Type: Law Bulletins
Date: 08/04/2020

Domestic Preference Requirements for Manufacturers: The Buy American Act and Trade Agreements Act

Indiana has a strong manufacturing sector. The three most significant manufacturing industries are industrial equipment, automotive, and aerospace and defense. As a result, if you are a manufacturer in Indiana, there is a strong chance you manufacture items that are ultimately sold to the federal government.

If you sell items directly to a federal agency ((e.g., the Defense Logistics Agency, Department of Defense (Air Force, Army, Navy, etc.), Department of Transportation, Health & Human Services, etc.)), or if you have a construction contract directly with a federal agency, you are a government prime contractor. If you sell items or materials to a prime contractor who in turn sells them to a federal agency, or if you provide construction services or materals on a federal construction project, you are a government subcontractor/supplier. Domestic preference laws, such as the Buy American Act (BAA), the Trade Agreements Act (TAA), the Berry Amendment, or various federal agency Buy America Acts, apply to many government contracts and subcontracts. This article focuses solely on the compliance requirements of the BAA and TAA.

The BAA and TAA are made applicable to government contracts, subcontracts, or purchase orders through specific Federal Acquisition Regulation (FAR) provisions. Those FAR provisions are 52.225-1, Buy American—Supplies, 52.225-11, Buy American—Construction Materials, 52.225-5, Trade Agreements, or 52.225-11—Buy American Construction Materials under Trade Agreements. Unfortunately, because the wrong provision or conflicting provisions are often included in government prime contracts and subcontracts, you are responsible for determining which applies and how to comply with it.

Although both are domestic preference laws, the application and compliance requirements of the BAA and TAA are different and often confused by companies. To determine whether your company is compliant, you need to know which applies and its specific requirements.

Buy American Act

In general, the BAA applies to contracts with a federal agency that are valued at more than $25,000 and less than the TAA threshold. The current TAA thresholds are $182,000 for supply contracts and $7,008,000 for construction contracts. Although this is an oversimplification, it means the BAA generally applies to supply contracts valued between $25,000 and $182,000, and construction contracts valued between $25,000 and $7,008,000.

The BAA also applies to certain types of federal purchases regardless of the contract value. For example, the BAA always applies to: (1) acquisitions of arms, ammunition, war materials, or purchases indispensable for national security/defense; (2) contracts set aside for small businesses; (3) acquisitions from Federal Prison Industries Inc. or non-profit agencies employing people who are blind or severely disabled; and (4) sole-source contracts.

If the BAA applies, the government must give a preference to “domestic end products” when it purchases supplies and construction materials for use inside the U.S. There are two types of products that will qualify as a “domestic end product.” The first type is a commercially available off-the-shelf (COTS) item that is manufactured in the U.S. An example of this type would be a chair that is manufactured in Indiana and sold at various furniture stores. The second type is an item that is manufactured in the U.S., and which consists of more than 50% U.S. component parts (determined by component costs). According to the FAR, a component is “an article, material, or supply incorporated directly into an end product or construction material.” An example of this type of domestic end product would be an automobile engine that is manufactured in Indiana and which includes components made in China, Mexico, and the U.S. As long as more than 50% of the cost of the components in that engine are mined, produced, or manufactured in the U.S., and the engine is manufactured in the U.S., it is considered a domestic end product.

Here are two more examples: (1) Company A’s product consists of 70% domestic components/materials, but it is manufactured in China. It will not be considered a domestic end product under the BAA because the manufacturing does not take place in the U.S. (2) What if 65% of the cost of Company A‘s product is from its foreign components, but it is manufactured in the U.S.? Even though it is manufactured in the U.S., it is not a domestic end product under the BAA because more than 50% of the cost of its components must be U.S. components. To constitute a domestic end product, it must meet both elements of the two-part test.

Neither the BAA nor the FAR define what it means to “manufacture” a product in the U.S. According to case law, manufactured in the U.S. means the product is made suitable for its intended use in the U.S. and its identity is established by a manufacturing process which occurs in the U.S. Operations performed after an item has been completed (e.g., packaging, testing), mere re-assembly of foreign components, and work that does not alter the form or use of the components may not constitute domestic manufacturing.

As previously noted, the BAA is a domestic preference law. That means the government may purchase a “foreign end product” if it determines the price of the lowest domestic product offer is unreasonable or another exception applies. Before purchasing a foreign end product, government agencies are required to apply a “price penalty” during proposal evaluation. This is done for evaluation purposes only; it allows the government to compare the domestic product to a foreign product on a more equal price footing.

Here’s how it works: civilian agencies add 6% to offers of foreign products (12% if the lowest domestic product offer is from a small business). For example, if Company A offers a domestic product for $25,000 and Company B offers a foreign product for $20,000, a civilian agency would evaluate the foreign product as if it cost $21,200 (a 6% increase), or $22,400 (a 12% increase) if the company offering the foreign product was competing against a U.S. small business. If price were the deciding factor, the foreign item would be awarded the contract because it is cheaper, even with the price penalty. Since the price preference applies for evaluation purposes only, the government would pay the original proposed price of $20,000. And, if a Department of Defense agency is making the purchase, end products and components manufactured in certain qualifying countries qualify as domestic end products and a larger (50%) price penalty is added to foreign products during proposal evaluation.

The BAA restrictions do not apply to products that are not available domestically or to “information technology that is a commercial item.” Therefore, agencies can procure commercial item information technology (e.g., computer software, firmware, etc.) regardless of its domestic content and place of manufacture.

Trade Agreements Act

The TAA prohibits the government from purchasing end products from certain non-designated countries (e.g., China, India), but allows the president to waive domestic sourcing requirements, including the BAA, so the government can purchase products from other “designated countries.” “Designated countries” are those that have trade agreements with the U.S. that require their goods to be treated the same as U.S. domestic products. Thresholds for TAA applicability vary depending on the trade agreement. The most widely applicable trade agreement is the World Trade Organization’s Agreement on Government Procurement (WTO GPA). The current thresholds for the WTO GPA are $182,000 for products/services contracts and $7,008,000 for construction contracts.

So, in general terms, the TAA applies under three circumstances: (1) the procurement is valued at more than $182,000 for products/services or more than $7,008,000 for construction; (2) the procurement involves goods or construction materials listed in the relevant trade agreement; and (3) none of the other exceptions outlined in the trade agreements apply (e.g., the procurement is set aside for small business concerns or is being conducted as a sole source procurement).

The TAA requires the product to be either (1) wholly grown, produced, or manufactured in the U.S. or a “designated country,” or (2) “substantially transformed” in the U.S. or a “designated country.” The TAA’s substantial transformation requirement is different from the BAA’s manufacturing requirement. A product is “substantially transformed” when a fundamental change in its form, nature, or character occurs—when it has been transformed into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was transformed. Substantial transformation is more likely to be found when an assembly operation involves considerable time, skill, and attention to detail; stringent quality control; sophisticated equipment and facilities; and technically skilled employees. The TAA’s substantial transformation test is focused on where (i.e., in which country) the product took on its essential character and form — where it became capable of functioning or was sufficiently functional to be tested for its ultimate purpose. For example, Company A sells desks to the Department of Energy. It orders the legs and drawers from a company in the U.S., and the rest of the desk’s parts from China. All of the desk’s parts are delivered to Company A’s facility in Mexico where they are assembled into the desk, the desktop is treated with a special coating, and the desk undergoes various quality control and testing procedures. Since the various parts were substantially transformed into a new article of commerce (the desk), in Mexico (a designated country), the desks are TAA compliant.

FAR 52.225-5 lists all of the “designated countries” for purposes of the TAA. The countries include those that are signatories to the WTO GPA, have a free trade agreement with the U.S., or that have been identified as a “least developed country” or “Caribbean Basin country.” If it is a Department of Defense procurement, the list of designated countries is even longer because it also includes those that have been identified as “qualifying countries.”

Unlike the BAA, the country of origin of the components is largely irrelevant under the TAA. A product can be compliant with the TAA even if 100% of its components are foreign components, as long as the components are substantially transformed in the U.S. or a designated country. For example, Company A’s product consists of 80% Chinese components/materials. Those components/materials are substantially transformed into the end product in Mexico. The end product is TAA compliant because the components are substantially transformed in Mexico, which is a designated country.

Failure to comply with the domestic preference requirements can be costly for both prime contractors and subcontractors. If your company has certified that its products are BAA or TAA compliant and they aren’t, the company can be sued for fraud or for making a false claim, both of which carry significant monetary fines and penalties as well as possible jail time. The company can also be suspended or debarred from doing business with the federal government. So, if your prime contract, subcontract, or purchase order requires compliance with the BAA or TAA, make sure you are compliant. Failing to do so isn’t worth the risk.

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