(c) Rental costs under short-term leasing are allowable to the extent that:

(1) The rates are reasonable at the time of the decision to lease in light of such factors as rental costs of comparable property, if any, and market conditions in the area, the type, life expectancy, condition, and value of property leased, alternatives available and other provisions of the agreement; and (2) They do not give rise to a material equity in the property (such as an option to renew or purchase at a bargain rental or price) other than that normally given to industry at large, but represent charges only for the current use of the property including, but not limited to, any incidental service costs such as maintenance, insurance and applicable taxes.

(d) (1) Rental costs under long-term leasing are allowable only up to the amount the contractor would be allowed had he purchased the property unless he can demonstrate on the basis of facts existent at the time of the decision to lease on a long-term basis, documented in accordance with paragraph (e) of this section, that long-term leasing will result in less cost to the Government over the anticipated useful life of the property. If the contractor can demonstrate that long-term leasing will result in less cost to the Government, the rental costs for the term of the lease shall be subject to the same criteria set forth in paragraph (c) of this section for short-term leasing. However, if he subsequently renews the lease he must again demonstrate that leasing will result in less cost to the Government if he wishes to continue having rental costs evaluated by the criteria in paragraph (c) of this section.

(2) In estimating the least cost to the Government for the anticipated useful life, the cumulative costs that would be allowed if the contractor owned the property should be compared with cumulative costs that would be allowed under the leasing arrangement. For the purposes of this comparison, the costs of property include, but are not limited to, the costs of operation, maintenance, insurance, taxes, depreciation, leasehold improvements, and rental as applicable; and exclude interest, in the case of ownership costs, and other unallowable costs pursuant to Part 18-15 in either

case.

(3) In those situations where leasing was formerly classified as short-term

leasing, the purchase cost for purposes of cost comparison in subparagraph (2) of this paragraph will be the price at which the property could be acquired on the date that the agreement meets the qualifications for long-term leasing. If purchase is determined to be the method of acquisition which would result in least cost to the Government, such determination shall not be applied to the years when the leasing was classified as shortterm leasing.

(e) Contractor's justifications, under paragraph (d) of this section, of his long-term leasing decisions shall consist of, but are not limited to, the following supporting data, prepared prior to leasing:

(1) Analysis of utilization of existing property;

(2) Application of comparative cost criteria in paragraph (d) of this section; (3) Specific objectives or requirements;

(4) Solicitation of proposals from available sources; and

(5) Proposals received in response to the solicitation, and reasons for selection of the property chosen and for the decision to lease.

(f) Rental costs under a sale and leaseback arrangement shall be allowable only up to that amount the contractor would be allowed had he retained title to the property, except rental cost may be allowed:

(1) In accordance with paragraphs (b), (c), and (d) of this section where the sale and leaseback immediately followed purchase of the property; or

(2) The sale and leaseback is otherwise in the best interests of the Government and specifically authorized in the contract.

(g) Charges in the nature of rent between any divisions, subsidiaries, or organization under common control are allowable to the extent such charges do not exceed the normal costs of ownership, such as depreciation, taxes, insurance, and maintenance (excluding interest or other unallowable costs pursuant to Part 18-15): Provided, That no part of such costs shall duplicate any other allowed costs. However, rental cost of personal property, which is leased from any division, subsidiary, or affiliate of the contractor under common control, which has an established practice of leasing the same or similar property to unaffiliated lessees shall be allowed in accordance with paragraphs (b), (c), and (d) of

this section. In addition, where the lessor is also the manufacturer of the personal property, the purchase price for the purposes of paragraph (d) (1) of this section and the cost of ownership for the purposes of paragraph (d) (2) of this section shall be determined in accordance with § 18-15.205-22(e).

(h) Rental costs under long-term leasing entered into prior to the effective date of this 18-15.205-34 are allowable for the remaining term of the lease (excluding unexercised options) to the extent they would have been allowable under § 18-15.205-34 as of January 1, 1969.

(i) The allowability of rental costs under unexpired leases in connection with terminations is treated in § 18-15.205-42

(a) Basic research, for the purpose of this Subpart 18-15.2, is that type of research which is directed toward increase of knowledge in science. In such research, the primary aim of the investigator is a fuller knowledge or understanding of the subject under study, rather than any practical application thereof. Applied research, for the purpose of this Subpart 18-15.2, consists of that type of effort which (1) normally follows basic research, but may not be severable from the related basic research; (2) attempts to determine and expand the potentialities of new scientific discoveries or improvements in technology, materials, processes, methods, devices, and techniques; and (3) attempts to "advance the state of the art." Applied research does not include any such efforts when their principal aim is the design, development, or test of specific articles or services to be offered for sale, which are within the definition of the term development as hereinafter provided.

(b) Development is the systematic use of scientific knowledge which is directed toward the production of, or improvements in, useful products to meet specific

manufacturing

engineering.

(c) A contractor's independent research and development is that research and development which is not sponsored by a contract, grant, or other arrangement.

(d) A contractor's cost of independent research as defined in paragraphs (a) and (c) of this section shall be allowable as indirect costs (subject to the following provisions of this § 18-15.205-35) provided they are allocated to all work of the contractor.

(e) Costs of a contractor's independent development, as defined in paragraphs (b) and (c) of this section (and subject to the following provisions of this § 18-15.205-35), are allowable to the extent that such development is related to the product lines for which the Government has contracts, provided the costs are reasonable in amount and are allocated as indirect costs to all work of the contractor on such product lines. In cases where a contractor's normal course of business does not involve production work, the cost of independent development is allowable to the extent that such development is related and allocated as an indirect cost to the field of effort of Government research and development contracts.

(f) Independent research and development costs shall include an amount for the absorption of their appropriate share of indirect and administrative costs, unless the contractor, in accordance with his accounting practices consistently applied, treats such costs otherwise.

(g) Research and development costs (including amounts capitalized), regardless of their nature, which were incurred in accounting periods prior to the award of a particular contract, are unallowable except where allowable as precontract costs (see § 18-15.205-30).

(h) The reasonableness of expenditures for independent research and development when otherwise allowable in accordance with the provisions of this § 18-15.205-35 should be determined in light of all pertinent considerations, such as previous contractor research and development activity, cost of past programs, and changes in science and technology. Such expenditures should be pursuant to a broad planned program, which is reasonable in scope and well managed. Such expenditures (especially

for development) should be scrutinized with great care in connection with contractors whose work is predominantly or substantially with the Government. Advance agreements as described in § 1815.107 are particularly important in this situation. In recognition that cost sharing of the contractor's independent research and development program may provide motivation for more efficient accomplishment of such program, it is desirable in some cases that the Government bear less than an allocable share of the total cost of the program. Under these circumstances, the following are among the approaches which may be used as the basis for agreement:

(1) Review of the contractor's proposed independent research and development program and agreement to accept the allocable costs of specific projects;

(2) Agreement on a maximum dollar limitation of costs, an allocable portion of which will be accepted by the Government; and

(3) An agreement to accept the allocable share of a percentage of the contractor's planned research and development program.

§ 18-15.205-36 Royalties and other costs for use of patents.

(a) Royalties on a patent or amortization of the costs of acquiring by purchase a patent or rights thereto, necessary for the proper performance of the contract and applicable to contract products or processes, are allowable unless:

(1) The Government has a license or the right to free use of the patent;

(2) The patent has been adjudicated to be valid, or has been administratively determined to be invalid;

(3) The patent is considered to be unenforceable; or

(4) The patent has expired.

(b) Special care should be exercised in determining reasonableness where the royalties may have been arrived at as a result of less than arm's length bargaining; e.g.:

(1) Royalties paid to persons, including corporations, affiliated with the contractor;

(2) Royalties paid to unaffiliated parties, including corporations, under an agreement entered into in contemplation that a Government contract would be awarded; or

(3) Royalties paid under an agreement entered into after the award of the contract.

(c) In any case involving a patent formerly owned by the contractor, the amount of royalty allowed should not exceed the cost which would have been allowed had the contractor retained title thereto.

(d) See § 18-15.107 regarding advance understandings.

§ 18-15.205-37 Selling costs.

(a) Selling costs arise in the marketing of the contractor's products and include costs of sales promotions, negotiation, liaison between Government representatives and contractor's personnel, and other related activities.

(b) Selling costs are allowable to the extent they are reasonable and are allocable to Government business (but see §§ 18-15.107 and 18-15.205-1). Allocability of selling costs will be determined in the light of reasonable benefit to the Government arising from such activities as technical, consulting, demonstration, and other services which are for purposes such as application or adaptation of the contractor's products to Government use.

(c) Notwithstanding paragraph (b) of this section, salesmen's or agents' compensation, fees, commissions, percentages, or brokerage fees, which are contingent upon the award of contracts, are allowable only when paid to bona fide employees or bona fide established commercial or selling agencies maintained by the contractor for the purpose of securing business.

ment is being terminated. Costs of severance pay are allowable only to the extent that, in each case, it is required by (1) law, (2) employer-employee agreement, (3) established policy that constitutes, in effect, an implied agreement on the contractor's part, or (4) circumstance of the particular employment.

(b) Cost of severance payments is divided into two categories, as follows:

(1) Actual normal turnover severance payments shall be allocated to all work performed in the contractor's plant; or, where the contractor provides for accrual of pay for normal severances, such method will be acceptable if the amount of the accrual is reasonable in light of payments actually made for normal severances over a representative past period, and if amounts accrued are allocated to all work performed in the contractor's plant; and

(2) Abnormal or mass severance pay is of such a conjectural nature that measurement of costs by means of an accrual will not achieve equity to both parties. Thus accruals for this purpose are not allowable. However, the Government recognizes its obligation to participate, to the extent of its fair share, in any specific payment. Thus, allowability will be considered on a case-by-case basis in the event of occurrence.

§ 18-15.205-40 Special tooling and special test equipment costs.

(a) The term "special tooling" means all jigs, dies, fixtures, molds, patterns, taps, gauges, other equipment and manufacturing aids, and replacements thereof, which are of such a specialized nature that, without substantial modification or alteration, their use is limited to the development or production of particular supplies or parts thereof, or the performance of particular services. The term includes all components of such items, but does not include:

(1) Consumable property;
(2) Special test equipment; or

(3) Buildings, nonseverable structures (except foundations and similar improvements involving relatively minor expense which are necessary for the installation of special tooling), general or special machine tools, or similar capital items.

(b) The term "special test equipment" means electrical, electronic, hydraulic, pneumatic, mechanical or other items or assemblies of equipment, which are of such a specialized nature that, without

modification or alteration, the use of such items (if they are to be used separately) or assemblies is limited to testing in the development or production of particular supplies or parts thereof, or in the performance of particular services. The term "special test equipment" includes all components of any assemblies of such equipment, but does not include: (1) Consumable property;

(2) Special tooling; or

(3) Buildings, nonseverable structures (except foundations and similar improvements necessary for the installation of special test equipment), general or special machine tools, or similar capital items.

(c) The cost of special tooling and special test equipment used in the performance of one or more Government contracts is allowable and shall be allocated to the specific Government contract or contracts for which acquired, except that the cost of

(1) Items acquired by the contractor prior to the effective date of the contract, or replacements of such items, whether or not altered or adapted for use in the performance of the contract, or

(2) Items the acquisition of which by the Government is specifically excluded by the Schedule

shall be allowable only as depreciation or amortization.

(d) Where items are disqualified as special tooling because with less than substantial modification or alteration they can be made general purpose, and where items are disqualified as special test equipment because with relatively minor expense they can be made suitable for general purpose use and have a value as such commensurate with their value as special test equipment, the cost of adapting the items for use under the contract and the cost of returning them to their prior configuration will be allowable.

(1) Federal income and excess profits taxes;

(2) Taxes in connection with financing, refinancing, or refunding operations (see § 18-15.205-17);

(3) Taxes from which exemptions are available to the contractor directly or available to the contractor based on an exemption afforded the Government except when the contracting officer determines that the administrative burden incident to obtaining the exemption outweighs the corresponding benefits accruing to the Government;

(4) Special assessments on land which represent capital improvements; and

(5) Taxes on any category of property which is used solely in connection with work other than on Government contracts. (Taxes on property used solely in connection with either non-Government or Government work should be considered directly applicable to the respective category of work unless the amounts involved are insignificant or comparable results would otherwise be obtained; e.g., taxes on contractor-owned work in process which is used solely in connection with non-Government work should be allocated to such work, and taxes on contractor-owned work-in-process inventory, and Government-owned workin-process inventory when taxed, used solely in connection with Government work, should be charged to such work.)

(b) Income tax accruals designed to account for the tax effects of differences between taxable income and pretax income as reflected by the books of account and financial statements are unallowable.

(c) Taxes otherwise allowable under paragraph (a) of this section, but upon which a claim of illegality or erroneous assessment exists, are allowable; provided that the contractor prior to payment of such taxes:

(1) Promptly requests instructions from the contracting officer concerning such taxes; and

(2) Takes all action directed by the contracting officer arising out of paragraph (c) (1) of this section or an independent decision of the Government as to the existence of a claim of illegality or erroneous assessment, including cooperation with and for the benefit of the Government to (a) determine the legality of such assessment or (b) secure a refund of such taxes.

Reasonable costs of any such action undertaken by the contractor at the

direction or with the concurrence of the contracting officer are allowable. Interest and penalties incurred by a contractor by reason of the nonpayment of any tax at the direction of the contracting officer or by reason of the failure of the contracting officer to issue timely direction after prompt request therefor, are also allowable.

(d) Any refund of taxes, interest, or penalties, and any payment to the contractor of interest thereon, attributable to taxes, interest, or penalties which were allowed as contract costs, shall be credited or paid to the Government in the manner directed by the Government, provided any interest actually paid or credited to a contractor incident to a refund of tax, interest, or penalty shall be paid or credited to the Government only to the extent that such interest accrued over the period during which the contractor had been reimbursed by the Government for the taxes, interest, or penalties.

§ 18-15.205-42 Termination costs.

Contract terminations generally give rise to the incurrence of costs, or the need for special treatment of costs, which would not have arisen had the contract not been terminated. Cost principles covering these items are set forth below. They are to be used in conjunction with the remainder of this subpart in termination situations.

(a) Common items: The cost of items reasonably usable on the contractor's other work shall not be allowable unless the contractor submits evidence that he could not retain such items at cost without sustaining a loss. In deciding whether such items are reasonably usable on other work of the contractor, the contracting officer should consider the contractor's plans and orders for current and scheduled production. Contemporaneous purchases of common items by the contractor shall be regarded as evidence that such items are reasonably usable on the contractor's other work. Any acceptance of common items as allocable to the terminated portion of the contract should be limited to the extent that the quantities of such items on hand, in transit, and on order are in excess of the reasonable quantitative requirements of other work.

(b) Costs continuing after termination: If, in a particular case, despite all reasonable efforts by the contractor, certain costs cannot be discontinued im