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The United States Tax Court Issues Taxpayer-friendly Decision Regarding R&D Tax Credits 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 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 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 case 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. Key Holdings Ding-Dong, the Discovery Rule is DEAD! 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. Tax Court Gives Taxpayers Relief on Substantiating the R&D Credit Since the IRS issued its Tier I Directive in April 2007, the IRS has demanded that taxpayers provide contemporaneous documentation to substantiate their R&D tax credit claims. These demands have been made by the IRS despite the absence of legal authority establishing this as a requirement. 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. Specific Holdings by the Tax Court Concluded That: • Taxpayers were not required to have the same documentation for the base period as it had for the claim years • Reliance on “informal documentation” such as emails and notes was permissible • Estimates were permissible in the absence of underlying documentation • Estimates for a base period company were allowed in the absence of any accounting records for that particular entity Conclusion 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. 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 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. - 4/6/2009
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