The opinion
Case: 22-30764 Document: 00516965151 Page: 1 Date Filed: 11/13/2023
United States Court of Appeals
for the Fifth Circuit United States Court of Appeals
Fifth Circuit
____________ FILED
November 13, 2023
No. 22-30764 Lyle W. Cayce
____________ Clerk
United States of America,
Plaintiff—Appellee,
versus
Leonard L. Grigsby; Barbara F. Grigsby,
Defendants—Appellants.
______________________________
Appeal from the United States District Court
for the Middle District of Louisiana
USDC No. 3:19-CV-596
______________________________
Before HIGGINBOTHAM, SMITH, and ELROD, Circuit Judges.
PATRICK E. HIGGINBOTHAM, Circuit Judge:
Today, we visit the classic congressional practice of using its taxing
powers to achieve permissible policy goals; here, the lure of a tax credit to
incentivize creative research. Leonard L. Grigsby and Barbara F. Grigsby ap-
peal the judgment of the United States District Court for the Middle District
of Louisiana which rejected research and development tax credits claimed by
Cajun Industries LLC and upheld the resulting tax deficiency.
We AFFIRM.
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I.
Cajun Industries LLC (“Cajun”) claimed tax credits for the 2013 tax
year pursuant to § 41 of the Internal Revenue Code, 26 U.S.C. § 41. First,
the Code provision at issue in this case, § 41 offers a tax credit for “qualified
research expenses” including wages and expenditures incurred in pursuit of
qualified research.1
The Internal Revenue Code provides a tax credit for qualified
research activities, as defined by the Code.2 To constitute “qualified
research,” the research must satisfy the four tests laid out in § 41(d)(1): “(1)
the expense must be of the type deductible under § 174 of the Code (i.e., R
& D expenses that are reasonable under the circumstances), (2) the research
must be undertaken for the purposes of discovering information that is
‘technological in nature,’ (3) the information must be ‘intended to be useful
in the development of a new or improved business component of the
taxpayer,’ and (4) ‘substantially all of the activities [must] constitute
elements of a process of experimentation.’”3 Relevant here, “business
_____________________
1
26 U.S.C. § 41(b).
2
See generally id.
3
Shami v. Comm’r, 741 F.3d 560, 563 (5th Cir. 2014) (citing 26 U.S.C. § 41(d)(1)). The full
text of 26 U.S.C. § 41(d)(1) reads:
(d) Qualified research defined.--For purposes of this section--
(1) In general.--The term “qualified research” means research--
(A) with respect to which expenditures may be treated as specified
research or experimental expenditures under section 174,
(B) which is undertaken for the purpose of discovering information--
(i) which is technological in nature, and
(ii) the application of which is intended to be useful in the
development of a new or improved business component of the
taxpayer, and
(C) substantially all of the activities of which constitute elements of a
process of experimentation for a purpose described in paragraph (3).
Such term does not include any activity described in paragraph (4).
2
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components” are defined as “any product, process, computer software,
technique, formula, or invention which is to be (i) held for sale, lease, or
license, or (ii) used by the taxpayer in a trade or business of the taxpayer.”4
However, qualified research expressly excludes so-called “funded”
research.5 Funded research include “any research to the extent funded by
any grant, contract, or otherwise by another person (or governmental en-
tity).”6 Treasury Regulations further explain that research is funded if, in any
agreement to perform research (1) the researcher retains no substantial rights
to their research; or (2) payment is not contingent upon the research’s suc-
cess.7
A. Claimed Credits
Cajun provides construction services throughout the Gulf Coast
Region and engaged in over one hundred construction projects during the
time period in question. In 2015, Cajun hired a consulting firm to evaluate its
projects and advise whether Cajun was eligible for research credits under
§ 41. Based on the firm’s report, Cajun, believing it was entitled to a
$1,341,420 research credit, filed an amended Form 1120S for the 2013 tax
year claiming the $1,341,420 credit.
_____________________
26 U.S.C. § 41(d)(1).
4
Id. § 41(d)(2)(B).
5
Id § 41(d)(4)(H) (“(4) Activities for which credit not allowed. --The term ‘qualified
research’ shall not include any of the following . . . (H) Funded research.--Any research to
the extent funded by any grant, contract, or otherwise by another person (or governmental
entity).”).
6
Id.
7
26 C.F.R. § 1.41-4A(d).
3
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As an S-Corporation, Cajun’s income, losses, deductions, and credits
pass through to its shareholders for income tax purposes. At all relevant
times, Appellant Leonard Grigsby owned a 73% interest in Cajun and was thus
entitled to a pro rata allocation of Cajun’s tax credit, which amounted to
$979,237. The $979,237 credit reduced Mr. and Mrs. Grigsby’s tax liability
for 2013 and indicated the couple overpaid their federal income taxes by
$576,756. Appellants filed an amended 2013 tax return and sought a refund
of $576,756 plus statutory overpayment interest in the amount of $73,633.38
(the “Contested Refund”). On September 15, 2017, the Internal Revenue
Service (“IRS”) issued Appellants a refund of $671,071.38, comprised of the
Contested Refund and an additional $20,652 not at issue in this case.8
However, on August 13, 2019, the IRS notified Appellants that the
Contested Refund was issued erroneously and challenged Cajun’s claimed
credit. The Commissioner demanded Appellants repay the amount and
warned that if Appellants did not do so, the IRS would recommend “an
action be commenced in District Court to recover the erroneous refund, as
permitted by I.R.C. § 6532(b) and 7405.” Shortly thereafter, the United
States initiated this suit.
B. The Representative Projects
Before the District Court, the Parties agreed that four projects
adequately represented Cajun’s research activities: (1) Project 13-020 (the
“Methanex Project”); (2) Project 12-051 (the “Chevron Project”);
(3) Project 12-001 (the “Claiborne Project”); and (4) Project 12-023 (the
“East Bank Project”) (together, the “Representative Projects”). Thus,
_____________________
8
Of the $671,071, $576,756 was “solely due” to Cajun’s tax credit and $73,663.38 stemmed
from the statutory overpayment interest.
4
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Cajun’s eligibility for the tax credit, and Appellants’ by extension, hinged on
whether it performed qualified research while completing these projects.
1. The Methanex Project
In 2012, Jacobs Field Services North America, Inc. (“Jacobs”) hired
Cajun as a subcontractor on a project to relocate a Methanex USA, LLC
methanol plant from Chile to Louisiana. Cajun was originally tasked with cre-
ating temporary facilities at the new site. According to the Scope of Work
provisions of the contract, Cajun’s responsibilities included:
3.0 GENERAL SCOPE OF SERVICES (WORK)
3.1 [Cajun] shall complete the Work and support functions
required to effectively manage and report on the status of the
Work as specified.
3.2 [Cajun] shall provide all management, supervision, labor,
consumable materials, construction equipment, construction
aids, tools, services, testing devices, warehousing, supplies,
inspections, insurance, fully furnished and equipped offices,
communication devices, and all other necessary items to
successfully accomplish the construction described by the
Scope of Work. This includes, but is not limited to, on and off
site transportation, receiving, loading and unloading, storing,
maintenance, and distribution of construction materials,
installation of such materials into the Work, proper care of
materials, testing and final construction punch list completion
and turnover of the Work Scope as specified.9
In executing these tasks, Cajun was “solely responsible for and have
[sic] control over construction means, methods, techniques, sequences and
procedures and for coordinating all portions of the Work.” This included
_____________________
9
“Work” was defined as the “work, services, deliverables, duties and activities to be
performed or provided by, or on behalf of, [Cajun] under this Subcontract.”
5
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obtaining approval for materials, identifying and coordinating vendors,
offering design input, and participating in “a lot of review processes.”
However, Jacobs retained “ultimate authority to resolve issues in the field.”
The contract was subject to a capped price of $6,485,000 and payment
was conditioned on Cajun’s completion of “all Work.”10 Cajun accepted
payment “as full compensation for doing all Work and furnishing all material
contemplated by and embraced in this Subcontract,” “for all loss or damage
arising out of the nature of the Work,” “from any unforeseen or unknown
difficulties or obstructions which may arise or be encountered in the
prosecution of the Work,” and “for all risks of every description connected
with the Work.”
Section 26 of the contract addressed ownership of any work product
and provided that all “Work Product prepared by [Cajun] shall be ‘works
made for hire,’ and all rights, title and interest to the Work Product . . . shall
be owned by [Methanex].” To the extent any “work product” was not
considered work for hire, “or if ownership of all right, title and interest in the
Work Product shall not otherwise vest in [Methanex],” Cajun agreed that
ownership of said “Work Product . . . shall be automatically assigned from
[Cajun] to [Methanex] without further consideration, and [Methanex] shall
thereafter own all right, title and interest in the Work Product.”11
_____________________
10
This price included “billed actual manhours and actual cost of other cost reimbursable
items in accordance with the agreed labor wage rates, construction equipment rates,
mobilization and demobilization rates as included in this Exhibit D.” Cajun was also
entitled to additional compensation if Jacobs modified its scope of work. By the end of the
project, the contract price rose from $6 million to approximately $90 million because of 65
work scope modifications.
11
The contract defined Methanex as the “Owner.”
6
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The contract defined “work product” as “all documents, data,
analyses, reports, plans, procedures, manuals, drawings, specifications,
calculations, or other technical tangible manifestations of [Cajun]’s efforts
(whether written or electronic) created by [Cajun] in the performance of the
Work, including but not limited to all Documents.” In turn, “documents”
included “any or all tracings, designs, drawings, field notes . . . specifications,
electronic information . . . and other documents or records developed or
acquired by [Cajun] and its suppliers or sub-subcontractors in performing the
Work.”
2. The Chevron Project
In 2011, Chevron Products Company, a division of Chevron U.S.A.,
Inc., contracted with Cajun to provide construction services to expand Chev-
ron’s Pascagoula Refinery (the “Chevron Project”). Cajun’s responsibilities
included providing “all labor, supervision, quality control, administration,
document control, equipment, [and] tools,” in addition to completing spe-
cific civil tasks such as surveying, excavation and backfill, installing piping,
and performing field inspections. Appellants maintain that Cajun also offered
“constructability reviews” of the engineer’s designs and specifications.
However, the engineer of record, who was not a Cajun employee, retained
“ultimate authority to resolve any issues that arose in the field.”
The Chevron contract was a fixed-price contract and compensated
Cajun for all work described in Exhibit B of the contract, the “Schedule of
Compensation for Work.” Exhibit B detailed all costs covered by the contract
price, including craft labor, non-manual, and equipment costs in addition to
all overhead and profit. Furthermore, according to the “Pricing” section of
the contract, Chevron paid for “performance of all Work” and the contract
prices were “all inclusive” of Cajun’s “supply and services including with-
out limitation; salaries and wages . . . the cost of supervision and support
7
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services from personnel other than those permanently assigned to the Con-
tract . . . employee income tax and statutory payroll deductions, social secu-
rity charges, [and] all taxes (except sales and use taxes) . . . .” Cajun agreed
that payment “constituted full payment for the performance of the Work,
and completion of [Chevron]’s payment obligations under the Contract.”
The contract designated Chevron as the owner of all work product
generated during the project and provided:
2.20.3. All drawings, documents, engineering and other data
prepared or furnished by [Cajun] in performing the Work are
considered to be [Chevron’s] work for hire and shall become
[Chevron’s] property from the time of preparation and may be
used by [Chevron] for any purpose whatsoever without obliga-
tion or liability whatsoever to [Cajun]. [Cajun] assigns all rights
in the above referenced drawings, documents, engineering and
other data to [Chevron], including copyrights.
[. . .]
18.4. All inventions, discoveries and improvements (patentable
and unpatentable) that are made or conceived by [Cajun] or
[Cajun]’s employees in performing the Services and all domes-
tic and foreign patent rights based thereon shall belong to
[Chevron] or an Affiliate designa1ed by [Chevron]. [Cajun]
shall promptly and fully disclose all such inventions, discover-
ies and improvements to [Chevron] or the designated Affiliate.
Furthermore, Cajun agreed that all “Technical Information will be
used only for performance of the Services for [Chevron]” and that it would
not disclose this information without Chevron’s express written consent.12
This obligation remained in force even after the Chevron Project concluded.
_____________________
12
Section 1.1.31 of the contract defined “technical information” as:
8
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3. The Claiborne Project
In September 2011, Cajun contracted with the U.S. Army Corps of
Engineers to construct a “box culvert,” or an underground canal, as part of
the Southeast Louisiana Urban Flood Control Project (the “Claiborne Pro-
ject”). In doing so, Cajun was responsible for selecting the means and meth-
ods of construction, including equipment selection, personnel decisions, and
“how to produce the work in accordance with the plans and specifications.”
The Claiborne contract was a “fixed price” contract valued at
$25,971,694.50.
The contract incorporates various provisions of the Federal Acquisi-
tion Regulations (“FAR”), Title 48 of the Code of Federal Regulations, ei-
ther “by reference” or by “full text.” Relevant here, the contract incorpo-
rates FAR 52.232. FAR § 52.232-5(f) dictates the ownership rights of any
material generated throughout the contract’s performance and states “all
material and work covered by progress payments made shall, at the time of
payment, become the sole property of the Government.”13 “Work” includes
“construction activity . . . [including] buildings, structures, and improve-
ments of all types.”14
_____________________
[A]ny and all information, data and knowledge which is either made
available to [Cajun] by [Chevron] relating to the performance of the Work,
or developed by [Cajun] as a consequence or arising out of this Contract.
Technical Information includes all inventions, discoveries or
improvements (patentable or otherwise) that are made or conceived with
by [Cajun] in performing the Work and all patent rights associated these
inventions, discoveries or improvements.
13
FAR § 52.232-5(f), codified as 48 C.F.R. § 52.232-5(f).
14
Section 00700 of the contract “incorporate[s] by reference” FAR 52.202-1, which
provides that “when a solicitation provision or contract clause uses a word or term that is
defined in the Federal Acquisition Regulation (FAR), the word or term has the same
meaning as the definition in FAR 2.101 in effect at the time the solicitation was
9
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4. The East Bank Project
In January 2012, the Sewerage and Water Board of New Orleans
(“SWBNO”) awarded Cajun a construction contract to modify the flood
protection system at the East Bank Wastewater Treatment Plant in New Or-
leans. Cajun’s scope of work included providing “all labor, materials, super-
vision, construction equipment, [and] mechanical and electrical equip-
ment.”15
The East Bank contract was a “firm, fixed-price contract” originally
valued just under $24.4 million, although the contract eventually totaled
$29.4 million due to changes in the scope of work. Cajun’s compensation in-
cluded payment for “all general foremen, foremen, labor, teams and trucks
actually engaged on such specific work for the time actually so employed at
the rates actually paid.” Compensation also included a “fee for [Cajun’s] su-
perintendence, general expense and profit,” which “shall be understood also
to reimburse [Cajun] for any sub-contractor’s general expense and profit
which [Cajun] may allow to one or more sub-contractors.”
Cajun accepted payment as “full compensation for furnishing all the
labor, materials, tools, equipment, etc., needed to complete the whole work
of the contract” and also “as full compensation for all loss, damages or risks
of every description, connected with or resulting from the nature of the work,
_____________________
issued . . . .” See FAR 52.202-1, codified as 48 C.F.R. § 2.101. Thus, the reference to 48
C.F.R. § 52.202-1 effectively incorporates all definitions provided in FAR 2.101. Section
2.101 defines “work” as noted.
15
Unlike the Methanex, Chevron, and Claiborne projects, Cajun was not solely responsible
for the means and methods of executing these tasks. SWBNO hired an engineering firm,
Burk-Kleinpeter, Inc. (“BKI”) to design the system modification(s). BKI oversaw Cajun’s
daily construction activities and was required to approve Cajun’s means and methods and
any materials Cajun selected for permanent features of the project.
10
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or from any obstructions or difficulties encountered, of any sort or nature
whatsoever[.]”
The East Bank contract contained no provisions relating to ownership
of work product or research developed during the project.
C. District Court Proceedings
Throughout discovery, Appellants claimed Cajun engaged in research
which led to the development of four new “products:” two oil refineries and
two flood control systems. When the United States moved for summary
judgment, the Government argued these products failed the “business
component[s]” test and, as such, that Cajun did not perform qualified
research. Furthermore, the Government claimed the Representative Projects
were otherwise ineligible for the credit because they were “funded.”
Appellants responded that Cajun had also developed “processes”
that amounted to business components, in addition to the “products”
identified during discovery. Appellants claimed their new “processes”
encompassed the various “construction means and methods” Cajun used to
perform on its contracts and develop these products. Appellants also
disputed that the Representative Projects were funded, and maintained that
Cajun retained substantial rights to its “research results.” Alternatively,
Appellants contended that the contracts were contingent upon Cajun’s
provision of deliverables and were not funded, as set out in 26 C.F.R. § 1.41-
4A(d).
The District Court granted the United States’s motion for summary
judgment on three bases. First, the District Court rejected Appellants’
“processes” argument pursuant to Federal Rule of Civil Procedure 37(c)(1)
because this argument was inconsistent with Cajun’s prior discovery
disclosures which, instead, “unequivocally state that, as to each
11
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Representative Project, Cajun developed a ‘product.’”16 The District Court
further found that Appellants’ construction processes claim failed for lack of
specificity because Appellants “fail[ed] to specifically identify even one new
or improved process that resulted from Cajun’s work on the Representative
Projects.”
Second, the District Court found that Appellants’ briefing “fail[ed] to
cite any evidence or offer any argument establishing that Cajun’s work on the
Representative Projects resulted in new ‘products.’” Because the excluded
evidence of any construction processes was the “only evidence (and
argument) offered to establish the business component element of their
QRTC claim,” the court concluded the Representative Projects failed to
establish a business component.
Third, as an alternative basis for its holding, the District Court held
that the Representative Projects were “funded.” In particular, the District
Court determined that the Methanex, Chevron, and Claiborne Projects failed
the substantial rights prong of the “funded research exclusion,” and that the
East Bank contract was funded because Cajun was fully compensated for any
research performed or risk incurred.
Appellants timely appealed. This Court has jurisdiction under 28
U.S.C. § 1291.
_____________________
16
“If a party fails to provide information or identify a witness as required by Rule 26(a) or
(e), the party is not allowed to use that information or witness to supply evidence on a
motion, at a hearing, or at a trial, unless the failure was substantially justified or is
harmless.” FED. R. CIV. P. 37(c)(1).
12
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II.
We review a district court’s grant of summary judgment de novo,
applying the same standard as the district court.17 Grants of summary
judgment may be affirmed for any reason raised to the district court and
supported by the record, and we are not bound by the grounds articulated by
the district court.18 Decisions to exclude evidence under Federal Rule of Civil
Procedure 37 are reviewed for abuse of discretion.19
III.
Appellants advance three arguments on appeal. None are persuasive.
A. Burden on Summary Judgment
The District Court granted summary judgment after finding
Appellants did not “offer competent evidence or argument establishing that
Cajun performed qualified research,” namely on the business components
element. Appellants argue that this improperly placed the burden on
Appellants as the non-moving party at summary judgment.
It is well established that the IRS’s assessment of tax liability may be
presumed correct so long as it is not “without rational foundation and
excessive.”20 The Government satisfies this burden by “specify[ing] the
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17
Roberts v. City of Shreveport, 397 F.3d 287, 291 (5th Cir. 2005).
18
Chevron U.S.A., Inc. v. Traillour Oil Co., 987 F.2d 1138, 1146 (5th Cir. 1993).
19
CQ, Inc. v. TXU Min. Co., L.P., 565 F.3d 268, 277 (5th Cir. 2009).
20
United States v. Janis, 428 U.S. 433, 441 (1976); Portillo v. Comm’r, 932 F.2d 1128, 1133
(5th Cir. 1991) (“[W]e begin with the well settled principle that the government’s
deficiency assessment is generally afforded a presumption of correctness . . . The tax
collector’s presumption of correctness has a herculean muscularity of Goliathlike reach,
but we strike an Achilles’ heel when we find no muscles, no tendons, no ligaments of fact.”)
(internal citations omitted); Sealy Power, Ltd. v. Comm’r, 46 F.3d 382, 386 (5th Cir. 1995)
(“A determination of deficiency issued by the Commissioner is generally given a
13
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amount of the deficiency or provid[ing] the information necessary to
compute the deficiency.”21 Once an assessment is presumed correct, the
burden shifts to the taxpayer to rebut the presumption.22 Importantly, the
taxpayer bears this burden regardless of whether the case is a refund suit
_____________________
presumption of correctness, which operates to place on the taxpayer the burden of
producing evidence showing that the Commissioner’s determination is incorrect.”).
21
Sealy, 46 F.3d at 386. At oral argument, Appellants’ counsel argued that the IRS
assessment was insufficient because it did not result from an administrative proceeding.
However, Appellants provided no citations for this proposition and the Court has found
none in support of this position. To the contrary, this Court in Portillo recognized that
“there is no prescribed form for a deficiency notice,” Portillo, 932 F.2d at 1132 (citing
Donley v. Comm’r, 791 F.2d 383 (5th Cir. 1986)), and such notice must merely evince “a
thoughtful and considered determination that the United States is entitled to an amount
not yet paid,” id. (quoting Scar v. Comm’r, 814 F.2d 1363, 1369 (9th Cir. 1987)).
22
Portillo, 932 F.2d at 1133 (“This presumption is a procedural device that places the
burden of producing evidence to rebut the presumption on the taxpayer.”). The
presumption is consistent with the general principle that taxpayers must demonstrate their
entitlement to any refund, deduction, or credit as well as the taxpayer’s record-keeping
obligations imposed by the Revenue Code. See id. at 1134 (“The taxpayer clearly bears the
burden of proof in substantiating claimed deductions.”); United States v. McFerrin, 570
F.3d 672, 675 (5th Cir. 2009) (“Tax credits are a matter of legislative grace, are only
allowed as clearly provided for by statute, and are narrowly construed.”); 26 U.S.C. § 6001
(“Every person liable for any tax imposed by this title, or for the collection thereof, shall
keep such records, render such statements, make such returns, and comply with such rules
and regulations as the Secretary may from time to time prescribe.”) (emphasis added); 26
C.F.R. § 1.6001-1(a) (“Except [for farmers and wage-earners], any person subject to tax
under subtitle A of the Code . . . or any person required to file a return of information with
respect to income, shall keep such permanent books of account or records, including
inventories, as are sufficient to establish the amount of gross income, deductions, credits, or
other matters required to be shown by such person in any return of such tax or
information.”) (emphasis added); 26 C.F.R. § 1.41-4(d)(“Recordkeeping for the research
credit. A taxpayer claiming a credit under section 41 must retain records in sufficiently
usable form and detail to substantiate that the expenditures claimed are eligible for the
credit.”).
14
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initiated by the taxpayer or a collection suit brought by the Government.23
Thus, ultimately, “[t]he burden and the presumption, which are for the most
part but the opposite sides of a single coin, combine to require the taxpayer
always to prove by a preponderance of the evidence that the Commissioner’s
determination was erroneous.”24
The IRS assessment in this case was entitled to the presumption of
correctness. This burden is a low one; the assessment must merely “advise
the taxpayer that the [IRS] has determined that a deficiency exists for a
particular year,” and “specify the amount of the deficiency or provide the
information necessary to compute the deficiency.”25 The IRS’s August 13,
2019, letter to Appellants (the “Letter”) met these requirements.26 Thus,
the burden shifted to Appellants to refute the IRS’s determination.
Therefore, the District Court properly required Appellants to introduce
evidence on this point to establish a genuine dispute meriting trial.
Moreover, even if the IRS’s assessment was not entitled to the
presumption of correctness, the Government still met its burden of
_____________________
23
Carson v. United States, 560 F.2d 693, 696 (5th Cir. 1977) (“This burden applies whether
the proceeding is in Tax Court for redetermination of a deficiency or in district court upon
a refund claim or a government counterclaim.”).
24
Id. at 695–96.
25
Portillo, 932 F.2d at 1132 (5th Cir. 1991) (internal citation omitted); see also Sealy, 46 F.3d
at 386 (same).
26
The Letter recounted that Appellants requested a tax credit of $576,756 for the 2013 tax
year and received a total refund of $671,071.38, which was comprised of Appellants’
$576,756 claimed research credit plus $73,663.38 in statutory interest and an additional,
undisputed, refund of $20,652. It further explained that the $576,756 refund was “solely
due to information” reported on Appellants’ amended return which, in turn, was based on
Cajun’s Amended Form 1120S. Because the IRS “determined that Cajun Industries, LLC
& Subsidiaries is not entitled to the Research Credit claimed,” the Letter concluded that
the “refund resulting from the Research Credit should not have been allowed and the
refund paid to [Appellants] was erroneous.”
15
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production at summary judgment. As the moving party, the Government
needed to show that there was no genuine dispute as to any material fact and
that it was entitled to judgment as a matter of law.27 The Government could
do so by submitting evidence negating the existence of some material element
of Appellants’ claim or defense; alternatively, because taxpayers must
demonstrate their entitlement to credits, the Government could have
pointed out that the evidence in the record was insufficient to support
Appellants’ claim that they performed qualified research.28
The Government did so by providing approximately forty exhibits—
including excerpts from the Representative Projects’ contracts, Appellants’
2013 amended tax return, and corporate representative depositions from
parties to the Methanex, Chevron, Claiborne, and the East Bank Projects—
that refuted Appellants’ entitlement to the credit. At that point, the District
Court was correct in offering Appellants the opportunity to rebut this
evidence and thus create a genuine issue of fact. The District Court did not
err on this basis.
_____________________
27
FED. R. CIV. P. 56(a).
28
See Little v. Liquid Air Corp., 952 F.2d 841, 847 (5th Cir. 1992), on reh’g en banc, 37 F.3d
1069 (5th Cir. 1994) (citing Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986)).
16
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No. 22-30764
B. Business Components Determination
Research must satisfy the so-called “business components” test in
order to qualify for the tax credit.29 The business components test requires
that research be “undertaken for the purpose of discovering information (i)
which is technological in nature, and (ii) the application of which is intended
to be useful in the development of a new or improved business component
of the taxpayer.”30 The test must be applied separately to each business
component, defined as “any product, process, computer software,
technique, formula, or invention which is to be (i) held for sale, lease, or
license, or (ii) used by the taxpayer in a trade or business of the taxpayer.”31
During discovery, Appellants stated that they developed four new
“products:” two oil refineries and two flood control systems. At summary
judgment, however, Appellants claimed Cajun also created new business pro-
cesses, a separate type of business component, which Appellants define as
the “means and methods of construction,” “the means and methods of per-
forming [] construction services,” and “construction processes.”
The District Court found that the asserted products and processes did
not satisfy the business components test because Appellants put forth no ev-
idence of the alleged products, any assertions of new construction processes
were inconsistent with their prior disclosures and excludable under Federal
Rule of Civil Procedure 37, and notwithstanding those inconsistencies, Ap-
pellants did not specifically identify the new construction processes at issue.32
_____________________
29
26 U.S.C. § 41(d)(1)(B).
30
Id.
31
Id. § 41(d)(2)(B).
32
See FED. R. CIV. P. 37(c)(1) (“If a party fails to provide information or identify a
witness as required by Rule 26(a) or (e), the party is not allowed to use that information or
17
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No. 22-30764
Appellants now argue that the District Court’s determinations were
in error.
1. Business Components: Products
Appellants argue they presented sufficient evidence that Cajun
developed four business component products and cite to the “Taxpayers’
Response to Proposed Statement of Facts” (the “Response”) as support.
However, cited provisions primarily describe Cajun’s “means and
methods,” i.e., their processes, and not the products. While Appellants may
be correct that their construction processes led to the final product, the
Revenue Code requires this Court to evaluate each business component
separately.33
Accordingly, Appellants have not created a genuine dispute as to
whether the four products constitute business components.
2. Business Components: Processes
Appellants further assert the District Court erred in excluding their
construction processes argument because the “development processes and
techniques” used on the Representative Projects were “almost inextricably
intertwined with the tangible deliverables,” the final product.
We are not persuaded that the District Court’s decision to exclude
Appellants’ construction processes claim was an abuse of discretion.34
_____________________
witness to supply evidence on a motion, at a hearing, or at a trial, unless the failure was
substantially justified or is harmless.”).
33
26 U.S.C. § 41 (d)(2)(A); see also id. § 41(d)(2)(C) (“Special rule for production
processes.--Any plant process, machinery, or technique for commercial production of a
business component shall be treated as a separate business component (and not as part of
the business component being produced).”).
34
CQ, Inc., 565 F.3d at 277.
18
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No. 22-30764
Federal Rule of Civil Procedure 37(c)(1) provides that “if a party fails to pro-
vide information . . . as required by Rule 26(a) or (e), the party is not allowed
to use that information . . . to supply evidence on a motion, at a hearing, or at
a trial, unless the failure was substantially justified or is harmless.”35 To eval-
uate whether a Rule 26 violation was harmless, and “thus whether the district
court was within its discretion in allowing the evidence to be used at trial,”
this Court weighs four factors: (1) the importance of the evidence; (2) the
prejudice to the opposing party of including the evidence; (3) the possibility
of curing such prejudice by granting a continuance; and (4) the explanation
for the party’s failure to disclose.36
First, the argument that Cajun developed new construction processes
is important because it provided Appellants with a wholly new basis by which
to claim the tax credit. By raising this argument for the first time at summary
judgment, Appellants effectively asserted a new defense that was neither dis-
closed nor explored during discovery. Moreover, as the District Court noted,
“evidence of Cajun’s new construction processes is plainly important to [Ap-
pellants] insofar as it is the only evidence (and argument) offered to establish
the business component element of their QRTC claim.”
Second, this omission was highly prejudicial to the Government given
the procedural posture of the case. The record reflects that Cajun’s initial
discovery responses described the business components for the Representa-
tive Projects as “products.” Appellants’ supplemental disclosures likewise
describe the Projects as producing “product[s].” By raising the processes ar-
gument at summary judgment, Appellants deprived the Government of the
opportunity investigate this claim.
_____________________
35
FED. R. CIV. P. 37(c)(1).
36
Texas A&M Rsch. Found. v. Magna Transp., Inc., 338 F.3d 394, 401–02 (5th Cir. 2003).
19
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No. 22-30764
Third, although the District Court acknowledged that reopening dis-
covery would mitigate prejudice to the Government, the case was “more
than three years old” and one month from trial. The District Court was enti-
tled to weigh the value of reopening discovery against providing a timely res-
olution of the case.37
Finally, Appellants failed to explain their change in argument before
the District Court and, before this Court, deny that any change occurred. In
doing so, Appellants direct the Court to their “pretrial briefing” as evidence
that Appellants’ position has remained consistent. However, the cited pre-
trial briefing is the Parties’ Joint Pretrial Order, which was filed over one
month after the Government moved for summary judgment and three weeks
after Appellants responded raising the construction process argument for the
first time. Appellants have not directed the Court to any previous statements
indicating that the claimed business components involved processes. This
explanation is thus unpersuasive.
Given these facts, the District Court did not abuse its discretion in
excluding Appellants’ arguments about construction processes. However,
even if the District Court abused its discretion, the error was harmless
because the court nonetheless evaluated the merits of Appellants’ claim.
Ultimately, the District Court determined that Appellants put forth “vague”
and “conclusory” statements regarding their construction processes without
identifying “even one new or improved process that resulted from Cajun’s
work on the Representative Projects.”
_____________________
37
A district court has “broad discretion in all discovery matters,” and “such discretion will
not be disturbed ordinarily unless there are unusual circumstances showing a clear abuse.”
Kelly v. Syria Shell Petroleum Dev. B.V., 213 F.3d 841, 855 (5th Cir. 2000) (internal citation
omitted).
20
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No. 22-30764
The District Court did not abuse its discretion in excluding evidence
of Cajun’s construction processes. Alternatively, Appellants did not offer
sufficient evidence to create a genuine dispute as to whether Cajun’s
products or processes constituted business components. Without a viable
business component, the Representative Projects are not eligible for the tax
credit, and the Government is entitled to summary judgment as a matter of
law.
C. Funding Exclusion
Qualified research excludes “funded” research projects.38 Funded re-
search include “any research to the extent funded by any grant, contract, or
otherwise by another person (or governmental entity).”39 To determine
whether research was funded, courts must first evaluate “all agreements (not
only research contracts) entered into between the taxpayer performing the
research and other persons.”40 Research is funded if: (1) the researcher re-
tains no substantial rights in its research; 41 or (2) payment is not contingent
upon the research’s success.42
The District Court determined that “the Methanex, Chevron, and
Claiborne Projects each fail the ‘substantial rights’ prong of the ‘funded
_____________________
38
26 U.S.C. § 41 (d)(4)(H).
39
Id.
40
26 C.F.R. § 1.41-4A(d)(1).
41
Id. § 41-4A(d)(2)(“If a taxpayer performing research for another person retains no
substantial rights in research under the agreement providing for the research, the research
is treated as fully funded for purposes of section 41(d)(4)(H), and no expenses paid or
incurred by the taxpayer in performing the research are qualified research expenses.”).
42
Id. § 1.41-4A(d)(1)(“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 § 1.41–2(e)(2)) are not treated as funding.”).
21
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No. 22-30764
research’ exclusion because in each instance Cajun transferred all rights to
any new or improved ‘construction processes’ to its contracting counter-
part.” The Court found that the East Bank contract was funded because
“SWBNO plainly paid Cajun for whatever alleged research Cajun may have
performed.”
On appeal, Appellants dispute this finding and argue (1) that Cajun
retained substantial rights in its research, and (2) that the Representative
contracts were “contingent” upon delivery of a product and, as such, are not
funded as defined by Treasury Regulation 26 C.F.R. § 1.41-4A(d).
1. Methanex, Chevron, and Claiborne Projects
Researchers cannot claim the tax credit if they retain no “substantial
rights in research under the agreement providing for the research.”43 A
researcher retains no “substantial rights” if the agreement or contract
“confers on another person the exclusive right to exploit the results of the
research.”44 Whether Cajun retained substantial rights to its research is
determined by the contracts for each Representative Project.45
Even assuming Cajun satisfied the business components test, by the
express terms of the Methanex, Chevron, and Claiborne contracts, Cajun
gave up its rights to any research performed under the contracts. Pursuant to
section 26 of the Methanex contract, Methanex retained “all rights, title and
interest” in any “work product” prepared by Cajun. The provision applies
to all “works made for hire” as well as any work “not considered a work
_____________________
43
26 C.F.R. §1.41-4A(d)(2).
44
Id.
45
Id. § 1.41-4A(d)(1) (“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.”).
22
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No. 22-30764
made for hire.” By contracting away “all right, title and interest” in its work
product, Cajun gave up its rights to all “documents, data, analyses, reports,
plans, procedures, manuals, drawings, specifications, calculations, or other
technical tangible manifestations of [Cajun]’s efforts (whether written or
electronic)” created while performing the contract, as well as “any or all
tracings, designs, drawings, field notes, requisitions, purchase orders,
specifications, electronic information . . . and other documents or records
developed or acquired by [Cajun] and its suppliers or sub-subcontractors in
performing the Work.”
Similarly, Cajun assigned to Chevron “all rights” to any “drawings,
documents, engineering and other data prepared or furnished by [Cajun]”
under the Chevron contract. These items became “[Chevron’s] property
from the time of preparation and may be used by [Chevron] for any purpose
whatsoever without obligation or liability whatsoever to [Cajun].” Further-
more, the contract also states that Chevron owns all “inventions, discoveries
and improvements (patentable and unpatentable) that are made or conceived
by [Cajun] or [Cajun’s] employees” during the Project. Cajun was permitted
to use this information “only for performance of the Services for [Chev-
ron],” and pledged not to disclose such information “to any third party with-
out [Chevron’s] express written consent.” Importantly, this obligation per-
sists “notwithstanding the termination of this Contract.”
Finally, by incorporating various provisions of the Federal Acquisition
Regulations, the Claiborne contract provides that “all material and work cov-
ered by progress payments made shall, at the time of payment, become the
sole property of the Government.”46 “Work” is defined broadly and includes
_____________________
46
FAR § 52.232-5(f), codified as 48 C.F.R. § 52.232-5.
23
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No. 22-30764
“construction activity,” “buildings, structures, and improvements of all
types.”
Ultimately, “it is hard to see what rights—much less what substantial
rights” Cajun retained in its undefined research.47 After assigning away all
rights to work developed during each Representative Project, Cajun retained
no substantial rights in its research.48
2. East Bank Project
Treasury Regulation 26 C.F.R. § 1.41-4A(d) defines “funded”
research.49 Relevant here, the Regulation explains that “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 §
1.41–2(e)(2)) are not treated as funding . . . .”50
_____________________
47
Tangel v. Comm’r of Internal Revenue, 121 T.C.M. (CCH) 1001, 2021 WL 81731, at *6
(T.C. 2021) (internal quotations omitted).
48
Appellants argue Cajun retained substantial rights to its research because “there is
nothing [in the contracts] that precludes Cajun from performing the same types of activities
and utilizing the same means and methods on other projects, or building other flood
structures, or modifying refineries.” However, Appellants provided no specific examples
of these “means and methods,” leaving the district court and this Court to guess what
Cajun could bring to future projects aside from additional experience in its field.
“[I]ncreased experience in a field of research” does not constitute substantial rights to
research. 26 C.F.R. § 1.41-4A(d)(2).
49
26 C.F.R. § 1.41-4A(d).
50
Id. § 1.41-4A(d)(1). Together, 26 C.F.R. §§ 1.41-2(e) and 1.41-4A(d) provide “mirror
image” rules “for determining when the customer for the research, rather than the
researcher, is entitled to claim the tax credit.” Fairchild Indus., Inc. v. United States, 71 F.3d
868, 870 (Fed. Cir. 1995), modified (Feb. 23, 1996). Fairchild interpreted 26 C.F.R § 1.41-5,
which was redesignated as § 1.41-4A in 2001. See Credit for Increasing Research Activities,
66 Fed. Reg. 280, 295 (2001). Section § 1.41-4A addresses when a researcher can claim the
credit, whereas § 1.41-2(e) addresses when the payor to a contract can (or cannot) claim it.
Accordingly, § 1.41-2(e)(2) explains that payors cannot claim expenses for
research contracts “if an expense is paid or incurred pursuant to an agreement under which
24
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No. 22-30764
Appellants offer three reasons why the East Bank Project was not
funded. First, Appellants rely on 26 C.F.R. § 1.41-4A(d) and 26 C.F.R. §
1.41-2(e) to argue the East Bank Project was not funded because payment was
contingent upon Cajun delivering a “result or product,” the refineries and
flood systems. Second, and relatedly, Appellants maintain they are entitled
to the credit simply because SWBNO, the payor on the East Bank Project,
was not. Finally, Appellants argue that the Project was not funded because it
was “inherently risky.” These arguments miss the mark.
Appellants’ argument that all contracts “for the product or result”
are not funded improperly conflates “amounts payable under any agreement
that are contingent on the success of the research” with contracts for
products or services. This argument ignores the operative portion of the
sentence: “amounts payable under any agreement that are contingent on the
success of the research.” Structurally, the phrase “and thus considered to be
paid for the product or result of the research” merely describes or modifies
“amounts payable . . . contingent on the success of the research.” It does not,
as Appellants urge, stand on its own to establish an additional type of contract
“not treated as funding.”
More to the point, § 1.41-4A(d)(1) only concerns agreements
contingent upon the success of research. Simply put, the East Bank contract
was not contingent on the success of the research because Appellants admit
that “none of Cajun Industries’ payment was for merely conducting
research.” Indeed, Appellants’ briefing admits “payments to Cajun
_____________________
payment is contingent on the success of the research” because “the expense is considered
paid for the product or result rather than the performance of the research.” 26 C.F.R. §
1.41-2(e)(2). In doing so, “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.” Fairchild, 71 F.3d at 870.
25
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No. 22-30764
Industries were not contingent upon whether Cajun Industries conducted
research activities.” Consequently, this argument lacks merit.
Furthermore, Appellants are not entitled to the research credit merely
because SWBNO could not claim the credit. The Regulations do not require
that a tax credit be allocated in every contract.51
Third, Appellants assert the East Bank Project was not funded
because it was a fixed price contract and “inherently risky.” This argument
stands on more solid ground and finds some support in a line of cases
including Fairchild Industries, Inc. v. United States and Geosyntec Consultants,
Inc. v. United States.52 Fairchild explained that sections 1.41-2 and 1.41-4A
“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.”53
Because fixed price contracts may not fully compensate researchers if their
research is unsuccessful, the researcher bears the financial risk of failure, and
fixed price contracts are more likely to be deemed unfunded.
However, Fairchild and Geosyntec do not stand for the proposition that
all fixed price contracts are per se not funded. Indeed, Geosyntec found that
the fixed price contract at issue was funded.54 Furthermore, even if this Court
_____________________
51
See 26 C.F.R. § 1.41-A(d)(2) (addressing a scenario in which “a taxpayer performing
research for another person retains no substantial rights in the research and if the payments
to the researcher are contingent upon the success of the research, neither the performer nor
the person paying for the research is entitled to treat any portion of the expenditures as
qualified research expenditures.”) (emphasis added).
52
Fairchild, 71 F.3d at 870; Geosyntec Consultants, Inc. v. United States, 776 F.3d 1330 (11th
Cir. 2015).
53
Fairchild, 71 F.3d at 870.
54
Geosyntec, 776 F.3d at 1339 (“[W]e find that both the Cherry Island Contract and the
WM Contract were ‘funded’ as that term is used in § 41 and Treasury Regulation § 1.41–
4A(d).”).
26
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No. 22-30764
agreed that the Regulations allocate the tax credit to the party bearing the risk
of unsuccessful research, Cajun was compensated for all risks associated with
the East Bank Project. According to the express terms of the contract, Cajun
accepted payment “as full compensation for all loss, damages or risks of
every description, connected with or resulting from the nature of the work,
or from any obstructions or difficulties encountered, of any sort or nature
whatsoever . . . .”
Finally, the East Bank Project was funded for the simple reason that
Cajun was compensated for all expenditures incurred and claimed when it
sought the tax credit. According to Cajun’s IRS Form 6765, Cajun claimed
the research credit entirely for “wages” incurred in pursuit of qualified
services.55 However, Cajun was compensated under the East Bank contract
for “all general foremen, foremen, labor, [and] teams” as well as Cajun’s
“superintendence, general expense and profit.” Cajun accepted this
payment as “full compensation for furnishing all the labor, materials, tools,
equipment, etc., needed to complete the whole work of the contract.”
Therefore, Cajun was fully compensated for all wages and labor, making
these expenditures funded under any plain meaning of the term.56
_____________________
55
Although Appellants’ brief claims that “Cajun Industries included portions of employee
wages, contractor costs, and supply costs incurred for various construction projects as part
of the computation of the R&D tax credits,” their tax filings indicate otherwise. In its Form
6567, Cajun left blank spots next to the “cost of supplies” category. To the extent
Appellants argue Cajun claimed the credit for the difference between compensation
received and wages paid, Appellants bore the burden of demonstrated this value before the
District Court and on appeal. They provided no such calculations.
56
See also 26 C.F.R. § 1.41-4A (Example 1, indicating if a researcher is wholly compensated
for otherwise qualified expenditures, the researcher is not entitled to the credit,
notwithstanding any rights retained in the research).
27
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No. 22-30764
IV.
Based upon the record before the District Court and arguments made
on appeal, the Court finds that the Representative Projects yielded no viable
business components and were funded. Appellants are ineligible for the
research tax credit provided by 26 U.S.C. § 41. Therefore, the District
Court’s grant of summary judgment is AFFIRMED.
28