Tax Court sinks claim for research credit

Arguments made by a custom boat builder along the Ohio River failed to float in a case of first impression after the Indiana Tax Court found the company did not qualify for the state’s research expense tax credit.

In January 2015, Tell City Boatworks filed an Indiana Amended Corporate Income Tax Return for the 2010 tax year. The company maintained it was entitled to a refund for its increased research activities on six projects.

However, the Indiana Department of State Revenue denied the claim in March 2016, concluding Tell City failed to provide any creditable evidence to verify that its research expense met the criteria as qualified research expenses.

Tell City appealed to the Indiana Tax Court and a five-day trial was held in November 2019. Ultimately, the Tax Court affirmed the denial in Tell City Boatworks, Inc., v. Indiana Department of State Revenue, 18T-TA-4  finding the company had not met its burden of showing that qualified research was performed during the 2010 tax year.

At issue were three vessels referred to as Project 107, Project 109 and Project 111. To meet the qualified research standard, the research must satisfy four distinct tests.

The three projects cleared the business component test (the research was intended to discover information that will be useful in the development of a new or improved business component of the taxpayer) and the technology information test (the research was undertaken for the purpose of discovering technological information). Also, the three projects satisfied the Section 174 test, which governs the deductibility of research or experimental expenditures that are defined as “research and development costs in the experimental or laboratory sense.”

However, none of the projects met the process for the experimentation test. This standard requires that substantially all of the research activities constitute elements of a process of experimentation for the purpose of discovering a new or improved function, performance, reliability or quality.

Tell City asserted the design and development of the vessels would have been impossible without each phase of its iterative design process. The department countered that Tell City did not design the vessels from scratch but rather made “standard modifications to existing designs and/or incorporated well-known capabilities into another vessel.”

The Tax Court found Project 107 and Project 109 mostly consisted of integrating known capabilities into the vessels. Also, the Tax Court noted the evidence for Project 111 did not explain how the research activities “constituted even a simple trial and error process, much less (exhibited) a series of trials to test a hypothesis, analyze data, refine the hypothesis, and retest it to constitute a process of experimentation in the scientific sense.”

In addition, the Tax Court found a fourth vessel, Project 112, was also ineligible for the Indiana credit. The court held Tell City did not have the right to sell, lease, license or use the boat in its trade or business and was not a party to an assignee of the construction contract. Also, the Tax Court did not consider the shrinking-back rule in this case.