Ryan, LLC v. Hegar

Texas's 2013 research and development incentive legislation, House Bill 800, allows a taxable entity to elect either a franchise tax credit or a sales tax exemption for qualified research expenses, with Texas Tax Code sections 171.651 and 151.3182 defining 'qualified research' and 'qualified research expenses' by reference to IRC section 41 and the applicable Treasury Regulations, limited to research conducted in Texas. In 2021, following a multi-year rulemaking process, the Texas Comptroller adopted amended Rules 34 TAC section 3.340 (sales tax) and section 3.599 (franchise tax) that Ryan, LLC — joined in public comments by the Texas Taxpayers and Research Association, the Council On State Taxation, and the Texas Oil and Gas Association — contends significantly narrow eligibility for the credit and exemption relative to both federal law and the incentives available in most other states.

Core Challenges to the Amended Rules

Ryan's summary judgment briefing raises numerous challenges to the Amended Rules, including that they: require research to be 'cutting-edge' or 'innovative' in a way federal law and Treasury guidance expressly reject; impose a 'clear and convincing evidence' burden of proof exceeding the federal preponderance-of-the-evidence standard and unsupported by any Texas statute; categorically exclude 'services' and 'designs' from qualifying as business components; treat the use of commercially available or a taxpayer's own existing technology as automatically disqualifying a process of experimentation, contrary to Treasury Regulation section 1.41-4(a)(5)(i)'s allowance for evaluating even a single alternative; and require every element of a research credit claim to be supported by contemporaneous business records, a requirement the IRS itself considered and rejected as unduly burdensome when finalizing the federal research credit regulations in 2001.

Oil and Gas Industry Examples and Retroactivity

Ryan specifically challenges two Comptroller examples asserting that an oil and gas operator's use of commercially available drilling technology, or its own existing technology, in a horizontal drilling program can never constitute a process of experimentation. Citing Trinity Industries, Inc. v. United States, 691 F. Supp. 2d 688 (N.D. Tex. 2010), and a supporting affidavit describing a drilling project that required extensive redesign of casing, mud properties, and bottom-hole assembly configurations after repeated stuck-pipe and wellbore-stability failures, Ryan argues that integrating existing or commercially available components does not foreclose a genuine, uncertain process of evaluating alternatives. Ryan further argues that applying the Amended Rules retroactively to franchise tax reports originally due as far back as January 1, 2014 violates the Texas Constitution's prohibition on unconstitutionally retroactive laws.

As of the filing reflected in this record, the Comptroller had conceded that certain challenged provisions (concerning the definition of 'Internal Revenue Code' and related regulatory cross-references) were invalid and had proposed further amendments, while continuing to defend the remaining provisions; the case remained pending before the district court, with the parties' cross-motions for summary judgment under submission.

Significance: This litigation is a significant, closely watched challenge to the Texas Comptroller's administration of the state's research and development tax incentives, and its resolution stands to determine whether Texas's rules can impose documentation and substantive standards materially stricter than federal law and those of most other states offering a similar credit.