SUBJECT: Michigan Department of Management and Budget

DECISION

The State of Michigan, through its Department of Management and Budget (MDMB), appealed a February 1, 2005 determination by the Department of Health and Human Services' Division of Cost Allocation (DCA). The determination under appeal concerns funds collected by MDMB from the Boise Cascade Corporation pursuant to a contract under which that company provides office supplies to Michigan state agencies. DCA determined that the funds collected under the Boise Cascade contract during fiscal years 2001, 2002, and 2003 constituted rebates of amounts paid by Michigan agencies for office supplies under the contract and claimed as expenses under federal awards, and, therefore, the federal government is entitled to a cash refund of a share of the rebates.

For the reasons discussed below, we find that the disputed Boise Cascade contract funds were "applicable credits" that should have been applied to reduce the office supply costs charged to federal awards. We also find, among other things, that Michigan could not properly treat the funds collected under the contract as fees for billed central services, such as purchasing and recycling, since Michigan did not meet applicable requirements for billed central services. We therefore uphold DCA's determination, as modified during our proceeding, that Michigan owes an additional cash refund of $517,028 in federal funds.

Background

The challenged determination was made pursuant to Office of Management and Budget Circular A-87 (OMB Circular A-87). ⁽¹⁾ OMB Circular A-87 establishes uniform principles for determining the costs that state, local, and Indian tribal governments may charge to "Federal awards," a term that includes grants, cost reimbursement contracts, and other agreements. ⁽²⁾ The program costs that a state may charge to such an award consist of the program's allowable direct costs, plus the program's allocable share of allowable indirect costs, less "applicable credits." OMB Circular A-87, Att. A, � D � 1. "Applicable credits refer to those receipts or reduction of expenditure-type transactions that offset or reduce expense items allocable to Federal awards as direct or indirect costs." Id., Att. A, � C � 4.a. To the extent that an applicable credit relates to an allowable cost, a state must credit the federal award or issue a cash refund. Id.

Most states provide certain services - such as purchasing, accounting, or computer services -- to their operating agencies on a centralized basis. OMB Circular A-87, Att. C, � A.1. Because federal awards are performed or administered by or within these operating agencies, there must be a reasonable and consistent process by which the costs of centrally provided services, or "central service costs," are identified and assigned to the awards that those costs benefit. Id. This process is provided by the requirement for a central service cost allocation plan, which becomes part of a state-wide cost allocation plan (SWCAP) when submitted by a state. Id.; DCA Ex. 14, at 33, � 4.2. ⁽³⁾ The SWCAP accumulates and identifies the costs of central services provided by a state governmental unit to other agencies that use the services, then apportions those costs by allocating or billing them to the user agencies. OMB Circular A-87, Att. A, � B � 4. The SWCAP should be "supported by formal accounting and other records that will support the propriety of the costs assigned to Federal awards." Id., Att. C, � A. � 1. A state must submit a SWCAP for approval by the federal "cognizant agency" for each year that it claims central service costs under federal awards. Id., Att. C, � D. � 1. HHS is the cognizant agency for all states.

MDMB provides a variety of centralized services to Michigan agencies, some of which operate programs that are administered under federal awards. DCA Ex. 15, at 1, 17. MDMB's Office of Purchasing operates and supervises the state purchasing system. DCA Ex. 4, at 11. One function of the Office of Purchasing is to supervise or oversee the Just-in-Time Delivery of Office Supplies contract with Boise Cascade. ⁽⁴⁾ Under that contract (a copy of which is Michigan's only exhibit), Michigan's operating agencies purchase office supplies directly from Boise Cascade. A provision of the contract, entitled "Level of Pricing," states:

The State will receive a 50% discount off all non-contract (general catalog) items. Users of the Contract will be assessed a 5% user fee on all items purchased. Therefore, because of the 5% user fee, agencies will receive a 45% discount off all non-contract (general catalog) items. All items listed on the attached Item Listing (specially-priced catalog) have been marked up by 5% to reflect the user fee.

In the next provision, entitled "Payment of User Fees to the State," the contract requires Boise Cascade to remit to MDMB, promptly after the end of each billing period, a payment equal to the "user fees" paid by the agencies during that billing period. The provision further indicates that Michigan "intends" to use the remitted funds to implement a "Statewide Electronic Commerce Program."

The record indicates, and Michigan does not deny, that the costs of operating the Office of Purchasing are "allocated central service" costs under Michigan's SWCAPs for fiscal years 2001-2003. DCA Exs. 4-6. Central services are classified in a SWCAP as either "allocated central services" (also known as section I costs) or "billed central services" (also known as section II costs). OMB Circular A-87, Att. C, � B. Allocated central services are not billed to the agencies on a fee-for-service or similar basis. Id., Att. C, � B � 2. Instead, the costs of allocated central services are allocated to the benefitting agencies on some other reasonable basis, such as number of employees, amount of square footage occupied, etc. Id. The costs of operating the Office of Purchasing are allocated to Michigan's operating agencies based on the weighted number of purchase requisitions processed for each agency. See, e.g., DCA Ex. 4, at 11.

"Billed central services," on the other hand, are billed to the user department on an individual fee-for-service or similar basis. OMB Circular A-87, Att. C, � B � 1. The governmental unit that supplies billed services normally establishes an internal service fund (ISF) to account for the financing of the goods and services it provides to user departments. DCA Ex. 16, � 8; see also OMB Circular A-87, Att. C, � E � 3.b. OMB Circular A-87 permits an ISF to maintain a working capital reserve of up to 60 days cash expenses for normal operating purposes (or for a longer period under exceptional circumstances). OMB Circular A-87, Att. C, � G.2.; DCA Ex. 16, � 8.

As permitted by OMB Circular A-87, MDMB has established several ISFs to account for the financing of the goods and services it provides to the user departments or agencies. DCA Ex. 4. One of these ISFs is called the Office Service Fund. Id. at 2. According to Michigan's Comprehensive Annual Financial Report, the Office Service Fund accounts for the financing and provision of "printing, reproduction, microfilm, mailing, distribution of federal and state surplus property, and materials management." DCA Ex. 4, at 4; DCA Ex. 5, at 4; DCA Ex. 6, at 4. The costs of providing these services are billed to user agencies. DCA Ex. 4, at 4; DCA Ex. 5, at 4; DCA Ex. 6, at 4. Funds collected by the MDMB under the Boise Cascade office supply contract are recorded as revenue in an Office Service Fund sub-fund called "Boise Cascade." DCA Ex. 4, at 5; DCA Ex. 5, at 6; DCA Ex. 6, at 5. Revenue in this sub-fund consists solely of these Boise Cascade office supply contract funds. See, e.g., DCA Ex. 4, at 5 (Eighth column).

During its review of MDMB's fiscal year 2000 SWCAP, DCA determined that the Boise Cascade ISF had a fund balance that exceeded the amount permitted by OMB Circular A-87's working capital reserve requirement. DCA Ex. 16, � 9. Consequently, in August 2000, DCA requested repayment of the federal share of what DCA determined to be the excess fund balance for fiscal year 2000. Id. Michigan refunded this amount to DCA. Id. In requesting the refund, DCA noted that the purpose of the Boise Cascade user fees "was not payment for services rendered, but to accumulate a reserve to be used to implement a statewide electronic commerce program." DCA Ex. 1, at 1.

In February 2002, after further examination of the Boise Cascade sub-fund, DCA requested a refund of the federal share of all revenue recorded in that sub-fund during fiscal years 1997, 1998, 1999, and 2000. DCA Ex. 2. DCA again found that the revenues were not payment for services rendered by MDMB but instead constituted a capital reserve dedicated to the implementation of a statewide electronic commerce program. ⁽⁵⁾ Id. at 1. DCA also determined that the Boise Cascade contract revenue represented an "applicable credit" that should have been applied to federal awards as a "cost reduction" or cash refund, or, alternatively, that the revenue constituted an "unallowable profit." Id. (quoting the Implementation Guide to OMB Circular A-87, which states that "[p]rofit continues to be unallowable"); DCA Ex. 14, at 15. Michigan complied with DCA's refund request. DCA Ex. 16, � 11.

In response to a September 26, 2003 inquiry from DCA, MDMB provided information about the use of the Boise Cascade contract revenue. DCA Ex. 10. MDMB explained that this revenue had been used in fiscal years 2001, 2002, and 2003 to finance the following centralized services: (1) "Acquisition Services," apparently provided by the Office of Purchasing; and (2) Michigan's recycling program. DCA Ex. 10, at 2. MDMB stated that the costs of Acquisition Services are treated as section I (allocated) costs and included in its SWCAP, and that the Boise Cascade funds used for Acquisition Services "will require that a credit be included in the SWCAP." Id. Michigan also said that the recycling program is accounted for in the Materials Management sub-fund within the Office Services Fund. Id. at 1-2; DCA Ex. 4, at 4, 10.

On February 1, 2005, DCA issued the determination now under appeal. DCA Ex. 3. The determination letter requested a refund equal to the federal share of funds collected by MDMB for fiscal years 2001, 2002, and 2003 pursuant to the Boise Cascade contract. DCA described its position in part as follows:

[MDMB] has an arrangement with Boise Cascade for it to return to the Department the amount which it has charged state departments and agencies more than its agreed to prices for goods which they buy from it. This rebate is then used to fund various activities of the Department. It is our position that the federally funded programs administered by the state should receive the credit for the Boise Cascade charges in excess of cost.

Id. (emphasis added). DCA found that because the "rebate arrangement" offset the cost of goods purchased by the state agencies, those proceeds were "applicable credits," which had to be credited to Michigan's federal awards or returned to the Federal Government as a cash refund. Id. DCA also determined that a cash refund was the appropriate method of compensation. Id. at 2.

DCA originally requested a refund of $1,096,782. Id. According to DCA, this amount was equal to the federal share (30 percent) of the Boise Cascade contract revenue for fiscal years 2001, 2002, and 2003, plus interest (at 5 percent) on each year's revenue, calculated from the end of the relevant fiscal year. DCA advised Michigan that it could submit data demonstrating that its federal share, or the actual interest rate for the periods in question, was lower.

On February 28, 2005, Michigan appealed DCA's determination of February 1, 2005. Michigan's argument in support of the appeal is set forth in a three-page letter brief dated April 8, 2005.

While the appeal was pending, Michigan submitted additional information to DCA indicating that lower interest rates and a lower federal financial participation rate (28%) might apply. See DCA Ex. 11. In response, DCA recalculated the amount owed. The parties now agree that the federal share of Boise Cascade contract revenues for fiscal years 2001-2003 -- plus interest as of March 3, 2005 -- is $825,493, a portion of which ($308,465) Michigan has already refunded, after acknowledging that that amount was in excess of what Michigan would be permitted to retain as a working capital amount under an ISF. DCA Ex. 12-13. Thus, the amount at issue before us is $517,028.

Issues

Michigan disputes DCA's determination that the Boise Cascade funds collected by MDMB constitute "applicable credits." According to Michigan, this determination was based solely on DCA's characterization of the funds as "rebates." Michigan insists that the funds were not rebates but "user fees" that are unrelated to the price discounts negotiated with the vendor. Michigan asserts that the funds are "user fees" that Boise Cascade agreed to collect and to remit to MDMB "as a customer service to the State of Michigan" and that this is an appropriate mechanism for collecting the fees. MI Br. at 1-2. ⁽⁶⁾ Michigan asserts that using Boise Cascade to collect the "user fees" is an "accurate and efficient method for allocating costs" of purchasing services (such as contract management) and paper recycling costs. Id. at 2.

DCA responds that the Boise Cascade contract revenues are indeed "applicable credits" because there is a direct relationship between the expenditure of federal funds on office supplies by agencies that administer federal awards, and the funds collected by MDMB from Boise Cascade pursuant to the contract under which those supplies were purchased. DCA Brief at 12-13. DCA suggests that even if the revenues are not applicable credits, the Board should uphold its refund request because MDMB's financial records do not support its contention that the revenues were used to fund the Office of Purchasing in fiscal years 2001, 2002, and 2003, and has otherwise failed to document that the revenues constitute allowable costs. Id. at 15, 19. DCA also argues that because the Office of Purchasing costs were allocated as section I costs under the SWCAPs for fiscal years 2001 - 2003, permitting Michigan to claim the Boise Cascade funds as fees to cover the same costs would result in duplicate claims for federal funds. DCA further points out that the effect of Michigan's method of collecting the fees by having Boise Cascade charge Michigan agencies five percent more for supplies than the contract rate is that these amounts might be treated as direct costs to federal awards, rather than being treated as indirect costs, as they would be if billed by MDMB as central services costs. DCA Brief at 15-21. DCA's allocation expert attests that the result may be causing the amounts charged to some federal programs to exceed limits on administrative costs. DCA Ex. 16, � 15.

Michigan submitted no reply to DCA's assertions and evidence.

Discussion

1. The amounts paid by Boise Cascade to MDMB were applicable credits.

OMB Circular A-87 provides the following definition:

Applicable credits refer to those receipts or reduction of expenditure-type transactions that offset or reduce expense items allocable to Federal awards as direct or indirect costs. Examples of such transactions are: purchase discounts, rebates or allowances, recoveries or indemnities on losses, insurance refunds or rebates, and adjustments of overpayments or erroneous charges.

OMB Circular A-87, Att. A, � C.4.a.

This definition does not provide an exclusive or complete list of applicable credits but merely "examples." Pennsylvania Office of the Budget, DAB No. 1234 (1991). The Board has noted with respect to these examples that --

[t]here is a direct link, or nexus, between the credit in those situations and the amount to which it must be applied. For example, if the state received a discount or rebate on the purchase of a desk for its Medicaid program it could not seek FFP on the full retail price. Similarly, the State would have to subtract from its Medicaid expenditures amounts it recovered from a provider where it originally paid the provider in error.

Hawaii Dept. of Social Services and Housing, DAB No. 779, at 6 (1986); see also Colorado Dept. of Personnel and Administration, DAB No. 1872, at 10 (2003) (noting that in each of the applicable credit examples given in the Circular, "there is a direct relationship or nexus between a grant-related cost and some form of discount or credit, between the questioned receipts and the federally funded program").

The Board has also emphasized that it looks to the substance of the transaction, not its label, to determine whether a state has received an applicable credit:

The determination of whether funds received by a grantee constitute applicable credits should not turn on whether the grantee, in describing the funds, has or has not utilized words in the list of examples of applicable credits provided [in the Circular]. Instead, the inquiry must focus on whether the questioned payments have the characteristics of applicable credits as given in OMB A-87's definition and examples.

A common theme in the applicable credit cases (and in the examples of applicable credits in OMB A-87) is the receipt of monies (or reductions of expenditures) by a state related to its federally funded program which, if unaccounted for in the program, would result in a savings or gain to the state alone. This characteristic springs from the description of applicable credits in OMB A-87 as funds or savings which "offset or reduce expense items allocable to grants. . ." If a state has receipts or reductions in expense items allocable to a federally-funded grant but fails to credit the grant for the receipts or reductions accordingly, then the state experiences savings which it does not pass on to the federal funding source as well.

Oregon Dept. of Human Resources, DAB No. 1298, at 10 (1992).

It is undisputed that Michigan agencies incur costs to purchase office supplies under the Just-in-Time Contract MDMB has with Boise Cascade. To the extent that these office supply costs are charged to federally funded programs, they are financed partly with federal dollars. Under the cost principles in OMB Circular A-87, the federal government's participation in these costs is limited to the "actual prices" of the office supplies. OMB Circular A-87, Att. B, � 29. Under the cost principles, the actual price of an item is one that reflects all discounts, rebates, or allowances. Id.

During fiscal years 2001-2003, Michigan agencies that operate or administer programs financed in part with federal awards purchased office supplies under the Boise Cascade contract. For each item purchased, the amount given by these agencies in payment to Boise Cascade was five percent greater than the negotiated price of the item. Indeed, as indicated above, the contract specifically provides that Michigan will receive a discount of 50% from the normal purchase price on general catalog items, but that Boise Cascade will charge the state agencies a price equal to 45% less than the normal purchase price and remit the difference to MDMB. MI Ex. 1, at 9. Similarly, for listed items, the agencies will pay five percent more than the negotiated prices on the listing attached to the contract (specially-priced catalog). Id.

Michigan does not dispute that the office supplies purchased by state agencies under the contract were "expense items" allocable to, and financed in part by, federal awards. Nor does it deny that the full amounts of the payments made to Boise Cascade were charged to federal awards as costs of office supplies. These payments, however, exceeded the actual cost to Michigan of the office supplies because Boise Cascade promptly returned a portion of the payments to MDMB.

If the funds that Boise Cascade remitted to MDMB are not credited to the office supply purchases, then the federal awards sharing in the costs of the purchases will not have reaped the savings that Michigan realized from the contractual arrangement.

In short, there was a direct and close relationship between MDMB's receipt of funds from Boise Cascade and the incurrence of expense items -- namely, the purchase of office supplies by Michigan agencies -- claimed under federal awards. MDMB collected funds from Boise Cascade only when Michigan agencies purchased office supplies under the contract, and the amount collected was the difference between the contract price and the higher amount paid by Michigan agencies for those supplies. This relationship supports a conclusion that the Boise Cascade funds were applicable credits, regardless of whether these funds were correctly characterized as "rebates." The funds remitted by Boise Cascade effectively offset or reduced Michigan's payments for expense items (office supplies) that were assigned to and financed by federal awards. The full amount of those payments was charged to the federal awards. When Boise Cascade returned a portion of those payments, Michigan was required to credit the federal awards to ensure that federal funds were not overcharged for the expense items.

Finally, we note that Michigan's letter misconstrues the basis for the DCA determination here that the amounts paid by Boise Cascade to MDMB constitute applicable credits. DCA's determination is not based on the manner in which the amounts were collected, but on what the contract provides. While the contract refers to the amounts remitted to MDMB as "user fees," the contract provisions as a whole make clear that this was just a mechanism for giving the benefit of part of the negotiated discounts to MDMB, rather than to the purchasing agencies. As discussed above, the label that a state gives to a transaction is not controlling. Moreover, as we discuss below, the amounts were not the types of user fees which a state may properly bill to state agencies for section II costs, nor did Michigan establish that it incurred allowable costs which it has not already allocated to federal funds as section I costs through its SWCAPs.

2. The funds may not be retained on the basis that they were used to pay for central service costs.

Michigan suggests that the funds collected by MDMB are used to finance the costs of managing the Boise Cascade contract and for the costs of recycling and therefore benefit the agencies who utilize the Boise Cascade contract. Michigan also asserts that the contract's user fee provision is merely an efficient cost allocation mechanism.

Central service costs paid for with the Boise Cascade contract revenues may not be charged to a federal award unless they are identified in an approved SWCAP and allocated or billed to the awards in accordance with methodologies described in a SWCAP and approved by DCA. Michigan has made no effort whatsover to show that it complied with OMB Circular A-87 requirements, and the record shows that the requirements were not met.

First, the amounts collected as "user fees" under the Boise Cascade contract were intended under the contract to be used to fund an electronic commerce system, but Michigan does not deny it never implemented that system. The amount of the "user fees" was, moreover, determined by the prices of supplies purchased by Michigan agencies, rather than being determined by the costs of either an electronic commerce system or the purchasing or recycling activities for which Michigan now says it ultimately used the funds. To constitute an allowable billed central service (section II) cost under OMB Circular A-87, costs must be charged using a billing rate that is based on the estimated costs of providing the service, and an appropriate adjustment must be made for the difference between the revenues received (or imputed to) the service and the actual allowable costs of providing the service. OMB Circular A-87, Att. C, � G, � 4. While Michigan tried to associate the revenues MDMB received from Boise Cascade with its Office Service Fund ISF by placing the funds in a sub-fund of the ISF, it is clear from the record that Michigan was not meeting the requirements for charging central service costs through a billing rate determined according to the applicable requirements. ⁽⁷⁾

Moreover, if part of the revenue from the "user fees" was used for statewide purchasing services, as Michigan claims, then Michigan should have adjusted downward the costs allocated to federal awards as section I costs under its SWCAPs to account for costs covered by the revenues from Boise Cascade. Michigan does not deny DCA's assertions that MDMB's section I allocation did not reduce total costs by the amounts allegedly covered with contract revenues. DCA submitted evidence that the cost adjustments that were made for the fiscal years in question related to income from other sources (such as a procurement card rebate), rather than to the revenue from Boise Cascade. See, e.g., DCA Ex. 4, at 14. DCA alleges, and Michigan does not deny, that the effect of allocating the costs to federal funds both through section I of the SWCAPs and by adding "user fees" to the price of the supplies charged to federally funded agencies would result in duplicate reimbursement of federal funds for the same costs.

Finally, while Michigan argues that collecting funds for the costs of its Office of Purchasing and for recycling by adding "user fees" to the contract purchase price for supplies is a reasonable allocation method, Michigan did not support this theory with any evidence that there is any equitable relationship between the benefit to state agencies from the particular purchasing or recycling services for which the funds were used and the amount of supplies purchased by those agencies under the Boise Cascade contract. Indeed, evidence submitted by DCA indicates that some agencies might not even be using the recycling services offered by MDMB. DCA Ex. 15, at 10.

In sum, even if the amounts at issue were not required to be treated as applicable credits (which we determine they were), Michigan has not shown that they constitute allowable costs, properly allocated to federal programs.

Conclusion

For the reasons stated above, we uphold DCA's revised determination that Michigan must refund an additional $517,028 in federal funds attributable to amounts charged to federal programs for supplies, but for which Michigan was repaid by Boise Cascade.

Cecilia Sparks Ford

Donald F. Garrett

Judith A. Ballard
Presiding Board Member

1. Unless otherwise noted, all references to OMB Circular A-87 are to the version as amended on August 29, 1997, which was in effect during the three fiscal years (2001-2003) at issue in this case. See 60 Fed. Reg. 26,484 (May 4, 1995); 62 Fed. Reg. 45,934 (August 29, 1997).

2. By regulation, OMB Circular A-87 is applicable to state, local, and Indian tribal governments that receive awards under programs administered by the Department of Health and Human Services (HHS). 45 C.F.R. � 74.27(a); 45 C.F.R. � 92.22(b); Mississippi Dept. of Human Services, DAB No. 1717 (2000). Each federal agency administering awards was required to issue codified regulations to implement the circular by September 1, 1995. OMB Circular A-87, � 7.

3. DCA Exhibit 14 is HHS's implementation guide for OMB Circular A-87, entitled A Guide for State, Local and Indian Tribal Governments: Cost Principles and Procedures for Developing Cost Allocation Plans and Indirect Cost Rates for Agreements with the Federal Government.

4. The contract refers to an "Acquisition Services" office. An MDMB financial report indicates that the services provided by the Office of Purchasing include "Acquisition Services Administration." DCA Ex. 5, at 11.

5. DCA noted that it had been informed that Michigan had not incurred any expenditures for that program, other than those for "feasibility studies." DCA Ex. 2, at 1.

6. In a March 31, 2005 letter responding to DCA's adjustment of the disallowance amount, Michigan says that it "continues to assert that using a vendor to collect our user fees does not automatically make that fee a rebate, nor convert otherwise allowable costs, to unallowable costs." DCA Ex. 13, at 1.

7. DCA points out that the way Michigan was using the Boise Cascade sub-fund, applying the funds to different types of costs in different years, means that sub-fund was functioning as a contingency reserve. Contributions to such a reserve are unallowable under OMB Circular A-87, Attachment B, � 12.