What Is a Small Business? The SBA Office of Hearings and Appeals Rejects the Bid Solve Standard

The Small Business Act and Small Business Administration (SBA) regulations establish a variety of programs to promote small businesses, including creating small business preferences and goals for government procurements and requiring large businesses to establish small business subcontracting plans. But what is a small business? At the most basic level, a small business is a concern that does not exceed the SBA size standard, stated in terms of average annual receipts or employee headcount, for a particular North American Industry Classification System (NAICS) code. The United States District Court for the District of Columbia in United States ex rel. Bid Solve, Inc. v. CWS Marketing Group, Inc.¹ and the SBA Office of Hearings and Appeals (OHA) in Colossal Contracting, Inc.² created a split of authority about how receipts are calculated and, in turn, injected uncertainty into how size status is determined. This Advisory discusses those two decisions and their impact on small businesses.

Overview of Size Standards and Calculating Average Annual Receipts

SBA has established size standards for NAICS codes stated as either average annual receipts or employee headcount.³ This article focuses on size standards based on average annual receipts because that is the type of standard implicated in Bid Solve and Colossal Contracting. To calculate average annual receipts, a concern must calculate the average of its receipts (and receipts of its affiliates) for the past five completed fiscal years.⁴

SBA regulations define “receipts” broadly as “all revenue” that a concern receives with certain deductions.⁵ SBA interprets this to mean total income plus cost of goods sold, “as these terms are defined and reported on Internal Revenue Service (IRS) tax return forms.”⁶ SBA regulations establish certain exclusions, namely “net capital gains or losses,” certain “taxes collected for and remitted to a taxing authority if included in gross or total income” (e.g., sales taxes), “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.”⁷

SBA simplifies this analysis by stating that “[t]he Federal income tax return and any amendments filed with the IRS on or before the date of self-certification must be used to determine the size status of the concern.”⁸ If a concern has not filed a tax return for one of the five completed fiscal years relevant to assessing size status, “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.”⁹

But what if a concern’s tax returns do not align with SBA’s definition of “receipts”? That is the issue Bid Solve and Colossal Contracting address. In doing so, the U.S. District Court for the District of Columbia in Bid Solve and OHA in Colossal Contracting reached opposite conclusions.

Bid Solve

Bid Solve began with a size protest. CWS Marketing Group, Inc. (CWS) and Bid Solve, Inc. (Bid Solve) competed in an IRS procurement set aside for small businesses under a NAICS code with a US$7.5 million size standard.¹⁰ The IRS awarded the contract to CWS. Bid Solve filed a size protest with the SBA, and CWS responded by submitting tax returns that purportedly proved CWS was a small business. SBA then denied the protest and determined that CWS was a small business. Bid Solve appealed to OHA, but OHA dismissed the appeal as untimely.

Bid Solve then filed a qui tam action under the False Claims Act (FCA) at the U.S. District Court for the District of Columbia. Bid Solve’s theory was that CWS’ average annual receipts calculation violated SBA regulations because CWS excluded so-called “flowthrough income” (subcontractor costs and reimbursements made at a customer’s request) from its receipts. Bid Solve alleged that CWS, in turn, misrepresented its size status to the IRS and SBA, wrongly obtained the IRS set-aside contract, and made false claims for payment under that contract. CWS responded, in part, that it relied upon its tax returns in accordance with SBA regulations.

The court granted Bid Solve’s motion for partial summary judgment, and the case remains active. The court agreed that SBA regulations prohibited CWS from excluding flowthrough income from its average annual receipts calculation and held that CWS could not rely solely upon its tax returns if the tax returns excluded revenue SBA regulations did not exempt from the calculation of receipts. This is a significant decision if applied broadly because not only would it upend how small businesses typically calculate average annual receipts, it also would expose small businesses to potential FCA liability for relying solely on tax returns.

Colossal Contracting, LLC

Colossal Contracting involved a size protest where an unsuccessful offeror in a small business set-aside procurement challenged the eligibility of the awardee Colossal Contracting, a value-added reseller, on the basis that Colossal Contracting did not qualify as a small business. That procurement involved a US$34 million size standard, meaning a concern could participate in that procurement only if its average annual receipts did not exceed US$34 million.

Colossal Contracting calculated its average annual receipts using data in its tax returns. Per its revenue recognition policy, Colossal Contracting “recognizes only the commission or the difference between the sales price and the product purchase price as revenue.” In line with this definition of revenue, Colossal Contracting “does not report the full cost of goods sold for its value-added revenue on its tax returns.” The SBA Office of Government Contracting – Area II (Area Office), relying on Bid Solve, determined that Colossal Contracting could not rely on its tax returns because the tax returns excluded certain cost of goods sold amounts, while SBA regulations required the full cost of goods sold to be included in Colossal Contracting’s receipts. The Area Office concluded that if Colossal Contracting included the full cost of goods sold in its receipts, Colossal Contracting would have exceeded the US$34 million size standard.

Colossal Contracting appealed the Area Office’s size determination to OHA, arguing that OHA precedent, which has generally focused on tax returns, should control over a nonprecedential decision from a single district court. SBA provided comments in connection with the protest and took the position that the Area Office properly relied upon Bid Solve because that decision is not “contrary to the meaning of SBA’s rules.” OHA disagreed with SBA and agreed with Colossal Contracting, reversed the Area Office, and held Colossal Contracting qualified as a small business under the US$34 million NAICS code. OHA rejected the Bid Solve decision, which it viewed as “not binding on either SBA or OHA” because “Bid Solve involved a False Claims Act dispute, to which SBA was not a party.” Instead, OHA relied upon its own precedent and SBA regulatory history requiring SBA to focus on tax returns (when available) to calculate average annual receipts.

Conclusion

SBA regulations are often technical and littered with potential pitfalls, and these decisions demonstrate that the process of determining whether a company qualifies as small is a prime example of these challenges. Many potential small businesses are now at a crossroads. Relying on the Bid Solve decision, a single decision from one district court, could result in companies that would be small based on their tax returns exceeding applicable size standards and thus being ineligible to compete in small business set-aside procurements. Relying on Colossal Contracting could leave small businesses vulnerable to FCA liability if a court were to follow the Bid Solve interpretation. Ultimately, it may take a decision from the U.S. Court of Federal Claims, which has jurisdiction to hear protests challenging OHA decisions, or an appellate court to resolve this issue. In the interim, small businesses should assess these issues carefully before making size status representations to the government to ensure they are not unnecessarily excluding themselves from government procurements while also limiting potential FCA exposure.

© Arnold & Porter Kaye Scholer LLP 2024 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.