Corporation sponsors a SEP which only covers the owner since the other employees are not yet eligible. Corporation makes contributions for 2000, 2001, and 2002 which comply with all legal limits (i.e., no excess contributions). Now the corporation is saying they never took the deductions for the contributions and they want the contributions refunded to the corporation.

Can otherwise legally allowable contributions be returned to the sponsor if the sponsor later changes its mind? If so, how are gains/losses treated?

Not in this life. File amended returns for all open years.

If all traditional IRAs are distributed, and the basis hasn't been recovered, then a loss may be claimed (subject to the 2% of AGI limit). Failure to deduct the allowable contribution does not creat basis.