 7430, and the District Court did not make the required determinations for such an award. The District Court thus failed to make the required findings of fact for any award of fees under I.R.C. § 7430, it erroneously found that taxpayer had substantially prevailed in the case, and it misapplied the legal standard for an award of attorney's fees. Accordingly, if the Court finds that the Government is liable for attorney's fees and costs under I.R.C. § 7430 under the final judgment, the Court should also find that the District Court abused its discretion in determining such liability and reverse that determination.

CONCLUSION

For the foregoing reasons, the judgment of the District Court with regard to the tax year ended March 31, 2008, is incorrect and should be vacated, and the case should be remanded for a determination of the proper base amount to use in calculating any research credit to which taxpayer may be entitled for that tax year. In addition, the District

Court's determination, if any, of the Government's liability for attorney's fees and costs under I.R.C. § 7430 should be reversed.

Respectfully submitted,

RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General

Randolph L. Hutter
ELLEN PAGE DELSOLE
(202) 514-8128
RANDOLPH L. HUTTER
(202) 514-2647
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:
JUSTIN E. HERDMAN
United States Attorney

JANUARY 2020

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ADDENDUM

DESIGNATION OF RELEVANT DISTRICT COURT DOCUMENTS

Pursuant to Sixth Circuit Rule 30(g)

Record Entry No.	Description	Page ID Range
1	Complaint	1-61
23	Amended Complaint	197-256
58-2	Plaintiff’s Memorandum in Response to Motion to Compel, Ex. 2	912-930
58-3	Plaintiff’s Memorandum in Response to Motion to Compel, Ex. 3	931-934
80	Plaintiff’s Motion in Limine	1122-1124
80-1	Brief in Support of Motion in Limine	1125-1133
89	Defendant’s Response to Motion in Limine	1234-1237
114	Order	1345-1346
123-1	Jury Verdict	2214-2224
126	Judgment Entry	2259
129-1	Proposed Supplemental Final Judgment	2497-2523
131	Motion to Dismiss	2555-2557
131-1	Memorandum in Support of Motion to Dismiss	2558-2562
132	Objection to Proposed Final Judgment	2569-2577
143	Order	2885-2889
144	Final Judgment	2890-2894
145	Motion for Costs	2895-2908
146	Opposition to Motion for Costs	2909-2912
148	Notice of Appeal	2918-2919
149	Order and Decision	2920-2925
	District Court Docket Sheet Case No. 5:16-cv-02052-JRA