The Small Business Administration (“SBA”) must use a concern’s tax returns when making a size determination, unless the returns are not available. Since many size standards are based on the receipts of the company, the SBA regulation on this is important. A recent case issued by the SBA Office of Hearings and Appeals (“OHA”) case demonstrated the importance of using tax returns. Colossal Contracting, LLC, SBA No. SIZ-6285, May 17, 2024. But first, the relevant SBA regulation on receipts:
(a) Receipts means all revenue in whatever form received or accrued from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances. Generally, receipts are considered “total income” (or in the case of a sole proprietorship “gross income”) plus “cost of goods sold” as these terms are defined and reported on Internal Revenue Service (IRS) tax return forms (such as Form 1120 for corporations; Form 1120S for S corporations; Form 1120, Form 1065 or Form 1040 for LLCs; Form 1065 for partnerships; Form 1040, Schedule F for farms; Form 1040, Schedule C for other sole proprietorships). Receipts do not include net capital gains or losses; taxes collected for and remitted to a taxing authority if included in gross or total income, such as sales or other taxes collected from customers and excluding taxes levied on the concern or its employees; 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. For size determination purposes, the only exclusions from receipts are those specifically provided for in this paragraph. All other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from receipts.
(1) The 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 a concern. SBA will not use tax returns or amendments filed with the IRS after the initiation of a size determination.
(2) When a concern has not filed a Federal income tax return with the IRS for a fiscal year which must be included in the period of measurement, 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.
13 CFR § 121.104 How does SBA calculate annual receipts? (Emphasis added).
The SBA Area office in January 2024. held that Colossal was not a small business under a $34 million size standard, and the company appealed to OHA. Colossal was a value-added reseller of Information Technology (“IT”) equipment. Colossal’s financial statements recognized only the commission or the difference between sales price and the product purchase price as its revenue (receipts). As a result, the company does not report the full cost of goods sold for its value added revenue on its tax returns. Colossal’s accountant asserted that it is common practice for value-added resellers to calculate net revenue by disregarding the cost of goods sold. It is only by using the total cost of goods sold (instead of net revenue) that Colossal’s revenues exceeded the $34 million size standards.
In making its size determination, the SBA Area office cited to a U.S. District Court case on false claims, which stated which stated that tax returns could not be used to skirt the clear guidance in the regulations, which include all receipts “with only exclusions from receipts specifically listed” in the size reglations. United States ex rel. Bid Solve, Inc. v. CWS Mktg Grp, Inc. 678 F. Supp. 3d 53, 50-60 (DDC May 18, 2023). When OHA contacted the appropriate SBA officials for their Comments before issuing this case, the SBA stated that the tax returns do not contain all the information required by the size regulations, and in that case, SBA will consider other financial information when making its size determination—which the SBA Area Office did consider. The SBA supported its Area Office.
Colossal noted that SBA has repeatedly interpreted § 121.104(a) to mean that if tax returns are available for the relevant years, such returns must be used to calculate a concern’s receipts, to the exclusion of any extrinsic financial information.
OHA noted that in 1996, § 121.204 was changed to state that:
Use of information other than the Federal Tax return. Where other information gives SBA reason to regard Federal Income Tax returns as false, SBA may base its size determination on such other information.
However in 2004, this provision was rescinded, and replaced by the cited provision in this blog above which indicates that information other than tax returns may be used only when tax returns are unavailable.
OHA concluded that the because the plain language of 13 CFR § 121.204(a) and the relevant regulatory history so indicated, the Area Office of SBA errored by utilizing information beyond Colossal’s tax returns to determine receipts. The Federal income tax returns must be used to determine a concern’s size, and other external information may be used only where there is no filed income tax return.
Takeaway: In determining size, do not use information beyond a company’s tax returns to determine receipts. The Federal income tax returns must be used to determine a concern’s size, and other external information may be used only where there is no filed income tax return.