By David Gallacher and John Bonn
On January 2, 2011, the President signed the James Zadroga 9/11 Health and Compensation Act of 2010, Pub. L. No. 111-347, which set up a relief fund for victims, first responders, and construction workers who were injured in the September 11 terrorist attacks in New York City. To pay the estimated $4.3 billion price tag for the Act, Section 301 of the Act imposed on any foreign person a tax equal to 2% of federal procurement payment received by that foreign person. See 26 U.S.C. § 5000C. In addition, any person who makes or otherwise is a withholding agent with respect to such a payment is required to withhold the 2% tax from the federal procurement payment and remit the tax withheld to the Internal Revenue Service (“IRS”) under tax laws and regulations applicable to withholding of United States taxes from payments made to foreign persons. Although the tax has been in place for more than 14 months and the IRS has issued a revised Form 1042 with revised instructions to implement withholding and reporting obligations, the Government is only now turning to the details of how this tax will be accounted for in connection with the procurement process. And – as is often the case – there is quite a lot of devil in those details.
A proposed Federal Acquisition Regulation was issued on February 22, 2012 stating that the 2% tax cannot be recovered by foreign offerors on any new flexibly-priced or fixed-price contracts. See 77 Fed. Reg. 10461. Exactly how this will play out in the world of government contracting remains to be seen, but foreign companies should be aware of how this new tax may impact their bottom line, and U.S. companies should be aware of the IRS withholding and reporting requirements imposed by the Act with respect to the 2% tax. Companies should pay particular attention to the following points:
- Be aware that "foreign person" does not necessarily mean the same thing under the tax code as it does under the procurement or export laws. As such, companies could be subject to this tax even if they are organized under U.S. law.
- This tax poses significant risks for withholding agents, who are required under tax laws to withhold certain taxes owed by foreign persons. If the foreign person fails to pay the tax, the withholding agent could be on the hook for the tax liability.
- Determining what payments this tax applies to will be a nightmare because it could apply to a host of different persons and products in a host of different circumstances, none of which are clearly spelled out in the statute, the IRS guidance, or the proposed acquisition rules. Consider that the statute imposes the tax on certain specified Federal procurement payments, which are made to certain foreign persons, for the purchase of certain foreign-made products or foreign-performed services, with the tax being applied consistent with certain international agreements (including, presumably, free trade agreements and international tax treaties). It will be difficult for a company to craft a "one size fits all" solution to identify taxable transactions and to ensure that the tax is withheld and paid appropriately.
Good advice here would be "Consult your tax counsel," particularly for those government contractors who are most likely to be dealing with taxable "specified Federal procurement payments" in the regular course of business.