Final rules issued for tax on payments to foreign federal contractors
TAX ALERT |
The James Zadroga 9/11 Health and Compensation Act of 2010 added section 5000C to the Internal Revenue Code, which imposes a 2 percent excise tax on certain U.S. government payments to foreign contactors. Although section 5000C was effective Jan. 2, 2011, regulations implementing the tax were not proposed until April 22, 2015. These proposed regulations have now been finalized, and provide for various procedures and exemptions relating to the section 5000C excise tax. Taxpayers who have not complied with section 5000C may satisfy their obligations without penalty provided they follow special rules.
The section 5000C tax applies to any payment made to a foreign person pursuant to a contract with the U.S. government for the purchase of goods or services, if the goods are produced or services are provided in a country that is not a party to an international procurement agreement with the United States. The final regulations provide several additional types of payments that are exempt from the tax:
- Payments made under federal simplified acquisition procedures (applies to certain purchases under $150,000)
- Payments made for emergency acquisitions
- Payments for services provided by a single individual that does not (and will not) exceed the simplified acquisition threshold in a given calendar year
- Payments made pursuant to foreign humanitarian assistance contracts
- Payments that are otherwise exempt from tax based on an income tax treaty or other international agreement
The regulations provide that payments under a given contract may be fully or only partially exempt from the section 5000C tax, and provide procedures for calculating the tax for partially exempt payments. Only direct contractors are liable for the tax—foreign subcontractors of U.S. direct contractors are not liable for the tax (subject to anti-abuse considerations).
Section 5000C also provides that the tax will be collected through withholding by the government agency making the contract payment. In furtherance of this, the regulations provide a self-certification mechanism, similar to the existing W-8/W-9 regime, for foreign contractors to establish themselves as wholly or partially exempt from the tax. Withholding will be done in the same manner as withholding on payments of fixed, determinable, annual or periodic (FDAP) income paid to foreign persons—foreign contractors will receive an annual Form 1042-S showing their taxable income and withholding (with certain exemptions for classified or confidential contracts). Although withholding will usually satisfy a foreign contractor’s section 5000C liability, the contractor nevertheless remains liable to file a return and pay the tax if the contracting agency fails to perform withholding.
Finally, the IRS is aware that some foreign contractors have delayed complying with section 5000C while waiting for these final regulations to be promulgated. While the IRS reiterated that the effective date of the tax was Jan. 2, 2011, the regulations allow impacted taxpayers 90 days from Aug. 18, 2016, to satisfy its section 5000C filing and payment obligations for prior years without penalty.