Internal Revenue Service
Revenue Ruling
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smRev. Rul. 54-83
1954-1 C.B. 288
IRS Headnote
Section 3806 of the Internal Revenue Code and Rev. Rul. 53, C.B. 1953-1, 479, do not apply to upward adjustments of income under price redetermination clauses embodied in Government contracts.
Excessive profits on Government contracts, if made the subject of a credit memorandum or a definite commitment to reduce the contract price, preferably in writing, prior to the filing of the return, may be eliminated from income to be reported on the return. The adjustment for the excessive profits is, however, subject to the application of the credit provided for by section 3806(b) of the Code as to any further downward price revision and to the restoration to income of the taxable year in which the amount of the commitment or credit was excluded, of any amount not included in the price redetermination as finally consummated.
Full Text
Rev. Rul. 54-83
Advice is requested as to (1) whether the provisions of section 3806 of the Internal Revenue Code apply to upward adjustments of contract price under price redetermination clauses embodied in Government contracts and (2) what is meant by the terms `definitely determinable' and `repaid' as used in Rev. Rul. 53, C.B. 1953-1, 479.
Section 3806 of the Code is silent on the subject of upward adjustments, referring to downward adjustment only. Such upward adjustments are therefore not subject to the provisions of section 3806 of the Code. The treatment of retroactive upward adjustments is to be determined under the regular rules of accrual of income. The general rule is as stated in section 39.41-1 of Regulations 118 which provides:
The time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer's income. If the method of accounting regularly employed by him in keeping his books clearly reflects his income, it is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for.
As to what method may constitute a clear reflection of income, section 39.41-2 of Regulations 118 provides:
Approved standard methods of accounting will ordinarily be regarded as clearly reflecting income. A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross income and all deductions are treated with reasonable consistency.
Ordinarily, to a taxpayer on the accrual basis, such upward adjustment of income is includible in gross income for the taxable year in which the contract is modified to provide for increased prices. As to downward adjustments only , section 3806 of the Code requires that such adjustments which represent excessive profits as defined in such section be related back to the year or years in which the original contract prices were included in gross income, unless permission is granted to adopt a different method of accounting under the provisions of section 3806(a)(4) of the Code.
The rules of accounting enforced upon a taxpayer by any regulatory body are not binding on the Internal Revenue Service, except as otherwise specifically provided for by statute, for the determination of tax liability under the Internal Revenue Code. See Old Colony Railroad Company v. Commissioner , 284 U.S. 552, Ct. D. 456, C.B. XI-1, 274 (1932).
With respect to (2) above, to the extent applicable to goods billed during the taxable year for which the income tax return has not yet been filed, a credit memorandum issued by the taxpayer or a definite commitment to reduce the contract price made to the contracting officer, preferably in writing, prior to the filing of the return, may be considered as rendering the amount of such credit memorandum or commitment `definitely determinable' so that the amount thereof which would otherwise be included in income may be eliminated therefrom in filing the return. Also, where excessive profits have been agreed upon with a local representative of a contracting agency and only the final approval thereof and repayment are necessary to give full effect to the redetermination, the amount agreed upon, to the extent applicable to goods billed during the taxable year, may be eliminated from income to be reported on the income tax return. However, where the taxpayer excludes the amount of such credit memorandum or commitment, a statement to that effect, including the amount and the contract involved, should be made on the return. When the price redetermination is finally consummated, if the amount thereof exceeds the amount of the credit memorandum or commitment which was excluded from income in filing the return, the credit provided for in section 3806(b) is applicable but shall be applied only to such excess. If the amount of the price redetermination as finally consummated is less than the amount of the credit memorandum or commitment, the difference shall be restored to income for the year for which the amount of the credit memorandum or commitment was excluded.