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Part 1459 Costs Allocable to and Allowable Against

Renegotiable Business


count of the taxes measured by income, other than 1459.1 Statutory provisions and general regulations. Federal taxes, which are attributable to the portion 1459.2 Salaries, wages and other compensation.

of the profits which are not excessive. (Matter in 1459.3 Amortization and depreciation.

italics added by Pub. Law. 870, 84th Cong., approved 1459.4 Conversion to renegotiable production.

August 1, 1956; and see section 103 (m) of the act 1459.5 Losses.

(8 1457.9 of this subchapter) for allowance of losses 1459.6 Interest.

incurred in fiscal years ending on or after December 1459.7 Selling and advertising expenses.

31, 1956.] 1459.8 Other costs, expenses and reserves.

(b) Profits, cost allocation and allowance; 1459.9 Taxes measured by income ("State income taxes").

general.-(1) Accounting methods. In conAUTHORITY: Sections 1459.1 to 1459.9 issued under nection with renegotiation on an over-all fiscal section 109, Pub. Law 9, 82d Cong. Interpret or apply

year basis, except as otherwise provided in section 103, Pub, Law 9, 82d Cong.

these regulations, income received or accrued 1459.1 Statutory provisions and general and costs paid or incurred will be considered as regulations.-(a) Determination of costs.- having been received or accrued or paid or inSection 103(f) of the Act provides as follows: curred in the fiscal year to which such items are

The term "profits derived from contracts with the to be attributed in accordance with the method Departments and subcontracts" means the excess of

of accounting employed by the contractor in dethe amount received or accrued under such contracts

termining net income for Federal income tax and subcontracts over the costs paid or incurred with

purposes or in accordance with such other respect thereto and determined to be allocable thereto.

method of accounting as the contractor and the All items estimated to be allowed as deductions and exclusions under chapter 1 of the Internal Revenue Board may agree upon pursuant to the proviCode (excluding taxes measured by income) shall, to sions of subparagraph (2) of this paragraph. the extent allocable to such contracts and subcontracts,

Nothing in the preceding sentence shall affect be allowed as items of cost, except that no amount

the authority of the Board under section 103 shall be allowed as an item of cost by reason of the application of a carry-over or carry-back. Notwith

(f) and (i) of the Act to determine the income standing any other provision of this section, there shall received or accrued or the costs paid or incurred be allowed as an item of cost in any fiscal year ending by the contractor with respect to renegotiable before December 31, 1956, subject to regulations of the

business in a fiscal year in accordance with such Board, an amount equal to the excess, if any, of costs

method of accounting as, in the opinion of the (computed without the application of this sentence)

Board, properly reflects such income or costs, if paid or incurred in the preceding fiscal year with respect to receipts or accruals subject to the provisions

the method of accounting employed by the conof this title over the amount of receipts or accruals tractor in determining net income for Federal subject to the provisions of this title which were re

income tax purposes does not, in the opinion of ceived or accrued in such preceding fiscal year, but

the Board, properly reflect such income or costs, only to the extent that such excess did not result from

and the contractor and the Board are unable gross inefficiency of the contractor or subcontractor. For the purposes of the preceding sentence, the term to agree upon a method which does properly "preceding fiscal year” does not include any fiscal year reflect such income or costs. ending prior to January 1, 1951. Costs shall be de

(2) Differing accounting methods.(i) The terminated in accordance with the method of accounting regularly employed by the contractor or subcontractor

Board will permit a contractor to adopt for in keeping his records, but, if no such method of ac

renegotiation purposes a method of accountcounting has been employed, or if the method so em

ing other than that used by the contractor for ployed does not, in the opinion of the Board, or, upon Federal income tax purposes, provided that: redetermination, in the opinion of The Tax Court of the United States, properly reflect such costs, such

(a) The Board finds that the method of accosts shall be determined in accordance with such counting employed by the contractor for Fedmethod as in the opinion of the Board, or, upon re- eral income tax purposes is manifestly unsuitdetermination, in the opinion of The Tax Court of

able for the purposes of renegotiation because the United States, does properly reflect such costs.

it does not clearly reflect the profits attributable In determining the amount of excessive profits to be eliminated, proper adjustment shall be made on ac

to the contractor's performance of renegotiable (3-15-68)

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contracts for the fiscal year under review, and different from that which it employed for the
the method of accounting to be adopted does purposes of a renegotiation proceeding relating
clearly reflect such profits; and

to the preceding fiscal year, whether pursuant
(6) The contractor enters into a written to this section or otherwise, it will be required
agreement with the Board before the conclu- to employ such different method of accounting
sion of the renegotiation proceedings for the for the purposes of all subsequent renegotiation
year under review, providing among other proceedings, and the amounts received or ac-
things substantially as follows:

crued and costs paid or incurred which have (1) That the contractor will employ such dif- been recognized in prior renegotiation proceedferent method of accounting for the purposes ings will not be recognized in the proceedings of the renegotiation proceedings for the year relating to the year under review. under review and all subsequent years, whether (3) Allocation of costs.-In general, the costs such proceedings are concluded by agreement paid or incurred with respect to renegotiable or order;

business in the fiscal year under review will be (2) That no cost or expense recognized in the costs allocated to such business and such the renegotiation proceedings for the first year year by the contractor's established cost accovered by the agreement will be recognized counting method if that method reflects recin any subsequent renegotiation proceeding; ognized accounting principles and practices. and

If in the opinion of the Board there is no ade(3) That the computation of losses, if any, quate or effective cost accounting method in in preceding fiscal years (see section 1457.8 of use, or if the method employed does not propthis subchapter) will be made on the basis of erly reflect such costs because there are unjustisuch different method of accounting.

fied or improper allocations of items of cost in (ii) Under this section, a contractor may the accounting records or in the reports or stateadopt a different method of accounting for the ments filed for the purpose of renegotiation, purpose of determining all amounts received costs will be allocated in accordance with such or accrued and costs paid or incurred in a fiscal method as in the opinion of the Board does year, as in the case of a change from a cash re- properly reflect such costs. The fact that all ceipts and disbursements method of accounting receipts and accruals during a fiscal year are to an accrual method of accounting; or it may classifiable as renegotiable does not necessarily adopt a different method of accounting for a mean that all items of cost estimated to be departicular item of cost or for a particular class ductible in that year are allocable to renegotiof items of cost which would result in recogniz- able business. ing such item or items in one fiscal year rather (4) Tax deductions. When an item of cost than another.

is allocable in whole or in part to renegotiable (iii) Subject to the foregoing conditions, the business, the Board will estimate the amount Board will also permit a contractor to adopt allowable as a deduction or exclusion under for renegotiation purposes the completed con- chapter 1 of the Internal Revenue Code, and tract method of accounting for contracts to be such estimated amount will be allowed as a cost performed over a period of more than one fiscal of renegotiable business in the fiscal year under year, which, because of circumstances of per- review to the extent that it is allocable to such formance, would require estimates of perform- business and such year in accordance with the ance and allocation of income and cost that principles set forth in this paragraph (b). No could result in material distortion in account- such item of cost will be allowed in an amount ing on an interim basis prior to completion. less than or in excess of that estimated to be Such contracts may include contracts for con

deductible or excludable from income under struction of major facilities or major units the Internal Revenue Code, and all items of (such as a vessel or group of vessels) when the cost will be allocated to the fiscal year in which profits can best be determined upon completion. they are allowable in the determination of tax

(iv) If a contractor employs, for the pur- able income under said Code, except as otherposes of a renegotiation proceeding relating to wise provided in this paragraph (b). When it the year under review, a method of accounting is clear that a contractor's deductions and ex

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clusions under the Internal Revenue Code re- item allowable as a "cost" by such Regulation
sult in allowable costs of renegotiable business or by specific contractual agreement will not be
which are in the aggregate either high or low allowed unless it is a proper Federal income tax
on a comparative basis, this circumstance will deduction. Furthermore, a specific agreement
be considered in connection with the factor of that additional proper costs incurred in per-
the "reasonableness of costs” of the contractor forming a contract will not be claimed as an
and the determination of the amount of any addition to the contract price, will not result

in the non-recognition of such cost for renego-
profit adjustment to be required of the con-

tiation purposes. tractor. In estimating amounts allowable as deductions or exclusions under chapter 1 of the (6) Conditional allowance of cost.-If an Internal Revenue Code, due consideration will occasion should arise in which the Board is unbe given to any pertinent action by the Internal able to make a reasonable estimate of whether or Revenue Service. Published rulings of the In- the extent to which a particular item is allowternal Revenue Service on matters of general able as a deduction or exclusion under the Inapplication will be adhered to in making such ternal Revenue Code for the year under review estimates. However, the allowance of items as and the item is material in relation to the excosts is not required merely because they have cessive profits to be eliminated, the Board may been or are expected to be allowed for tax pur- allow the item as a cost in renegotiation, proposes by particular revenue agents or other field vided that the contractor agrees to refund as representatives of the Internal Revenue Service. additional excessive profits the amount so Occasionally cases may be encountered in which allowed to the extent that such amount may revenue agents will have allowed salaries or finally be determined to be not allowable as a other items as deductions for tax purposes

deduction or exclusion under the Internal which the Board concludes are not properly al- Revenue Code for the year under review. lowable under the Internal Revenue Code or (7) Costs previously allowed in renegotiaare properly allowable in a different amount or tion.

No item of cost will be deemed allocable for a different year. In such cases the action of to renegotiable business to the extent that such the revenue agents is not regarded as conclusive. item has, in a previous renegotiation under the Similarly, disallowances by such officials are not act or under any other renegotiation law, been conclusive. The Board will exercise independ- allocated to renegotiable business in determinent judgment on whether and to what extent ing excessive profits, notwithstanding that such and for what year items are allowable as deduc- item may be a deduction or exclusion under tions or exclusions under the Internal Revenue chapter 1 of the Internal Revenue Code in comCode. Such judgment will be based upon an puting taxable net income for the taxable period estimate of what the courts would do if the corresponding to the fiscal period covered by deductibility or excludability of the items were

the current renegotiation. the subject of litigation.

(8) Replacement of inventory involuntarily (5) Effect of cost principles promulgated liquidated. Under section 22(d) (6) of the Inby other agencies.-Agreements for the allow

ternal Revenue Code, a taxpayer using the last ance or disallowance of costs entered into by a

in, first out inventory method may, for any year contractor with another agency of the Govern

in which it involuntarily liquidated any part of ment, either by specific contractual provision or its base stock inventory, elect to adjust retroby acceptance (expressed or implied) of Gov

actively its net income for tax purposes for such ernment regulations or policies, are not control- year by reference to the costs of replacing in a ling with respect to recognition of such costs for subsequent year the inventory so involuntarily renegotiation purposes. Thus, a cost properly liquidated. The excess of such replacement disallowed in accordance with the Armed Sery- costs over base stock costs is neither an exclusion ices Procurement Regulation, in connection nor a deduction under the Internal Revenue with a contract to which such Regulation is Code, but merely a retroactive adjustment of applicable, will nevertheless be recognized for

net income. For purposes of renegotiation, renegotiation purposes if such cost is a proper

there will be allowed as a cost and allocated Federal income tax deduction. Similarly, an between renegotiable and non-renegotiable (3-15-66)


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business according to the principles set forth in (3) Effect of waiver of termination claims.-
this paragraph the base stock costs and the ex- The principles stated in subparagraphs (1) and
cess of replacement costs, or of the estimated (2) of this paragraph with respect to the al-
replacement value in the fiscal year in which the lowance of costs allocable to the uncompleted
involuntary liquidation occurred, over the base portions of terminated contracts and subcon-
stock costs. Similarly, the cost of renegotiable tracts and the segregation of such costs are
business will be reduced, to the extent allocable equally applicable whether or not the contractor
thereto, by any excess of base stock costs over has waived all or any part of the compensa-
replacement costs, or over the estimated replace- tion to which it might be entitled.
ment value in the fiscal year in which the 1459.2 Salaries, wages and other compen-
involuntary liquidation occurred. Such cost sation.—(a) Allocation.-Salaries, wages and
allowance or reduction will be made whether other compensation which are estimated to
or not the use of the base stock inventory con- and other compensation which are estimated to
stitutes involuntary liquidation under the pro-

be deductible for Federal income tax purposes visions of the Internal Revenue Code and even will be allocated between renegotiable and nonthough such inventory is not actually replaced renegotiable business according to the princiuntil a susbequent year.

ples established in section 1459.1 (b). (c) Costs allocable to uncompleted portions (b) Allowances.Under section 23 (a) of of terminated contracts and subcontracts.-- the Internal Revenue Code, salaries or other (1) Allowed in renegotiation.—Costs allocable compensation for personal services are allowed to the uncompleted portion of any terminated to the extent found "reasonable.” In determincontract or subcontract which is subject to re- ing whether any salaries or other compensation negotiation will be allowed as costs in renego- paid by a contractor to its officers or employees tiation. (See sec. 1457.6(a) of this subchapter.) are reasonable, consideration will be given to Such costs will be allowed however, only the nature of the work, extent of responsibility, to the extent that, and for the fiscal year for experience and effectiveness of the officer or emwhich, they are estimated to be deductible in ployee, recent compensation record, and such the computation of taxable income under the other factors as may be pertinent. CompariInternal Revenue Code (see sec. 29.42-1 of son will be made when possible with the comBureau of Internal Revenue Regulations (29 pensation of officers or employees in similar CFR 29.42-1) and see also Bureau of Internal positions in other companies within the particRevenue Mimeograph No. 5897) and will not ular industry. When the contract of employbe allowed to the extent theretofore allowed as ment is an arm's length transaction, reasonableitems of cost in any previous renegotiation ness of compensation may be determined only under the act or under any other renegotiation within the broadest limits, and weight will be law.

given to the determination by the contractor of (2) Segregation of costs allocable to uncom- the worth of the services of an officer or empleted portions of terminated contracts and ployee. Whether or not the profit and loss subcontracts.-Costs allocable to the uncom- statement of a partnership or individual propleted portions of terminated contracts and sub- prietorship includes salaries or drawing accontracts shall be segregated from other costs counts for the partners or the individual propripertaining to renegotiable business, unless the etor as an expense, in determining the amount of costs allocable to such uncompleted portions of excessive profits to be eliminated a so-called contracts and subcontracts do not constitute a "salary allowance” may be made for reasonable material portion of the contractor's total rene- salaries for such partners as are active in the gotiable costs. Such segregation may be re- business or for the individual proprietor if he quired to be made in such general or such de- is active in the business; but this provision tailed manner as the Board may deem neces- shall not apply with respect to any fiscal year

to which the Internal Revenue Code of 1954 is sary.

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