2) the Central Invoice Project ("CIP") for paperless invoicing and recordkeeping; 3) Concept 90, a computer-run marketing program; 4) Unilink, a computer-to-computer order entry system; 5) the Facility Database Project ("FDP") for inventory records, forecasting and replenishment; 6) the Automated Inbound Shipment Processing Program ("SCS") to automate shipping procedures; 7) the Forecasting/Replenishment Application software to create a more timely inventory control and planning system; and 8) the Receiving System software to improve performance and reliability in warehouse productivity, reduce time for merchandise on the receiving dock, increase inventory turnover, and improve inventory accuracy. (These will be collectively referred to as the "projects.")
Stationers used the projects generally in its business and did not attempt to sell them. In addition, part of Stationers' business was to permit customers and suppliers to access and utilize the projects to a certain extent.
In its original tax return for the taxable year ending August 31, 1988, Stationers deducted the costs of developing the projects under 26 U.S.C. § 174 ("§ 174"), which allows a current deduction for research and experimental expenditures. Based on an examination of Stationers' tax return, the IRS agreed to the amounts that Stationers took as deductions under § 174. Good news, for awhile.
In an amended tax return for the taxable year ending August 31, 1988, Stationers claimed a refund for $ 156,457 based upon § 41's credit for increasing research activities. Stationers computed its § 41 credit wholly upon those amounts that the IRS had previously agreed were properly deducted under § 174. This suit is for the refund of income taxes and interest which Stationers contends were erroneously and illegally assessed against and collected from it prior to Stationers' claim of a § 41 credit for the taxable year ending August 31, 1988. Stationers asserts that it is entitled to the tax credit because it expended considerable amounts of time and money developing the projects for purposes of increasing productivity and to make Stationers more competitive within the office supply industry.
A. Standard of Review
Tax credits, like deductions, are matters of legislative grace, and the taxpayer must clearly demonstrate entitlement to the credit. Hauptli v. Commissioner, 951 F.2d 1193, 1195 (10th Cir. 1991); Schiff v. United States, 942 F.2d 348, 352 (6th Cir. 1991); see also New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 54 S. Ct. 788, 78 L. Ed. 1348 (1934) (deductions are a matter of legislative grace).
"In a tax refund suit the taxpayer bears the burden of proving the amount he is entitled to recover." United States v. Janis, 428 U.S. 433, 440, 49 L. Ed. 2d 1046, 96 S. Ct. 3021 (1976) (citing Lewis v. Reynolds, 284 U.S. 281, 76 L. Ed. 293, 52 S. Ct. 145 (1932)). "The Commissioner's tax deficiency assessments are entitled to the 'presumption of correctness.' This presumption imposes upon the taxpayer the burden of proving that the assessment is erroneous." Pittman v. C.I.R., 100 F.3d 1308, 1313 (7th Cir. 1996) (quoting Gold Emporium, Inc. v. Commissioner, 910 F.2d 1374, 1378 (7th Cir. 1990)). "The presumption is not irrebuttable however." Pittman, 100 F.3d at 1313. "To rebut the presumption of correctness and shift the burden to the Commissioner, the taxpayer must demonstrate that the Commissioner's deficiency assessment lacks a rational foundation or is arbitrary and excessive." Id.
B. Section 41
Section 41, entitled "Credit for increasing research activities," provides a tax credit for "qualified research" activities. 26 U.S.C. § 41(d)(1) (1986). Even if a taxpayer's research project meets the general requirements for a tax credit under § 41(d)(1), certain exclusions may apply, limiting the availability of the credit. See 26 U.S.C. § 41(d)(4). Most relevant here is the exclusion which states that qualified research shall not include, "except to the extent provided in regulations, any research with respect to computer software which is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer . . . ." 26 U.S.C. § 41(d)(4)(E).
Though § 41 was enacted over 11 years ago, the Treasury Department has yet to adopt Final Regulations for § 41. Nonetheless, the first step toward adopting a final version of Regulations for § 41 recently went underway when the Treasury promulgated Proposed Regulations in January 1997. See Prop. Treas. Reg. § 1.41-4(e), 62 Fed Reg. 82 (1997). We look forward to the adoption of the Final Regulations to aid taxpayers and the courts. At this point, however, the court is aware that Proposed Regulations carry no more weight than a position espoused in a brief. See F.W. Woolworth Co. v. Commissioner, 54 T.C. 1233, 1265-66 (1970).
In any event, even if Stationers initially qualifies for the tax credit under § 41(d)(1), it must still overcome the exclusionary hurdle under § 41(d)(4)(E). Because the Magistrate Judge denied Stationers' claim under both § 41(d)(1) and § 41(d)(4)(E), the court will examine, in turn, whether Stationers' projects survive under each section.
The parties' disagreement as to whether Stationers' several projects were qualified research activities under § 41(d) is at the heart of this dispute. The statute defines qualified research as research:
(A) with respect to which expenditures may be treated as expenses under section 174,
(B) which is undertaken for the purpose of discovering information--