the United States in respect of such contracts.

§ 16.18 Determination of liability for excess profit, interest and penalties; assessment, collection, payment, refunds. (a) The duty of determining the correct amount of excess profit liability on contracts and subcontracts coming within the scope of the act and the regulations in this part is upon the Commissioner of Internal Revenue. Under section 3(b) of the act of March 27, 1934, as last amended, all provisions of law (including the provisions of law relating to interest, penalties and refunds) applicable with respect to the taxes imposed by Title I of the Revenue Act of 1934 and not inconsistent with section 3 of the act of March 27, 1934, as last amended, are applicable with respect to the assessment, collection, or payment of excess profits on contracts and subcontracts coming within the scope of the act and the regulations in this part and to refunds of overpayments of profits into the Treasury under the act. Claims by a contracting party for the refund of an amount of excess profit, interest, penalties, and additions to such excess profit shall conform to the general requirements prescribed with respect to claims for refund of overpayments of taxes imposed by Title I of the Revenue Act of 1934 and, if filed on account of any additional costs incurred pursuant to guarantee provisions in a contract, shall be supplemented by a statement under oath showing the amount and nature of such costs and all facts pertinent thereto.

(b) Administrative procedure for the determination, assessment and collection of excess profit liability under the act and the regulations in this part and the examination of reports and claims in connection therewith will be prescribed from time to time by the Commissioner of Internal Revenue.

PART 17-EXCESS PROFITS ON NAVY CONTRACTS

REGULATIONS FOR INCOME-TAXABLE YEARS ENDING AFTER APRIL 3, 1939

AUTHORITY: Sections 17.1 to 17.19 issued under 52 Stat. 467; 26 U.S.C. 3791. Interpret or apply sec. 3, 48 Stat. 505, as amended, 53 Stat. 112; 34 U.S.C. 496, 26 U.S.C. 650, 651.

SOURCE: Sections 17.1 to 17.19 contained in T.D. 4906, 4 FR 2492, June 27, 1939, except as otherwise noted.

§ 17.1 Definitions. As used in the regulations in this part the term:

(a) "Act" means the act of March 27, 1934 (48 Stat. 505; 34 U.S.C. 496), as originally enacted, as amended by the act of June 25, 1936 (49 Stat. 1926; 34 U.S.C. 496), and as further amended by the act of April 3, 1939 (53 Stat. 560; 34 U.S.C. 496).

(b) "Person" includes an individual, a corporation, a partnership, a trust or estate, a joint-stock company, an association, or a syndicate, group, pool, joint venture or other unincorporated organization or group, through or by means of which any business, financial operation or venture is carried on.

(c) "Contract" means an agreement made by authority of the Secretary of the Navy for the construction or manufacture of any complete naval vessel or aircraft or any portion thereof.

(d) "Contractor" means a person entering into a direct contract with the Secretary of the Navy or his duly authorized representative.

(e) "Subcontract" means an agreement entered into by one person with another person for the construction or manufacture of a complete naval vessel or aircraft or any portion thereof, the prime contract for such vessel or aircraft or portion thereof having been entered into between a contractor and the Secretary of the Navy or his duly authorized representative.

(f) "Subcontractor" means any person other than a contractor entering into a subcontract.

(g) "Contracting party" means a contractor or subcontractor as the case may be.

(h) "Contract price" or "total contract price" means the amount or total amount to be received under a contract or subcontract as the case may be.

(i) "Income-taxable year" means the calendar year, the fiscal year ending during such calendar year or the fractional part of such calendar or fiscal year, upon the basis of which the contracting party's net income is computed and for which its income tax returns are made for Federal income tax purposes.

§ 17.2 Scope of this part. The regulations in this part deal with liability for excess profit on contracts and subcontracts for the construction or manufacture of any complete naval vessel or aircraft or any portion thereof completed within income-taxable years ending after April 3, 1939. As to the date of the completion of a contract or subcontract, see § 17.5.

§ 17.3 Contracts and subcontracts under which excess profit liability may be incurred. Except as otherwise provided with respect to contracts or subcontracts for certain scientific equipment (see § 17.4), every contract awarded for an amount exceeding $10,000 and entered into after the enactment of the act of March 27, 1934 for the construction or manufacture of any complete naval vessel or aircraft, or any portion thereof, is subject to the provisions of the act relating to excess profit liability. Any subcontract made with respect to such a contract and involving an amount in excess of $10,000 is also within the scope of the act.

If a contracting party places orders with another party, aggregating an amount in excess of $10,000, for articles or materials which constitute a part of the cost of performing the contract or subcontract, the placing of such orders shall constitute a subcontract within the scope of the act, unless it is clearly shown that each of the orders involving $10,000 or less is a bona fide separate and distinct subcontract and not a subdivision made for the purpose of evading the provisions of the act.

§ 17.4 Contracts or subcontracts for scientific equipment. No excess profit liability is incurred upon a contract or subcontract entered into after the amendment of section 3(b) of the act of June 25, 1936, if at the time or prior to the time such contract or subcontract is made it is designated by the Secretary of the Navy as being exempt under the provisions of the act pertaining to scientific equipment used for communication, target detection, navigation, or fire control. The exemption of contracts or subcontracts for scientific equipment does not extend to any contract or subcontract entered into prior to the enactment of such amendment of section 3(b) of the act.

17.5 Completion of contract defined. The date of delivery of the vessel, aircraft or portion thereof covered by the contract or subcontract shall be considered the date of completion of the contract or subcontract unless otherwise determined jointly by the Secretary of the Navy and the Secretary of the Treasury or their duly authorized representatives. Except as otherwise provided in the preceding sentence, the replacement of defective parts of delivered articles or the performance of other guarantee work in respect to such articles will not operate to extend the date of completion. As to the treatment of the cost of such work as a cost of performing a contract or subcontract, see 17.9(h). As to a refund in case of adjustment due to any subsequently incurred additional costs, see § 17.19. If a contract or subcontract is at any time cancelled or terminated, it is completed at the time of the cancellation or termination.

17.6 Manner of determining liability with respect to contracts or subcontracts for complete naval vessles or portions thereof. If in an income-taxable year ending after April 3, 1939 a contracting party completes one or more contracts or subcontracts coming within the scope of the act and entered into for the construction or manufacture of any complete naval vessel or any portion thereof, the amount of excess profit to be paid to the United States with respect to all such contracts and subcontracts completed within the income-taxable year shall be computed as follows:

(a) The first step is to ascertain the total contract prices of all such contracts and subcontracts completed by the contracting

party within the income-taxable year. As to total contract prices, see §§ 17.1 and 17.8.

(b) The second step is to ascertain the cost of performing such contracts and subcontracts (see § 17.9) and to deduce such cost from the total contract prices of such contracts and subcontracts as computed in the first step.

The amount remaining after such subtraction is the amount of net profit or net loss upon such contracts and subcontracts completed within the income-taxable year.

(c) The third step, in case there is a new profit upon such contracts and subcontracts, is to subtract from the amount of such net profit as computed in the second step the sum of:

(1) An amount equal to 10 percent of the total contract prices of such contracts and subcontracts completed within the incometaxable year; and

(2) The amount of any net loss which was sustained in the preceding income-taxable year with respect to contracts or subcontracts entered into for the construction or manufacture of any complete naval vessel or any portion thereof, and which is allowable as a credit in determining the excess profit for the income-taxable year with respect to contracts and subcontracts entered into for the construction or manufacture of any complete naval vessel or any portion thereof (see § 17.10(a)).

The amount remaining after such subtraction is the amount of excess profit for the income-taxable year with respect to contracts and subcontracts entered into for the construction or manufacture of any complete naval vessel or any portion thereof.

(d) The fourth step is to ascertain the amount of credit allowed for Federal income taxes paid or remaining to be paid upon the amount of such excess profit as computed in the third step (see § 17.11) and then subtract from the amount of such excess profit the amount of credit for Federal income taxes. The amount remaining after this subtraction is the amount of excess profit to be paid to the United States by the contracting party for the income-taxable year with respect to contracts and subcontracts entered into for the construction or manufacture of any complete naval vessel or any portion thereof and completed within the incometaxable year.

(e) The application of the provisions of this section of the regulations may be illustrated by the following example:

Example: On September 1, 1939 the A Corporation, which keeps its books and makes its Federal income tax returns on a calendar year basis, entered into a contract with the Secretary of the Navy for the construction of portions of a naval vessel coming within the scope of the act, the total

contract price of which $200,000. On March 10, 1940 the A Corporation entered into another such contract, the total contract price of which was $40,000. Both contracts were completed within the calendar year 1940, the first at a cost of $155,000 and the second at a cost of $45,000. During the year 1940 the A Corporation also completed at a loss of $10,000 two contracts entered into for the construction or manufacture of naval aircraft coming within the scope of the act. For the year 1939 the A Corporation sustained a net loss of $2,500 on all contracts and subcontracts for any complete naval vessel or any portion thereof coming within the scope of the act and completed within the calendar year 1939. For the year 1939 the A Corporation also sustained a net loss of $1,800 on all other contracts and subcontracts coming within the scope of the act which were completed within the calendar year 1939. For purposes of Federal income tax, the net income of the A Corporation for the year 1940 amounted to $96,000, which amount included the net profit of $40,000 upon the contracts entered into on September 1, 1939 and March 10, 1940. For the year 1940 the A Corporation paid Federal income taxes amounting to $19,200. The excess profit liability of the A Corporation for 1940 is payable with respect to the contracts for portions of a naval vessel which were completed in 1940. The loss of $10,000 on other contracts completed in 1940 and the net loss of $1,800 for 1939 on contracts and subcontracts for naval aircraft do not enter into the computation of such liability. Accordingly, the excess profit liability of the A Corporation for 1940 is $10,800 computed as follows:

§ 17.7 Manner of determining liability with respect to contracts or subcontracts for complete naval aircraft or portions thereof. If in an income-taxable year ending after April 3, 1939 a contracting party completes one or more contracts or subcontracts coming within the scope of the act and entered into for the construction or manufacture of any complete naval aircraft or any portion thereof, the amount of excess profit to be paid to the United States with respect to all such contracts and subcontracts completed within the income-taxable year shall be computed as follows:

(a) The first step is to ascertain the total contract prices of all such contracts and subcontracts completed by the contracting party within the income-taxable year. As to total contract prices, see § § 17.1 and 17.8.

(b) The second step is to ascertain the cost of performing such contracts and subcontracts (see § 17.9) and to deduct such cost from the total contract prices of such contracts and subcontracts as computed in the first step.

The amount remaining after such subtraction is the amount of net profit or net loss upon such contracts and subcontracts completed within the income-taxable year.

(c) The third step, in case there is a net profit upon such contracts and subcontracts, is to subtract from the amount of such net profit as computed in the second step the sum of:

(1) An amount equal to 12 percent of the total contract prices of such contracts and subcontracts completed within the incometaxable year;

(2) The amount of any net loss which was sustained in the same or a prior incometaxable year with respect to contracts or subcontracts for the construction or manufacture of any complete aircraft or any portion thereof, and which is allowable as a credit in determining the excess profit for the income-taxable year with respect to contracts and subcontracts entered into for the construction or manufacture of complete aircraft or any portion thereof (see § 17.10(b)); and

(3) The amount of any deficiency in profit which was sustained in the same or a prior income-taxable year with respect to contracts or subcontracts for the construction or manufacture of any complete aircraft or any portion thereof, and which is allowable as a credit in determining the excess profit for the income-taxable year with respect to contracts and subcontracts entered into for the construction or manufacture of complete aircraft or any portion thereof (see § 17.10(c)).

The amount remaining after such subtraction is the amount of excess profit for the income-taxable year with respect to con

tracts and subcontracts entered into for the construction or manufacture of complete naval aircraft or any portion thereof.

(d) The fourth step is to ascertain the amount of credit allowed for Federal income taxes paid or remaining to be paid upon the amount of such excess profit as computed in the third step (see § 17.11) and then subtract from the amount of such excess profit the amount of credit for Federal income taxes. The amount remaining after this subtraction is the amount of excess profit to be paid to the United States by the contracting party for the income-taxable year with respect to contracts and subcontracts entered into for the construction or manufacture of complete naval aircraft or any portion thereof and completed within the incometaxable year.

(e) The application of the provisions of this section of the regulations may be illustrated by the following example:

Example. On September 1, 1939, the B Corporation, which keeps its books and makes its Federal income tax returns on a calendar year basis, entered into a contract with the Secretary of the Navy for the construction of naval aircraft coming within the scope of the act, the total contract price of which was $200,000. On March 10, 1940, the B Corporation entered into another such contract, the total contract price of which was $40,000. Both contracts were completed within the calendar year 1940, the first at a cost of $155,000 and the second at a cost of $45,000. During the year 1940, the B Corporation also completed at a deficiency in profit of $2,000 a contract entered into for the construction of Army aircraft coming within the scope of the act. During the year 1940, the B Corporation also completed at a loss of $10,000 two contracts entered into for the construction or manufacture of portions of a naval vessel coming within the scope of the act. For the year 1939, the B Corporation sustained a net loss of $2,500 and a deficiency in profit of $1,000 on all contracts and subcontracts for naval aircraft coming within the scope of the act and completed within the calendar year 1939. For the year 1939, the B Corporation also sustained a net loss of $1,800 on a contract for the construction of Army aircraft coming within the scope of the act which was completed within the calendar year 1939. For the purposes of the Federal income tax, the net income of the B Corporation for the year 1940, on which the tax was paid, amounted to $96,000, which included the net profit of $40,000 upon the contracts entered into on September 1, 1939, and March 10, 1940. The excess profit liability of the B Corporation for 1940 is payable with respect to the contracts for naval aircraft which were completed in 1940. The loss of $10,000 on the contracts for portions of a naval vessel completed in 1940 does not

[T.D. 4906, 4 FR 2492, June 27, 1939, as amended by T.D. 6512, 25 FR 12443, Dec. 6, 1960]

§ 17.8 Total contract price. The total contract price of a particular contract or subcontract (see § 17.1) may be received in money or its equivalent. If something other than money is received, only the fair market value of the thing received, at the date of receipt, is to be included in determining the amount received. Bonuses earned for bettering performance and penalties incurred for failure to meet the contract guarantees are to be regarded as adjustments of the original contract price. Trade or other discounts granted by a contracting party in respect of a contract or subcontract performed by such party are also to be deducted in determining the true total contract price of such contract or subcontract.

§ 17.9 Cost of performing a contract or subcontract-(a) General rule. The cost of performing a particular contract or subcontract shall be the sum of (1) the direct costs, including therein expenditures for materials, direct labor and direct expenses, incurred by the contracting party in perform

ing the contract or subcontract; and (2) the proper proportion of any indirect costs (including therein a reasonable proportion of management expenses) incident to and necessary for the performance of the contract or subcontract.

(b) Elements of cost. No definitions of the elements of cost may be stated which are of invariable application to all contractors and subcontractors. In general, the elements of cost may be defined for purposes of the act as follows:

(1) Manufacturing cost, which is the sum of factory cost (see paragraph (c) of this section) and other manufacturing cost (see paragraph (d) of this section);

(2) Miscellaneous direct expenses (see paragraph (e) of this section);

(3) General expenses, which are the sum of indirect engineering expenses, usually termed "engineering overhead" (see paragraph (f) of this section) and expenses of distribution, servicing and administration (see paragraph (g) of this section); and

(4) Guarantee expenses (see paragraph (h) of this section).

(c) Factory cost. Factory cost is the sum of the following:

(1) Direct materials. Materials, such as those purchased for stock and subsequently issued for contract operations and those acquired under subcontracts, which become a component part of the finished product or which are used directly in fabricating, converting or processing such materials or parts.

(2) Direct productive labor. Productive labor, usually termed "shop labor," which is performed on and is properly chargeable directly to the article manufactured or constructed pursuant to the contract or subcontract, but which ordinarily does not include direct engineering labor (see subparagraph (3) of this paragraph).

(3) Direct engineering labor. The compensation of professional engineers and other technicists (including reasonable advisory fees), and of draftsmen, properly chargeable directly to the cost of the contract or subcontract.

(4) Miscellaneous direct factory charges. Items which are properly chargeable directly to the factory cost of performing the contract or subcontract but which do not come within the classifications in subparagraphs (1), (2), and (3) of this paragraph, as for example, royalties which the contracting party pays to another party and which are properly chargeable to the cost of performing the contract or subcontract (but see paragraph (d) of this section).

(5) Indirect factory expenses. Items, usually termed "factory overhead," which are not directly chargeable to the factory cost of performing the contract or subcontract but which are properly incident to and neces

sary for the performance of the contract or subcontract and consist of the following:

(i) Labor. Amounts expended for factory labor, such as supervision and inspection, clerical labor, timekeeping, packing and shipping, stores supply, services of tool crib attendants, and services in the factory employment bureau, which are not chargeable directly to productive labor of the contract or subcontract.

(ii) Materials and supplies. The cost of materials and supplies for general use in the factory in current operations, such as shop fuel, lubricants, heat-treating, plating. cleaning and anodizing supplies, nondurable tools and gauges, stationery (such as time tickets and other forms), and boxing and wrapping materials.

(iii) Service expenses. Factory expenses of a general nature, such as those for power, heat and light (whether purchased or produced), ventilation and air conditioning and operation and maintenance of general plant assets and facilities.

(iv) Fixed charges and obsolescence. Recurring charges with respect to property used for manufacturing purposes of the contract or subcontract, such as premiums for fire and elevator insurance, property taxes, rentals and allowances for depreciation of such property, including maintenance and depreciation of reasonable standby equipment; and depreciation and obsolescence of special equipment and facilities necessarily acquired primarily for the performance of the contract or subcontract. In making allowances for depreciation, consideration shall be given to the number and length of shifts.

(v) Miscellaneous indirect factory expenses. Miscellaneous factory expenses not directly chargeable to the factory cost of performing the contract or subcontract, such as purchasing expenses; ordinary and necessary expenses of rearranging facilities within a department or plant; employees' welfare expenses; premiums or dues on compensation insurance; employers' payments to unemployment, old age and social security, Federal and State funds not including payments deducted from or chargeable to employees or officers; pensions and retirement payments to factory employees; factory accident compensation (as to self-insurance, see paragraph (g) of this section); but not including any amounts which are not incident to services, operations, plant, equipment or facilities involved in the performance of the contract or subcontract.

(d) Other manufacturing cost. Other manufacturing cost as used in paragraph (b) of this section includes items of manufacturing costs which are not properly or satisfactorily chargeable to factory costs (see paragraph (c) of this section) but which upon a complete showing of all pertinent facts are