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Independent R&D Development Costs Were Allowable

A ruling the government improperly disallowed a defense contractor's development effort was affirmed by the Court of Appeals for the Federal Circuit because the contractor's independent research and development costs were allocable as indirect costs under Cost Accounting Standards and Federal Acquisition Regulation cost principles. The contractor developed and produced launch vehicle motors for the government and subsequently contracted with a commercial party to upgrade a motor delivered under a government contract. The contractor accounted for its costs to develop the enhanced motor as indirect IR&D costs and disclosed its accounting practice to the government in a proposed advance agreement. The government, however, issued a notice of intent to disallow the development costs. According to the divisional administrative contracting officer, the definition of IR&D in the FAR excludes efforts "required in the performance of a contract" and, therefore, because the upgrade cost was necessary to the performance of the commercial contract, the development effort had to be charged, if at all, directly to the commercial contract. The contractor filed an action in the Court of Federal Claims, arguing the DACO's refusal to treat the development effort as indirect IR&D was improper. The CFC agreed, holding the contractor's allocation of the development effort as indirect costs complied with CAS 402 and 420, and FAR 31.205-18 (50 CCF 78,492).

Identical Phrase

On appeal, the Federal Circuit agreed with the CFC that the costs at issue qualified as indirect IR&D. The appellate court also noted that CAS 420-30 and FAR 31.205-18 define IR&D as excluding costs that are "required in the performance of a contract," but the parties disputed the meaning of this phrase. The government argued the words "in the performance of a contract" indicate the focus is on whether the R&D work was necessary to perform the contract, not whether the work was expressly required by the contract. The contractor countered the term "required" must refer to a contract requirement. The court found both textual arguments unpersuasive, concluding the language standing alone was ambiguous and the regulatory history inconclusive. Instead, the court determined that the meaning of the phrase in the definition of IR&D is the same as the meaning of the identical phrase in the definition of bid and proposal costs, and because B&P costs are addressed in the same regulations that govern IR&D costs, both types of costs should be treated similarly in all pertinent respects. The court, therefore, construed the reference to costs "required in the performance of a contract" as those that are specifically required by the contract. The government argued that this result contravened sound procurement policy by inviting contractors to "game the system" by shifting commercial contract costs to the government. The government's policy argument, however, lacked merit because the purpose of IR&D is to benefit both government contractors and the government by encouraging contractors to engage in research that is likely to benefit multiple contracts, both governmental and commercial. Therefore, because the development effort was related to the commercial contract but was not specifically required by that contract, the costs were properly allocated as indirect IR&D costs. (ATK Thiokol, Inc. v. U.S., CA-FC, 54 CCF 79,288)




(The news featured above is a selection from the news covered in the Government Contracts Report Letter, which is published weekly and distributed to subscribers of the Government Contracts Reporter. )


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