Excise Tax on Foreign Companies with Government Contracts

Its not very often that a FAR cost principle gets added or modified but that's what happened last Tuesday, the 29th. The FAR councils added a provision to FAR 31.205-41, Taxes, making excise tax paid by foreign persons (individuals or legal persons) unallowable. Although this one is not likely to affect many contractors directly, it is important from the standpoint that prime contractors must administer the provision in dealings with foreign subcontractors.

It all started with Public Law 111-347, an Act to extend and improve protections and services to individuals directly impacted by the terrorist attack in New York on 9/11. Section 301 contains a provision that levies a 2% excise tax on foreign persons receiving payments under Government contracts for goods and services.

The statute also prohibited these foreign persons (or foreign contractors) from paying the tax but turning around and charging it back to the Government as a reimbursable cost, or including the cost in pricing negotiated contracts.

Paragraph (b)(8) was added to FAR 31.205-41 to make this clear. It adds the language "Any tax imposed under 26 U.S.C. 5000C" to the listing of enumerated unallowable taxes. The FAR revision also added companion contract clauses in FAR Part 52 which provides that taxes imposed under 26 U.S.C 5000C may not be included in the contract price nor reimbursed.

The effective date of this prohibition on excise taxes is February 28, 2013.

Level the Playing Field - No Contracts to Companies Skipping the Country

The Federal Acquisition Regulation was recently amended to implement a section of the Consolidated Appropriations Act of 2012 that prohibits the award of contracts using appropriated funds to any foreign incorporated entity that is treated as an inverted domestic corporation or to any subsidiary of such entity. Actually, this prohibition has been effective for some time but the provision was about to sunset. This new regulation extends it indefinitely.

An inverted domestic corporation is one that used to be incorporated in the United States, or used to be a partnership in the United States, but now is incorporated in a foreign country, or is a subsidiary whose parent corporation is incorporated in a foreign (see FAR 9.108-1).

The purpose of the statute and regulation is to help keep Government work here in the U.S. rather than have it sent offshore. Respondents to the proposed rule were overwhelmingly supportive of the restriction. Several respondents stated that when millions of people in the US are unemployed or under-employed, corporation that have "turned their back" on the US and eliminated jobs for American personnel should not receive Government contracts. Many respondents had an income tax angle. They contend that companies should not be rewarded for tax avoidance, which enables them to compete unfairly with U.S. companies.

The FAR councils acknowledged that there may be certain situations where there is no alternative but to purchase or contract with an inverted domestic corporation so they made a provision for this. The regulations allow for a waiver of the prohibition, if an agency head determines in writing that the waiver is required in the interest of national security, documents the determination, and reports it to Congress.

Advance Payments under Government Contracts - Part II

In yesterday's Part I of this two part series on Advance Payments, we discussed the availability of this particular financing option and how the Government considers it a last resort. Today we want to focus on where and when such financing may be useful and appropriate as well as provide you a flavor of what you will be expected to "deliver" as part of your request, should you decide to go in that direction.

The Government has provided us examples of cases where advance payments may be considered useful and appropriate. If you are considering a request for advance payment, one of these examples should fit. These include

• Contracts for experimental, research, or development work with nonprofit educational or research institutions.
• Contracts solely for the management and operation of Government-owned plants.
• Contracts for acquisition, at cost, of property for Government ownership.
• Contracts of such a highly classified nature that the agency considers it undesirable for national security to permit assignment of claims under the contract.
• Contracts entered into with financially weak contractors whose technical ability is considered essential to the agency. In these cases, the agency shall closely monitor the contractor's performance and financial controls to reduce the Government's financial risk.
• Contracts for which a loan by a private financial institution is not practicable if
• loans with reasonable interest rates or finance charges are not available
• contracts involve operations so remote from a financial institution that the institution could not be expected to suitably administer a guaranteed loan
• Contracts with small business concerns, under which circumstances that make advance payments appropriate often occur.
• And finally, the catch-all - Contracts under which exceptional circumstances make advance payments the most advantageous contract financing method for both the Government and the contractor.

Contractors can apply for advance payments either before or after contract performance. Requests must be in writing and contain the following information. This is usually the key to sucessfully obtaining advance payments.

• A reference to the contract or solicitation
• A cash flow forecast showing estimated disbursements and receipts for the period of contract performance. Some contracting officers have required monthly forecasts, others quarterly. Whether monthly or quarterly, you can be certain that it will be analyzed and subjected to some form of audit.
• The proposed total amount of advance payments.
• The name/address of the financial institution at which the contractor expects to establish a special account as depository for the advance payment
• A description of the contractor's efforts to obtain unguaranteed private financing
• Other information appropriate to an understanding of the contractors financial condition and need, the contractor's ability to perform the contract without loss to the Government and financial safeguards needed to protect the Government's interest. 

Financial safeguard to protect the Government can take many forms. In one case the Government required that the advance payment be put in an escrow account and funds could only be disbursed for specific expenses (such as payroll). In another case, the Government added a provision that all expenditures from the fund be co-signed (or approved) by the contracting officer.

There are a lot of hoops to jump through when requesting advance payments and sometimes there are strings attached. Nonetheless, obtaining advance payments may make the difference between successful performance and failure or default.

Advance Payments under Government Cotnracts

There are many methods of payments under Government contracts; progress payments based on cost, progress payments based on milestones, public vouchers, invoices, DD250s, to name a few. Advance payments is another method that is not well known, is rarely used, but is provided for by regulations (The Government estimates that it entertains about 500 requests per year).

The Government does not really like to enter into advance payment agreements. The current regulations state that advance payments shall be used "sparingly" and "advance payment is the least preferred method of contract financing (see FAR 32.402(b)). Nonetheless, in certain circumstances, from a contractor's perspective, it may be the only viable method of financing a contract. One big disadvantage for a contractor is that it will have to pay interest on the advance and that interest will not be an allowable cost (it will come out of profits).

There are statutory requirements and regulatory standards that must be met before advance payments will be authorized. The statutory requirements include:

• The contractor gives adequate security
• The advance payments will not exceed the unpaid contract price and
• The contracting officer certifies that advance payment is 
• in the public interest or
• facilitates the national defense.

 The regulatory standards include:

• The advance payments shall not exceed the contractor's interim cash needs based on
• analysis of the cash flow required for contract performance
• consideration of the reimbursement or other payment cycle, and
• to the extent possible, employment of the contractor's own working capital
• The advance payments are necessary to supplement other funds or credit available to a contractor
• The recipient is otherwise qualified as a responsible contractor
• The Government will benefit from performance prospects or there are other practical advantages.

Tomorrow we will take a look cases where, according to the Government, advance payments are "useful and appropriate". Also, we will discuss the data required from contractors. Concerning the latter, it is significant and will require a lot of effort and perhaps, expert help.

Subcontractors and Suppliers Must Be Paid

Most contractors are familiar with the Prompt Payment Act of 1988 when it comes to receiving timely payments from the Government. Any billings, invoices, progress payments, or public vouchers not paid withing a certain period (typically 30 days) will begin accruing interest. The Government finance offices are extremely efficient in calculating interest and adding it to the invoiced amounts.

What is less well known about the Prompt Payment Act is its requirement for prime contractors, in turn, to promptly pay their subcontractors and suppliers after they receive payment from the Government. Failure to do so will require contractors to pay interest back to the Government.

For example, Part 32 of the Federal Acquisition Regulations (FAR) and the clause at FAR 52.232-5 (Payments Under Fixed-Price Construction Contracts), require that contractors under fixed-price construction contracts certify for every progress payment request  that payments to subcontractors and suppliers have been made from previous payments received under the contract and timely payments will be made from the proceeds of the payment covered by the certification, and that this payment request does not include any amount which the contractor intends to withhold from a subcontractor or supplier.

FAR Part 32 further requires that (i) contractors notify subcontractors and suppliers of any amount to be withheld and furnish a copy of the notification to the contracting officer, (ii) pay interest to subcontractors and suppliers if payment is not made by seven days after receipt of payment form the Government, and (iii) pay interest to the Government if amounts are withheld from subcontractors and suppliers after the Government has paid the contractor the amounts subsequently withheld.

Making timely payments to subcontractors and suppliers is the right and ethical thing to do, it helps maintain a healthy supplier base, and it helps avoid any contract performance problems. There are sometimes legitimate reasons to withhold payments to subcontractors and suppliers. There could be quality control issues, warranty issues, or any number of performance related reasons. When that happens, contractors must (i) not bill for the amount of the withholds and (ii) notify the contracting officer of the issue.

Prohibition on Contract Awards to Scofflaws

The Department of Defense issued a directive last Tuesday that prohibits the award of any contract, using funds made available by the 2013 Continuing Appropriations Resolution (Public Law 112-175) to companies that have unpaid Federal taxes and companies convicted of felony criminal violations within the preceding 24 month period.

Specifically, the prohibitions are worded as follows:

• Has any unpaid Federal tax liability that has been assessed, for which all judicial and administrative remedies have been exhausted or have lapsed, and that is not being paid in a timely manner pursuant to an agreement with the authority responsible for collecting the tax liability, where the awarding agency is aware of the unpaid tax liability, unless the agency has considered suspension or debarment of the corporation and made a determination that this further action is not necessary to protect the interests of the Government, or
• Was convicted of a felony criminal violation under any Federal law within the preceding 24 months, where the awarding agency is aware of the conviction, unless the agency has considered suspension or debarment of the corporation and made a determination that this further action is not necessary to protect the interest of the Government.

Its unlikely that an agency would be aware of these events in the regular course of business so there is the added provision that requires bidders to make affirmative responses to representations to the effect that these situations do not apply. Those representations are found in DFARS (the DoD FAR Supplement) 252.209-7996 and 2523209-7997.

Contracting officers are directed to consult with agency debarring and suspending officials if and when they receive affirmative responses from bidders. As a practical matter however, there doesn't seem to be any value in submitting a bid in the first place for contractors that admit to not paying taxes or have been convicted of a criminal violation; their offers will be tossed out of the competition anyway.

Looming Crisis in Pension Plan Funding

According to a recent GAO study of the defined benefit pension plans at the 10 largest DoD contractors, pension costs have grown from $500 million to more than $5 billion over the course of the last decade. The GAO also warned that this explosive growth will continue for two reasons. First, since the 2008 market downturn, pension funds investments have not performed as well as initial projections which will require contractors to make additional contributions to make up the shortfall. Secondly, the Pension Plan Protection Act of 2006 (PPA) changed the funding requirements. Prior to PPA companies were required to fund current year liabilities as well as an additional amount required to amortize, over a 30 year period, past service liabilities. After PPA, the 30 year amortization period was lowered to seven years.

The PPA was incompatible with CAS (Cost Accounting Standards) and required the CAS Board to harmonize the CAS requirements with PPA. It took about four years to finalize the harmonization rules. The impact of the PPA on Government contracts will be felt beginning 2014. The DoD Comptroller was quoted last year saying that the impact to the Department "could be billions of dollars, conceivably".

DoD (and other Executive agencies) is understandably concerned about the impact of future pension plan costs on their programs. DoD will be stepping up its oversight on pension costs. It needs auditors and contracting officers that are better trained and equipped to deal with the intricacies of pension plan rules and regulations. As a starting point, DoD will focus on the following:

• How contractors determine pension costs
• Who within DoD ensures the contractor pension costs it pays are appropriate
• How DoD contractor plans compare with the private sector
• Understanding and assessing factors that contribute to increased costs
• How the harmonization of CAS with PPA will affect the amounts DoD will pay in coming years.

DoD Planning for Budget Uncertainty

Earlier this month, the Department of Defense issued guidance to its departments on how to plan for uncertainties related to the Continuing Resolution and Sequestration. The Department is currently operating under a CR that effectively caps spending at fiscal year 2012 levels. Additionally, potential sequestration that was recently deferred from January 2 to March 1 creates significant uncertainty for managing the Department.

The strategies for dealing with budget cuts impact Government contractors, either directly or indirectly.

One of the strategies laid out by the Department is to reduce the civilian workforce by releasing temporary employees, imposing hiring freezes, authorizing voluntary separation incentives, and furloughing employees for up to 30 days. This will undoubtedly impact the procurement community, slowing down contract awards, and more delays in finishing up incurred cost audits. Since the strategies apply to all civilians, payment offices will be impacted as well.

Military personnel funding is exempt from the DoD spending cut plans and the civilian workforce cuts can only go so far. That means contracting will be cut. Specifically, the DoD plans call for

• Reduction in base operating funding
• Curtailing facilities maintenance
• Curtailing supplies and IT purchases
• Cancelling ship maintenance and aviation and ground depot-level maintenance
• Figuring out which research can be cut without impacting research priorities.

The actions taken in response to these instructions are to be structured to be reversible at a later date should Congress act to remove the risks caused by the CR and sequestration threat.

Fraud Indicators

Did you know that every time an auditor conducts an audit at your facility, he or she is also looking for evidence of fraud? Even for the most benign or perfunctory audit, the auditor is assessing the risk of fraud.

Government auditors are required by professional auditing standards (Generally Accepted Government Auditing Standards or GAGAS) to design the engagement to detect instances of fraud and noncompliance with provisions of laws, regulations, and contracts that may have a material effect on the subject matter under review. Auditors are required to assess the risk of fraud and, when risk factors are identified, to perform audit tests to determine the existence and, if applicable, the impact.

To meet this standard, DCAA (Defense Contract Audit Agency) has included steps in each of its standard audit programs to require a planning meeting among the audit team to discuss the risks including prior audit experience, the contractor's environment (e.g. the extent of incentives, pressures and opportunities to commit fraud and the propensity to rationalize misstatements) and other known risk factors.

The results of the planning meeting is documented and included in the audit working papers. If necessary, specific tests are designed into the audit to provide reasonable assurance that nothing is or was amiss. Communication among team members throughout the audit is also a requirement.

Questions have arisen as to what specifically the auditor is looking for as possible fraud indicators. The possibilities vary depending upon the type of audit being performed. As a general rule, the auditor is looking for the possibility of:

• Falsification of documents such as time cards or purchase orders
• Charging personal expenses to Government contracts.
• Submission of false claims, such as invoices for services not performed or materials not chargeable to the contract.
• Intentional mischarging or misallocation of costs.
• Deceit by suppression of the truth.
• Acts, such as bribery, corrupt payments, which violate the Foreign Corrupt Practices Act, theft  graft, gratuities, and kickbacks.
• Any unlawful or fraudulent acts resulting from accounting classification practices that are designed to conceal the true nature of the expenses, such as unallowable costs for advertising  entertainment, etc., being classified as office supplies to avoid detection or the concealment of accounting data comprising a proposed estimating factor, such as a material decrement factor used to reduce proposed material costs
• Any attempt or conspiracy to engage in or use, the above devices.

For additional reading on this subject, refer to the DoD Inspector General's Handbook of Fraud Indicators for Contract Auditors.

SBA's "RFP-EZ" Pilot Program

Here's some interesting news that should be of interest to small businesses who have been thinking about entering the Government contracting arena but haven't quite gotten around to it.

The SBA (Small Business Administration) just announced a beta version of "RFP-EZ", a new online marketplace that streamlines the government contracting process, making it simpler for small businesses to find and bid on low dollar contracts from federal agencies. The maximum value for contracts under this new program will be limited to $150 thousand.

Currently, the requirements showing up under this new pilot program are geared toward web-based digital professional services - services like web design and development, social media, digital video, and the like. The SBA intends to grow the platform to include other categories, as they learn more through the pilot program.

The Government procurement process can be complicated and intimidating. "RFP-EZ" represents a unique opportunity for innovative startups to easily access the federal government marketplace and, in turn, help fuel job growth throughout the country. It should also help the Government as well by allowing it to secure better and less expensive products and services.

The streamlined process will help save significant amounts of time. By creating a company profile on the beta site, each small business can search and bid for contracts relevant to its skill set. A small business can search for an opportunity, see a statement of work, and bid - all within the RFP-EZ web interface.

To register, learn more about the pilot program, and to start bidding, go here.

Post-Award Briefings - Ask Lots of Questions

Yesterday we discussed the regulations that require the Government to conduct post-award briefings when requested by one or more offerors to a solicitation. These briefings are great opportunities for contractors and potential contractors to find out the strengths and weaknesses in their bid and how well the bid stacked up against the competition. Contractors can learn a lot from these briefings and become better prepared for the next time.

Not all post-award briefings are the same in detail and candidness. There are good ones and some where the presenter, usually the contracting officer, is inexperienced, or seems to be reticent about sharing certain information. Either way, offerors should be prepared to ask lots of penetrating questions. The questions may not be answered for some reason, perhaps the contracting officer is concerned about sharing proprietary data. But, it doesn't hurt to ask. Here are some sample questions offerors might consider, if the topic has not already been discussed.

• Please identify the strengths, weaknesses, or deficiencies in our proposal for each evaluation factor and sub-factor?
• What were the most significant weaknesses?
• Were there any solicitation requirements that we failed to address? If so, what were they? 
• Were any significant deficiencies identified by the Government during discussions not adequately addressed in our response to your Evaluation Notices? If so, did the evaluation of the deficiencies change during the evaluation of our final proposal revision?
• Were there any specific considerations that precluded us from being selectied as the awardee? If so, what were those considerations?
• What if anything did you want that was missing from our proposal?
• Please explain how past performance was evaluated. What was our rating? How was that rating applied to the source selection process?
• Was experience evaluated? If so, what was our rating and how was that information used in the source selection process?
• Please explain the procedure for the evaluation of risk? What risks were identified in our proposal? How did they impact the ration of our proposal?
• Please provide evaluated cost/price and technical, management, and past performance ratings for our proposal and all other offerors.
• Please provide the overall ranking for all offerors.
• In what areas was our proposal considered overpriced?
• Were we compliant with all technical requirements?
• In the proposal risk portion of the technical/management area, what criteria did the Government use to determine the final evaluation ratings?
• Please explain in detail the methodology used to determine which proposal offered the greatest overall value to the Government, especially with respect to any comparisons/trade-offs made between technical factors and costs proposed.
• Was a cost realism analysis used? If so, please describe what process was used.
• Please identify any information not contained in our proposal that was used by the evaluators in assessing our offer.

We could go on but you get the idea. Many times, as a result of these debriefs, unsuccessful offerors come away with a basis for appealing the award. Sometimes, contractors will bring legal counsel to these briefings. Contracting officers don't usually appreciate and will expect that an appeal is right around the corner. As a result, they will be very guarded in what they say and are willing to discuss.

Post-Award Debriefings - Better Hurry

You got the letter, or phone call, telling you that the bid you submitted didn't make it. The contract was awarded to someone else. This notification usually invokes a range of emotions, but at the core, you wonder what your competitor had that you didn't.

You don't need to sit and wonder. The Government is required by regulation (see FAR 15.506) to debrief and furnish the basis for the selection decision to any offeror that requests a debriefing - as long as that request is received within three days of receiving notification.

The debriefing serves to assure offerors that the Government properly evaluated their proposals and made the award determination in accordance with the RFP terms and conditions. The debriefing also provides feedback to offerors to assist in improving future proposal submissions. The Government hopes that, effective debriefings will deter a protest by demonstrating that the Government conducted a thorough, fair evaluation and made a sound decision according to the established source selection methodology.

During a debrief, offerors can expect to see a comparison of their ratings at the factor level (or sub-factor level) with the winning offeror and, at the discretion of the contracting officer, all offerors, both winning and losing. This comparison should also be accompanied with the rationale for award. What you will not receive in a debrief is a discussion on the validity of requirements, validity and integrity of evaluation process, and prohibited information including any information that might be considered proprietary to other offerors.

Other information typically disseminated at a debrief include:

• The Government's evaluation of the significant weaknesses or deficiencies in the offeror's proposal.
• The overall evaluated cost or price and technical ratings.
• The overall ranking of all offerors.
• A summary of the rationale for award.
• Responses to relevant questions about whether source selection procedures contained in the solicitation, applicable regulations, and other applicable authorities were followed.

Some offerors don't bother with the debrief opportunity. We believe that is a mistake. Tomorrow we'll explain and offer some questions you might consider asking during the debrief process.

Bang, bang, bang ...

...bang, bang, bang.  That hammering sound you hear is another nail in DCAA's coffin. DoD should just bury the corpse now and quit pretending that the Agency still serves a useful purpose. Let me explain.

Last Friday, January 11th, DoD's Under Secretary for Acquisition, Technology, and Logistics announced the establishment of enhanced proposal price analysis teams within the DCMA (Defense Contract Management Agency) organization. (See memorandum here). These teams have been designated as Integrated Cost Analysis Teams or ICATs. The "Integrated" aspect of the name is to exemplify the joint business and technical composition of these teams. The teams are entirely dedicated to the performance of proposal pricing and pricing process evaluation at major DoD contractors.

These teams, according to DoD, will have insight into contractor estimating systems and practices that DCMA gains from experience with major contractors. DoD hopes to leverage this inherent advantage and enhance DCMA's capability "to the maximum extent". ICAT assistance can vary from a full-up proposal pricing report, to a specified tailored pricing product that covers specific elements within a contractor's proposal.

This describes DCAA's role in the acquisition process a few years back. DCAA with its bevy of CPAs, auditors, and pricing experts, was the "go to" source for not only DoD pricing support needs but for all executive agencies. The Agency had the resources and were the "experts" on estimating systems, price proposal evaluations, indirect expense rates, labor costs, purchasing systems, and all those things that contribute to helping DoD be responsible stewards of taxpayer monies.

Along the way, DCAA lost its way. Fundamentally, the concept of auditing according to GAGAS (Generally Accepted Government Auditing Standards, or, the GAO Yellow Book) is not compatible with the nimbleness required to provide responsive and timely pricing support. The acquisition community needed field pricing support in thirty days. DCAA thumped its chest announcing that it would henceforth conduct only audits according to the Yellow Book and would not be pilloried into delivering an audit until all audit requirements were satisfied. "Fine", DoD said, "Stand on principle and we'll get our services elsewhere". So they did. They've been building up DCMA's capabilities for awhile now. This new policy is more evidence of the trend that has been continuing for the past couple of years of diminishing DCAA influence.

Can't Find Your Old Accounting Records?

About two and a half years ago, we posted a topic called How Long Should I Keep My Records? It laid out the FAR (Federal Acquisition Regulations) requirements for how long Government contractors were required by regulation, to keep certain books and records. It might be useful to read that posting before proceeding further.

Negotiated contracts have (or should have) the clause at FAR 52.215-2, Audit and Records - Negotiation. This is a lengthy clause but the relevant portion for this discussion is Section (f), Availability. This section states:

The Contractor shall make available at its office at all reasonable times the records, materials, and other evidence described (earlier), for examination, audit, or reproduction, until 3 years after final payment under this contract or for any shorter period specified in Subpart 4.7, Contractor Records Retention, of the Federal Acquisition Regulation (FAR), or for any longer period required by statute or by other clauses of this contract.

So, the basic record retention rule is 3 years after final payment or a shorter period as prescribed by Subpart 4.7.

Note, the three year requirement begins after final payment, not after contract completion. Some contractors mistakenly believe, to their detriment, that the three year period begins after contract completion.

Flipping back to FAR 4.7, you will find the record retention requirements for most types of documentation that might be required in connection with an audit of an annual incurred cost proposal including cost accounting records (4 years), payroll records (4 years), timesheets (2 years), etc. For a full rundown on other record types, refer to FAR 4.7 or read our previous blog post on the subject.

This brings us to the reason we're alerting you to the FAR requirements. As most contractors know, DCAA (Defense Contract Audit Agency) is chronically behind in auditing incurred costs. There are a lot of reviews going on right now covering 2006, 2007, and 2008 and we've seen one audit covering the years 2004 and 2005.

Some contractors are finding it very difficult, and in some cases impossible, to support costs for those years because, in following the FAR 4.7 requirements, did not retain documents beyond the regulatory retention periods. From DCAA's perspective, this is a problem. Without contractor records, the Agency has no basis to render an opinion on the propriety of incurred costs. This lack of documentation however, is not the contractors' problem. It just moves the resolution of final incurred costs from the auditor up to the Contracting Officer level where, they are not bound by audit standards in settling incurred costs.

When Does FAR Part 31 (Cost Principles) Apply?

The cost principles found in FAR (Federal Acquisition Regulations) Part 31 apply to many, but not all, contracting situations. For example, the cost principles do not apply in a competitive award situation or for procurement of commercial items. FAR 31.1 describes the situations where FAR Part 31 must be used in determining contract costs.

Pricing

FAR Part 31 must be used in the pricing of fixed-price contracts, subcontracts, and modifications to contracts and subcontracts whenever (i) cost analysis is performed or (ii) a fixed-price contract clause requires the determination or negotiation of costs (see FAR 31.102).

FAR Part 31 shall be used in pricing negotiated supply, service, experimental, developmental, and research contracts and contract modifications with commercial organizations whenever cost analysis is performed (see FAR 31.103(a)).

Reimbursement

FAR Part 31 is required as the basis for determining reimbursable costs under cost-reimbursable contracts and subcontracts (see FAR 31.103(b)(1)(i)).

FAR Part 31 is required as the basis for determining reimbursable costs for the reimbursable portion of time and material contracts (see FAR 31.103(b)(1)(ii)).

Other Situations

FAR Part 31 is required for negotiating indirect cost rates (see FAR 31103(b)(2)).

FAR Part 31 is required for proposing, negotiating, or determining costs under terminated contracts (see FAR 31.103(b)(3))

Finally, the cost principles found in FAR Part 31 apply when pricing changes and other contract modifications (see FAR 31.103(b)(6)). In this regard, modifications or requests for equitable adjustment to contracts awarded based on competition (or any method where cost analysis was not performed) must utilize   FAR Part 31 cost principles, even where those cost principles were not used in determining the price of the original contract.

Information other than Certified Cost or Pricing Data

Some contracts are awarded based on data provided but not certified by contractors - information other than certified cost or pricing data. FAR Part 31 does not apply however, we have seen cases where the contracting officer will apply FAR Part 31 cost principles to such data. We advise contractors, when responding to a solicitation requiring information other than certified cost or pricing data, to use the same estimating techniques they would use when certified cost or pricing data is required.


 

Procurement Fraud

Everyday, the Department of Justice announces convictions or settlements in civil and criminal cases. Many of these involve some sort of procurement fraud. And, with the beefed up "qui tam" provisions ("qui tam" is where the the relater, usually a inside whistle-blower gets to share in the money that's recovered), there is seemingly no end to the cases flowing in to the investigative pipeline.

Once the investigative wheels start turning, there is little a contractor can do to control the events. Cooperation with the investigation and self-disclosing may help reduce the punishment and expedite a settlement but the Government is going to do what it's going to do.

The best way to avoid fraud from occurring is make certain that you have strong ethics programs in place, good internal control systems, and a management team that sets the proper tone at the top. Those of you who have audited financial statements understand this well and have experienced the increased emphasis by the independent public accountants on fraud.

Concerning procurement fraud, there are six general categories.

Defective product/product substitution. This refers to cases where contractors deliver goods which to not conform to contract requirements, without informing the Government.

Defective testing. This involves the failure of a contractor to perform contractually required tests, or its failure to perform such testing in the required manner.

Bid-rigging. The absence of competition deprives the government of its most reliable measure of what the price should have been.

Bribery and public corruption. The breach of an employee's duty or loyalty.

Defective pricing. The Truth in Negotiations Act (TINA) requires contractors in negotiated procurement to disclose and certify that details concerning expected costs are current, complete, and accurate. A violation of TINA may result in a fraud referral.

False invoices. Invoices submitted when the contractor was knowlingly not complying with contract terms can be the basis of a False Claims Act.

Examples of Cost or Pricing Data

Most contractors have a pretty good understanding of the definition of and the types of items that constitutes "cost or pricing" data. If not, the idea is usually drilled into them during negotiations and when the certificate of current cost or pricing data is pushed across the table for signature, contractors will need to read and understand the definition before signing it.

Nevertheless, the Government continues to dedicate resources to defective pricing reviews (TINA audits) to test whether the contractor did indeed provide all the factual information it was aware of at the time of agreement on price. They dedicate these resources because there is payback, a return on their investment. The Government continues to find cases where contractors did not provide the most current, complete, and accurate data available to them as of the date of agreement on price. The consequences of getting caught are severe. The contract price is adjusted downward to reflect the impact of the non-disclosure, interest is applied on any overpayments that occurred, and more than likely, there will be a referral to an investigative body. Regarding the latter, audit guidance is written in such a way that an auditor, having disclosed defective pricing data, must have a good reason not to refer the matter for investigation.

The official definition of "cost or pricing data" is found in FAR 2.101 (Federal Acquisition Regulations). It states in part, "Cost or pricing data means all facts that, as of the date of price agreement ...prudent buyers and sellers would reasonable expect to affect price negotiations significantly. Cost or pricing data are factual, not judgmental, and are verifiable.

A contractor's judgment is not cost or pricing data but to the extent that judgment is based on factual matters, it is. The definition provides that "While they do not indicate the accuracy of prospective contractor's judgment about estimated future costs or projections, they do include the data forming the basis for that judgment".

FAR provides a non-exclusive list of items that are included in the definition of cost or pricing data. These include (parentheses are ours):

• Vendor quotations (even the ones that are not used in pricing)
• Nonrecurring costs
• Information on changes in production methods and production/purchasing volume,
• Data supporting projections of business prospects, business objectives, and related operational costs (this will impact indirect rate projections),
• Unit-cost trends such as those associated with labor efficiency (learning curve applications),
• Make-or-buy decisions (or, even if decisions have not been made, the fact that you're considering such alternatives should be disclosed),
• Estimated resources to attain business goals (affects indirect cost allocation bases), and
• Information on management decisions that could have a significant bearing on costs (union negotiations).

What Would the Government Do?

We frequently come across what we consider goofy audit positions. Of course, one of the things we do is to help contractors implement internal controls to reduce the occurrence of potentially unallowable costs and when a particular cost is challenged by the Government, provide advice and guidance on how to respond. 

Sometimes the allowability of a particular cost is not black and white. There may be no FAR cost principle that discusses the allowability of the item. When there is no specific cost principle to apply and the contract is otherwise silent on the matter, contractors and the Government usually decide on "reasonableness". 

Recently, we came across a situation where the Government questioned a contractor's purchase of bottled water. In this case, the cumulative cost turned out to be rather significant - evidently contractor employees were guzzling a lot of water. There being no specific cost principle that addresses the purchase of bottled water, the Government questioned the amount based on reasonableness. The city water supply was perfectly safe for drinking, therefore the cost to purchase bottled water was unreasonable and therefore unallowable under Government contracts.

Sometimes it is interesting, informative, and instructive to know the Government's policy in similar situations. In this case, given the same set of circumstances, would the Government purchase bottled water for its employees? Probably not. Back in 1961, the GAO ruled that a Government agency could not use appropriated funds to purchase bottled water. They ruled that bottled water generally does not materially contribute to an agency's mission accomplishment, and is ordinarily considered a personal expense. The decision did allow for some exceptions however. Where water is unhealthy or unpotable, agencies may buy bottled water.

There is also a DoD Regulation (FMR vol. 10, chapter 12, paragraph 120203) that governs the purchase of bottled water. Essentially, the regulation permits the purchase of water where the public water is unsafe or unavailable.

Note, the GAO decision and the DoD regulation do not apply directly to contracts. However, these can be and have been used by the Government to support a position of "unreasonableness". If the Government does not allow it for their own employees, is it reasonable to expect that contractors should be allowed to purchase it for their employees?    

Evaluation Factors - When Less Important Factors Trump More Important Factors

GAO recently issued a bid protest decision that illustrates one of the vagaries in selecting a winning bid. In a case where technical evaluation factors, when combined, were more important than price, GSA awarded a contract to a firm who's overall technical score was inferior to the company that filed the protest (in fact, it was rated "marginal") but who's price was 24 percent lower than the unsuccessful bidder (you can read the entire decision here). The GAO denied the protest on the basis that the protester's technically superior proposal was not worth its much higher price.

The contract itself was an 8(a) set-aside for operations and maintenance of a courthouse. The solicitation advised that the award would be made on a "best value" basis, considering price and three technical evaluation factors; prior experience, key personnel, and past performance. Offerors were informed that the three technical factors, when combined, were more important than price.

The bid protester complained that GSA placed too much emphasis on price in its selection decision. GAO ruled that source selection officials in negotiated procurements have broad discretion in determining the manner and extent to which they will make use of the technical and price evaluation results; price/technical tradeoffs may be made, and the extent to which one may be sacrificed for the other is governed only by the test of rationality and consistency with the solicitation's evaluation criteria.

Even where technical merit is significantly more important than price, an agency may properly select a lower-priced, lower-rated proposal if it reasonably decides that the price premium involved in selecting a high-rated, higher-priced proposal is not justified.

Donations and Contributions

The FAR cost principle on contributions and donations (FAR 31.205-8) is rarely controversial. The regulation states "Contributions or donations, including cash, property and services, regardless of recipient, are unallowable, except as provided in FAR 31.205-1(e)(3)". The "except for" provision was inserted in 1986 because Government auditors were broadly defining "contributions and donations". The 1986 revision specifically allows costs for participating in community service activities (e.g. blood bank drives, charity drives, savings bond drives, disaster assistance, etc). However, costs associated with the donation of excess food to nonprofit organizations in accordance with the Federal Food Donation Act of 2008 is unallowable (FAR 31.205-1(f)(8)).

There have been a couple of cases that allow the cost of contributions and donations made in exchange for a benefit. In one case, General Dynamics made a $50 thousand contribution to the California State Highway Commission in exchange for a promise that the Highway Commission would expedite construction of an overpass near the contractor's facility. The auditors questioned the cost but ASBCA sustained an appeal on the bases that there was a bargained for quid pro quo.

In another case, contributions by a contractor to a regional hospital planning program were deemed allowable because they produced a readily discernible economic benefit.

Most often, however, contributions and donations are going to be unallowable, particularly if they are deductible by the donor for income tax purposes. Contractors should still review their donations to determine whether any might be allowable based on the aforementioned case law.

Facilities Capital Cost of Money and Rent Paid to Affiliated Parties

As a general rule, in order to claim cost of money, a contractor must first propose it. FAR 31.205-10, Cost of Money, states that facilities capital cost of money (FCCOM) is allowable provided an estimate of FCCOM was specifically identified and proposed in cost proposals relating to the contract under which the cost is to be claimed. So, to claim it, you have to had proposed it.

Over in FAR 31.205-36, there is a discussion on how to compute allowable rental costs when contractors are paying rent to related parties. According to FAR 31.205-36(b), the following costs are allowable:

Charges in the nature of rent for property between any divisions, subsidiaries, or organizations under common control, to the extent that they do not exceed the normal costs of ownership, such as depreciation, taxes, insurance, facilities capital cost of money, and maintenance (excluding interest or other unallowable costs pursuant to Part 31), provided that no part of such costs shall duplicate any other allowed cost (emphasis added).

Similarly, Section 7-206.2 of the Defense Contract Audit Manual includes the following:

Leasing costs between divisions, subsidiaries, or organizations under common control for operating leases are generally allowable to the extent that costs do not exceed the normal costs of ownership (excluding interest or other costs unallowable and including cost of money) (emphasis added).

Periodically, a question arises concerning the allowability of FCCOM in a rental computation when the contractor did not originally propose FCCOM. If the contractor did not initially propose FCCOM, can it include FCCOM as one of the elements for calculating the cost of ownership?

The NASA Board of Contract Appeals answered that question in a 1988 case involving Engineering, Inc. (NASA BCA No. 187-2, CCH 88-2, pg 105.029). The Government had questioned FCCOM as part of the cost of ownership because Engineering, Inc. had waived FCCOM in its contract. The Board, in ruling against the Government, specifically ruled that Engineering Inc. was entitled to rental costs not to exceed the normal costs of ownership including FCCOM, despite having waived FCCOM in its contract.

You can read more about FCCOM here. If you have any questions concerning the application of FCCOM, feel free to contact David Koeltzow ("Kelso") at 360-910-4146.

Avoid Potential Problems - Don't React to Them

Its a new year and it looks like we've avoided the so-called "fiscal cliff". "The sequestration can (automatic spending cuts) has been kicked down the road for a couple of months and tax rates will not rise unless you earn $450 thousand or more. All of these matters of great pith and moment are well beyond our and your abilities to influence - we're merely bystanders. But, when it comes to contract compliance, contractors do not want to be caught unawares. There are many things contractors can and should do to prevent problems before they occur.

Contract compliance has been and will continue to be a recurring theme in this blog. There are many things contractors can do to avoid problems down the road. However, it does take a certain amount of persistence and consistency. Here then is our short list of ways to avoid contract problems in 2013.

Adopt and comply with written policies and procedures - There are two elements here - have them and follow them. Some contractors have written policies and procedures but fail to consistently follow them. We've stated it before but will do so again - failing to follow internal policies and procedures is sometimes worse than not having them at all. And not having them all is bad. Failing to follow internal policies is a "slam-dunk" finding for an auditor - there's no adequate defense.

Keep good records - Many contractors have experienced first-hand the consequences of inadequate records or missing records - costs are disallowed. This is more poignant now that the auditors are working off the backlog of incurred cost audits - back to 2004 in some cases we know of. Contractors are expected to dig out archived records back that far!

Develop an ethics/compliance plan - It all begins at the top, so they say. Management must show a commitment to ethical behavior and expect the same from employees. Not only is it the right thing to do but in addition to auditors looking over your shoulders, contractors are now increasingly faced with the prospect of in-house whistle-blowers filing qui-tam actions. In fiscal year 2012, the Justice Department reported a record 647 whistle-blower cases were filed. Some employees see this as their way to riches and an entire industry has developed to support and encourage whistle-blowing. All it takes to bring out a whistle-blower is one falsified timecharge.

Conduct internal audits (reviews) - Contractors may have the best of intentions, great internal controls, excellent record retention practices, and effective ethics programs but never know whether they are being followed. It is critical that contractors implement internal reviews to ascertain the degree to which employees are adhering to the company's policies.

We will be coming back to these themes from time to time, expanding upon them and offering some ideas on how to avoid problems in cost-effective ways. Implementing these practices should not become a burden to contractors - particularly small businesses.