Trinity Indus., Inc. v. United States

• Decision Date: 02 July 2014
• Docket Number: No. 12–11012.,12–11012.
• Citation: 757 F.3d 400
• Parties: TRINITY INDUSTRIES, INC., for Itself and on Behalf of Certain Subsidiaries, Plaintiff–Appellant, v. UNITED STATES of America, Defendant–Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

757 F.3d 400

TRINITY INDUSTRIES, INC., for Itself and on Behalf of Certain Subsidiaries, Plaintiff–Appellant,

v.UNITED STATES of America, Defendant–Appellee.

No. 12–11012.

United States Court of Appeals, Fifth Circuit.

July 2, 2014.

Thomas S. Leatherbury, Esq., Daniel L. Tobey, Esq., John C. Wander, Vinson & Elkins, L.L.P., Dallas, TX, Douglas Scott Draper, Esq., Heller, Draper, Hayden, Patrick & Hom, L.L.C., New Orleans, LA, George Matthew Gerachis, Vinson & Elkins, L.L.P., Houston, TX, for Plaintiff–Appellant.

Andrew M. Weiner, Richard Bradshaw Farber, Esq., Supervisory Attorney, U.S. Department of Justice, Washington, D.C., Michael D. Powell, U.S. Department of Justice, Dallas, TX, for Defendant–Appellee.

Appeal from the United States District Court for the Northern District of Texas.

Before OWEN, SOUTHWICK, and GRAVES, Circuit Judges.

PRISCILLA R. OWEN, Circuit Judge:

Trinity Industries, Inc. (Trinity) designed and built vessels during the taxable years ending March 1994 and March 1995 (the claim years). On its amended tax returns, Trinity claimed research tax credits under Internal Revenue Code (I.R.C.) § 41 based on several of these vessel projects. The I.R.S. denied these claims. Trinity then filed this tax refund action in federal court, seeking research tax credits based on the projects. After a two-phase bench trial, the district court held that the tax credit due Trinity was $135,787.60 for 1994 and $0 for 1995. Trinity now appeals, asserting that it is entitled to a tax credit of $1,808,832.53 for 1994 and $2,712,977.00 for 1995. We affirm in part and vacate and remand in part.

I

Trinity's amended tax returns for 1994 and 1995 claimed that it was entitled to a research tax credit because its claim year expenses in developing certain vessels constituted qualified research expenses (QREs). As discussed more fully below, I.R.C. § 41 generally provides a 20% credit for claim year QREs that exceed what the taxpayer spent on research in an earlier comparison period (the base amount).¹ The base amount, in turn, is a “fixed base percentage” multiplied by the company's average annual gross receipts for the four years preceding the claim year.² In calculatingits research tax credit, Trinity's amended tax returns reported a fixed base percentage (the ratio of base period QREs over base period gross receipts ³) of 1.3152% for the taxable year ending March 1994 and 1.3125% for the year ending March 1995. The tax returns themselves do not report the base period QREs or the base period gross receipts used to calculate the fixed base percentage. The I.R.S. denied these claims in a 2001 claim disallowance letter.

Trinity subsequently filed this tax refund action in federal court. Before trial began, Trinity retained James Bennett as an expert. Bennett submitted a report finding that the “consistency rule” under I.R.C. § 41(c)(6)—which requires that claim year QREs and base period QREs be computed on a consistent basis ⁴—was satisfied on Trinity's amended tax returns. Bennett noted only one caveat to this conclusion: the records available for the claim years were more complete than those available for the base period years, so he estimated certain costs for the base period. Based on documentation provided by Trinity, Bennett also provided specific calculations of the base period QREs, the base period gross receipts, and the fixed base percentage. Bennett calculated the overall base period QREs as $49,483,136. Dividing this base period QRE figure by the base period gross receipts ($3,851,683,536) yielded a fixed base percentage of 1.2847%, which was slightly lower than the fixed base percentages reported in the amended tax returns. Although Bennett based his calculations on the same records used to complete the amended tax returns, it is not clear why his fixed base percentage figure was slightly lower.

The district court conducted a two-phase bench trial. In Phase I, the court considered claimed tax credits for six vessel development projects. In its order following Phase I, the court decided that Trinity was wrongly denied credits for only two of the six projects it considered because these two projects (the Mark V and the Dirty Oil Barge) met all four requirements for constituting QREs.⁵ According to the court, the other four vessels (the XFPB, the T–AGS 60, the Crew Rescue Boat, and the Hurley Dredge) did not meet the fourth QRE requirement: that substantially all of the research activities in developing the project (i.e., 80% or more) were part of a process of experimentation.⁶

In reaching these conclusions, the court explained that the “shrinking-back rule” in the Treasury regulations ordinarily allows taxpayers to show that smaller subcomponents of a given project satisfy the process-of-experimentation test even if the entire project does not.⁷ For instance, if a whole vessel project does not satisfy the test, perhaps the development of the vessel's engine is sufficiently experimental. In this case, however, the court noted that “Trinity took an all or nothing approach” because it did not offer proof of its claim year expenses at the subcomponent level. Trinity was unable to offer evidence of its expenses at a more specific level partly because Hurricane Katrina destroyed many of its records. The court thus made its determination on the fourth QRE requirement based on whether, considering each of the six claim year projects as a whole, 80% of the costs incurred in the development of each project were part of a process of experimentation. It did not apply the shrinking-back rule in analyzing the claim year QREs.

In Phase II of the trial, two other vessel projects (the Queen of New Orleans and the Penn Tugs), as well as the method of calculating Trinity's base period QREs were at issue. With regard to its base period QRE calculation, Trinity called as a witness Phil Nuss, Trinity's former Vice President of Engineering. Nuss first confirmed that the ten vessels identified by Bennett in his report were the vessels used in computing the base period QREs on the amended tax returns. Trinity's counsel then asked Nuss whether he believed expenses related to those ten vessels should still be counted as QREs given the district court's Phase I order holding that certain claim year vessel expenses were not QREs. Nuss answered that expenses relating to four of the ten base period vessels should no longer be counted. According to Nuss, two of the base period vessels—the LSV and the North Carolina Auto Ferry—were similar to the Hurley Dredge, one of the claim year vessels held not to be qualified research in Phase I, since they all involved Trinity constructing a vessel based on a design provided to Trinity by a third party. In addition, Nuss believed that another base period vessel—the Cajun Queen—was like the Crew Rescue Boat, a claim year vessel held not to be qualified research in Phase I, since the Cajun Queen was also not a complicated technological boat to build. Finally, Nuss testified that a fourth base period vessel—the Ecuador—was like the XFPB, which the district court held was not qualified research in Phase I, since the Ecuador similarly had some experimental features but not enough to satisfy the QRE test. Nuss thus concluded that these four base period vessels should no longer be included in the base period QRE figure, though the other six base period vessels still should be. There was also similar testimony from Sam Charters, Trinity's former Chief Project Engineer, that the LSV was similar, in terms of the amount of experimentation involved, to the Hurley Dredge held not to constitute qualified research.

After Phase II of the trial concluded, the parties submitted briefing addressing whether the two vessel projects at issue constituted QREs, as well as the proper base period QRE figure under the consistency rule. Trinity made two distinct arguments about the consistency rule. Its first was that it had followed the consistency rule on its amended tax returns by calculating both its claim year QREs and its base period QREs using an all-or-nothing approach. In making this argument, Trinity acknowledged that it did not use the shrinking-back rule in computing its base period QREs on its returns:

On the Amended Returns, Trinity sought a tax credit for only certain vessels that could be considered prototypes. In presenting its claim, Trinity took an “all or nothing” approach— i.e., it did not seek shrink-back credit for any subcomponents of any vessels constructed in the Claim Years. To be consistent with this determination of Claim Year expenditures, Trinity included in the Base Period only expenditures for those vessels that it believed were sufficiently experimental such that the entire vessel constituted qualified research. Consistent with the manner in which it determined QREs for the Claim Years, Trinity did not shrink-back to subcomponents of any vessels in the Base Period.

In taking this position, Trinity was not asking the court to allow it to recalculate its base year QREs; it was simply defending how it originally calculated its base period QREs on its amended tax returns.

Trinity then made a second, distinct argument regarding the consistency rule. Relying primarily on the testimony of Nuss but also citing Charters's testimony, Trinity asserted it should be able to remove four vessels from its base period QREs as calculated on its amended tax returns, since those vessels were similar, in terms of how much experimentation was involved, to the four vessels held not to be claim year QREs in Phase I:

In Trinity I the Court articulated a different standard for “prototype” than Trinity applied on the Amended Return. The Court's holding defined the universe of QREs allowable in the Claim Years.... With respect to four of the projects claimed by Trinity, the Court found that the integration of subsystems did not rise to the level required for the cost of developing and constructing the...