United States v. GrigsbyUnited States v. Grigsby
PATRICK E. HIGGINBOTHAM, Circuit Judge:
Today, we visit the classic congressional practice of using its taxing powers to achieve permissible policy goals; here, the lure of a tax credit to incentivize creative research. Leonard L. Grigsby and Barbara F. Grigsby appeal the judgment of the United States District Court for the Middle District of Louisiana which rejected research and development tax credits claimed by Cajun Industries LLC and upheld the resulting tax deficiency.
We AFFIRM.
I.
Cajun Industries LLC (“Cajun”) claimed tax credits for the 2013 tax year pursuant to
The Internal Revenue Code provides a tax credit for qualified research activities, as defined by the Code.2 To constitute “qualified research,” the research must satisfy the four tests laid out in
components” are defined as “any product, process, computer software, technique, formula, or invention which is to be (i) held for sale, lease, or license, or (ii) used by the taxpayer in a trade or business of the taxpayer.”4
However, qualified research expressly excludes so-called “funded” research.5 Funded research include “any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity).”6 Treasury Regulations further explain that research is funded if, in any agreement to perform research (1) the researcher retains no substantial rights to their research; or (2) payment is not contingent upon the research‘s success.7
A. Claimed Credits
Cajun provides construction services throughout the Gulf Coast Region and engaged in over one hundred construction projects during the time period in question. In 2015, Cajun hired a consulting firm to evaluate its projects and advise whether Cajun was eligible for research credits under
As an S-Corporation, Cajun‘s income, losses, deductions, and credits pass through to its shareholders for income tax purposes. At all relevant times, Appellant Leonard Grigsby owned a 73% interest in Cajun and was thus entitled to a pro rata allocation of Cajun‘s tax credit, which amounted to $979,237. The $979,237 credit reduced Mr. and Mrs. Grigsby‘s tax liability fоr 2013 and indicated the couple overpaid their federal income taxes by $576,756. Appellants filed an amended 2013 tax return and sought a refund of $576,756 plus statutory overpayment interest in the amount of $73,633.38 (the “Contested Refund”). On September 15, 2017, the Internal Revenue Service (“IRS”) issued Appellants a refund of $671,071.38, comprised of the Contested Refund and an additional $20,652 not at issue in this case.8
However, on August 13, 2019, the IRS notified Appellants that the Contested Refund was issued erroneously and challenged Cajun‘s claimed credit. The Commissioner demanded Appellants repay the amount and warned that if Appellants did not do so, the IRS would recommend “an action be commenced in District Court to recover the erroneous refund, as permitted by
Before the District Court, the Parties agreed that four projects adequately represented Cajun‘s research activities: (1) Project 13-020 (the “Methanex Project”); (2) Prоject 12-051 (the “Chevron Project”); (3) Project 12-001 (the “Claiborne Project”); and (4) Project 12-023 (the “East Bank Project”) (together, the “Representative Projects”). Thus,
Cajun‘s eligibility for the tax credit, and Appellants’ by extension, hinged on whether it performed qualified research while completing these projects.
1. The Methanex Project
In 2012, Jacobs Field Services North America, Inc. (“Jacobs”) hired Cajun as a subcontractor on a project to relocate a Methanex USA, LLC methanol plant from Chile to Louisiana. Cajun was originally tasked with creating temporary facilities at the new site. According to the Scope of Work provisions of the contract, Cajun‘s responsibilities included:
3.0 GENERAL SCOPE OF SERVICES (WORK)
3.1 [Cajun] shall complete the Work and support functions required to effectively manage and report on the status of the Work as specified.
3.2 [Cajun] shall provide all management, supervision, labor, consumable materials, construction equipment, construсtion aids, tools, services, testing devices, warehousing, supplies, inspections, insurance, fully furnished and equipped offices, communication devices, and all other necessary items to successfully accomplish the construction described by the Scope of Work. This includes, but is not limited to, on and offsite transportation, receiving, loading and unloading, storing, maintenance, and distribution of construction materials, installation of such materials into the Work, proper care of materials, testing and final construction punch list completion and turnover of the Work Scope as specified.9
In executing these tasks, Cajun was “solely responsible for and have [sic] control over construction means, methods, techniques, sequences and procedures and for coordinating all portions of the Work.” This included
obtaining approval for materials, identifying and coordinating vendors, offering design input, and participating in “a lot of review processes.” However, Jacobs retained “ultimate authority to resolve issues in the field.”
The contract was subject to a capped price of $6,485,000 and payment was conditioned on Cajun‘s completion of “all Work.”10 Cajun accepted payment “as full compensation for doing all Work and furnishing all material contemplated by and embraced in this Subcontract,” “for all loss or damage arising out of the nature of the Work,” “from any unforeseen or unknown difficulties or obstructions which may arise or be encountered in the prosecution of the Work,” and “for all risks of every description connected with the Work.”
Section 26 of the contract addressed ownership of any work product and provided that all “Work Product prepared by
The contract defined “work product” as “all documents, data, analyses, reports, plans, procedures, manuals, drawings, specifications, calculations, or other technical tangible manifestations of [Cajun]‘s efforts (whether written or electronic) created by [Cajun] in the performance of the Work, including but not limited to all Documents.” In turn, “documents” included “any or all tracings, designs, drawings, field notes . . . specifications, electronic information . . . and other documents or records developed or acquired by [Cajun] and its suppliers or sub-subcontractors in performing the Work.”
2. The Chevron Project
In 2011, Chevron Products Company, a division of Chеvron U.S.A., Inc., contracted with Cajun to provide construction services to expand Chevron‘s Pascagoula Refinery (the “Chevron Project”). Cajun‘s responsibilities included providing “all labor, supervision, quality control, administration, document control, equipment, [and] tools,” in addition to completing specific civil tasks such as surveying, excavation and backfill, installing piping, and performing field inspections. Appellants maintain that Cajun also offered “constructability reviews” of the engineer‘s designs and specifications. However, the engineer of record, who was not a Cajun employee, retained “ultimate authority to resolve any issues that arose in the field.”
The Chevron contract was a fixed-price contract and compensated Cajun for all work described in Exhibit B of the contract, the “Schedule of Compensation for Work.” Exhibit B detailed all costs covered by the contract price, including craft labor, non-manual, and equipment costs in addition to all overhead and profit. Furthermore, according to the “Pricing” section of the contract, Chevron paid for “performance of all Work” and the contract prices were “all inclusive” of Cajun‘s “supply and services including without limitation; salaries and wages . . . the cost of supervision and support
services from personnel other than those permanently assigned to the Contract . . . employee income tax and statutory payroll deductions, social security charges, [and] all taxes (except sales and use taxes) . . . .” Cajun agreed that payment “constituted full payment for the performance of the Work, and completion of [Chevron]‘s payment obligations under the Contract.”
The contract designated Chevron as the owner of all work product generated during the project and provided:
2.20.3. All drawings, documents, engineering and other datа prepared or furnished by [Cajun] in performing the Work are considered to be [Chevron‘s] work for hire and shall become [Chevron‘s] property from the time of preparation and may be used by [Chevron] for any purpose whatsoever without obligation or liability whatsoever to [Cajun]. [Cajun] assigns all rights in the above referenced drawings, documents, engineering and other data to [Chevron], including copyrights.
[. . .] 18.4. All inventions, discoveries and improvements (patentable and unpatentable) that are made or conceived by [Cajun] or [Cajun]‘s employees in performing the Services and all domestic and foreign patent rights based thereon shall belong to [Chevron] or an Affiliate designated by [Chevron]. [Cajun] shall promptly and fully disclose all such inventions, discoveries and improvements to [Chevron] or the designated Affiliate.
Furthermore, Cajun agreed that all “Technical Information will be used only for performance of the Services for [Chеvron]” and that it would not disclose this information without Chevron‘s express written consent.12 This obligation remained in force even after the Chevron Project concluded.
3. The Claiborne Project
In September 2011, Cajun contracted with the U.S. Army Corps of Engineers to construct a “box culvert,” or an underground canal, as part of the Southeast Louisiana Urban Flood Control Project (the “Claiborne Project”). In doing so, Cajun was responsible for selecting the means and methods of construction, including equipment selection, personnel decisions, and “how to produce the work in accordance with the plans and specifications.” The Claiborne contract was a “fixed price” contract valued at $25,971,694.50.
The contract incorporates various provisions of the Federal Acquisition Regulations (“FAR”), Title 48 of the Code of Federal Regulations, either “by reference” or by “full text.” Relevant here, the contract incorporates
4. The East Bank Project
In January 2012, the Sewerage and Water Board of New Orleans (“SWBNO”) awarded Cajun a construction contract to modify the flood protection system at the East Bank Wastewater Treatment Plant in New Orleans. Cajun‘s scope of work included providing “all labor, materials, supervision, construction equipment, [and] mechanical and electrical equipment.”15
Cajun accepted payment as “full compensation for furnishing all the labor, materials, tools, equipment, etc., needed to complete the whole work of the contract” and also “as full compensation for all loss, damages or risks of every description, connected with or resulting from the nature of the work,
or from any obstructions or difficulties encountered, of any sort or nature whatsoever[.]”
The East Bank contract contained no provisions relating to ownership of work product or research developed during the project.
C. District Court Proceedings
Throughout discovery, Appellants claimed Cajun engaged in research which led to the development of four new “products:” two oil refineries and two flood control systems. When the United States moved for summary judgment, the Government argued these products failed the “business component[s]” test and, as such, that Cajun did not perform qualified research. Furthermore, the Government claimed the Representative Projects were otherwise ineligible for the credit because they were “funded.”
Appellants responded that Cajun had also developed “processes” that amounted to business components, in addition to the “products” identified during discovery. Appellants claimed their new “processes” encompassed the various “construction means and methods” Cajun used to perform on its contracts аnd develop these products. Appellants also disputed that the Representative Projects were funded, and maintained that Cajun retained substantial rights to its “research results.” Alternatively, Appellants contended that the contracts were contingent upon Cajun‘s provision of deliverables and were not funded, as set out in
The District Court granted the United States‘s motion for summary judgment on three bases. First, the District Court rejected Appellants’ “processes” argument pursuant to
Representative Project, Cajun developed a ‘product.’”16 The District Court further found that Appellants’ construction processes claim failed for lack of specificity because Appellants “fail[ed] to specifically identify even one new or improved process that resulted from Cajun‘s work on the Representative Projects.”
Third, as an alternative basis for its holding, the District Court held that the Representative Projects were “funded.” In particular, the District Court determined that the Methanex, Chevron, and Claiborne Projects failed the substantial rights prong of the “funded research exclusion,” and that the East Bank contract was funded because Cajun was fully compensated for any research performed or risk incurred.
Appellants timely appealed. This Court has jurisdiction under
II.
We review a district court‘s grant of summary judgment de novo, applying the same standard as the district court.17 Grants of summary judgment may be affirmed for any reason raised to the district court and supported by the record, and we are not bound by the grounds articulated by the district court.18 Decisions to exclude evidence under
III.
Appellants advance three arguments on appeal. None are persuasive.
A. Burden on Summary Judgment
The District Court granted summary judgment after finding Appellants did not “offer competent evidence or argument establishing that Cajun performed qualified research,” namely on the business components element. Appellants argue that this improperly placed the burden on Appellants as the non-moving party at summary judgment.
It is well established that the IRS‘s assessment of tax liability may be presumed correct so long as it is not “without rational foundation and excessive.”20 The Government satisfies this burden by “specify[ing] the
amount of the deficiency or provid[ing] the information necessary to compute the deficiency.”21 Once an assessment
initiated by the taxpayer or a collection suit brought by the Government.23 Thus, ultimately, “[t]he burden and the presumption, which are for the most part but the opposite sides of a single coin, combine to require the taxpayer always to prove by a preponderance of the evidence that the Commissioner‘s determination was erroneous.”24
The IRS assessment in this case was entitled to the presumption of correctness. This burden is a low one; the assessment must merely “advise the taxpayer that the [IRS] has determined that a deficiency exists for a particular year,” and “specify the amount of the deficiency or provide the information necessary to compute the deficiency.”25 The IRS‘s August 13, 2019, letter to Appellants (the “Letter”) met these requirements.26 Thus, the burden shifted to Appellants to refute the IRS‘s determination. Therefore, the District
Moreover, even if the IRS‘s assessment was not entitled to the presumption of correctness, the Government still met its burden of
production at summary judgment. As the moving party, the Government needed to show that there was no genuine dispute as to any material fact and that it was entitled to judgment as a matter of law.27 The Government could do so by submitting evidence negating the existence of some material element of Appellants’ claim or defense; alternatively, because taxpayers must demonstrate their entitlement to credits, the Government could have pointed out that the evidence in the record was insufficient to support Appellants’ claim that they performed qualified research.28
The Government did so by providing approximately forty exhibits—including excerpts from the Representative Projects’ contracts, Appellants’ 2013 amended tax return, and corporate representative depositions from parties to the Methanex, Chevron, Claiborne, and the East Bank Projects—that refuted Appellants’ entitlement to the credit. At that point, the District Court was correct in offering Appellants the opportunity to rebut this evidence and thus create a genuine issue of fact. The District Court did not err on this basis.
B. Business Components Determination
Research must satisfy the so-called “business components” test in order to qualify for the tax credit.29 The business components test requires that research be “undertaken for the purpose of discovering information (i) which is technological in nature, and (ii) the application of which is intended to be useful in the development of a new or improved business component of the taxpayer.”30 The test must be applied separately to each business component, defined as “any product, process, computer softwarе, technique, formula, or invention which is to be (i) held for sale, lease, or license, or (ii) used by the taxpayer in a trade or business of the taxpayer.”31
During discovery, Appellants stated that they developed four new “products:” two oil refineries and two flood control systems. At summary judgment, however, Appellants claimed Cajun also created new business processes, a separate type of business component, which Appellants define as the “means and methods of construction,” “the means and methods of performing [] construction services,” and “construction processes.”
The District Court found that the asserted products and processes did not satisfy the business components test because Appellants put forth no evidence of the alleged products, any assertions of new construction processes were inconsistent with their prior disclosures and excludable under
1. Business Components: Products
Appellants argue they presented sufficient evidence that Cajun developed four business component products and cite to the “Taxpayers’ Response to Proposed Statement of Facts” (the “Response”) as support. However, cited provisions primarily describe Cajun‘s “means and methods,” i.e., their processes, and not the products. While Appellants may be correct that their construction processes led to the final product, the Revenue Code requires this Court to evaluate each business component separately.33
Accordingly, Appellants have not created a genuine dispute as to whether the four products constitute business components.
2. Business Components: Processes
Appellants further assert the District Court errеd in excluding their construction processes argument because the “development processes and techniques” used on the Representative Projects were “almost inextricably intertwined with the tangible deliverables,” the final product.
We are not persuaded that the District Court‘s decision to exclude Appellants’ construction processes claim was an abuse of discretion.34
First, the argument that Cajun developed new construction processes is important because it provided Appellants with a wholly new basis by which to claim the tax credit. By raising this argument for the first time at summary judgment, Appellants effectively asserted a new defense that was neither disclosed nor explored during discovery. Moreover, as the District Court noted, “evidence of Cajun‘s new construction processes is plainly important to [Appellants] insofar as it is the only evidence (and argument) offered to establish the business component element of their QRTC claim.”
Second, this omission was highly prejudicial to the Government given the procedural posture of the case. The record reflects that Cajun‘s initial discovery responses described the business components for the Representative Projects as “products.” Appellants’ supplemental disclosures
Third, although the District Court acknowledged that reopening discovery would mitigate prejudice to the Government, the case was “more than three years old” and one month from trial. The District Court was entitled to weigh the value of reopening discovery against providing a timely resolution of the case.37
Finally, Appellants failed to explain their change in argument before the District Court and, before this Court, deny that any change occurred. In doing so, Appellants direct the Court to their “pretrial briefing” as evidence that Appellants’ position has remained consistent. However, the cited pretrial briefing is the Parties’ Joint Pretrial Order, which was filed over one month after the Government moved for summary judgment and three weeks after Appellants responded raising the construction process argument for the first time. Appellants have not directed the Court to any previous statements indicating that the claimed business components involved processes. This explanation is thus unpersuasive.
Given these facts, the District Court did not abuse its discretion in excluding Appellants’ arguments about construction processes. However, even if the District Court abused its discretion, the error was harmless because the court nonetheless evaluated the merits of Appellants’ claim. Ultimately, the District Court determined that Appellants put forth “vague” and “conclusory” statements regarding their construction processes without identifying “even one new or improved process that resulted from Cajun‘s work on the Representative Projects.”
The District Court did not abuse its discretion in excluding evidence of Cajun‘s construction processes. Alternatively, Appellants did not offer sufficient evidence to create a genuine dispute as to whether Cajun‘s рroducts or processes constituted business components. Without a viable business component, the Representative Projects are not eligible for the tax credit, and the Government is entitled to summary judgment as a matter of law.
C. Funding Exclusion
Qualified research excludes “funded” research projects.38 Funded research include “any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity).”39 To determine whether research was funded, courts must first evaluate “all agreements (not only research contracts) entered into between the taxpayer performing the research and other persons.”40 Research is funded if: (1) the researcher retains no substantial rights in its research;41 or (2)
The District Court determined that “the Methanex, Chevron, and Claiborne Projects each fail the ‘substantial rights’ prong of the ‘funded
research’ exclusion because in each instance Cajun transferred all rights to any new or improved ‘construction processes’ tо its contracting counterpart.” The Court found that the East Bank contract was funded because “SWBNO plainly paid Cajun for whatever alleged research Cajun may have performed.”
On appeal, Appellants dispute this finding and argue (1) that Cajun retained substantial rights in its research, and (2) that the Representative contracts were “contingent” upon delivery of a product and, as such, are not funded as defined by Treasury Regulation
1. Methanex, Chevron, and Claiborne Projects
Researchers cannot claim the tax credit if they retain no “substantial rights in research under the agreement providing for the research.”43 A researcher retains no “substantial rights” if the agreement or contract “confers on another person the exclusive right to exploit the results of the research.”44 Whether Cajun retained substantial rights to its research is determined by the contracts for each Representative Project.45
Even assuming Cajun satisfied the business components test, by the express tеrms of the Methanex, Chevron, and Claiborne contracts, Cajun gave up its rights to any research performed under the contracts. Pursuant to section 26 of the Methanex contract, Methanex retained “all rights, title and interest” in any “work product” prepared by Cajun. The provision applies to all “works made for hire” as well as any work “not considered a work
made for hire.” By contracting away “all right, title and interest” in its work product, Cajun gave up its rights to all “documents, data, analyses, reports, plans, procedures, manuals, drawings, specifications, calculations, or other technical tangible manifestations of [Cajun]‘s efforts (whether written or electronic)” created while performing the contract, as well as “any or all tracings, designs, drawings, field notes, requisitions, purchase orders, specifications, electronic information . . . and other documents or records developed or acquired by [Cajun] and its suрpliers or sub-subcontractors in performing the Work.”
Similarly, Cajun assigned to Chevron “all rights” to any “drawings, documents, engineering and other data prepared or furnished by [Cajun]” under the Chevron contract. These items became “[Chevron‘s] property from the time of preparation and may be used by [Chevron] for any purpose whatsoever without obligation or liability whatsoever to [Cajun].” Furthermore, the contract also states that Chevron owns all “inventions, discoveries and improvements (patentable and unpatentable) that are made or conceived by [Cajun] or [Cajun‘s] employees” during the Project. Cajun was permitted to use this
Finally, by incorporating various provisions of the Federаl Acquisition Regulations, the Claiborne contract provides that “all material and work covered by progress payments made shall, at the time of payment, become the sole property of the Government.”46 “Work” is defined broadly and includes
“construction activity,” “buildings, structures, and improvements of all types.”
Ultimately, “it is hard to see what rights—much less what substantial rights” Cajun retained in its undefined research.47 After assigning away all rights to work developed during each Representative Project, Cajun retained no substantial rights in its research.48
2. East Bank Project
Treasury Regulation
Appellants offer three reasons why the East Bank Project was not funded. First, Appellants rely on
More to the point,
Industries were not contingent upon whether Cajun Industries conducted research activities.” Consequently, this argument lacks merit.
Furthermore, Appellants are not entitled to the research credit merely because SWBNO could not claim the credit. The Regulations do not require that a tax credit be allocated in every contract.51
Third, Appellants assert the East Bank Project was not funded because it was a fixed price contract аnd “inherently risky.” This argument stands on more solid ground and finds some support in a line of cases including Fairchild Industries, Inc. v. United States and Geosyntec Consultants, Inc. v. United States.52 Fairchild explained that sections
However, Fairchild and Geosyntec do not stand for the proposition that all fixed price contracts are per se not funded. Indeed, Geosyntec found that the fixed price contract at issue was funded.54 Furthermore, even if this Court
agreed that the Regulations allocate the tax credit to the party bearing the risk of unsuccessful research, Cajun was compensated for all risks associated with the East Bank Project. According to the express terms of the contract, Cajun accepted payment “as full compensation for all loss, damagеs or risks of every description, connected with or resulting from the nature of the work, or from any obstructions or difficulties encountered, of any sort or nature whatsoever . . . .”
IV.
Based upon the record before the District Court and arguments made on appeal, the Court finds that the Representative Projects yielded no viable business components and were funded. Appellants are ineligible for the research tax credit provided by
Notes
(d) Qualified research defined.--For purposes of this section--
(1) In general.--The term “qualified research” means research--
(A) with respect to which expenditures may be treated as specified research or experimental expenditures under section 174,
(B) which is undertaken for the purpose of discovering information--
(i) which is technological in nature, and
(ii) the application of which is intended to be useful in the development of a new or improved business component of the taxpayer, and
(C) substantially all of the activities of which constitute elements of a process of experimеntation for a purpose described in paragraph (3).
Such term does not include any activity described in paragraph (4).
[A]ny and all information, data and knowledge which is either made available to [Cajun] by [Chevron] relating to the performance of the Work, or developed by [Cajun] as a consequence or arising out of this Contract. Technical Information includes all inventions, discoveries or improvements (patentable or otherwise) that are made or conceived with by [Cajun] in performing the Work and all patent rights associated these inventions, discoveries or improvements.