[Federal Register Volume 70, Number 109 (Wednesday, June 8, 2005)]
[Rules and Regulations]
[Pages 33673-33676]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-11184]


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DEPARTMENT OF DEFENSE

GENERAL SERVICES ADMINISTRATION

NATIONAL AERONAUTICS AND SPACE ADMINISTRATION

48 CFR Part 31

[FAC 2005-04; FAR Case 2004-005; Item VIII]
RIN 9000-AJ93


Federal Acquisition Regulation; Gains and Losses

AGENCIES: Department of Defense (DoD), General Services Administration 
(GSA), and National Aeronautics and Space Administration (NASA).

ACTION: Final rule.

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SUMMARY: The Civilian Agency Acquisition Council and the Defense 
Acquisition Regulations Council (Councils) have agreed on a final rule 
amending the Federal Acquisition Regulation (FAR) by revising the 
contract cost principles for Gains and losses on disposition or 
impairment of depreciable property or other capital assets, 
Depreciation costs, and Rental costs. The final rule adds language to 
specifically address the gain or loss recognition of sale and leaseback 
transactions to be consistent with the date at which a contractor 
begins to incur an obligation for lease or rental costs. A date for 
recognition of gain or loss associated with sale and leaseback 
transactions was previously undefined within the cost principles. In 
addition, revised language is also added to recognize that an 
adjustment to the lease/rental cost limitations are required to ensure 
that the total costs associated with the use of the subject assets do 
not exceed the constructive costs of ownership.

[[Page 33674]]


DATES: Effective Date: July 8, 2005.

FOR FURTHER INFORMATION CONTACT: The FAR Secretariat at (202) 501-4755 
for information pertaining to status or publication schedules. For 
clarification of content, contact Mr. Jeremy Olson at (202) 501-3221. 
Please cite FAC 2005-04, FAR case 2004-005.


SUPPLEMENTARY INFORMATION:

A. Background

    DoD, GSA, and NASA published a proposed FAR rule for public comment 
in the Federal Register at 68 FR 40466, July 7, 2003, under FAR case 
2002-008. The proposed rule related to FAR 31.205-16, Gains and losses 
on disposition or impairment of depreciable property or other capital 
assets; FAR 31.205-24, Maintenance and repair costs; and FAR 31.205-26, 
Material costs. As result of the public comments received, the Councils 
converted the proposed rule relating to FAR 31.205-24 and FAR 31.205-26 
to a final rule, with minor changes. The Councils also decided to make 
substantive changes to the proposed rule for FAR 31.205-16 and 
published a second proposed FAR rule in the Federal Register at 69 FR 
29380, May 21, 2004, with a request for comments by July 20, 2004.
    Three respondents submitted public comments in response to the 
second proposed FAR rule. A discussion of these public comments is 
provided below. The Councils considered all comments and concluded that 
the proposed rule should be converted to a final rule, with changes to 
the proposed rule and changes to FAR 31.205-11 and FAR 31.205-36 to 
address concerns raised in the public comments. Differences between the 
second proposed rule and final rule are discussed in Section B, 
Comments 1, 2, 3, and 5, below.

B. Public Comments

    The Government and the contractor

    1. Comment: Two respondents are opposed to the language ``the 
Government and Contractor shall'' take certain actions. One of the 
respondents specifically states, ``The new phrase implies that both 
parties perform such duties as accounting entries when in reality FAR 
provides requirements that must be met by the contractor and approved 
by the contracting officer.'' The respondents recommend removing the 
language ``the Government and Contractor shall'' and retaining the 
current language structure.
    Councils' response: Concur. The Councils concur that the FAR cost 
principles are regulations that the contractor must meet with regard to 
the allowability of contract costs. Since the current language has not 
resulted in any problems and the proposed revision could cause 
potential confusion, the Councils have retained the current language 
and removed reference to ``the Government and the contractor shall'' at 
proposed FAR 31.205-16(a), (c), (d), (e)(1), (f), and (g).

    Disposition date

    2. Comment: Two respondents support the disposition date being the 
date of the sale and leaseback arrangement. However, the respondents 
noted that the use of the term ``arrangement'' is ambiguous and subject 
to various interpretations. The respondents have recommended using 
language that represents the effective date (i.e., the date title 
passes from seller to buyer) as the disposition date for the sale and 
leaseback transaction.
    Councils' response: Partially concur. The Councils agree that the 
date of the sale and leaseback arrangement may be subject to various 
interpretations. However, the Councils believe that the term 
``effective date'' also would be subject to various interpretations 
because of the numerous underlying legal relationships that can affect 
a sale and leaseback arrangement. The Councils therefore have revised 
the language at FAR 31.205-16(b) to state that the gain or loss is 
determined on the date that the contractor becomes a lessee of the 
property. In addition, for clarity purposes, the Councils have removed 
the term ``disposition date'' from the proposed rule at FAR 31.205-
16(b)(1) and (2), since that term is not used elsewhere in this 
provision in discussing other asset dispositions.

    Depreciation recapture/lease cost limitation

    3. Comment: One respondent asserts that ``the combined reading of 
proposed 31.205-16(a), (b), (c) and (d) with 31.205-11(m)(1) and 
31.205-36(b)(2) to mean that the contractor must provide both 
depreciation recapture and limit future lease charges to what would 
have been the continuing ownership costs.'' This respondent further 
states:
    ``This unclear and contentious area has long been an inequitable 
proposition. For example, a contractor sells a building for the 
original value. This results in a full depreciation recapture and 
means that the Government received goods and services free of any 
building costs. However, if the leaseback exceeds the previous 
ownership costs, then the contractor is forced to provide future 
facilitization at less than cost. This is clearly inequitable 
compared to other contractors who receive full recovery of their 
facility costs.''
    The respondent suggests that the sale and leaseback transaction 
should be limited to an ``either or'' negotiation. Either apply the 
depreciation recapture at the time of sale, or limit the lease cost for 
the period of time necessary to liquidate an amount equal to the 
depreciation recapture.
    Councils' response: Partially concur. The Councils disagree with 
the respondent's recommendation regarding an ``either or'' negotiation. 
As stated in the Federal Register at 69 FR 29380, May 21, 2004, the FAR 
``will continue to limit future lease costs to the costs of 
ownership.'' In addition, the long-standing policy, referred to as 
``depreciation recapture'' by the respondent, will continue in that 
``gains and losses on disposition of tangible capital assets, including 
those acquired under capital leases (see 31.205-11(i)), shall be 
considered as adjustments of depreciation costs previously 
recognized.'' (see FAR 31.205-16(c)).
    However, the Councils have recognized that some additional language 
is needed to ensure that the contractor's and Government's interests 
are protected. The intent of this longstanding limitation in the cost 
principles is that, for Government contract costing purposes, the 
contractor should not benefit, nor should the contractor be harmed, for 
entering into a sale and leaseback agreement, and that the recovery of 
costs should be limited to the normal cost of ownership. As the 
respondent has noted, under the current proposed rule, the recognition 
of a gain may limit the contractor in its ability to recoup what would 
otherwise be considered allowable costs up to the original acquisition 
cost. Likewise, the recognition of a loss may have the opposite effect 
that being the Government would actually reimburse the contractor for 
costs in excess of the original acquisition cost. As a result, the 
limitation at FAR 31.205-11(i)(1) and FAR 31.205-36(b)(2) has been 
modified to reflect these concerns.

    Limitation on losses from less than arm's-length transactions

    4. Comment: One respondent states that the proposed rule ``is a 
boon for government contractors and a bust for the government and 
taxpayers.'' The respondent notes that proposed paragraph 31.205-16(d) 
clearly limits the amount of credit accruing to the Government but that 
the proposed rule has no limit on the losses the contractor can charge 
to the Government. The respondent recommends that paragraph (b) include 
language that eliminates the recognition of losses on Government

[[Page 33675]]

contracts that are not entered into in an arm's-length transaction.
    Councils' response: Nonconcur. The provisions in the proposed 
paragraph 31.205-16(d) limiting recognition of any gain on the 
disposition of capital assets to the accumulated depreciation as of the 
disposition date has been the cost principle provision for many years. 
This provision is currently found in FAR 31.205-16(b). For contract 
costing purposes, gains and losses are ``considered as adjustments of 
depreciation costs previously recognized.'' The Government participates 
in the cost associated with the use of the capital asset by the 
contractor; this does not include any appreciation in asset value in 
excess of its original cost. Therefore, the cost principle limits the 
Government's recognition of the gain to the accumulated depreciation 
costs. In addition, the proposed paragraph at 31.205-16(b)(2) limits 
the allowable loss to the amount computed using ``fair market value,'' 
which protects the Government from participating in any potential 
``paper losses.'' As a result, the Councils do not believe the 
recommendation to add a provision relative to less than arm's-length 
transactions is necessary.

    Fair Market Value

    5. Comment: Two respondents are opposed to using the language 
``fair market value'' and recommend using the existing term ``net 
amount realized,'' which is used in the proposed paragraph at 31.205-
16(c). The assertion is that the ``fair market value'' is an undefined 
term and subject to multiple interpretations, which one of the 
respondents noted as being a problematic concept that has led to 
litigation. In addition, one respondent asserted that the use of ``fair 
market value'' to measure the gain is inconsistent with the language 
provided at CAS 409.50(j)(1). This respondent stated that CAS 409 
measures the gain or loss as the difference between the net amount 
realized and its undepreciated balance. The respondent believes that 
since CAS is the determining authority for the measurement and 
assignment of cost, the language should be revised to make it 
consistent with CAS.
    Councils' response: Partially concur. The concept of ``fair market 
value'' is adopted widely in the financial and accounting literature 
and is representative of the price for which the property could be sold 
in an arm's-length transaction between unrelated parties. In the case 
of sale and leaseback arrangements, the use of ``net amount realized'' 
instead of ``fair market value'' places the Government at risk for 
potentially reimbursing the costs of raising capital. Sale and 
leaseback arrangements are unique and can be structured by the parties 
involved in many ways. Therefore, the use of ``fair market value'' 
helps to protect the Government from participating in any potential 
``paper losses'' or artificially reduced gains. However, the Councils 
recognize that the CAS governs the measurement of the gain or loss for 
CAS covered contracts. Thus, the final rule reflects the measurement 
provisions at CAS 409 for such contracts. Since the Councils believe 
the measurement should be the same for all contracts, the final rule 
also measures the gain or loss for non-CAS covered contracts in 
accordance with CAS 409.
    Although CAS 409 provides for the measurement of the gain or loss, 
the Councils continue to be concerned that the Government may be at 
risk of reimbursing the costs of raising capital (a cost the Government 
does not normally reimburse, as indicated by the provision at FAR 
31.205-27). In addition, the parties can structure the transaction such 
that the Government participates in ``paper losses.'' Therefore, the 
final rule in 31.205-16(b)(2) limits the allowable portion of any loss 
to the difference between the fair market value and the undepreciated 
balance of the asset on the date the contractor becomes a lessee. While 
the Councils are also concerned about artificially reduced gains, the 
FAR cannot recognize a gain in excess of the amount measured by CAS. 
Thus, the allowable portion of the gain under the final rule is equal 
to the amount measured by CAS 409.
    This is not a significant regulatory action and, therefore, was not 
subject to review under Section 6(b) of Executive Order 12866, 
Regulatory Planning and Review, dated September 30, 1993. This rule is 
not a major rule under 5 U.S.C. 804.

C. Regulatory Flexibility Act

    The Department of Defense, the General Services Administration, and 
the National Aeronautics and Space Administration certify that this 
final rule will not have a significant economic impact on a substantial 
number of small entities within the meaning of the Regulatory 
Flexibility Act, 5 U.S.C. 601, et seq., because most contracts awarded 
to small entities use simplified acquisition procedures or are awarded 
on a competitive, fixed-price basis and do not require application of 
the cost principle discussed in this rule.

D. Paperwork Reduction Act

    The Paperwork Reduction Act does not apply because the changes to 
the FAR do not impose information collection requirements that require 
the approval of the Office of Management and Budget under 44 U.S.C. 
3501, et seq.

List of Subjects in 48 CFR Part 31

    Government procurement.

    Dated: May 27, 2005.
Julia B. Wise,
Director, Contract Policy Division.

0
Therefore, DoD, GSA, and NASA amend 48 CFR part 31 as set forth below:

PART 31--CONTRACT COST PRINCIPLES AND PROCEDURES

0
1. The authority citation for 48 CFR part 31 is revised to read as 
follows:

    Authority:  40 U.S.C. 121(c); 10 U.S.C. chapter 137; and 42 
U.S.C. 2473(c).

0
2. Amend section 31.205-11 by revising paragraph (i)(1) to read as 
follows:


31.205-11  Depreciation.

* * * * *
    (i)* * *
    (1) Lease costs under a sale and leaseback arrangement are 
allowable only up to the amount that would be allowed if the contractor 
retained title, computed based on the net book value of the asset on 
the date the contractor becomes a lessee of the property adjusted for 
any gain or loss recognized in accordance with 31.205-16(b); and
* * * * *

0
3. Amend section 31.205-16 by--
0
a. Removing from paragraph (a) the words ``paragraph (d)'' and 
inserting ``paragraph (f)'' in its place;
0
b. Redesignating paragraphs (b), (c), (d), (e), (f), and (g), as (c), 
(e), (f), (g), (h), and (i), respectively;
0
c. Adding new paragraphs (b) and (d); and
0
d. Revising the newly designated paragraph (e)(2)(ii).
0
The revised and added text reads as follows:


31.205-16  Gains and losses on disposition or impairment of depreciable 
property or other capital assets.

* * * * *
    (b) Notwithstanding the provisions in paragraph (c) of this 
subsection, when costs of depreciable property are subject to the sale 
and leaseback limitations in 31.205-11(i)(1) or 31.205-36(b)(2)--
    (1) The gain or loss is the difference between the net amount 
realized and the undepreciated balance of the asset on the date the 
contractor becomes a lessee; and

[[Page 33676]]

    (2) When the application of (b)(1) of this subsection results in a 
loss--
    (i) The allowable portion of the loss is zero if the fair market 
value exceeds the undepreciated balance of the asset on the date the 
contractor becomes a lessee; and
    (ii) The allowable portion of the loss is limited to the difference 
between the fair market value and the undepreciated balance of the 
asset on the date the contractor becomes a lessee if the fair market 
value is less than the undepreciated balance of the asset on the date 
the contractor becomes a lessee.
* * * * *
    (d) The gain recognized for contract costing purposes shall be 
limited to the difference between the acquisition cost (or for assets 
acquired under a capital lease, the value at which the leased asset is 
capitalized) of the asset and its undepreciated balance (except see 
paragraphs (e)(2)(i) or (ii) of this subsection).
    (e)* * *
    (2)* * *
* * * * *
    (ii) Recognize the gain or loss in the period of disposition, in 
which case the Government shall participate to the same extent as 
outlined in paragraph (e)(1) of this subsection.
* * * * *

0
4. Amend section 31.205-36 by revising paragraph (b)(2) to read as 
follows:


31.205-36  Rental costs.

* * * * *
    (b)* * *
    (2) Rental costs under a sale and leaseback arrangement only up to 
the amount the contractor would be allowed if the contractor retained 
title, computed based on the net book value of the asset on the date 
the contractor becomes a lessee of the property adjusted for any gain 
or loss recognized in accordance with 31.205-16(b).
* * * * *
[FR Doc. 05-11184 Filed 6-7-05; 8:45 am]
BILLING CODE 6820-EP-S