Renegotiation and Federal Taxation

Abstract

The solution of the problems arising in coordinating renegotiation with the Internal Revenue Code has been accomplished through a process of development. As originally enacted, the renegotiation statute' which became effective April 28, I942, did not state expressly the effect of the elimination of excessive profits upon income for the taxable year affected. The Statute, however, provided that, although the purpose of renegotiation was to eliminate excessive profits, nevertheless, this purpose was to be achieved through revision of price by renegotiation.2 At the outset, the situation was clear where excessive profits were eliminated through price reductions upon future deliveries or future performance. It also seemed clear that even though excessive profits were eliminated by retroactive price reductions resulting in a refund, if the obligation to make the refund was fixed or if the refund was paid within the taxable year in which the delivery or performance took place, then income for that taxable year was reduced.3 If, however, the renegotiation took place after the fiscal year of the contractor in which delivery or performance took place and for which year the Federal income and excess profits tax returns had been filed, questions arose concerning the taxable year in which the adjustment should be reflected. It was puzzling, too, whether the answer to this question would vary, depending upon a number of circumstances. Some of those circumstances were whether the contract had been entered into prior to the effective date of the Act, whether the deliveries with respect to which the prices were retroactively reduced had been made prior to that date, and whether the contract contained a renegotiation clause inserted pursuant to the directions contained in subsection (b) of the Renegotiation Statute. If it were determined that the retroactive price adjustment affected income for a prior fiscal year, for which a Federal tax return had been filed, must the contractor make his renegotiation refund in full through the renegotiation agency and file a claim for a refund with the Bureau of Internal Revenue, or should the Federal taxes paid with respect