April 10, 2020 Public Contract Law Journal

Maintaining Profitability of Government Contracts in the Age of Increasing Tariffs

by Jedediah R. Bodger

Jed Bodger is the Vice President of Taxation at Sierra Nevada Corporation (SNC). He holds a law degree from Temple University and an LLM in taxation from Northwestern University. Recognized as one of “The World’s Top 10 Most Innovative Companies in Space,” SNC provides customer-focused advanced technology solutions in the areas of space, aviation, electronics, and systems integration. SNC’s diverse technologies are used in space exploration and satellites, aircraft integrations, navigation and guidance systems, threat detection and security, scientific research, and infrastructure protection, among others.

I.  Introduction

The imposition of tariffs on imported goods and services is likely to create headaches for government contractors who source goods from foreign countries, either for direct delivery to the U.S. Government or for integration into goods and services being delivered to the U.S. Government.1 In particular, the imposition of tariffs will increase the costs of goods and services that government contractors, including those working with the Department of Defense (DoD), are going to pay for materials and goods in furtherance of their contract with the U.S. Government.2 Without careful planning, these increased costs may erode the profit margins that these companies expect to realize from execution of the underlying contracts.3 Through careful planning and review of existing contracts, there is an opportunity for contractors to preserve their profit margins through a price adjustment from the U.S. Government. While contractors are likely familiar with economic price adjustment provisions, such price adjustments may not provide sufficient relief to maintain profitability in the midst of the current escalating trade war and corresponding tariffs imposed.4 While customs and duty relief is available to government contractors through the Federal Acquisition Regulation (FAR), such relief requires treatment of the contractor as a buying agent for the U.S. Government, which at times may be impractical, and the government may be unwilling to classify contractors as such.5 Therefore, the price adjustment mechanism for after-imposed federal taxes may be the best opportunity for government contractors to maintain profitability on contracts impacted by the imposition of increased tariff costs.6 Specifically, this article argues that the imposition of a tariff is considered the imposition of an excise tax, and contractors may be able to use the FAR in order to preserve their profit margins though a price adjustment for after-imposed federal excise taxes.7 The linchpin in such an analysis will be whether the imposition is considered an after-imposed federal tax as that term is defined at FAR 52.229-3.8 Thus, analysis of the Internal Revenue Code (IRC) and the attendant provisions and rulings will assist in the determination that a tariff constitutes a federal excise tax.9 The interplay between the FAR and the IRC is the crux of such a determination.

Part II of this article walks (briefly) though the current trade war and how we have ended up in a position where the U.S. Government has imposed significant tariffs on certain goods and services imported from various countries. Part III analyzes how these tariffs will impact acquisition costs for government contractors and how those contractors may be able to use certain FAR clauses (and more specifically, the corresponding Defense Federal Acquisition Regulations Supplement (DFARS) clauses for defense contractors) in order to preserve profitability of existing contracts. Part IV looks at the treatment of tariffs under the IRC to confirm treatment of tariffs as a federal excise tax for a conclusive determination that such tariffs constitute after-imposed federal taxes for FAR purposes. Part V concludes and reflects on the article’s findings. This article focuses upon the treatment of tariffs under the IRC and its interplay with the FAR and concludes that the imposition of tariffs is considered an after-imposed federal excise tax, which provides a path to profitability salvation for government contractors impacted by increased tariffs on goods utilized in the completion of government contracts. Ultimately, the best option to maintain profitability on government contracts for defense contractors is to utilize the after-imposed federal taxes clause of FAR 52.229-3, as it is applicable to tariffs enacted under the current administration and is not subject to the limitations or specific requirements that economic price adjustment or duties clauses require.10

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