Consulting Firm Requests Additional Research Credit Guidance

May 28, 2021

Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2021-28)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: Recommendations for 2021-2022 Priority Guidance Plan Pursuant to Notice 2021-28

Dear Ladies and Gentlemen:

Pursuant to the Request for Comments contained in Notice 2021-28 (the “Notice”), alliantgroup, L.P. respectfully submits the following recommendations for items to include in the 2021-2022 Priority Guidance Plan (the “Plan”), alliantgroup is a national tax consulting services firm that works with CPA firms and their clients, generally in the small and mid-size business areas, alliantgroup, through its national office, operating as alliantNational, provides tax consulting services on a variety of complex topics. In the course of working with CPA firms and clients, alliantgroup has observed several areas of tax law and administration that currently burden businesses or can benefit from clear guidance. We believe that solutions to these issues exist that will alleviate taxpayer burden and will streamline tax administration. Below, we have included several of these recommendations. We look forward to working with the IRS, Office of Chief Counsel, and Office of Tax Policy on these and other matters. We stand ready to discuss the below described matters as they are essential to the small businesses we serve.

I. Research Credit

A. Guidance on the Four Part Test

Additional guidance is needed on the elements of the four part test to determine whether an activity constitutes qualified research under Sec. 41(d). In particular, we have observed inconsistency regarding the uncertainty and technological in nature tests amongst both taxpayers and examiners. In certain instances, examiners have disqualified activities on the grounds that they fail to meet the technological in nature test because they are characterized as “routine engineering” or “routine product development” or similar verbiage even though these terms are not listed in the statute or regulations and engineering is one of the disciplines described in Treas. Reg. 1.41-4(a)(4). Similarly, examiners have described research as lacking “technical uncertainty” in disallowing activities. Again, that term is not used or defined in existing guidance. Additional clarification on the definition of qualified research would assist both taxpayers and agents in assessing activities.

B. Funding Limitation

In order to ensure the R&D Tax Credit is available only to taxpayers incurring the financial risk inherent to R&D investment, Congress excluded R&D funded by others from the definition of qualified research.¹

While the Internal Revenue Code does not define the term “funded,” the Department of Treasury (“Treasury”) promulgated regulations that outlined when R&D would not be considered “funded.” R&D is not “funded” when two conditions are satisfied: first, the payment for the research must be “contingent on the success of the research and thus considered to be paid for the product or result of the research,”² and second, the taxpayer must have retained “substantial rights” in the research.³ (emphasis added).

Unfortunately, the regulations do not sufficiently or thoroughly delineate when unfunded research ends and funded research begins. Consequently, often the courts are left to answer such questions. Fairchild Industries, Inc. v. United States⁴ was the first such case. In Fairchild, the Federal Circuit focused solely on the first prong of the “funding” exclusion — payment contingent on success of the research — and did so in the context of a contract with a fixed price paid via progress payments, which were refundable to the government should it be dissatisfied with Fairchild Industries, Inc.'s (“Fairchild”) performance.⁵ Ultimately, the Court held that payment is contingent on success for the party “who bears the research costs upon failure. . . .”⁶ (emphasis added). Furthermore, the Federal Circuit held that Fairchild did bear the costs of failed research because (1) it was required to provide a conforming product and (2) the government had the right to reject the product prior to payment.⁷ The U.S. District Court for the Southern District of Florida has subsequently reviewed the funding issue and found fixed fee contracts to be inherently risky⁸. After Fairchild Industries, Lockheed Martin Corp. v. United States⁹ addressed the second prong of the “funding” exclusion — substantial rights — where the contract in question gave the government extensive rights to Lockheed Martin Corporation's (“Lockheed”) research, including an unlimited right to use Lockheed's technical data and disclose it to third parties. Despite Lockheed's inability to exclude others from using its research, the Federal Circuit ultimately held that Lockheed retained “substantial rights” because it had retained “the right to use the results of its research in its business without paying for it”¹⁰ (emphasis added).

The Tax Court's recent order in Populous Holdings, Inc. v. Comm'r, Docket No. 405-17 (Dec. 6, 2019) clarified that “fixed price contracts are inherently risky for the contractor if the research is unsuccessful. Id at 3. The Court also focused on a much more fundamental issue finding that “[n]one of the contracts expressly requires research; thus, none of the contracts expressly states that petitioner is being paid for research.” Id at 3. The Court further rejected IRS arguments that the taxpayer did not bear risk because provisions such as travel expense reimbursement or additional services (beyond the scope of the contract) were to be provided at an hourly rate. The reason for the funded research exclusion is to reward companies that are bearing the risk of research being performed and to prevent two companies from claiming credit on the same research. The breadth and scope of the arguments being made highlight the need for additional guidance to provide a clear delineation between what is qualified and what is not qualified.

Cases subsequent to Fairchild and Lockheed, but prior to Populous Holdings, have created confusion amongst both taxpayers and examiners regarding which contracts should be considered funded. Additional guidance consistent with the Populous Holdings order is needed to clarify these issues.

C. Statistical Sampling

Guidance is needed to facilitate the use of statistical sampling by small and mid-size businesses in the calculation of their research credits. The most recent IRS guidance on sampling is contained in Rev. Proc. 2011-42. Exam has interpreted Rev. Proc. 2011-42 as requiring the use of variable sampling which would require project based recordkeeping that most small and mid-size businesses are unable to meet. Under the Small Business Regulatory Enforcement Fairness Act of 1996, Treasury and IRS must provide guidance to help small business comply with the regulatory requirements.

D. Notice of Research Claim

In the last few years there have been some challenges to the sufficiency of notice provided through the prescribed tax forms filed with tax returns to claim tax credits. Taxpayer claims for the Tax Credit for Increasing Research activity filed on Form 6765 has been specifically targeted. Motions have been made in U.S. Courts to dismiss cases asserting the courts have no jurisdiction to even hear taxpayer's case alleging that taxpayers are required to provide more detail with regard to the legal theories and facts. One case, Harper v. United States, required a reversal by the Ninth Circuit Court of Appeals of the decision to dismiss a case by the United States District Court for the Southern District of California. The Government argument asserts that the information requested by the Treasury in Form 6765 is insufficient notice of a claim for research credits. The Government has asserted that more detail regarding legal theories and factual basis is needed on the tax forms supporting the claim for research credits under Treasury Regulation 301.6402(b)(1). Some assertions have been that business components should be identified in detail in taxpayer tax returns, some motions have insisted that the taxpayer provide the facts supporting the elements and exclusions on tax returns, or even list projects considered in the base calculation. Treasury Regulation 301.6402(c) states that If a particular form is prescribed on which the claim must be made, then the claim must be made on the form so prescribed. We ask for guidance to provide clarity that the filing of Form 6765 is sufficient notice to claim the research credit. Should additional information be necessary, guidance from Treasury as to the specific information to submit is needed to inform taxpayers claiming this benefit.

II. 179D Designer Definition

IRC Sec. 179D allows a deduction for the cost of energy efficient commercial building property (“EECBP”) placed in service during the taxable year. Sec. 179D(d)(4) authorizes the promulgation of regulations, in the case of EECBP installed on or in property owned by a Federal, State, or local government or a political subdivision thereof, to allow the allocation of the deduction to the person primarily responsible for designing the property. IRS Notice 2008-40, Sec. 3, clarifies that a government owner may allocate the Sec. 179D deduction one or more designers of EECBP at their discretion. Sec. 3.02 of Notice 2008-40 defines a designer as “a person that creates the technical specifications for installation of energy efficient commercial building property . . . A designer may include, for example, an architect, engineer, contractor, environmental consultant or energy services provider who creates the technical specifications for a new building or an addition to an existing building that incorporates energy efficient commercial building property . . .” The definition of designer found in Notice 2008-40 is appropriately broad and contemplates the wide variety of taxpayers who may contribute to the design of EECBP. However, since the promulgation of Notice 2008-40, there has been little additional guidance regarding the creation of technical specifications or the definition of designer. Examination has increasingly taken inconsistent and overly narrow stances on what is required to meet the definition in Notice 2008-40. Additional guidance which confirms and elaborates on the broad language in Sec. 3.02 is thus required to provide certainty for both taxpayers and examiners. '

III. Guidance under Section 6676

Issue guidance under section 6676 regarding the erroneous claim for refund penalty and the level of authority needed to establish reasonable cause. Reasonable cause is subjective in nature and could be applied inconsistently to claims.

Conclusion

Thank you for the opportunity to comment on items to include in the Plan. We welcome the chance to meet to discuss the above comments in greater detail or to answer any questions that you may have.

Respectfully submitted,

Steven T. Miller
alliantgroup — National Office
National Director of Tax
Washington, DC