Denial of research credit for computer software program costs.

• Author: Hudson, David S.

The district court has decided United Stationers, DC Ill., 3/18/97, dealing with the application of the research credit provisions to the development of internal use software; it disallowed the company's research credit claim because the activities did not constitute a process of experimentation, were not technological in nature and did not represent a significant economic risk.

United Stationers is a leading supplier of office products. It developed eight different computer software programs dealing with individual functions, including paperless invoicing, inventory management, purchasing, online order processing, shipping and other internal functions, and claimed a refund due to research credits arising from the development of these programs.

United Stationers had argued that because the software involved in this case related to its core business of dealing with and delivering products to customers, it did not meet the definition of "internal use." Relying on examples in the committee report and the clear definition of the term, the court held that the software in question was clearly intended to be for internal use by United in its business. As a result, the taxpayer had to meet the additional requirements discussed in the Sec. 41 committee reports.

To qualify for the credit, the development of internal use software must meet the four general tests of Sec. 41 (d), as well as three additional tests under the legislative history to Sec. 41 (d)(4)(E). These tests, as well as the court's findings 011 the matters, are summarized in the chart below.

Looking to the legislative history of the research credit, the court noted that the term "process of experimentation" meant "a process...to design a business component where the design...is uncertain at the outset." The court noted that the only evidence submitted by the taxpayer in addressing the existence of any uncertainty involved concerns as to the potential business and financial benefits of the projects (e.g., whether there would be increased sales and ordering efficiencies from the use of the systems). Absent from the documents submitted was any description of the uncertainties surrounding the system's design that the company faced at the beginning of the project. These facts allowed the court to conclude that there was no process of experimentation; the company had documented no uncertainty as to its ability to design and implement the project.

One of the major stipulations in the case was...