iStock_000016952672LargeYesterday, the FAR Council issued an interim regulation addressing inverted corporations involved in government contracting. This interim regulation goes into effect immediately, and companies with inverted corporate structures—or those considering a restructuring—need to understand this development.

Federal procurement law has prohibited some companies with inverted corporate structures from contracting with the Department of Homeland Security since 2002, and subsequent appropriations legislation temporarily made the ban government wide during FY 2007 (and several later fiscal years). Current law prohibits contracting with certain inverted domestic corporations and contracting officers must include the clause implanting this requirement in each solicitation and contract (FAR 52.209-10).

Much of the legislative and regulatory focus concerns the definition of an inverted domestic corporation to which the statutory prohibition applies. The new FAR provision adopts (by cross-reference) the pre-existing definition set forth in Homeland Security statute, 6 U.S.C. § 395(b), under which a foreign incorporated entity is treated as an inverted domestic corporation under specified conditions. Specifically, foreign corporations are deemed inverted domestic companies if:

  • the entity completes before, on, or after November 25, 2002, the direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership;
  • after the acquisition at least 80% of the stock (by vote or value) of the entity is held:
    • in the case of an acquisition with respect to a domestic corporation, by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation; or
    • in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership.
  • the expanded affiliated group which after the acquisition includes the entity does not have substantial business activities in the foreign country in which or under the law of which the entity is created or organized when compared to the total business activities of such expanded affiliated group.

Government contractors incorporated abroad, or that are a subsidiary of a foreign corporation, will be considered “inverted domestic corporations”—and the contracting prohibition will apply—if those conditions are satisfied. FAR 52.209-2 makes clear that by submitting an offer, a contractor is representing that it is neither an inverted domestic corporation nor a subsidiary of such an entity. Contracting officers are the officials who make determinations concerning such representations, but the extent to which agencies are performing due diligence concerning a offeror’s status (as opposed to accepting representations that a company is not inverted) is not clear. It is also unclear whether procurement officials have been (or are being) given the necessary training in corporate and tax law to perform an “inversion” analysis.

pushing social network structureSome members of the House and Senate have proposed bills in the current Congress that would tighten the definition of inverted domestic corporations—and thereby expand the prohibition on contracting with companies incorporated abroad. For instance, the “No Federal Contracts for Corporate Deserters Act of 2014” (H.R.5278, S.2704) would reduce the U.S. ownership threshold to 50% (rather than 80%) and would dramatically alter the “substantial business activities” test—applying the prohibition to more contractors. These bills appear to be dead for now, but similar efforts will (and should be) closely monitored by the government contracts community.