Populous Holdings, Inc. v. Commissioner of Internal Revenue

Court hammer

December 6, 2019 | Joseph Robert Goeke, United States Tax Court Judge | Docket No. 405-17

Short Summary

In a pivotal decision by the United States Tax Court, Populous Holdings, Inc. contended with the IRS over the eligibility of claimed research credits for the years 2010 and 2011. The case revolved around whether the research expenses incurred by Populous Holdings were for “funded research,” which would disqualify them from tax credits under section 41 of the Internal Revenue Code. The Court evaluated the nature of payments and rights retained in five specific contracts to determine if the expenses qualified as unfunded and therefore eligible for the credit.

Key Issues

The central issues in this case were:

  1. Contingency of Payment: Whether the payments under the contracts were contingent upon the success of the research, which is a requirement for the research expenses to qualify as unfunded.
  2. Substantial Rights: Whether Populous Holdings retained substantial rights to the research outcomes, another requirement for the research to be considered unfunded under section 41.

The resolution of these issues hinged on the interpretation of contract terms and the nature of the contractual relationships between Populous Holdings and its clients.


The Tax Court ruled in favor of Populous Holdings, Inc., granting their motion for summary judgment. The Court found that:

  • The payments under all five representative contracts were contingent on the success of the research, thereby satisfying the first condition for the research to be considered unfunded.
  • Populous Holdings retained substantial rights to the research outcomes in all contracts, satisfying the second condition.

This decision allowed Populous Holdings to claim the research tax credits for 2010 and 2011, as the research expenses met the qualifications of being unfunded under the tax code.

Specific Issues/Rulings

1. Contingency of Payments

Ruling: The court ruled that payments under all five contracts reviewed were contingent on the success of the research. 


  • The court analyzed the nature of the contracts, which were predominantly fixed-price. Under such contracts, Populous Holdings would only receive full payment upon delivering the contracted results, thus bearing the financial risk if the research did not yield the desired outcomes.
  • The judge emphasized that fixed-price contracts inherently place maximum economic risk on contractors, who are responsible for all costs and resulting profit or loss. This risk of bearing additional costs if the research fails was a strong indicator of payment contingency.
  • The court also noted that none of the contracts required additional payment for unsuccessful research, supporting the conclusion that the research payments were indeed contingent on success.

2. Substantial Rights Retained

Ruling: The court determined that Populous Holdings retained substantial rights in the research conducted under all contracts. 


  • The court found that while the clients owned certain documents, Populous Holdings retained the right to use the knowledge and technology developed from the research without further payment to the clients. This ability to use the research outcomes freely in other aspects of their business constituted substantial rights.
  • The ruling underscored that retaining such rights does not require exclusivity. The substantial rights criterion is met if the contractor can utilize the research results in its operations or for other purposes without additional costs or significant restrictions from the clients.

3. Analysis of Specific Contractual Provisions

Ruling: The court concluded that specific contractual provisions cited by the IRS did not alter the unfunded nature of the research. 


  • The judge reviewed various contractual clauses related to payment procedures, quality and performance standards, termination clauses, and warranties. It was noted that these provisions did not make the client’s obligation to pay conditional upon acceptance of a final product, thus reinforcing the contingency of payments.
  • Furthermore, the court examined clauses regarding revisions and additional work at the expense of Populous Holdings. These clauses supported the notion that the company bore the risk of research failure, as it was required to remedy failed research at its own expense.
  • The court also highlighted that the contracts allowed for review and approval of work by clients but did not restrict Populous Holdings from using the researched technology or findings, confirming that substantial rights were retained.

Helpful Takeaways for Taxpayers

1. Careful Contract Drafting

  • Contingency Clauses: Ensure that contracts clearly specify that payment is contingent upon the success of the research. This establishes that the research is not funded by another entity, which is crucial for qualifying for R&D tax credits. The Populous case shows the importance of explicitly defining what constitutes “success” of the research in contractual terms.

2. Substantial Rights

  • Rights Retention: Contracts should allow the R&D performing party to retain substantial rights to the research results. This doesn’t necessarily mean exclusive rights but should at least include the ability to use the research for other projects or commercial purposes without additional fees or significant restrictions. The case underlines that retaining these rights is essential for the expenses to qualify as unfunded.

3. Risk Allocation

  • Financial Risk: Contracts should structure financial terms so that the R&D provider bears the financial risk if the research fails. This means absorbing the costs of unsuccessful research efforts. The court’s decision helps clarify that bearing such risks is a strong indicator that the research is unfunded.

4. Document and Record-Keeping

  • Thorough Documentation: Maintain detailed documentation not only of the contract terms but also of the research process, invoices, payments, and any correspondence related to the project’s success or failure. Such documentation will be invaluable in case of an IRS audit.

5. Understanding of Fixed Price Contracts

  • Use of Fixed Price Contracts: Recognize that fixed price contracts can be beneficial for R&D tax credit claims as they inherently involve risk assumption by the contractor. The case provides an example of how fixed price contracts, if properly drafted, are considered to place the economic risk on the contractor, favoring the claim for R&D tax credits.

6. Proactive Legal Review

  • Engage Tax Experts: Before finalizing any R&D-related contracts, consult with tax professionals or legal experts like TaxRobot who specialize in tax credits. Their expertise can help ensure that the contracts meet all the necessary criteria established by the IRS and highlighted in court cases like Populous.

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