Engineering Firms Loses R&D Credits in Court Ruling

Key Issues and Court Findings

1. Process of Experimentation: PDG’s claims failed to demonstrate that substantially all activities involved a systematic evaluation of alternatives using the scientific method. The court rejected the argument that broad American Institute of Architects (AIA) design phases inherently reflected a POE. The lack of documentation tying specific employee activities to resolving technical uncertainties during various design stages proved fatal.

   
   Example: For Gerald Champion Military Psychiatry Unit, Project No. 13008.00, the court noted that while PDG engineers revised designs and issued updated drawings, there was no explanation of why or how these revisions addressed uncertainties. For example, the decision to use a variable air volume system to allow individual temperature control was described but not substantiated as part of an iterative design process.

   Takeaway: Clients must clearly document specific qualified activities under the scientific method at every AIA phase (Pre-Design, Schematic Design, Design/Development, and Construction Documents). Use detailed surveys and narratives to align these activities with resolving technical uncertainties. Avoid relying solely on broad categorizations like AIA design phases.

2. Shrink-Back Rule Application: The court applied the shrink-back rule to evaluate subsets of PDG’s MEPF systems and found none qualified. Even granular subsets failed to demonstrate a sufficient nexus to qualifying research.

   
   Example: For Vanderbilt University Engineering and Science Building (VU ESB), Project No. 12010.01, PDG engineers designed an HVAC system that accounted for laboratory exhaust air, plume height, and room-specific pressure requirements. However, the court found that the activities were routine design adaptations rather than elements of a POE, as uncertainties were neither clearly defined nor systematically resolved. The court found that PDG failed to present evidence that a POE was followed with respect to any business components and subcomponents. The court instead held that PDG merely made decisions or selected options when faced with issues or resolved uncertainties through the actions of other contractors.

   Takeaway: Break down business components into manageable subsets for evaluation. Ensure that all subsets meet the statutory requirements for qualified research, including satisfying the substantially all and POE tests.

3. Lack of Contemporaneous Documentation: PDG employees recorded time using generic narratives without tying activities to the technical uncertainties resolved or to specific phases. This lack of detail undermined the credibility of the claims and the consistency of the process. The hour sheets did not detail specific activities engineers undertook to resolve uncertainty, and there were discrepancies between hour sheet descriptions and descriptions of PDG’s six-stage design process.

   
   Example: In the BHNM Oxford project, Project No. 13003.00, PDG engineers recorded significant time revising designs for HVAC systems and electrical configurations but provided no contemporaneous records explaining how or why these changes were made. For instance, the placement of air handling units on the roof instead of mechanical rooms was influenced by client preference rather than documented technical evaluation. Throughout the trial, PDG did not clearly distinguish the work performed by various types of engineers at the Company, including mechanical engineers, electrical engineers, and plumbing engineers. PDG also failed to clearly distinguish the work done by CAD designers.

   Takeaway: Encourage clients to maintain contemporaneous documentation, such as detailed employee time records, meeting notes, design calculations, and revisions. Use AIA phase templates as testimony to document how each phase constitutes elements of a POE.