Some background
For an entity to be eligible for a federal procurement set aside for small businesses, the entity generally must be “small” under the SBA size standard for the NAICS code assigned to that procurement. For revenue-based NAICS codes, an entity’s size is based on its “receipts,” defined by the SBA as “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.”
In determining an entity’s receipts, the SBA’s regulations (13 C.F.R. § 121.104) state that “[g]enerally, 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….” 13 C.F.R. § 121.104(a) also permits an entity to exclude only certain specific items from the entity’s “receipts”:
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. For size determination purposes, the only exclusions from receipts are those specifically provided in this paragraph. All other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from receipts.
As such, the SBA’s regulations: (i) define what constitutes a small business for revenue-based size standards by reference to the entity’s receipts, (ii) define what constitutes receipts for purposes of size determinations, and (iii) limits what can be excluded from an entity’s receipts to a specific list of items.
Having defined what constitutes an entity’s recipes, the SBA’s regulations also address what sources of information will be used to calculate those receipts. Under 13 C.F.R. § 121.104(a)(1), if an entity’s federal tax returns (including any amendments) for a fiscal year are filed with the IRS, the entity must use those tax returns to calculate its annual receipts. If an entity has not filed a tax return for the applicable fiscal year, 13 C.F.R. § 121.104(a)(2) provides that “SBA will calculate the concern’s annual receipts for that year using any other available information, such as the concern’s regular books of account, audited financial statements, or information contained in an affidavit by a person with personal knowledge of the facts.”
Notably, the regulation stating that the small business must use their federal income tax filings to calculate their receipts does not change the definition of what constitutes “receipts.” It merely identifies the source of information to be used, if tax returns have been filed at the time of the size determination. Accordingly, the SBA’s regulations:
Bid Solve addresses this approach. Bid Solve and CWS Marketing Group, Inc. (“CWS”) competed for an IRS procurement. CWS won the contract and, after an unsuccessful size protest, Bid Solve brought a qui tam action against CWS under the False Claims Act, alleging that CWS had misrepresented its size to win the contract. Bid Solve argued that when calculating its “receipts” for purposes of determining its size, CWS improperly deducted reimbursements CWS had received for expenses incurred on behalf of and for the benefit of customers. If those reimbursements had been included in its “receipts,” CWS would not have been “small” for purposes of the IRS procurement.
CWS argued that it properly calculated its “receipts” because it used the figures from its income tax returns it had filed, and those tax returns, as a matter of tax law, properly excluded the reimbursements.
The District Court for the District of Columbia rejected CWS’s arguments, finding that the SBA regulation that identified income tax returns as the source of information to be used to determine an entity’s “receipts” did not change the definition of what constitutes “receipts”:
The regulation says that “the only exclusions from receipts are those specifically” listed. 13 C.F.R. § 121.104(a). In other words, if an item is not listed in the provision, a company may not subtract it from “all revenue . . . reduced by returns and allowances.” Id. And the regulation gives examples of things that may not be excluded from receipts, including “reimbursements for purchases a contractor makes at a customer’s request.” Id.
Yet here, Defendants excluded one of those prohibited items by removing “flowthrough income.” They say that is okay because the regulation directed them to use tax returns when calculating receipts. Defs. MSJ at 1. But therein lies the problem. To agree with them is to simply ignore the prohibitions that they flouted: they subtracted an item not specifically listed as subtractable (violating the fourth sentence) and by doing that subtracted an item the regulation says is not subtractable (violating the fifth sentence). See 13 C.F.R. § 121.104(a).
Despite Defendants’ protests, the regulation’s statement that tax returns “must be used,” does not change the best reading. There is another plausible way to read it—that sub-provision merely speaks to timing. When a company does look to its tax returns to calculate receipts, it must use those returns “filed with the IRS on or before the date of” its bid. Id. Indeed, as the next sentence explains, “SBA will not use tax returns . . . filed with the IRS after the initiation of a size determination.” Id.
…
The Court’s reading also fits with related provisions. For example, 13 C.F.R. § 121.1009(b) says that when making a size determination, the SBA will mostly rely on the information a bidder provided but “may use other information and may make requests for additional information.” So the agency is not limited to tax returns. More, the Administration “will give greater weight to specific, signed, factual evidence than to general, unsupported allegations or opinions.” 13 C.F.R. § 121.1009(d). Thus, the agency may consider “allegations or opinions,” another knock against the Defendants’ “only tax returns” theory.
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Finally, Defendants urge that their certifications cannot be false because CWS’s tax returns were (at the very least) reasonably prepared. See Defs. MSJ at 10. But that does not matter. Tax returns may be used to calculate receipts, but they cannot be used to skirt § 104(a)’s clear guidance. Even if the CWS’s tax returns were prepared correctly, Defendants still needed to calculate receipts using § 104(a)’s basic formula: receipts are “all revenue . . . reduced by returns and allowances,” and “the only exclusions from receipts are those specifically” listed in § 104(a).
(emphasis added).
Accordingly, as Bid Solve recognizes, “[t]ax returns may be used to calculate receipts, but they cannot be used to skirt § 104(a)’s clear guidance.”
For small business concerns, Bid Solve instructs that, when making representations about size based on their federal tax returns, small business concerns should ensure they are only subtracting from their “receipts,” as that term is defined by 13 C.F.R. § 121.104(a), those items that are specifically permitted to be subtracted by 13 C.F.R. § 121.104(a), regardless of what is permitted to be deducted or excluded by applicable tax laws. As a reminder, the only categories under 13 C.F.R. § 121.104(a) that may be subtracted when determining a small business concern’s “receipts,” regardless of whether an entity is using their tax returns or some other source, are:
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.
Bid Solve also provides an example of the type of evidence that can be used to prove the knowledge requirement of a False Claims Act claim. Bid Solve had brought a False Claims Act claim against CWS, alleging that CWS falsely represented its size to the IRS to win the procurement. To be liable under the False Claims Act, a person or entity must make a false claim knowingly. A person or entity acts knowingly under the False Claims Act by (1) having actual knowledge of the falsity of their claim, (2) acting in deliberate ignorance of the truth or falsity of their claim, or (3) acting in reckless disregard of the truth or falsity of their claim.
In Bid Solve, the court found there was sufficient evidence that CWS knowingly made a false claim to submit the issue to a jury based on the following:
- 13 C.F.R. § 121.104(a) “specifically says not to subtract “reimbursements for purchases a contractor makes at a customer’s request” from revenue when calculating receipts. Yet Defendants did exactly that. And try as they might to explain it away, § 104(a) remains clear.”
- “CWS appears to have simply conjured a random receipts number for its bid. Even under their own reading of § 104(a), CWS’s reported $5.5 million in receipts was off by more than a million dollars. See DSUMF ¶ 4. Defendants missed by a country mile. And that type of carelessness suggests (at least) a reckless indifference to the truth.”
- Internal emails suggested that CWS knew it was making inappropriate deductions, including:
- An email from CWS’s owner after Bid Solve filed its size protest: “I think we are fine but makes me nervous”;
- An email from a consultant to CWS stating that “flow-through income includes all of the items we were afraid they did and that should not be excluded from the ‘annual receipts’ calculation.” (emphasis in opinion)
The court in Bid Solve also rejected the defendant’s arguments that even if they were ultimately legally incurred as to what to include as “receipts,” their reading of the SBA’s regulations was reasonable and therefore they did not “knowingly” submit a false claim:
Finally, Defendants say that they made all the challenged statements based on a good-faith reading of § 104(a) and the tax code. See Defs. MSJ at 33–41. As the D.C. Circuit has held, if a legal obligation is ambiguous, and the Defendants’ reading of it was “objectively reasonable,” then they win on knowledge. MWI, 807 F.3d at 288. But this doctrine does not save Defendants now.
For one, § 104(a) is unambiguous. It specifically barred them from removing flowthrough income. And its statement about using tax returns must be read to refer merely to timing; if tax returns are used, they must have been submitted to the IRS before the bid is entered. Nor is Defendants’ reading of that regulation “objectively reasonable.” Id. They would have the Court ignore half the provision. More, their reading would reward tax fraud. A company could file bogus returns and then rely on those to claim that it is a small business. And a rejected competitor would be out of luck, even if it could prove that the winning company had lied on its returns.
Defendants also claim that CWS prepared its tax returns reasonably. But on the right reading of § 104(a), this does not save them because they were not allowed to rely solely on those tax returns. Instead, they needed to follow § 104(a)’s direction not to remove flowthrough income. So even if the tax returns were reasonably accurate, Defendants’ certifications about CWS’s receipts and small business status were not. And thus, MWI’s safe harbor provides no escape from summary judgment.
Notably, the United States Supreme Court decision in United States ex. rel. Schutte, et. al. v. SuperValu, Inc. et. al., issued after the decision in Bid Solve, supports the District Court’s conclusion that there was sufficient evidence to permit the False Claims Act case to go to the jury. As we previously discussed, in Schutte the Supreme Court held that the knowledge element of a False Claims Act claim refers to a defendant’s knowledge and subjective belief as to the falsity of their claim—not to what an objectively reasonable person may have known or believed. The primary takeaway from Schutte is that post-hoc legal justifications for why a claim complies with the law are not a defense if the defendant subjectively or actually believed that the claim was false and that clever lawyering will not immunize a contractor’s subjective or actual belief that a claim was false or not in compliance with the law.
Bid Solve is a helpful reminder that small business entities making representations regarding their size under SBA size standards should not blindly rely on their tax returns, and should instead ensure their size calculations do not include subtractions of items not specifically permitted to be subtracted by 13 C.F.R. § 121.104(a).
