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that Fairchild’s research was funded performed the contracted work for a Geosyntec’s research. This distinguished
research. It found that the sole inquiry fixed total price, and the remaining Geosyntec from the contract in Fairchild,
in evaluating financial risk is who bears three sample contracts were “capped” which contained detailed contract
the research costs upon failure, not contracts, under which Geosyntec billed specifications approval requirements
the likelihood of a project’s success or its clients for labor and other expenses and became the cornerstone of the
failure. The court determined the in- incurred up to an agreed-upon maxi- court’s decision.
spection and acceptance clauses clearly mum price.
placed financial risk on Fairchild, as it Citing Fairchild, the court deter- Funded-research case law
had no right to payment until it fully mined that the fixed-price agreements A prominent case that addresses the
succeeded in each phase of the project. did not constitute funded research, ref- substantial-rights standard of the
Additionally, the court determined erencing the inspection and acceptance funded-research exclusion is Lockheed
the “advances” or “progress payments” clauses, which permitted clients to with- Martin Corporation, 210 F.3d 1366 (Fed.
distributed during performance did not hold payment to Geosyntec until each Cir. 2000). Lockheed Martin Corp., a
shift financial risk away from Fairchild, milestone was completed and accepted. defense contractor for the federal gov-
as Fairchild was not entitled to retain In contrast, the court concluded that ernment, entered into multiple contracts
any such payments if it did not success- the capped contracts constituted funded for a variety of defense technology de-
fully produce the product to which the research. Geosyntec argued, in part, that velopment programs. During litigation,
payment related. its risk of not receiving the full maxi- contracts associated with a total of four
Another instructive case as it per- mum price or, conversely, of exceeding programs were evaluated. The contracts
tains to the risk standard is Geosyntec its own budget resulted in its retaining included regulatory clauses that detailed
Consultants, Inc., 776 F.3d 1330 (11th financial risk over the contracts. patent rights, technical data, and com-
Cir. 2015), aff’g No. 12-80334-Civ The court disagreed, contending that puter software rights; security classifica-
(S.D. Fla. 4/15/13). Geosyntec Con- the sole focus when assigning financial tion guidelines; and provisions regarding
sultants, a consulting and engineering risk is which party bears the financial the government’s recovery of nonrecur-
firm, claimed the research credit for loss in the event of failure, not the ring costs on commercial sales (cost
work performed pursuant to certain underlying profitability of a given agree- recovery). Under the cost-recovery pro-
contractual agreements. Geosyntec and ment. Relevant to current developments vision, Lockheed Martin was required
the government agreed to have the issue in the Perficient case, the court indicated to reimburse the government a propor-
decided based on six sample contracts to that the capped contracts contained tionate share for the sale or license of
expedite the examination process. Three no inspection or acceptance criteria or similar technology and products that
of the sample contracts were fixed-price method for rejection that expressly made the company sold to consumers, subject
agreements, under which Geosyntec payment contingent on the success of to any patent or technology software
restrictions provided in the contracts.
However, Lockheed Martin retained
the right to use its research results in its
business without any further payment to
the government.
The Lockheed Martin case was ul-
timately decided on appeal, where the
Federal Circuit held that the programs
at issue did not constitute funded
research because Lockheed Martin re-
tained substantial rights in the research.
The court cited Regs. Sec. 1.41-2(a) and
rejected the government’s argument that
substantial rights exist only when the
taxpayer retains the right to exclude oth- IMAGE BY PROFESSOR25/GETTY IMAGES
ers from its research and other parties do
not also have the right to use or disclose
the taxpayer’s research. Important to
the Perficient case, the court in Lockheed

12 March 2023 The Tax Adviser