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 (b), (c), and (d) above. In addition, where the lessor is also the manufacturer of the personal property, the purchase price for the purposes of (d)(1) above and the cost of ownership for the purposes of (d)(2) above shall be determined in accordance with 15-205.22(e).

(h) Rental costs under long-term leasing entered into prior to the effective date of this 15-205.34 are allowable for the remaining term of the lease (excluding unexercised options) to the extent they would have been allowable under 15-205.34 dated January 1, 1969.

(i) The allowability of rental costs under unexpired leases in connection with terminations is treated in 15–205.42(e).

(j) Allowable rental costs shall not be adjusted by the amount of any investment credit accruing to the contractor by reason of an election made by a lessor of new "section 38" property to treat the contractor as the purchaser of such property pursuant to section 48(d) of the Revenue Act of 1962, as amended.

15-205.35 Independent Research and Development Costs.

(a) Definitions. A contractor's independent research and development effort (IR&D) is that technical effort which is not sponsored by, or required in performance of, a contract or grant and which consists of projects falling within the following three areas: (i) basic and applied research, (ii) development, and (iii) systems and other concept formulation studies. IR&D effort shall not include technical effort expended in the development and preparation of technical data specifically to support the submission of a bid or proposal. For the purposes of this paragraph:

(1) Basic research is that research which is directed toward increase of knowledge in science. The primary aim of basic research is a fuller knowledge or understanding of the subject under study, rather than any practical application thereof.

(2) Applied research is that effort which (A) normally follows basic research, but may not be severable from the related basic research, (B) attempts to determine and exploit the potential of scientific discoveries or improvements in technology, materials, processes, methods, devices, or techniques, and (C) attempts to advance the state of the art. Applied research does not include efforts whose principal aim is design, development, or test of specific items or services to be considered for sale; these efforts are within the definition of the term "development," defined below.

(3) Development is the systematic use, under whatever name, of scientific and technical knowledge in the design, development, test, or evaluation of a potential new product or service (or of an improvement in an existing product or service) for the purpose of meeting specific performance requirements or objectives. Development shall include the functions of design engineering, prototyping, and engineering testing.

(4) Systems and other concept formulation studies are analyses and study efforts either related to specific IR&D efforts or directed toward the identification of desirable new systems, equipments or components, or desirable modifications and improvements to existing systems, equipments, or components.

(5) Company includes all divisions, subsidiaries, and affiliates of the contractor under common control.

(b) Composition of Costs. IR&D costs shall include not only all direct costs, but also all allocable indirect costs except that general and administrative costs shall not be considered allocable to IR&D. Both direct and indirect costs shall be determined on the same basis as if the IR&D project were under contract.

(c) Allocation. As a general rule, IR&D costs shall be allocated to contracts on the same basis as the general and administrative expense grouping of the profit center (see 3-1003.3) in which such costs are incurred. However, where IR&D costs clearly benefit other profit centers, or the entire company, such costs shall be allocated through the G&A of such other profit centers or through the corporate G&A, as appropriate. In those instances when allocation of IR&D through the G&A base does not provide equitable cost allocation, the contracting officer may approve use of a different base. Where allowable IR&D is established by advance agreement pursuant to (d)(1) below, the advance agreement shall specify the allocation procedures.

(d) Allowability. Except as provided in (e) below, costs for IR&D are allowable only in accordance with the following:

(1) Companies Required to Negotiate Advance Agreements (CWAS-NA).
(A) Any company which received payments, either as a prime con-
tractor or subcontractor, in excess of $2 million from the DoD
for IR&D and B&P in a fiscal year, is required to negotiate an
advance agreement with the Government which establishes a
ceiling for allowability of IR&D costs for the following fiscal
year. Computation of the amount of IR&D and B&P costs to
determine whether the $2 million criterion was reached will in-
clude only those recoverable IR&D and B&P costs allocated
during the company's previous fiscal year to all DoD prime con-
tracts and subcontracts for which the submission and certifica-
tion of cost or pricing data was required in accordance with Sec-
tion 2306(f) of Title 10, United States Code. The computation
shall include full burdening in the same manner as if the IR&D
and B&P projects were contracted for except that G&A will not
be applied.

(B) When a company meets the criterion in (A) above, required ad-
vance agreements may be negotiated at the corporate level
and/or with those profit centers (see 3-1003.3) which contract
directly with the DoD and which in the preceding year allocated
recoverable IR&D and B&P costs in excess of $250,000 includ-
ing burdening as in (A) above, to DoD contracts and subcon-
tracts for which the submission and certification of cost or pric-
ing data was required in accordance with Section 2306(f) of
Title 10, United States Code. When ceilings are negotiated for
separate profit centers of the company, the allowability of IR&D
costs for any center which, in its previous fiscal year, allocated
less than $250,000 of IR&D and B&P costs to such DoD con-
tracts and subcontracts may be determined in accordance with
(d)(2) below.

(C) Companies which meet the threshold in (A) above shall submit technical and financial information to support their proposed IR&D program in accordance with guidance furnished by the Armed Services Research Specialists Committee. Results of the technical evaluation performed by the Armed Services Research Specialists Committee, including determination of potential relationship, will be made available to the contractor by the cognizant Departmental central office.

(D) Ceilings are the maximum dollar amounts of total costs for IR&D work that will be allowable for allocation to all work of that part of the company's operation covered by an advance agreement. Within the ceiling limitations contractors will not be required to share IR&D costs. In negotiating a ceiling, in addition to other considerations, particular attention must be paid to such factors as:

(i) The technical evaluation of the Armed Services Research Specialists Committee including the potential relationship of IR&D projects to a military function or operation.

(ii) Comparison with previous year's programs including the level of the Government's participation.

(iii) Changes in the Company's business activities.

(E) The total amount of IR&D costs allocated to DoD contracts pursuant to this subparagraph (1) shall not exceed the total of expenditures for IR&D projects with a potential relationship to a military function or operation. For contracts which do not provide for cost determinations on a historical basis, this requirement will be considered to have been met if the estimated IR&D costs allocated to the contract do not exceed its proportionate share of the total estimated costs of IR&D with a potential relationship to a military function or operation.

(F) No IR&D costs shall be allowable if a company fails to initiate negotiation of a required advance agreement prior to the end of the fiscal year for which the agreement is required.

(G) When negotiations are held with a company meeting the $2 million criterion or with separate profit centers (when negotiations are held at that level under (B) above) and an advance agreement is not reached, payment for IR&D costs is required to be reduced substantially below that which the company or profit center would otherwise have received. The amount of such reduced payment shall not exceed 75% of the amount which, in the opinion of the contracting officer, the company or profit center would be entitled to receive under an advance agreement. Written notification of the contracting officer's determination of a reduced amount shall be provided the contractor. In the event that an advance agreement is not reached prior to the end of the contractor's fiscal year for which such agreement is to apply, negotiations shall immediately be terminated and the

contracting officer's determination of the reduced amount shall be furnished.

(H) Contractors may appeal decisions of the contracting officer to
reduce payments. Such appeal shall be filed with the contracting
officer within 30 days of receipt of a decision. For the purpose
of hearing and deciding such appeals, each department will
establish an appeals hearing group consisting of the following:
(i) A representative to be designated by the Assistant Secretary
(Installations and Logistics) or the Director, DSA, who shall be
Chairman;

(ii) A representative to be designated by the Assistant Secretary
(Research and Development) or ODDR&E in the case of DSA; and
(iii) A representative to be designated by the General Counsel, Judge Ad-
vocate General of the Department or Counsel of DSA. Determina-
tions of the appeals group shall be the final and conclusive deter-
mination of the Department of Defense.

(I) Advance agreements negotiated shall include at least the follow-
ing:

(i) A separate dollar ceiling for IR&D. However, provision shall be
made permitting the contractor to recover costs for IR&D above the
negotiated ceiling, provided that recovery of B&P costs covered by
the same agreement is decreased below its ceiling by a like amount.
(ii) A provision stating how IR&D costs are to be allocated (see (c)
above).

(iii) A statement that the costs for IR&D work recoverable under con

tracts citing DoD funds subject to Section 203, P.L. 91-441 limitations shall not exceed A such contracts' allocable share of the ceiling, and B the total costs of the contractor's IR&D determined to have a potential relationship to a military function or operation. (iv) A statement that estimated costs or actual costs incurred, as appropriate, not in excess of the ceilings negotiated shall be used in the pricing of all contractual actions when negotiations are based on elements of cost and in final price determinations.

(J) Prior to the execution of an advance agreement, the IR&D factor to be used for forward pricing and interim billing will be developed by and obtained from the cognizant central office of the Department responsible for negotiating IR&D advance agreements. The IR&D factor shall exclude estimated or actual costs for projects considered unrelated to a military function or operation.

(2) Companies Not Required to Negotiate Advance Agreements (CWAS). Allowable IR&D costs for companies not required to negotiate advance agreements in accordance with (1) above shall be established by a formula, either on a company-wide basis or by profit centers, computed as follows:

(i) Determine the ratio of IR&D costs to total sales (or other base acceptable to the contracting officer) for each of the preceding three years and average the two highest of these ratios; this average is the IR&D historical ratio;

(ii) Compute the average annual IR&D costs (hereafter called average),

using the two highest of the preceding three years;

(iii) IR&D costs for the center for the current year which are not in excess of the product of the center's actual total sales (or other accepted base) for the current year and the IR&D historical ratio computed under (i) above (hereafter called product) shall be considered allowable only to the extent the product does not exceed 120% of the average. If the product is less than 80% of the average, costs up to 80% of the average shall be allowable.

(iv) Costs which are in excess of the ceiling computed in (iii) above are not allowable except where the ceiling computed for bid and proposal cost under 15-205.3 is reduced in an amount identical to the amount of any increase over the IR&D ceiling computed in (iii) above.

However, at the discretion of the contracting officer, an advance agreement may be negotiated when the contractor can demonstrate that the formula would produce a clearly inequitable cost recovery. The requirements of (d)(1) above are not mandatory for such agreements.

(e) Deferred Costs (CWAS-NA). IR&D costs which were incurred in previous accounting periods are unallowable, except when a contractor has developed a specific product at his own risk in anticipation of recovering the development costs in the sale price of the product provided that:

(1) The total amount of IR&D costs applicable to the product can be identified,

(2) The proration of such costs to sales of the product is reasonable, (3) The contractor had no Government business during the time that the costs were incurred or he did not allocate IR&D costs to Government contracts except to prorate the cost of developing a specific product to the sales of that product, and

(4) No costs of current IR&D programs are allocated to Government work except to prorate the costs of developing a specific product to the sales of that product.

When deferred costs are recognized, the contract (except firm fixed-price and fixed-price with escalation) will include a specific provision setting forth the amount of deferred IR&D costs that are allocable to the contract. The negotiation memorandum will state the circumstances pertaining to the case and the reason for accepting the deferred costs.

15-205.36 Royalties and Other Costs for Use of Patents.

(a) (CWAS) Royalties on a patent or amortization of the cost 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(i) the Government has a license or the right to free use of the patent; (CWAS-NA)

(ii) the patent has been adjudicated to be invalid, or has been adminis-
tratively determined to be invalid; (CWAS-NA)

(iii) the patent is considered to be unenforceable; (CWAS-NA) or
(iv) the patent is expired. (CWAS-NA)