Dynetics, Inc. v. United States

| May 31, 2015 | Campbell-Smith, Chief Judge, United States Court of Federal Claims | Docket No. 12-576T

Short Summary 

Dynetics, Inc., an engineering company based in Alabama, filed a lawsuit against the United States after the IRS denied its claim for research tax credits. The main dispute centered on whether Dynetics’ research activities under certain government and private contracts qualified for the R&D tax credit, specifically questioning if the work was “funded” by others or if Dynetics kept substantial rights to the results. The court found that the contracts in question were considered “funded” under tax law, and that in some cases Dynetics did not retain substantial rights in the research. As a result, Dynetics was not entitled to the research tax credits it claimed. 

Key Issues 

• Was the research performed by Dynetics considered “funded” by another party? 

  The court needed to decide if the payments Dynetics received under its contracts were “contingent on the success of the research” or if Dynetics was paid regardless of results. If the research was “funded” under tax law, Dynetics could not claim the R&D tax credit for those expenses. 

• Did Dynetics retain “substantial rights” in the results of its research? 

  Another key question was whether Dynetics kept meaningful rights to use or benefit from the research outcomes, or if all rights were given to the government or other contracting parties. If Dynetics did not keep substantial rights, the work would not qualify for the R&D tax credit. 

Primary Holding 

The court decided that Dynetics was not entitled to the research tax credits it claimed. The main reason was that the research work Dynetics performed under its sample contracts was considered “funded” by government agencies or other parties, meaning Dynetics would be paid whether the research was successful. Because of this, Dynetics did not meet the tax law requirement that only truly “at-risk” research can qualify for the R&D credit. In addition, for some contracts, the court found that Dynetics did not keep substantial rights to use or benefit from the research results, which is another requirement for the credit. As a result, the court ruled in favor of the government and denied Dynetics’ claims for the credits. 

Specific Rulings 

1. Was Dynetics’ research “funded” by others? 

   • Ruling: The court determined that Dynetics’ research projects were “funded” by the government agencies and private companies who paid for the work, so the costs did not qualify for the research tax credit.
   • Reasoning: The court reviewed the contracts and found that Dynetics was paid for its time and effort no matter how the research turned out. In other words, even if Dynetics didn’t produce successful results, it still received payment. Because the law only allows the R&D credit when a company is financially “at risk” for the research, the court found that these projects didn’t meet that requirement. Simply put, if a business gets paid regardless of the outcome, it isn’t risking its own money, so it can’t claim the credit.
     
     

2. Did Dynetics keep “substantial rights” in the research results?

   • Ruling: The court found that, for certain contracts, Dynetics did not keep important rights to use or benefit from the research it performed.
   • Reasoning: In reviewing the agreements, the court saw that some contracts transferred all intellectual property rights, like patents or copyrights, to the government, or had strict security rules that meant Dynetics couldn’t freely use the results of its research. The tax law requires a company to keep some real control or rights over what it develops to claim the credit. Since Dynetics gave up these rights in certain cases, those projects didn’t qualify.
     
     

3. Did past business practices (“course of dealing”) change how the contracts should be interpreted? 

   • Ruling: The court rejected Dynetics’ argument that its long-standing business relationships and habits with its clients made the contracts less “funded.”
   • Reasoning: The court explained that what matters for tax purposes is what’s written in the contract, not unwritten understandings or traditions. Even if Dynetics typically took extra steps or continued working at its own expense to keep clients happy, this didn’t legally change the fact that the contracts guaranteed payment regardless of results. So, these informal practices did not affect the tax credit analysis.

Helpful Takeaways for Taxpayers 

• Carefully review contract terms when claiming the R&D tax credit. 

  Before you assume your research expenses qualify for the R&D credit, take a close look at your contracts. The IRS and the courts will focus on whether your company is taking on financial risk; meaning, you only get paid if you deliver successful results. If the contract guarantees you’ll be paid regardless of the outcome, those costs probably don’t qualify for the credit. So, it’s important to make sure your contracts reflect this “at-risk” requirement if you want to claim the credit. 

• Retain substantial rights to your research results. 

  To qualify for the R&D tax credit, your business must keep important rights to use, license, or benefit from the research you’re performing. If you sign away all those rights, like patents, copyrights, or the ability to use the results in your own business, to your client or to the government, the IRS will likely deny your claim. It’s important to ensure your agreements allow your company to keep some meaningful benefit or control over the research outcomes. 

• Written contracts matter more than informal business practices. 

  Even if you’ve had a long, trusting relationship with a client or often “go the extra mile” to deliver good results, what really counts is what’s written in the contract. Courts and the IRS won’t consider handshake deals, emails, or a history of helpfulness if the actual contract says you’re guaranteed payment. Always put important terms and understandings into the written agreement, rather than relying on unwritten habits or expectations. 

• Double-check intellectual property and confidentiality clauses. 

  Pay special attention to any sections of your contracts that address intellectual property or confidentiality. If your contract says that all inventions, patents, or research results belong to the client or must be kept confidential, you might lose the ability to claim the R&D credit on that project. Make sure you understand and negotiate these clauses, so you retain enough rights to benefit from your research. 

• Work with tax professionals when structuring research agreements. 

  Consulting a tax expert or advisor before you sign research contracts can make a big difference. They can help you design your agreements so that you meet the requirements for the R&D tax credit and avoid common pitfalls. This proactive step can save time, reduce risk in the event of an audit, and help you maximize your tax benefits.