Fairchild Industries Incorporated v. United States, 71 F.3d 868 (Fed. Circ. 1995)
Fairchild Industries Corporation v. United States discusses the regulations in regards to qualified research expenses and the role of “funding”. Qualified Research Expenses (QREs) shall not include the following:
- research conducted outside of the United States
- research in the humanities or social sciences sectors
- research funded by any contract, grant or any other person including a government entity
The research tax credit was established in 1981 to provide incentives to American industries to invest in research. The main issue in this case is the application and implementation of regulations to Fairchild’s contract with the Air Force.
In 1982, Fairchild Industries Incorporated and the Air Force entered into a fixed-price incentive contract where Fairchild would design and produce a “next generation trainer” aircraft intended to train new pilots. This design included many phases of production, development and testing which also had over 1,000 pages of technical specifications and performance standards that were Fairchild were required to adhere to. For Fairchild’s 1982-1985 federal income tax returns they reported $109.4 million of qualified research expenses related to this project of which the IRS disallowed around $19.6 million not related to this program. Because the Air Force funded 55.8% of Fairchild’s research, the IRS disallowed $5.8 million in research tax credits claimed for those years. The interpretation of the statute and regulation for this case is up for debate and review. The question here is whether Fairchild’s research is considered “funded” by the Air Force in terms of research credits. Fairchild claims that the Air Force “funded” none of its research because their right to pay was considered upon the success of the research project. The government argues that the determination of whether the research is funded or not does not depend on whether the contract reserves the right to pay for unsuccessful research. Fairchild remained at risk throughout this process time until the research was successfully completed. The Regulation places importance on the fact that in order for the researcher to claim credit, accounts payable under the agreement must be contingent upon success.
Fairchild’s QREs were not considered “funded” and they are entitled to the research tax credit. The decision of the Court of Federal Claims is reversed and further proceedings will determine how much Fairchild is owed.
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