Legal and Administrative Framework of Written Agreements for Contract Research under the Louisiana Research and Development Tax Credit

A Written Agreement for contract research in the context of the Louisiana Research and Development (R&D) Tax Credit is a formal, legally binding contract executed prior to the commencement of research that explicitly assigns financial risk to the taxpayer and grants them substantial rights to the resulting information. 1 This document serves as the essential evidentiary nexus required by Louisiana Economic Development (LED) to certify that third-party expenditures qualify as research activities rather than the mere procurement of a finished product. 2

The detailed analysis of the Written Agreement requirement reveals it as the cornerstone of compliance for any entity utilizing external consultants, labs, or engineering firms to conduct innovation within the state. Under Louisiana law, specifically R.S. 47:6015, and the administrative rules in the Louisiana Administrative Code (LAC 13:I.2901), the existence and structure of this agreement determine whether a taxpayer can claim a 65% inclusion of their contractor costs toward their qualified research expenditures (QREs). 1 The requirement is not merely a formality but a substantive rule designed to ensure that the taxpayer is the actual driver of the research and development process, bearing the risk of failure while securing the right to exploit the technological breakthroughs discovered during the process. 5 Without a pre-performance agreement that defines the experimental nature of the engagement, the state revenue authorities and economic development reviewers are likely to reclassify such costs as non-qualifying service fees or capital investments. 1

Statutory Origins and Legislative Intent

The Louisiana Research and Development Tax Credit was established to foster a climate of innovation within the state, recognizing that the health, safety, and welfare of the people are dependent upon the growth of the private sector. 3 The legislature intended for this credit to encourage both new and continuing efforts to conduct research activities, particularly in sectors where technological uncertainty is high and the cost of experimentation might otherwise be prohibitive for small and mid-sized firms. 3

The program has undergone several iterations, with significant changes occurring in 2015 and 2017 to refine the calculation of the credit and the verification of expenditures. 10 One of the most critical evolutions was the transition to a tiered system based on the number of employees, which emphasizes support for small businesses through higher credit rates and lower base amount thresholds. 13 The “Written Agreement” requirement for contract research serves as a safeguard in this system, ensuring that as businesses grow and increasingly outsource specialized research tasks, the state continues to incentivize actual innovation performed within Louisiana borders rather than subsidizing the general operational costs of out-of-state contractors. 1

The Tiered Credit Structure

The credit is calculated as a percentage of the difference between the Louisiana QREs for the current year and a “base amount” determined by the entity’s historical spending. 3 The amount of the credit is dictated by the total number of employees based on the aggregate of all affiliated companies, as outlined in the following table:

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For taxpayers who have no prior research expenditures, the base amount is effectively zero, allowing the credit rate to apply to the entirety of the current year’s Louisiana QREs. 13 This tiered approach underscores the importance of correctly identifying and documenting contract research expenses through Written Agreements, as a single disqualified contract could significantly reduce the 30% credit available to a small startup. 13

The Meaning of “Contract Research” under Louisiana Law

Contract research expenses are defined as amounts paid to non-employees, such as outside consultants, laboratories, or engineering firms, to perform qualified research. 1 To qualify for the Louisiana credit, the activities performed under the contract must meet the “Four-Part Test” established by federal law (IRC Section 41) and adopted by Louisiana. 1

The Four-Part Test Integration

1. The Section 174 Test: The expenditures must be for research and development in the experimental or laboratory sense, aimed at discovering information that would eliminate uncertainty concerning the development or improvement of a business component. 5
2. Technological in Nature: The research must rely on the principles of physical or biological sciences, engineering, or computer science. 1
3. Business Component Test: The research must be intended to discover information useful in the development of a new or improved product, process, software, technique, formula, or invention to be held for sale, lease, or license. 1
4. Process of Experimentation: Substantially all of the research activities must constitute elements of a process of experimentation, involving the evaluation of alternatives through modeling, simulation, or systematic trial and error. 1

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The Written Agreement must be drafted such that the scope of work clearly outlines how the contractor’s activities satisfy these tests. 1 For instance, if the agreement simply tasks a consultant with “designing a website,” it fails the technological and experimentation tests. 5 However, if the agreement tasks the consultant with “developing a novel algorithm to resolve latency in distributed cloud computing environments through iterative load testing,” it provides the necessary framework for a qualified research claim. 5

Core Requirements of the Written Agreement

Louisiana Economic Development (LED) and the Louisiana Department of Revenue (LDR) mandate five specific conditions for a Written Agreement to be considered valid for the R&D tax credit. 1

1. Execution Prior to Performance

The taxpayer must enter into the written agreement prior to the performance of any research services. 1 This is a strict temporal requirement. If a consultant begins work on a project on January 1st and a contract is not signed until February 1st, all expenditures incurred in January are ineligible for the credit. 1 This prevents “post-hoc” reclassification of general service fees into R&D expenses. 8

2. Allocation of Financial Risk

The taxpayer must bear the costs of the research even if the research is unsuccessful. 1 This distinguishes “contract research” from “funded research.” 5 In a compliant Written Agreement, payment must be based on the effort or the services performed (such as an hourly rate or a fixed fee for a testing phase) rather than being contingent upon reaching a specific technological milestone or successful outcome. 5 If a contract states that the consultant is only paid if they successfully develop a prototype that meets certain performance specs, the consultant is bearing the risk, and the taxpayer is merely purchasing a successful product. 19

3. Geographic Sourcing (Louisiana Performance)

The consultant must perform the research within the state of Louisiana. 1 If the research is conducted both within and outside of Louisiana, only the expenditures incurred within Louisiana qualify. 1 The Written Agreement should explicitly state where the work will be performed and require the contractor to provide location-specific billing if necessary. 1

4. Retention of Substantial Rights

The taxpayer must retain substantial rights to the research results. 5 This does not necessarily mean the taxpayer must have exclusive rights, but they must be able to use the research in their trade or business without paying an additional fee to the contractor. 5 Contracts that grant “all right, title, and interest” to the taxpayer are standard, but even a non-exclusive license can suffice if it allows the taxpayer to exploit the data and discoveries without further approval. 6

5. The 65% Qualifying Limitation

Only 65% of the Louisiana contract research expense is eligible to be included in the credit calculation. 1 This “haircut” is intended to remove the contractor’s profit margin and general administrative overhead from the innovation incentive. 8 This limitation is applied automatically during the credit computation phase, provided the underlying Written Agreement meets all other criteria. 1

Detailed Analysis of “Financial Risk” and “Substantial Rights”

The nuances of financial risk and substantial rights are frequently the subject of litigation and administrative denial. The U.S. Fifth Circuit Court of Appeals, which has jurisdiction over Louisiana, clarified these concepts in Grigsby v. Commissioner. 19

Case Study: Grigsby and the Construction Conflict

In the Grigsby case, Cajun Industries, a Louisiana construction firm, attempted to claim R&D credits for engineering work on large-scale infrastructure projects. 19 The court upheld the denial of the credits because the construction contracts were structured as “funded research.” 19 Specifically, the contracts required the delivery of a finished project for a fixed price. 19 Because the taxpayer (Cajun) was only paid upon successful completion of the “Work” and bore the burden of any failures or damage during construction, they were deemed to be performing work where the risk was a business/contractual risk, not a research risk. 19

Furthermore, the contracts often contained “work for hire” provisions that assigned all intellectual property and data to the end-client. 6 This meant the performing contractor (the potential claimant) did not retain substantial rights to the research. 6 For a business hiring a contractor, the reverse is true: the Written Agreement must ensure the taxpayer is the one bearing the cost of “failed” experiments and the one owning the “Work Product” to successfully claim the credit. 5

Drafting the Payment Clause

To demonstrate financial risk, the Written Agreement should utilize language such as:

“The Taxpayer shall compensate the Consultant for all hours worked on the Project at the rates specified in Exhibit A. Payment is due for all services rendered, regardless of whether the research activities result in a viable commercial product or resolve the identified technological uncertainties.” 1

This contrasts with non-compliant “Success-Fee” language:

“The Consultant shall receive $50,000 upon the successful demonstration of a prototype meeting the 200mph velocity requirement. No payment shall be due if the prototype fails to meet this specification.” 5

Local State Revenue Office and LED Guidance

The administration of the R&D credit is split between the Louisiana Economic Development (LED) office, which certifies the eligibility of the project and expenditures, and the Louisiana Department of Revenue (LDR), which manages the tax returns and audits. 1

The Certification Process

Taxpayers seeking the credit must apply to LED via the online FastLane portal. 1 The application must include:

• A federal income tax return (Form 6765) or supporting documentation. 1
• An application fee (0.5% of the credit, min. $500, max. $15,000). 10
• A detailed breakdown of costs, specifically segregating contract research. 1

LED staff review these applications and select at least 10% for a detailed examination. 1 During such an examination, the Written Agreement is the primary document reviewed to verify the “prior to performance” and “risk” requirements. 1

Expenditure Verification Reports (EVR)

For certain entities, particularly those with fewer than 50 employees who do not file a federal R&D claim, a formal Expenditure Verification Report (EVR) is required. 3 LED assigns an independent Louisiana-licensed CPA or tax attorney to perform this verification. 3

The fees for these reports are standardized:

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The CPA will review invoices, proof of payment, and the Written Agreement to ensure that the “nexus” between the expense and the research activity is documented. 8 The auditor will also look for 1099 forms issued to the contractors listed in the R&D claim to ensure consistency with reported wage data. 1

Example of a Compliant Contract Research Scenario

Company: Bayou Bio-Fuels, LLC (12 employees)

Project: Developing a new distillation process for algae-based fuel.

Contractor: NOLA Lab Solutions, Inc.

Step 1: Pre-Performance Agreement

On February 1, 2024, Bayou Bio-Fuels and NOLA Lab Solutions sign a “Research Services Agreement.” This date is recorded before any testing begins. 1

Step 2: Defining the Scope

The scope of work (SOW) defines the technological uncertainty: “The project aims to determine the optimal temperature threshold to prevent lipid degradation during rapid distillation, which is currently unknown in the industry.” 5

Step 3: Payment and Risk

The agreement states: “Bayou Bio-Fuels shall pay NOLA Lab Solutions $200 per hour for laboratory time and $500 per data analysis report. Payments are due monthly based on activity performed. Bayou Bio-Fuels acknowledges that the distillation process may fail to achieve desired purity levels, and that such failure does not relieve Bayou Bio-Fuels of its payment obligations.” 1

Step 4: Geographic Nexus

The agreement specifies: “All laboratory testing and data analysis shall be performed at NOLA Lab Solutions’ facility located at 123 Research Way, New Orleans, Louisiana.” 1

Step 5: Calculation

Bayou Bio-Fuels pays $100,000 to NOLA Lab Solutions in 2024.

• Total Expenditure: $100,000
• Inclusion Rate: 65%
• Qualified Research Expense (QRE): $65,000
• Credit Rate (Small Business): 30%
• Total Tax Credit Earned: $\$65,000 \times 0.30 = \$19,500$

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Statistical Landscape and Economic Trends

The Louisiana R&D tax credit is a high-cost program for the state, which has led to increased scrutiny of Written Agreements. 22 In Fiscal Year 2023, the program saw a significant increase in disbursed incentives, rising to $11.48 million from $5.50 million in FY 2022. 23

Return on Investment (ROI) Data

The fiscal impact of the program is monitored annually. The following table illustrates the recent ROI trends:

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The negative fiscal ROI (-92.67%) indicates that the state recoupment is only about 7.33 cents for every dollar spent on the credit. 23 This data has driven the legislature to implement a $12 million statewide aggregate cap starting July 1, 2025. 13 Because the credits will be issued on a first-come, first-served basis, businesses with deficient Written Agreements face the risk of not only having their claims denied but also missing out on the annual allocation while they attempt to correct their documentation. 13

Sector Trends

Chemical Manufacturing (NAICS 325) has become a dominant player in the program, accounting for 33.29% of the credits in FY 2023, up from 9.87% in FY 2022. 23 Conversely, Railroad Construction and Petroleum products saw a decrease in their share of the incentive. 23 This suggests that the “Written Agreement” for contract laboratory services is increasingly becoming a standard document in the Louisiana manufacturing sector. 23

Compliance and Audit Strategies

For a business operating in Louisiana, the R&D credit is often a “target” for LDR and LED auditors due to its high value and the subjective nature of the four-part test. 1

Maintaining the R&D Ledger

To support a Written Agreement, a company should maintain a contemporaneous R&D ledger. 25 This ledger should link every invoice from a contractor to the specific business component being developed. 1 If an auditor finds that a company is using a generic “consulting” account for both R&D and general business advice, they are likely to disqualify the entire account unless the Written Agreement can clearly bifurcate the research activities. 8

Common Mistakes in Written Agreements

1. Missing “Fail-Safe” Provisions: Many contracts assume success. If a contract doesn’t explicitly state that the taxpayer pays regardless of the outcome, it may fail the risk test. 5
2. Generic Scope of Work: Using terms like “technical support” or “implementation” instead of “prototyping,” “experimentation,” or “uncertainty resolution.” 5
3. Post-Performance Signature: Signing the contract after the consultant has already begun experimental runs. 1
4. Lack of Geographic Specificity: Failing to specify that the work must be done in Louisiana, which is a unique requirement of the state credit compared to the federal version. 1

Conclusion: The Path Forward for Louisiana Innovators

The Louisiana Research and Development Tax Credit offers one of the most generous incentives in the nation, particularly for small businesses that can access a 30% credit rate. 13 However, the “Written Agreement” is the gatekeeper of this incentive for any company that relies on external expertise. 1 As the state moves toward a more capped and competitive environment in 2025, the precision of these legal documents will determine which companies successfully offset their tax liabilities and which are left with disallowed claims. 13

Business owners and tax professionals must view the Written Agreement not as a secondary administrative task, but as a strategic legal instrument. 1 By ensuring that contracts are signed early, that financial risk is clearly defined, and that the geographic nexus to Louisiana is explicitly stated, innovators can secure their claims and contribute to the long-term economic vitality of the state. 1 Consistent documentation, supported by the rigorous standards of the Expenditure Verification Report, remains the best defense against the “funded research” challenges that frequently arise in state and federal audits. 5

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