Basim Shami and Rania Ardah, et al. v. Commissioner of Internal Revenue (T.C. Memo 2012-78)
This case was filed on March 21, 2012 in the United States Tax Court. The sole issue for decision in this case is whether or not certain wages from Farouk Systems, Inc. (FS) paid to petitioner Farouk Shami (Mr. Shami) for 2003, 2004 and 2005 and petitioner John McCall (Mr. McCall) for 2003 and 2004 qualify as research expenses for purposes of claiming credit and increasing research activities.
FS was a hair, skin and nail company that sold and developed products. FS employed hundreds of people who were in several departments like manufacturing, education and research, marketing and sales. Activities involving scientific research and experimentation were conducted by the research and development department, which employed 18-27 staff at any time, or the activities were outsourced.
Mr. Shami was FS’s chief executive officer, president and secretary for 2003 and 2004. Mr. McCall was a principal for a company who distributed FS products and he was a shareholder in FS in the 1990s.
In order to conduct research and development tax studies, FS contracted with alliantgroup to cover the relevant years. These studies claimed that FS was able to qualify for research and tax credits from the wages paid to Mr. Shami ($8.7-$9.5 million) and Mr. McCall ($1.8-$5.7 million) on an annual basis.
QREs (Qualified Research Expenses) can include wages paid to employees when performing qualified research activities. All wages paid to an employee can constitute QREs if 80% of their wages are attributable to qualified services for the taxable year. Taxpayers must retain records of this qualified research to prove these findings.
- Taxpayers (FS) must be prove they are entitled to claim tax credits. Petitioners have not shown that they have provided adequate information to suffice this.
- Mr. Shami and Mr. McCall say that they spent 80% of their time dedicate to product search and development for 2003 and 2004 and Mr. McCall spent 30% of his time in 2005 for these services. The Commissioner of Internal Revenue argues that they did not provide substantial evidence that these activities corresponded to their wages because Mr. Shami and Mr. McCall failed to provide any documentation that proves these services occurred during the relevant years.
- Several testimony petitioners offered to substantiate this time however they were seen as inadequate and sometimes contradictory to the Mr Shami’s and Mr. McCall’s statements. Petitioners turned to United States v. McFerrin in saying the Court must make an estimate in regards to the amount of wages allocable to qualified services however, this case argued that the Court will make an estimate if the taxpayer provides adequate documentation to substantiate costs associate with their research activities. The Court will not make an estimate for the allocation of wages because the plaintiff failed to provide sufficient evidence.
- The Court rejected the petitioners’ argument.
Click here to read the full Tax Court Memorandum: Basim Shami and Rania Ardah, et al. v. Commissioner of Internal Revenue (T.C. Memo 2012-78)