On April 15, 2019, the United States Tax Court ruled in favor of the commissioner in Siemer Milling Company (Siemer Milling) v. Commissioner of Internal Revenue, finding that Siemer Milling lacked sufficient documentation to support the R&D credits claimed. The case reiterates the critical importance of substantively documenting qualifying activities providing eligibility to claim the R&D tax credit.
In Siemer, the Court disallowed approximately $238,670 dollars in R&D credits claimed by Siemer Milling (taxpayer) during tax years 2010 and 2011. This disallowance was due in large part to the taxpayer’s failure to retain and provide supporting documentation demonstrating how the company’s activities met all four tests necessary to constitute qualified research expenses.
Background (Presented Facts)
Siemer Milling Co. (Siemer) is based in Illinois and is engaged in the business of milling and selling wheat flour. During tax years ending May 31, 2011 and 2012, Siemer conducted activities for which it claimed. During the years in issue Siemer owned and operated two mills, one in Illinois and one in Kentucky. Siemer employed millers, maintenance personnel, lab technicians, lab supervisors, a research and development manager, research and development staff, and others during the years in issue. Siemer did not have any employees with the title engineer or geneticist during the years in issue. Nor did Siemer employ anyone who held a degree in computer science or chemical and mechanical engineering during the years in issue.
Key Holding:
Failure to Establish "Process of Experimentation"(e.g. Flour Heat-Treatment Project)
- "it is not clear how it set out to do that and whether that process was a true process of experimentation"
-"... documents in the record nor the testimony offered at trial proves that Siemer [taxpayer] had a methodical plan involving a series of trials to test a hypothesis, analyze the data, refine the hypothesis, and retest the hypothesis so that it constitutes experimentation in the scientific sense"
Failure to Establish "Technical Uncertainty"(e.g. Pulsewave Project)
- "adjustments to the machine, such as replacing the bearings, did not constitute experimentation"
Failure to Establish "Business Component Test" (e.g. Wheat Hybrids Project)
-"Siemer [taxpayer] was simply determining what was available from wheat breeders and growers. Without an identifiable product or process that Siemer was attempting to develop or improve, Siemer fails the business component test with respect to its wheat hybrids project"
Taxpayer Friendly Findings:
(1) The Court acknowledged that technical uncertainties need not be solved in the credit year but can span more than one year.
- The Court stated "Siemer could have faced the same uncertainties for several years in a row; not all uncertainties are neatly resolved within the confines of a single taxable year. There is no requirement under the statute or regulations that the taxpayer face different uncertainty each year, only that the taxpayer face uncertainty concerning 'the development or improvement of a product' in the year for which he wishes to claim the credit."
(2) The Court rejected the notion that in order for a company to establish it participated in technical activities they must employ individuals with specialized degrees.
-The Court stated "Nothing requires a taxpayer to employ or contract with someone with a specialized degree to prove that research relied on the physical or biological sciences, engineering, or computer science. While the degrees held by those conducting the research for which a credit is claimed may be a factor in determining whether the technological information test is satisfied, no specific set of degrees is required. "
Lastly, the Court provided additional insight into types of documentation and/or support concerning estimates useful to properly support credits claimed.
Key Takeaways: Importance of Documentation Retention & Reporting
For taxpayers claiming the R&D credit, this case is a reminder on the importance of retaining thorough documentation, when calculating and documenting qualified research activities, for the R&D tax credit. As such, using a skilled professional, who can assist with reducing your company’s risk of Section 6662 Accuracy-Related Penalties, while helping maximizing your potential cash savings benefit can be the difference in a successful credit claim.