BDO: Tax Court Concludes Taxpayer Lacks Substantial Rights to Claim R&D Credit

January 1, 1970


On January 11, 2021, the U.S. Tax Court ruled in favor of the IRS in Tangel v. Commissioner, determining that the terms and conditions negotiated by the petitioners to develop and build turbines left the petitioners with no substantial rights as required to claim research tax credits under Section 41 of the Internal Revenue Code.


The case centers around research tax credits claimed by Enercon Engineering, Inc. (Enercon) for a project that it undertook for Vericor Power Systems, LLC (Vericor) during the period 2008-2010. Enercon is an S corporation that designs and produces integrated controls and switchgears for custom applications in the power generation industry. The IRS filed a motion for partial summary judgment with respect to the expenses that Enercon incurred while providing services to Vericor and for which Enercon claimed research tax credits. Specifically, the IRS contended that the research expenses were funded, and thus were not eligible for research tax credits because, in its view, Enercon retained no substantial rights under the negotiated terms and conditions to the research Enercon performed.

With regard to the research rights at issue, Enercon and Vericor negotiated a detailed set of contract terms (of which Vericor was the primary drafter). The principal relevant provision was in Paragraph 15, which addressed the ownership of designs, drawings and data. Paragraph 15 explicitly restricted Enercon’s use or disclosure of technical information, except in the case of the performance of work for Vericor. Specifically, the term “information” included “any technical information that (i) Vericor has supplied to Enercon; (ii) Enercon has designed at Vericor’s expense; or (iii) Enercon has designed specifically to meet Vericor’s technical requirements.” The research rights as defined in the contract were expansive and included not only Enercon’s right to Vericor’s technical information, but also to the tooling created by Enercon to develop or sell the product or similar items.

Significantly, Paragraph 15 contained a broad prohibition against Enercon using the research for any purpose outside of the project without Vericor’s prior written consent: “[Enercon] shall not use such or disclose such Information except in the performance of work for Vericor.” The Tax Court also evaluated language used in another part of Paragraph 15, under which the copyrightable materials prepared by Enercon constituted “works made for hire” within the meaning of the U.S. copyright laws and Vericor was deemed the author of such works.

The petitioners argued that Paragraph 15 was a standard non-disclosure agreement to prevent Enercon from disseminating technical information and specifications that Vericor provided to enable the execution of the contract, and that Enercon retained the right to use institutional knowledge gathered during the project for future use. First, the court determined that such a reading would overlook the totality and context of the rights that were assigned to Vericor. Second, the court disagreed with the petitioner’s argument that Enercon retained the right to use institutional knowledge gathered as part of its research efforts. Under the contractual agreement, Enercon was required to obtain permission to use the results of the research for any purpose outside of the project and there were no conditions that limited Vericor’s ability to withhold consent. According to the court, this factor prevented Enercon from having substantial rights to the research; instead, the court concluded that any institutional knowledge gain by Enercon from the research could be characterized as an incidental benefit, which does not constitute a substantial right.


The Tax Court’s decision should not come as a surprise to tax professionals, as it is well-established that a taxpayer is entitled to research tax credits under Section 41 only if the taxpayer “retains substantial rights in the research.” The decision reinforces the importance of the contractual language used in a research agreement with regard to determining which parties to the arrangement are eligible to claim research tax credits for the performance of research services. Although the petitioners argued that rights that were not specifically articulated in the agreement, such as institutional knowledge, should be “read-in” and considered a “substantial right,” the court ruled that such a right in this case is more properly characterized as an “incidental benefit to the taxpayer” and thus does not meet the substantial rights requirement. Taxpayers should carefully consider the rights that are explicitly granted in any contractual arrangement related to the performance of research services before deciding whether to claim research tax credits for such services.


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