CRA Holdings US, Inc. and Subsidiaries v. United States Government
Filing
113
DECISION AND ORDER. Defendant's Motion to Compel 72 is DISMISSED in part, and DENIED in part. Plaintiffs shall show cause within 10 days of this Decision and Order why Defendant's expenses incurred in connection with Defendant's Mot ion to Compel should not, pursuant to Fed.R.Civ.P. 37(a)(5)(A), be granted; Defendant's response shall be filed within 10 days thereafter; Plaintiffs' reply, if any, may be filed within five days after Defendants response. Oral argument shall be at the courts discretion. Signed by Hon. Leslie G. Foschio on 7/12/2018. (SDW)
UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF NEW YORK
________________________________________
CRA HOLDINGS US, INC. AND SUBSIDIARIES,
Plaintiffs,
DECISION
and
ORDER
v.
15-CV-239W(F)
UNITED STATES OF AMERICA,
Defendant.
________________________________________
APPEARANCES:
ZERBE FINGERET FRANK & JADAV
Attorneys for Plaintiffs
JOHN H. DIES,
JEFFERSON H. READ,
ROBERT G. WONISH, II, of Counsel
3009 Post Oak Boulevard, Suite 1700
Houston, Texas 77056
RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General
Tax Division, U.S. Department of Justice
Attorney for Defendant
JAMES M. STRANDJORD, of Counsel
PO Box 55
Ben Franklin Station
Washington, DC 20044
In this R&D tax refund case based on Plaintiffs’ claim that Plaintiffs, a national
environmental remediation company, are entitled to recover $618,143 in taxes for
Plaintiffs’ tax years 2002 ($245,077) and 2003 ($413,066). Plaintiffs’ claim is predicted
on various amounts of R&D tax credits to which Plaintiffs allege Plaintiffs are entitled
pursuant to 28 U.S. C. § 41 et seq. (“§ 41 ___”) arising from Plaintiffs’ Qualified
Research Expenses as defined in § 41 (b)(1) (“QREs”) incurred in connection with 159
environmental remediation projects undertaken by Plaintiffs during the tax years at
issue. Initially, Plaintiffs sought refunds based on 6,100 such projects, however,
Plaintiffs subsequently reduced to 159 the number of projects upon which the refund is
calculated resulting from Plaintiffs’ assessment of the litigation costs expected in
asserting a refund based on the 6,100 projects as originally alleged by Plaintiffs in the
Complaint including numerous projects for which Plaintiffs sought small refunds. At the
parties’ request, discovery has been extended to June 28, 2018, with dispositive
motions to be filed November 28, 2018. See Third Amended Scheduling Order ¶¶ 2, 4
(Dkt. 92). Upon Plaintiffs’ motion, the court determined that in this case discovery and
trial should be based on a random sample of 12 of the 159 projects. See CRA Holdings
US, Inc. and Subsidiaries v. United States of America, 2017 WL 3404758, at *1
(W.D.N.Y Aug. 8, 2017) (Dkt. 69); CRA Holdings US, Inc. and Subsidiaries v. United
States of America, 2017 WL 370811, at **5-6 (W.D.N.Y. Jan. 26, 2017). In accordance
with the court’s directions, see CRA Holdings US, Inc. and Subsidiaries, 2017 WL
3404758, at *4, the parties thereafter selected 12 projects which are the basis of ongoing merit-based discovery, summary judgment practice and, if necessary, trial. See
Dkt. 72-1 ¶ 4.
In response to Defendant’s First Request for Production and Third Set of
Interrogatories dated September 15, 2017, Dkt. 72-3, directed to the 12 projects
included in the sample, Defendant moves to compel, as relevant, Plaintiffs’ answers to
Interrogatories No. 2 relating to experiments conducted by Plaintiffs, No. 3 (requesting
Plaintiffs identify all of Plaintiffs’ business components that are relevant to 26 C.F.R. §
1.41-4(b)(2) (“shrink-back rule”)), and Nos. 4-5 (relating to Plaintiffs’ computation of
qualified research expenses (“QREs”) for the base period 1984 – 1988) (“Defendant’s
2
September 2017 Discovery Requests”).1 The shrink-back rule permits a taxpayer to
comply with the requirement of § 41(d)(1) that the R&D credit arise from QREs relating
to the taxpayer’s business components (i.e., Plaintiffs’ “product, process, computer
software, technique, formula, or inventions to be held for sale, lease or license”) if the
taxpayer’s “overall business component” fails to meet § 41(d)(1)’s definition of a
business component by establishing that “the most significant subset of elements of”
such process, etc. satisfies the requirement of § 41(d)(1). See 26 C.F.R. § 1.42-4(b)(2).
Plaintiffs responded to Defendant’s September 2017 Discovery Requests by serving on
September 29, 2017, Plaintiffs’ Amended Disclosures (“Plaintiffs’ Amended
Disclosures”) (Dkt. 72-4) and, on October 16, 2017, Plaintiffs’ responses to Defendant’s
September 2017 Discovery Requests (“Plaintiffs’ Responses”) (Dkt. 72-5).
In Plaintiffs’ Amended Disclosures Plaintiffs identified 15 former CRA employees
with knowledge of the facts supporting Plaintiffs’ refund requests,2 described five
categories of documents related, inter alia, to Plaintiffs’ Base Period calculation as a
required component for Plaintiffs’ calculation of damages, i.e., Defendant’s denials of
Plaintiffs’ refund requests, which response included a copy of a page from Plaintiffs’ IRS
Form 6765 which requires taxpayers seeking R&D tax credit-based refunds to
1
Under § 41, the R&D tax credit is an amount equal to 20% of any excess of the taxpayer’s QREs for a
taxable, i.e., credit year, over a base amount, 28 U.S.C. § 41(a)(1), which amount is defined as the
product of the fixed-base percentage and the taxpayer’s average gross receipts for the four years
preceding the credit year, § 41(c)(1), but not less than 50% of the QREs for the credit year. § 41(c)(2).
The fixed-base percentage is generally the lesser of 16% of the percentage of the aggregate QREs of the
taxpayer for the base period years, or the aggregate gross receipts of the taxpayer for those years. See
§ 41(c)(3)(A) and (C). See Suder v. Comm’r. of Internal Revenue, 2014 WL 4920724, at **12-13 (U.S.
Tax Ct. 2014). The formula for computation of the R&D tax credit to demonstrate the importance of the
Fixed-Base Percentage in calculating Plaintiffs’ damages, i.e., alleged refund based on Plaintiffs’
demonstrated R&D tax credit pursuant to § 41 is more fully stated in the Appendix to this Decision and
Order. As the formula shows, as a taxpayer’s Fixed-Base Percentage declines, the requested R&D tax
credit and resultant refund increases.
2
It appears that Plaintiffs were acquired by a company named GHD. See Dkt. 72-4 at 7 (stating that the
15 listed former CRA employees are now GHD employees).
3
summarize basic information relevant to a calculation of the refund, see Dkt. 72-4,
including Plaintiffs’ Fixed-Base Percentage stated as 3.34% for each tax year at issue.
Dkt. 72-4 at 9. Plaintiffs also represented in response to Defendant’s Discovery
Requests that Plaintiffs would provide copies of responsive documents within 45 days.
Dkt. 72-5.
In answer to Defendant’s Interrogatory No. 1 requesting Plaintiffs describe the
business component for each of the 12 projects, a requirement for a § 41 R&D tax
credit, Plaintiffs’ provided a one-paragraph description of each project in which Plaintiffs
engaged in the “[d]evelopment of a new process of remediation” – all involving
remediation of some form of environmental contamination. Dkt. 72-5 at 7-11. Plaintiffs
responded to Defendant’s Interrogatory No. 2 by stating the term “experimentation” as it
relates to Plaintiffs’ business components was ambiguous and that applicable IRS
regulations and caselaw does not support Defendant’s request as stated. Dkt. 72-5 at
11. In answer to Defendant’s Interrogatory No. 3, Plaintiffs stated Plaintiffs did not then
contend the “shrink-back rule” was applicable to Plaintiffs’ case, and that Defendant’s
interrogatory requesting how the rule may apply to Plaintiffs’ 12 projects was in any
event premature. Dkt. 72-5 at 12. Plaintiffs answered Defendant’s Interrogatories 4-5,
requesting Plaintiffs’ gross receipts information for the base period 1984-88 and,
identification of Plaintiffs’ business components and Plaintiffs’ related QREs for the base
period, by stating Plaintiffs had previously provided to Defendant financial statements
for Plaintiffs’ gross receipts during the base period, and explained how Plaintiffs
calculated on a consistent basis Plaintiffs’ QREs for the base period and the tax years
at issue including Plaintiffs’ gross receipts for each tax year at issue, and a list of
projects for the base period. Plaintiffs also asserted that under § 41 a calculation of
4
Plaintiffs’ QREs for the base period by business component is not required and that the
calculation of Plaintiffs’ base period QREs need only be consistent with that employed
by Plaintiffs for the tax years at issue. Dkt. 72-5 at 12-14.
Defendant objected to Plaintiffs’ responses as deficient in several particulars,
including Plaintiffs’ failure to describe “the process of experimentation” or an actual
“experiment” utilized by Plaintiffs for each project as required by § 41(d)(1)
(“substantially all of the research must contain elements of experimentation”) as
requested by Defendant’s Interrogatory No. 2, respond directly to Defendant’s
Interrogatory No. 3 requesting Plaintiffs particularize Plaintiffs’ possible reliance on the
shrink-back rule, and insisted on a complete response to Defendant’s request in
Interrogatories Nos. 4-5 for gross receipts information and a detailed statement of
Plaintiffs’ QREs for each project. See Dkt. 75-6 at 2-3. Defendant also objected that
Plaintiffs’ disclosure erroneously demanded refunds based on Plaintiffs’ assertion of
6,100 projects rather than Plaintiffs’ subsequent allegation of 159 projects as stated in
the Amended Complaint (Dkt. 51) filed March 10, 2017. Id. at 1. Plaintiffs responded
by disagreeing that Plaintiffs are required to elect at this time whether it intends to rely
on the shrink-back rule, agreed to provide more complete gross-receipts information,
but disagreed Plaintiffs are required to calculate Plaintiffs’ QREs on a business
component basis. Dkt. 75-7 at 1-2. Because of Plaintiffs’ alleged failure to provide
amended responses by November 8, 2017, Dkt. 72-9, as Plaintiffs had represented (see
Dkt. 72-1 ¶ 11) Defendant moved to compel Plaintiffs’ responses to Defendant’s
September 2017 Discovery Requests by papers filed November 8, 2017 (Dkt. 72)
(“Defendant’s Motion to Compel”). On November 9, 2017, Defendant also moved to
strike Plaintiffs’ Second Amended Complaint (Dkt. 73) (“Defendant’s Motion to Strike”).
5
Oral argument was conducted January 10, 2018 (Dkt. 81). Preliminary determinations
on Defendant’s Interrogatories Nos. 2, 3, 4, and 5 were made by the court at that time,
see, Discussion, infra, at 15-16; decision was reserved on the remaining issues
particularly, the adequacy of Plaintiffs’ disclosure under Fed.R.Civ.P. 26(a)(1)(A)(iii)
(“Rule 26(a)(1)(A)(iii)”) relative to Plaintiffs’ Fixed-Base Percentage.
1.
Plaintiffs’ Initial Disclosures.
In Defendant’s Motion to Compel, Defendant requests Plaintiffs’ Amended
Complaint (Dkt. 51) be dismissed as a sanction, pursuant to Fed.R.Civ.P.
37(b)(2)(A)(iii), (v) (“Rule 37(b)(2)(A)(iii), (v)”) for Plaintiffs’ failure to provide timely
disclosures required by Rule 26(a)(1)(A)(iii) regarding Plaintiffs’ damages, i.e., refund
claim in this case.
Specifically, Defendant contends Plaintiffs violated Rule 26(a)(1) by failing to
timely and accurately disclose to Defendant by September 30, 2017, the date
established for Rule 26(a)(1) disclosures by the court’s Second Amended Scheduling
Order (Dkt. 70), how Plaintiffs calculated Plaintiffs’ damages as alleged in the Amended
Complaint. Defendant also points to the fact that in Plaintiffs’ Amended Initial
Disclosures Plaintiffs erroneously included a damages calculation that failed to take into
account the substantially reduced refund amount based on the significant reduction in
the number of projects for Plaintiffs’ 2002 and 2003 tax years at issue upon which
Plaintiffs’ revised refund claim is based. Dkt. 72-2 at 3-4. Defendant asserts Plaintiffs’
attached schedule, a copy of Plaintiffs’ IRS Form 6765, also failed to account for
Plaintiffs’ reduced claim. Id. at 4. Nor, as Defendant argues, Dkt. 72-2 at 8, do
Plaintiffs’ Amended Disclosures correlate to either the Complaint or Amended
Complaint, demonstrating Plaintiffs’ Amended Disclosures failed to comply with Rule
6
26(a)(1)(A)(iii) with respect to exactly how Plaintiffs calculate Plaintiffs’ damages.
Defendant therefore requests dismissal of the Amended Complaint as a sanction based
on Plaintiffs’ willful disregard of the actual facts underlying Plaintiffs’ refund claim. Dkt.
72-2 at 10. (“[Plaintiffs] plainly . . . knew it was not the calculation of damages they
were claiming.”). With only three months remaining for discovery Plaintiffs’ unexcused
failures to timely and accurately disclose how Plaintiffs’ damages were to be calculated,
according to Defendant, demonstrate Plaintiffs’ “egregious” discovery misconduct was
intended to “obstruct [Defendant’s] discovery,” and such conduct therefore warrants
dismissal as a sanction pursuant to Rule 37(a)(3)(A)(iii), (v), which includes “striking the
pleadings” of the offending party. Id. at 9-10. Plaintiffs responded to Defendant’s
contentions by pointing to several alleged deficiencies in Defendant’s disclosures. Dkt.
76 at 1-2.
At oral argument on Defendant’s Motion to Compel, the court, as noted, reserved
decision to allow Defendant to review Plaintiffs’ Second Amended Disclosures which
Plaintiffs served on November 29, 2017, after Defendant’s Motion to Compel was filed.
See Dkt. 76-2 at 1-13. Specifically, Defendant contends that instead of providing an
accurate damages calculation to which Defendant is entitled, Plaintiffs’ Second
Amended Disclosure further compounds Plaintiffs’ failure to fully comply with Rule
26(a)(1)(A)(iii) in that Plaintiffs’ latest calculations do not match up with the refund claim
as alleged in the Amended Complaint or the Second Amended Complaint (Dkt. 71).
Part of the confusion created by Plaintiffs in this regard arises apparently from Plaintiffs’
acknowledgment that whereas the Amended Complaint did not include a $204,558 tax
credit carry back resulting from an earlier settlement of a Tax Court proceeding
involving Plaintiffs’ 2004 tax year (“the carry back”), Plaintiffs’ Second Amended
7
Complaint included such a claim. In Plaintiffs’ Second Amended Disclosures Plaintiffs
indicate Plaintiffs’ damages include refunds of $424,352 for tax year ending September
30, 2002, and $918,824 for tax year ending September 30, 2003, plus an additional
$204,558 representing the carry-back. However, Plaintiffs’ Second Amended
Disclosures refers to Plaintiffs’ “original” claims and includes only numbers included in
Plaintiffs’ Form 6765 which state refunds for Plaintiffs’ 2001-2002 and 2002-2003 years
of $424,352 and $918,824, respectively, neither of which correspond to the refunds
alleged in either the Amended Complaint ¶ 15 ($245,077; $413,066) or the Second
Amended Complaint ¶ 15 ($245,077; $413,066). The court therefore finds Plaintiffs’
Second Amended Disclosure does not sufficiently comply with Rule 26(a)(1)(A)(iii) with
respect to Plaintiffs’ calculation of damages. Under Rule 37 the court shall impose
sanctions that are “just.” Linde v. Arab Bank, PLC, 706 F3d 92, 101 (2d Cir. 2013)
(“Rule 37(b) authorizes district court to impose sanctions upon a party for failing to
comply with discovery order, so long as those sanctions are ‘just’”). In complying with
Rule 26(a)(1), a party is expected to exercise reasonable efforts including consulting
available records and employees as sources upon which to prepare the required
disclosures. See Chen-Oster v. Goldman, Sachs & Co., 285 F.R.D. 294, 308 (S.D.N.Y.
2012) (requested party’s “obligation is to make reasonable efforts to locate and produce
information responsive to the [requesting party’s] legitimate discovery demands”).
In this case, Plaintiffs have engaged in an IRS audit prior on Plaintiffs’ refund
claim to commencing this action in 2015 thus providing Plaintiffs ample opportunity to
ascertain both the actual amounts of refunds sought and the factual basis for Plaintiffs’
requests. Plaintiffs’ failure to do so on a timely basis, even after reducing the number of
projects upon which Plaintiffs’ claim is now based, certainly has delayed the orderly
8
prosecution of this case and also interfered with Defendant’s ability to prepare a
defense within the period allotted for discovery and, given the pendency of Defendant’s
Motion to Compel, will require the court to further enlarge the time for discovery to be
completed. Plaintiffs’ opposition (Dkt. 75), while explaining the apparent discrepancies
in Plaintiffs’ total damage claim, ignores the fact that Plaintiffs’ disclosures do not
provide a reasonably comprehensible basis for ascertainment of Plaintiffs’ R&D taxcredit based refunds for Plaintiffs’ 2002 and 2003 tax years as alleged in the Amended
and Second Amended Complaint. Other than referring to Defendant’s alleged failure to
complete disclosures, and explaining that Plaintiffs’ inadvertence caused Plaintiffs’
failure to include the $204,558 tax credit carry-back to be dropped from the Amended
Complaint, Plaintiffs provide no explanation sufficient to establish Plaintiffs’ inadequate
disclosures regarding Plaintiffs’ calculations of Plaintiffs’ damages was substantially
justified as required by Fed.R.Civ.P. 37(a)(5)(A) to avoid an award of moving party’s
expenses, even where the required disclosures are provided subsequent to the filing of
a motion to compel. That Defendant’s disclosures may be incomplete does not, of
course, excuse Plaintiffs’ failure to do so. See Fed.R.Civ.P. 26(a)(1)(E) (party required
to provide required disclosure even where the party has challenged to the adequacy of
the moving party’s disclosures). Following oral argument, Plaintiffs served on January
25, 2018, Plaintiffs’ Third Amended Initial Disclosures, which Defendant acknowledges
appear to adequately comply with Rule 26(a)(1). Dkt. 88 at 2 (“These disclosures
contain calculations of plaintiff’s claimed damages that, on their own, appear to satisfy
plaintiff’s obligation under Rule 26(a)(1) . . ..”). Accordingly, the court will not
recommend striking Plaintiffs’ Amended Complaint but will consider awarding Defendant
its reasonable expenses incurred in connection with Defendant’s Motion to Compel.
9
As a further ground for Defendant’s requested sanctions based on Plaintiffs’
inconsistent Rule 26(a)(1) disclosures with respect to Plaintiffs’ damages, Defendant
points to Plaintiffs’ Third Amended Disclosures stating that Plaintiffs’ Fixed-Based
Percentage of Plaintiffs’ 2002 and 2003 tax years was 1.67% versus 3.34% as Plaintiffs
had stated in Plaintiffs’ previous disclosures. See Dkt 88 at 2. Specifically, Defendant
maintains that although Plaintiffs, in the Amended Complaint, had vastly reduced the
number of projects upon which Plaintiffs’ refund claim is based to 159 from 6,100,
Plaintiffs now disclose Plaintiffs had also reduced Plaintiffs’ QREs for the 1984-88 base
period, a required element for calculation of a § 41 tax credit. Dkt. 88 at 2. Thus, in
Plaintiffs’ Third Amended Initial Disclosures Plaintiffs failed to explain that the basis for
Plaintiffs’ damages calculation include the asserted reduction in QREs yet continued to
allege in the Amended and Second Amended Complaints that the Fixed-Base
Percentage for the Base Period was 3.34%. Id. (referencing Dkt. 88 at 3) (Defendant’s
Exh. D). In short, Defendant argues Plaintiffs misleadingly and repeatedly asserted
such percentage was 3.34% and only recently disclosed in response to Defendant’s
Motion to Compel, that Plaintiffs’ damage calculation utilized a Fixed-Base Percentage
of 1.67%. Dkt. 88 at 3. Defendant also contends Plaintiffs’ Third Amended Disclosures
shows that Plaintiffs changed, i.e., “recalculated,” Plaintiffs’ method of calculating
Plaintiffs’ refund claim, i.e., by substantially reducing the number of projects Plaintiffs
conducted in the tax years at issue producing a newly disclosed Fixed Base Percentage
of 1.67%. Dkt. 88 at 4. Such change in methodology is, as Defendant also contends,
contrary to Plaintiffs’ answer to Defendant’s Interrogatory No. 6 which asserted that in
computing a base amount and the Fixed Base Percentage, a claimant need only apply
“a basis consistent with the definition of QREs . . . for the credit year,” Dkt. 88 at 6
10
(underlining added), and not based on the same method. Defendant therefore asserts
such significant inconsistencies amount to evasive answers and, pursuant to
Fed.R.Civ.P. 37(a)(4), are equivalent to a failure to accurately disclose, despite
Plaintiffs’ belated disclosures in Plaintiffs’ Third Amended Initial Disclosures describing
Plaintiffs’ methodology in calculating damages, warranting as a sanction, as Defendant
requests, that the Second Amended Complaint be dismissed or that Plaintiffs be
precluded from establishing Plaintiffs’ Fixed-Base Percentage is less than 3.34%, but
without prejudice to Defendant’s ability to contest such percentage, as Plaintiffs have
previously represented. Dkt. 88 at 5-6. Such inconsistent disclosures are material and
prejudicial to Defendant as any reduction in a claimant’s Fixed-Base Percentage in
seeking § 41 R&D tax credits and potential refunds has, according Defendant’s
calculation, increased Plaintiff’s total damages claim by $250,000. Dkt. 88 at 2.
Defendant does not provide any details demonstrating how Defendant’s asserted
$250,000 increase in Plaintiffs’ damages was computed; however, Plaintiffs have not
disputed Defendant’s assertions.
In Plaintiffs’ Memorandum In Opposition to United States [sic] February 7, 2018
Letter To The Court, Dkt. 94 (“Plaintiffs’ Response”) Plaintiffs noted that at oral
argument Plaintiffs agreed to supplement Plaintiffs’ disclosures to “provide additional
details on the computation [of Plaintiffs’ damages] and to clarify confusion with regard to
a prior calculation [of Plaintiffs’ damages].” Dkt. 94 at 2. In Plaintiffs’ response to
Defendant’s contentions seeking sanctions based on alleged inconsistencies between
Plaintiffs’ answer to Defendant’s Interrogatory No. 6, Plaintiffs’ Third Amended
Disclosure, and Plaintiffs’ change in the resulting computation, reducing Plaintiffs’ FixedBase Percentage to 1.67%, Plaintiffs maintain Plaintiffs’ disclosures were
11
straightforward and satisfactorily explain Plaintiffs’ method of computation, as
Defendant recently acknowledged, and that supplementation to Rule 26(a)(1)
disclosures is to be expected in the course of R&D tax credit litigation and, as such,
does not justify severe sanctions such as dismissal. Dkt. 94 at 3-4. Plaintiffs also argue
that there is no inconsistency between Plaintiffs’ answer to Defendant’s Interrogatory
No. 6 regarding Plaintiffs’ method for determination of Plaintiffs’ QREs for the base
period years 1984-88, as Plaintiffs were required to employ different methods based on
significant variations in Plaintiffs’ available records, e.g., lack of retention of physical
records, requiring Plaintiffs’ use of estimates, supporting such calculation. Dkt. 94 at 5.
Plaintiffs also contend Defendant’s complaints are too insubstantial to warrant any
sanctions. Dkt. 94 at 6-8 (citing Trinity Indus., Inc. v. United States, 757 F.3d 400 (5th
Cir. 2015) (reversing district court’s denial of plaintiff’s request to amend the plaintiff’s
Base-Period Percentage post trial)), and that because when Plaintiffs’ Third Amended
Disclosures were served on January 25, 2018, discovery was on-going and the Third
Amended Scheduling Order, filed February 26, 2018, extended the discovery period to
June 28, 2018, in order to allow the parties to sort out and resolve, through additional
discovery requests, including depositions, any remaining issues, including a definitive
understanding of Plaintiffs’ damages calculation, necessary to render the case ready for
summary judgment or trial. Dkt. 94 at 8 (citing caselaw). Plaintiffs also noted
Defendant’s Motion to Strike Plaintiffs’ Second Amended Complaint to include Plaintiffs’
carry-back refund was moot because Plaintiffs agreed to withdraw Plaintiffs’ Second
Amended Complaint thereby removing that claim from the case. Dkt. 94 at 8-9.
In Defendant’s reply (“United States’ Reply To Plaintiffs’ Memorandum in
Opposition To United States’ February 7, 2018 Letter To The Court”), filed March 19,
12
2018, (Dkt. 96) (“Defendant’s Reply”), Defendant reasserts that in opposition to
Defendant’s Motion to Compel filed November 29, 2017, Plaintiffs misstated Plaintiffs’
actual Fixed-Base Percentage as 3.34%, Dkt. 96 at 3 (Second Amended Initial
Disclosures show “how the [Plaintiffs’] R&D credits being claimed were calculated are
attached”) (citing to Dkt. 76-2 at 12 referencing the CRA Bates No. 1842 (“The base
amount and fixed base percentage are indicated at bates [sic] number CRA 1842”).
Bates number CRA 1842, included in the record at Dkt. 88 at 21, does not reflect
Plaintiffs’ base amount or Fixed Base Percentage. However, CRA 1843 (reproduced in
Defendant’s Motion to Compel in Dkt. 88 at 22) states Plaintiffs’ Fixed-Base Percentage
for Plaintiffs’ 2002 and 2003 tax years is 3.34%, not 1.67% as now stated in Plaintiffs’
Third Amended Disclosure, a fact which Defendant asserts Plaintiffs should have wellunderstood upon filing the Amended Complaint in March 2017 including Plaintiffs’
Second Amended Initial Disclosures, prior to serving on November 19, 2017 faulty
responses to Defendant’s discovery requests. Dkt. 96 at 3. Defendant further contends
that Plaintiffs’ reliance, see Dkt. 94 at 7-8, on Trinity Indus., Inc. v. United States, 757
F.3d 400, 412 (5th Cir. 2014) (allowing potential recalculation of Fixed-Base Percentage
after trial to achieve consistency between base period and claim period years with
respect to plaintiffs’ QREs) is misplaced in that although the 5th Circuit permitted such
potential recomputation, in that case there was no indication, unlike in the instant case,
plaintiff had improperly represented its Base-Period or Claim-Period information. Dkt.
96 at 4. However, in Trinity the court held remand to potentially recalculate plaintiff’s
R&D tax credit based on proper application of the required consistency of calculation of
plaintiff’s QREs for the base period and the claim period was required, Trinity, 787 F.3d
at 412, and, as such, the court’s holding does not assist this court in resolving the
13
asserted inadequacy of Plaintiffs’ disclosures for computation of Plaintiffs’ Base Period
Percentage. Accordingly, Trinity does not support Defendant’s request that Plaintiffs be
held to Plaintiffs’ Base Percentage of 3.34% as Plaintiffs initially disclosed, nor does it
support Plaintiffs’ opposition to Defendant’s request for sanctions. Defendant also
argues the delay associated with compelling Plaintiffs to correctly disclose Plaintiffs’
Base-Period Percentage has interfered with Defendant’s ability to prepare its defense
without incurring unnecessary expense and delay in addressing the merits of this case.
Dkt. 96 at 5. In particular, Defendant argues that even if such failure to make timely
disclosure of materials facts is the fault of Plaintiffs’ counsel in order to deter similar
misconduct, such a flagrant inattention to detail warrants preclusion of Plaintiffs’ use of
the 1.67% as Plaintiffs’ recently asserted Fixed-Base Percentage. Dkt. 96 at 6 (citing
Haas v. Delaware & Hudson Ry. Co., 282 Fed.Appx. 84, 86 (2d Cir. 2008) (failure to
properly disclose available facts precluded subsequent use of undisclosed witness’s
affidavit on issue of notice of defect to avoid summary judgment)).
Although Plaintiffs correctly point to the value of flexibility in enforcing Rule
26(a)(1) disclosure requirements in obtaining early and accurate disclosures to facilitate
the smooth development of discovery in R&D tax refund cases, such flexibility cannot
justify Plaintiffs’ repeated failure to promptly and correctly reveal its methodology with
respect to calculation of Plaintiffs’ Fixed-Base Percentage, a required and significant
element for correct computation of Plaintiffs’ R&D tax credits and resulting § 41 refund
claim. However, it is also the case that preclusion is one of the strongest sanctions
available to the court pursuant to Rule 37(b) which courts hesitate to impose, World
Wide Polymers, Inc v. Shinkong Synthetic Fibers Corp., 694 F.3d 155, 159 (2d Cir.
2012) (striking claims is a drastic remedy to be imposed only in extreme circumstances
14
after considerations of alternative sanctions) (citing cases); see also Safespan Platform
Systems, Inc. v. EZ Access, Inc., 2011 WL 747367, at *4 (W.D.N.Y. Dec. 30, 2011)
(declining to assess sanctions for lack of prejudice where discovery issue did not arise
on eve of trial or present any novel theory late in the proceedings), if other sanctions,
under the circumstances can sufficiently rectify the problem. Here, discovery is not yet
complete and has been recently stayed (Dkt. 112) to allow for complete judicial
resolution of Defendant’s Motion to Compel and Defendant’s Motion to Compel proper
responses to Defendant’s Fourth Set of Interrogatories, filed in March 2018 (Dkt. 95)
which remains pending while awaiting further briefing. A mutually acceptable schedule
for depositions of Plaintiffs’ Rule 30(b)(6) witness(es) and depositions of several of
Plaintiffs’ non-party fact witnesses, i.e., Plaintiffs’ employees and former employees, is
also being contested by the parties, Dkt. 112, requiring an extension of discovery for the
case. Thus, Defendant will have a reasonable and fair opportunity to inquire, in
sufficient detail including serving additional interrogatories, if necessary, into Plaintiffs’
methods for Plaintiffs’ calculation of damages, including the calculation of Plaintiffs’
Fixed-Base Percentage, and the facts upon which Plaintiffs’ Fixed-Base Percentage is
calculated. Accordingly, the court finds Defendant maybe entitled, as a sanction for
Plaintiffs’ insufficient Fixed-Base Percentage disclosure required by Rule 25(a)(1)(A)(iii),
to Defendant’s reasonable expenses incurred in prosecuting Defendant’s Motion to
Compel, but not dismissal of the Amended Complaint or preclusion limiting Plaintiffs’
evidence to Plaintiffs’ recently asserted 1.67% percentage in support of Plaintiffs’ claims
as Defendant requests. Plaintiffs’ Third Amended Disclosures, served January 25,
2018, provided such detail served after Defendant’s motion does not preclude, as
15
discussed, Discussion, supra, at 9, the award of Defendant’s expenses as a sanction.
See Fed.R.Civ.P. 37(a)(5)(A).
2.
Defendant’s Interrogatories.
With respect to Defendant’s Interrogatory No. 2 requesting Plaintiffs’ description
of “experimentation” as used in § 41(d)(1) conducted by Plaintiffs in relation to Plaintiffs’
business components for each of the 12 projects, at oral argument Defendant agreed to
serve an amended interrogatory. Accordingly, as to this Interrogatory, Defendant’s
Motion to Compel is deemed WITHDRAWN and as such is DISMISSED without
prejudice.
As to Defendant’s Interrogatory No. 3 requesting Plaintiffs provide a more
definitive statement with regard to Plaintiffs’ expected reliance on the shrink-back rule,
at oral argument the court determined Plaintiffs’ answer was, at the present time,
sufficient. As to Plaintiffs’ Interrogatory No. 3, Defendants’ Motion to Compel is
DENIED. Plaintiffs are, however, reminded of Plaintiffs’ duty to provide
supplementation to the extent required by Fed.R.Civ.P. 26(e).
As to Defendant’s Interrogatory No. 4 with regard to Plaintiffs’ gross receipts for
the base period information, at oral argument Defendant withdrew Interrogatory No. 4.
Accordingly, with respect to this Interrogatory, Defendant’s Motion to Compel is deemed
WITHDRAWN and, as such, is DISMISSED as moot.
As to Defendant’s Interrogatory No. 5 requesting information with regard to
Plaintiffs’ base period QREs with respect to Plaintiffs’ asserted business components for
the base period 1984-88, Plaintiffs were directed to serve an amended answer within
two weeks, and Defendant was to advise whether such answer was satisfactory. The
record does not indicate any further dispute by Defendant with regard to this
16
Interrogatory. Accordingly, Defendant’s Motion to Compel with respect to Defendant’s
Interrogatory No. 5 is deemed WITHDRAWN and, as such, DISMISSED without
prejudice.
3.
Defendant’s Request for Document Production.
Regarding Defendant’s Request for Production, Plaintiffs at oral argument
agreed to provide supplemental responsive document production, and Defendant
agreed. Defendant’s motion was withdrawn as to Defendant’s requested production.
There is no indication in the record that Plaintiffs have failed to provide the promised
supplemental production. Accordingly, as to this request, Defendant’s Motion to
Compel is deemed to have been WITHDRAWN and, as such, is DISMISSED without
prejudice
CONCLUSION
Based on the foregoing, Defendant’s Motion to Compel is DISMISSED in part,
and DENIED in part. Plaintiffs shall show cause within 10 days of this Decision and
Order why Defendant’s expenses incurred in connection with Defendant’s Motion to
Compel should not, pursuant to Fed.R.Civ.P. 37(a)(5)(A), be granted; Defendant’s
response shall be filed within 10 days thereafter; Plaintiffs’ reply, if any, may be filed
within five days after Defendant’s response. Oral argument shall be at the court’s
discretion.
SO ORDERED.
/s/ Leslie G. Foschio
________________________________
LESLIE G. FOSCHIO
UNITED STATES MAGISTRATE JUDGE
Dated: July 12, 2018
Buffalo, New York
17
APPENDIX
The QRE R&D tax credit allows a company to claim as a tax credit a
percentage of their expenses for research and development incurred in a particular
year. To calculate a taxpayer’s R&D tax credit, the following information is needed:
(1)
The Base Period is defined as the taxable years beginning after December 31,
1983 and before January 1, 1989;3
(2)
The Claim Year QREs defined as the qualified research expenses (as defined
under 26 U.S.C. § 41), incurred in the year for which the tax credit is sought;
(3)
Aggregate Base Period QREs, i.e., the sum of all QREs for the Base Period;
(4)
Aggregate Base Period Gross Receipts, i.e., the sum of a taxpayer’s gross
receipts for the Base Period;
and
(5)
Average Annual Gross Receipts for the four years immediately preceding the
year for which the R&D credit is sought.
This information is entered into two different formulas and the lower result is the
taxpayer’s R&D tax credit.
The first method is calculated as 20 % of the difference between the QREs
claimed for the particular tax year and a “Base Amount,” which is calculated as the
“Fixed Base Percentage” multiplied by the taxpayer’s Average Annual Gross Receipts
for the four year period immediately preceding the claim year, 26 U.S.C. § 41(a), but in
3
Congress has never explained its selection of these five years to serve as the statutory based period,
but the selection appears to have been “chosen because they were the five-year period immediately
preceding the 1989 amendments.” Legal Guide to the Research Credit § 7:3 (Westlaw 2018). Although
not applicable here, the court notes the fixed-base percentage is computed according to a different
formula for newer or “start-up” companies that did not have both QREs and gross receipts for the
requisite years. See 26 U.S.C. § 41(c)(3)(B).
18
no event may the Fixed Base Percentage exceed 16 %. 26 U.S.C. § 41(c)(3)(C). The
Fixed Base Percentage is calculated by dividing the aggregated QREs for the
immediately preceding four year period by the aggregate gross receipts for the same
period. The resulting mathematical formula is:
Claim
Aggregate Base Period QREs
20% X Year – ________________________________
QREs
Aggregate Base Period Gross Receipts
Aggregate Annual
X Gross Receipts for
4 Years Preceding
Claim Year
See Trinity Industries, Inc. v. United States of America, 757 F.3d 400, 407 (5th Cir.
2014).
This first formula thus takes into account the taxpayer’s historical research expenses for
the four years immediately preceding the claim year, with the R&D tax credit available
only when the QREs for the claim year exceed the average QREs for the preceding four
years. When calculating the R&D tax credit according to this first formula, an increase
in the Aggregate Base Period QREs will result in an increased Fixed Base Percentage,
which ultimately will yield a lower R&D tax credit for a given year.
The second method is simpler:
20% X ( 50% X Claim Year QREs).4
26 U.S.C. § 41(c); Trinity Industries, Inc., 757 F.3d at 3.
The lower resulting number is the amount of the taxpayer’s R&D tax credit for the
claimed year.5
4
The second method can be even more simply expressed as 10% of the claimed QREs.
Because the maximum allowed R&D tax credit is the lower of the two, the maximum amount of the R&D
tax credit for any given year is 10% of the claimed QREs.
19
5
Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.
Why Is My Information Online?