Bayer Corp. et al. v. United States

September 20, 2012 | William L. Standish | Western District of Pennsylvania | Civil Action No. 09-351

 

Short Summary

Bayer Corporation and its subsidiaries filed a lawsuit against the United States seeking a refund of federal income taxes. The dispute centered on the IRS’s complete or partial denial of research tax credits (for Qualified Research Expenses or QREs) that Bayer claimed for tax years 1990–2006. Bayer argued that it was entitled to credits for a large number of research projects carried out at many different sites, while the IRS challenged the way Bayer substantiated its claims and tracked its expenses. The case ultimately addressed whether Bayer had provided sufficient detail and documentation for its R&D tax credit claims and whether Bayer could use statistical sampling to prove its entitlement to credits. The court denied Bayer’s request to rely on statistical sampling but allowed the case to proceed based on the detailed documentation and cost center data Bayer had already submitted. 

Key Issues

• Did Bayer’s documentation and accounting method meet the requirements for claiming the R&D tax credit? 

  Bayer tracked its research expenses using a “cost center” system, which means expenses were grouped based on the type of activity rather than being assigned to a specific product or business project. The IRS wanted Bayer to show exactly which expenses related to each “business component” (like a particular product or invention), as required by law. The court had to decide whether Bayer’s broader cost center tracking, combined with detailed explanations and supporting documents, was enough to claim the R&D tax credit or if the law required more precise project-by-project tracking. 

• Could Bayer use statistical sampling to prove its R&D tax credit claims? 

  Given the enormous volume of Bayer’s research activities, spanning millions of expenses and thousands of employees, Bayer argued it was not practical to document every single qualifying expense in detail. Instead, Bayer proposed using a statistical sample: examining a random selection of projects or cost centers in detail and then using those results to estimate the total credit across all projects. The court had to determine whether this approach would satisfy tax law and whether Bayer could rely on sampling to meet its legal burden of proof. 

• Was Bayer required to connect every expense to a specific business component for every year? 

  The IRS insisted that, for each year and for every dollar claimed, Bayer must identify exactly which business component (product, process, or software) each expense related to. Bayer, however, did not keep its records in this way and argued that its alternative methods (such as interviews, supporting documents, and expert studies) provided a reasonable way to connect expenses to business components. The court needed to decide if Bayer’s methods were acceptable, or if a strict, detailed mapping to each business component was required. 

• Did Bayer’s court claim “substantially vary” from what it told the IRS in its original refund request? 

  A long-standing tax rule says that taxpayers cannot base a refund lawsuit on facts or legal arguments that are very different from those presented in the original claim to the IRS. The government argued that Bayer’s lawsuit relied on new details or different methods, which they claimed was a “substantial variance” from the original IRS filings. The court had to decide whether Bayer’s claim in court truly changed the core of what it asked for from the IRS, or whether it was simply adding more evidence and clarification without shifting the main basis of its claim. 

Primary Holding

The court ultimately decided that Bayer could continue its lawsuit seeking a refund for denied R&D tax credits. The court rejected the government’s argument that Bayer’s claims in court were too different from what it originally told the IRS (“substantial variance”). The judge found that Bayer had consistently based its claim on the R&D tax credit and had provided enough information in its original filings and during the IRS audit to put the government on notice about the nature of the claim. The court also decided that Bayer’s method of documenting expenses by cost center, rather than by individual business component, did not automatically disqualify its refund claim at this stage.  

However, the court did not grant Bayer’s request to use statistical sampling as the primary way to prove its entitlement to the credits. The judge held that Bayer could not avoid the legal requirement to maintain detailed and usable records simply because collecting more evidence would be time-consuming or expensive. Instead, Bayer needed to continue working to connect its claimed research expenses to specific business components as much as possible. 

In short, the court’s main reasoning was that Bayer provided enough information for its lawsuit to proceed, but it still has the burden to show (using detailed documentation) how its research expenses qualify for the R&D tax credit. The court emphasized that practical difficulties in recordkeeping do not excuse the taxpayer from meeting these legal requirements. 

Specific Rulings

1. Whether Bayer’s court claim “substantially varied” from its original refund request to the IRS: 

   • Ruling: The court decided that Bayer’s lawsuit did not “substantially vary” from its original IRS claim.
   • Reasoning: The court explained that Bayer’s claim for the R&D tax credit was always based on the same core facts, even if Bayer provided more detail and evidence during the lawsuit. The court said the law does not require a taxpayer to include every piece of supporting evidence or documentation in the original IRS filing. What matters is that the IRS had enough information to understand the basis for the claim and could audit it. Since Bayer’s filings and audit responses gave the IRS detailed information about its research activities, costs, and the way its expenses were tracked, the court found no substantial change in the core claim. 
     
     

2. Whether Bayer’s cost center accounting system disqualified its R&D tax credit claims: 

   • Ruling: The court decided that using a cost center system (grouping expenses by activity type, not by project) did not automatically disqualify Bayer’s refund claim.
   • Reasoning: The court recognized that Bayer did not track research costs by individual business component, as the IRS ideally wanted. However, there is no law or regulation that specifically requires this exact tracking method. As long as Bayer could ultimately show which expenses related to qualified research and tie them, at least with reasonable clarity, to business components, the claim could proceed. The court pointed out that cost center tracking, supported by other documentation and explanations, could meet the requirements, but Bayer would still need to provide sufficient detail in the end.
     
     

3. Whether Bayer could use statistical sampling as its main proof for R&D tax credits: 

   • Ruling: The court denied Bayer’s request to use statistical sampling as the primary method for proving its entitlement to the tax credits.
   • Reasoning: While the court agreed that statistical sampling can be useful in some situations, it found that Bayer could not use sampling to avoid its responsibility to keep and present detailed, usable records as required by law. The court said that allowing Bayer to rely mainly on sampling would effectively let the company off the hook for poor recordkeeping. The judge also noted that, in similar tax cases, sampling has only been allowed with government agreement or when there is no other practical way to estimate, which was not the situation here. 

Helpful Takeaways for Taxpayers 

• Keep Detailed and Usable Records: 

  Even if your business is large and complex, it’s crucial to maintain clear and organized records that connect research expenses to specific projects or business components. Good recordkeeping is essential for supporting R&D tax credit claims and can save significant time and expense in the event of an audit or legal dispute. 

• Be Consistent in Claims to the IRS: 

  When filing for the R&D tax credit, make sure the information and basis for your claim are clear and consistent from the start. While you can add supporting evidence later, your core arguments and facts should stay the same. This helps prevent disputes about whether your lawsuit or audit response “substantially varies” from what you originally filed. 

• Understand the Limits of Statistical Sampling: 

  Statistical sampling can be a useful tool for managing large volumes of data, but it cannot replace the fundamental requirement to keep proper documentation. Taxpayers should not expect to rely on sampling alone to prove their eligibility for credits unless the IRS specifically agrees to it. 

• Don’t Assume Flexibility in IRS Documentation Requirements: 

  The IRS and the courts expect businesses to follow the rules for substantiating R&D tax credits, regardless of a company’s size or accounting systems. Being proactive about recordkeeping and documentation is the best way to avoid issues down the road. 

• Work Collaboratively with the IRS During Audits: 

  Providing timely, clear, and comprehensive responses to IRS audit requests can help show good faith and may make it easier to resolve disputes. Open communication and transparency can reduce the chances of a prolonged legal battle.