IRS Finalizes Rules for Taxes on Foreign Federal Contractors

The Internal Revenue Service issued final regulations Wednesday for a 2 percent tax on payments from the U.S. government to foreign contractors.

The final regulations relate to section 5000C of the Tax Code and affect federal government agencies and foreigners who provide certain goods or services to the U.S. government under a contract. The document also contains final regulations under section 6114, with respect to foreign persons claiming an exemption from the 2 percent tax under an income tax treaty. The regulations took effect Aug. 17, 2016.

Section 301 of the James Zadroga 9/11 Health and Compensation Act of 2010 added section 5000C to the Tax Code on Jan. 2, 2011. It imposes on any foreign person who receives a specified federal procurement payment a tax equal to 2 percent of the amount of the payment.

Section 5000C(b) defines the term “specified federal procurement payment” as any payment made pursuant to a contract with the U.S. government for goods or services if the goods are manufactured or produced or the services are provided in any country that is not a party to an international procurement agreement with the United States. Section 5000C applies to payments received under contracts entered into on and after Jan. 2, 2011. The law is supposed to be applied in a way that's consistent with U.S. obligations under international agreements. The amount deducted and withheld is increased by the amount of tax imposed. 

In April of last year, the Treasury Department and the IRS published a notice of proposed rulemaking. The proposed regulations described a number of exemptions from the tax and provided procedures for collecting the tax. Notice 2015-35 was issued at the same time, providing a list of income tax treaties in effect that prevented the imposition of the tax. Among the countries exempted from the tax are Canada, the United Kingdom, Mexico, Germany, Japan, Italy, the Netherlands and others.

No public hearing was requested or held, though the Treasury and the IRS did receive some written comments on the proposed regulations. After considering the comments, they adopted and amended the proposed regulations with a few changes, including for payments by contracting parties to subcontractors and an exemption for certain foreign humanitarian assistance contracts.