Inter-Company Transfers - Limitations

Material costs, including such items as raw materials, parts, sub-assemblies, components, whether manufactured by the contractor or purchased are, of course, allowable costs on Government contracts (see FAR 31.205-26, Material Costs). There are limitations however, when those materials are being purchased from an affiliated company.

Paragraph (e) of the aforementioned FAR (Federal Acquisition Regulations) Cost Principle provides the following:

Allowance for all materials, supplies, and services that are sold or transferred between any divisions, subdivisions, subsidiaries, or affiliates of the contractor under a common control shall be on the basis of cost incurred. That means, no profit can be added. However, allowance may be at price when (i) it is the established practice of the transferring organization to price inter-organizational transfers at other than cost for commercial work of the contractor or any division, subsidiary or affiliate under a common control and (ii) the item being transferred qualifies for an exception under FAR 15.403-1(b) and the contracting officer has not determined the price to be unreasonable.

Note the two conditions; there must be an established practice that is followed for both commercial and Government customers and the item(s) must qualify for some kind of exemption. What are those exemptions? FAR 15.403-1(b) lists the exceptions to certified cost or pricing data requirements. Among them are

1. When the contracting officer determines that prices agreed upon are based on adequate price competition
2. When the contracting officer determines that prices agreed upon are based on prices set by law or regulation
3. When a commercial item is being acquired
4. When a waiver has been granted, or
5. When modifying a contract or subcontract for commercial items.

The idea behind these limitations is to avoid doubling up on profit, to pay a contractor profit on top of a material item for which it has already received profit. Contract auditors are very aware of this potential and will closely scrutinize any estimates or costs incurred under cost-type contracts for inter-company transactions to ensure that costs are consistent with the FAR limitations.