Fairchild Industries, Inc. v. U.S.
| Decision Date | 29 November 1995 |
| Docket Number | No. 94-5116,94-5116 |
| Citation | 71 F.3d 868 |
| Parties | -7707, 95-2 USTC P 50,633 FAIRCHILD INDUSTRIES, INCORPORATED, Plaintiff-Appellant, v. The UNITED STATES, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Federal Circuit |
Albert G. Lauber, Jr., Caplin & Drysdale, Chartered, Washington, D.C., argued for plaintiff-appellant. With him on the brief were Ralph A. Muoio and Julie W. Davis.
Steven I. Frahm, Attorney, Department of Justice, Washington, D.C., argued for defendant-appellee. With him on the brief were Loretta C. Argrett, Assistant Attorney General, Gary R. Allen and Jonathan S. Cohen, Attorneys.
Alexander Zakupowsky, Jr. and Alan I. Horowitz, Miller & Chevalier, Chartered, Washington, D.C., were on the brief for the Amicus Curiae, Aerospace Industries Association of America, Inc.
Before RICH, NEWMAN, and SCHALL, Circuit Judges.
This case requires interpretation of the statute governing research tax credits under section 44F of the Internal Revenue Code of 1954, as applied to certain of the research costs incurred by Fairchild Industries, Inc. in a fixed-price incentive contract with the government. On Fairchild's appeal of the decision of the United States Court of Federal Claims, 1 we conclude that the court erred in its interpretation of the statute and regulations.
The research tax credit was established by the Economic Recovery Tax Act of 1981, Pub.L. No. 97-34, Sec. 221(a), 95 Stat. 172, 241. 2 Section 44F provides a tax credit of 25% of increased research expenditures compared with a baseline measured by the previous three years' research expenditures:
GENERAL RULE--There shall be allowed as a credit against the tax imposed by this chapter for the taxable year an amount equal to 25 percent of the excess (if any) of--
(1) the qualified research expenses for the taxable year, over
(2) the base period research expenses.
I.R.C. Sec. 44F(a); 26 U.S.C. Sec. 44F(a). Section 44F(d) defines "qualified research":
(2) qualified research in the social sciences or humanities, and
(3) qualified research to the extent funded by any grant, contract, or otherwise by another person (or any governmental entity).
The tax code does not define "funded" as the term is used in Sec. 44F(d)(3). However, Treasury Regulation Sec. 1.41-5(d)(1), 26 C.F.R. Sec. 1.41-5(d)(1), sets the criterion for "funded" on which this case turns, viz. whether payment for the research is "contingent on [its] success":
In general. Research does not constitute qualified research to the extent it is funded by any grant, contract, or otherwise by The regulations contain "mirror image" rules for determining when the customer for the research, rather than the researcher, is entitled to claim the tax credit. In accordance with Treasury Regulation Sec. 1.41-2(e)(2) the contractual arrangement is the factor that determines who is entitled to the tax benefit, for the customer may claim the credit only if the agreement requires the customer to pay for the research even if it is unsuccessful. If, however, the customer need not pay unless the research is successful, the customer has "paid for the product or result rather than the performance of the research" and can not claim the tax credit because it has assumed no risk. Id. Thus, the regulations 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.
another person (including any governmental entity). All agreements (not only research contracts) entered into between the taxpayer performing the research and other persons shall be considered in determining the extent to which the research is funded. Amounts payable under any agreement that are contingent on the success of the research and thus considered to be paid for the product or result of the research (see Sec. 1.41-2(e)(2)) are not treated as funding.
Congress intended that the research tax credit would provide an incentive to American industry to invest in research. The overarching purpose was to "reverse [the] decline in research spending by industry" and to induce companies "to bear the significant costs ... which must be incurred to initiate or expand research programs in a trade or business." Staff of Jt.Comm. on Taxation, 97th Cong., 1st Sess., General Explanation of the Economic Recovery Tax Act of 1981 120-21 (Jt.Comm.Print 1981). The House Report further explained that:
The committee believes that a substantial tax credit for incremental research and experimental expenditures will overcome the resistance of many businesses to bear the significant costs of staffing, supplies, and certain computer charges which must be incurred in initiating or expanding research programs.
H.R.Rep. No. 201, 97th Cong., 1st Sess. 111 (1981).
The legislative evolution of I.R.C. Sec. 44F records the care with which this provision was written, from an initial bill that exempted all research "performed for another person," to the later bill that as amended and enacted contained the "funded" qualification. The Joint Committee Print recognized the substantive change whereby the bill as enacted denied the credit only when research was "funded" by another, whether or not it was performed for another. Moreover, the implementing regulations explicitly state that the credit is available even when another entity pays for the research, provided that the payment is contingent on the success of the research. Treas.Reg. Sec. 1.41-5(d)(1).
The issue is the application of I.R.C. Sec. 44F and implementing regulations to Fairchild's contract with the Air Force.
In July 1982 Fairchild and the Air Force entered into a fixed-price incentive contract 3 whereby Fairchild would design and produce the T-46A aircraft, a "next generation trainer" (NGT) intended for use in training new pilots. The T-46A contract included a full-scale development (FSD) phase and a production phase. In the FSD phase Fairchild was to develop and deliver two prototype aircraft and all necessary support systems. In the production phase, Fairchild was to produce and deliver a target quantity of fifteen additional aircraft. The tax credits at issue relate solely to the FSD phase.
The contract contained over 1,000 pages of technical specifications that required Fairchild to meet specific design, construction, quality, and performance standards. Fairchild Total System Responsibility is the responsibility for the installation and integration of the NGT system elements, i.e., its systems, subsystems, components, support equipment, and software/data; including the responsibility for undertaking any and all actions necessary to assure that the total system will meet all requirements as defined in the system specification, 210S100001 dated 21 Apr 82, the Air Vehicle Prime Item Development Specification, 210S310001 dated 21 Apr 82 and the Support Equipment General Specification, 210S1200001 dated 21 Apr 82, all as identified in Section J of this contract. The contractor hereby accepts Total System Responsibility for the NGT System, whether or not its elements are fabricated, manufactured, or assembled by the Prime Contractor, Subcontractor, Vendor/Supplier, or furnished as GFP.
was to bear "total system responsibility" for the installation and integration of all T-46A aircraft elements, described in the contract as follows:
The T-46A aircraft contract provided that the Air Force was obligated to pay for the research only if Fairchild produced results that met the contract specifications, in accordance with certain provisions of the Defense Acquisition Regulations (DAR). Fairchild was entitled to payment only for work product delivered and accepted. DAR 7-302.2 (1976). The contract contained quality assurance procedures whereby the Air Force would evaluate Fairchild's work. If the work was deemed unacceptable, the Air Force could either (1) reject the work, (2) require Fairchild to correct the work at its own expense, or (3) accept the work subject to an equitable price reduction. DAR 7-302.4 (1976). The contract provided that the Air Force could terminate the contract either for default or for the convenience of the government. DAR 7-302.9(a) (1976) (termination for default); DAR 7-103.21(b) (1976) (termination for convenience).
The financing provisions of the contract provided that, if Fairchild was making satisfactory progress, the Air Force would pay bimonthly refundable advances, termed "progress payments," calculated as a percentage of the expenditures Fairchild actually incurred. DAR 7-104.35(a) (1981). Fairchild had no right to retain the progress payments unless the contract line items to which they applied were delivered and accepted. DAR 7-104.35(a), (b) (1981). After formal acceptance of a specific contract line item the progress payment was "liquidated" by crediting it against the total fixed price. In the event the Air Force terminated the contract for default, the contract provided that all unliquidated progress payments were repayable to the Air Force. DAR 7-104.35(h) (1981).
The amended total ceiling price for the FSD phase was $133,485,885. The work was subdivided into eleven contract line items that were separately priced. During 1982-86 Fairchild spent $216,056,000 for the FSD phase of the T-46A contract. By the time Congress cancelled the T-46A program in late 1986, the Air Force had paid Fairchild $53.0 million for successfully completed work and another $60.8 million in progress payments that remained unliquidated. Fairchild and the Air Force agreed to termination for convenience terms. An Air...
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