Small Business Size Regulations; 8(a) Business Development/Small Disadvantaged Business Status Determinations, 8222-8264 [2011-2581]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 76, Number 29 (Friday, February 11, 2011)]
[Rules and Regulations]
[Pages 8222-8264]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-2581]



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Vol. 76

Friday,

No. 29

February 11, 2011

Part VII





Small Business Administration





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13 CFR Parts 121 and 124



Small Business Size Regulations; 8(a) Business Development/Small 
Disadvantaged Business Status Determinations; Final Rule

Federal Register / Vol. 76 , No. 29 / Friday, February 11, 2011 / 
Rules and Regulations

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SMALL BUSINESS ADMINISTRATION

13 CFR Parts 121 and 124

RIN 3245-AF53


Small Business Size Regulations; 8(a) Business Development/Small 
Disadvantaged Business Status Determinations

AGENCY: U.S. Small Business Administration.

ACTION: Final rule.

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SUMMARY: This rule makes changes to the regulations governing the 
section 8(a) Business Development (8(a) BD) program, the U.S. Small 
Business Administration's (SBA or Agency) size regulations, and the 
regulations affecting Small Disadvantaged Businesses (SDBs). It is the 
first comprehensive revision to the 8(a) BD program in more than ten 
years. Some of the changes involve technical issues such as changing 
the term ``SIC code'' to ``NAICS code'' to reflect the national 
conversion to the North American Industry Classification System 
(NAICS).

DATES: Effective Date: This rule is effective March 14, 2011.
    Compliance Dates: Except for 13 CFR 124.604, the revisions to 13 
CFR part 124 apply to all applications for the 8(a) BD program pending 
as of March 14, 2011 and all 8(a) procurement requirements accepted by 
SBA on or after March 14, 2011. These rules do not apply to any 8(a) BD 
appeals pending before SBA's Office of Hearings and Appeals. The 
requirements of Sec.  124.604 apply to all 8(a) BD program participants 
as of September 9, 2011, unless SBA further delays implementation 
through a Notice in the Federal Register. The amendments to 13 CFR part 
121 apply with respect to all solicitations issued and all 
certifications as to size made after March 14, 2011.

FOR FURTHER INFORMATION CONTACT: LeAnn Delaney, Deputy Associate 
Administrator, Office of Business Development, at (202) 205-5852, or 
leann.delaney@sba.gov.

SUPPLEMENTARY INFORMATION: On October 28, 2009, SBA published in the 
Federal Register a comprehensive proposal to revise the 8(a) BD program 
and several proposed revisions to SBA's size regulations. 74 FR 55694. 
Some of the proposed changes involve technical issues. Others are more 
substantive and result from SBA's experience in implementing the 
current regulations. In addition, SBA has made changes in this final 
rule in response to comments received to its notice of proposed 
rulemaking. SBA has learned through experience that certain of its 
rules governing the 8(a) BD program are too restrictive and serve to 
unduly preclude firms from being admitted to the program. In other 
cases, SBA determined that a rule is too expansive or indefinite and 
sought to restrict or clarify those rules. In one case, SBA made 
wording changes to correct past public or agency misinterpretation. 
Additionally, this rule makes changes to address situations that were 
not contemplated when the previous revisions to the 8(a) BD program 
were made. The proposed rule called for a 60-day comment period, with 
comments required to be received by SBA by December 28, 2009. The 
overriding comment SBA received in the first few weeks after the 
publication was to extend the comment period. Commenters felt that the 
nature of the issues raised in the rule and the timing of comments 
during the holiday season required more time for affected businesses to 
adequately review the proposal and prepare their comments. In response 
to these comments, SBA published a notice in the Federal Register on 
December 9, 2009, extending the comment period an additional 30 days to 
January 28, 2010. 74 FR 65040. In addition to providing a 90-day 
comment period, SBA also solicited the public's views regarding the 
proposal through a series of listening sessions held throughout the 
country. SBA held listening sessions in Washington, DC on December 10 
and 11, 2009; in New York, New York on December 16, 2009; in Seattle, 
Washington on December 17, 2009; in Boston, Massachusetts on December 
18, 2009; in Dallas, Texas on January 11, 2010; in Atlanta, Georgia on 
January 12, 2010; in Albuquerque, New Mexico and Miami, Florida on 
January 14, 2010; and in Chicago, Illinois and Los Angeles, California 
on January 19, 2010.
    Additionally, SBA conducted Tribal consultations pursuant to 
Executive Order 13175, Tribal Consultations, on December 16, 2009 in 
Seattle, Washington; on January 14, 2010 in Albuquerque, New Mexico; 
and on January 27, 2010 for Anchorage, Alaska in Vienna, Virginia via a 
video teleconference with representatives located in Anchorage, Alaska.
    In addition to the many comments received from those testifying at 
the various public forums and Tribal consultations conducted around the 
country, SBA received 231 timely written comments during the 90-day 
comment period, with a high percentage of commenters favoring the 
proposed changes. A substantial number of commenters applauded SBA's 
effort to clarify and address misinterpretations of the rules. For the 
most part, the comments supported the substantive changes proposed by 
SBA. Additionally, in response to specific requests for information, 
SBA received comments with alternative approaches on many aspects of 
the proposed rule.
    The proposed rule contained changes to SBA's size regulations (part 
121) and the regulations governing SBA's 8(a) BD program (part 124). 
SBA received substantive comments on the proposed changes to both of 
these program areas. With the exception of comments which did not set 
forth any rationale or make suggestions, SBA discusses and responds 
fully to all the comments below.

Summary of Comments and SBA's Responses

Part 121

    SBA received a substantial number of comments addressing the 
proposed changes to the size rules.

Production Pools

    In response to the proposed changes on affiliation, one commenter 
noted that Sec.  121.103(b) was not entirely consistent with the 
statutory authority regarding exclusions from affiliation for certain 
types of small business pools. Specifically, section 9(d) of the Small 
Business Act (the Act), 15 U.S.C. 638(d), authorizes an exclusion from 
affiliation for research and development pools. Similarly, section 11 
of the Act, 15 U.S.C. 640, authorizes an exclusion from affiliation for 
defense production pools. SBA's current regulation set forth in Sec.  
121.103(b)(3) inadvertently omitted the reference to defense production 
pools. It was never SBA's intent to exclude defense production pools 
from the exception to affiliation. The words ``or for defense 
production'' were inadvertently omitted from Sec.  121.102(b)(3) after 
the words ``joint program of research and development.'' Accordingly, 
this final rule corrects this omission.

Exception to Affiliation for Mentor/Prot[eacute]g[eacute] Programs

    The proposed rule intended to clarify when SBA would consider a 
prot[eacute]g[eacute] firm not to be affiliated with its mentor based 
on assistance received from the mentor through a mentor/
prot[eacute]g[eacute] agreement. In practice, the former regulation was 
at times misconstrued by other Federal agencies that believed they 
could establish mentor/prot[eacute]g[eacute] programs and exempt 
prot[eacute]g[eacute]s from SBA's size affiliation rules on their own. 
That was never SBA's intent. The

[[Page 8223]]

exception to affiliation contained in Sec.  121.103(b)(6) is meant to 
apply to SBA's 8(a) BD mentor/prot[eacute]g[eacute] program and other 
Federal mentor/prot[eacute]g[eacute] programs that specifically 
authorize an exception to affiliation in their authorizing statute. 
Because of the business development purposes of the 8(a) BD program, 
SBA administratively established an exception to affiliation for 
prot[eacute]g[eacute] firms. Specifically, prot[eacute]g[eacute] firms 
are not affiliated with their mentors based on assistance received from 
their mentors through an SBA-approved 8(a) BD mentor/
prot[eacute]g[eacute] agreement. That exception exists in the current 
rule and remained in the rule as proposed. The proposed rule also 
clarified that an exception to affiliation for prot[eacute]g[eacute]s 
in other Federal mentor/prot[eacute]g[eacute] programs will be 
recognized by SBA only where specifically authorized by statute (e.g., 
the Department of Defense mentor/prot[eacute]g[eacute] program) or 
where SBA has authorized an exception to affiliation for a mentor/
prot[eacute]g[eacute] program of another Federal agency under the 
procedures set forth in Sec.  121.903. The Supplementary Information to 
the proposed rule noted that SBA did not anticipate approving 
exceptions to affiliation to agencies seeking to have such an exception 
for their mentor/prot[eacute]g[eacute] programs except in limited 
circumstances. SBA reasoned that the 8(a) BD program is a unique 
business development program that is unlike other Federal programs.
    SBA received a number of comments in response to this proposal. 
Several comments supported the current requirement, that was not 
amended in the proposed rule, that SBA would not find affiliation 
between a prot[eacute]g[eacute] firm and its mentor based solely on the 
assistance received under a mentor/prot[eacute]g[eacute] agreement. SBA 
does not change that provision in this final rule.
    SBA received comments both in support and of and in opposition to 
the clarification contained in the proposed rule that other agencies 
could create mentor/prot[eacute]g[eacute] programs containing an 
exclusion to affiliation only where authorized by statute or by SBA 
after requesting such an exception under Sec.  121.903 of SBA's size 
regulations. Those supporting the proposal recognized that were 
agencies able to waive SBA's affiliation rules whenever they thought it 
to be appropriate (i.e., without requesting or receiving approval from 
SBA), legitimate small businesses could be adversely affected. Several 
commenters stated that other agencies should be able to construct 
mentor/prot[eacute]g[eacute] programs for their purposes as they see 
fit. Specifically, these commenters believed that if another agency 
wanted to allow an exclusion from affiliation for a joint venture 
between a prot[eacute]g[eacute] firm and its mentor for a program of 
that other agency, the agency should be able to do so. By statute, SBA 
is the agency authorized to determine size, specifically including 
whether a firm qualifies as a small business for any Federal program. 
See 15 U.S.C. 632(a). In particular, the Act specifies that ``[u]nless 
authorized by statute, no Federal department or agency may prescribe a 
size standard for categorizing a business concern as a small business 
concern, unless such proposed size standard * * * is [among other 
things] approved by the [SBA] Administrator.'' 15 U.S.C. 632(a)(2)(C). 
SBA firmly believes that another agency should not be able to exempt 
firms from SBA's affiliation rules (and in effect make program-specific 
size rules) without SBA's approval. SBA's regulations set forth a 
formal process that a Federal department or agency must follow in order 
to request, and possibly receive SBA's approval, to deviate from SBA's 
size rules, including those relating to affiliation. See 13 CFR 
121.903.
    The 8(a) BD program is a unique Federal program. It is not a 
contracting program, but rather a business development program. The 
program is designed to assist in the business development of 
disadvantaged small businesses through management and technical 
assistance, contractual assistance, and other means. Requiring mentors 
to provide business development assistance to prot[eacute]g[eacute] 
firms in order for a mentor/prot[eacute]g[eacute] relationship to 
receive an exclusion from affiliation is merely one tool to assist in 
the business development of 8(a) firms. SBA's size regulations 
generally aggregate the receipts/employees of joint venture partners 
for size purposes, and SBA believes that is the correct approach since 
the combined resources of the partners are available to the joint 
venture. The exclusion to affiliation for mentor/prot[eacute]g[eacute] 
relationships approved for the 8(a) BD program is designed to encourage 
the business development purposes of the 8(a) BD program. Where a 
mentor/prot[eacute]g[eacute] program of another agency is also intended 
to promote the business development of specified small business 
concerns, SBA would be inclined to approve the agency's request for an 
exclusion from affiliation because it would serve the same purpose as 
the exclusion from affiliation for 8(a) mentor/prot[eacute]g[eacute] 
relationships. As such, the final rule continues to allow exclusions 
from affiliation for mentor/prot[eacute]g[eacute] relationships of 
other agencies only where specifically authorized by statute or where 
the agency asks for and SBA grants such an exclusion.

Joint Ventures

    The proposed rule also amended the size rules pertaining to joint 
ventures. Under current Sec.  121.103(h), a joint venture is an entity 
with limited duration. Specifically, the current regulation limits a 
specific joint venture to submitting no more than three offers over a 
two-year period. The proposed rule changed this requirement to allow a 
specific joint venture to be awarded three contracts over a two-year 
period. It also clarified that the partners to a joint venture could 
form a second joint venture and be awarded three additional contracts, 
and a third joint venture to be awarded three more. At some point, 
however, such a longstanding relationship or contractual dependence 
could lead to a finding of general affiliation, even in the 8(a) 
mentor/prot[eacute]g[eacute] joint venture context. The proposed rule 
also asked for comments on other alternatives, including limiting the 
number of contract awards that the same partners to one or more joint 
ventures could receive without the partners being deemed affiliates for 
all purposes.
    Many commenters supported the proposed change from three offers 
over two years to three contract awards over two years, noting that 
this change would provide more certainty to offerors. One commenter 
asked for more clarity regarding what constitutes a contract. That 
commenter was concerned that a contract could be awarded and then 
ultimately not performed due to a protest or otherwise and that such an 
award would still count against the three contract award limit for that 
joint venture. SBA does not see this as a significant problem. As 
previously noted, two partners could form an additional joint venture 
entity and that new entity could be awarded three additional contracts. 
The fact that one of the three contracts awarded to the first joint 
venture entity was not performed in no way inhibits the ability of the 
two firms from forming a new joint venture and receiving additional 
contracts. As such, SBA does not adopt the comment that recommended the 
word contract to mean only a contract that was kept and performed by 
the joint venture.
    The majority of comments received also preferred limiting one joint 
venture to three contract awards (and allowing the firms to form 
additional joint venture entities for additional contract awards) 
rather than limiting the overall

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number of contracts that two (or more) firms acting as a joint venture 
could receive. Several commenters contended that they often go after 
and are awarded many small dollar projects through joint venture 
relationships. Even though the combined value of the contracts awarded 
could be very small, the alternative option, which would prohibit no 
more than five total awards to two firms acting through a joint 
venture, would prohibit them from seeking and being awarded additional 
contracts. They felt that such a prohibition would adversely affect 
their overall business development. Other commenters observed that 
limiting the total number of contract awards to a specific number 
(e.g., five) would make mentor/prot[eacute]g[eacute] relationships 
short term, which would encourage less business development assistance 
to prot[eacute]g[eacute] firms in the long term. SBA concurs with these 
comments and does not adopt this alternative in this final rule.
    The proposed rule also clarified when SBA will determine whether 
the three contract awards in two years requirement has been met. The 
proposal set the time at which compliance with the three awards in two 
years rule should be determined as of the date a concern submits a 
written self-certification that it is small as part of its initial 
offer including price. This point in time coincides with the time at 
which size is determined and SBA believed that consistency dictated 
this approach. Commenters supported this approach, particularly 
favoring allowing joint venture offerors the flexibility to ultimately 
be awarded more than three contracts if they had not yet received three 
awards as of the date they submitted several offers and happened to win 
more than one of the awards pertaining to those offers. A few 
commenters specifically supported the example contained in the 
supplementary information to the proposed rule and suggested that it be 
included in the actual regulatory text. SBA sees no reason not to 
include the example in the regulation if that will help further clarify 
SBA's intent. As such, SBA has added the example to the regulatory text 
for Sec.  121.103(h) in this final rule.
    The proposed rule also clarified that while a joint venture may or 
may not be a separate legal entity (e.g., a limited liability company 
(LLC)), it must exist through a written document. Thus, even an 
``informal'' joint venture must have a written agreement between the 
partners. In addition, the rule clarified SBA's longstanding policy 
that a joint venture may or may not be populated (i.e., have its own 
separate employees). The supplementary information to the proposed rule 
indicated that whether a joint venture needs to be populated or have 
separate employees would depend upon the legal structure of the joint 
venture. If a joint venture is a separate legal entity, SBA thought 
that it must have its own employees. If a joint venture merely exists 
through a written agreement between two or more individual business 
entities, then SBA felt that it need not have its own separate 
employees and employees of each of the individual business entities may 
perform work for the joint venture. SBA received several comments on 
this interpretative language. A few commenters asked SBA to clearly 
delineate what ``populated'' means in the regulatory text. The final 
rule adopts this comment and has identified that a populated joint 
venture is joint venture formed as a separate legal entity that has its 
own separate employees.
    The majority of comments on the provision addressing the population 
of joint ventures believed that any regulation that required a 
populated joint venture would unintentionally deprive joint venture 
partners of the opportunity to structure joint ventures as LLCs because 
of the requirements contained in other regulatory provisions. For 
example, in an 8(a) joint venture, Sec.  124.513(c)(2) requires an 
employee of the 8(a) Participant to be the project manager. If an LLC 
was populated, so that it hired its own employees to perform an 8(a) 
contract, the project manager hired by the LLC to oversee the project 
(even if he/she came from the 8(a) Participant) would not be an 
employee of the 8(a) Participant. Similarly, Sec.  124.513(d) requires 
the 8(a) Participant to a joint venture to perform a specific 
percentage of work (``a significant portion'' in the regulations prior 
to this final rule, and at least 40% of the work done by the joint 
venture in this final rule). If an LLC is populated, the LLC is 
performing the work; the work is not being performed individually by 
the two (or more) partners to the joint venture. SBA understands these 
concerns and has made several changes in this final rule in response to 
them. SBA believes that the individual businesses involved in the joint 
venture should determine whether to form a separate legal entity for 
the joint venture (e.g., LLC) and, if they do, whether or not to 
populate the new entity. SBA will not require any joint venture to be 
populated, and will not find a joint venture ineligible merely because 
it is or is not populated. In addition, SBA believes clarifications 
need to be made in the substantive 8(a) rules between populated and 
unpopulated joint ventures. The requirement contained in Sec.  
124.513(d) that an 8(a) Participant must perform at least 40% of the 
work done by a joint venture, and the requirement contained in Sec.  
124.513(c)(2) that the project manager be an employee of the 8(a) 
Participant, make sense only for unpopulated joint ventures or joint 
ventures populated only with administrative personnel. For joint 
ventures populated with individuals intended to perform any awarded 
contracts, the joint venture must demonstrate that the 8(a) Participant 
to the joint venture controls the joint venture, is responsible for the 
books and records of the joint venture, owns at least 50% of the joint 
venture, and receives profits commensurate with its ownership interest. 
SBA has made these clarifications in Sec.  124.513 of the final rule. A 
detailed description of these changes is included below in the 
discussion of the comments on Part 124.
    A few commenters questioned SBA's application of the ostensible 
subcontractor rule in Sec.  121.103(h)(4). Specifically, they sought 
clarification as to whether SBA applied the ostensible subcontractor 
rule only at the time of size certification (as part of the firm's 
offer for a particular contract) or if it also applied after contract 
performance. SBA believes that it would not make sense to allow a firm 
to submit an offer proposing how it will perform a contract in which it 
will perform the primary and vital portions of a contract, and thus 
qualify individually as a small business, and then subcontract out the 
entire contract after award and have the contract count as an award to 
small business. SBA believes that if options are exercised on such a 
contract, the options should not count as a small business award if the 
aggregate size of the contractor and its ostensible subcontractor 
exceeds the applicable size standard. The final rule adds clarifying 
language to a new Sec.  121.404(g)(4).

Exclusion From Affiliation for Mentor/Prot[eacute]g[eacute] Joint 
Ventures

    The proposed rule also attempted to clarify that any joint venture 
seeking to use the 8(a) mentor/prot[eacute]g[eacute] status as a basis 
for an exception to affiliation requirements must follow the 8(a) 
requirements (i.e., it must meet the content requirements set forth in 
Sec.  124.513(c) and the performance of work requirements set forth in 
Sec.  124.513(d)). Although SBA does not approve joint venture 
agreements for procurements outside the 8(a) program, if the size of a 
joint venture claiming an

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exception to affiliation is protested, the requirements of Sec.  
124.513(c) and (d) must be met in order for the exception to 
affiliation to apply. For purposes of clarification Sec.  124.513(d) 
references the percentage of work requirements of Sec.  124.510 which 
include the percentage of work requirements set forth in Sec.  125.6.
    In connection with a size protest, one commenter opposed requiring 
the 8(a) joint venture rules to be met in order for a mentor/
prot[eacute]g[eacute] joint venture to receive an exclusion from 
affiliation for a non-8(a) contract. This commenter did not believe it 
was appropriate to apply 8(a) rules to non-8(a) contracts, thinking 
that such a requirement would impose an undue burden on 8(a) firms 
seeking non-8(a) contracts. SBA disagrees. Receiving an exclusion from 
affiliation for any non-8(a) contract is a substantial benefit that 
only SBA-approved mentor/prot[eacute]g[eacute] relationships can 
receive. The intent behind the exclusion generally is to promote 
business development assistance to prot[eacute]g[eacute] firms from 
their mentors. Without a requirement that a prot[eacute]g[eacute] firm 
must be the project manager and take an active and substantial role in 
contract performance on a non-8(a) joint venture with its mentor, the 
entire small business contract could otherwise be performed by an 
otherwise large business.
    Overall, however, SBA received many favorable comments to this 
proposed change. Commenters noted that without such a clarification, a 
joint venture between an 8(a) prot[eacute]g[eacute] firm and its large 
business mentor on a non-8(a) small business contract could perform the 
contract with minimal work being performed by the prot[eacute]g[eacute] 
8(a) firm. The commenters believed such a scenario was inappropriate. 
SBA agrees. SBA recognized this potential abuse of small business 
contracting programs and has not changed the requirement in this final 
rule that a mentor/prot[eacute]g[eacute] joint venture seeking an 
exception to affiliation on a non-8(a) contract must follow the 8(a) 
requirements regarding control and performance by the 8(a) 
prot[eacute]g[eacute] firm.
    SBA also requested comments on whether to continue to allow the 
exclusion to affiliation for mentor/prot[eacute]g[eacute] joint 
ventures on non-8(a) contracts, or whether the exclusion to affiliation 
should apply only to 8(a) contracts. Related to this inquiry was the 
proposed change that would allow the exclusion to apply not just to 
Federal prime contracts, but to subcontracts as well. This change was 
particularly important to the Department of Energy, which has a 
significant amount of contracting activity go through government owned 
contractor operated (GOCO) facilities, and the contracts between the 
GOCO and a contractor technically are government subcontracts. The 
overwhelming majority of comments supported permitting the exclusion to 
affiliation for both 8(a) and non-8(a) contracts. They believed that 
performing non-8(a) contracts is just as or more important in a firm's 
business development than performing 8(a) contracts. They noted that 
understanding and being able to perform non-8(a) government contracts 
is critical to a firm's ultimate survival and success after leaving the 
8(a) BD program, and getting that experience through a mentor/
prot[eacute]g[eacute] relationship while still in the 8(a) BD program 
is essential. In addition, the majority of commenters supported the 
proposed change applying the exclusion to affiliation to both 
government subcontracts as well as prime contracts. They viewed this 
extension as further assisting 8(a) Participants realize the business 
development purposes of the 8(a) BD program. As such, this final rule 
continues to allow the exclusion to affiliation for mentor/
prot[eacute]g[eacute] joint ventures for all government prime contracts 
and subcontracts.

Classification of a Procurement for Supplies

    SBA's regulations provide that acquisitions for supplies must be 
classified under the appropriate manufacturing NAICS code, not under a 
wholesale trade NAICS code. The proposed rule amended the size 
regulations to clarify that a procurement for supplies also cannot be 
classified under a retail trade NAICS code. SBA received seven comments 
supporting and three comments opposing this proposed change. SBA 
continues to believe that procurements for supplies should be 
classified under the appropriate manufacturing or other supply NAICS 
code. The retail trade NAICS code is appropriate for financial 
assistance (e.g., loans), but not for the procurement of specified 
supply items. As such, SBA does not change this provision in the final 
rule.

Application of the Nonmanufacturer Rule

    The proposed rule also attempted to provide further guidance to the 
current nonmanufacturer rule (i.e., the rule that requires, in 
pertinent part, a firm that is not itself the manufacturer of the end 
item being procured to provide the product of a small business 
manufacturer). The proposed rule explicitly provided that the 
nonmanufacturer rule applies only where the procuring agency has 
classified a procurement as a manufacturing procurement by assigning 
the procurement a NAICS code under Sectors 31-33.
    In addition, the proposed rule clarified that the nonmanufacturer 
rule applies only to the manufacturing or supply component of a 
manufacturing procurement. Where a procuring agency has classified a 
procurement as a manufacturing procurement and is also acquiring 
services, the nonmanufacturer rule would apply to the supply component 
of that procurement only. In other words, a firm seeking to qualify as 
a small business nonmanufacturer must supply the product of a small 
business manufacturer (unless a nonmanufacturer waiver applies), but 
need not perform any specific portion of the accompanying services. 
Since the procurement is classified under a manufacturing NAICS code, 
it cannot also be considered a services procurement and, thus, the 50% 
performance of work requirement set forth in Sec.  125.6 for services 
does not apply to that procurement. In classifying the procurement as a 
manufacturing/supply procurement, the procuring agency must have 
determined that the ``principal nature'' of the procurement was 
supplies. As a result, any work done by a subcontractor on the services 
portion of the contract cannot rise to the level of being ``primary and 
vital'' requirements of the procurement, and therefore cannot be the 
basis or affiliation as an ostensible subcontractor. Conversely, if a 
procuring agency determines that the ``principal nature'' of the 
procurement is services, only the requirements relating to services 
contracts apply. The nonmanufacturer rule, which applies only to 
manufacturing/supply contracts, would not apply. Thus, although a firm 
seeking to qualify as a small business with respect to such a contract 
must certify that it will perform at least 50% of the cost of the 
contract incurred for personnel with its own employees, it need not 
supply the product of a small business manufacturer on the supply 
component of the contract.
    In order to qualify as a nonmanufacturer, a firm must be primarily 
engaged in the retail or wholesale trade and normally sell the type of 
item being supplied. The proposed rule further defined this statutory 
requirement to mean that the firm takes ownership or possession of the 
item(s) with its personnel, equipment or facilities in a manner 
consistent with industry practice. This change is primarily in response 
to

[[Page 8226]]

situations where SBA has waived the nonmanufacturer rule and the prime 
contractor essentially subcontracts all services, such as warehousing 
or delivery, to a large business. Such an arrangement, where the prime 
contractor can legally provide the product of a large business and then 
subcontract all tangential services to a large business, is contrary to 
the intent and purpose of the Small Business Act, i.e., providing small 
businesses with an opportunity to perform prime contracts. Such an 
arrangement inflates the cost to the Government of contract performance 
and inflates the statistics for prime contracting dollars awarded to 
small business, which is detrimental to other small businesses that are 
willing and able to perform Government contracts.
    In response to the proposed changes to the nonmanufacturer rule, 12 
commenters addressed the proposal to require a nonmanufacturer to take 
possession of the items with its own facilities, equipment or personnel 
in a manner consistent with industry practice. Eight commenters 
supported the change, while four opposed it. Those in opposition 
believed that the change would limit opportunities for small 
businesses. Two commenters also stated that taking possession of supply 
items is not consistent with industry practices. Those supporting the 
change believed that it was a reasonable requirement to ensure that 
small business nonmanufacturers were providing some value to the 
procurement other than their status as small or small 8(a) businesses. 
These commenters particularly thought that the proposal made sense in 
the scenario outlined in the supplementary information for the proposed 
rule, where there are no small business manufacturers available for the 
contract (and either a class or individual waiver to the 
nonmanufacturer rule is granted). In such a case, small business 
participation is minimal, yet the entire value of the contract is 
counted as an award to small business for goaling purposes. In response 
to these comments, SBA first notes that the proposed rule did not 
require a small business nonmanufacturer to take possession of the 
supply items in every case. It required that the nonmanufacturer take 
ownership or possession. If the nonmanufacturer arranged for 
transportation of the supply items (e.g., it uses trucks it owns or 
leases to transport the items to the final destination), then it need 
not take ownership of the supply items. If it does not arrange for the 
transportation, then it must at least take ownership of the supply 
items. SBA recognizes the validity of small business dealers and does 
not seek to harm legitimate small business dealers. SBA continues to 
believe, however, that the ownership or possession requirement provides 
a necessary safeguard to abuse. A multi-million dollar supply contract 
in which a large business manufacturer provides the supply items 
directly to the Government procuring agency and the small business 
nonmanufacturer provides nothing more than its status as a small 
business does not foster small business development. As such, this 
provision is not changed in the final rule.
    One commenter disagreed with the proposal to limit application of 
the nonmanufacturer rule to acquisitions that have been classified with 
a manufacturing NAICS code. The commenter argued that some supply 
contracts cannot be classified as manufacturing. We agree. Thus, we 
have removed this requirement from the final rule. The commenter 
further argued that SBA should allow procuring agencies to assign 
wholesale NAICS codes to procurements because not all supply contracts 
can be classified under a manufacturing or supply NAICS code. We 
disagree. First, the Small Business Act and SBA's regulation do not 
contain performance requirements applicable to wholesale or retail 
contracts. Thus, wholesale and retail NAICS codes cannot be used for 
government procurement purposes. The wholesale and retail trade NAICS 
codes are for purposes of SBA financial assistance only. Second, a 
contracting officer should assign the NAICS code to a procurement which 
best describes the principal purpose of the acquisition. While some 
procurements call for the provision of supplies and services, a 
procurement should be classified as one or the other, and cannot be 
classified as both. The classification dictates what an offeror must 
perform in order to qualify as a small business concern for a small set 
aside procurement. These limitations on subcontracting performance 
requirements vary depending on whether the contract is classified as a 
service, supply, construction or specialty trade construction 
procurement. If a contract is classified as a service contract, then 
only the requirements pertaining to service contracts apply. There is 
no requirement that the ultimate contractor meet any performance of 
work requirements relating to the manufacture of products, which may be 
ancillary to the services contract. The relevant consideration is the 
cost of the contract incurred for personnel. If a contract is 
classified as a supply contract, then only the requirements pertaining 
to supply contracts apply. The concern must either be the manufacturer 
of the items being procured or be a dealer that supplies the products 
of a small business manufacturer (unless a waiver to the 
nonmanufacturer rule applies), and there is no requirement that the 
concern provide any ancillary services. The relevant consideration is 
the cost of manufacturing the supplies or products. In the acquisition 
described by the commenter, for the delivery of fruits and vegetables, 
if a manufacturing or supply NAICS code is not appropriate then the 
procurement should be classified under a warehousing or delivery 
service NAICS code. In response to this comment, the final rule also 
clarifies that a waiver of the nonmanufacturer rule does not waive the 
requirement that a nonmanufacturer not exceed the 500 employee size 
standard or the requirement that the nonmanufacturer must take 
ownership or possession of the items with its personnel, equipment or 
facilities. A waiver of the nonmanufacturer rule only applies to the 
requirement that a nonmanufacturer supply a product of a small business 
concern made in the United States.
    Finally, one commenter recommended that Sec.  121.406 specifically 
reference the service disabled veteran-owned (SDVO) program as a 
program to which the nonmanufacturer rule applies. Section 125.15(c) 
currently states that the nonmanufacturer rule applies to SDVO 
requirements for supplies. Thus, although it is not necessary to also 
add that requirement to Sec.  121.406 of the size regulations, this 
final rule has done so in order to provide more clarity regarding the 
rule's application. Similarly, the final rule also clarifies in Sec.  
121.406 that the nonmanufacturer rule applies to women-owned small 
business (WOSB) and economically disadvantaged women-owned small 
business (EDSOB) requirements for supplies. Again, Sec.  127.505 of 
SBA's regulations currently states that the nonmanufacturer rule 
applies to WOSB and EDWOSB requirements for supplies, but it is added 
to Sec.  121.406 as well for clarity purposes.

Request for Formal Size Determination

    The proposed rule also amended Sec.  121.1001(b) to give the SBA's 
OIG the authority to ask for a formal size determination. Because the 
OIG is not currently listed in the regulations as an individual who can 
request a formal size determination, the OIG must currently seek a 
formal size

[[Page 8227]]

determination through the relevant SBA program office. SBA believes 
that the Inspector General should be able to seek a formal size 
determination when questions about a concern's size arise in the 
context of an investigation or other review of SBA programs by the 
Office of Inspector General. SBA received several comments regarding 
the proposed change to allow the SBA's OIG to ask for formal size 
determinations. All but one commenter supported the change. The 
dissenting commenter believed that the change is unnecessary and would 
give the OIG too much power. SBA believes that it is reasonable for the 
OIG to be able to request a formal size determination where it deems it 
to be appropriate, and, thus, has not changed this provision in this 
final rule.

Part 124

    Because the primary focus of the October 28th proposed rule was to 
comprehensively revise the regulations relating to the SBA's 8(a) BD 
program, the vast majority of the comments SBA received pertained to 
proposed changes to part 124. SBA will address each of the substantive 
comments made regarding proposed changes to part 124 in turn.

Completion of Program Term

    The proposed rule clarified that every firm that completes its 
nine-year program term will not be deemed to ``graduate'' from the 8(a) 
BD program. Pursuant to the Small Business Act, a Participant is 
considered to graduate only if it successfully completes the program by 
substantially achieving the targets, objectives, and goals contained in 
the concern's business plan, thereby demonstrating its ability to 
compete in the marketplace without 8(a) assistance. 15 U.S.C. 
636(j)(10)(H). After nine years in the program, a firm will be deemed 
to graduate only where SBA determines that is has substantially 
achieved the targets, objectives and goals set forth in its business 
plan. Where those targets, objectives and goals have not been 
substantially achieved, the firm will merely be deemed to have 
completed its nine-year program term. The proposed rule made changes to 
Sec. Sec.  124.2, 124.301 and 124.302 to effect this change. In 
addition, the proposed rule added a new Sec.  124.112(f) to require SBA 
to determine if a firm should be deemed to have graduated from the 8(a) 
BD program at the end of its nine-year program term or to merely have 
completed its program term. As part of the final annual review 
performed by SBA prior to the expiration of a Participant's nine-year 
program term, SBA will determine whether the firm has met the targets, 
objectives and goals set forth in its business plan and whether it has 
``graduated'' from the program.
    Several commenters voiced support for the clarification to 
distinguish between graduation and completion of a firm's program term, 
but did not provide reasoning for their support. Other commenters 
misinterpreted the purpose of the proposed change, believing that SBA 
intended to extend the program term beyond nine years. This conclusion 
was incorrect. A few commenters recommended extending the program term 
beyond nine years. That is something SBA cannot do. The Small Business 
Act specifically restricts the maximum amount of time a firm may 
participate in the BD program to nine years; no more than four years in 
the developmental stage and no more than five years in the transitional 
stage. See 15 U.S.C. 636(j)(15). As such, SBA is precluded by statute 
from extending a firm's participation in the program beyond nine years, 
and the nine-year program term remains in this final rule. The final 
rule also retains the proposed language pertaining to graduation and 
program term completion with minor changes in wording.
    Finally, two commenters recommended that the nine-year program term 
begin on the date that a firm receives its first 8(a) contract award, 
stating that many firms are in the 8(a) BD program for four, five or 
more years before receiving their first 8(a) contract, and believing 
that true business development does not begin until contractual 
assistance is received. Again, the Small Business Act prevents such a 
change. Specifically, the Act states that a firm cannot participate in 
the 8(a) BD program ``for a total period of not longer than nine years, 
measured from the date of its certification'' into the 8(a) BD program. 
15 U.S.C. 636(j)(15). Thus, SBA does not have the discretion to change 
the date upon which the nine-year program term begins to run.

Definitional Changes

    The proposed rule amended Sec.  124.3, to add a definition of NAICS 
code. It also proposed to change the term ``SIC code'' to ``NAICS 
code'' everywhere it appears in part 124 to take into account the 
replacement of the Standard Industry Classification (SIC) code system 
with the North American Industry Classification System. Commenters 
applauded SBA changing the references in the 8(a) BD regulations from 
SIC codes to NAICS codes, believing it was long overdue and would 
eliminate any confusion to those new to the Government contracting 
arena. Specifically, in this final rule, the term ``NAICS code'' 
replaces the term ``SIC code'' in Sec. Sec.  124.110(c), 124.111(d), 
124.502(c)(3), 124.503(b), 124.503(b)(1), 124.503(b)(2), 
124.503(c)(1)(iii), 124.503(g)(3), 124.505(a)(3), 124.507(b)(2)(i), 
124.513(b)(1), 124.513(b)(1)(i), 124.513(b)(1)(ii)(A), 124.513(b)(2), 
124.513(b)(3), 124.514(a)(1), 124.515(d), 124.517(d)(1), 124.517(d)(2), 
124.519(a)(1), 124.519(a)(2), 124.1002(b)(1), 124.1002(b)(1)(i), 
124.1002(b)(1)(ii), and 124.1002(f)(3).
    The proposed rule also amended the definition of primary industry 
classification to specifically recognize that a Participant may change 
its primary industry classification over time. Specifically, the 
proposed rule authorized a firm to change its primary NAICS code by 
demonstrating that the majority of its revenues during a two-year 
period have evolved from its former primary NAICS code to another NAICS 
code. The vast majority of comments supported the proposed change. One 
commenter recommended that the language be changed from ``SBA may 
permit'' a change in a firm's primary industry classification to ``SBA 
shall permit'' to make it clear that no criteria other than a 
demonstration that the source of a firm's revenues has changed from one 
NAICS code to another is required for SBA to recognize such a NAICS 
code change. A few other commenters suggested that SBA should define 
the term ``majority of its revenues'' and describe specifically SBA's 
analysis and the process by which a firm can demonstrate that the 
``majority of its revenues'' have evolved from one NAICS code to 
another. One commenter opposed the proposed language believing that a 
firm should be able to change its primary NAICS code at any time 
without any demonstration to SBA as it is a business decision for the 
concern.
    SBA agrees that the wording of the provision should be clarified to 
make it clear that a primary industry classification change is entirely 
within the control of a Participant. If the Participant can show that 
the majority of the revenues that it has received have changed from one 
NAICS code to another, that is all that is needed. SBA will not look at 
any other factors. SBA does not believe, however, that a firm can 
independently deem that its primary NAICS code has changed without 
providing any support to demonstrate that the work that it performs 
(and thus the firm's primary industry classification) has in fact 
changed over time. Thus, the final rule clarifies that SBA will look 
only at a

[[Page 8228]]

firm's total revenues. SBA intended that the majority of a firm's 
revenues means that NAICS code accounting for the largest amount of all 
of its revenues from whatever source. If the firm performs work only in 
two NAICS codes, then a majority would mean at least 51% of its 
revenues. If a firm performs work in more than two NAICS codes, the new 
primary industry would be that NAICS code accounting for the most 
dollars. For example, if a firm comes into the program with a primary 
industry classification in NAICS code X, but also does work in NAICS 
codes Y and Z, and over time its revenues change so that for the last 
two years it has 40% of its revenues in NAICS code Y, 30% in NAICS code 
X and 30% in NAICS code Z, then its primary industry would change to 
NAICS code Y. That interpretation is consistent with how SBA defines 
``revenues'' for size purposes (i.e., to specifically include all 
receipts from whatever source). As such, SBA does not believe that 
further clarification of that term is required.
    In addition, one commenter was concerned that only the Participant 
should be able to initiate a primary NAICS code change, and did not 
believe that SBA should be able to force such a change on its own 
initiative. It was never SBA's intent that SBA would be able to change 
a firm's primary NAICS code on its own. However, SBA does not believe 
that a change is needed to the regulations since Sec.  124.112(e) 
recognizes only the right of a Participant to request a change in 
primary industry classification.
    The proposed rule also added a definition of the term ``regularly 
maintains an office.'' This definition is important in determining 
whether a Participant has a bona fide place of business in a particular 
geographic location. The proposed rule took this definition from 
current SBA policy contained in SBA's Standard Operating Procedures. 
Several commenters supported this change. In particular, commenters 
supported the clarification contained in the supplementary information 
that although a firm would generally be required to have a license to 
do business in a particular location in order to ``regularly maintain 
an office'' there, the firm would not be required to have a 
construction license or other specific type of license in order to 
regularly maintain an office and thus have a bona fide place of 
business in a specific location. One commenter recommended that this 
clarification be included in the actual regulatory text. SBA agrees and 
has made that change in this final rule.

Fees for Applicant and Participant Representatives

    SBA has permitted firms applying to the 8(a) program and 
Participants in the program seeking contracts to hire agents or 
representatives to assist them in that process. In response to concerns 
that SBA's policy is not set forth in the regulations, this final rule 
adds a new Sec.  124.4 to address fees for agents and representatives. 
The final rule provides that the compensation received by any agent or 
representative of an 8(a) applicant or Participant for assisting the 
applicant in obtaining 8(a) certification or for assisting the 
Participant in obtaining 8(a) contracts must be reasonable in light of 
the service(s) performed by the agent or representative. The rule 
captures SBA's current policy and responds to concerns raised that some 
applicants and Participants have paid unreasonable amounts to 
representatives. In particular, several commenters believed that some 
representatives have obtained compensation that has been a percentage 
of gross contract value, that unsophisticated 8(a) firms may not have 
fully understood what fee they were agreeing to, and that such a fee is 
unreasonable. In response, the final rule provides that the 
compensation received by any agent or representative assisting the 8(a) 
firm, both at time of application or any other assistance to support 
program participation, must be reasonable. Compensation that is a 
percentage of the gross contract value will be prohibited. 
Additionally, compensation that is a percentage of profits may be found 
to be unreasonable. The final rule sets out procedures by which SBA 
will suspend or revoke an agent's or representative's privilege to 
assist applicants. SBA's authority to suspend or revoke an agent's or 
representative's privileges is already contained in Sec.  103.4 and is 
included here for purposes of ease and clarity.

Residence in the United States

    Under the basic requirements a firm must meet in order to be 
eligible for the 8(a) BD program, the proposed rule added a provision 
to Sec.  124.101 requiring individuals claiming social and economic 
disadvantage status to reside in the United States. SBA received four 
comments to this proposed change. All four supported the change 
thinking that such a requirement is reasonable in light of the benefits 
afforded through the program. As such, this provision remains unchanged 
in the final rule.

Size for Primary NAICS Code

    The proposed rule sought to amend Sec.  124.102(a) to require that 
a firm remain small for its primary NAICS code during its term of 
participation in the 8(a) BD program, and correspondingly sought to 
revise Sec.  124.302 to permit SBA to graduate a Participant prior to 
the expiration of its program term where the firm exceeds the size 
standard corresponding to its primary NAICS code for two successive 
program years. SBA received numerous comments to this proposed change 
which were overwhelmingly opposed to the proposed change.
    Several commenters believed that looking at a firm's size over a 
two year period was inconsistent with the Agency's size regulations, 
which determines size for a firm with a revenue-based primary NAICS 
code over a three year period. Other commenters questioned the purpose 
and wisdom of this entire provision, believing that the natural 
progression of many small businesses necessarily leads them into 
various business opportunities and SBA should not inhibit firms' 
growth. They argued that the proposed change would have a chilling 
effect on the growth of small businesses and in essence penalized firms 
for succeeding in the program.
    The 8(a) program is a business development program designed to 
assist Participant firms advance toward competitive viability. Where a 
firm has grown to be other than small in its primary NAICS code, SBA 
believes that the program has been successful and it is reasonable to 
conclude that the firm has achieved the goals and objectives of its 
business plan. Because the Small Business Act authorizes early 
graduation where a firm has met the targets, goals and objectives set 
forth in its business plan, SBA believes that growing to other than 
small in a firm's primary industry classification similarly warrants 
consideration of early graduation. The program would resemble a 
contracting program more than a business development program where a 
firm is permitted to remain in the program after it has grown to be 
other than small in its primary NAICS code and be able to shop for 
contracting opportunities in NAICS codes having accompanying larger 
size standards. A firm that is other than small in its primary NAICS 
code is, and has always been, ineligible to be admitted to the 8(a) BD 
program. That being the case, SBA believes that it follows that a firm 
that grows to exceed its primary NAICS code once in the 8(a) BD program 
and does not intend to change its primary

[[Page 8229]]

NAICS code may no longer need the business development assistance the 
program provides and should be early graduated from the program. SBA 
recognizes, however, that it would be unfair to early graduate a firm 
from the 8(a) BD program where it has one very successful program year 
that may not again be repeated. In response to the comments received, 
the final rule changes the number of years that a Participant must 
exceed its primary NAICS code before SBA will consider early graduation 
from two years (as proposed) to three years. Additionally, in response 
to the many comments received regarding this provision, the rule allows 
a firm to demonstrate that it has made attempts and continues to move 
to one of the secondary NAICS codes identified in its business plan and 
that it will change the primary NAICS code accordingly. This will more 
closely align to the way SBA determines size under Sec.  121.104.
    This provision is not meant to conflict with the change made to the 
definition of primary industry classification in Sec.  124.3 that 
permits a Participant to change its primary NAICS code during its 
participation in the 8(a) BD program. Where a firm demonstrates that it 
has changed its primary NAICS code, SBA would consider early graduation 
only where the Participant exceeds the size standard corresponding to 
its new primary NAICS code for three successive program years.

Definition of American Indian

    A few commenters asked for clarification of the term ``American 
Indian'' in Sec.  124.103. Section 124.103(b) includes Native Americans 
as individuals who are presumptively socially disadvantaged. The 
previous regulatory provision defined Native Americans to be ``American 
Indians, Eskimos, Aleuts, or Native Hawaiians.'' This final rule 
clarifies that an individual must be an enrolled member of a Federally 
or State recognized Indian Tribe in order to be considered an American 
Indian for purposes of presumptive social disadvantage. This definition 
is consistent with the majority of other Federal programs defining the 
term Indian. An individual who is not an enrolled member of a Federally 
or State recognized Indian Tribe will not receive the presumption of 
social disadvantage as an American Indian. Nevertheless, if that 
individual has been identified as an American Indian, he or she may 
establish his or her individual social disadvantage by a preponderance 
of the evidence, and be admitted to the 8(a) BD program on that basis. 
In addition, the rule inserts the words ``Alaska Native'' to take the 
place of Eskimos and Aleuts.

Economic Disadvantage

    SBA proposed several revisions to Sec.  124.104 Who is Economically 
Disadvantaged?, including: A clarification regarding how community 
property laws affect an individual's economic disadvantage; adding a 
provision to exempt certain Individual Retirement Accounts (IRAs) from 
SBA's net worth calculation; clarifications relating to S corporations; 
and adding objective standards by which an individual can qualify as 
economically disadvantaged based on his or her income and total assets. 
SBA received a substantial number of comments regarding these proposed 
changes. Overall, the comments to the proposed changes supported the 
revisions. However, several commenters opposed the requirement that 
individuals remain economically disadvantaged after their admission 
into and throughout their participation in the 8(a) BD program. SBA 
believes that the Small Business Act requires individuals upon whom 
program eligibility is based to remain economically disadvantaged 
throughout the program term of the Participant firm. Specifically, the 
Small Business Act authorizes firms owned and controlled by socially 
and economically disadvantaged individuals to be eligible for the 
program. Where one of these underlying requirements is not met (e.g., 
the individual owners no longer qualify as economically disadvantaged), 
the firm ceases to be eligible for the program. Several other 
commenters recommended that net worth, personal income and total asset 
standards should vary either by industry or geographically. SBA 
believes that any such change would require additional public comment 
and could not be made final in this rule. As such, SBA has not 
addressed these comments in this rule, but will consider them for a 
possible future proposed rulemaking. The specific comments regarding 
economic disadvantage are addressed below.
    A few commenters addressed the proposed change to add a sentence to 
paragraph (b)(2) to clarify that SBA does not take community property 
laws into account when determining economic disadvantage. Those that 
did generally supported the change. Pursuant to the change, property 
that is legally in the name of one spouse would be considered wholly 
that spouse's property, whether or not the couple lived in a community 
property state. This policy also results in equal treatment for 
applicants in community and non-community property states. Community 
property laws will continue to be applied in Sec.  124.105(k) for 
purposes of determining ownership of an applicant or Participant firm, 
but they will not be applied for any other purpose.
    Several commenters expressed concern with the proposed amendment to 
paragraph (b)(2) that would allow SBA to consider a spouse's financial 
situation in determining an individual's access to capital and credit. 
The commenters suggested that a spouse's finances should be reviewed 
only if the spouse is active in the business or lending money to the 
company. This was particularly true of individuals who intentionally 
have kept separate finances from their spouses. They felt that the 
proposed rule did not look at their individual economic disadvantage 
status as required by the Small Business Act, but rather at their joint 
economic condition with their spouses. Several commenters suggested 
that SBA should clarify the limited circumstances when SBA will 
consider the financial situation of a socially disadvantaged owner's 
spouse. After careful review, SBA has determined that a spouse's 
financial condition should not be attributed to the individual claiming 
disadvantaged status in every case. Instead, SBA will consider a 
spouse's financial condition only when the spouse has a role in the 
business (e.g., an officer, employee or director) or has lent money to, 
provided credit support to, or guaranteed a loan of the business.
    Several commenters believed that the provision requiring SBA to 
consider the financial condition of the applicant compared to the 
financial profiles of small businesses in the same industry which are 
not owned by socially and economically disadvantaged individuals 
confused personal economic disadvantage with the applicant firm's 
potential for success. They believed that the applicant firm's 
financial condition was already considered under the potential for 
success requirement and that it has no relationship as to whether an 
individual qualifies as economically disadvantaged. SBA believes that 
the financial condition of the applicant firm could have a bearing on 
whether an individual is considered to have access to credit and 
capital, but understands the confusion noted by the commenters. To 
eliminate any confusion and because SBA already reviews the financial 
condition of the applicant as part of its potential for success 
determination, this rule deletes from an individual's personal economic 
disadvantage review the requirement that SBA compare the financial 
condition of the applicant to

[[Page 8230]]

that of non-disadvantaged small businesses.
    SBA's proposed treatment of income from an S corporation and 
exclusion of IRAs from an individual's net worth determination in 
paragraph (c)(2) received wide support. Several commenters suggested 
that all IRA accounts should be excluded from the net worth calculation 
whether there is a penalty or not. SBA continues to believe, however, 
that the presence of a penalty with a retirement account will lessen 
the potential for abuse of this provision. Individuals will be less 
likely to attempt to hide current assets in funds labeled ``retirement 
accounts'' when there is a substantial penalty for accessing the 
account. A significant penalty would be one equal or similar to the 
penalty assessed by the Internal Revenue Service (IRS) for early 
withdrawal. Although, as one commenter notes, it is true that the 
practical effect of the rule may treat older individuals differently 
than younger individuals because individuals of a certain age will not 
incur a penalty with a withdrawal, SBA believes that any account that 
may be accessed immediately without a penalty must be treated as a 
present asset and included within an individual's net worth 
determination. If an individual invests funds from a retirement account 
into the participant concern, those funds would be excluded from the 
net worth analysis as part of the exclusion of business equity even 
where there was not a significant penalty for access to the 
``retirement'' funds prior to the investment in the business. The 
applicant may be required to submit evidence that the funds were 
invested into the participant concern.
    One commenter suggested Participants should be required to submit 
retirement account statements when applying for 8(a) certification and 
filing their 8(a) status updates, and the Participants should have to 
certify that the funds remain in ``legitimate'' retirement accounts. 
SBA agrees that some verification of retirement account information 
should be required. As such, the final rule provides that in order for 
SBA to determine whether funds invested in a specific account labeled a 
``retirement account'' may be excluded from an individual's net worth 
calculation, the individual must provide to SBA information about the 
terms and conditions of the account and certify in writing that the 
``retirement account'' is legitimate.
    SBA also proposed an amendment to paragraph (c)(2) to exempt income 
earned from an S Corporation from the calculation of both an 
individual's income and net worth to the extent such income is 
reinvested in the firm or used to pay taxes arising from the normal 
course of operations of an S corporation. This change will result in 
equal treatment of corporate income for C and S corporations. Most 
commenters applauded SBA's consideration of the tax treatment for S 
corporations. A few commenters believed that the clarification 
contained in the supplementary information that S corporation losses 
are losses to the company only, and not losses to the individual, 
should be specifically set forth in the regulatory text to clear up 
confusion on this issue. SBA agrees and has included that clarification 
in this final rule. In addition, the final rule has clarified that the 
treatment of S corporation income applies to both determinations of an 
individual's net worth and personal income. Several commenters also 
recommended that Limited Liability Companies (LLCs) and other pass-
through entities be treated the same