The court entered another order in the CRA Holdings U.S., Inc. v. United States, No. 15-CV-239W(F) (W.D.N.Y. 2017) case. The order addressed a dispute over the appropriate sample to be used to evaluate the taxpayer’s research tax credit. We previously commented on this case here.
The current order focuses on the IRS’s strong-handed litigation tactic of moving for sanctions as it was not satisfied with the taxpayer’s responses. The court had previously ordered the taxpayer to provide information to the IRS to allow the parties to decide what size of a sample was appropriate.
The court noted that the IRS was not entitled to full information to evaluate whether the projects were qualified under Sec. 41. Rather, the IRS was only to be provided with information sufficient to help the IRS assess whether the sample size was appropriate. So the court denied the IRS’s request for sanctions as it concluded that the taxpayer had provided what it had in its files and providing more information would not help determine the sample size.
The order touches on one of the more difficult issues with the research tax credit, namely, at what granular level are taxpayers required to substantiate their activities and expenses? When qualifying thousands of projects a year, as in this case, is it reasonable to require the taxpayer to keep documentation of each project on a finite level and then, at the same time, push for a large sample size?
If the answer is in the affirmative, this would place a burden on taxpayers that would negate the very incentive effect the research tax credit is intended to have. It should be noted that it would also do this for the taxpayers who have a large number of qualifying projects, i.e., taxpayers who are most likely to be conducting activities that Congress was clearly targeting with the research tax credit. Unfortunately, this is the standard that the IRS feels is appropriate and it is the standard the IRS has been demanding. The prior Procter & Gamble and Union Carbide cases are a testament to this.