Tax Court disallows wheat milling company's research credit

On April 15, 2019, the Tax Court held in Siemer Milling Company v. Commissioner, T.C. Memo. 2019-37, that the petitioner did not properly support the research credit under Internal Revenue Code section 41. The Tax Court therefore disallowed the petitioner’s claimed research credits for the tax years ended May 31, 2011, and May 31, 2012.

The petitioner (Siemer) is an Illinois-based company that has been in the business of milling wheat since the 1950s. Siemer’s longtime accounting firm prepared its returns, credit studies, certified audits and financial statements during the tax years at issue. During those tax years, Siemer claimed the research credit for research activities related to seven different projects, some of which spanned both tax years.

The Tax Court applied the section 41 research credit rules to each project separately. To qualify for the research credit, an activity or project must meet a four-part test: the section 174 test, the technological information test, the business component test and the process of experimentation test.

1. The section 174 test: There must be a permitted purpose under section 174 relating to a new or improved business component’s function, performance, quality, reliability or composition.
2. The technological information test: The research must rely on principles of the physical sciences, biological sciences, computer science or engineering.
3. The business component test: The activity must be intended to discover information to eliminate technical uncertainty regarding the capability or method for developing or improving a process or product or the appropriateness of the product design.
4. The process of experimentation test: There must be a systematic process of experimentation used to resolve technical uncertainties.

The Tax Court agreed with Siemer that the projects represented business components meeting the requirements of section 41. The court noted that the development process of a single business component can span multiple years. Further, a project can face the same uncertainty in more than one year.

Nonetheless, the court agreed with the IRS that Siemer was not entitled to the research credit in either year. Siemer failed to provide adequate documentation to demonstrate its process of experimentation. Asserting that the petitioner used an iterative process, or trial and error, was not enough in the opinion of the Tax Court. The credit studies produced by Siemer’s accounting firm did not help. The studies “included very little evidence of Siemer’s asserted process of experimentation.”