## Facts

- Lockheed Martin Corporation (as successor to Martin Marietta entities) performed defense-related research and development under numerous fixed-price contracts with the United States during 1982–1988.
- In 1991, Lockheed filed administrative refund claims for tax years 1984–1988 seeking research tax credits under former I.R.C. § 44F and I.R.C. § 41.
- The claims were supported by detailed schedules (“Green Books”) tying qualified research expenses largely to approximately thirteen major contracts.
- The IRS disallowed the refund claims, asserting the research was excluded as “funded” under Treasury regulations because the government allegedly held the research rights and Lockheed allegedly did not bear sufficient financial risk.
- In the Court of Federal Claims, Lockheed sought during discovery to add previously unclaimed (“late-filed”) research expenses beyond those presented administratively.
- The Court of Federal Claims denied the effort to expand the claim on substantial variance grounds and granted summary judgment to the government on four representative contracts, ruling Lockheed did not retain “substantial rights” in the research and thus the research was “funded.”
- Lockheed appealed both the denial of late-filed expenses and the adverse summary judgment on the “substantial rights” issue.

## Issues

1. Whether adding “late-filed” research expenses in litigation impermissibly “substantially varied” the factual basis of Lockheed’s administrative refund claims.
2. Whether research performed under fixed-price government contracts was “funded” under I.R.C. § 41 and Treas. Reg. § 1.41-4A(d) because Lockheed allegedly failed to retain “substantial rights” in the research results and/or did not bear financial risk.

## Decision

- The Federal Circuit affirmed the denial of Lockheed’s attempt to add late-filed expenses, holding the proposed expansion substantially varied the factual basis presented to the IRS and deprived the agency of fair administrative notice.
- The Federal Circuit reversed summary judgment for the government on the “substantial rights” determination, holding the trial court misconstrued the contracts by treating broad government rights as negating Lockheed’s retained rights.
- The court explained that “substantial rights” focus on whether the contractor retains meaningful rights to use the research results in its trade or business without additional payment, even if the government also obtains extensive rights.
- The court noted that fixed-price contracting can place meaningful cost-overrun risk on the contractor, which weighs against characterizing the research as fully “funded.”
- The case was remanded for further proceedings consistent with the Federal Circuit’s interpretation.

## Legal Principles

- A taxpayer may not raise in a refund suit a ground that substantially varies from the legal theories and factual bases set forth in the administrative refund claim; the claim must give the IRS fair notice of the nature of the claim and the specific supporting facts.
- Under Treas. Reg. § 1.41-4A(d), research is treated as “funded” (and therefore excluded from the research credit) if the taxpayer does not retain substantial rights in the research results and/or does not bear the financial risk of the research.
- “Substantial rights” exist when the taxpayer retains meaningful, non-illusory rights to use the research results in its trade or business without having to pay for that use; extensive government data or use rights do not automatically eliminate the contractor’s substantial rights.
- Fixed-price contract terms may indicate the contractor bears financial risk because cost overruns can be absorbed by the contractor, while efficient performance can yield profit.

## Conclusion

The Federal Circuit enforced the substantial variance doctrine to bar litigation expansion of unpresented refund-claim facts, but rejected a rule that broad government rights alone make fixed-price contract research “funded,” holding that the correct inquiry is whether the contractor retained meaningful rights to use the research results and bore financial risk.


Lockheed Martin Corp. v. United States, 210 F.3d 1366 (Fed. Cir. 2000)