What happens when the irresistible force meets the immovable object?  Well, in the case of a recent diplomatic dispute between the U.S. and Afghan governments, the answer is that the contractor pays out of pocket. The issue of U.S. defense contractors paying taxes to a foreign government is, unsurprisingly, a thorny one, deeply entangled with diplomatic and national security concerns that go far beyond your typical tax treaty.  And, you can imagine the sort of briar patch faced by defense contractors trying to negotiate the Afghan tax system, under the shadow of a U.S. military presence and the still-unsteady Karzai government.  Thorny may not be the right word; untenable is more like it.

In 2013, a report by the Special Inspector General for Afghanistan found that U.S. contractors had been charged nearly $1 billion in business taxes and penalties by the Afghan government, despite the fact that many of the projects in question were exempted from taxation under diplomatic agreements between the Afghan government and the U.S. [1]   This has put dozens of U.S. contractors in a catch-22 situation.  U.S. law and the diplomatic agreements with Afghanistan say they don’t have to pay those local taxes; but the Afghan government says they do, and has taken steps to collect on the mostly-unpaid penalties, including denying business licenses and arresting contractor personnel. [2]

Into this politically-fraught situation steps the Department of Defense, with a proposed DFARS clause (DFAR Case 2014-D0003) stipulating that contractors performing work in Afghanistan are exempt from most local taxes and duties charged by the Afghan government. [3]   Unfortunately for the contractors, as a fallout of declaring U.S. contractors immune to Afghan taxation, the proposed DFARS clause also states that no such taxes or fines shall be included in contract pricing. [4] In short, because the U.S. government will not reimburse contractors for Afghan taxes and fees—and because the Afghan government is likely to continue demanding them—contractors may be forced to absorb those costs out of pocket, treaty or no treaty.

While the proposed DFARS clause appears to have been drafted with the best of intentions—namely, to clarify U.S. contractors’ legal responsibility regarding Afghan taxes—ironically, the proposed rule is likely to have an overall negative effect on U.S. contractors: denying them reimbursement for actual contract costs while doing nothing to resolve the diplomatic impasse that created the situation in the first place.  Contractors are unlikely to take much comfort in a DFARS “piece of paper” saying they are immune to local taxation when, on the ground, they face the real possibility of being denied a business license or having their personnel detained by the Afghan Ministry of Finance (which does not share the U.S. government’s interpretation of the relevant agreements).  More importantly, the diplomatic shoving match between the U.S. and Afghanistan is not something private businesses are equipped to or should be expected to handle on their own.  Given the U.S. government’s own report acknowledging that contractors continue to be charged Afghan taxes (diplomatic accords notwithstanding), it seems patently unfair for the DFARS to turn a blind eye to that reality and force contractors to absorb the costs of a foreign policy dispute over which they have no control.  In short, while we may not know who wins when the irresistible force strikes the immovable object, we definitely know who loses.  Whoever’s standing in the middle.

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[1] See Federal Contracts Report, Afghanistan Reconstruction: Afghan Government Wrongly Taxing U.S. Contractors, SIGAR Report Says, Bloomberg BNA (May 21, 2013), available at:  ≪http://news.bna.com/fcln/FCLNWB/split_display.adp?fedfid= 31182616&vname=fcrnotallissues&jd=a0d8q5e4v9&split=0≫ (last visited July 1, 2014).

[2] See Federal Contracts Report, Afghanistan Reconstruction: Proposed Rule Clarifies No Afghan Taxation On Contractors, Bloomberg BNA (June 24, 2014), available at: ≪http://news.bna.com/fcln/FCLNWB/split_display.adp?fedfid=48539338&vname=fcrnotallissues&jd=a0f2b1q6v5&split=0≫ (last visited July 1, 2014).

[3] See DFARS Case 2014-D0003, Defense Federal Acquisition Regulation Supplement: Taxes―Foreign Contracts in Afghanistan, available at: ≪http://www.ofr.gov/OFRUpload/OFRData/2014-14595_PI.pdf≫ (last visited July 1, 2014).

[4] See id.