In almost two decades of litigating cases tied to the Section 41 R&D credit, ZMFF&J has worked with taxpayers big and small to defend credit claims. Every once in a while, though, a case comes across our desks that carries the gravitas of an entire industry, and not just one taxpayer.
Last month’s validation of R&D claims for livestock producers by the U.S. Tax Court, via its decision in George’s of Missouri, Inc. v. Commissioner, was one of those moments.
Setting the stage
The Credit for Increasing Research Activities has evolved since its inception, but the fundamentals remain the same: taxpayers can claim a powerful credit for wages, supplies, contractors, and computer rental costs related to the development of new or improved products, processes, software, and other “business components” held for sale. The world of agriculture, where products and processes are developed to maximize yield and quality, is rife with activities that qualify for this incentive.
Every day, American farmers, ranchers, growers, food scientists, and processors look for ways to bring more product faster to their customers. Their work ranges from experimenting with seed varieties and treatment chemicals, to assessing the impacts of processing methodologies and equipment. Although it’s not always done in a lab by PhD scientists, the process of experimentation leveraged by the ag sector is as highly technical as you’ll find in any other industry such as manufacturing or software development.
What were the activities in question?
alliantgroup, LP, which shares several of our co-founders, was engaged in 2014 to perform an R&D study for George’s of Missouri, Inc. (GOMI), one of the largest fully-integrated poultry producers in the USA. During this engagement, alliantgroup determined that many of GOMI’s activities constituted qualified research and calculated credits based on the associated supply costs.
These expenditures consisted of feed supplied to poultry subjected to different vaccines, antibiotics, probiotics, genetics, and disease prevention protocols. The results of these different trials were assessed from the standpoint of growth, disease, and mortality rates, to the end of increasing the amount and quality of poultry raised for sale, as well as the animals’ health.
What were the key issues evaluated by the Tax Court?
The Internal Revenue Service took issue with several aspects of the claim, the first of which was the nature of the activities. Since George’s was not developing any medications or chemicals themselves, the IRS characterized its activities as routine evaluation of commercially-available alternatives. Moreover, the IRS took issue with the extent to which the activities were documented in certain research projects.
Although the Tax Court had previously validated R&D claims for row crop operations in JG Boswell Co vs. Commissioner (2022), the GOMI case was its first foray into how livestock producers qualified for this incentive.
How did the Tax Court react to GOMI’s claim?
The Tax Court concurred with George’s regarding the qualified aspects of GOMI’s activities. Since poultry producers routinely deal with margins as low as one cent per pound of meat, any incremental improvement in animal health or size is hard-fought and meaningful. When experimenting with different compounds and processes, GOMI utilized an analytical approach rooted in the hard sciences of biology and chemistry. The work was systematic and heavily data-driven. As such, it met all requirements laid out in Section 41.
The feed provided to the poultry during the course of these trials was a necessary component of the process of experimentation. Thus, the Tax Court concurred that the feed was used directly in GOMI’s R&D, and since it was tangible property not subject to a depreciation allowance or constituting land or improvements to land, its purchase legitimately constituted supply costs.
The primary area where the Tax Court sided with the IRS related to several projects whose activities were not sufficiently documented. Although this slightly decreased the ultimate amount of credits sustained during the audit, it provided some much-needed guidance and clarification for an industry that hitherto lacked both.
The importance of finding the right provider
During the course of this litigation, the IRS sought accuracy-related penalties for the downward adjustment in credits. Here the Tax Court also differed in opinion, as GOMI had acted in good faith by engaging the services of a reputable provider, and thus did not meet the threshold for Section 6662(a) penalties.
In fact, the Court specifically referenced alliantgroup’s highly-qualified personnel, which included industry experts and former federal executive and legislative heavyweights. The Court also referenced alliantgroup’s extensive study process, which included multiple on-site visits, employee interviews, and detailed review of costing and project documentation.
Conclusion
On top of the Boswell decision validating R&D claims for row crop growers, the recent GOMI decision is welcome news for America’s hard-working livestock growers and processors, even earning kudos from Former U.S. Secretary of Agriculture Mike Johanns.
Our lead counsel in the case, John Dies, said it best: “The Tax Court deserves tremendous credit for carefully analyzing the science and innovation happening every day on American farms, ranches, and food science businesses. These rulings recognize that agriculture is an innovation-driven industry where producers constantly experiment to improve yields, animal health, disease resistance, and sustainability. The Court’s decisions solidify the legislative intent of promoting innovation for livestock and crop producers nationwide.”
