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Department of Defense Continues to Tinker with the Allowability of IR&D

Beginning in 2011, the Department of Defense (“DoD”) began making changes to the supplemental cost principle on Independent Research and Development (IR&D) found at the Defense Federal Acquisition Supplement (DFARS) 231.205-18. These changes have not affected the definition of IR&D found at Federal Acquisition Regulation 31.205-18. Instead, they have addressed what certain contractors must do in order for their IR&D costs to be allowable on government contracts. The latest proposed change in the allowability requirements set forth in the DFARS was published in the Federal Register on February 16, 2016.

The proposed change reformats the existing DFARS 231.205-18(c)(iii)(C) and adds a new requirement that reads:

For IR&D projects initiated in the contractor’s fiscal year 2017 and later, as a prerequisite for the subsequent determination of allowability, major contractors must:

(i) Engage in a technical interchange with a technical or operational DoD government employee before IR&D costs are generated so that contractor plans and goals for IR&D projects benefit from the awareness of and feedback by a DoD employee who is informed of related ongoing and future potential interest opportunities; and

(ii) Use the online input form for IR&D projects reported to Defense Technical Information Center (“DTIC”) to document the technical interchange, which includes the name of the DoD government employee and the date the technical interchange occurred.

The proposed change does not define who is “a technical or operational DoD Government employee,” or provide any further guidance as to how a contractor is to determine who this individual is. This is particularly troublesome because allowability of IR&D costs depends upon the required “technical interchange.” In this regard, it must be remembered that IR&D costs are subject to audit by the Defense Contract Audit Agency (“DCAA”). Thus, it is conceivable that the DCAA would question these costs if the technical interchange occurred with an employee that the DCAA did not consider to be the proper government employee.

Note that this proposed requirement only applies to “major contractors.” What constitutes a “major contractor” is defined by statute so the DoD has little “wiggle room” in this regard.

10 U.S.C. §2372 directs, the Secretary of Defense to “prescribe regulations governing the payment, by the Department of Defense, of expenses incurred by contractors for independent research and development and bid and proposal costs.” It goes on to state that a contractor is considered major “if for the preceding fiscal year the contractor’s covered segments[1] allocated to Department of Defense contracts a total of more than $10,000,000[2] in independent research and development and bid and proposal costs.”

In addition to the DFARS cost principle only being applicable to “major contractors,” it also limits its applicability to “DoD prime contract[s] for an amount exceeding the simplified acquisition threshold, except for… fixed-price contract[s] without cost incentives. The term also includes a subcontract for an amount exceeding the simplified acquisition threshold, except for a fixed-price subcontract without cost incentives under such… prime contract[s].” These requirements appear to be inconsistent with the statute which ties applicability of the rules to the Truth in Negotiations Act threshold and excludes contracts for commercial items from its coverage. Plainly, the DFARS has set a lower threshold and includes Time & Materials contracts for commercial items within its coverage.

While it is clear that the proposed change would not apply to any contractors except “major contractors,” major prime contractors may attempt to impose the requirements of DFARS 231.205-18 on subcontractors if the change is adopted, particularly since the cost principle currently states that “Contractors that do not meet the threshold as a major contractor are encouraged to use the DTIC on-line input form to report IR&D projects to provide DoD with visibility into the technical content of the contractors’ IR&D activities.” Obviously, if a major contractor prime attempts to impose the requirements of DFARS 231.205-18 on non-major subcontractors, the subcontractor should resist those efforts.

Contractors who are interested in filing comments on the proposed change have until April 18, 2016, to file those comments.

Cherry Bekaert will continue to monitor the proposed change. If you have any questions, please do not hesitate to contact us.

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[1] For purposes of this statute, a “covered segment” is “a product division of the contractor that allocated more than $1,100,000 in independent research and development and bid and proposal (IR&D/B&P) costs to covered contracts during the preceding fiscal year. In the case of a contractor that has no product divisions, the term means that contractor as a whole.”

[2] Adjusting the threshold amount for inflation, the DFARS lists the current amount as $11,100,000.

 

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