Over the past three years, Congress has taken upon itself to regulate the compensation of government contractor employees and, in particular, defense contractor employees. Congressional interest first manifested itself in the 1995 DOD Appropriations Act and has continued through the 1998 DOD Authorization Act. Five separate statutes are presently involved for purposes of accounting for individual or executive compensation from April 1995 through December 1997. Beginning January 1, 1998, a sixth statute came into play.
Congress regulates executive compensation by disallowing compensation costs that exceed a statutory limit even if properly allocated to defense or non-defense contracts. The limit varies in amount from $340,000 to $200,000, depending on when the contract funds apply to a given defense or non-defense contract action or when the compensation cost was incurred. It appears that the number of statutes addressing the unallowability of executive compensation costs has ended with the 1998 DOD Authorization Act.
This article analyzes the most recent statute that became effective in February 1998 for senior executive compensation costs incurred after January 1, 1998. For purposes of accounting for individual or executive compensation for defense contracts under the 1995, 1996, and 1997 Appropriations Acts and the 1997 DOD Authorization Act, this Feature Article explains: (1) what happened before the 1998 DOD Authorization Act; (2) which 1997 laws on individual and executive compensation has priority; and (3) the various Defense Contract Audit Agency's ("DCAA") guidance and FAR or DFARS guidance on the allowability of executive compensation.
The 1998 Department of Defense Authorization Act, Pub. L. 105-85
On November 17, 1997, the President signed into law the 1998 DOD Authorization Act. Section 808 of Pub. L. 105-85, entitled "Limitation on Allowability of Compensation for Certain Contractor Personnel," amends Title 10 and Title 41 dealing with procurement by the Department of Defense and non-defense agencies respectively. Section 808 became effective on or about February 17, 1998. (1) For both defense and non-defense contracts, Section 808 makes unallowable:
Costs of compensation of senior executives of contractors for a fiscal year, (2) regardless of the contract funding source, to the extent that such compensation exceeds the benchmark compensation amount determined applicable for the fiscal year by the Administrator for Federal Procurement Policy under section 39 of the Office of Federal Procurement Policy Act (41 U.S.C. 435).
The term "benchmark compensation amount" means "the median amount of compensation provided for all senior executives of all benchmark corporations for the most recent year for which data is available at the time the determination under subsection (a) is made." See Pub. L. 105-85, ' 808 (b). The term "benchmark corporation" means "a publicly owned, United States corporation that has annual sales in excess of $50,000,000 for the fiscal year." Id. at ' 808(b)(2). This does not mean that only publicly held U.S. companies are subject to the executive compensation allowability statute, but only that such companies provide the database from which the OFPP Administrator determines the benchmark compensation amount.
The benchmark compensation amount for the contractor's fiscal year 1998 is $340,650. See 63 Fed. Reg. 8981. This amount will remain in effect for subsequent fiscal years until revised by the Office of Federal Procurement Policy. In its announcement of the benchmark compensation amount, OFPP emphasized that,
The benchmark compensation amount established as directed by Section 39 [of the Office of Federal Procurement Policy Act] limits the allowability of compensation costs under government contracts. The 'benchmark compensation amount' does not limit the compensation that an executive may otherwise receive.
63 Fed. Reg. 8981.
(1) See Pub. L. 105-85, ' 808(e)(1). "The amendments made by this section shall -- (1) take effect on the date that is 90 days after the date of enactment of this Act." Id. at ' 808(d). Regulations implementing ' 808 were published in the Federal Register. See 63 Fed. Reg. 9067.
(2) The term "fiscal year" means a fiscal year established by a contractor for accounting purposes. Pub. L. 105-85, '808(b). See also FAR 31.205-6(p)(2)(iii), 63 Fed. Reg. 9067.
The concept of "benchmark compensation amount" appears to be driven principally, if not solely, by political perceptions that the high salaries of top level executives at government contractor companies (particularly defense contractors) must not be paid for by the taxpayer. Given that the 1998 DOD Authorization Act modifies the Administration's March 1997 proposed "Contract Costs Act of 1997" (a statutory proposal that was directed by Congress in ' 809 of the 1997 DOD Authorization Act), the 1998 statute's principal contribution to the Administration's proposal was to compare the salaries of executives in the "commercial sector" with salaries of executives in the "government contract sector" and then devise a formula that would result in the lowest dollar limitation for government contractors. The Senate Report to ' 808 supports this view by stating:
The committee has carefully reviewed this proposal as well as a number of other approaches, such as a specified dollar limitation for compensation, as was imposed by Congress on an interim basis in the National Defense Authorization Act for Fiscal Year 1997. The committee believes that a limitation based on comparability with commercial industry practice is preferable to a specific limitation based on an arbitrary dollar amount. A comparability approach recognizes that defense must compete with the commercial sector for the same pool of experienced, skilled managers, scientists and engineers.
However, the committee believes that the approach proposed by the administration is unsupportable because it would allow individual compensation of up to $4.0 million for large contractors. Therefore, the committee recommends a provision that would adopt the framework of the administration proposal, but would change the method of calculating the limitation on individual compensation by using the median salary of senior executives in all public corporations with annual sales in excess of $50.0 million, regardless of the size of the company. The Defense Contract Audit Agency has stated that the compensation limitation imposed by this formula would be $340,000 based on the most recently available data.
The committee believes that this approach will provide appropriate flexibility for small and medium business that rely primarily on contracts with the Department of Defense.
Sen. Rep. 105-29, 105th Cong., 1st Sess. at 301.
Section 808 further states:
The term "compensation," for a year, means the total amount of wages, salary, bonuses and deferred compensation for the year, whether paid, earned, or otherwise accruing, as recorded in an employer's cost accounting records for the year.
The interim FAR rule issued on February 23, 1998, provides virtually an identical definition. See FAR 31.201-6(p)(2)(i), 63 Fed. Reg. 9067.
The term "senior executive," with respect to a contractor, means -
(A) the chief executive officer of the contractor or any individual acting in a similar capacity for the contractor;
(B) the four most highly compensated employees in management positions of the contractor other than the chief executive officer; and
(C) in the case of a contractor that has components which report directly to the headquarters, the five most highly compensated employees in management positions at each such component.
Pub. L. 105-85, ' 808(a), (b); see also FAR 31.205-6(p)(ii), 63 Fed. Reg. 9067.
Finally, the newest law adopted the definition of "covered contract" from the 1997 DOD Authorization Act and approved the definitions of "compensation" and "senior executive" (as stated above) that originated in FAR guidance issued during the preceding years. (3)
The new law firmly establishes that ' 808 is the only law that applies to "costs of compensation incurred after January 1, 1998, under covered contracts entered into before, on, or after the date of enactment of the 1998 DOD Authorization Act." Pub. L. 105-85, ' 808(f) (emphasis supplied). The interim FAR guidance explicitly states:
Costs incurred after January 1, 1998, for compensation of a senior executive in excess of the benchmark compensation amount determined applicable for the contractor fiscal year by the Administrator, Office of Federal Procurement Policy (OFPP), under Section 39 of the OFPP Act (41 U.S.C. 435) are unallowable (10 U.S.C. 2324(e)(1)(P) and 41 U.S.C. 256(e)(1)(P)). This limitation is the sole statutory limitation on allowable senior executive compensation costs incurred after January 1, 1998, under new or previously existing contracts. This limitation applies whether or not
the affected contracts were previously subject to a statutory limitation on such costs.
(3) "Covered contract" means a contract for an amount in excess of $500,000 that is entered into by the head of an agency, except that such term does not include a fixed-price contract without cost incentives or any firm fixed-price contract for the purchase of commercial items. Pub. L. 104-201, ' 809 (b)(2). This definition is identical to that found at 10 U.S.C. '2324(l) and 41 U.S.C. '256(l).
FAR 31.201-6(p)(1); 63 Fed. Reg. 9067. (4)
In summary, the 1998 DOD Authorization Act means that the CEO, the four most highly compensated personnel of the contractor, and the five most highly compensated personnel of the contractor at various components of the company (if applicable) may not have any part of their compensation (as defined above) allocated to covered contracts (as defined above) to the extent that such executive compensation exceeds the "benchmark compensation amount" for costs of compensation incurred after January 1, 1998. (5)
By specifying the time of the incurred cost, rather than focusing on the contract award date, the 1998 law no longer requires that contractors allocate and account for individual FY 1995, FY 1996 or FY 1997 defense contract compensation costs or senior executive FY 1997 non-defense contract compensation costs. (6) Although guidance has yet to be issued, it seems likely that much of the DCAA guidance issued for the 1997 DOD Authorization Act can be applied to allocation issues related to the 1998 DOD Authorization Act. In its Memorandum for Regional Directors dated January 26, 1998, 98-PAC-014(R), relating to audit guidance on changes to the FAR under FAC 97-03, DCAA observed:
(4) Due to the unequivocal FAR rule issued in FAC 97-04 (see 63 Fed. Reg. 9066) stating that it was the "sole statutory limitation on allowable senior executive compensation costs incurred after January 1, 1998, the Defense Department deleted its previous DFARS coverage on March 26, 1998. See 63 Fed. Reg. 14640. The DFARS was amended by removing DFARS 231.205-6(a)(2)(i)(A) through (a)(2)(ii)(B), by removing DFARS 231.303(3), by removing DFARS 231.603(a), and by removing DFARS 231.703(1). See 63 Fed. Reg. 14641.
(5) See generally Conf. Rep. No. 105-340, 105th Cong., 1st Sess. 773.
(6) For those individuals or senior executives who are compensated at less than $340,650 (or $250,000 or $200,000 depending on the contract award date, the timing of the incurred compensation cost, the management position of the individual, and the contract's funding), the customary standards of reasonableness and allocability (see FAR 31.201-3 and 31.201-4) must still be satisfied in order for the cost to be allowable.
In July 1996, the Armed Services Board of Contract Appeals explained how the "reasonableness" of an executive's compensation would likely be determined. According to the ASBCA, experts in the compensation field generally take the following steps to evaluate the reasonableness of executive compensation: (1) determine the position to be evaluated; (2) identify surveys of compensation for the position to be evaluated that match the company in terms of revenues, industry, geographic locations and/or other relevant factors; (3) update the surveys to a common data point for each year through the use of escalation factors; (4) array the data from the surveys from the relevant compensation elements at various levels of compensation such as the average (mean) or selected percentiles and develop a composite number for each; (5) determine which of the numbers to use for comparative purposes; (6) apply a range of reasonableness such as 10% to the number or numbers selected; (7) adjust the actual total cash compensation for lower than normal fringe benefits; and (8) compare the adjusted compensation to the range of reasonableness. Techplan Corp., ASBCA Nos. 41470 et al., 96-2 BCA 6 28,426 at 141,989, see also Information Systems & Network Corp., ASBCA No. 47849, 97-2 BCA 6 29,132.
2. Compensation of Certain Contractor Personnel (FAR CASF 96-325) - This final rule converts the 2 January 1997 interim rule to a final rule with minor clarifying amendments. The rule implements Section 809 of the FY 1997 Authorization Act and places a government wide ceiling of $250,000 per year on allowable compensation costs for contractor personnel in senior management positions. The language in the Supplementary Information section of the Federal Register notification clarified that the FY 1997 compensation cap applies only to contracts awarded after 1 January 1997. Therefore, the final rule is applicable only for costs incurred from 1 October 1996 through 30 September 1997 for contracts awarded after 1 January 1997. CAM 6-414.8.d. and the summary compensation ceiling table at CAM 6-414.8 will be revised to reflect that the FY 1997 compensation cap applies only to contracts awarded after 1 January 1997. (Note: FY 1998 DoD Authorization Act contains different allowability provisions for executive compensation. Guidance will be provided when the Act's requirements are incorporated into the FAR.)
Memorandum No. 98-PAC-014(R) (emphasis in original).
The 1995, 1996, and 1997 DOD Appropriation Acts; 1997 DOD Authorization Act
For senior executive and individual defense employee compensation costs incurred before January 1, 1998, contractors must still apply the previous laws and regulations in order to properly allocate and account for the then applicable statutory limitations on compensation costs.
For defense contractors, the accounting intricacies involve the personal compensation for any individual (not just senior executives) paid in excess of $250,000 or $200,000 (depending on the fiscal year of the contract) under defense contracts funded by the 1995, 1996, 1997 Appropriation Acts and awarded as a "new" contract during the relevant time frames. For non-defense contractors, an accounting must be made for senior executives (or "officials") beginning with the 1997 DOD Authorization Act if "covered" contracts awarded during FY 1997 used funds from that fiscal year in order to pay senior executive compensation. Companies performing defense, non-defense, and commercial contracts during the relevant time periods under the relevant funds have a compounded allocation problem.
The following analysis of the 1995, 1996, and 1997 Appropriations Acts and the 1997 Authorization Act and their implementing regulations reveals how the guidance from the DCAA and DFARS seemed to evolve in favor of the government even though the 1995, 1996, and 1997 Appropriations Act language remained basically the same and the 1997 Authorization Act language was not particularly complicated.
1. The 1995 Defense Appropriations Act
Effective April 15, 1995, pursuant to ' 8117 of the 1995 DOD Appropriations Act (Pub. L. 103-355), Congress prohibited any and all personal compensation exceeding $250,000 to any defense contractor employee (not only the "senior executives" as defined above) to be charged (directly or indirectly) to any new defense contracts paid for with 1995 Defense appropriations. Section 8117 was in effect from April 15, 1995 to September 30, 1995. (For the following nine months (i.e., October 1, 1995 to June 30, 1996), there was no executive compensation prohibition in effect).
The regulatory guidance for ' 8117 (the 51/2 months) was straightforward and stated:
Costs for individual compensation in excess of $250,000 per year are unallowable under DoD contracts that are awarded after April 15, 1995, and are funded by fiscal year 1995 appropriations (Public Law 103-355).
DFARS 231.205-6(a)(2). (7)
This initial DFARS guidance did not make compensation limits an expressly unallowable cost subject to the indirect cost rate certification requirements of FAR 31.110 and the accompanying penalty provisions of FAR 42.703-2, and 42.709. In July 1997, however, the DCAA expressly stated that such costs were subject to these penalty provisions. See DCAM, 6 6-414.8e. (July 1997 ed.). In November 1997, ' 808 also made "excess" executive compensation costs an express and statutory unallowable cost by amending 10 U.S.C. ' 2324(e)(1) and 41 U.S.C. ' 256(e)(1). See Pub. L. 105-85, ' 808(a), (b). Presumably, most contractors (whether defense or non-defense) would have treated the compensation in excess of the statutory limits as an expressly unallowable cost. CAM 66-414.9c. (Jan. 1998 ed.) states: "any costs in excess of the limitations included in the final indirect cost settlement proposal are expressly unallowable and subject to the penalty provisions at FAR 42.709 (previously at DFARS 231.70). It is the contractor's responsibility to identify the contracts subject to any of the compensation limitations."
(7) The above guidance applied equally to educational institutions (DFARS 231.602), state, local and federally recognized Indian tribal governments (DFARS 231.603), and non-profit organizations (DFARS 231.703) with defense contracts.
The DFARS guidance for the 1995 Appropriation Act was refined by the DCAA in July 1997. Therein the Defense Contract Audit Agency Manual ("DCAM") states:
a. DFARS Compensation Ceilings for 1995
DFARS 231.205-6(a)(2)(i)(A) implements provisions of the 1995 DoD Appropriations Act (Section 8117 of Public Law 103-355; the "Act"), limiting the allowability of individual compensation on covered DoD contracts. Covered contracts are DoD contracts, entered into after 15 April 1995, that are funded by the Act. They do not include modifications, whenever executed, to contracts entered into on or before 15 April 1995. They also do not include separately priced line items of contracts entered into after 15 April 1995, if those line items are not funded by the Act. The DFARS provision imposes an allowable compensation ceiling of $250,000 for each individual employee. This $250,000 ceiling includes the total of all elements of compensation (as defined in FAR 31.205-6(a)) provided to an individual employee.
DCAM 66-414.7a (July 1997 ed.); 66-414.8a (Jan. 1998 ed.). (8)
Note that a "covered contract" for FY 1995 means a new contract awarded during a specific time period versus a "covered contract" as defined under the 1997 DOD Authorization Act (and adopted by the 1998 DOD Authorization Act).
2. 1996 Defense Appropriations Act
Effective July 1, 1996, Congress next decided that the amount of allowable compensation for defense contractor employees should be further reduced. Pursuant to ' 8086 of the 1996 DOD Appropriations Act (Pub. L. 104-61), no part of 1996 DOD appropriations could be used to pay any individual compensation in excess of $200,000. Section 8086 applied to any new defense contracts issued for the four months between July 1, 1996 and October 30, 1996. For purposes of accounting for FY 1995 and FY 1996 defense contracts, the DFARS guidance was again relatively straightforward. It appeared in the July 10, 1996 Federal Register as follows:
(i) Costs for individual compensation in excess of $250,000 per year are unallowable under DoD contracts that are awarded after April 15, 1995, and are funded by fiscal year 1995 appropriations (Section 8117 of Pub. L. 103-355).
(ii) Costs for individual compensation in excess of $200,000 per year are unallowable under DoD contracts that are awarded after July 1, 1996, and are funded by fiscal year 1996 appropriations (Section 8086 of Pub. L. 104-61).
DFARS 231.205-6(a)(2), 61 Fed. Reg. 36306; DAC 91-11, 61 Fed. Reg. 50446.
(8) The July 1997 coverage in the DCAM superseded Memorandum for Regional Directors ("MRD") 97-PAC-009(R), January 21, 1997 entitled, "Audit Guidance on Allowable Compensation for 1997," and MRD 96-PAC-190(R), December 13, 1996 entitled, "Audit Guidance on Interim Rule on Compensation Costs." The July 1997 DCAM coverage did not supersede MRD 97-PIC-051(R), April 2, 1997 entitled "Audit Guidance on Implementation of Compensation Caps for Incurred Cost Audits Imposed by the FY 1995 and 1996 DoD Appropriation Acts." However, the April 1997 MRD was superseded in the January 1998 edition of the DCAM.
The DCAA published guidance in the July 1996 edition of the DCAM concerning the 1995 Appropriations Act prohibition disallowing individual compensation amounts exceeding $250,000. This audit guidance began simply enough with the following:
The applicability [of the 1995 Act] is narrowly construed. It does not include modifications to contracts entered into before 15 April 1995. It does not include separately priced line items of contracts entered into after 15 April 1995 if those line items are funded by appropriations from 1996 or after.
DCAM 66-414a (July 1996 ed.).
The DCAM's remaining July 1996 guidance for FY 1995 funded contracts is troubling, however, because it invokes the all-encompassing definition of compensation in FAR 31.205-6, includes compensation charged to the indirect cost pool or charged direct, and provides no useful guidance to contractors in establishing internal accounting procedures with respect to FY 1995 funded contracts. The July 1996 DCAM further stated:
d. If the entire amount of an employee's compensation is charged to an indirect cost pool, the disallowance may be effected by disallowing the amount in excess of $250,000. If the employee charges a contract as direct labor, the auditor should calculate the percentage of unallowable compensation in total and then apply that allowable cost percentage to employee's compensation included both in the contract as a direct cost and in the indirect pool for allocation to the contract. (9)
e. A contractor may have both contracts subject to the DFARS limitation and contracts not subject to the limitation. Contractors may, at their option, propose separate sets of labor and indirect rates for contracts covered and not covered by this limitation. If only one rate is proposed, it must reflect the disallowance in order to comply with the statutory requirement. If the contractor proposes separate rates for contracts not subject to the limitation, those rates should be evaluated using the cost principles at FAR 31.205-6.
DCAM 66-614d-e (July 1996 ed.).
The January 1997 DCAM refined the July 1996 guidance for FY 1995 defense contracts by omitting the phrase, "[T]he applicability is narrowly construed," when referring to FY 1995 funded contracts. Except for this omission, the DCAM guidance, which at this point was only six months apart, is essentially identical. Subparagraph a.(2), a January 1997 addition to the July 1996 DCAM guidance for FY 1995 contracts, states as follows:
a. DFARS Individual Employee Compensation Ceilings.
(1) DFARS 2.31.205-6(a)(2)(i) implements provisions of the 1995 DoD Appropriations Act (Section 8117 of Public Law 103-335; the "Act"), limiting allowability of individual compensation on covered DoD contracts. Covered contracts include DoD contracts, entered into after 15 April 1995, that are funded by the Act. It does not include modifications to contracts entered into on or before 15 April 1995. It also does not include separately priced line items of contracts entered into after 15 April 1995, if those line items are not funded by the Act.
(2) DFARS 231.205-6(a)(2)(ii) implements provisions of the 1996 DoD Appropriations Act (Section 8086 of Public Law 104-061), limiting the allowability of individual compensation on covered DoD contracts. Covered contracts include DoD contracts, entered into after 1 July 1996, that are funded by the Act. It does not include modifications to contracts entered into on or before 1 July 1996. It also does not include separately priced line items of contracts entered into after 1 July 1996, if those line items are not funded by the Act.
DCAM 66-414.7a(1)-(2) (Jan. 1997 ed.)
(9) In January 1997, the DCAA added a reference to the $200,000 compensation ceiling from the 1996 DoD Appropriations Act for the apparent purpose of applying the previously issued 1995 Appropriations Act guidance to the 1996 Appropriations Act. See DCAM 66-414.7d (Jan. 1997 ed.).
b. DFARS Compensation Ceiling for 1996
Predictably, the July 1997 DCAM further refined DCAA's guidance for the 1996 Appropriations Act. Therein, the DCAM stated:
DFARS 231.205-6(a)(2)(i)(B) implements provisions of the 1996 DoD Appropriations Act (Section 8086 of Public Law 104-061; the "Act"), limiting the allowability of individual compensation on covered DoD contracts. Covered contracts are DoD contracts, entered into after 1 July 1996, that are funded by the Act. They do not include modifications, whenever executed, to contracts entered into on or before 1 July 1996. They also do not include separately priced line items of contracts entered into after 1 July 1996, if those line items are not funded by the Act. The DFARS provision imposes an allowable compensation ceiling of $200,000 for each individual employee. This $200,000 ceiling includes the total of all elements of compensation (as defined in FAR 31.205-6(a)) provided to an individual employee.
DCAM 66-414.7b (July 1997 ed.); 66-414.8b (Jan. 1998 ed.).
3. The 1997 Defense Authorization and Appropriations Acts
With the 1995 and 1996 Defense legislation presumably in the minds of Congress, Congress enacted the 1997 DOD Authorization and Appropriation Acts. The President signed the 1997 Defense Authorization Act on September 23, 1996 (Pub. L. 104-201) and the 1997 Defense Appropriations Act on September 30, 1996 (Pub. L. 104-208). Both statutes specifically address the allowability of personal compensation charged to government contracts. Although both statutes cover the same time frame (October 1, 1996 to September 30, 1997) and have the same allowable compensation limits of $250,000, they are nevertheless notably different.
The principle difference in scope is that the 1997 Defense Authorization Act applies to all federal contracts (including defense contracts) while the 1997 Defense Appropriations Act applies only to defense contracts. There are three other noteworthy differences in the terms used in each statute that influence the accounting treatment of the compensation costs. They are:
(1) the 1997 Authorization Act refers to "officer" while the 1997 Appropriations Act refers to "individuals;"
(2) the 1997 Authorization Act refers to a "covered contract" versus a "new contract" as referenced in the 1997 Appropriations Act; and
(3) the 1997 Authorization Act refers to Internal Revenue Code provisions for the definition of "compensation" while the 1997 Appropriations Act has no such reference nor any definition of compensation.
Which statute has priority, the 1997 Authorization Act or the 1997 Appropriations Act?
The first question to address in order to be compliant for 1997 contracts is which 1997 statute prevails for defense contracts and non-defense contracts. In resolving apparent conflicts between statutes, the Supreme Court has consistently applied a principal rule of statutory construction which is to read the two statutes harmoniously so as to give maximum effect to both wherever possible. Tennessee Valley Authority v. Hill, 437 U.S. 153 (1978); Morton v. Mancari, 417 U.S. 535 (1974); Posadas v. National City Bank, 296 U.S. 497 (1936). The General Accounting Office also takes this view. See, e.g., 68 Comp. Gen. 19 (1988); 64 Comp. Gen. 143 (1984). If an irreconcilable conflict exists between two statutes addressing the same or similar subject, then the "last in time" rule of statutory construction applies and then only to the extent of the irreconcilable conflict. See, e.g., Posadas, 296 U.S. at 593; Eisenberg v. Corning, 179 F.2d 275, 277 (D.C. Cir. 1949) (holding that, "the statutes are thus in conflict, the earlier permitting and the later prohibiting. The later statute supersedes the earlier."); B-203900, Feb. 2, 1989; B-226389, Nov. 14, 1988; B-214172, July 10, 1984, aff'd upon recon., 64 Comp. Gen. 282 (1985).
Based on these rules of statutory construction, the 1997 DOD Appropriations Act governs defense contractors from October 1, 1996 to September 30, 1997 to the extent there are inconsistencies between the Authorization Act and the Appropriations Act. This is because the Appropriations Act is later in time (which assumes that elements of the two Acts cannot be read harmoniously). Thus the 1997 Appropriations Act governs DOD-funded contracts regarding definitional issues related to "individual" versus "officer" or "senior executive," "covered contract" versus "new contract," and "compensation." For contractors performing defense contracts under the 1997 Appropriations Act, the $250,000 compensation ceiling applies to all individuals whose compensation is allocated to new contracts awarded between October 1, 1996 and September 30, 1997. (10) Defense contractors need not be concerned with the definition of "officials" or "covered contracts" in the 1997 DOD Authorization Act because the language of the 1997 Defense Appropriations Act is virtually identical to the 1995 and 1996 Defense Appropriations Acts. That is, the terms "new" and "individual" still apply for the 1997 DOD Appropriations Act. A prudent defense contractor will continue to abide by the guidance in the FAR, the DFARS and the DCAM as noted above for FY 1995, FY 1996 and FY 1997 funded defense contracts.
An interim Defense Department rule (see 61 Fed. Reg. 65478), effective on December 13, 1996, adopts the definition of "compensation" from the Authorization Act. (11) That DOD guidance states in DFARS 231.205-6(a)(2)(ii):
Costs for individual compensation in excess of $250,000 per year are unallowable under new DoD contracts funded by fiscal year 1997 appropriations (Section 8071 of Public Law 104-208). For purposes of this limitation, the term "compensation" means --
(A) the total amount of taxable wages paid to the employee for the year concerned; plus
(B) the total amount of elective deferred compensation earned by the employee in the year concerned.
61 Fed. Reg. 65479.
Compliance for non-defense contracts
Under ' 809 of the 1997 DOD Authorization Act, non-defense contractors and defense contractors performing non-defense contracts must accommodate in their accounting the three salient distinctions between the 1997 Appropriation Act and the 1997 Authorization Act to insure compliance with the relevant allowability limitations.
(10) This also indicates that defense and non-defense contractors have another "gap" (similar to the October 1, 1995 to June 30, 1996 gap) where no compensation limitations apply for contracts awarded after September 30, 1997 and before January 1, 1998. This appears to be the case because the 1998 DOD Authorization Act is not effective until February 1998 and executive compensation costs are not covered by the 1998 Authorization Act unless incurred after January 1, 1998 regardless of the contract award date.
(11) Prior to this interim rule, DCAA instructed Defense activities that the definition of compensation in FAR 31.205-6(a) would be the applicable definition of compensation. See DCAM 66-414.7 (July 1996 ed).
The first distinction between the two statutes is that a "covered contract" under the Authorization Act (versus a "new" contract under the Appropriations Act) means a contract awarded in fiscal year 1997 that exceeds $500,000 except (1) fixed-price contracts without cost incentives and (2) any firm, fixed-price contract for commercial items. See ' 809(c), Pub. L. 104-208, 10 U.S.C. ' 2324(l). (12)
The second distinction between the 1997 statutes is the definition of "compensation" which is defined in the Authorization Act as total "wages" plus total "elective deferrals" as those terms are defined in the tax code (26 U.S.C. ' 3401 for wages and 26 U.S.C. ' 402(g)(3) for elective deferrals). The practical effect of this distinction appears minimal because the term "wages" in the FAR cost principle on personal compensation includes benefits and the term "elective deferral" includes an employer's contribution to a qualified cash or deferred arrangement. It appears then, that a contractor's reliance upon the definition of "compensation" in the existing cost principle (FAR 31.205-6(a)) should suffice for compliance purposes with both the 1997 DOD statutes. The FAR appears to countenance this approach where it states at FAR 31.205-6(p)(2)(i):
Compensation means -
(A) The total amount of taxable wages paid to the employee for the year concerned; plus
(B) The total amount of elective deferred compensation earned by the employee in the year concerned.
(12) The present FAR guidance inexplicably overlooks any reference to "covered contract." See FAR 31.205-6(p) (December 1997), FAC 97-03, 62 Fed. Reg. 64912. Although one could argue that a definition of "covered contract" is not strictly necessary because the term is defined in the statute, since a "covered contract" is not a "new" contract it would be useful for the FAR language to identify this distinction. Also, a reference to the FAR 2.101 definition of "commercial item" would be useful for contractor compliance purposes in order to identify at least one class of contracts specified in the Authorization Act that are exempt from the statute; i.e., a firm, fixed-price contract for commercial items. Further, under the Authorization Act, all cost reimbursement contracts and fixed-price incentive contracts appear subject to the compensation ceiling, and the FAR should explicitly state this rule. Another area the FAR should clarify is the statute's emphasis on "fixed price" contacts. Under the 1997 Authorization Act, a fixed-price contract in excess of $500,000 (with no cost incentives) is not subject to the compensation limitation.
The third distinction between the two 1997 DOD statutes is the term "officer" in the 1997 Authorization Act versus the term "individual" in the 1997 Appropriation Act. "Officer" is defined in ' 809(c) of the Authorization Act as "a person who is in a senior management position." The phrase is defined in FAR 31.205-6(p)(2)(ii) as follows:
Officer in a senior management position means -
(A) The contractor's Chief Executive Officer (CEO) or any individual acting in a similar capacity;
(B) The contractor's four most highly compensated officers in senior management positions, other than the CEO; and
(C) If the contractor is organizationally subdivided into intermediate home offices and/or segments, the five most highly compensated individuals in senior management positions at each such intermediate home office and/or segment. (13)
The DCAA guidance refined the above FAR provisions with the issuance of the July 1997 DCAM. The DCAA's guidance, addressing both 1997 statutes and both the DFARS and the FAR, stated:
c. DFARS Compensation Ceiling for 1997
DFARS 231.205-6(a)(2)(ii), effective 13 December 1996, implements provisions of the 1997 DoD Appropriations Act (Section 8071 of Public Law 104-208; the "Act"), limiting the allowability of individual compensation charged to covered contracts. Covered contracts are new DoD contracts funded by the Act. The DFARS provision imposes allowable compensation ceiling of $250,000 for each individual employee. Compensation is defined in DFARS as the total amount of "taxable wages paid to the employee for the year concerned" plus "elective deferred compensation earned by the employee in the year concerned."
d. FAR Compensation Ceiling for 1997
FAR 31.2105-6(p) implements provisions of the 1997 National Defense Authorization Act (Section 809 of Public Law 104-201), limiting the allowability of individual compensation on government contracts. Covered contracts include all contracts awarded during the government fiscal year 1997 (i.e., from 1 October 1996 through 30 September 1997). The FAR provision imposes an allowable compensation ceiling of $250,000 on the five most highly compensated individual senior management positions at each company segment, including corporate home office and nay intermediate home offices. However, the ceiling is applicable only to costs incurred from 1 October 1996 through 30 September 1997. The definition of compensation is identical to the 1997 DFARS definition, i.e., the total amount of "taxable wages paid to the employee for the year concerned" plus "elective deferred compensation earned by the employee in the year concerned." This new FAR rule does not affect DoD contracts since DoD contracts are subject to the more restrictive provisions in DFARS (discussed in paragraph c. above).
DCAM 66-414.7c-d (July 1997 ed.), 66-414.8c-d (Jan. 1998 ed.)
(13) This is essentially the same definition of "senior executive" found in the 1998 DOD Authorization Act.
Accounting for "Covered contracts" or "new contracts" awarded between April 15, 1995 and January 1, 1998 by Defense Contractors or Non-defense Contractors
Defense contractors should pay careful attention to whether they have a new contract and for what fiscal year's appropriations. The following list of dates and accompanying remarks may be useful in contractor planning:
Prior to April 14, 1995: no compensation ceiling, so any new contract prior to April 14, 1995 will be subject only to the FAR allowability and cost principle standards.
April 15, 1995 - September 30, 1995: any new defense contracts awarded during this time prohibit a contractor for charging more than $250,000 to a defense contract for any employee.
October 1, 1996 - June 30, 1996: no compensation ceiling, so any new defense or non-defense contract formed during this nine month time frame will be subject only to the FAR allowability and cost principle standards.
July 1, 1996 - September 30, 1996: any new defense contract awarded during this four month time frame and funded with 1996 DOD appropriations is subject to a compensation ceiling of $200,000 per employee (note that a contract modification issued during this time, but funded with 1995 DOD appropriations, is subject to the $250,000 compensation ceiling).
October 1, 1996 - September 30, 1997: any new defense contract awarded during this time and funded with 1997 DOD appropriations is subject to a compensation ceiling of $250,000 for any employee; but an option (as defined in FAR 17.201) exercised from a January 1995 contract but funded with 1997 DOD appropriations is not "new" and would be subject only to the FAR rule on allowability and to the FAR 31.205-6(a) definition of compensation.
any non-defense contract exceeding $500,000 awarded during this time and funded with 1997 non-defense appropriations (except for fixed-price contracts without cost incentives or any firm, fixed-price contract for commercial items) is a covered contract and the CEO (or equivalent) and "senior level management" are limited to allowable compensation of $250,000.
October 1, 1997 - January 1, 1998 no compensation caps on contracts awarded during this period because the 1998 DOD Authorization Act is not yet in effect (accounting for senior executive compensation costs for purposes of the 1998 Authorization Act begins when the cost is incurred after January 1, 1998).
if compensation costs are charged to a contract funded with 1995, 1996, 1997 DOD Appropriation Act funds or 1997 non-DOD appropriations, the previous statutes apply as indicated above.
January 2, 1998 - [next change] 1998 DOD Authorization Act applies to all federal contracts (no distinction between "new" or "covered" for senior executives subject to allowable "benchmark compensation amount" as determined by the OFPP Administrator's survey (currently $340,650) for compensation costs incurred after January 1, 1998 (14)
DCAA further refined its guidance relating to the 1995 and 1996 compensation ceilings. See "Compensation Ceilings - Audit Considerations for FY 1995 and FT 1996 Ceilings," DCAM 66-414.10 (Jan. 1998 ed.). (15) The January 1998 DCAM discusses three methods for implementing the 1995 and 1996 compensation limits.
The first method is the "multiple rate method." This method requires contractors to establish two sets of G&A rates (or other indirect cost rates as necessary); one set of rates for "covered contracts" or "new" contracts and another set of rates for contracts that are not subject to the limitations. (Note that DCAA apparently equates "covered contracts" with "new contracts" even though "new contracts" are a function of time under the 1995 and 1996 DOD Appropriation Acts while a "covered contract" is a defined term under the 1997 DOD Authorization Act and adopted by the 1998 DOD Authorization Act.) Under the multiple rate method, considered acceptable by the DCAA, all of the unallowable compensation is allocated to the contractor's "covered" contracts. See DCAM 66-414.10a.(1). Obviously, it is more expensive for a company to maintain two sets of G&A rates and equally more expensive to be audited or negotiate contracts under two rates.
Under the second method, the "representative contract(s) adjustment method," companies would continue to allocate compensation as if there were no limitations. The company would then calculate the total unallowable compensation "allocable to flexibly priced contracts." The excess amount is then credited to a representative mix of flexibly priced, cap-covered contracts. The adjustment is a dollar-for-dollar credit against otherwise allowable contract costs. A prerequisite to the acceptability of this method is coordination with the administrative contracting officer. The method reduces contractor efforts to comply with the 1995 and 1996 statutes because only one set of rates is developed. Moreover, each DOD agency funding source receives credit for its proportional share of all unallowable compensation. See DCAM 66-414.10a(2).
(14) The DCAA provided a "compliance" chart that appeared in the January 1998 CAM as follows:
FYI Ceiling Applicability FAR/DFARS 1995 $250,000 DoD contracts after 4/15/95 DFARS 231.205- 6(a)(2)(i)(A) 1996 200,000 DoD contracts after 7/1/96 DFARS 231.205- 6(a)(2)(i)(B) 1997 250,000 DoD contracts after 12/12/96 DFARS 231.205- 6(a)(2)(ii) 1997 250,000 All contracts after 9/30/96* FAR 31.205-6(p)
* Limitation applicable only for costs incurred during government fiscal year (GFY) 1997.
DCAM 66-414.8, Compensation Ceilings - General Policy, (Jan. 1998 ed.). For purposes of providing audit guidance to DCAA field auditors, the January 1998 DCAM contains an example for dealing with executive compensation claimed for 1997 DOD covered contracts. See DCAM 66-414.11a(3), Figure 6-4-3 (Jan. 1998 ed.).
(15) This guidance is based on, but supersedes, Memorandum for Regional Directors, "Audit Guidance on Implementation of Compensation Caps for Incurred Cost Audits Imposed by the FY 1995 and 1996 DOD Appropriation Acts," 97-PIC-051(R), April 2, 1997).
The third method, termed the "blended rate method," is considered unacceptable by DCAA. Under this method, contractors calculate the total unallowable compensation applicable to covered contracts. The excess amount is then credited against the contractor's entire G&A (or other) cost pool. A "blended" G&A rate is then developed and applied to both covered and non-covered contracts. DCAA considers this approach illegal under 31 U.S.C. ' 1301(a) (the "purpose statute") and 31 U.S.C. ' 1341(a)(1) (the "Anti-deficiency Act"). According to DCAA:
Both sections would be violated, at most contractor locations, since use of the blended rate would result in a predominant misallocation of the unallowable compensation credit to the contract work that is not subject to the cap or authorized by the appropriation. . . . If contractors do not carry out or expand their blended rate calculation to an appropriate number of decimal places, the impact of the unallowable compensation may not be significant enough to lower the G&A rate. As a result, unallowable compensation costs will not be recovered by the government.
DCAM 66-414.10a(3)(i)-(ii) (Jan. 1998 ed.). (16)
Indefinite-Quantity Contracts Awarded During the 1995-97 Fiscal Years
One of the more puzzling areas for application of the executive compensation cost limitations is indefinite-quantity contracts. Indefinite-quantity contracts, whether single or multiple award type contracts, (see FAR 16.505) are the same as other types of contracts for purposes of the executive compensation rules for the FY 95-97 DOD Appropriations Act.
An indefinite-quantity contract is the contract vehicle under which deliveries or tasks are ordered by the agency. (See Pub. L. 103-355, ' 1004(a), the Federal Acquisition Streamlining Act of 1994, codifying the definition of "task order contract" and "delivery order contract" at 10 U.S.C. ' 2304d.) Therefore, an indefinite-quantity contract constitutes a "new" contract under the DOD Appropriations Act language for fiscal years 1995, 1996, and 1997 if the contract is awarded during the time frames relevant to those appropriations. (17)
When executive compensation costs are allocated to a "new" DOD indefinite-quantity contract during contract performance (i.e., task order or delivery order performance) coinciding with the fiscal year's ceiling and time period, the allocated cost would count towards the ceiling amount of the relevant fiscal year's appropriations used to pay for the order under the contract. Either $250,000 (FY 1995) or $200,000 (FY 1996) or $250,000 (FY 1997) depending upon when the contract was awarded.
If a DOD indefinite-quantity contract also contains options, then it follows from the DCAA guidance issued in January 1997 for DOD FY 95 and 96 appropriations (see DCAM 66-414.7a(1)-(2) (Jan. 1997 ed.)), that the exercise of an option (i.e., a contract modification) would not be included under the definition of a "new" contract. The result would likely be the same for new contracts awarded during the 1997 DOD Appropriations Act's fiscal year where options are exercised between September 30, 1997 and January 1, 1998. (18) This has the effect of keeping the DOD contractor's compensation allocation requirements at the applicable limitation ceiling in effect when the indefinite-quantity contract was awarded if that year's appropriations are used for payment. For example, if a new DOD indefinite-quantity contract (whether delivery order or task order), with 2 option years, is awarded on June 1, 1995, then that contract would be subject to the FY 1995 executive compensation ceiling of $250,000 from June 1 to September 30, 1995 and thereafter if the delivered items or service tasks were paid with FY 1995 funds. If FY 1996 or 1997 DOD appropriations are used during subsequent option years, those compensation ceilings in effect at the time of the exercise of the option do not apply to the option time period because the option is not a "new" contract that would be subject to the FY 1996 and 1997 executive compensation statutes. See FAR 17-207(g), FAR 52.217-9, Option to Extend the Term of the Contract. The expiration of the use of FY 1995 funds terminates the executive compensation ceiling for that indefinite-quantity contract's option years.
(16) The January 1998 DCAM provides comparative examples of the three methods at DCAM 66-414.10a, Figure 6-4-2 (Jan. 1998 ed.).
(17) See Ervin and Associates, Inc., B-278850, Mar. 23, 1998, 98-1 CPD 6 ___ for the proposition that orders under indefinite-quantity contracts are not separate contracts. Therein, the GAO held that:
Once a [multiple indefinite quantity task order] contract is awarded, GAO generally will not review modifications to that contract, such as a task order, because such matters are related to contract administration and are beyond the scope of GAO's bid protest function. [Citations omitted.] An exception to this rule is where it is alleged that the task order is beyond the scope of the original contract, since the work covered by the task order would otherwise be subject to the statutory requirements for competition ...
Id. at 5 (emphasis supplied).
(18) If an option is exercised from a FY 1997 contract after January 1, 1998, then the compensation costs allocated to the performance of the option would be subject to the 1998 DOD Authorization Act's dollar limitation (of $340,650) for senior executives under covered contracts.
The above explanation illustrates how complicated the accounting can be for compensation of individuals working under government contracts. The complexity created for defense contracts awarded after April 15, 1995 only begins to recede after January 1, 1998. Contractors must be wary of gap periods and face additional complexities with the cost principles if compensation is allocated at a different level during one time period versus another. Mindful of the overhead certification requirements, contractors may wish to conclude advance agreements (see FAR 31.109(h)(1)) with their ACO on the applicability of the statutory limitations for compensation.