April 10, 2020 Public Contract Law Journal

Grappling with Tax Exemption Under Foreign Assistance Contracts, Grants, and Cooperative Agreements

by Andrew Victor & Samuel Jack

Andrew Victor is an associate with Nichols Liu LLP. Samuel Jack is an attorney with the U.S. Agency for International Development (USAID), Office of the General Counsel. This article was co-authored by Mr. Jack in his personal capacity. The opinions expressed in this article are his own and do not necessarily reflect the views of USAID or the U.S. Government. The authors wish to thank Raphael Metzger, Robert Nichols, Jennifer Norling, and Scott Sheffler for their review of this article and insights.

I.  Introduction

When the U.S. Government provides foreign assistance to developing countries, it is typically with the condition that the assistance be exempt from local taxes.1 In turn, the U.S. Government expects organizations that perform foreign assistance contracts, grants, and cooperative agreements to invoke these exemptions.2 As discussed in this article, this policy is designed to maximize the effectiveness of U.S. foreign aid, but it can pose implementation challenges for the U.S. Government and firms performing foreign assistance awards.

Government contractors and grant- or cooperative-agreement recipients that operate abroad enter a web of legal obligations. They must comply not only with U.S. law, such as the Federal Acquisition Regulation (FAR) or the Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance), but also with local law.3 U.S. and foreign compliance requirements can intersect when it comes to taxes — specifically, the foreign legal obligation to pay a local tax and the allowability of such payments for reimbursement under the FAR or Uniform Guidance.4

Jurisdictions, whether foreign or domestic, can impose a variety of taxes upon contractors and recipients, such as income or sales taxes. Entities working overseas may be assessed customs duties to import supplies into a country and excise taxes, which are paid when a contractor or recipient purchases a specific good, such as gasoline, or engages in a specific activity, such as driving a truck on a highway.5 In many countries, firms are required to pay value added tax (VAT) at various points in the supply chain.6 Because of the way taxes are levied, a contractor or recipient may find it difficult to recognize that a tax is being paid.

While exemptions may be available, invoking the exception can be challenging. Depending on the country, contractors and recipients may be unable to invoke effectively the tax exemption because of local tax bureaucracies, inconsistent treatment by local vendors, or a general lack of understanding of the scope of the exemption. In these situations, U.S. Government personnel must assess whether the tax exemption was truly “available” and if the tax payment is otherwise allowable.7 This decision requires an understanding of federal regulations and the applicable bilateral agreement with the host nation, as well as the functioning of the local tax system.

For contractors and recipients, navigating tax exemptions can be a frustrating, time-consuming process that might not be worth the effort. Some organizations certainly shrug and view paying (and not being reimbursed for) a potentially exempt tax as a cost of doing business.8 For others, particularly smaller recipients, the stakes can be higher; payment of taxes for which there is an exemption may result in a disruptive cost disallowance.9 Organizations operating abroad must take the time to understand the tax regimes in the countries in which they are working and make clear-eyed decisions on whether and how to segregate taxes among their expenses.

This article begins with a general discussion of the allowability of tax payments under federal contracts, grants, and cooperative agreements and the relevant case law. It proceeds to describe the kinds of exemptions that exist when performing overseas, how such exemptions are invoked, and practical considerations for determining the allowability of foreign tax payments, notwithstanding the availability of an exemption. It concludes by discussing the contract disputes process and the significantly more complex process for appeals of disallowances under grants and cooperative agreements. While this article focuses on allowability under foreign assistance awards issued by the U.S. Agency for International Development (USAID), it will discuss the government-wide legal requirements and draw upon the practices of other agencies, most notably the Department of Defense (DoD).

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