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which expressly stated that all of Cajun’s to what extent, expenditures could po- which allows those taxpayers to avoid
work product transferred to its client. tentially be considered funded research. the documentation rules as long as they
For example, contract terms for one It would be prudent for taxpayers to treat 70% of the success-based fee as
project defined Cajun’s work product as evaluate all agreements related to the an amount that does not facilitate the
“work for hire” and expressly transferred qualified research and memorialize transaction and capitalize the remainder
all “rights, title, and interest” in the work supplemental facts if elements of the as facilitative. A covered transaction
product to the client. Contract terms for funded-research exclusion rules are not means (1) a taxable acquisition by the
another sample project cited by the court specifically addressed in contemporane- taxpayer of assets that constitute a trade
provided that “[a]ll inventions, discover- ous documentation. or business; (2) a taxable acquisition of
ies, and improvements (patentable and From Jennifer Frost, Esq., J.D., at least 50% of the ownership interest in
unpatentable) that are made or con- LL.M., Washington, D.C.; Jason Seo, a business entity; or (3) certain reorgani-
ceived by [Cajun] or [Cajun’s] employees J.D., LL.M., Washington, D.C.; John zations described in Sec. 368(a)(1).
in performing the Services … shall be- Andress, CPA, Atlanta; Dennis St. Mar- Rev. Proc. 2011-29 was published
long to Company.” Citing Dynetics, the tin, CPA, Washington, D.C.; and Kevin over a decade ago with the goal of re-
court found such contract language to Benton, E.A., Dallas, all with Grant ducing the controversy between taxpay-
be convincing and indicated that Cajun Thornton LLP. ers and the IRS over the allocation of
failed to show a plausible contractual success-based fees between facilitative
basis that it retained substantial rights to and nonfacilitative activities. While
the research. Expenses & Deductions the safe harbor has been largely suc-
The court made no ruling on the cessful in its goals, taxpayers still face
fourth sample project regarding the Uncertainties remain in several areas of uncertainty in analyzing
substantial-rights standard, since the analyzing success-based fees success-based fees. This item surveys
contract was silent on the ownership Under Regs. Sec. 1.263(a)-5(a), a tax- four such areas.
of the construction process developed payer must capitalize an amount paid
during the project. However, the court to facilitate an acquisition of a trade or Milestone payments
concluded that the project did not meet business, a change in the capital struc- In addition to receiving success-based
the risk standard. Acknowledging that ture of a business entity, and certain fees, investment bankers are often paid
the contract associated with the project other transactions. An amount is paid milestone payments that are contingent
was a fixed-price contract, the court to facilitate a transaction if it is paid in on something other than the successful
distinguished Cajun’s facts from those the process of investigating or otherwise closing of a transaction. For example, a
in Populous and other prior case law by pursuing the transaction. banker might receive a retainer payable
referencing specific contract terms that The regulations require taxpayers to upon the execution of the engagement
stated monthly payments included “full satisfy a special documentation require- letter between the banker and the tax-
compensation for all loss, damages, or ment for success-based fees, which are payer, a signing fee contingent on the
risks of every description connected amounts paid that are contingent on the execution of the deal agreement, or a
with or resulting from the nature of the successful closing of a transaction. Under fairness opinion fee contingent upon the
work.” The court found such language Regs. Sec. 1.263(a)-5(f), a success- provision of a fairness opinion by the
conclusive in determining the research based fee is treated as facilitative, and banker to the taxpayer. These fees are
performed during the sample project therefore capitalized, unless the taxpayer generally creditable against the success-
was funded. maintains sufficient documentation to based fee, meaning the amount of
establish that a portion of the fee is al- success-based fee owed by the taxpayer
Importance of case law to locable to activities that do not facilitate is reduced by the amount of the mile-
structuring agreements the transaction. Such documentation stone payments.
As evidenced by the developments in must consist of more than merely an al- In 2014, the Large Business and
Perficient and Grigsby, the funded- location between activities that facilitate International (LB&I) Division of the
research exclusion continues to be a the transaction and activities that do not IRS issued a directive instructing its
highly contentious and evolving provi- facilitate the transaction. examiners to not challenge the ap-
sion of the research credit. In lieu of Taxpayers that engage in a “covered plication of the Rev. Proc. 2011-29
additional, much-needed guidance on transaction” under Regs. Sec. 1.263(a)- safe harbor to milestone payments
the matter, taxpayers should consider 5(e)(3) may take advantage of a safe creditable against success-based fees
prior case law when evaluating if, and harbor provided by Rev. Proc. 2011-29, (LB&I-04-0114-001). This directive

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