PAYMENTS BY DEFENSE CONTRACTOR UNDER CRIMINAL PLEAS WERE NOT PURSUANT TO CONTRACT RENEGOTIATIONS.

PAYMENTS BY DEFENSE CONTRACTOR UNDER CRIMINAL PLEAS WERE NOT PURSUANT TO CONTRACT RENEGOTIATIONS.

Sundstrand Corporation and its subsidiaries, including Sundstrand Data Control, Inc. (SDC), were prime contractors and subcontractors on various defense contracts. The defense contracts were subject to regulatory requirements, including the Cost Accounting Standards (CAS), the Truth-in-Negotiations Act (TINA), the Federal Acquisition Regulations (FAR), and the Defense Acquisition Regulations (DAR). In 1988, following grand jury investigations, Sundstrand and SDC entered guilty pleas to bills of information charging various criminal acts associated with some of the defense contracts, including activities relating to violations or noncompliance with CAS, TINA, FAR, and DAR. Under a plea agreement, Sundstrand agreed to pay the government $115 million in full payment of restitution, damages, penalties, fines, and costs. SDC, under its plea agreement and related settlement agreements, agreed to pay the government $500,000 as a criminal fine, $11.3 million plus interest in full administrative settlement of contractual claims of the government, $520,000 for statutory and common law relief and reimbursement of the costs of the grand jury investigation. Under another settlement agreement, Sundstrand agreed to pay the government $62.3 million and $1.9 million for alleged noncriminal CAS compliance issues and further agreed not to charge to any government contract $7.1 million of costs contested by the government. Under other settlement agreements, SDC agreed to pay the government $1.3 million and $370,000 for various noncriminal CAS compliance issues. The IRS determined deficiencies in federal income tax against Sundstrand and its subsidiaries for the years 1979 through 1982 totaling almost $75.5 million. Sundstrand and its subsidiaries filed Tax Court petitions contesting the deficiencies. The IRS filed a motion for partial summary judgment contending that section 1481 does not apply to certain payments made to the government in years subsequent to the years in issue. Specifically, the government argued that there was no renegotiation of any government contract, and that the repayments by Sundstrand were made pursuant to the government's exercise of its legal rights. Accordingly, the IRS maintained, Sundstrand would be entitled to offset income by the amount of the repayments, if at all, in the year of repayment. Sundstrand and its subsidiaries contended that they made overpayments in tax to the government as a result of the payments pursuant to the litigation with the government over the defense contracts. Specifically, Sundstrand argued that the payments were made pursuant to the renegotiation of government contracts and were thus entitled to tax treatment as provided in sections 1481 and 1482. Under section 1481(a)(1), a taxpayer who, pursuant to the renegotiation of a government contract, is required to repay to the government amounts determined to be excessive profits that were received or accrued by the taxpayer for a prior taxable year is not entitled to a deduction in the year of repayment, but rather must reduce gross income for the prior taxable year by the amount of the repayment. According to Sundstrand, the criminal violations to which it and SDC pled guilty were entirely separate and distinct from the repayments under the settlement agreement. Tax Court Judge Hamblen has held that the payments made by Sundstrand and its subsidiaries did not arise from the recovery of excessive profits through a renegotiation of a government contract within the meaning of section 1481. The court agreed with the IRS that there must be some discussion of a fair or excessive profit for a renegotiation under section 1481 to have taken place. The settlement agreements, the court found, focused entirely on Sundstrand's illegal contracting practices. The court cited Fleet Carrier Corp. v. Commissioner, 37 T.C. 527 (1961), in support of its reasoning. Citing the legislative history of section 1481, Judge Hamblen wrote, "it is apparent that Congress considered renegotiation to be a tool for the recovery of abnormally high profits." Furthermore, the court found nothing in the legislative history of section 1481 to indicate that Congress intended that section to apply to anything but the recapture of abnormally high profits on defense contracts.

Sundstrand Corp., et al. v. Commissioner, 98 T.C. No. 36 (May 4, 1992), Tax Ct. Dkt. No. 1875-91

The Tax Court has held that payments made by a defense contractor pursuant to criminal pleas and related settlement agreements did not arise from the recovery of excessive profits through a renegotiation of a government contract under section 1481.

Sundstrand Corporation and its subsidiaries, including Sundstrand Data Control, Inc. (SDC), were prime contractors and subcontractors on various defense contracts. The defense contracts were subject to regulatory requirements, including the Cost Accounting Standards (CAS), the Truth-in-Negotiations Act (TINA), the Federal Acquisition Regulations (FAR), and the Defense Acquisition Regulations (DAR). In 1988, following grand jury investigations, Sundstrand and SDC entered guilty pleas to bills of information charging various criminal acts associated with some of the defense contracts, including activities relating to violations or noncompliance with CAS, TINA, FAR, and DAR. Under a plea agreement, Sundstrand agreed to pay the government $115 million in full payment of restitution, damages, penalties, fines, and costs. SDC, under its plea agreement and related settlement agreements, agreed to pay the government $500,000 as a criminal fine, $11.3 million plus interest in full administrative settlement of contractual claims of the government, $520,000 for statutory and common law relief and reimbursement of the costs of the grand jury investigation. Under another settlement agreement, Sundstrand agreed to pay the government $62.3 million and $1.9 million for alleged noncriminal CAS compliance issues and further agreed not to charge to any government contract $7.1 million of costs contested by the government. Under other settlement agreements, SDC agreed to pay the government $1.3 million and $370,000 for various noncriminal CAS compliance issues. The IRS determined deficiencies in federal income tax against Sundstrand and its subsidiaries for the years 1979 through 1982 totaling almost $75.5 million. Sundstrand and its subsidiaries filed Tax Court petitions contesting the deficiencies. The IRS filed a motion for partial summary judgment contending that section 1481 does not apply to certain payments made to the government in years subsequent to the years in issue. Specifically, the government argued that there was no renegotiation of any government contract, and that the repayments by Sundstrand were made pursuant to the government's exercise of its legal rights. Accordingly, the IRS maintained, Sundstrand would be entitled to offset income by the amount of the repayments, if at all, in the year of repayment. Sundstrand and its subsidiaries contended that they made overpayments in tax to the government as a result of the payments pursuant to the litigation with the government over the defense contracts. Specifically, Sundstrand argued that the payments were made pursuant to the renegotiation of government contracts and were thus entitled to tax treatment as provided in sections 1481 and 1482. Under section 1481(a)(1), a taxpayer who, pursuant to the renegotiation of a government contract, is required to repay to the government amounts determined to be excessive profits that were received or accrued by the taxpayer for a prior taxable year is not entitled to a deduction in the year of repayment, but rather must reduce gross income for the prior taxable year by the amount of the repayment. According to Sundstrand, the criminal violations to which it and SDC pled guilty were entirely separate and distinct from the repayments under the settlement agreement. Tax Court Judge Hamblen has held that the payments made by Sundstrand and its subsidiaries did not arise from the recovery of excessive profits through a renegotiation of a government contract within the meaning of section 1481. The court agreed with the IRS that there must be some discussion of a fair or excessive profit for a renegotiation under section 1481 to have taken place. The settlement agreements, the court found, focused entirely on Sundstrand's illegal contracting practices. The court cited Fleet Carrier Corp. v. Commissioner, 37 T.C. 527 (1961), in support of its reasoning. Citing the legislative history of section 1481, Judge Hamblen wrote, "it is apparent that Congress considered renegotiation to be a tool for the recovery of abnormally high profits." Furthermore, the court found nothing in the legislative history of section 1481 to indicate that Congress intended that section to apply to anything but the recapture of abnormally high profits on defense contracts.

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PAYMENTS BY DEFENSE CONTRACTOR UNDER CRIMINAL PLEAS WERE NOT PURSUANT TO CONTRACT RENEGOTIATIONS.