Could a qualified-production-service contractor buy overhead materials for resale when its federal contract included FAR 52.245-2 but omitted FAR 52.232-16?

Plain-English summary

A contractor providing assumed qualified production services would normally be the consumer of tangible personal property used to perform those services under Regulation 1529.

The contractor argued that the Aerospace title-passage rule allowed it to buy overhead materials for resale to the United States. The contract incorporated FAR 52.245-2, but did not incorporate FAR 52.232-16.

That distinction controlled. The opinion said FAR 52.232-16 was the progress-payment clause that could pass title to overhead materials before use. FAR 52.245-2 accelerated title only for direct-cost items.

Because no contract clause passed overhead materials to the government before the contractor used them, the contractor remained the consumer and could not purchase those materials for resale.

Common questions

Did the memorandum decide whether Aerospace overrides the production-service consumer rule?

No. It expressly left that question open because this contract had no clause passing title to overhead materials before the contractor used them.

Was FAR 52.245-2 enough?

No. It covered direct-cost items, not the overhead at issue.

What important clause was missing?

FAR 52.232-16.

Could the contractor buy the overhead ex-tax for resale?

No, under the reviewed contract.

Citations and references

• Cal. Code Regs., tit. 18, reg. 1529(a)(1) — qualified-production-service provider treated as consumer
• Aerospace Corp. v. State Board of Equalization, 218 Cal.App.3d 1300, 1311 and 1313 (1990) — contract-clause title-passage analysis
• FAR 52.232-16 — missing progress-payments clause for overhead title passage
• FAR 52.245-2(c) — incorporated clause accelerating title only for direct-cost items
• DFARS 252.227.7013 — incorporated restricted-transfer software provision noted by the memorandum

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/565-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/565-1415.pdf

Original ruling text

State of California

Board of Equalization

565.1415

Memorandum
To:

From:

Subject:

Mr. William R. Pitts
Supervising Tax Auditor,

Date:

July 29, 1996

John L. Waid
Senior Tax Counsel
United States Government Service Contracts—Title Clauses
At the request of Mr. Michael P. Kitchen of the Audit Review and Refund Section, I am responding to your memorandum to him dated April 24, 1996. You ask if REDACTED TEXT may buy overhead materials ex tax for resale to the United States under the ruling in Aerospace Corporation v. State Board of Equalization (1990) 218 Cal.App.3d 1300. Attached to your memorandum are excerpts from its contract with the United States that contain the title clauses and describe certain aspects of the work. According to the contract documents, REDACTED TEXT is providing its services directly to the REDACTED TEXT at REDACTED TEXT AFB. Although it is not clear from the documents, the conversations I have had with Mr. Kitchen on this indicate that the taxpayer is providing “qualified production services” under Regulation 1529. We will assume for the purposes of this discussion that it is. As a result, it would normally be the consumer of any tangible personal property it purchases for use in providing such services. (Reg. 1529(a)(1).) As I understand it, the issue is whether or not Aerospace overrides the regulation and permits the taxpayer to buy the property for resale. We find under the facts of this case, however, that we do not need to reach this issue. Section I of the Contract is the part which incorporates by reference FAR contract clauses. FAR 52.245-2 is specifically incorporated, but 52.232-16 is not. We note that DFARS 252.227.7013, which provides that the contractor remains the consumer of any software it purchases that contains a restriction on transfer, is also incorporated. OPINION The Aerospace case construed two title clauses that are substantially similar to those contained in FAR 52.232-16 and FAR 52.245-2. The first, which provides for progress payments, was the clause which the court held passed title to overhead materials to the government prior to use by the contract, thus permitting the contractor to buy such materials free of tax for resale. (Ibid. at 1311.) FAR 52.245-2(c) provides for accelerated title passage to items of direct cost only.

Aerospace held that the resolution of this issue is determined by the clauses of the contract. (Ibid. at 1313.) As FAR 52.232-16 is not incorporated into this contract, no clause in this contract provides for accelerated passage of title to overhead materials to the United States prior to its use by REDACTED TEXT. Therefore, REDACTED TEXT is the consumer of the items that it purchases to perform qualified production services and may not purchase such property for resale to the United States. JLW:sr cc:

Mr. Michael Kitchen (MIC:39)