News and Events : PVBS Newsletter September 2007

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Pleasant Valley Business Solutions Partner Articles
PVBS Helps Launch Dynamics NAV SaaS Company to Serve Growing Contractors
The Good, The Bad and The Ugly – Tax issues for Government Contractors By Melinda L. C. Davis, CPA, Goodman and Company.
Dynamics NAV for Government Contractors DCAA-Compliance Discussed by Former Auditor.

Microsoft Dynamics NAV and Industry News for Government Contractors
PVBS Announces Full Support for Government Contractor Requirements in the New Microsoft Dynamics NAV 5.0
Incentive contracts can provide the proper balance of risk between government and contractor
Oxley: I'm Not Happy with Sarbox

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Welcome to the Fall 2007 Issue of the High-Growth Government Contractor Newsletter from PVBS

Welcome to the Fall 2007 issue of the High-Growth Government Contractor newsletter from PVBS.

Our customers, typically fast-growing companies that offer services and/or products to the Federal Government, have been asking us for regular communications on the developments with our ERP, project accounting and financial management solutions. Many have asked us to offer insight into the companies we have partnered with that provide products, services, and other business solutions to government contractors.

And everyone wants us to keep them informed on what Microsoft is providing for government contractors on the enterprise systems and financial management side.

In this issue, we'll give you an update on what Microsoft has been creating for government contractors and discuss some of great things that are included in the recent release of Microsoft Dynamics NAV 5. We'll introduce you to one of our key partners, Black Ink, who offers Dynamics NAV for Government Contractors as a hosted service, which our small and emerging customers have been asking for. And we'll update you on PVBS news.

We're also excited to announce that we have added two new sales executives to the PVBS sales team. Jeff Lubbell has been a leading figure in the Dynamics NAV world for some time. We are excited to have him at PVBS. Rob Kaplan recently joined the company from Nortec. Rob knows the challenges government contractors face and looks forward to introducing his new clients to our solution.

Best regards,
Bernard Mustafa
CEO, Pleasant Valley Business Solutions
www.pvbs.net

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Pleasant Valley Business Solutions Partner Articles

PVBS Partner Black Ink Launches Dynamics NAV as a Service for Growing Contractors

The Good, The Bad and The Ugly – Tax issues for Government Contractors
By Melinda L. C. Davis, CPA, Goodman and Company.

If you are wondering why it seems that there have been income tax changes every year for the last several years, the reason is because there have been income tax changes every year for the last several years. Compound these changes with sales tax issues and court cases and you could end up spending your entire day reading to find the issues that relate to you and your company. Meanwhile, business must go on. We have attempted to do some of the sifting for you and have identified three issues that will undoubtedly have an impact on your business.

The Good (or at least more reasonable) - Virginia Sales and Use Taxes – Act II
As previously reported, government contractors are subject to the “true object test” in the determination of sales and use taxes in Virginia. Previously, this test was applied to the original Statement of Work (SOW) of a contract to determine if the contract was for services or tangible personal property. If the original SOW of the contract were determined to be a service contract, then the contractor was deemed to be the ultimate consumer of materials and property and the purchases of these items would be subject to sales and use taxes by the contractor. This finding would also hold for all subsequent changes to the contract, even if a particular change, in and of itself, was clearly for the provision of property to the government. If these taxes were not included in the original bid of a fixed price contract, this would obviously have a negative impact on the contracts gross profit. The negative impact would also carryover to cost-plus or time and materials contracts as well. This occurs because sales to the federal government are generally exempt from all sales and use taxes. Federal contracting personnel may disallow the taxes under this reasoning while Virginia tax auditors require the tax under the true object test.

Effective July 1, 2006, the Virginia Department of Taxation changed its interpretation of the true object test when there are multiple or subsequent task orders (TO), work orders (WO) or SOW’s. This change is effective for TO’s, WO’s or SOW’s entered into on or after July 1, 2006. Under this new interpretation, instead of applying the true object test at the contract level, the Department of Taxation will apply the test to each separate TO, WO, or SOW. This change does not relieve contractors from sales and use tax liability if the true object of an item is the provision of services or with respect to real estate construction projects with government entities. Emergency regulations implementing this change in policy have not yet been issued and are not required until June 30, 2007.

Based on this new interpretation, it would appear that the most advantageous situation can be obtained by the contractor when they carefully negotiate each TO, WO, or SOW. For example, a single order to provide system support, including replacing needed equipment, would likely be held to be a service contact resulting in the equipment purchases being subject to tax. However, if the order were split into two, one to provide services and one to provide the equipment, then the contractor would be in a better position to exempt the equipment purchases from sales and use taxes. Until final regulations are issued, this will continue to be an area of uncertainty.

As indicated earlier, this new interpretation does not relieve the contractor from incurring sales and use taxes on property used in the provision of services. Using the same example as above, while the computers that were replaced under WO 2 could be exempt, the computer used by the contractor to provide the system support would be subject to tax. Also keep in mind that this is only effective after July 1, 2006 and only on contracts with multiple TO’s, DO’s or SOW’s. Any items purchased for orders issued prior to July 1, 2006 would still be subject to the older, more restrictive interpretation.

The Bad – DCAA and state income taxes for pass-through entities.
Under FAR 31.205-41, state income taxes paid or accrued are allowable costs of the contractor. In one court case (Information Sys. & Networks Corp. vs. United States), the Court of Federal Claims sided with the contractor and determined that the shareholders state income taxes associated with the pass-through entity’s income were an allowable cost. This ruling provided a precedent to rely on, and more businesses started including them in the incurred cost submissions. The DCAA appealed the case and in February, 2006, the Court of Appeals reversed the decision and indicated that the lower court had misinterpreted the FAR. This finding is based on the requirement in the FAR that the taxes be paid or accrued in accordance with generally accepted accounting principles (GAAP). Since the state income taxes of the shareholders/members are not required to be paid by the pass-through entity, they would not be recorded as an expense of the pass-through entity under GAAP. Therefore, the Court of Appeals has ruled they are not allowable.

If state income taxes are a significant issue to the owners of a pass-through entity, consideration should be given to tax planning opportunities within the business to minimize this impact. This may also be one more item to consider when starting new entities and deciding on the entity type (c-corporation vs. s-corporation vs. partnership/llc). Lastly, while this case applies to the income tax effect on the shareholder/members, taxes that are required to be paid by the business (i.e. intangible’s, net worth, required minimums) are still allowable.

The Ugly – Federal Withholding requirements under TIPRA
In May of 2006, congress passed and the President signed the Tax Increase Prevention and Reconciliation Act (TIPRA). While certain aspects of this act were discussed in great detail by most media outlets, there was one item in particular that has a direct and possibly significant negative impact on anyone that does business with any type of government (Federal or State) or governmental agency.

Effective for payments made after December 31, 2010, most governmental agencies will be required to withhold 3% of payments to most for profit entities. Those agencies exempt from the withholding requirement include only those political subdivisions of a state or state instrumentalities which make less than $100 million of payments annually. This withholding will not replace wage or other withholdings currently required or allowed (i.e. foreign corporation withholding, unemployment compensation, wages, etc). Nor will this withholding apply to interest, payments for real property, payments for public assistance based on income (i.e. welfare, food stamps, Medicaid) or payments to tax-exempt entities or foreign governments. The withholding agency will have to report the amount of payments made and taxes withheld to the IRS and to the recipient.

While regulations have yet to be drafted, it would appear that even though pass-through entities (i.e. partnerships and S-corporations) generally do not pay taxes, they do not meet the definition of a tax-exempt entity. Therefore, payments to these entities would be subject to the withholding requirement. Whether this withholding would then be reported out to the shareholders/partners on a K-1 or refunded to the companies is unclear.

As stated earlier, this requirement doesn’t take effect until 2011. However, if this requirement stands, it may affect contracts currently in place. For example if a contractor has a five-year contract which started July 1, 2006, this requirement will come into play during the second half of year 4.

To demonstrate the impact of this requirement, let’s assume that Con Co. has a cost plus contract with a 4% fee that is allowed to be paid as items are invoiced. Con Co. prepares an invoice with the following summary totals:

Direct Costs             $50,000
Overhead/G&A          $10,000
                               $60,000

Fee $ 2,400
Total Invoice $62,400

To finance the cost above, Con Co. has an outstanding line of credit which carries an 8% interest rate. This would generate approximately $400 per month of interest. If the terms of this invoice are 60 days, the carrying cost of the invoice would be $60,800 (total cost plus 2 months interest). If this invoice is paid after December 31, 2010, Con Co. will only receive $60,528 ($62,400 – $1,872 (3%)) which is less than the carrying cost of the invoice. This creates a remaining balance on the line of credit that will continue to accrue interest. The end result could have the effect of ever increasing outstanding debt balances incurring unallowable interest costs. While the example above is based on a cost-plus type contract, the end result could be the same or worse for firm-fixed price contracts if gross profit margins are insufficient.

Now is the time to plan for what’s coming. Determining the effect of this requirement on your cash flow can help you determine how to plan for the future. Items to consider analyzing could include gross profit margins, contract mix, government/non-government revenue mix, rate structure, fee percentages, expected interest rates, and borrowing capacity. If you are currently operating on low fee or gross profit jobs, taking steps to increase those fees and gross profits could mean the difference between keeping the doors open for yourself or turning the keys over to your lenders.