In a December 2019 motion, the taxpayer Populous Holdings, an architectural design firm, won the motion allowing them to claim the R&D tax credit on its contracts with clients. Populous claimed the R&D tax credit for architectural work it does for clients and the IRS denied the R&D credit claiming the R&D is funded, arguing both that the Populous is not at financial risk for failed research and that it not retain substantial rights in the R&D to claim the R&D credit.
Financial Risk – held – Populous did have the risk under all contracts reviewed: The Court held that these are fixed price contracts so as a starting point, the contractor is usually at economic risk under these contracts in that it can’t increase the funding unless the contract is amended. Here, the Court held that the contract did not allow Populous to charge additional fees for work to fix any problems with the designs, etc. Even though the contract did not specifically state that Populous would fix work at their cost, the nature of the fixed price contract meant that they could not charge for this additional work to fix any problems with the R&D or research conducted. Held – Populous can still claim the R&D credit as having the financial risk.
Right to the R&D – held – Populous did retain substantial rights to the R&D to claim the R&D tax credit despite the client retaining all documentation, models, drawings, and even copyrights. Populous even had to seek permission to use work that was subject to the copyright. However, the Court held that nothing in the contracts stated that Populous would have to pay the client for the R&D (i.e., similar holding as Lockheed Martin Corp. v. U.S., 210 F.3d 1366 (Fed Cir 2000). This implicit right meant that Populous could claim the R&D credit as having retained substantial rights, largely because the contracts were silent and didn’t expressly state that Populous had to pay to use any results of the R&D work.
Bottom line – This case is worth reviewing for R&D tax credit clients who initially believe their rights are restricted in some context such that they don’t have substantial rights, which may not be the case under this holding (and Lockheed). Moreover, fixed price contracts generally qualify for the contractor under the financial risk criteria, particularly when the contract is silent on whether the contractor or its client has to pay for additional work or re-work on the R&D. Under this holding, the contractor generally has to fix work on its nickel under a fixed price R&D contract unless the contract expressly states otherwise. This motion and case remind us of the need to review all contracts in determining whether the R&D tax credit criteria are met.