Maintaining Profitability of Government Contracts in the Age of Increasing Tariffs

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.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.Without careful planning, these increased costs may erode the profit margins that these companies expect to realize from execution of the underlying contracts. 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. 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. 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. 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. 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. 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. 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.

II. President Trump Enacts Tariffs

Throughout 2018, the United States imposed increasing tariffs as part of the federal government’s current policy to protect domestic economic interests, including an approximately twenty-five percent tariff on imported steel and an approximately ten percent tariff on imported aluminum.

The U.S. Government, primarily through the Office of the President, has escalated a trade war with China, increasing tariffs on goods imported from China. However, the increased tariffs implemented by the U.S. Government touch not only Chinese goods, but also goods imported from other countries such as Canada. While a number of other countries are impacted by the U.S. Government’s position of escalating tariffs, the trade war with China will serve as the backdrop for this article. However, the analysis herein is applicable to tariffs imposed on other countries of import, not solely imports from China.

On December 2, 2018, the United States and China agreed to a temporary postponement of the pending trade tariffs against one another. Specifically, the United States and China agreed to a temporary truce to deescalate trade tensions during the G20 Summit in Buenos Aires. According to the agreement, both the United States and China would refrain from increasing tariffs or imposing new tariffs for ninety days (until March 1, 2019), as the two sides worked towards a larger deal. With a ninety-day reprieve given to persons impacted by the implementation of tariffs imposed by the U.S. Government on Chinese imports, affected industries had a little more time to breathe and reevaluate their positions during the ongoing U.S.-China trade war.

Pursuant to the statements issued by both countries at the announcement of the temporary armistice in this trade war, the United States promised to refrain from increasing so-called “List 3” tariffs of the Chinese imports to be impacted by increasing tariffs that were slated to increase from ten percent to twenty-five percent on January 1, 2019. In addition, the United States agreed to not impose previously threatened tariffs on an additional U.S. $267 billion worth of Chinese goods. At the same time, China agreed to not restrict its spending on U.S.-produced goods and services and promised to attempt to restrict the production and distribution of Fentanyl, a synthetic opioid produced primarily in China. How did we get here?

Prior to this reprieve, the two nations had been trading jabs over an escalating trade war that saw the implementation of U.S. tariffs on Chinese goods and corresponding counter-tariffs imposed by China against U.S. goods. The first round of tariffs imposed on Chinese goods by the United States was issued by the White House in June 2018, listing 818 products subject to tariff and becoming effective on July 6, 2018. The July 2018 tariffs required col- lection of a twenty-five percent tariff on the 818 listed products. In response, China took a retaliatory posture, imposing its own twenty-five percent tariff on 545 goods originating from the United States. After release of the first round of listed products, the U.S. Trade Representative, apparently at the direction of the White House, issued a proposed second round of tariffs, proposing the same twenty-five percent tariff on an additional 279 Chinese products, with a focus on iron, steel, electrical machinery, railway products, and instruments and apparatuses.

This updated list of goods subject to tariffs, which was to take effect on August 23, 2018, came after much debate about the appropriate scope of the second round of tariffs to be imposed. This second round of tariffs on Chinese goods also implemented a twenty-five percent tariff on goods originating from China, such as semiconductors, chemicals, plastics, motorbikes, and electric scooters. This second tranche of goods subject to tariffs was met with a similar expansion from China, which implemented retaliatory tariffs on 333 goods originating from the United States, including commodities such as coal, copper scrap, fuel, buses, and medical equipment.

On September 18, 2018, the United States once again increased the list of items originating from China that it intended to subject to import tariffs. This expanded group of Chinese-imported goods subject to U.S. import tariffs became effective on September 24, 2018; they carried an initial tariff rate of ten percent and the threat of an escalation to twenty-five percent by January 1, 2019. Once again reacting to the United States, China expanded their list of U.S. goods subject to import tariffs and matched the initial tariff rate of ten percent for certain products.

The date for triggering the escalation clause within the last tranche of tariffs was originally suspended until March 1, 2019, with periodic tariff exemptions from both sides enacted since then. While the trade war toggles between states of temporary cease fire and active engagement, the evocation of protective clauses within the FAR, regardless of where the trade war currently finds itself postured, will be key to effective maximization and maintenance of profit for government contractors who may otherwise find themselves the unintended casualties of trade negotiations between the United States and other countries. Ultimately, even with all of the posturing and sabre rattling between the countries, there is a high likelihood that the imposition of tariffs will create a significant impediment to profitability for government contractors whose costs of performance have increased in the midst of trade tension. The current tariff situation is fluid; prior planning and advanced considerations by government contractors, however, may provide an ability to apply concrete analysis and ensure profit stability on ground that otherwise appears to be unstable.

III. Potential for Maintaining Profitability

With government contracts already in place and in the period of performance at the time of the imposition of tariffs from China, Canada, and beyond, government contractors face increased pressure to maintain their profit margins in the face of expanding costs in the form of tariffs. Depending on the type of contract and the provisions included in the standard government contracting vehicle, the contractor may have an opportunity for cost recovery and the preservation of profitability through the application of a pricing adjustment. The contractor may be able to use the economic price adjustment provision at FAR 52.216, the customs and duties provision of FAR 25.9, or possibly the after-imposed federal tax adjustment at FAR 52.229-3 and FAR 52.229-4. The after-imposed federal tax adjustment seems to provide the best opportunity for maintaining profitability, as it has no cap to the adjustment that can be had, and it does not require agency relationship between the U.S. Government and the contractor. However, there must be a conclusive determination that the tariffs constitute an “after-imposed federal tax” as that term is defined in FAR 52.229-3.

A. FAR Provisions Indicating That Increase in Excise Is Reimbursable Cost

The FAR is applicable to all purchases of goods and services by the U.S. Government and its agencies. Defense contractors are subject to another layer of contracting regulation, the DFARS, which provides a secondary overlay to the bedrock contracting requirements of the FAR. These standards are promulgated by the DoD. The FAR sets out the requirements for contract formation and administration, and where necessary, price adjustments. Contractors have several options for price adjustment in situations where the underlying cost of performance varies from the stated contract price, which was based on the type of contract between the contractor and the U.S. Government.

When the imposition of tariffs increases the cost of performance to the contractor, an equitable adjustment to the contract value through the economic price adjustment provisions may provide relief to the contractor. However, there are qualification requirements and limitations on the use of the economic price adjustment provisions. Similarly, a contractor may be able to mitigate the impact of tariffs through an exclusion from their application under FAR 25.9. This exclusion requires the contractor to be in a direct agency relationship with the U.S. Government, which may prove to be a high bar to clear. Where an after-imposed tax is placed on a contract, the contractor has an opportunity to obtain a price adjustment through utilization of FAR 52.229-3, which permits a pricing adjustment for an after-imposed federal tax where such “newly imposed [f]ederal excise tax . . . [was not] included in the contract price, as a contingency reserve or otherwise.” As more fully fleshed out below, the imposition of a tariff is likely considered an after-imposed federal tax giving rise to the availability of a contract price revision under FAR 52.229-3.

Therefore, establishing a clear tie between federally imposed tariffs and the IRC will permit a contractor to argue that it is entitled to a price increase if the tariffs imposed by an increasing tariff environment constitute an after-imposed federal excise tax for purposes of FAR 52.229-3. It may be possible, under a “belt and suspenders” approach, to further bolster the con- tractor’s position through application of an economic price adjustment pursu- ant to FAR 52.216-4 or pursuant to the customs and duties provision of FAR 25.9, in addition to the after-imposed federal excise provisions. However, those price adjustment provisions have limitations that may make recovery by the contractor difficult.

1. Economic Price Adjustments

In most fixed price contracts, “the contractor bears the risk of any increase in material costs unless there is a contract clause shifting the risk to the [g]overnment.” There are economic price adjustment clause provisions that allow a contractor to preserve profit in the face of unanticipated events: these economic price adjustment tools are vehicles that government contractors may use to mitigate the profit erosion that occurs from an increase in cost of performance. The economic price adjustment provision of FAR 52.216-4, “Economic Price Adjustment — Labor and Material,” is one such clause that allows a contractor to request a price adjustment from the government where there is a change in material costs.

Generally speaking, FAR 52.216-4 provides an equitable adjustment in the contract price if the rate of pay for labor or the unit prices for materials shown in the contract schedule either increases or decreases in a volume sufficient to create at least a three percent net change in the then-current total contract value. The contractor may request multiple increases over time; however, there is a limit in the aggregate adjustments that may be granted under the clause — ten percent of the original unit price unless the standard clause has been modified to increase this limitation.

An economic price adjustment is permissible under FAR 52.216-4 where an economic price increase clause exists in the contract and the contractor noti- fies the Contracting Officer during the period of performance for the contract that the cost of materials shown in the contract schedule are subject to either increase or decrease due to factors outside the contractor’s control. Once this change in pricing is identified and determined, the contractor must notify the Contracting Officer within sixty days after identification of the increase or decrease. The contractor must also submit a proposal for a contract adjustment along with the notice and provide supporting data, including the cause of the increase or decrease, the effective date, the “amount of the increase or decrease[,] and the amount of the [c]ontractor’s adjustment proposal.”

Concerns may arise that no economic price adjustment is available in the instance of an imposition of tariffs. This is because price adjustment under the economic price adjustment provision requires that the change in cost be a direct change to unit price for material shown in the materials schedule. FAR 52.216-4(c)(1) states:

Any adjustment shall be limited to the effect on unit prices of the increases or decreases in the rates of pay for labor (including fringe benefits) or unit prices for material shown in the [s]chedule. There shall be no adjustment for . . . (i) [s]upplies or services for which the production cost is not affected by such changes; (ii) [c]hanges in rates or unit prices other than those shown in the [s]chedule; or (iii) [c]hanges in the quantities of labor or material used from those shown in the [s]chedule for each item.

Therefore, it is clearly stated that there shall be no adjustment for changes in rates or unit prices other than those shown in the schedule. Practically speaking, this means that when a tariff rate is imposed on the cost of goods, the contractor may not be entitled, under the economic price adjustment clause, to a contract price adjustment if there is no change in unit price for imported goods within the schedule. Frequently, the schedule does not include unit prices for any integration, building, or construction materials; rather, there is simply a lump sum unit price for the entire effort. Without a unit price for a specific item, it is unclear how effective FAR 52.216-4 will be for contractors seeking to recover an equitable adjustment for increased material costs due to tariffs.

Even where imported goods are specifically listed within a contract schedule, the possibility remains that the Contracting Officer will dispute the charge as not a direct increase to the cost of the goods (as the unit price of such goods may remain stagnant). Specifically, the imposition of a tariff is likely a separately stated line item either through the customs agent or otherwise split out from the unit cost of the materials, meaning that the total cost has risen by the imposition of the tariff but the unit price cost has not. In this instance, the U.S. Government arguably has an ability to resist the requested price increase under the economic price adjustment clause, meaning the Contracting Officer has leverage to reject the requested contract value increase under the economic price adjustment clause in its entirety, as it is arguably not a permissible price increase under FAR 52.216-4(c).

Alternatively, assuming there is an argument that because the tariffs are scheduled to specific items, the direct cost of the tariff is calculable based on the unit price of goods imported by the contractor, there may be a rationale for concluding there is indeed an increase to the listed unit price of the goods. Assuming the goods in question are listed within the contract schedule, there is at a minimum a way to tie the increased tariff costs directly to the imported goods set out within the schedule. However, it will still not register as an increase in the listed price of the imported property. This may be enough to give some contractors heartburn on the issue of even attempting to request a pricing increase through the economic price adjustment clause.

Even where an economic price adjustment is permissible under FAR 52.216-4, the benefit of such an upward adjustment may be limited, as upward adjustments under this provision are typically limited to ten percent of the unit price within the contract. Alternatively, there may be a better path to preserving profitability through the price adjustment clause for after-imposed federal excise taxes.

2. Economic Price Adjustment Under DFARS

For defense contractors, the analysis above should continue to hold true because the DFARS provides for the utilization of the economic price adjustment provision as set out in FAR 52.216-4. Specifically, DFARS 216.203-4 states that defense contractors should “[g]enerally, use the clauses at FAR 52.216-2, Economic Price Adjustment — Standard Supplies, FAR 52.216-3, Economic Price Adjustment — Semistandard Supplies, and FAR 52.216-4, Economic Price Adjustment — Labor and Material” when the total contract price exceeds the simplified acquisition threshold (currently $250,000) and when delivery or performance occurs more than six months after the contract award. The current simplified acquisition threshold was increased via the National Defense Authorization Act for Fiscal Year 2018 and is determined in accordance with appropriate inflation adjustment pursuant to 41 U.S.C. § 1908. Based on the relatively low value of the simplified acquisition threshold, there is ample opportunity for contract price revision for defense contractors. Similarly, the period of performance for many DoD contracts extends well beyond six months after contract award. Therefore, it is reasonable to conclude that most DoD contractors will be able to utilize the standard economic price adjustment provisions of the FAR.

Based on DFARS 216.203-4, the economic price adjustment clauses are available for the adjustment of prices where tariffs have increased the scheduled list price of goods shown within the contract schedule. Again, however, the ten-percent cap on upward revision could limit the benefit that defense contractors receive from an economic price adjustment where, say, a twenty-five percent tariff has been applied. Under this DFARS analysis, similar to the FAR economic price adjustment analysis above, if the tariff has not affected scheduled list price, there is a possibility that an economic price adjustment is not available to the contractor or that the Contracting Officer may reject the economic price adjustment request out of hand.

3. FAR Part 25.9: Customs and Duties

Specifically enumerated within the FAR are the treatment of certain customs and duties, such as tariff duties. However, as demonstrated below, FAR 25.9 may not offer the perfect solution in the case of increased tariffs on imported goods.

FAR 25.9 provides authority for the exemption of tariffs and other import duties from certain acquisitions of supplies purchased on behalf of the U.S. Government. Where cost savings may be had, FAR 25.901 provides the government policy to utilize exemptions from import duties. More specifically, “[a]gencies must use these exemptions when the anticipated savings to appropriated funds will outweigh the administrative costs associated with processing required documentation.” The exemption from tariff duties on procured supplies is applicable to those goods under Subchapters VIII and X of Chapter 98 of the Harmonized Tariff Schedule of the United States. Subchapter X deals with importation of religious, educational, scientific, and other institutions and is therefore not pertinent to this discussion.

Subchapter VIII is specific to importations of the U.S. Government. These importations include articles designated for military departments and for the National Aeronautics and Space Administration (NASA). It is these provisions that will provide an opportunity for defense contractors seeking to use an exclusion from the application of tariff duties.

For the exemption from import duties under FAR 25.903 to be applicable, the contractor must be operating as a purchasing agent for the U.S. Government. Typically, the government is loath to consider a contractor as a purchasing agent for the U.S. Government, especially with regard to the application of state and local taxes in connection with the acquisition of goods for the U.S. Government. However, in the acquisition of goods on a direct contract with the federal government, where the acquisition is impacted by import duties, the contractor may wish to make use of FAR 25.903 to work with the federal government to avoid the import duties entirely. Where the Contracting Officer agrees, contractors may be able to utilize FAR 51.1 in conjunction with FAR 25.9 to remove tariffs from importation of materials needed under a government contract.

i. FAR Part 51: Contractor Use of Government Supply Sources

FAR 51 provides government contractors with a mechanism to use government sources for the acquisition of materials and goods through government supply sources. FAR 51.1 outlines the authority and procedures for both the federal Contracting Officer and government contractor and “prescribes policies and procedures under which contractors may use government supply sources.” For a government contractor to utilize government supply sources, the Contracting Officer must authorize the contractor “to use General Services Administration (GSA) sources of supply in the performance of cost-reimbursement contracts and under other limited scenarios when determined to be in the best interest of the [g]overnment.”

Ultimately, where the contractor and the Contracting Officer agree to utilize FAR 51.1 for the acquisition of materials in furtherance of a contract, the Contracting Offer must authorize the contractor to use such acquisition sources (FAR 51.1 Letter). Where a FAR 51.1 Letter has been issued, the contractor may use GSA acquisition avenues, which allows for streamlining procurements, leveraging the buying power of the U.S. Government, and for purposes of this article, demonstrating both the characterization of the contractor as a buying agent for the United States and the applicability of FAR 25.9 in the elimination of customs and duties on the acquisition price. Obtaining a FAR 51.1 Letter and the use of FAR 51.1-sanctioned government supply sources for acquisition of goods should have the effect of eliminating any tariff levy on the goods acquired in furtherance of a contract.

In addition, “the GSA Senior Procurement Executive signed a class deviation that allows [C]ontracting [O]fficers to authorize all GSA contractors per- forming on a time-and-materials (T&M) or labor-hour (LH) basis to purchase ancillary supplies and services from [s]chedule contractors and/ or to process requisitions through the GSA Global Supply Program” (FAR 51 Deviation). The FAR 51 Deviation provides an additional avenue to avoid tariffs — albeit under the FAR 25.9 theory of agency — for T&M and LH contracts, which otherwise would not be eligible to use government supply sources under FAR 51.1. The application of FAR 51.1 acquisition practices could eliminate the application of tariffs on materials entirely under FAR 25.9. The risk remains that the Contracting Officer will conclude that the contractor is not a purchasing agent for the U.S. Government and will consequently refuse to issue a FAR 51.1 Letter. In that instance, FAR 25.903 may not serve to exempt the contractor for the increased tariff costs, and the contractor will have to explore other avenues.

4. Price Adjustment Under After-Imposed Excise Tax (FAR 52.229-3)

In a situation where the import duties or tariffs are unavoidable, and where their imposition occurs after the establishment of the contract and during the period of performance by the contractor, the contractor may be able to utilize a pricing revaluation clause, such as that found at FAR 52.229-3. Where a contractor is subject to the imposition of increasing after-imposed tariffs, assuming that the tariffs meet the regulatory requirements of FAR 52.229-3, relief may be available to the contractor for increased costs, thereby maintaining profitability of the underlying contract. When evaluating whether a tariff triggers this clause, there must be an evaluation of the specific requirements within FAR 29 as well as a determination that such tariff actually qualifies as an after-imposed federal tax.

FAR 52.229-3 states that “[t]he contract price includes all applicable [f]ederal, [s]tate, and local taxes ” Relatively little case law interprets the impact of FAR 52.229-3 through the application of an after-imposed federal tax, as the majority of case law on this clause stems from disputes with regard to application of state and local tax levies not contemplated in the contract price bid to the U.S. Government. The imposition of an after-imposed federal tax is one of the limited exceptions to firm fixed price contracting, and it permits the contractor as taxpayer to request a price adjustment based on the increased costs due to the after-imposed federal tax.

Tariffs have a significant impact on the economics of any market based transaction, and escalating tariffs will naturally flow to the end consumer in the form of higher prices. In the government contractor and defense industries, where large-scale contracts are set and performance typically takes the form of a long-term contract in excess of twelve months for performance, the imposition of a tariff after the contract has been executed but before performance has concluded increases costs and can significantly erode profits. However, this article proposes that there is a mechanism for contractors to maintain profitability in the face of a changing cost structures due to rising tariffs.

As a general matter, this article argues that a tariff likely constitutes an after-imposed federal tax for purposes of FAR 52.229-3. FAR 52.229-3 provides a repricing mechanism for federal contractors upon the imposition of an after-imposed federal tax. Specifically, FAR 52.229-3(c) states that a contract price “shall be increased by the amount of any after-imposed [f]ederal tax, provided the [c]ontractor warrants in writing that no amount for such newly imposed [f]ederal excise tax or duty or rate increase was included in the contract price, as a contingency reserve or otherwise.”

Where an after-imposed tariff increases cost of performance under a con- tract, the contractor may be able to avail itself to the terms of FAR 52.229- 3(c). To take advantage of a cost adjustment clause within FAR 52.229-3, the contractor must demonstrate that the increased cost is due to a newly imposed federal excise tax that was not included in the pricing terms of the contract, as a contingency or otherwise.

When evaluating whether a tariff triggers these clauses, there must be an observation of the specific requirements within FAR 29, as well as a determination that such a tariff qualifies as an after-imposed federal excise tax. The sections below will address whether tariffs constitute federal excise taxes under both the FAR and the IRC, as well as whether there are other mechanisms for relief under the FAR.

i. Christian Doctrine Considerations

Where contracts are being reviewed and there is a requirement for acquisition of goods from a foreign country, contractors should pay special attention to the inclusion of the after imposed federal excise tax provision within the contract. Even where that provision is not initially provided within the contract, there is a possibility that it could be read into the contract at a later date under the Christian doctrine.

As a general matter, the Christian doctrine provides that certain clauses are of such importance in government procurement that a “mandatory statute or regulation that expresses a significant or deeply ingrained strand of public procurement policy shall be read into a federal contract by operation of law, even if the clause is not in the contract.” Whether the Christian doctrine applies “turns not on whether the clause was intentionally or inadvertently omitted, but on whether procurement policies are being avoided or evaded (deliberately or negligently).” The Christian doctrine provides an exception to the general rule of incorporation by reference within contract construction and interpretation. Ultimately, the Christian doctrine is a pragmatic approach to government contracting, recognizing the broad breadth of the FAR and providing a rationale for government procurement policies that may not have been appropriately memorialized within final executed contracts.

The effect of the Christian doctrine is the ability for a court (or possibly even the federal government itself, if it is amenable to it prior to litigation) to reform a contract and impute standard government contracting canons that are imperative to the implementation of government procurement policies. The Christian doctrine, however, is somewhat limited. For it to apply, there must be specific procurement regulations relating to the issue at hand that express a “significant or deeply ingrained strand” of public policy. These limitations thus prevent the application of the Christian doctrine in every single government contract-related dispute and in relation to every single FAR and DFARS provision and, ultimately, limit its scope.

While no universal list of clauses covered by the Christian doctrine exists, courts have consistently held that certain clauses are generally so ingrained within the procurement policy of the United States that such clauses can effectively be read into the contract where such has been omitted. Such clauses include the disputes clause; termination clauses; changes and payment clauses; Equal Opportunity and Affirmative Action clauses; clauses implementing the Miller Act and Davis-Bacon Act; and clauses implementing provisions of the Buy America Act and Truth in Negotiations Act. The perception is that such clauses meet the “significant or deeply ingrained strand of public procurement policy standard.” “Again, while the Christian doctrine does not require a court to insert a clause into a government contract, it has been utilized in numerous instances and as to a variety of provisions.”

Of particular importance with regard to tariffs in the context of the Christian doctrine are the changes and payment clauses. For example, with regard to time and materials contracts, the time and materials payments clause, mandated by regulation to be included in time and materials contracts, expresses a purpose “sufficiently ingrained in public procurement policy to properly trigger use of the Christian [d]octrine.” As such, this article proposes that clauses relating to payment and changes to payments impacting government contracts may have a foothold to demand insertion of the after-imposed federal excise provision of FAR 52.229-3.

While such an argument may make logical sense, contractors still face an uphill battle in having the after-imposed federal excise tax clause of FAR 52.229-3 imputed to a commercial items contract. In 2012, the Civilian Board of Contract Appeals held in Hillcrest Aircraft Co. v. Department of Agriculture (Hillcrest Aircraft) that the after-imposed federal excise tax provision does not warrant inclusion in a contract under the Christian doctrine as it is not of such policy significance to require it to be read into contracts where it has failed to be originally included.

In Hillcrest Aircraft, a helicopter services company contracted with the Department of Agriculture for the provision of fire support services. The resulting contract incorporated clauses of the FAR, specifically FAR sections 52.212-1, 52.212-3, 52.212-4, and 52.212-5; it failed, however, to incorporate FAR 52.229-3. There, the board held that the standard tax clause of FAR 52.229-3 “is not a mandatory clause for commercial item contracts. Rather, the mandatory clause is the Commercial Item Tax clause[] incorporated into the appealed contract.”

Similarly, in Diebold Enterprises Security Systems, Inc. v. Low Voltage Wiring, Ltd., Diebold Enterprises Security Systems (Diebold), as a subcontractor, attempted to achieve an equitable price adjustment for sales tax that it failed to adequately account for when submitting a bid proposal to the prime contractor performing work for the United States Army Engineering and Support Center. There, the after-imposed federal excise provision was included within the contract, but the court held that the imposition of a sales tax was neither an after-imposed tax, nor a federal excise as required under FAR 52.229-3.

A full analysis of the Christian doctrine and its applicability to FAR 52.229-3 is outside the scope of this article, but practitioners should proceed with caution, as it is not entirely clear that the after-imposed federal excise provision of FAR 52.229-3 will be considered within the scope of the Christian doctrine. As such, practitioners should be conscious of FAR 52.229-3 and ensure its inclusion in any contract that may be subject to tariff price fluctuations.

IV. Tariffs as an After-Imposed Federal Excise

While not specifically enumerated as such within the IRC, a strong case could be made that tariffs constitute a federal excise tax and therefore trigger the price adjustment clause within FAR 52.229-3. However, to be certain in this approach, the contractor should feel confident that the tariffs not only constitute a duty under the FAR but are also considered a federal excise tax under the IRC.

A. Tariffs as a Reimbursable Cost Under the FAR

FAR 52.229-3(c) allows for a contract price increase in the event of an “after-imposed [f]ederal tax.” “After-imposed [f]ederal tax” is defined at FAR 52.229-3(a) to include “any new . . . duty” that is the result of administrative action. Using the March 8, 2018, presidential proclamation on steel tariffs as an example, the tariff is likely such a qualifying duty for several reasons. The tariff was imposed following a Secretary of Commerce investigation, pursuant to section 232 of the Trade Expansion Act of 1962 and section 604 of the Trade Act of 1974 (Trade Act). While FAR 52.229-3(a) does not use the term “tariff,” the Trade Act defines a duty as “the rate and form of any import duty, including but not limited to tariff-rate quotas.” Further, the Trade Act uses the term “duty” to describe the scope of the president’s power to amend the Harmonized Tariff Schedule. In the presidential proclamation, the terms duty and tariff are used interchangeably. Accordingly, this article posits that the term “duty” in FAR 52.229-3 encompasses a tariff, such as the steel tariff outlined in the March 2018 presidential proclamation.

It also appears evident that a tariff would constitute a duty pursuant to FAR 25.9. However, when evaluating the determination that a tariff is indeed a duty under the FAR, in particular when attempting to determine whether a tariff is considered an after-imposed federal excise tax, it is instructive to look at FAR 29, entitled “Taxes.” Specifically, the imposition of FAR 52.229-3 is based on the requirements for contract clauses stemming from FAR 29.401-3.

FAR 29 deals exclusively with taxes, and Subpart 29.2 focuses specifically on federal excise taxes. FAR 29.201(a) provides: “Federal excise taxes are levied on the sale or use of particular supplies or services.” This sentence is directly followed by the citation “[s]ubtitle D of the Internal Revenue Code of 1954 [sic], Miscellaneous Excise Taxes, 26 U.S.C 4041, et seq., and its implementin regulations, 26 CFR parts 40 through 299....... ” As such, the FAR definition of excise taxes and the IRC definition of taxes are intrinsically linked.

B. Excise Taxes Generally

“Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks. One of the major components of the excise program is motor fuel.”

The IRC provides for specific excise taxes within Subtitle D, as referenced by the FAR. None of the taxes outlined in these sections is a tariff. Rather, they are specific federal excises that relate primarily to fuels, heavy trucks, and trailers.

The imposition of an excise tax on specific activities or goods or services has been regularly referred to as a “tariff,” even prior to the inception of the income tax. In 1909, Congress adopted an excise tax on the income of corporations. The Tariff Act of 1909 imposed a tax on “every corporation organized for profit. . . .” Such direct taxation of corporations was later refined and is reflected in the current system of direct taxation under the IRC. However, instances of excise taxes levied by the federal government continue to exist, and, in fact, the levy of tariffs represents a significant instance of such an excise tax levy by the U.S. Government. Thus, an excise tax can be levied on any transaction, good, or service. An early Supreme Court case involving the validity of such a tax was Flint v. Stone Tracy Co. The Court sustained the corporation tax law under the Tariff Act of 1909 and determined that it was a valid excise tax on doing business in the corporate form. Thus, import tariffs, whether referred to as tariffs, duties, or import taxes, are without a doubt the imposition of a federal excise on the importation of such goods. Ultimately, the distinctions between “duty,” “tariff,” and “tax” are irrelevant, as all three represent a federally imposed excise. As they say, “What’s in a name? [T]hat which we call a rose [b]y any other name would smell as sweet.” That being said, tariffs can be tied to the levy of an excise tax directly through Subtitle I of the IRC, which further confirms their status as a federally imposed excise tax.

C. Tariffs as Excise Tax Under the Internal Revenue Code

As a general matter, IRC section 164 provides for the deductibility of taxes paid by a taxpayer during the year. In contrast, IRC section 275 provides a denial of such deductibility for certain taxes. Pursuant to enactment of the Tax Cuts and Jobs Act (TCJA), taxpayers have become limited in their ability to take miscellaneous itemized deductions, including the deduction for certain taxes paid.

Specifically, Treasury Regulation (Treas. Reg.) section 1.164-2(f) provides that tariff duties are not deductible taxes. To put a finer point on the fact that the IRC considers tariffs excise taxes, Treas. Reg. section 1.164-2(f) states: “Federal import or tariff duties, business, license, privilege, excise, and stamp taxes . . . paid or accrued within the taxable year [are not deductible].”

However, limitation to deductibility under IRC section 164 does not fully limit the deductibility of such taxes paid. Treas. Reg. section 1.164-2(f) goes on to state:

The fact that any such tax is not deductible as a tax under section 164 does not prevent (1) its deduction under section 162 or section 212, provided it represents an ordinary and necessary expense paid or incurred during the taxable year by a corporation or an individual in the conduct of any trade or business or, in the case of an individual for the production or collection of income, for the management, conservation, or maintenance of property held for the production of income, or in connection with the determination, collection, or refund of any tax, or (2) its being taken into account during the taxable year by a corporation or an individual as a part of the cost of acquiring or producing property in the trade or business or, in the case of an individual, as a part of the cost of property held for the production of income with respect to which it relates.

In a similar vein, IRC section 275 provides for a denial of deduction for certain taxes paid. Treas. Reg. section 1.275-1 states in full: “For description of the taxes for which a deduction is denied under section 275, see paragraphs (a), (b), (c), (e), and (h) of [section] 1.164-2.” Ultimately, as demonstrated by these excerpts, these provisions within the IRC both have direct references to tariffs within the section addressing denial of deductibility for excise taxes paid.

As such, the language of Treas. Reg. section 1.164-2(f) seems to confirm that tariffs are considered a federal excise tax because it is specifically lumped in with various other federal excise taxes, with the specific intention of limiting deductibility under section 164 as a tax paid or accrued during the year. While carve-outs are made with regard to deductibility under IRC sections 162 (trade or business expenses) and 212 (expenses for the production of income), the net impact appears to be simply for the Treasury Department (Treasury) to permit the allowance of an itemized deduction for ordinary and necessary business costs without requiring the classification of tariffs as an excise tax for deductibility in the year incurred. This analysis is not fatal to the argument that a tariff is a federal excise tax under the IRC and the Treasury Regulations. On the contrary — it is beneficial to that conclusion, based on the premise that it has been specifically included in the regulations dealing with denial of deductibility of federal excise taxes. This legal principle has been consistently applied to deductibility under the IRC since at least 1942 and is often referred to as “inclusio unius est exclusio alterius” or “expressio unius est exclusio alterius.” As a matter of practice, the inclusion of the term “tariff” within regulation is interpreted to be intentional, and therefore its use must be a guiding principle for interpretation of the regulation.

The specific reference to tariffs within Treas. Reg. section 1.164-2(f) for denial of deduction for certain taxes seems indicative of the intention of the Treasury, that is, that tariffs be considered a federal excise tax. Treas. Reg. section 1.164-2 is titled “Deduction [D]enied in [C]ase of [C]ertain [T]axes,” and tariffs are specifically enumerated within Treas. Reg. section 1.164-2(f). Therefore, it is reasonable to conclude that tariffs are included in this section as “certain taxes.”

Further, tariffs are an excise tax by their very nature because they are imposed on the purchase of goods or importation of goods and are not by nature an income tax or other type of direct tax. Therefore, the imposition of a tariff, as a tax, is necessarily an excise tax. This characterization of a tariff as an excise tax under the IRC ties into the imposition of the IRC and the promulgation of Treas. Regs. themselves.

D. History of IRC Section 164: Demonstrating Tariffs as an Excise Tax Under the IRC

The treatment of tariffs as excise taxes and their fluctuating deductibility, or lack thereof, as excise tax payments has been established and has existed in the IRC from inception. As will be discussed shortly, import or tariff duties were allowable as deductible taxes in early iterations of federal tax law, provided they were not included as deductible business expense within the taxpayer’s books. As noted above, the current analysis has flipped, insofar as such taxes are not currently deductible as taxes themselves but are permissible where such costs are ordinary and necessary business expenses.

In a case from the 1920s, the Court of Claims analyzed article 132, a pre- cursor to IRC section 164. The language of article 132 stated:

Art. 132. Federal duties and excise taxes. — Import or tariff duties paid to the proper customs officers, and business, license, privilege, excise and stamp taxes paid to internal revenue collectors, are deductible as taxes imposed by the authority of the United States, provided they are not added to and made a part of the expenses of the business or the cost of articles of merchandise with respect to which they are paid, in which case they cannot [sic] be separately deducted.

This key language remained unchanged through the 1940 — while renumbered article 23, the language still provided:

Art. 23(c)-2. Federal duties and excise taxes. — Import or tariff duties paid to the proper customs officers, and business, license, privilege, excise, and stamp taxes paid to internal revenue collectors, are deductible as taxes imposed by the authority of the United States, provided they are not added to and made a part of the expenses of the business or the cost of articles of merchandise with respect to which they are paid, in which case they cannot [sic] be separately deducted.

By the time section 164 was addressed pursuant to the Tax Reform Act of 1986, the drafters determined that deductibility of excise taxes was to be eliminated where not in furtherance of a trade or business, leaving deductibility for tariff expenditures in furtherance of a business purpose — but not simply due to their nature as an excise tax.

This historic backdrop furthers the position that tariff duties and excise taxes should be deemed equivalent within the IRC and in the eyes of the Internal Revenue Service. The continued reliance on IRC section 164 and its predecessors bolsters this article’s position that the Treasury itself has a well-worn and established belief that tariffs are considered a federal excise tax, whether deductible or not. This places such contractor costs squarely within the requirements set out within FAR 52.229-3.

V. Conclusion

While there are a number of mechanisms for price adjustment to government contracts within the FAR, in the face of newly imposed tariffs with an impact of greater than ten percent, the after-imposed federal tax provisions, and the corresponding price adjustments available pursuant to FAR 52.229-3, appear to provide the greatest opportunity for relief to government contractors. While an economic price adjustment pursuant to FAR 52.216 is likely the more familiar path to adjusted costs for most government contractors (and DFARS 216.203-4 for defense contractors), the cap on adjustment at ten percent is a potential impediment to profitability for contractors impacted by tariff enactment. The implementation of tariffs at the rate of twenty-five percent is immediately detrimental to the ability to use the economic price adjustment provisions of FAR 52.216, as the hit to contractor profitability pursuant to such a large increase in tariffs on materials likely decreases net profit on a contract beyond the ten percent cap for recovery. Thus, under the economic price adjustment provisions, contractors would still see profitability suffer. While the imposition of tariffs could be eliminated entirely where the contractor is considered a purchasing agent for the U.S. Government, this is a rarity, because the government typically does not consider contractors to be agents of the U.S. Government and would be less likely to declare their purchases acquisitions exempt from the application of tariffs on foreign imports. Thus, while the customs and duty provisions of FAR 25.9 would provide relief to government contractors, in reality, it is unlikely to be utilized given the agency requirements.

The clearest path to maintaining profitability, therefore, is the application of the often forgotten and ignored after-imposed federal tax provisions of FAR 52.229. FAR 29 specifically ties the FAR to the IRC for purposes of determining taxes and classification of such taxes. While tariffs are not specifically enumerated within the IRC as a federal tax, there is tangential and historical precedent supporting that such tariffs likely qualify as a federal excise tax under the IRC. The interplay between the FAR and the IRC has demonstrated that the imposition of tariffs should be considered the imposition of a federal excise tax. As such, newly imposed tariffs that meet the requirements of FAR 29 can be treated as an after-imposed federal excise tax under FAR 52.229, and these provisions may be utilized to request a pricing adjustment for ongoing government contracts where the component goods are subject to increased tariff costs. Without a cap on this price adjustment, the contractor is able to maintain profitability in the face of increased tariffs. Maintenance of profitability is the primary objective for government contractors, and indeed any business. Maintenance of services and a functioning government is the primary objective for U.S. Government agencies procuring goods and services from government contractors. The two are necessarily on opposite sides of the same economic coin, with the government wanting to lower prices and to increase availability of goods and services, while businesses are intent on increasing profit margins. Tariff levies impose an additional cost burden on businesses without changing the original requirements for delivery of goods or services. Tariffs simply reduce profit margin by increasing costs to perform without providing a corresponding increase in revenue generated by performance. The ability to utilize the imposition of new tariffs as an after-imposed federal tax to fully recover tariffs as an unanticipated cost gives contractors the flexibility necessary to continue to perform the obligations of their contracts without concern for the bottom line of enhanced profit protection in furtherance of defense, national security, and national prerogatives.