We first brought this rule to your attention when it was issued as a proposed revision to the DFARS Supplemental Cost Principles.  We didn’t have many nice things to say about it.  We wrote—

… our point of view is that the statute permits (or requires) the Secretary of Defense to obtain contractor IR&D information ‘in a reasonable manner.’ But the statute does not permit the DOD to make a contractor’s IR&D expenditures unallowable if it fails to comply.

We invited readers to submit comments on the proposed rule to the DAR Council.  Did you?

Regardless of the comments received—or perhaps in spite of them—the DAR Council issued a final rule on January 20, 2012.

One of the key changes between the proposed and final rule was the elimination of the $50,000 reporting threshold.  Comments noted that, as drafted, the proposed rule was ambiguous in that it was unclear whether the $50,000 threshold applied to a single IR&D project or to the contractor’s aggregate IR&D spend in a single fiscal year.  Instead, the final rule now applies only to—

… major contractors, which are defined as those whose covered segments allocated a total of more than $11,000,000 in IR&D/B&P costs to covered contracts during the preceding fiscal year.

That’s good news, because it will exempt a large number of defense contractors—especially small businesses—from the new IR&D reporting requirements.

What reporting requirements, you may well be asking.

Well, the new rule states that if you want your IR&D expenses to be considered allowable by the Department of Defense, then you must make an annual reporting of each IR&D project to the Defense Technical Information Center (DTIC) using DTIC’s on-line input form.  If you don’t make that report, DCAA and your cognizant ACO may consider your IR&D expenses to be unallowable for purposes of reimbursement by DOD.

As the DAR Council noted in its promulgating comments, there has always been a rule in the DFARS Supplemental Cost Principles (at 231.205-18(c)(iii)(B)) the establishes the rule that “allowable IR&D/B&P costs are limited to those costs for projects that are of potential interest to DoD.”  The issue is that DOD hasn’t focused on enforcing that rule in quite some time.  More specifically, DCAA has not had a formal role in reviewing IR&D costs to determine allowability in accordance with that rule in recent memory.

In sum, the new rule establishes two requirements:  (1) reporting to DTIC, and (2) review of the information reporting by DCAA and the cognizant DOD ACO to determine which IR&D projects are “of potential interest” to the Pentagon.  Failure to meet the first requirement will lead to disallowed IR&D associated with specific, individual, IR&D projects.

At first blush, it should be fairly easy to establish that your IR&D projects are “of potential interest” to DOD.  Savvy contractors will have a Technology Roadmap and their IR&D expenditures will like to that Roadmap.  But the reality is that the individual IR&D project descriptions are going to have to be clear and easily comprehensible by non-technical auditors and contracting officers—and experience has shown that project description clarity is more honored in the breach.  Further, it is not clear how classified IR&D projects will be reported, reviewed, and vetted—since the DAR Council stated that “Only unclassified IR&D project summary information should be provided.”

We also think defense contractors with direct sales to foreign customers may run into problems.  DCAA may well assert that any IR&D projects related solely to those direct foreign sales are not of potential interest to DOD, and thus not allowable costs under the revised DFARS Supplemental Cost Principle.  That may be a tough sell for some.

Any entity that is foreign-controlled may also have trouble explaining to DCAA why its corporate IR&D projects—perhaps performed OCONUS—are of potential interest to the U.S. Defense Department.  Again, we believe that success in “selling” the potential benefit to Pentagon will be based on the clarity of the project description(s) and the linkage between the company’s Technology Roadmap and the current/future mission of the DOD.

Fun times ahead!