Funded R&D – Rights – Tangel Case R&D Tax Credits

In a recent Tax Court case, Tangel v. Commissioner, T.C. Memo. 2021-1 (Jan 2021), the Tax Court concluded that the taxpayer who claimed the R&D tax credit did not retain substantial rights and thus the R&D work was ‘funded’ and the R&D tax credit disallowed. The taxpayer, Enercon, engaged in a contract to develop controls for turbines used in the power generation industry and retrofitting several existing turbines. The contract terms, prepared by the other party, Vericor, restricted Enercon’s ability to use the results of the research without express written permission of Vericor. This included all results of the research, information, tooling and pretty broadly anything developed on the project.

Contrast these facts with Lockheed Martin Corp. v. United States, 210 F.3d 1366 (Fed. Cir. 2000), where that contract did not expressly state that the taxpayer needed the government’s permission to use any results of the research. Thus, absent such terms in the contract, Lockheed was able to show substantial rights in the ability to use the results of the research without paying for that right and without any written government restrictions.

The taxpayer in this recent case Tangel, attempted to make an argument rejected in the Lockheed case; namely that increased knowledge or institutional knowledge is a substantial right. That claim was again rejected by the Tax Court similar to the discussion in the Lockheed case decades ago.

So it appears that express language in a contract requiring written permission from the other party to use any results of the work on the taxpayer’s next project may be restrictive enough to conclude that a contract is ‘funded’ but it does depend on all of the contract terms, and a careful review of contracts claimed for the R&D tax credit. IRS has been focused on this issue and with this recent case, likely more so on future R&D tax credit audits.

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