The FAR cost principles and their DAR and ASPR predecessors have long provided that “materials, supplies, and services” can be transferred between “divisions, subdivisions, subsidiaries, or affiliates of the contractor” at a “price,” rather than at the transferring entity’s cost, only when (i) it is the transferor’s established practice to make such transfers at price for the contractor’s (or affiliate’s) commercial work, (ii) the item being transferred qualifies for an exemption from the obligation to submit cost or pricing data under the Truth in Negotiations Act, and (iii) the Contracting Officer has not found the transfer price to be unreasonable. FAR 31.205-26(e). Transfers between divisions or affiliates that fail to meet these requirements must be at the transferring division’s cost. Contractors and auditors have struggled at times to determine whether a particular intracompany transfer justifies an exception to the rule requiring transfer at cost (i.e., without profit). While one rationale for the rule is to avoid the “pyramiding” of profit among affiliates, the terms of the rule are broader than this rationale and may apply even when profit is not duplicated in the transfer.
In A-T Solutions, Inc., ASBCA No. 59338 (Feb. 8, 2017), the Government unsuccessfully attempted to graft onto this cost principle an additional, ill-defined requirement that the transfer have “economic substance.” ATS entered into a cost-plus-fixed-fee contract to provide training to the armed forces in defeating improvised explosive devices (“IEDs”), delivering training materials, training services, different types of IEDs, and IED “defeat tools.” ATS’s proposal stated that all its training products, which it had previously sold to the Government as commercial items, would be priced at ATS’s commercial catalog price and that training services would be billed at cost plus fixed fees.  ATS’s manufacturing division transferred the training products to its training division at its catalog prices. ATS initially invoiced for the catalog prices of the training products, and the Government initially paid those catalog price invoices. After DCAA’s audit concluded that the interdivisional transfers did not meet FAR 31.215-26(e), ATS asserted a claim for the difference between cost and price of the training products.
The Government contended that “the transfers of training materials were mere physical transfers lacking economic substance.” The Board noted that the cost principle contained no such requirement, and it declined the Government’s invitation to read such a requirement into the regulation. At any rate, the Board found, the transactions did have economic substance. The Board sustained the appeal, permitting ATS recovery of the profit in the manufacturing division’s catalog price.
It should come as no surprise that, when the transfer price was less than the transferor division’s cost, the Government has argued that the cost principles require transfers be made at price rather than cost. These efforts have had mixed success. In Teledyne Indus., Inc., ASBCA No. 20900, 77-1 BCA ¶ 12,416, Teledyne, which was performing a cost-plus-fixed-fee contract for engine parts, issued a fixed-price intercompany purchase order to its affiliate for $81,800 for tooling and manufacturing aids and actually paid the affiliate this amount. The affiliate’s actual costs to complete the purchase order were $115,141, and the contractor invoiced the Government for the higher amount. The Government disallowed the difference between the affiliate’s cost and the intercompany purchase order price, and the contractor appealed to recover the difference. The Board sustained the appeal, finding that the requirements under the applicable version of the material cost principle permitting transfer at a price had not been met and that the allowable cost therefore was the transferring division’s cost.
The Board reached a different result a few years later in General Dynamics Corp., Electric Boat Div., ASBCA No. 23977, 84-1 BCA ¶ 17,027. The key difference was that the fixed-price interdivisional work orders involved in General Dynamics were issued to its affiliate as a result of adequate price competition. Finding all the factors in the cost principle for transfer at a price had been met, the Board held that the contractor was to be paid on the basis of the interdivisional work orders’ fixed prices.
ATS provides another example of why contractors must be vigilant when planning to perform a government contract in part with transfers of materials or services from company affiliates. Unless one of the exceptions to the cost principle applies, these transfers must be made at the transferee’s actual cost rather than at price.
 The solicitation included only CFPP line items, but the Government accepted ATS’ proposal and stated that the solicitation, ATS proposal, and award document constituted the contract. ATS argued that the Government thus had agreed to pay its catalog prices for training products. The Government argued that ATS couldn’t be paid for its catalog prices because the solicitation and contract were “unambiguously CPFF”; the contract contained FAR 52.216-7, Allowable Cost and Payment; and that it was obligated to pay only ATS’s costs, unless the requirements of FAR 31.205-26(e) for billing at a price were met.
The Board never addressed the parties’ primary contentions about the nature of the contract, choosing instead to deal only with the interdivisional transfer cost principle issue. The case starkly illustrates the problems that can arise when the offeror’s proposal was directly at odds with the solicitation and when that proposal was incorporated directly into the contract. This issue about the nature of the contract was in some ways the more interesting issue.
 The Government’s “economic substance” argument apparently was based only on the fact that, according to one type of accounting record kept by ATS, the training products were never entered into the transferee division’s “inventory.” The Board disagreed, finding ATS’ other accounting records clearly showed sales by the training division, orders by the training division to the manufacturing division, and transfers from the manufacturing division to the training division at price.