In a recent TC Memo case, the Tax Court determined that certain higher level individuals within a cosmetics company did not materially participate in the R&D process (or at least did not prove they participated) to substantiate their R&D claim. In Basim Shami et al. v. Commissioner, T.C. Memo 2012-78, the company claimed all wages paid to their president and vice-president as qualified for the tax years 2003-2005. Basim Shami claimed its company that manufacturers hair, skin and nail products had qualified R&D in developing its products but specifically claimed that the two key officers were involved in the R&D process so as to claim their wages towards the research credit. The two individuals did not have technical backgrounds, but moreover the Court found their testimony unreliable and at times contradictory and that the company failed to provide adequate documentation.
In Basim Shami, the parties stipulated to many other facts and the only remaining issue was the wages of the two executives, indicating that the parties settled the issue of whether numerous other employees’ wages qualified for the R&D credit. The company argued that even without adequate substantiation that the Tax Court should rely on the Cohan Rule in estimating the time spent by Mr. Shami and Mr. McCall on qualified activities. The Tax Court refused to do so on the grounds that there was no reasonable basis to make such an estimate given the lack of sufficient testimony or documentation.
This case highlights the importance of substantiating wages paid to higher level personnel. Such personnel can still qualify for the research credit if they hands-on participated in the R&D process (which can be common on matrixed/cross-team R&D projects), but the Basim Shami case highlights the importance of showing how such personnel participated in R&D or directly supervised or supported R&D, via detailed testimony and documentation.