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Ruling in Tax Court Lawsuit Signals End of R&D Credit “Discovery Rule”

On March 10, 2009, the United States Tax Court issued an opinion regarding Research and Development tax credits (R&D credits) claimed by Union Carbide. Union Carbide Corporation and Subsidiaries, TC Memo 2009 – 50, Code Sec(s) 41; 174. (hereinafter the UCC Opinion). The ruling in this lawsuit confirmed that taxpayers were not required, contrary to prior law, to satisfy a discovery test in their research.

The claimed R&D activities centered on a manufacturer that conducted R&D activities in its manufacturing facilities and plants. The opinion covers a broad range of topics pertaining to the law of the R&D tax credit, from substan­tiation of the underlying R&D credit to establishing a fixed base period and expansion of substantial rights. The vast majority of legal holdings in this case rejected IRS arguments for heightened standards on the R&D tax credit. Although the taxpayer in this lawsuit had its credits substantially reduced due to certain improperly included supply costs, this opinion is a victory for taxpayers who are electing to claim the R&D tax credit.

This case is especially important for manufacturers that operate under the mistaken belief that they do not qualify for the Research & Development (R&D) tax credit. Such companies are under the impression that the R&D credit only applies to basic research (e.g. research done in universities and laboratories); however, the intent of Congress, and the holdings in this lawsuit, further reinforce that the R&D credit is meant for manufactur­ers to claim with regard to activities that occur at their manufacturing facilities/plants (i.e. “applied research”). In fact, much of the basis for the R&D claim in this case arose from research undertaken for the development and improvement of manufacturing processes. Furthermore, wages were claimed for all types of employees, including engineers, testers, and operators. It bears noting that this is a U.S. Tax Court decision, and significant deference will be given by all courts as the Tax Court is a specialty venue for tax matters, and the judges are appointed based on their tax expertise.

Prior to trial, the IRS conceded that the claims would be decided under the current Treasury regulations (TD 9104) and not the prior Treasury regulations that included the Discovery Test (TD 8930). This is of significance as the IRS has been inconsistent in its treatment of the Discovery Test, especially when auditing R&D Claims from tax years prior to 2004. The instant case involved tax years 1994 and 1995, and furthermore, the amended claims for R&D credits were filed in 1999 before the proposed regulations (eliminating the Discovery Test) were even issued. Again, this is a critical concession, as the IRS has been trying to raise the Discovery Test from the dead, and now appear to have finally accepted the position that it should not be used under any circumstance.

In addition, throughout the UCC opinion, the Court dismissed IRS assertions that the testimony relied upon was insufficient to substantiate UCC’s R&D credits. In fact, the Court accepted oral testimony by UCC employees, 15 years after the R&D activities oc­curred, and found it to be sufficient to substantiate both the various R&D tax credit claims and the fixed base percentage.

The significance to taxpayers is that IRS examiners have sought to undermine the use of estimates during ex­amination and assert that oral testimony is insufficient in accounting for claimed amounts. This case should stop the IRS dead in its tracks from using this tactic during examination, as estimates have, once again, been validated for use in quantify­ing R&D credits and in determining the fixed base percentage for a taxpayer.

This is clearly good news for taxpayers and their accounting and legal services advisers as they seek to take advantage of one of the most important incentives for business in the tax code, the R&D Tax Credit.

“This ruling further supports the need for continual dialogue between IRS and taxpayers as to the methods upon which an R&D credit should be examined,” said Dhaval Jadav, CEO of alliantgroup.

About alliantgroup

Alliantgroup is the nation’s premier provider of specialty tax services. The company, headquartered in Houston, TX, works with alliantgroup accounting and legal services providers and their clients to ensure that they receive the full benefits of all available federal and state government sponsored tax credit and incentive programs, such as the research and development tax credit, export tax incentives, manufacturing tax incentives, federal and state hiring credits, sales and use tax refund reviews, and a dedicated tax controversy services team that assists in various legal matters, including IRS and State Tax Matters and various lawsuits.  For additional information please visit


Contact our team today with any tax controversy concern you’re facing. We fight every day to protect the interests of the taxpayer, and we look forward to putting you in the best tax situation possible.


Contact our team today with any tax controversy concern you’re facing. We fight every day to protect the interests of the taxpayer, and we look forward to putting you in the best tax situation possible.

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