On August 18, 2016, the Department of the Treasury and the IRS issued final regulations (TD 9782) under Section 5000C relating to the 2% tax on payments made by the US government to foreign persons pursuant to certain contracts for goods and services. The regulations affect US government acquiring agencies and foreign persons providing certain goods or services to the US government pursuant to a contract. Final regulations were also issued under Section 6114 with respect to foreign persons claiming an exemption from the 2% tax because they are eligible for relief pursuant to a nondiscrimination provision of an income tax treaty.

The final regulations largely adopt the proposed regulations issued in April 2015, while adding several new exemptions and making a number of clarifications. Concurrently with the final regulations, the IRS published Form W-14, which may be used by foreign contracting parties claiming an exemption from the tax under Section 5000C.

The tax imposed under Section 5000C applies to payments received pursuant to certain contracts with the US Government entered into on or after January 2, 2011. The final regulations apply on or after November 16, 2016 (90 days after August 18, 2016, the date that the regulations were published in the Federal Register). The preamble to the final regulations explains that this applicability date should give foreign persons that might have deferred compliance actions pending finalization of the regulations time to satisfy tax and filing obligations with respect to Section 5000C for payments received in tax years before the applicability date of the final regulations, and thereby avoid penalties.

Background

In general, Section 5000C applies to foreign persons that are party to certain contracts with the US government. For foreign persons receiving a specified Federal procurement payment (a SFPP), Section 5000C imposes on the foreign person a tax equal to 2% of the amount of the SFPP (the Section 5000C tax). A SFPP is any payment made to a foreign person under a contract with the US government entered on or after January 2, 2011, for either: (1) the provision of goods, if those goods are manufactured or produced in a foreign country that is not a party to an international procurement agreement (IPA) with the United States; or (2) the provision of services, if those services are provided in a foreign country that is not a party to an IPA with the United States.

In April 2015, the IRS issued proposed regulations (REG-103281-11) under Section 5000C. The proposed regulations (1) clarified the meaning of certain terms used in the statute, (2) provided rules on the imposition of, and exemption from, the Section 5000C tax, and (3) provided guidance on reporting and paying the tax. Concurrent with the proposed regulations, the IRS released a companion notice (Notice 2015-35), listing current US income tax treaties that may exempt certain persons from the tax. For a detailed discussion of the proposed regulations and additional background, see Tax Alert 2015-805.

Final regulations

In general, the final regulations adopt the definitions, exemptions, withholding and other rules as described in the proposed regulations. Changes in the final regulations are described below.

The final regulations clarify that the Section 5000C tax does not generally apply to a subcontractor that is not a party to a contract with the US government. However, the preamble notes that the activities of a subcontractor are taken into account for purposes of determining the country in which goods are manufactured or produced, or in which services are provided. Furthermore, the preamble notes that the final regulations retain the rules in the proposed regulations that payments received by a nominee or agent on behalf of a contracting party are considered to be received by that contracting party, in addition to the anti-abuse rule that in certain circumstances may treat a foreign subcontractor as being liable for Section 5000C tax.

The final regulations add a new exemption from the Section 5000C tax for certain foreign humanitarian assistance contracts. The exemption generally applies to contracts for the procurement of goods or services described in or authorized under certain specified statutes that are for the purpose of providing foreign humanitarian assistance when the acquiring agency (e.g., the US Agency for International Development) determines that the payment is for the purpose of providing foreign humanitarian assistance.

The final regulations extend the "simplified acquisition exemption" to personal service contracts. As proposed, the simplified acquisitions exemption applies when the payment is for a purchase under the Federal Acquisition Regulation (FAR) simplified acquisitions procedures and the payment does not exceed the simplified acquisitions threshold as defined in the FAR (generally, $150,000 or less). Under the final regulations, this exemption will apply to personal service contracts regardless of whether they are executed pursuant to the FAR. For these purposes, the final regulations specify that the amount paid should be determined on an annual (rather than per-contract) basis.

The final regulations include a number of other clarifications. While the proposed and final regulations use the FAR definition of "contract," the final regulations add a sentence to the definition to clarify that it can include contracts not executed under the FAR. In response to a comment, the final regulations also clarify that an acquiring agency should not withhold to the extent that a payment is for something other than goods or services. Furthermore, the final regulations add an example to illustrate the withholding obligation of an acquiring agency when it receives a revised Section 5000C Certificate due to a change in circumstances.

Form W-14: Section 5000C Certificate and qualified income tax treaties

To claim an exemption from the Section 5000C tax, the proposed and final regulations provide that a foreign contracting party must submit a "Section 5000C Certificate." While the proposed regulations included a model Section 5000C Certificate, the final regulations state that a foreign person may use new Form W-14, Certificate of Foreign Contracting Party Receiving Federal Procurement Payments, as its Section 5000C Certificate, provided it includes all the required information.

The preamble to the final regulations notes that the instructions to Form W-14 identify income tax treaties in force, as of the date of the form's issuance, that are qualified income tax treaties for purposes of exempting certain persons from the Section 5000C tax. This is intended to serve as an updated version of the list of qualified income tax treaties in Notice 2015-35.

Applicability date

As previously stated, the Section 5000C tax applies to payments received pursuant to contracts entered into on or after January 2, 2011. The preamble to the final regulations emphasizes this point, stating that Section 5000C does not require Treasury regulations or FAR amendments to be applicable before the requirements of the statute take effect.

Consistent with the proposed regulations, the final regulations apply on or after the date that is 90 days after the date they are published as final regulations in the Federal Register — meaning an applicability date of November 16, 2016. However, the preamble to the final regulations states that contracting parties and acquiring agencies may rely upon the rules in the final regulations before the applicability date.

The preamble also contains several important statements regarding the effect of the final regulations. To the extent that a foreign contracting party has a Section 5000C tax liability with respect to a SFPP received in tax years ending before the applicability date of the final regulations, and that liability has not been satisfied by withholding, the foreign contracting party should file a tax return and pay the tax due. If the liability is fully satisfied before the applicability date of the final regulations, penalties will not be asserted on those payments. Interest on underpayments, however, would apply. The preamble provides the following example:

"Assume a foreign corporation received a single specified Federal procurement payment during its tax year ending on December 31, 2013 that is not described in any of the exemptions in these final regulations, and the payment was not withheld upon. If the corporation files Form 1120-F, "U.S. Income Tax Return of a Foreign Corporation," for 2013 and pays the tax imposed under Section 5000C in the manner described in Section 1.5000C-4(d) before the applicability date of the final regulations, penalties will not be asserted with respect to that payment or return. However, the final regulations do not relieve a foreign person of any applicable rules relating to interest under Subtitle F."

Additionally, for purposes of Section 6114 and the regulations thereunder, if a foreign contracting party has received a payment exempt from tax under a qualified income tax treaty before the effective date of the final regulations under Section 5000C, reporting is waived if the foreign contracting party has properly relied on Notice 2015-35.

Implications

The final regulations provide a number of helpful clarifications to the rules under Sections 5000C and 6114, and should further reduce burdens on both US government acquiring agencies and foreign contracting parties. At the same time however, foreign contracting parties that have deferred compliance actions pending the issuance of final regulations should act swiftly to satisfy their Section 5000C tax and filing obligations for prior periods, as set forth above, in order to avoid penalties and halt the accrual of interest on those liabilities.

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