* Case tests line between research and prototype production
* Other companies closely monitoring $13.6 million dispute
* Retroactive R&D credit claims can be IRS red flag-tax
By Patrick Temple-West
WASHINGTON, Jan 25 Lockheed Martin Corp
is challenging the U.S. government in court over $13.6 million
in research tax credits in a case that tests the often hazy line
between research and production, with future R&D claims by other
companies possibly at stake.
The aerospace group argued in December in U.S. District
Court that the Internal Revenue Service had wrongly rejected
research tax credits Lockheed claimed for two projects: a space
rocket launcher and a New York City surveillance system.
The IRS disallowed Lockheed's claims in May 2012. Lockheed
has challenged the IRS' position that some retroactive R&D
credit claims were impermissible because they involved costs not
for research, but for making prototypes resulting from research.
Lockheed said in its court filing that some of the credits
were claimed for prototypes, but argued that the designs were
new and unproven and should qualify as research.
"With Lockheed, you have the actual question of whether this
is rocket science," said William Schmalzl, a partner at the law
firm Mayer Brown with clients facing similar issues.
The case also draws attention to the timing of R&D credit
claims. Lockheed's 2012 claims on the rocket launcher and
surveillance system projects were both made retroactively for
tax years 2004 through 2007, according to its court filing.
While retroactive claims are frequently allowed, they tend
to attract closer IRS scrutiny, tax lawyers said.
When a credit is sought retroactively, "you really aren't
relying on it as an incentive" to do research, Schmalzl said.
Maryland-based Lockheed, a top Defense Department supplier,
declined to comment. The IRS also declined to comment.
The agency has yet to file a formal response to the Lockheed
court action. No court date has been set in the U.S. District
Court for the District of Maryland in Greenbelt.
A Lockheed court loss could jeopardize other companies' R&D
claims and allow the IRS to be more aggressive, while a Lockheed
victory could prompt other companies to look at past tax returns
and claim retroactive credits, tax experts said.
The R&D credit was created by Congress in 1981 to encourage
business investment in science.
The "traditional" R&D credit allows companies to cut their
tax bills by 20 percent of qualified research spending based on
a formula dating back to the mid-1980s. An "alternative
simplified credit," established in 2007, allows a claim of 14
percent based on the three prior years of research spending.
The credit is not refundable for cash, except in limited
circumstances, and there is no cap on the credits a company can
claim. Unused credits can be carried back one year and carried
forward 20 years. The credit is limited to research funds spent
in the United States. Wages and supplies account for the bulk of
spending, and capital expenses are not applicable.
In reporting its quarterly financial results on Thursday,
Lockheed said separately from the case that it expects to
receive $75 million in R&D credits for 2012 and 2013.
Though simple in concept, the R&D credit is a frequent
source of messy tax disputes. Companies, including Dow Chemical
Co, Trinity Industries and Bayer AG,
are also fighting the IRS in court over research credits.
Dow lost a case in U.S. appeals court in September involving
$8 million in credits. Dow unit Union Carbide wanted to apply
the credits retroactively to cover costs for supplies, even
though it ended up selling the finished goods.
The Dow decision gave the IRS "ammunition to attack" certain
credit claims for supply costs, said Jeff Malo, a director with
tax advisory firm WTP Advisors.
In December, Dow asked the Supreme Court to hear its case.
Germany's Bayer is facing off against the IRS over $170
million of disputed research credits spanning 17 years.
Texas-based Trinity is appealing a $5 million tax credit
"The confusion and ambiguity as to what qualifies, and the
fights that this ambiguity engenders, undermine the credit's
intended incentive effect," said Alex Sadler, a partner at law
firm Ivins, Phillips & Barker.
The R&D credit is widely backed by President Barack Obama
and members of both political parties, many of whom want to make
it a permanent part of the tax code. It is presently a
"temporary" measure requiring regular extension.
It was renewed again this month, along with other tax breaks
known collectively as the "tax extenders." The R&D credit, which
will expire again at the end of this year, is estimated to cost
U.S. taxpayers $14.3 billion over 10 years.
This month the non-partisan Congressional Budget Office
urged Congress to consider changes to the credit "to reduce
excessive revenue costs and economic inefficiencies."
The case is Lockheed Martin Corp v. United States of
America, in the U.S. District Court for the District of Maryland
Southern Division No. 3725.