Excise Tax on Specified Federal Foreign Procurement Payments
Internal Revenue Code Section 5000C(a) imposes a tax equal to 2 percent of the amount of a specified Federal procurement payment to any foreign person. U.S. Government agencies must collect this tax via withholding on applicable payments.
IRC Section and Treasury Regulation:
- Notice 2015-35, I.R.B. 2015-18, 943
- Form W-14, Certificate of Foreign Contracting Party Receiving Federal Procurement Payments
- Form W-14 Instructions
- Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons
- Form 1042 Instructions
- Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding
- Form 1042-S Instructions
The James Zadroga 9/11 Health and Compensation Act of 2010 established a 2 percent excise tax on specified Federal procurement payments to certain foreign persons. Except as otherwise provided, U.S. Government agencies making the specified Federal procurement payments on which the tax applies must withhold an amount equal to 2 percent of the tax. This Act was signed into law and effective on January 2, 2011.
The U.S. Government contracts covered by Section 5000C are generally for goods produced or for services provided in a foreign country by a foreign person for the U.S. Government’s benefit. Accordingly, payments for the purchase or lease of land or an interest in land are not subject to this tax.
Further, the definition of a “contract” has the same meaning as provided in 48 CFR 2.101, and thus does not include a grant agreement or a cooperative agreement within the meaning of 31 U.S.C. 6304 and 6305, respectively. A contract may include an agreement that is not executed under the Federal Acquisition Regulations.
Exemption Provided to Certain Contracts
The 2 percent tax does not apply to payments made by an acquiring U.S. Government agency in the following situations -
- Payments pursuant to contracts under the simplified acquisition procedures that do not exceed the acquisition threshold as described in 48 CFR 2.101.
- Emergency acquisitions -
- Award under the “unusual and compelling urgency” authority (see 48 CFR 6.302-2), or
- Entered into under the emergency acquisitions as defined by 48 CFR part 18.
- Contracts with a single individual in which payments do not (or will not) exceed simplified acquisition threshold (48 CFR 2.101) on an annual basis for all years of the contract.
- Certain foreign humanitarian assistance contracts which are payments made by the U.S. Government agencies pursuant to a contract with a foreign contracting party to obtain goods or services described in or authorized under 7 U.S.C. 1691, et seq., 22 U.S.C. 2151, et seq., 22 U.S.C 2601 et seq., 22 U.S.C. 5801 et seq., 22 U.S.C. 5401 et seq., 10 U.S.C. 402, 10 U.S.C. 404, 10 U.S.C. 407, 10 U.S.C. 2557, and 10 U.S.C. 2561
Relief Provided to Certain Foreign Person
A foreign person is entitled to relief from the 2 percent tax for the following situations -
- The foreign person is entitled to relief pursuant to an international agreement, such as a qualified income tax treaty. See Instructions to Form W-14, Section 5000C Certificate. Notice 2015-35, provides a discussion of this exemption and current list of all “qualified income tax treaties” for purposes of this relief.
- Goods manufactured or services provided in the United States.
- Goods manufactured or services provided in a country that is a party to an international procurement agreement (48 CFR 25.400(a)(1)) and any free trade agreement that includes government procurement.
To receive relief from withholding in these situations the foreign person must furnish Form W-14 to the acquiring agency. Each contract requires its own Form W-14.
For purposes of the exemption for goods manufactured or services provided in a country that is a party to an international procurement agreement or a free trade agreement, it is immaterial where the contract is awarded or where the contractor is located. The important factor is where the goods are manufactured or where the services are performed.
For example, if the contractor is located in a country that is a member of an international procurement agreement with the United States, but the goods will be manufactured or services provided in a non-member country, the tax is imposed on payments to that contractor. On the contrary, if a contract is awarded to a contractor in a non-member country, but goods will be manufactured or services performed in a member country, the tax would not be imposed on payments to that contractor.
In contrast, if a foreign person is entitled to the benefit of a qualified income tax treaty for the tax imposed by Section 5000C, this exemption applies regardless of where the goods are produced or services are provided.
Once the acquiring agencies determine that a payment is under a contract for goods or services, the contract is with a foreign person, and that no exemption or relief applies, they are required to deduct and withhold an amount equal to 2% of the specified Federal procurement payment. This is true even if the payment is to a nominee or agent of the foreign contracting party.
U.S. Government Reporting
The acquiring agency will report the total excise tax withheld on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, Line 64b. The acquiring agency will also prepare a Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. The Form 1042-S should be furnished to the foreign contracting party and filed with the Internal Revenue Service by March 15 of the year after the payment date.
If the acquiring agency determines that furnishing the information required on a Form 1042-S will compromise national security, that information can be omitted from the form. The tax is still required to be withheld and reported on Form 1042.
If the acquiring agency fails to withhold the tax, then the foreign contracting party must file a U.S. income tax return and pay the tax due. The acquiring agency is not liable for any tax not withheld.
A non-Code provision requires the head of each executive agency to take measures to ensure that no foreign contractor is reimbursed for the tax. The non-Code provision calls for an annual review of the contracting activities of each executive agency to monitor compliance with the prohibition on reimbursements.
Section 5000C applies to specified Federal procurement payments received pursuant to contracts entered into on and after January 2, 2011. Treasury Reg. Sections 1.5000C-1 through 1.5000C-7 apply on and after November 16, 2016.
If a foreign contracting party fully satisfies its tax and filing obligations under Section 5000C with respect to any payments received in tax years ending before November 16, 2016, on or before the later of November 16, 2016, or the due date for the foreign person’s income tax return for the year in which the payment was received in a manner consistent with the final regulations, penalties will not be asserted on the foreign contracting parties with respect to those payments or returns.
Issue Indicators/Audit Tips:
- Request a listing of contracts for goods and services provided by foreign contracting party during the tax year under examination.
- Review FPDS-NG for procurement contracts for goods or services that are greater than $150,000 with foreign persons overseas.
- Review disbursements for payments to foreign persons.
- Request evidence and documentation to establish (1) location of goods produced or services provided and (2) the value of the procurement contract.
- Request evidence and documentation that supports the exemption from the tax.
Inspect the Forms 1042 and 1042-S filed for reporting of the tax imposed by Section 5000C.