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Bureau of Internal Revenue I.T. 3577.

Government, should the Bureau be required to refund Statement of policy of the Bureau of Inter

the income and excess profits taxes paid on such exnal Revenue as to the tax effect in cases in

cessive profits ?" The position of the Bureau is that which Government war contracts are renego

only the amount of such profits in excess of the Fed

eral income and excess profits taxes paid or assessed tiated, or in cases where, pursuant to action

thereon should be repaid by the contractor or sub-
by the Comptroller General, an item for which

contractor, and no refund or abatement of such taxes
a taxpayer has been reimbursed is disallowed
as an item of cost charges to a cost-plus-a-

should be made, since the taxes should be considered
fixed-fee contract.

as a recapture of a portion of the excessive profits

and as such a proper offset against the total excessive Advice is requested as to the policy of the Bureau

profits. The remainder of the excessive profits would of Internal Revenue with respect to the adjustment of

be recaptured through repayment thereof to the Govincome and excess profits taxes in cases in which

ernment by the contractor or subcontractor. The reGovernment war contracts are renegotiated and it is

payment should not be allowed as a deduction in the determined by the renegotiating department or agency

income and excess profits tax returns of the taxpayer that excessive profits have been, or are likely to be,

for any taxable year. To do so would result in a paid to the contractor or subcontractor, and in cases

double tax benefit where the income and excess profits where, pursuant to action by the Comptroller General,

taxes have been offset against the excessive profits. an item for which a taxpayer has been reimbursed is

Even though the right to such offset is foregone by the disallowed as an item of cost chargeable to a cost-plus

taxpayer and the offset is not made, the repayment a-fixed-fee contract, the taxpayer being required to

should not be allowed as a deduction in the taxpayer's repay to the Government the amount of such dis returns, since the taxpayer should not be permitted to allowance

forego the right to offset for the sake of obtaining a Under Title IV of the Sixth Supplemental National

deduction for a year for which the deduction will Defense Appropriations Act, 1942 (Public Law 528, 77th

result in a greater tax benefit. This may be illustrated Cong., 2d sess.), certain Government departments or

by the following example: agencies are authorized and directed to require con

Example.m-The M Corporation filed a return for the tractors or subcontractors to renegotiate the contract

calendar year 1941 on March 15, 1942, reporting therein price with respect to designated contracts and sub

an amount of $1,000,000, which was subsequently in contracts in case any amounts of excessive profits have

the year 1942 held by one of the designated renego been, or are likely to be, realized therefrom and to

tiating agencies to be excessive profits realized in recover such excessive profits paid, or to withhold pay

performance of a contract, on which excessive profits ment if the profits have not been paid.

income and excess profits taxes aggregating $400,000 The determination of the amount of the excessive

were paid. The $400,000 taxes should not be refunded profits and the making of an agreement with the con

and the remainder of the excessive profits, or $600,000, tractor or subcontractor in regard to the method by

should be repaid by the corporation to the Government. which repayment to the Government of the excessive

The amount of $600,000 repaid to the Government will profits is to be effected are matters within the juris

not constitute an allowable deduction from gross indiction of the particular renegotiating department or

come for any taxable year. This produces the correct agency. The Bureau of Internal Revenue has no au

result. Excessive profits, before Federal taxes, of thority to function in the determination or collection $1,000,000 would have been recaptured by the Governof these excessive profits. The Bureau, however, upon ment, $400,000 through the medium of taxes and request of the parties to the renegotiation will advise $600,000 by direct repayment to the Government, with them of the manner in which the renegotiation will

no aftermath affecting Federal taxes. To hold otheraffect the contractor's Federal income and excess wise, for instance, to hold that the $1,000,000 should profits taxes.

be repaid to the Government and allow such repayThe determination of tax liabilities and the collec

ment as a deduction for income tax purposes for the tion thereof are under the administration of the

year 1942, when the effective rate of tax, for example, Bureau, together with the making of rulings and is 75 percent, would produce the following incorrect closing agreements, under Section 3760 of the Inter

result: The tax benefit in 1942 would be $750,000. The nal Revenue Code, with the taxpayer with respect to

taxpayer would have paid $1,400,000 to the Government either actual tax liability for any taxable year or

and derived a tax benefit of $750,000. The taxpayer, prospectively with respect to proposed transactions. therefore, would have paid only $650,000 net to the In case the renegotiating agreement provides for

Government, whereas the excessive profits admittedly reduced contract prices to be retroactively applied to

were $1,000,000. Different results would be obtained prior taxable years for which returns have been filed

in other cases depending upon the factors of income

and effective rates of taxes being different from those and the income and excess profits taxes paid or as

in this example. sessed, repayment to the Government of the excessive

In case the renegotiating agreement determines re profits on which such taxes have been paid or assessed

duced contract prices to be charged during the year will be involved in the settlement. This raises the

of the agreement or subsequent thereto, or a repayquestions, "If the contractor or subcontractor repays

ment is to be made in lieu thereof which is not ap the entire amount of such excessive profits to the

plicable to profits for a year for which an income tax

equired in paid on

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enega ed in Tofits

return has been filed, and on which profits income and taxes, instead of after the taxes, entirely ignoring the
excess profits taxes have not been assessed or paid, previous recapture of a portion of the excessive profits
gross income to be reported in the returns for such through the medium of such taxes, an appropriation
years should be reduced to conform with the reduced from Congress to provide funds for such refunds would
prices, or in case of repayment, a deduction may be be necessary. The estimate of the sum necessary for
taken in computing net income, provided excessive such purposes logically would be based upon informa-
profits determined to have been realized and received tion from the negotiating agencies relative to the in-
by the taxpayer are repaid to the Government. Like come and excess profits taxes paid on the excessive
wise, in case the reduced contract prices are deter profits recaptured by such taxes previously paid
mined for the immediately preceding taxable year or thereon.
a repayment is to be made in lieu thereof, and the What has been said above applies with equal force
income and excess profits tax returns for such year to cases involving a cost-plus-a-fixed-fee contract where
have not been filed at the time of such determination, an item for which the taxpayer has been reimbursed
the gross income for such preceding year may be re is disallowed as an item of cost chargeable to such
ported to conform with the reduced prices agreed upon, contract and the taxpayer is required to repay to the
or a deduction may be taken in computing net income, United States the amount disallowed.
as the case may be, provided the taxpayer repays to
the Government the excessive profits determined to Bureau of Internal Revenue I.T. 3611.
have been realized. No deduction from gross income Section 3806: Mitigation of Effect of Renegotia-
will be allowed for any other taxable year for the

tion of War Contracts or Disallowance of
amount of such excessive profits so repaid. This may

Reimbursement.
be illustrated by the following example:
Bæample.The X Corporation filed a return for the

INTERNAL REVENUE CODE
calendar year 1942 on March 15, 1943. In February,
1943, it was determined that the taxpayer had realized

Effect for Federal income and excess profits
during 1942 excessive profits in the amount of $1,000,-

tax purposes of the renegotiation of Govern000 and the parties agree that during 1943 repayment ment contracts or subcontracts thereunder to of such excessive profits will be made to the Govern eliminate excessive profits for a particular ment in designated amounts per month until the entire year, and the allowance, in mitigation of the amount of $1,000,000 excessive profits is repaid. effect of such renegotiation, of a credit against The gross income to be reported by the corporation

the excessive profits, under section 3806 of the in its return for 1942 should not include the $1,000,000, Internal Revenue Code, as added by section and no tax attributable to excessive profits will thus 508 of the Revenue Act of 1942, for Federal be assessed or paid. No deduction from gross income income and excess profits taxes attributable will be allowed for any year for the amount of the

to such excessive profits. Practice of Bureau excessive profits excluded from gross income and re

(I.T. 3577, C.B. 1942-2, 163) restated. paid to the Government.

Advice is requested as to the effect for Federal In cases of renegotiation agreements with respect

income and excess profits tax purposes of the renegoto years for which income and excess profits tax re

tiation of Government contracts or subcontracts there turns have not been filed and income and excess profits

under to eliminate excessive profits for a particular taxes not assessed and paid, the reduction in gross

year, and the allowance, in mitigation of the effect income may be made, or the deduction may be taken

of such renegotiation, of a credit against the excessive in computing net income, as the case may be, although

profits, under section 3806 of the Internal Revenue the renegotiating agreement has not been completed,

Code, as added by section 508 of the Revenue Act of provided at the time of filing the return the negotia

1942, for Federal income and excess profits taxes attions have progressed to such a stage that the amount

tributable to such excessive profits. of the reduction in gross income, or the amount of the

Under Title IV of the Sixth Supplemental National repayment in lieu thereof, is certain, and in filing the

Defense Appropriation Act of 1942 (Public Law 528, income and excess profits tax return such reduction

77th Cong., 2d sess.), as amended by section 801 of is made or such deduction is taken.

the Revenue Act of 1942 (Public Law 753, 77th Cong., The Bureau, upon request of the parties to the re

2d sess.), certain Government departments or agennegotiation, in any case will advise them relative to the

cies are authorized and directed to require contractors amount of excessive profits previously recaptured

or subcontractors to renegotiate the contract price through the medium of income and excess profits taxes

with respect to designated contracts and subcontracts paid thereon.

in case any amounts of excessive profits have been In addition to the above stated considerations for

or are likely to be realized therefrom and recover the basis of the position of the Bureau that refunds of

such excessive profits paid, or to withhold payment income and excess profits taxes should not be allowed

if the profits have not been paid. in such cases, it may be stated that if the Bureau In case the renegotiating agreement provides that should be required to make refunds of the taxes paid excessive profits have been realized under contracts on excessive profits repaid to the Government because in effect during prior taxable years for which returns such excessive profits have been determined before the have been filed and the income and excess profits taxes

oded 2000, ent.

in. ect of

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paid or assessed, elimination of the excessive profits excessive profits eliminated is to be treated as an on which such taxes have been paid or assessed is amount previously credited to the taxpayer in respect involved in the settlement. The question was raised of the tax for such year. Also, the amount of the postwhether the contractor or subcontractor should repay war refund, under sections 780 and 781 of the Code, of the entire amount of such excessive profits to the excess profits tax shall be reduced to reflect the amount Government and the Bureau of Internal Revenue be of such tax which is credited against the excessive required to refund the income and excess profits taxes profits eliminated. Furthermore, where excessive paid on such excessive profits, or whether only the profits eliminated and repaid to the Government are amount of such profits in excess of the Federal in treated as a reduction of gross income, the amount of come and excess profits taxes paid or assessed thereon such excessive profits is not an allowable deduction should be repaid by the contractor or subcontractor from the gross income of the taxpayer for any taxable and no refund or abatement of such taxes be made, year. (See sec. 3806(a)(3) of the Code.) This may the taxes being considered as a recapture of a portion be illustrated by the following example: of the excessive profits, and as such a proper offset

Example.The A Corporation, which makes its inagainst the total excessive profits, and the remainder

come and excess profits tax returns on the calendarof the excessive profits being recaptured through pay year basis, filed its returns for 1942 on March 15, 1943. ment thereof to the Government by the contractor or As a result of a renegotiation consummated on May 1, subcontractor. The question was also raised whether 1943, it was determined that in 1942 the A Corporation the excessive profits eliminated give rise to a deduc realized excessive profits of $1,000,000 in the performtion in the income and excess profits tax returns of the ance of its Government contracts. On such amount taxpayer for any other taxable year, since to do so of $1,000,000, the A Corporation was assessed Federal would result in a double tax benefit where the income income and excess profits taxes aggregating $700,000, and excess profits taxes have been offset against the of which $10,000 represented declared value excess excessive profits. These questions have now been re profits taxes and $270,000 represented excess profits solved by section 3806 of the Code, as indicated below. taxes imposed by Subchapter E of Chapter 2 of the

Section 3806(a)(1) of the Code requires that a pay Code. Such taxes were credited against the $1,000,000 ment or repayment within a taxable year ending after of excessive profits eliminated for 1942, and on May 1, December 31, 1941, of excessive profits pursuant to a 1943, the A Corporation paid to the United States the renegotiation, shall be treated as a reduction of the net amount of $300,000 ($1,000,000 less $700,000). The price of the contracts or subcontracts for the taxable gross income of the A Corporation for 1942 is to be year for which such price was received or accrued. reduced by the $1,000,000 in excessive profits elimiSection 3806(b) of the Code requires that the decrease nated. The A Corporation is not entitled in computing in Federal income and excess profits taxes resulting its net income for 1942 or any subsequent taxable year from such contract price reductions be credited against to deduct any portion of such $1,000,000 excessive the amount of the excessive profits eliminated through profits. No part of the $700,000 Federal income and renegotiation. Consequently the taxpayer will, on ac excess profits taxes shall be refunded or credited to count of the renegotiation, pay or repay to the United the taxpayer under sections 321 and 322 of the Code. States only the net amount of excessive profits of a However, for the purpose of determining the correct prior taxable year which remain after there has been tax for 1942, the amount of tax shown by the A Corcredited against the excessive profits the amount of poration on its return for such year shall be decreased Federal income and excess profits taxes attributable by the $ 700,000 credit allowed against excessive profits. to such excessive profits. If the amount allowed as The postwar refund of excess profits tax is reduced such credit against the excessive profits is less than by $27,000 (10 percent of $270,000). the amount allowable, the difference is to be treated In giving effect to the principles applied by section as an overpayment of the tax to be refunded or credited 3806 of the Code in case the renegotiating agreement to the taxpayer as provided in section 3806(c) of the determines reduced contract prices to be charged durCode. Also, the credit allowed against the amount of ing the year of the agreement or subsequent thereto, excessive profits, for Federal income tax purposes, or a repayment is to be made in lieu thereof which is including computation of postwar refund of excess not applicable to profits for a year for which an profits taxes under section 780 of the Code, is treated income tax return has been filed, and on which profits the same as if such credit were a refund of the taxes income and excess profits taxes have not been assessed forming the basis of the credit.

or paid, the practice of the Bureau has been to perIn view of the provisions of section 3806, it is the mit the taxpayer to reduce the gross income to be reopinion of this office that the taxpayer's net income for ported in the returns for such years to conform with Federal income and excess profits tax purposes is re the reduced price or, in case of repayment, to permit quired to be, in effect, determined upon the basis of, a deduction to be taken in computing net income, and by giving effect to, the renegotiation. No refund provided excessive profits determined to have been of tax for any taxable year shall include any amount realized and received by the taxpayer are repaid to the of tax which, pursuant to section 3806(b), is credited Government. Likewise, in case the reduced contract against excessive profits eliminated for such year. prices are determined for the immediately preceding However, for the purpose of determining the correct taxable year or a repayment is to be made in lieu amount of the tax after a renegotiation has been made thereof, and the completed income and excess profits

2-16-68

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tax returns for such year have not been filed at the “The term 'renegotiation includes any transaction
time of such determination, the taxpayer has been which is a renegotiation within the meaning of section
permitted to report the gross income ior such preced 403 of the Sixth Supplemental National Defense Ap-
ing year to conform with the reduced prices agreed propriation Act (Public 528, 77th Cong., 2d sess.) or
upon or to take a deduction in computing net income, such section, as amended, any modification of one or
as the case may be, provided the taxpayer repays to more contracts with the United States or any agency
the Government the excessive profits determined to thereof, and any agreement with the United States or
have been realized. No deduction from gross income any agency thereof in respect of one or more such con-
is allowed for any other taxable year for the amount tracts or subcontracts thereunder."
of such excessive profits so repaid. This method of It will be noted that the above-quoted provision of
treatment will continue to be followed, subject to the the Code includes within the term “renegotiation"-
condition that the excessive profits be paid or repaid "any modification of one or more contracts with the
to the United States or credited against amounts due United States or any agency thereof, and any agree-
and payable from the United States, and no deduction ment with the United States or any agency thereof in
fron gross income will be allowed for any other tax respect of one or more such contracts or subcontracts
able year for the amount of such excessive profits so thereunder."
repaid. (See I.T. 3577, C.B. 1942-2, 163.)

It is held that the term "renegotiation," for the pur-
The above statements apply with equal force to poses of section 3806 of the Internal Revenue Code, as
(1) disallowance of items of cost for which a contrac amended, is not limited to a renegotiation within the
tor has been previously reimbursed under a cost-plus meaning of section 403 of the Sixth Supplemental
a-fixed-fee contract (see sec. 3806(a)(2) of the Code), National Defense Appropriation Act, 1942, as amended,
and (2) contracts involving any renegotiation within supra (which section is cited as the Renegotiation
the meaning of that term as it is defined in section Act). It includes an agreement in writing made in
3806(a)(1)(A) of the Code, including, but not limited respect of one or more Government contracts or sub-
to, (a) any modification of one or more contracts with contracts thereunder, and may be effected by an ex-
the United States or any agency thereof when such change of correspondence which embodies a binding
modification effects a voluntary elimination of exces agreement by both parties as to the amount repaid or
sive profits (as defined in section 3806 (a) (1) (B) of to be repaid and the year to which the repayment
the Code) for a prior year, or a price reduction made relates. A Government contractor, acting upon his
retroactive for a prior year pursuant to express pro own initiative and desirous of refunding direct to the
vision for price adjustment contained in the contract, United States, profits he has realized under a Govern-
and (b) any agreement with the United States or ment contract, or a subcontract thereunder, should,
any agency thereof in respect of one or more such however, get in touch with the renegotiating agency
contracts or subcontracts thereunder.

as to the form of agreement in writing which may be

employed. Bureau of Internal Revenue I.T. 3671.

Internal Revenue Service: Rev. Rul. 144. Section 3806: Mitigation of Effect of Renego Section 187: Partnership returns. tiation of War Contracts or Disallowance of

Advice is requested respecting the effect on a partnerReimbursement.

ship, for Federal income tax purposes, of the death, withdrawal, substitution, or addition of a partner.

As defined in section 3797 (a) (2) of the Internal The term "renegotiation,” for the purposes Revenue Code, the term “partnership" for tax purposes of section 3806 of the Internal Revenue Code,

is broader than the term under common law, the Unias amended, is not limited to a renegotiation form Partnership Act, or individual State laws. Acwithin the meaning of section 403 of the Sixth cordingly, the Federal tax consequences of transactions Supplemental National Defense Appropria involving partnerships and interests in partnerships tion Act, 1942 (56 Stat. 226), as amended.

will be determined upon the basis of their substance

and in accordance with the Federal tax laws without Advice is requested whether the term "renegotiation,” for the purposes of section 3806 of the Internal

regard to the technical refinements of State laws. (See Revenue Code, as amended, is limited to a renegotia

Commissioner v. Francis E. Tower, 327 U.S. 280; Ct. tion within the meaning of section 403 of the Sixth

D. 1670, C.B. 1946–1, 11, and Heiner v. Mellon, 304 U.S. Supplemental National Defense Appropriation Act,

271; Ct. D. 1345, C. B. 1938–1, 349.) 1942 (56 Stat., 226), as amended, or whether any Gov

Sections 187 and 188 of the Code, which refers to the ernment contractor, acting upon his own initiative

"taxable year" of the partnership, recognizes a partnerand desirous of refunding direct to the United States

ship as a unit for the purpose of filing returns. These profits he has realized under a Government contract,

sections do not contemplate that a partnership may or a subcontract thereunder, may effect a repayment

terminate its taxable year and thus change its accountof such profits in a manner coming within the provi

ing period by the mere act of admitting or retiring a sions of section 3806 of the Code, as amended.

partner, nor that the Commissioner may force a change Section 3806(a)(1)(A) of the Code provides as

of accounting period under such circumstances. follows:

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INTERNAL REVENUE CODE

2-15-08

Accordingly, it is held that a change in the member section 3806 of the Code since the refunds paid were ship of a partnership resulting from the death, with in the amount of the determination. drawal, substitution, or addition of a partner, or a With respect to (A), above, section 3806(a)(1) shift of interests among existing partners does not, in states in part as follows: itself, effect a termination of a partnership for Federal In the case of a contract with the United States or income tax purposes. Ordinarily, a partnership will be

any agency thereof, or any subcontract thereunder, treated as continuing where the business of the part which is made by the taxpayer, if a renegotiation is nership, or a substantial portion thereof, is continued.

made in respect of such contract or subcontract and The returns of a continuing partnership should con an amount of excessive profits for a taxable year tinue to be filed on the basis of the annual accounting

is eliminated, and * * * the taxpayer is required to period previously established by the partnership. *

pay or repay to the United States or any agency Internal Revenue Service: Rev. Rul. 54 thereof ***. [Italics supplied.] 82.- Section 3806: Mitigation of Effect of Re

Since section 3806 (a) deals only with payments or negotiation of War Contracts or Disallowance

repayments required to be made to the United States of Reimbursement.

or any agency thereof, payments made directly to a prime contractor by a subcontractor at the direction

of the Government agency do not fall within the proINTERNAL REVENUE CODE

visions of section 3806 of the Code or Rev. Rul. 53, The provisions of section 3806 of the Internal Reve supra, unless the payment is made to the prime connue Code will not apply to a subcontractor, who, at tractor as an agent of the subcontractor to transmit the direction of the Government agency that was the the payment to the United States and the payment is issuing office for the prime contract, makes a refund actually transmitted to the United States by the prime to the prime contractor, unless such payment to the contractor, or unless the payment is made under cirprime contractor is made under circumstances which cumstances which make the prime contractor a trusmeet the conditions of that section requiring payment tee of the payment for the benefit of the United States. to the United States.

It is not sufficient, for the purpose of treating such Where the provisions of section 3806 of the Code repayments under section 3806 of the Code, that the are applicable to a prime or a subcontractor and the refund is made to the prime contractor with the underexcessive profits, applicable to the prior as well as the standing that such refund will be taken into considcurrent year, are repaid, such repayment of excessive eration when a price redetermination or renegotiation profits to the United States Government shall be is made in the case of the prime contractor. allocated to the applicable years in the absence of the With respect to (B), above, since the repayment of application of section 3806(a)(4) of the Code. In excessive profits was made by the prime contractor the event that excessive profits have been repaid with to the United States Government, the provisions of out benefit of a tax credit, where such credit is allow section 3806 of the Code are applicable to the prime able under section 3806 (6) of the Code, the credit contractor. In the absence of the application of secshall be treated as an overpayment of tac for the tion 3806(a)(4) of the Code to the case, the excessive prior taxable year. Such overpayment is considered profits should be properly allocated between 1951 and made at the time the payment, repayment or offset was 1952 in order to comply with the provisions of section made, for the purpose of computing interest under 3806(a) (3) of the Code which reads: section 3771 (0) of the Code.

(3) DEDUCTIONS DISALLOWED.-The amount of pay

ment, repayment, or offset described in paragraph (1) Advice is requested as to the application of Rev.

or paragraph (2) shall not constitute a deduction for Rul. 53, C.B. 1953–1,479, to price redetermination cases

the year in which paid or incurred. under the following sets of circumstances :

If the excessive profits have been repaid without (A) A subcontractor to a prime Government con

the benefit of a tax credit, where such credit is allowtractor, had a subcontract prime redetermination

able under 3806(b), section 3806 (c) of the Code promade by the Government agency that was the issuing

vides in part as follows: office for the prime contract, and, at its direction,

(C) CREDIT IN LIEU OF OTHER CREDIT OR REFUND. made a contract price readjustment refund to the prime contractor. A refund was made in 1951, the

*** If the amount allowable as a credit under sub

section (b) exceeds the amount allowed under such year in which the applicable subcontract income was

subsection, the excess shall, for the purposes of the accrued. Under the same circumstances a refund was

internal revenue laws relating to credit or refund of made in 1952, but such refund to the prime contractor

tax, be treated as an overpayment for the prior taxcovered subcontract income which was accrued in

able year which was made at the time payment, re1951 and 1952.

payment, or offset was made. [Italics supplied.] (B) The prime contractor had a price redetermina

Accordingly, the provisions of section 3806 of the Intion made in 1952 and made refund to the Govern

ternal Revenue Code will not apply to a subcontractor, ment agency in 1952. Income under the prime contract who, at the direction of the Government agency that was accrued in 1951 and 1952. The prime contractor was the issuing office for the prime contract, makes a treated such refund, in 1952, as a reduction of sales refund to the prime contractor, unless such payment is for such year. No tax credits have been allowed under actually transmitted in full to the United States by

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