Federal Circuit Clarifies the Definition of IR&D Costs
March 29, 2010
By: Eric Whytsell
The U.S. Court of Appeals for the Federal Circuit recently issued a long-awaited decision clarifying the classification of costs as Independent Research and Development (IR&D). ATK Thiokol, Inc. v. United States, No. 2009-5036 (Fed. Cir. Mar. 19, 2010).
In ATK, the contractor (now known as ATK Launch Systems) funded an upgrade of one of its advanced “strap on” rocket motors in the mid-1990’s. In 1996, Mitsubishi Heavy Industries approached ATK to purchase the modified motors for use in Japanese government launch vehicles. The companies ultimately executed a contract under which Mitsubishi did not pay for the research associated with upgrading the motor.
As ATK had done with previous research efforts, it accounted for the research costs as IR&D and disclosed them as such in an advance agreement submitted to the Department of Defense (DoD). As a result of the IR&D classification, the charges were allocated to all of ATK’s contracts (commercial and governmental) during that year as part of overhead. However, in March 1999, DoD gave ATK notice that the IR&D costs for the upgraded motor were unallowable – leading to this case.
The issue in ATK was whether the IR&D costs for the rocket motor were “required in the performance” of the Mitsubishi contract. Where costs are “indirect” and not “required in the performance of a contract” they may qualify as IR&D. See FAR 31.205-18; 48 C.F.R. § 9904.420. ATK argued that this phrase was limited to costs explicitly required by contract. The government, however, took the position that all costs necessary to performance of a contract are “required in the performance of the contract.”
The Federal Circuit resolved the issue by analyzing the related definition of “bid and proposal costs.” FAR 31.205-18(a). A provision of the Cost Accounting Standards (CAS 402) provides important guidance on this issue:
[C]osts incurred in preparing, submitting, and supporting proposals pursuant to a specific requirement of an existing contract are considered to have been incurred in different circumstances from the circumstances under which costs are incurred in preparing proposals which do not result from such specific requirements. The circumstances are different because the costs of preparing proposals specifically required by the provisions of an existing contract relate only to that contract while other proposal costs related to all work of the contractor. (Emphasis added).
CAS 402-61(c). The court, using the B&P cost provision as a backdrop, held that costs that “do not result from such specific requirements” may be attributable to IR&D. From a policy standpoint the Federal Circuit approved of this practice since “[s]preading IR&D costs across multiple contracts encourages general research that enables the contractor to innovate, to maintain a high level of technological sophistication, and ultimately to improve the products it offers the government.” Slip op. at 11.
Until the ATK decision, the definition of IR&D was ambiguous. The ruling provides clarification that research that is likely to benefit multiple contracts is properly attributable to IR&D when the costs are (a) not specifically required by contract; and (b) disclosed to the government as part of an established cost accounting practice.
Written by: Eric Whytsell and Samuel Jack