Intra-company Transfers and Pyramiding of Cost and Profit
Under FAR, is it permissible for a wholly owned subsidiary to bill the parent company for work subcontracted on the parents contract with the government (including normal markup) and that the parent company contracted with the government is then able to submit a bill with their normal markup. Is this accurate?
Let’s start with the second part of the inquiry.
The parent company can generally add a burden, usually G&A or a Handling Fee, to any subcontract or material cost or price included in its proposal. This burden typically reflects the added administrative effort required to administer and manage subcontract or material costs. A contractors' normal practice becomes an important factor in determining the reasonableness of the amount of burden added.
The first part of the inquiry requires more in-depth research of FAR guidance so let’s start with the following basic premise:
Under certain circumstances, contractors may propose materials and supplies based on price rather than cost when they are sold or transferred between any division, subsidiary or affiliate of the contractor under common control. In these cases, ascertain whether the specific circumstances meet the criteria described in 6-313. If the audit discloses items that are improperly based on price rather than cost, appropriate adjustments should be made to eliminate the intra-company profit (plus any inapplicable indirect costs). [Source: DCAM 9-404.4]
Now let’s look at the FAR Part 31 reference for more specific guidance:
FAR 31.205-26 (e) states: Allowance for all materials, supplies, and services that are sold or transferred between any divisions, subsidiaries, or affiliates of the contractor under a common control shall be on the basis of cost incurred in accordance with this subpart. However, allowance may be at a price when -
(1) 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 of the contractor under a common control; and
(2) The item being transferred qualifies for an exception under 15.403-1(b) and the contracting officer has not determined the price to be unreasonable. [See below for more on 15.403-1(b)]
FAR 31.205-26 (f) further states: When a commercial item under paragraph (e) of this subsection is transferred at a price based on a catalog or market price, the contractor -
(1) Should adjust the price to reflect the quantities being acquired; and
(2) May adjust the price to reflect the actual cost of any modifications necessary because of contract requirements.
Now let’s look a little more in-depth at auditor directions.
According to auditor directions in the DCAM at 6-313 Intra-company Transfers:
a. Careful consideration should be given to items or services transferred at amounts other than cost. Of particular importance is whether the price charged for the item has been established by a competitive market place. If the item is:
(1) Proprietary,
(2) Sole source, or
(3) Produced solely or substantially for Government end use, it may be concluded that it does not meet the requirement for acceptance at price.
Under these conditions, amounts in excess of actual or estimated cost should be questioned.
b. For a contractor to obtain reimbursement on a basis other than cost, for items or services sold or transferred between divisions, subsidiaries, or organizations under common control, certain requirements of FAR 31.205-26(e), [see above] must be met. The initial requirement is that the transferring organization have an established practice of pricing inter-organizational transfers of materials, supplies and services at other than cost for commercial work of any division, subsidiary, or affiliate of the contractor under a common control. The existence of an established practice should be readily determinable from evidence such as catalogs, sales information, and delivery records.
c. Once the auditor is satisfied that the transferring organization has such a practice, a determination should be made as to whether reimbursement for the item under consideration is being requested based upon an exception from cost or pricing data at FAR 15.403-1(b). These exceptions include:
(1) Adequate price competition,
(2) Catalog or market price,
(3) Prices set by law or regulation,
(4) Commercial item exception and
(5) Modification to a commercial contract.
A waiver from the cost or pricing data requirements does not qualify as an exception. (See 14-907 for a detailed discussion of these exceptions). This information should be determinable from the contract file.
d. The final requirement for the interdivisional transfer to be allowed at price is that the contracting officer must not have determined the price to be unreasonable. There could be a situation where the auditor has evidence that the price of the item being transferred is unreasonable. In this case, amounts in excess of actual or estimated cost should be questioned.
Additional guidance on similar/related subject found at DCAM 9-404.5 Pyramiding of Costs and Profit on Material Purchases states:
a. Most major programs require the use of subcontractors, not only to obtain facilities and skills which may not be available within the upper-tier contractor, but to broaden the procurement base and to meet requirements for utilizing small business. However, the auditor should be alert to instances where a proposal may be excessive because of unreasonable pyramiding of costs and profits.
This may occur between divisions, plants, or subsidiaries of a company or between subcontractors and upper-tier contractors. The contractor's procurement program should be reviewed to determine whether the planned subcontracting pattern is reasonable. The auditor should not limit his or her considerations to first-tier subcontracts, but should coordinate with auditors at subcontractor locations to disclose unreasonable pyramiding of costs or profits at any of the levels of the procurement chain where significant costs are involved.
b. Situations likely to result in excessive or unreasonable pyramiding of costs include the following (where questionable practices seem to exist, consult with Government technical and procurement personnel as appropriate):
(1) Intra-company transactions through which items are charged to the contract at a list price (see above 9-404.4) or at a cost plus unnecessary or unreasonable handling charges.
(2) Purchases from a subcontractor who acts merely as an intermediary/agent rather than as a manufacturer. Items may be drop-shipped direct to the upper-tier contractor's plant or they may pass through the subcontract plant for minor additions, changes, or testing which could be done more economically and as well at a lower or an upper-tier contractor's plant.
(3) Purchases by an upper-tier contractor of items which are identical with or similar to items being purchased by the Government and which could more economically be sup-plied as Government-furnished property.
c. When proposed material costs include loadings added by the prime contractor and upper-tier subcontractors, and the added amounts appear to be disproportionate compared to their planned work contribution, the audit report should comment on the increased costs and profit attributable to the pyramiding. The report should state:
(1) The estimated savings which will result by eliminating the intermediary and shortening the procurement chain,
(2) The considerations underlying the treatment of the direct procurement as Government-furnished items, and
(3) The degree to which the component or item involved can be treated independently from the system for which it is to be procured.
FAR 14.403-1(b) Exceptions to cost or pricing data requirements - The contracting officer shall not require submission of cost or pricing data to support any action (contracts, subcontracts, or modifications) (but may require information other than cost or pricing data to support a determination of price reasonableness or cost realism) -
(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
Summary: Yes you can transfer costs at price. However, you must meet the appropriate guidelines as outlined above to ensure allowability.