Court Opinion

ID: 9949857
Source: CourtListenerOpinion
Date Created: 2024-03-12 19:05:48.548143+00
Date Added: 2024-06-11T14:34:05.657227
License: Public Domain

United States Tax Court

                               T.C. Memo. 2024-28

               RAMESH C. KAPUR AND CHANDA KAPUR,
                            Petitioners

                                           v.

               COMMISSIONER OF INTERNAL REVENUE,
                           Respondent

                                     __________

Docket No. 14017-21.                                         Filed March 12, 2024.

                                     __________

Jeremy M. Fingeret, Jefferson H. Read, and Matthew S. Reddington, for
petitioners.

Jonathan E. Behrens, Kerrington A. Hall, and Allison N. Kruschke, for
respondent.

                          MEMORANDUM OPINION

       PUGH, Judge: This case concerns petitioners’ entitlement to
Credits for Increasing Research Activities (research credits) under
section 41. 1 The Internal Revenue Service (respondent) disallowed
claimed research credits that flowed through Kapur & Associates, Inc.
(KAI), an S corporation, to petitioners during tax years 2014, 2016, 2017,
and 2018 (years in issue).

       Petitioners’ claimed research credits and respondent’s
determinations for the years in issue (in a notice of deficiency dated
April 12, 2021) are summarized below.

        1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the
Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and
Rule references are to the Tax Court Rules of Practice and Procedure.

                                 Served 03/12/24
                                            2

[*2]                          Claimed
                                                            Penalty
                    Year      Research      Deficiency
                                                           § 6662(a)
                               Credit

                    2014        $107,375        $107,375      —

                    2016           52,214         30,916      —

                    2017           35,935         35,935      $7,187

                    2018           43,434         12,422      —

                    Total       $238,958     $186,648         $7,187

      Before the Court is petitioners’ Motion for Protective Order. 2 The
parties dispute whether discovery and trial should be limited to a
sample of projects at this stage of litigation. 3 We decline to order
sampling for the reasons summarized below. 4

                                     Background

       The following facts are derived from the parties’ pleadings and
Motion papers, including the accompanying declarations and exhibits.
They are stated for purposes of deciding the Motions before us and not
as findings of fact in this case.

       Petitioners are married and jointly filed tax returns for the years
in issue. They resided in Wisconsin when they filed their Petition. The

        2 The disposition of petitioners’ Motion for Protective Order is a prerequisite to

disposition of respondent’s Motion to Compel the Taking of Deposition and Motion to
Compel Responses to Interrogatories, which also are pending. We expect the parties to
continue pretrial preparations including discovery and will order a future status report
informing the Court of their progress in this case taking this Opinion into account and
including in that status report the status of those two Motions before we decide them.
        3 We loosely refer to “projects” throughout this report to align with the relief

sought by petitioners. We note that entitlement to research credits is based on
evaluation of each “business component.” § 41(d)(2)(A); Treas. Reg. § 1.41-4(b). A
“business component” generally is defined as a product or process that the taxpayer
either holds for sale, lease, or license or uses in its trade or business. § 41(d)(2)(B).
        4 This appears to be a recurring issue. See, e.g., Phx. Design Grp., Inc. v.

Commissioner, No. 4759-22 (T.C. Aug. 29, 2023) (order); Feller v. Commissioner, No.
11581-20 (T.C. Aug. 10, 2023) (order). Respondent referred us to these orders but of
course they are not precedential.
                                    3

[*3] U.S. Court of Appeals for the Seventh Circuit is the appellate venue
for this case absent contrary stipulation by the parties. See
§ 7482(b)(1)(A), (2).

       Ramesh C. Kapur is the founder, chief executive officer,
president, and majority shareholder of KAI. KAI is a civil and
environmental engineering firm that designs transportation and
remediation systems. The research credits at issue are a function of
KAI’s claimed qualified research expenditures (QREs) flowing from KAI
to petitioners. These claimed QREs are attributable to wages KAI paid
its employees. It employed approximately 200–300 individuals during
the years in issue.

      KAI timely filed Forms 1120S, U.S. Income Tax Return for an
S Corporation, for the years in issue. Petitioners claimed flowthrough
research credits totaling $238,958 with respect to KAI’s projects. (They
did not claim research credits with respect to all of KAI’s projects.)
Respondent disallowed research credits claimed by petitioners on their
Forms 1040, U.S. Individual Income Tax Return, for the years in issue.

      KAI, with the assistance of alliantgroup, LP, used a “variable
sampling methodology” as part of its QRE calculation for the claimed
research credits. This involved drawing a “stratified random sample”
from a “sampling frame” (the 2,000–3,000 projects KAI undertook over
the course of the years in issue), removing nonqualifying projects, and
then determining eligibility for the research credits. The results of this
“study” then were extrapolated to the remaining projects.

      Before filing the pending Motions respondent issued informal
discovery requests to petitioners. Petitioners limited their responses to
KAI’s largest projects: the Zoo Interchange Project and the Louisville
ORB Project. Petitioners represented that these two projects account for
over 72% of the claimed QREs. Formal discovery ensued.

       Respondent’s formal discovery requests—interrogatories and
requests for production—seek information about the entire sampling
frame. Relatedly, respondent seeks to interview 16 KAI employees,
including Mr. Kapur, and petitioners request that we narrow the list to
two to four individuals with knowledge of the projects petitioners
selected. As to respondent’s Motion to Compel Mr. Kapur’s deposition
petitioners do not object outright but want to limit its scope to “specific
reasonable topics.” In short, the parties are unable to agree on whether
                                     4

[*4] discovery and trial should be limited to a sample of two to four
projects, as petitioners urge, or include the entire sampling frame.

                                Discussion

I.     Credit for Increasing Research Activities Under Section 41

        Section 41 generally allows taxpayers a research credit for
increases to QREs over a “base amount.” § 41(a), (c). To be eligible for a
research credit taxpayers must demonstrate that they have performed
“qualified research” during the tax year in issue. § 41(a)(1)(A), (b)(1),
(d)(1). To determine whether an activity is qualified research, we employ
a four-part test: (1) the section 174 test, (2) the technological information
test, (3) the business component test, and (4) the process of
experimentation test. § 41(d)(1); Max v. Commissioner, T.C. Memo.
2021-37, at *28 n.10 (citing Siemer Milling Co. v. Commissioner, T.C.
Memo. 2019-37, at *19). The four-part test is applied separately to each
“business component.” § 41(d)(2)(A); Treas. Reg. § 1.41-4(b).

II.    Burden of Proof

       Ordinarily, the burden of proof in cases before the Court is on the
taxpayer. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The
parties agree that petitioners have the burden at trial to prove
entitlement to the claimed research credits. See Feigh v. Commissioner,
152 T.C. 267, 270 (2019) (first citing INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); and then citing Segel v. Commissioner, 89 T.C.
816, 842 (1987)).

III.   Analysis

       Discovery must be proportional to the needs of the case. Rule
70(b)(1). We evaluate “the importance of the issues at stake in the
action, the amount in controversy, the parties’ relative access to relevant
information, the parties’ resources, the importance of the discovery in
resolving the issues, and whether the burden or expense of the proposed
discovery outweighs its likely benefit.” Id. We have broad discretion to
limit the scope of discovery. See Rule 70(c)(1).

      The parties dispute whether limiting discovery and trial to a
sample at this juncture would improperly relieve petitioners of their
burden of proof. Respondent contends that selecting a representative
sample for discovery and trial is not possible without first considering
preliminary information on all business components.
                                     5

[*5] The Government successfully argued similar points in Bayer
Corp. & Subs. v. United States, 850 F. Supp. 2d 522 (W.D. Pa. 2012). In
Bayer, the Government sought discovery on each business component
before entertaining a sampling proposal. Id. at 528. The district court
later rejected the plaintiff’s sampling proposal because it did not identify
all business components. Id. at 545–46. The court reasoned that “a
sampling plan that would not identify all of the business components
underlying the claimed QRE credits is not acceptable in the absence of
agreement by the Government.” Id. at 546. The court’s holding in Bayer,
while not binding on this Court, is instructive in the light of the
comparable issues presented in this case.

       In research credit cases it is common for parties to agree to
sampling in lieu of extensive discovery and litigation with respect to
each project. In some cases, the parties agree at the outset to try a
sample that is binding on all projects. See Suder v. Commissioner, T.C.
Memo. 2014-201, at *15. In others, the parties agree to try a sample with
the expectation that the Court’s conclusions will enable the parties to
resolve their differences with respect to the remaining projects. See
Little Sandy Coal Co. v. Commissioner, T.C. Memo. 2021-15, at *20–21,
aff’d, 62 F.4th 287 (7th Cir. 2023); Union Carbide Corp. & Subs. v.
Commissioner, T.C. Memo. 2009-50, 2009 WL 605161, at *2, *4, aff’d,
697 F.3d 104 (2d Cir. 2012). We also have selected the sampling
methodology where the parties are agreeable to sampling but are unable
to agree on a method. See Tangel v. Commissioner, No. 27268-13 (T.C.
Feb. 22, 2018) (order). More unusual is the situation before us in which
respondent objects wholesale to sampling.

       Respondent disputes that the two largest projects—the Zoo
Interchange Project and the Louisville ORB Project—are representative
of the remaining projects. Petitioners counter that discovery related to
2,000–3,000 projects is not proportional to the amount in controversy.
The flaw in petitioners’ position is that they have not identified business
components that would allow respondent to evaluate a sample before
arguing for sampling. That is, petitioners have not given respondent, or
us, enough information about all of the projects to determine whether a
sample of two to four projects would be a representative sample.

      Respondent also claims that we do not have discretion to order
sampling at the request of petitioners if respondent objects. We disagree:
We do have authority to limit discovery (including by ordering sampling)
over the objection of a party. See Rule 70(c)(1). Nonetheless, we agree
that exercising our discretion to limit the scope of discovery and trial in
                                    6

[*6] accordance with petitioners’ Motion for Protective Order is
improper at this stage. The only issue in this case is whether petitioners
are entitled to the research credits claimed for the years in issue.
Evaluating compliance with section 41 necessarily involves
consideration of the underlying business components. And petitioners
agree that they have the burden of showing entitlement to the claimed
research credits. See Feigh, 152 T.C. at 270. As we have said previously,
“[a]bsent an agreement between the parties, project sampling
improperly relieves the taxpayer of its burden of proving entitlement to
the research credit claimed.” Betz v. Commissioner, T.C. Memo. 2023-84,
at *77 n.30 (citing Bayer, 850 F. Supp. 2d at 538, 545–46).

       On balance, respondent’s formal discovery requests are
“reasonably calculated to lead to discovery of admissible evidence” with
respect to petitioners’ eligibility for the claimed research credits. See
Rule 70(b)(2). Respondent’s attempts to procure this information
through informal means were unsuccessful. And respondent has no
alternative method of acquiring this information. We therefore conclude
that the significance and necessity of this discovery to the resolution of
this case outweighs the expense to petitioners.

       In addition, to the extent that petitioners believe that the expense
is disproportionate they can limit their claim to research credits for
QREs relating to the two projects they represent should be the sample.
But if they claim more research credits, they must be prepared to
substantiate QREs. And nothing bars petitioners from identifying
information regarding business components in the sampling frame that
then might allow respondent to agree to a representative sample.

       We have considered all arguments made and, to the extent not
mentioned above, we conclude that they are moot, irrelevant, or without
merit.

      To reflect the foregoing,

      An appropriate order will be issued denying petitioners’ Motion for
Protective Order and requiring a status report in accordance with this
Opinion.