Offsets are industrial compensation practices that foreign governments or companies require U.S. firms to enter into as a condition of  purchase in either government-to-government or commercial sales of defense articles and/or defense services as defined by the Arms Export Control Act (22 U.S.C. § 2751, et seq.) and the International Traffic in Arms Regulations (22 C.F.R. §§ 120-130).  In defense trade, such industrial compensation can include mandatory co-production, licensed production, subcontractor production, technology transfer, and foreign investment.

The Bureau of Industry and Security (BIS) is responsible for submitting an annual report to Congress on the impact of defense offsets on the U.S. defense industrial base.  This requirement was initiated in 1984, when Congress enacted amendments, including the addition of Section 309, to the Defense Production Act of 1950 (50 U.S.C. app. § 2099 (2000)).  Pursuant to Section 309, the President is required to submit a report on the impact of offsets on the U.S. defense industrial base to Congress.  In 1992, the President directed the Secretary of Commerce to carry out the Section 309 responsibilities, including developing and administering the regulations necessary to collect offset data from U.S. firms.  The Secretary of Commerce has delegated this authority to BIS.  BIS published the first offset regulation in 1994 and has been submitting annual reports to Congress since 1996.  The offset regulation is located here.

U.S. firms providing defense articles or defense services to foreign countries or foreign firms under contracts that are associated with offset agreements valued at more than $5 million should report the offset agreements to BIS.  In addition, U.S. firms should report all offset transactions with values greater than $250,000 that are credited toward an offset agreement to BIS.  Additional detailed information on transactions that must be reported can be found here.

If a foreign subsidiary or foreign affiliate of a U.S. firm enters into an offset agreement with a foreign entity and is responsible for the fulfillment of that agreement, that agreement should not be reported to BIS.  However, if a foreign subsidiary or foreign affiliate of a U.S. firm performs an offset transaction to fulfill an offset agreement for which the U.S. firm is responsible, the U.S. firm that is party to the original offset agreement should report the offset transaction to BIS.

An offset agreement includes an offset agreed to by a U.S. firm in order to conclude a military export sales contract. The agreement is normally reflected in a contract that specifies the percentage of the total defense-related export sale to be offset, the forms of industrial compensation required, the duration of the offset agreement, and penalty clauses, if any.  

An offset transaction is any activity for which a U.S. firm claims credit for full or partial fulfillment of an offset agreement.  Offset transactions are categorized as “direct,” “indirect” or both.  

All offset transactions are direct, indirect, or a combination of both.  Direct offset transactions are those in which the items or services involved are directly related to the items or services exported or to be exported by the U.S. firm pursuant to the military export sales agreement associated with the offset agreement.  Conversely, indirect offset transactions are those in which the items or services involved in the transaction are unrelated to the items or services exported or to be exported by the U.S. firm pursuant to the military export sales agreement associated with the offset agreement.

For the purpose of its annual report on Offsets in Defense Trade, BIS classifies offset transactions into the following nine categories: co-production, credit assistance, investment, licensed production, purchases, subcontract, technology transfer, training, and other.   These categories are defined as follows:

Co-production:  Transactions that are based upon government-to-government agreements authorizing the transfer of technology to permit a foreign company to manufacture all or part of a U.S.-origin defense article.  Such transactions are based upon agreements specifically referenced in Foreign Military Sales (FMS) Letters of Offer and Acceptance (LOA) and a government-to-government Memorandums of Understanding (MOU). Co-production is always classified as a direct offset.

Credit Assistance:  Credit assistance includes direct loans, brokered loans, loan guarantees, assistance in achieving favorable payment terms, credit extensions, and lower interest rates.  Credit assistance specifically excludes the use of “banked” offset credits (credits that exceed the requirement of the offset agreement and are permitted, by the terms of the agreement, to be applied to future offset obligation).  Credit assistance is nearly always classified as an indirect offset transaction but can also be direct. 

Investment:  Investment arising from an offset agreement often takes the form of capital dedicated to the establishment of a foreign entity unrelated to the defense sale or to the expansion of the U.S. firm’s subsidiary or joint venture in the foreign country. [Investment can be either direct or indirect.]

Licensed Production:  Licensed production consists of the overseas production of a defense article based upon transfer of technical information under direct commercial arrangements between a U.S. manufacturer and a foreign government or producer.  It is not pursuant to a co-production agreement specifically referenced in a LOA and co-production MOU.  In addition, licensed production almost always involves the manufacturing of a part or component for a defense system, not a complete defense system.  Licensed production transactions can be either direct or indirect.  

Purchases:  Purchases are the procurement of off-the-shelf items from the offset recipient.  Purchases are indirect transactions. 

Subcontract:  In the offset context, subcontracting is the overseas production of a part or component of a U.S.-origin defense article.  The subcontract does not necessarily involve the license of technical information and is usually a direct commercial arrangement between the defense prime contractor and the foreign producer.

Technology Transfer:  Transfer of technology that occurs as a result of an offset agreement and that may take the form of research and development conducted abroad, technical assistance provided to the subsidiary or joint venture of overseas investment, or other activities under direct commercial arrangement between the defense prime contractor and a foreign entity.

Training:  Generally includes training related to the production or maintenance of the exported defense item.  Training, which can be either direct or indirect, may be required in unrelated areas, such as computer training, foreign language skills, or engineering capabilities. 

Other:  An offset transaction other than co-production, credit assistance, licensed production, investment, purchase, subcontract, technology transfer, or training.

The actual value of an offset transaction is the market value in U.S. dollars of the products and services provided.  The credit value of an offset transaction is the value in U.S. dollars that the U.S. firm is credited by the foreign entity, in acknowledgement of the fulfillment of the U.S. firm’s offset obligations.  The credit value may be greater than, equal to, or less than the actual value of the offset transaction.

Both co-production and licensed production categories involve overseas production of U.S.-origin defense articles; however, co-production is based upon a government-to-government agreement that authorizes co-production.  In other words, the offset transaction must be the result of a Foreign Military Sale (FMS) in which the Letter of Offer and Acceptance (LOA) authorized co-production, and the terms of the agreement were further detailed in a co-production Memorandum of Understanding between the Department of Defense and the foreign country. 

If the FMS and LOA are silent on co-production, the offset transaction should be classified as licensed production or another offset transaction category that best describes the transaction.

BIS defines subcontracting as overseas production of a part or component of a U.S.-origin defense article, when the sale of the defense article is subject to an offset agreement.  Therefore, all subcontracting transactions are direct offset transactions. 

BIS defines purchases as the procurement of off-the-shelf items from the offset recipient of a transaction.  Purchases are indirect offset transactions.   

If more than one transaction type was used to complete a transaction, please indicate under “transaction type” the category that best represents the majority of the transaction and include the other categories under “additional information”.

In order to measure the effectiveness of government programs, many government agencies require grantees and contract holders to report on specific performance measures related to their activities.  Non-performance penalties are fines incurred by service providers when they breach service levels, fail to perform as agreed to, or fail to perform the services on time.  The offset regulation requires U.S. firms to report offset agreement performance measures and non-performance penalties to better understand the trends in offset activities in defense trade.

The effective date of the amended regulation is January 22, 2010.  U.S. firms are required to incorporate the new requirements under the amended offset regulation in their submissions to BIS for offset activity in calendar year 2009, reportable to BIS by June 15, 2010.

The most significant change in the amended regulation is the new requirement that companies report the appropriate North American Industry Classification System (NAICS) code(s) for each military sale that triggers an offset agreement and for each offset transaction reported under the regulation. 

Additionally, certain definitions have been updated to reflect the offset activities frequently reported to BIS (see the definitions questions in this section).  In addition, for each offset transaction reported, companies are required to provide the month and year that the related offset agreement was signed. 

Federal statistical agencies use the NAICS to classify business establishments for the collection and analysis of data used to measure U.S. economic activity.  NAICS replaced the Standard Industrial Classification (SIC) system in 1997.  NAICS facilitates economic analyses which include producing information on inputs and outputs, industrial performance, productivity, unit labor costs, and employment.  More information on the NAICS is found here.

The U.S. Census Bureau’s (Census) website describes the NAICS as a six-digit hierarchical classification system, offering five levels of detail.  Each digit in the code is part of a series of categories, with more digits in the code signifying greater classification detail.  The first two digits designate the economic sector, the third digit identifies the sub-sector, the fourth digit classifies the industry group, the fifth digit designates the NAICS industry, and the sixth digit is the national industry.  A complete and valid NAICS code contains six digits.

BIS utilizes the NAICS because it is the standard used by Federal statistical agencies in classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy.  Standard use of NAICS by federal agencies provides for a high level of comparability within and among industries.

Census provides detailed conversion (concordance) tables on its website here.  Census provides spreadsheet files that can be used to cross-reference SIC codes with the corresponding 2002 NAICS code only.  NAICS codes are reviewed and updated every five years; therefore, to ensure that you have the most current NAICS code, enter the 2002 NAICS code into Census’ “NAICS Search” on the left side of the webpage. 

Another useful website to convert SIC codes to NAICS codes is here.  On this site, enter your SIC code into the search field on the left hand side of the webpage and the website will generate the corresponding NAICS code.  However, because this is not an official U.S. Government website, BIS can not guarantee the accuracy of the conversion results.

To determine the classification of your products that have not been previously classified against the SIC, access Census’ NAICS website.  Enter keywords that best describe your products, and the website will generate the corresponding NAICS code(s).

No.  BIS only requires that submissions due by June 15, 2010 and forward include NAICS codes.

BIS amended the offset regulation partly in response to recommendations by the Government Accountability Office relating to enhancing the assessment of the economic effects of offsets in defense trade by clarifying the information that BIS seeks to receive and by requiring more precise information on the industry sectors in which offset activity occurs.

U.S. firms must submit their offset reports in hardcopy to the Offset Program Manager, U.S. Department of Commerce, Bureau of Industry and Security, Room 3876, 14th Street and Constitution Avenue, N.W., Washington, DC 20230, and as an email attachment to OffsetReport@bis.doc.gov.  Email attachments must include the information in a computerized spreadsheet or database format.  All submissions must include a point of contact (name and telephone number). You may contact Ron DeMarines, Offset Program Manager, at (202) 482-3755 or (202) 482-4506, or by email (ronalddemarines@bis.doc.gov) for assistance.

In this situation, the U.S. firm should report the transaction to BIS in the year in which the transaction took place.  If, for example, the transaction took place in 2009, but the foreign offset authority did not officially grant credit for the transaction until sometime in 2010, the U.S. firm should include the transaction in its calendar year 2009 submission, due to BIS by June 15, 2010. 

Estimates are acceptable for actual values and credit values and should be designated with an “E” next to the U.S. dollar value.  If the estimated dollar values differ from the values granted from the foreign offset authority, the U.S. firm may submit an amended report to BIS with the correct dollar values.   

Yes, please submit a letter to BIS indicating that your company does not have offset agreements and/or offset transactions to report for the respective calendar year.

As provided by Section 309(c) of the DPA, and § 701.5 of the offset regulation, BIS is precluded from publicly disclosing the specific information it receives from U.S. companies.  As a result, BIS highly aggregates the offset-related information it collects from defense contractors, to the extent that the activities of individual companies cannot be determined.  In recent years, BIS has also revised the annual report to remove certain sections that were identified as beneficial to foreign governments and made other sections of the report available only within the U.S. Government.  BIS continues to consider additional measures specific to this concern.

Pursuant to the Defense Production Act (50 U.S.C. App. 2155), willful violation of the offset regulation may result in punishment by fine or imprisonment, or both.  The maximum penalty is a $10,000 fine, one year in prison, or both.  The U.S. Government may also seek an injunction from a court to prohibit the continuance of any violation of, or to enforce compliance with, the Defense Production Act.

The U.S. Government views offsets to be economically inefficient and market distorting.  Additional information specific to this topic is available here.

Every annual report that BIS has submitted to Congress can be found online here.
The right-hand side of the webpage provides a list of BIS’s offset reports and links to the reports, in chronological order, with the most recent report listed at the top.