Appealed from: U.S. Court of Federal Claims. Judge Lydon.
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,*fn1 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, § 221(a), 95 Stat. 172, 241.*fn2 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. § 44F(a); 26 U.S.C. § 44F(a). Section 44F(d) defines "qualified research":
QUALIFIED RESEARCH -- For purposes of this section the term "qualified research" has the same meaning as the term research or experimental has under section 174, except that such term shall not include --
(1) qualified research conducted outside the United States,
(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 § 44F(d)(3). However, Treasury Regulation § 1.41-5(d)(1), 26 C.F.R. § 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 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 ...