Hoping for some affirmation or clarification here re: FAR 52.215-22, 52.215-23, 31.203(i)

Relationship is Prime to Sub A to Sub B.

Subs A and B are Wholly-owned, separately incorporated, subsididaries of the same parent.

To avoid profit-on-profit/fee-on-fee, Sub B will propose to Sub A on a FFP basis with Sub B's internal cost build up ex of profit.

Sub A's FFP proposal to Prime will include profit.

Note that Sub B may be >75% of Sub A's total costs.

Assuming that Sub A's proposal will be >$1m, would one expect that DCAA will assert that Sub A is taking excessive profit while adding minimal value?

Given that Subs A and B are same family AND that Sub A is the sole entity accruing profit, does this possibly mitigate the 'excessive profit' assertion?

Alternatively, perhaps the safer route is to accrue reasonable profit at Sub B level, leaving Sub A to accrue profit, ex of the Sub B costs.

Thank you in advance for your feedback.

Generally, 31.205-26(e) establishes the proper pricing and accounting of Inter-organizational transfer costs. However, 31.205.26(f) provides an exception.

IOTs are not subcontracts (unless the exception applies. See 15.401 definition of "subcontract"). Because the transactions in question are not subcontracts, the excessive pass-thru rule at 15.215-23 would not apply, in my view.

In a related note, the Sub B FFP proposal to Sub A would appear to violate the requirements of 31.205-26(e).

Hope this helps.

H2H, based on your response, I take it that you believe that the cost principles apply to Sub B's pricing. If that is your belief, why do you believe so based on the information we have been provided?

H2H and Retreadfed, Thank you for your feedback.

H2H, "the Sub B FFP proposal to Sub A would appear to violate the requirements of 31.205-26(e).", I take it this is in response to the FFP relationship between A & B. You are therefor recommending a CR type arrangement? Makes sense.

To be clear, these are separate corporations under the same parent, therefore, no 'subcontract' would be placed, in lieu of, the document would be an internal statement referencing the work and that it be CR?

Is this correct.

V/R,

BTC.

BTC,

Commonly, separate corporations under common control are considered to be related (affiliated). There's a regulatory definition that supports this, but it's Saturday and I'm not going to look it up. You have correctly interpreted my post in all respects.

Retreadfed,

If the cost principles don't apply to the contract received by Sub A, and therefore to costs incurred by Sub A (including costs received via IOT from Sub , then why are we even discussing excessive pass-through costs? (I.e., costs made unallowable because they are subject to the excessive pass-thru cost rule.)

H2H

H2H, 52.215-23 only applies to cost reimbursement subcontracts unless the prime contract is awarded by DoD. In the latter case, 52.215-23 is to be inserted in certain firm fixed price subcontracts. The OP said that Sub A has submitted a proposal for a FFP contract. However, the OP did not say what agency has issued the solicitation. Thus, we don't know if 52.215-23 applies to Sub A. Also, since Sub A has submitted a proposal for a FFP sub, it is unclear as to the application of the cost principles to its proposal, let alone their application to Sub B or even the prime.

Retread,

All good points. But if the government customer is performing cost analysis -- and it's a fair assumption that's what's happening, based on the original question -- then the cost principles would apply. (Ref. 31.102.) Can we agree on that?

H2H

H2H and Retread,

Clarifications: End customer: DoD; Sub A to Prime via FFP subcontract;

Your inputs are greatly appreciated in (hypothetically) correcting a legacy process that was recently inherited.

BTC

H2H, we do not necessarily agree that the cost principles would apply if the government is conducting cost analysis. The FAR is ambiguous on this point. While 31.102 indicates that the government must apply the cost principles when conducting a cost analysis, 15.404-1© indicates that application of the cost principles is discretionary in this circumstance. Therefore, if the government does apply the cost principles in conducting cost analysis, it has complied with the FAR. At the same time, if the government uses some other cost analysis technique listed in 15.404-1, and does not use the cost principles, again, I think the government has complied with the FAR.

H2H,

Please allow me to reference your older post from last year. Based on your statement below that IOTs are not subcontracts, would you say that a defense contractor needs additional support for the hypothetical situation listed under your quote?

Generally, 31.205-26(e) establishes the proper pricing and accounting of Inter-organizational transfer costs. However, 31.205.26(f) provides an exception.

IOTs are not subcontracts (unless the exception applies. See 15.401 definition of "subcontract"). Because the transactions in question are not subcontracts, the excessive pass-thru rule at 15.215-23 would not apply, in my view.

In a related note, the Sub B FFP proposal to Sub A would appear to violate the requirements of 31.205-26(e).

Hope this helps.

There are two subsidiaries of a major defense contractor. Both subsidiaries are in different interim home divisions/companies that report to the parent holding company. Subsidiary A is negotiating a prime contract with a DoD customer and also negotiating a "subcontract"/inter-organizational transfer (IOT) with Subsidiary B. Approximately 80% of the "subcontract"/IOT would consist of purchasing non-commercial, component parts to be integrated by Subsidiary A into the prime contract with the DoD customer. The value added by Subsidiary B would consist of placing the order for component parts with the outside vendor, receiving the component parts into Subsidiary B's warehouse, and then shipping the component parts upon request to Subsidiary A.

The prime contract would be sole-source and FFP. When purchased from the outside vendor, the non-commercial, component parts would be under the TINA threshold for requiring certified cost or pricing data, but then greater than the TINA threshold for requiring certified cost or pricing data after applying Subsidiary B's overhead and G&A rates. While no profit would be proposed by Subsidiary B, over a 60% mark-up would be applied to the non-commercial, component parts by Subsidiary B prior to Subsidiary A applying its own indirect rates and profit mark-up on the prime contract. (Unknown in this hypothetical situation would be whether or not the outside vendor originally manufactured these component parts to the specifications of Subsidiary A or Subsidiary B.)

Potential Issues:

DCAA might assert that the "subcontract"/IOT is subject to FAR 51.215-23 due to the potential inclusion of this clause in the prime contract.

DCAA might assert that the cost is simply "unreasonable" based on FAR Part 31 and the nature of the value added by Subsidiary B.

DCAA might assert that Subsidiary A should have picked up the phone and placed the order itself instead of Subsidiary B (that would be funny.)

Do you know of any regulations or guidance that could be used to head off these kinds of issues with DCAA? (I think this hypothetical situation could potentially represent a widespread practice by defense contractor's to spread out their indirect costs over a larger base to make their rates lower on competitive DoD contracts.)

INoW--

IOTs are not subcontracts. They are not severably subject to TINA. They are a "make" and not a "buy". Please see FAR Part 15 for support for those statements.

The rest of your questions are speculative. DCAA might do (and will do) mostly anything these days.

In my experience, one division asks another division to do the procurement and warehousing because (a) the second division has a long-term agreement with the vendor, (3) the second division has special expertise in the area, (4) the second division has warehouse capacity available, (5) the second division has lower material handling overhead rates, or (6) another reason. My point is, there is usually a semi-valid reason and it has nothing to do with spreading out indirect costs over a larger base--because what you just described doesn't accomplish that objective.

Hope this helps.

H2H,

Thank you for the reply. I agree with you about IOTs being "makes" for purposes of FAR 15.407-2. DCAA takes this position as well. The company that I work for has taken the position of performing cost/price analysis on IOTs to minimize DCAA findings and issues. This hypothetical situation can very well "materialize" [no pun intended! ]

I may have a gap in my logic about spreading overhead cost over a wider base. With our hypothetical situation, Subsidiary B would have semi-fixed overhead pools. If it did not perform the procurement with the outside vendor, it would not have as great a direct material base for its material overhead rate and then for its G&A rate. Both subsidiaries would be similarly capable of performing the procurement and both would have sufficient capacity for warehousing the parts. Subsidiary A procuring the part would avoid a 60%+ mark-up from Subsidiary B, (besides Subsidiary A's mark-up and profit on top of that 60%+ mark-up.)

In the position I am in, I am trying to do the best I can to help my company avoid issues with DCAA. To paraphrase the words of the cognizant DCAA auditor, 'We tear up IOTs.' Any additional insight you may have about FAR 15.401 (a subcontract definition) or FAR 31 would be much appreciated. I am learning and thank you for your help.

INoW,

Since the decision to issue an IOT is not subject to make or buy anaysis (other than it being an element of the overall "make" decision) there is really no need for Division A to perform cost/price analysis. What appears to be needed is for Division B to submit cost or pricing data along with Division A in the company's proposal. Period. If Division B can submit decent Bases of Estimate (BOEs) and robust cost or pricing data, I see no reason to be worried about what DCAA will do. DCAA will take on both Divisions with equal passion to protect the taxpayer by generating as much questioned costs as possible.

Either Division A or Division B will perform the work. Whichever Division performs the work will record the associated "base" values -- i.e., direct labor, direct material, ODC -- and allocated burdens. One Division may see lower rates as a result and the other Division will not. One "wins" and the other "loses" -- but overall the company's position (which encompasses all Divisions) remains the same. In theory, the company has no interest in the IOT decision because it records essentially the same results (through elimination at consolidation) regardless. Consequently (all things being equal) the company should be indifferent to which Division performs the work.

Importantly, in your hypothetical there are no "corporate rates" to spread over a larger base so as to decrease them to be more competitive; there are only Divisional rates.

Hope this helps.

H2H,

Yes, and Thank You! I think you are right on about there being no need for Subsidiary A to perform cost or price analysis in the hypothetical situation. Maybe people higher up at my company will come around to the same conclusion. Your take on DCAA's role is also right on. Hopefully, the CO will understand. Thank you for your help.