Dynetics, Inc. and Subsidiaries v. United States, 12-576 (Fed. Cl. 2015)

Background

Dynetics, Inc., an engineering company headquartered in Huntsville, Alabama, filed amended tax returns for three tax periods seeking a refund based on certain research tax credits for contracted research services to which it claims entitlement under Section 41 of the I.R.C. The IRS rejected Dynetics’ refund claims.

Basic Facts

On September 7, 2012, Dynetics filed its complaint against the IRS based on tax refunds it claims for work performed on more than 100 contracts awarded by government, university and commercial entities. The court was asked to review seven of the 100 contracts to conclude whether the work Dynetics conducted under each contract constituted as “funded research.”

Section 41 states that qualified research excludes “any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity).” Research is declared funded if the taxpayer receives payment that is not contingent on the success of the research, meaning if the taxpayer is paid for the results of the research despite if the results were successful or not. Research is also considered funded if the taxpayer conducting the research for another person or entity does not keep substantial rights in the research. If any research is declared “funded,” the taxpayer will be ineligible for the R&D Tax Credit.

Dynetics made many arguments to support its claim that the work it conducted was not funded research due to the following reasons:

1. It had established a course of dealing with its contracting partner in six of the seven contracts, in which, despite the plain terms of the contracts, it was to produce a successful result in order to be paid.
2. An inspection clause or warranty clause that put Dynetics at financial risk of not receiving payment unless the results were successful was included in each contract.
3. It was at risk if it produced an unsuccessful result.
4. The termination clauses in each sample contract put it at risk of nonpayment.
5. Three of the seven contracts were initially issued as an “undefinitized” contract, which put it at risk.

The IRS argued against all five of Dynetics’ points.

The court addressed each point of argument from Dynetics. When addressing the first point, Dynetics found that a course of dealing relies on a “shared understanding” between the parties. After looking over the evidence provided, the court found that evidence failed to prove “joint understanding” between it and its contracting partners.

In regards to the second argument made by Dynetics, the court concluded that none of the clauses included in the contracts put it in financial risk. Dynetics’ cited two similar cases, Fairchild Industries v. U.S. and Lockheed Martin v. U.S.,  in which they pulled various analogies from as support for their case. The court disagreed and rejected both comparisons.

When addressing the rest of the risk-related arguments, the court failed to see Dynetics’ point of view and rejected all claims.

Court’s Decision

In summary, the court cited with the IRS and declared Dynetics’ work as “funded research,” therefore making it ineligible for a tax refund through the Research and Experimentation Tax Credit Laws.

This case sheds light on the different types of contract clauses that the IRS and the courts may analyze when trying to decide if a taxpayer has the risk of failure on an engineering contract.

Click here to view the full case: Dynetics, Inc. and Subsidiaries v. United States, 12-576 (Fed. Cl. 2015)