March 30, 2011
On January 2, 2011, the United States imposed a two-percent excise tax on payments received by foreign entities for the sale of goods or services to the U.S. government. The United States enacted this tax through the James Zadroga 9/11 Health and Compensation Act (the "Act") to pay for benefits for persons affected by the September 11, 2001 attacks.[1]
The Act specifically levies its two-percent tax on any "specified Federal procurement payment" received by a "foreign person." A "foreign person" is any person "other than a United States person," including a foreign business entity.[2] A "specified Federal procurement payment" is any payment made under a U.S. government contract for (1) goods produced in a country that is not a party to an "international procurement agreement" with the United States, or (2) services provided in a country that is not a party to such an agreement.
The Act does not define the term "international procurement agreement," but legislative history suggests that it describes the World Trade Organization Government Procurement Agreement ("WTO-GPA") and certain free trade agreements between the United States and other countries. The WTO-GPA is a "plurilateral agreement" under which signatories agree not to discriminate against suppliers of goods and services from other signatory nations in government-procurement matters. Forty nations have signed the WTO-GPA, including the member states of the European Union, Canada, Japan, Korea, and Israel. Some major U.S. trading partners, including China, Brazil, India, Russia, and nations of the Middle East have not signed the WTO-GPA. Free trade agreements covered by the term "international procurement agreement" likely include the North American Free Trade Agreement, the Dominican Republic-Central America-U.S. Free Trade Agreement, and bilateral agreements between the United States and Australia, Bahrain, Chile, Israel, Morocco, Oman, Peru, and Singapore.[3]
Application of the Act’s excise tax hinges on where a good is produced or a service is rendered–not on where the entity providing the good or service is based or organized. The tax thus applies to payments for goods produced or services rendered in a country that is not a party to an international procurement agreement with the United States, even if the foreign entity producing the goods or providing the services is based in a country that is a party to such an agreement.[4] This rule may have particular significance for foreign contractors producing goods or providing services to the U.S. government in Iraq or Afghanistan. Neither nation is a party to an international procurement agreement with the United States.
The excise tax imposed by the Act applies to the gross amount of all specified procurement payments "received pursuant to contracts entered into on and after" its effective date of January 2, 2011. The tax also may apply to specified procurement payments made under contracts that are materially modified after that date.[5]
The Act states that its excise tax shall be collected in accordance with the withholding tax provisions generally applicable to payments made to foreign persons. This requirement imposes withholding liabilities on all persons, including officers and employees of the United States, with control or custody of payments to foreign persons. If no withholding agent collects the tax, however, a payee must self-assess the tax and file a proper tax return.[6]
The Act provides that the head of each "executive agency" must ensure that "no funds are disbursed to any foreign contractor in order to reimburse the tax imposed under" the Act. This makes the two-percent excise tax an unallowable cost for foreign contractors.
Several questions remain unanswered regarding implementation of the Act’s excise tax, including:
- whether the tax will apply to payments made to foreign subsidiaries or subcontractors of U.S. companies;
- how a foreign person or company should determine whether goods are "produced" or services are "provided" in a country that is not a party to an international procurement agreement with the United States; and
- whether the tax applies to the full amount of a specified procurement payment to a foreign partnership if some partners are United States persons.
The two-percent excise tax established by the Act likely will affect a broad range of U.S. government contracts with foreign entities. Government contracting professionals should take the tax into account when pricing and performing procurement contracts, and potentially affected taxpayers should seek further guidance on application of the tax.
[2] Title 26, Section 7701(a)(30) of the United States Code defines "United States person" as (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, (4) any estate other than a foreign estate, and (5) certain trusts.
[3] The website of the WTO describes the WTO-GPA and other free trade agreements. See Government Procurement, World Trade Org. (Mar. 28, 2011, 11:00 AM), http://www.wto.org/english/tratop_e/gproc_e/gpa_overview_e.htm.
[4] See Joint Comm. on Taxation, Present Law and Background Information on Federal Excise Taxes, JCS-1-11, at 38 (Jan. 2011) ("If the origin of the goods or services is in a country that is not a member of the [WTO] GPA, payments made to a foreign parent located in a country that is a member of the GPA are subject to the excise tax.").
[5] Cf. Treas. Reg. § 1.61-22(j)(2)(i) (2008) (noting that agreements materially modified after effective date of tax are treated as new agreements and subject to tax).
[6] See 26 U.S.C.A. § 5000C(d)(1); Joint Comm. on Taxation, Present Law and Background Information on Federal Excise Taxes, JCS-1-11, at 38 (Jan. 2011); see also 26 U.S.C.A. §§ 1441-64, 6001-7874 (2010).
Gibson, Dunn & Crutcher’s Government and Commercial Contracts Practice Group is available to assist in addressing any questions you may have regarding this issue. Please contact the Gibson Dunn attorney with whom you work, or any of the following attorneys in the firm’s Washington, D.C. office:
Karen L. Manos (202-955-8536, [email protected])
Joseph D. West (202-955-8658, [email protected])
Diana G. Richard (202-887-3572, [email protected])
© 2011 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.