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Fifth Circuit Affirms Denial of Construction Contractor's Claims for Research Credits

(Parker Tax Publishing December 2023)

The Fifth Circuit affirmed a district court and held that a construction contractor could not claim the Code Sec. 41 research credit because it did not perform qualified research when completing four representative projects. The Fifth Circuit upheld the district court's conclusion that the oil refineries and flood control systems developed by the taxpayer did not satisfy the business components test under Code Sec. 41(d)(1)(B) and further found that the representative projects were funded research for which no credit is allowed under Code Sec. 41(d)(4)(H) and Reg. Sec. 1.41-4A(d). U.S. v. Grigsby, 2023 PTC 301 (11th Cir. 2023).


Cajun Industries LLC (Cajun) provides construction services throughout the Gulf Coast region. In 2015, Cajun hired a consulting firm to evaluate its projects and advise whether Cajun was eligible for research credits under Code Sec. 41. Based on the firm's report, Cajun, believing it was entitled to a $1,341,420 research credit, filed an amended Form 1120S for the 2013 tax year claiming the $1,341,420 credit.

As an S corporation, Cajun's income, losses, deductions, and credits pass through to its shareholders for income tax purposes. Leonard Grigsby owned a 73 percent interest in Cajun and was thus entitled to a pro rata allocation of Cajun's tax credit. The credit reduced Mr. and Mrs. Grigsby's tax liability for 2013, resulting in an overpayment for which the Grigsbys sought a refund by filing an amended return. In 2017, the IRS issued the refund. However, in 2019, the IRS notified the Grigsbys that the refund was issued erroneously and challenged Cajun's claimed credit. The government eventually brought a lawsuit in a district court to recover the erroneous refund.

Before the district court, the Grigsbys and the government agreed that four projects (Representative Projects) adequately represented Cajun's research activities: (1) the Methanex Project, which involved the relocation of a methanol plant from Chile to Louisiana; (2) the Chevron Project, where Cajun provided construction services to expand a refinery; (3) the Claiborne Project, in which Cajun contracted with the U.S. Army Corps of Engineers to construct an underground canal as part of a flood control project; and (4) the East Bank Project, in which the Sewerage and Water Board of New Orleans (SWBNO) awarded Cajun a construction contract to modify a flood protection system at a wastewater treatment plant. Thus, Cajun's eligibility for the tax credit hinged on whether it performed qualified research while completing these projects.

In a motion for summary judgment, the government argued that these products failed the "business components" test in Code Sec. 41(d)(1)(B) and, as such, that Cajun did not perform qualified research. Furthermore, the government claimed the Representative Projects were otherwise ineligible because they were "funded" under Code Sec. 41(d)(4)(H) and Reg. Sec. 1.41-4A(d). The district court granted the government's motion for summary judgment.

Research must satisfy the so-called "business components" test in Code Sec. 41(d))(1)(B) in order to qualify for the tax credit. 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." The test is applied separately to each business component, 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." Under Code Sec. 41(d)(4)(H), qualified research excludes "funded" research projects, which is defined as "any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity)." Reg. Sec. 1.41-3A(d)(1) provides that research is funded if: (1) the researcher retains no substantial rights in its research; or (2) payment is not contingent upon the research's success.

The district court found that the Grigsbys failed to establish that Cajun's work on the Representative Projects resulted in new "products" and therefore, the projects did not establish a business component. Alternatively, 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.

The Grigsbys appealed to the Fifth Circuit. They argued that they presented sufficient evidence that Cajun developed four business component products: two oil refineries and two flood control systems. The Grigsbys also contended that the Representative Projects were not funded. They asserted that the Cajun retained substantial rights in its research performed under the Methanex, Chevron, and Claiborne contracts. In addition, the Grigsbys offered three reasons why the East Bank Project was not funded. First, they relied on language in Reg. Sec. 1.41-4A(d) and Reg. Sec. 1.41-2(e) to argue the project was not funded because payment was contingent upon Cajun delivering a "result or product," the refineries and flood systems. Second, they maintained they were entitled to the credit simply because SWBNO, the payor on the East Bank Project, was not. Finally, the Grigsbys argued that the project was not funded because it was "inherently risky."


The Fifth Circuit affirmed the district court after finding that the Representative Projects yielded no viable business components. The court found that the Grigsbys' evidence primarily described Cajun's "means and methods," i.e., their processes, and not the products. The court said that, while the Grigsbys may be correct that their construction processes led to the final product, the Code required the court to evaluate each business component separately. Accordingly, the court held that the Grigsbys failed to create a genuine dispute as to whether the four products constituted business components.

The court further found that, even assuming Cajun satisfied the business components test, the Methanex, Chevron, and Claiborne contracts were funded because by their express terms Cajun gave up its rights to any research performed under the contracts. Reviewing the language of the contracts, the court agreed with the district court that it was hard to see what rights - much less what substantial rights - Cajun retained in its undefined research. The court concluded that, after signing away all rights to work developed during each Representative Project, Cajun retained no substantial rights in its research.

The court also rejected the Grigsbys' arguments in support of their assertion that the East Bank Project was not funded. The court said that the Grigsbys' argument that all contracts "for the product or result" of the research are not funded improperly conflated "amounts payable under any agreement that are contingent on the success of the research" in Reg. Sec. 1.41-2(e)(2) with contracts for products or services. The court found that this argument ignored the operative portion of the sentence: "amounts payable under any agreement that are contingent on the success of the research." According to the court, the phrase "and thus considered to be paid for the product or result of the research" merely describes or modifies "amounts payable ... contingent on the success of the research." It does not, as the Grigsbys urged, stand on its own to establish an additional type of contract "not treated as funding." Further, the court found that Reg. Sec. 1.41-3A(d)(1) only concerns agreements contingent upon the success of research, while the East Bank contract was not contingent on the success of the research. The court also rejected the argument that the Grigsbys were entitled to the credit merely because SWBNO could not claim the credit. The court reasoned that the regulations do not require that a tax credit be allocated in every contract.

The court found that the Grigsbys' argument that the East Bank Project was not funded because it was a fixed price contract and "inherently risky" stood on more solid ground and found some support in a line of cases including Fairchild Industries, Inc. v. U.S., 71 F.3d 868 (Fed. Cir. 1996), and Geosyntec Consultants, Inc. v. U.S., 2015 PTC 31 (11th Cir. 2015). Fairchild explained that Reg. Secs. 1.41-2 and 1.41-4A "implement allocation of the tax credit to the person that bears the financial risk of failure of the research to produce the desired product or result." Because fixed price contracts may not fully compensate researchers if their research is unsuccessful, the researcher bears the financial risk of failure, and fixed price contracts are more likely to be deemed unfunded. However, the Fifth Circuit found that Fairchild and Geosyntec do not stand for the proposition that all fixed price contracts are per se not funded. The court added that even if 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 under the express terms of the contract.

The court also found that the East Bank Project was funded for the simple reason that Cajun was compensated for all expenditures incurred and claimed when it sought the tax credit. According to Cajun's Form 6765, Credit for Increasing Research Activities, Cajun claimed the research credit entirely for "wages" incurred in pursuit of qualified services. However, the court found that Cajun was compensated under the East Bank contract for "all general foremen, foremen, labor, [and] teams" as well as Cajun's "superintendence, general expense and profit." Cajun accepted this payment as "full compensation for furnishing all the labor, materials, tools, equipment, etc., needed to complete the whole work of the contract." Therefore, the court concluded that Cajun was fully compensated for all wages and labor, making these expenditures funded under any plain meaning of the term.

For a discussion of the credit for qualified research expenses, see Parker Tax ¶104,905.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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