New Rule Limits Pass-Through Charges When 70 Percent Subcontracting Threshold is Met

The FAR Council issued an interim rule amending the FAR to prevent the government from paying “excessive pass-through charges” when subcontracting costs represent a “substantial amount” of work performed under a contract. The rules implement the 2009 Defense authorization act where the DFARS has already implemented the rule. The rule amends the FAR to minimize pass through charges by contractors to their subcontractor and from higher to lower tier subcontractors. It is intended to prevent companies receiving both indirect cost and profit/fee on work performed by their subcontractors. The rule is to be applied “consistent with existing cost accounting standards and FAR rules related to subcontract management, indirect cost allocations and profit analysis.”

For civilian agencies the rule will cover cost reimbursable contracts and task and delivery order over the simplified acquisition threshold (currently $100K) while for DOD it will apply to $550K contracts and task/delivery orders. Contracts will include a contract clause requiring offerors and contractors to identify percentage of work that will be subcontracted and when that percentage exceeds 70 percent of the total cost of work to be performed the offerors or contractors are to provide information on indirect costs and profit/fee and value added with regards to the subcontract work. The contractor or upper tier contractor is to verify it will “add value consistent with the contract clause” where added value is defined to mean contractor performance of “subcontract management functions that the CO determines to benefit the government (e.g. processing orders of parts or services, maintaining inventory, reducing delivery lead times, managing multiple sources for contract requirement, coordinating deliveries and performing quality assurance functions).” The rule also provides recovery mechanisms to recover pass through charges that were not justified.

When the proposal was originally made many industry groups expressed concern that the pass through language would not allow prime contractor profit on subcontractor labor under a time and material contract – that issue has not yet been resolved (Fed. Reg. 52853).

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