After a decision from the US Court of Federal Claims, it is clear that companies filing for small business determinations should take care to properly apply the Small Business Administration’s detailed calculation methodology for “annual receipts,” and ensure that such receipts are derived from their income tax returns for the calculation period.
US Small Business Administration (SBA) size standards for many industries are based on a company’s “annual receipts.” These are historically averaged over a three-year period, although SBA’s current proposed rule would extend this period to five years, allowing growing small businesses to remain “small” for longer. Small business owners attempting to calculate annual receipts without reference to SBA’s specific requirements often confuse “gross receipts” with “annual receipts.” However, as the United States Court of Federal Claims made clear in Kingfisher Systems, Inc. v. United States, SBA’s rule specifies a detailed calculation methodology and must be properly applied in the calculation of “annual receipts.”
This case originated from a size protest filed by a disappointed bidder upon learning that the US Navy had selected Kingfisher for the award of a small business set-aside contract to provide network cyber services. The SBA Area Office ultimately agreed with the disappointed bidder and found that Kingfisher did not qualify as a small business for this procurement, rendering it ineligible to compete. After several levels of appeals, the US Court of Federal Claims agreed that Kingfisher did not qualify as a small business because its annual receipts were above the small business size threshold applicable to the procurement in which Kingfisher was participating. In particular, the court ultimately concluded that amounts variously characterized by the parties as either “net gains from the sale of business property” or merely “a depreciation reversal” should be included in “total receipts” for purposes of whether Kingfisher qualified as a small business.
The court based its decision on a careful reading of SBA’s rule. In determining the scope of revenues included in “receipts,” the court quoted from the rule, which provides:
Receipts means all revenue in whatever form received or accrued from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances. Generally, receipts are considered “total income” (or in the case of a sole proprietorship “gross income”) plus “cost of goods sold” as these terms are defined and reported on Internal Revenue Service (IRS) tax return forms (such as Form 1120 for corporations; Form 1120S and Schedule K for S corporations; Form 1120, Form 1065 or Form 1040 for LLCs; Form 1065 and Schedule K for partnerships; Form 1040, Schedule F for farms; Form 1040, Schedule C for other sole proprietorships).
For entities filing Form 1120S, for example, the court found that SBA must base its size determination on the sum of (1) line 6 (total income), which includes adjusted “Gross receipts or sales” less cost of goods sold, “net gain,” and “other income,” and (2) line 2 (cost of goods sold), effectively reversing the cost of goods sold. The court found that included revenue was not limited to the list of specific types of revenue therein, which the court found was not exhaustive.
The court then noted that SBA’s rule specifically identified amounts not included in “receipts” as follows:
Receipts do not include net capital gains or losses; taxes collected for and remitted to a taxing authority if included in gross or total income, such as sales or other taxes collected from customers and excluding taxes levied on the concern or its employees; proceeds from transactions between a concern and its domestic or foreign affiliates; and amounts collected for another by a travel agent, real estate agent, advertising agent, conference management service provider, freight forwarder or customs broker. . . . All other items . . . may not be excluded from receipts.
Finding that neither “gain from the sale of business property” nor “depreciation reversal” income were on SBA’s list of excluded receipts, the court held that SBA did not err by including these amounts in Kingfisher’s “annual receipts” for purposes of SBA’s size determination. Further, the court ruled that SBA properly considered only the information contained in Kingfisher’s tax returns for the calculation period, and not additional documents provided, including the copies of the company’s financial statements.
Companies calculating annual receipts should do the following:
More broadly, companies should ensure that when SBA is making a size determination, all information necessary to demonstrate size and all explanations and arguments are provided to the Area Office in the first instance. Once the Area Office makes its decision, it will only be reviewed for clear errors of fact and law, making it much harder for companies to obtain a different result on appeal.
Finally, if a company believes that it has lost a contract in a set-aside procurement to a contractor that does not qualify as a small business, it must take prompt action. Contractors have only five days after a notification that they were not selected for award to file a size protest.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Sheila A. Armstrong