Appeal of Electronic Data Systems Corporation & Subsidiaries

Appeal of Electronic Data Systems Corporation & Subsidiaries, 2023-OTA-540, decided by Administrative Law Judge Sara A. Hosey, is a nonprecedential Office of Tax Appeals (OTA) opinion resolving a decade-long, multi-issue dispute over EDS's claimed California research credits and enterprise zone (EZ) credits for the 2003 through 2008 tax years, in which EDS sought refunds totaling more than $35 million.

Jurisdictional Bar for 2003 and 2004

EDS's original 2011 and 2012 refund claims for 2003 and 2004 expressly elected the alternative incremental credit (AIC) method rather than the regular research credit under IRC section 41(a). Only after FTB determined that EDS could not use the AIC -- because the election had not been made on EDS's original returns -- did EDS argue, for the first time in its 2019 supplemental opening brief, that it was entitled to the regular credit instead. Applying J.H. McKnight Ranch, Inc. v. Franchise Tax Bd. and Jimmy Swaggart Ministries v. State Bd. of Equalization, OTA held that a refund claim must be liberally construed but still requires that FTB have actual notice of the specific ground asserted; because a taxpayer cannot claim both the AIC and the regular credit for the same year, and because none of FTB's information document requests sought the base-period data unique to the regular credit, EDS's AIC-based claims did not encompass the later regular-credit theory, and OTA lacked jurisdiction to consider it for 2003 and 2004.

Failure to Substantiate the Regular Credit for 2005–2008

For 2005 through 2008, where EDS had separately and timely claimed the regular research credit, OTA found the claim unsubstantiated at nearly every step. EDS's method of computing California qualified research expenses (QREs) relied on unverified estimates: it allocated wages, supplies, and contractor costs among research projects using proportional "man-month" ratios and then allocated a further percentage to California using statewide payroll ratios, without underlying evidence that expenses actually tracked those ratios. Six sample employee surveys EDS offered as support related only to 2006, were undated and unsigned, contained no contemporaneous documentation, and did not address whether the described work occurred in California or met the 80-percent "substantially all" threshold. Nor did EDS substantiate its base-period fixed-base percentage or its California research gross receipts under section 23609(h)(3), which excludes receipts from services -- EDS's position on its own California gross receipts shifted repeatedly during the appeal, from claiming zero, to eventually conceding some receipts without explaining what categories of revenue were included or excluded. OTA also rejected EDS's request to import a 55-percent allowance rate it had negotiated with the IRS as an administrative compromise during a federal audit, explaining that OTA has no authority to resolve a state appeal based on litigation hazards, and that the IRS settlement addressed only the federal credit's different substantive requirements.

Enterprise Zone Credit Aggregation Rejected

EDS separately argued that former Revenue and Taxation Code section 23622.7, which capped its EZ hiring credit at the tax attributable to "the [EZ]," should be read to let it treat all of its California enterprise zone locations as a single, aggregated zone, maximizing the credit it could use against income earned anywhere in that combined zone. OTA held the statutory text unambiguous: each reference to "the [EZ]" throughout section 23622.7 refers to the specific zone where the qualified employee worked and where the credit was generated, and the statute's apportionment formula compares a taxpayer's property and payroll in that particular zone to its property and payroll statewide -- not to an aggregate of all zones. OTA further held that section 25137's alternative-apportionment relief, even if theoretically available, could not be invoked absent evidence that the enterprise-zone-specific formula failed to fairly reflect EDS's business activity in that zone, which EDS did not provide.

Significance

This nonprecedential opinion illustrates the full range of substantiation failures that can defeat a regular research credit claim -- unverified cost-allocation ratios, undated surveys, and shifting gross-receipts positions -- and forecloses any argument that California's enterprise zone credit limitation can be computed by combining multiple zones into one.