The U.S. is reportedly contemplating withdrawing from the World Trade Organization Government Procurement Agreement (WTO-GPA). That is because some U.S. officials believe that a U.S. withdrawal from the WTO-GPA could significantly reduce sales of WTO-GPA-country-originating goods and services for U.S. government (USG) projects. They believe this threat of U.S. withdrawal could cause other WTO-GPA members to offer to the U.S. additional trade concessions through separate U.S. Free Trade Agreements (FTAs) or renegotiation of the WTO-GPA.
U.S. withdrawal from the WTO-GPA could, through the foreign WTO-GPA members’ loss of U.S. trade benefits now granted to foreign-member-originating goods and services in the WTO-GPA, cause many sales of WTO-GPA-originating goods and services to the USG to no longer occur. Moreover, for those sales of WTO-GPA-originating goods and services that still do occur following a U.S. withdrawal, some of those sales could be subjected by the IRS to the tax code Section 5000C U.S. procurement tax for the first time. As discussed below, Section 5000C(b) generally now eliminates Section 5000C tax on WTO-GPA-country-originating goods and services.
This leads to the following tax-related question: if the U.S. does withdraw from the WTO-GPA, how strong an incentive will the Section 5000C tax be for the foreign members of the WTO-GPA to grant the U.S. sufficient trade concessions so that the U.S. will enter into an FTA or re-enter the WTO-GPA, and thereby eliminate Section 5000C tax on goods and services originating in that WTO-GPA member?
The WTO-GPA and FTAs
The U.S., Germany, Japan, Korea, Canada, Denmark, and many other countries are now members of the WTO-GPA. The WTO-GPA allows goods, services, and vendors of one country to compete on a non-discriminatory basis for many federal government procurement contracts issued by the other countries.
The U.S. is also now a party to a bilateral FTA with each of several WTO-GPA countries, as well as with several non-WTO-GPA countries. These include a bilateral FTA with Korea, and the trilateral NAFTA agreement including Canada. These FTAs likewise allow goods, services, and vendors of one country to compete on a non-discriminatory basis for many government contracts issued by the other countries.
However, the USMCA, which has been ratified by the U.S. and Mexico and is only awaiting ratification by Canada, would terminate the NAFTA U.S. and Canadian reciprocal government procurement obligations. The USMCA does not contain any U.S. or Canadian reciprocal government procurement obligations. Rather, under the USMCA, the U.S. and Canadian government procurement obligations would be governed by the WTO-GPA. Although President Trump has suggested that the U.S. and European Union enter into a “Transatlantic Trade and Investment Partnership” FTA, and that the U.S. and Japan likewise enter into an FTA, this has not occurred yet.
Accordingly, if the U.S. were to terminate its membership in the WTO-GPA, Germany, Japan, and Denmark would no longer be parties with the U.S. to either the WTO-GPA or an FTA. By contrast, it is apparently intended that Korea FTA reciprocal government procurement obligations would continue, even though the Korean FTA government procurement chapter does incorporate some terms of the WTO-GPA.
Canada would no longer be a member of an FTA with reciprocal government procurement obligations if Canada ratifies the USMCA to replace NAFTA. Accordingly, some observers suggest that Canada may seek to postpone ratification of the USMCA unless the U.S. commits not to deprive Canada of the rights Canada anticipated under the WTO-GPA when Canada conceded the elimination of a government procurement chapter in the USMCA. However, if Canada merely ratifies the USMCA in its present form, then, if the U.S. withdraws from the WTO-GPA, Canada, like Germany, Japan, and Denmark, would no longer be a party with the U.S. to either the WTO-GPA or to an FTA with government procurement commitments.
Section 5000C
The federal international procurement tax imposed by Section 5000C can apply to foreign, but not U.S., direct vendors, i.e. prime contractors, to the USG of certain products and services. The Section 5000C tax is applied at a rate of 2% of gross contract revenues and is applied by withholding by the USG at the source. For Section 5000C-taxable low-margin USG contracts, the Section 5000C tax can consume most, or even more than all, of the pretax net profit on those contracts. Foreign vendors subject to the Section 5000C tax usually consider increasing their bid price by most or all their projected Section 5000C tax. Such increase in bid price may, however, cause that foreign vendor not to be selected by the USG.
Under Section 5000C(b), only sales of goods manufactured in, and services performed in, foreign countries which are not parties to an international procurement agreement with the U.S. are taxable. The current Treasury Regulations define such an international procurement agreement to include only the WTO-GPA and FTAs with government procurement provisions. The Treasury Regulations do not include the numerous bilateral defense reciprocal purchasing agreements within the definition of international procurement agreements. Under the Treasury Regulations, certain USG contracts, such as those made pursuant to the simplified acquisition and emergency acquisition procedures, are exempted from Section 5000C tax and withholding.
If the U.S. does withdraw from the WTO-GPA, and Canada ratifies the USMCA, so that neither Germany, Japan, Canada, nor Denmark is then a party with the U.S. to the WTO-GPA or an FTA with government procurement commitments, then the IRS will presumably interpret Section 5000C(b) to mean that goods and services originating in Germany, Japan, Canada, and Denmark will lose their current exemption from the Section 5000C tax.
The enacting legislation of Section 5000C stipulates that Section 5000C is to be applied in a manner consistent with the U.S. obligations under international agreements. The Section 5000C tax does not apply to vendors that are U.S. persons. The non-discrimination clause of many U.S. income tax treaties generally provides that companies formed under the laws of the treaty partner are not to be treated more adversely for purposes of any U.S. tax than companies formed in the U.S. are treated in the same circumstances.
In IRS Notice 2015-35, the IRS, after a review of the non-discrimination clauses of U.S. income tax treaties, concluded that vendors formed under the laws of Germany, Japan, Canada, and Denmark, among several other countries with U.S. tax treaties, were exempt from Section 5000C tax. By contrast, Notice 2015-35 concluded that vendors formed under the laws of Korea, and several other countries with U.S. tax treaties, were not exempt from Section 5000C tax.
The 2011 legislative history of Section 5000C indicates that one of its purposes was to provide an incentive for non-WTO-GPA, non-FTA countries to enter into the WTO-GPA or an FTA with the U.S., thereby opening that country’s government procurement market to U.S. products and services and vendors.
GAO Report
A 2019 Government Accountability Office Report, entitled “International Trade: Foreign Sourcing in Government Procurement,” GAO-19-414, (The GAO Report) reviewed 2015 foreign sourcing, with a focus on WTO-GPA country sourcing, in USG procurement contracts. The GAO Report’s headline conclusion was that the USG likely procured more than twice as much from the other WTO-GPA parties as vice-versa. It is this 2019 conclusion that commentators believe triggered U.S. officials raising the possibility of a 2020 U.S. withdrawal from the WTO-GPA.
There were many other important conclusions in the GAO Report. For example, the GAO Report indicated that the Canadian government purchased far more U.S.-originating products and services than the USG purchased Canadian-originating products and services. This suggests that, to this extent, U.S. withdrawal from the WTO-GPA agreement, when considered in view of the USMCA termination of the NAFTA government procurement commitments, may harm the U.S.
The GAO Report focused on identifying which foreign firms received most USG contracts. Perhaps most striking, the GAO found that in 2015, $10 billion of the $12 billion in USG contracts awarded to foreign-located vendors of foreign-performed contracts were for U.S. Department of Defense (DoD) contracts performed by foreign-owned vendors. The GAO Report defined place of performance as the location of production of goods or the location of goods supplied from stock, or where the service was performed. The GAO Report found that 77% of those DoD contracts were covered under the WTO-GPA and NAFTA.
The DoD Balance of Payments of Program, 48 CFR Subpart 225.75, can apply to DoD purchases of goods and construction materials for use outside the U.S. Service contracts, a large proportion of DoD procurement contacts, are not covered by the DoD Balance of Payments Programs. Under the DoD Balance of Payments Program, a 50% upwards evaluation factor is generally adversely applied to the bid price of non-U.S., non-WTO-GPA-country, non-FTA-country, originating goods and construction materials in evaluating competing bids.
Presumably, if the U.S. withdraws from the WTO-GPA, sales of German, Japanese, Canadian, and Danish-originating goods and construction material to DoD for use abroad would no longer be exempted from the DoD Balance of Payments Program based on those countries’ WTO-GPA membership.
There are, however, many exceptions that permit a non-WTO-GPA foreign vendor to avoid the adverse application of the DoD Balance of Payments Program. Because of these other exceptions from applicability of the DoD Balance of Payments program, if the U.S. withdraws from the WTO-GPA, there is some doubt whether sales of German, Japanese, Canadian, and Danish-originating goods and construction material to DoD for use abroad would be significantly reduced. For example, goods and construction materials that are end products of countries that have reciprocal defense acquisition agreements with the U.S. are favorably exempted from the DoD Balance of Payments Program. Among the countries with a reciprocal defense acquisition agreement with the U.S. are Germany, Japan, Canada, and Denmark.
On the other hand, even if German, Japanese, Canadian, and Danish products could effectively compete for USG contracts without adverse application of the DoD Balance of Payments Program if the U.S. withdraws from the WTO-GPA, competition could increase from other foreign countries. Under the U.S. Trade Agreements Act, some non-FTA foreign country goods, under contracts covered by the WTO-GPA, are now prohibited from USG procurement. If the U.S. withdraws from the WTO-GPA, it is possible that some of these countries could compete for USG procurement, subject to the possible application of the DoD Balance of Payments Program and other U.S. procurement restrictions.
The GAO Report concluded that virtually all the $12 billion direct USG procurement from foreign vendors was for contracts performed outside the U.S. The GAO Report, however, further concluded that there was almost an equal dollar amount of USG procurement from U.S. vendors for contracts performed outside the U.S.
U.S. withdrawal from the WTO-GPA would presumably indirectly adversely affect some foreign subcontractors to U.S. vendors, although for reasons unrelated to the Section 5000C tax. Under the U.S. Buy American Act, non-WTO-GPA country, non-FTA country, originating products (not services) sold to the U.S. government for use in the U.S. can be subject to an adverse 6% or 12% bid price increase evaluation factor. Due to the Buy American Act, if the U.S. withdraws from the WTO-GPA, German, Japanese, Canadian, and Danish-originating products would presumably lose their U.S. Buy American Act protection. These products could become uncompetitive for USG procurement, not only through direct procurement from foreign vendors, but also through U.S. or foreign prime contractors, where those products are resold (with no change to qualifying country origin through subsequent processing) by those prime contractors to the USG for use in the U.S.
Implications for Section 5000C
The GAO Report does not mention Section 5000C or other U.S. taxes. However, the GAO Report has statistics concerning the situs of goods and services sourced in WTO-GPA members, which may be relevant in considering the implications of Section 5000C(b) for U.S. withdrawal from the WTO-GPA. The GAO Report likewise has statistics concerning the location of vendors located in WTO-GPA countries, which may be relevant in considering the implications of Notice 2015-35 for U.S. withdrawal from the WTO-GPA.
Table 16 of the GAO Report lists the location of the 10 largest countries, apparently by value of DoD contracts performed there, of the $10 billion of 2015 DoD contracts performed outside the U.S. by foreign-located, foreign-owned, vendors. WTO-GPA countries on that list include Germany, in second place, representing 11% of DoD contracts value; Japan, in third place, representing 11% of DoD contracts value; Korea, in fourth place, representing 7% of DoD contracts value; Canada, in eighth place, representing 5% of DoD contracts value; and Greenland, in ninth place, representing 5% of DoD contracts value. Although not addressed in the GAO Report, Table 13 of that report suggests that almost all the DoD Greenland contract value may have been fulfilled by Danish-located firms supplying Danish-originating goods and services.
U.S. withdrawal from the WTO-GPA could dramatically increase the applicability of the Section 5000C(b) taxable situs of goods and services bought by the DoD from foreign vendors by including, for the first time, German, Japanese, Canadian, and Danish-originating goods and services. Korean-originating goods and services would apparently remain outside the scope of Section 5000C(b) by reason of the Korean FTA.
Nevertheless, even if the Section 5000C(b) exemption for WTO-GPA-country-originating products and services is lost by Germany, Japan, Canada, and Denmark, Notice 2015-35, by exempting German, Japanese, Canadian, and Danish vendors, probably provides a major impediment to significant IRS collections under Section 5000C. The GAO Report does not discuss whether large volumes of German, Japanese, Canadian, and Danish-originating goods and services are subcontracted for and resold to the DoD by foreign prime contractors formed in non-exempt countries. Conversely, the GAO Report does not discuss whether large volumes of German, Japanese, Canadian, and Danish-originating goods and services are subcontracted for and resold to the DoD by U.S. prime contractors, and for that reason are exempted from Section 5000C tax.
However, there some clues that DoD foreign direct contractors may often sell locally originating products and services. Of special interest with respect to Germany and Japan, and to Denmark as it relates to Greenland, the GAO Report narrative states that DoD contracts awarded to foreign firms located abroad are mainly DoD contracts in support of military operations in those countries. While there are U.S. military bases in Germany, Japan, and Greenland, there are no U.S. military bases in Canada, so this local military supply factor would not exist for Canada. Table 13 of the GAO Report, in tracking vendor location of all USG contracts by foreign country, by contract value, and by place of performance, is generally consistent with the hypothesis that many DoD contracts to be performed in Germany, Japan, Canada, and Greenland involve vendors located in Germany, Japan, Canada, and Denmark, respectively.
Unfortunately, generalizing from the GAO Report is difficult, not only because the GAO Report was not directed to analyzing Section 5000C issues, but also in part because of terminology. For example, the GAO Report applied country of origin and place of performance rules that were not identical to the sometimes-differing rules of origin applied by the U.S. for purposes of applying the WTO-GPA, the various U.S. trade preference programs, and Section 5000C(b). As another example, the GAO Report used, to determine the location of the foreign vendor, the vendor’s address on bid documents, and apparently did not examine its foreign certificate of incorporation or any other data relevant to the application of Notice 2015-35.
Moreover, even though U.S. withdrawal from the WTO-GPA would make an exemption under Section 5000C(b) unavailable to German, Japanese, Canadian, and Danish-source goods and services, any Section 5000C liability could be potentially avoidable by interposing a prime contractor that is either a U.S. person or is a company that is exempt under an income tax treaty under Notice 2015-35. However, the Section 5000C regulations have a general-abuse rule that could block this strategy, and U.S. or foreign corporate taxes and similar items would have to be considered. Conversely, if DoD contracts are only feasibly filled by local vendors, and all those competing vendors became subject to Section 5000C tax simultaneously due to the U.S. withdrawal from the WTO-GPA, all those vendors might merely correspondingly increase their bid prices, offsetting the economic effects.
Because Section 5000C generally does not apply to U.S. prime contractors or to their foreign subcontractors, such as German, Japanese, Canadian, or Danish subcontractors, U.S. withdrawal from the WTO-GPA will not create any Section 5000C tax liability for U.S. vendors who now subcontract to foreign providers of WTO-GPA goods and services, nor to those foreign subcontractors themselves. Indeed, the GAO Report concluded that, for USG contracts to be performed abroad, about as many in value were awarded to U.S. vendors (e.g. U.S. parents of U.S.-based multinational defense contractors, and, to a smaller extent, U.S. subsidiaries of foreign-based multinational defense contractors) as were awarded to foreign vendors. However, as mentioned above, for those U.S. vendors now reselling subcontracted WTO-GPA-country manufactured goods to the USG for use in the U.S., after a U.S. withdrawal from the WTO-GPA, the Buy American Act may present an obstacle to such resales.
Conclusion
If the U.S. withdraws from the WTO-GPA, each foreign vendor to the USG of German, Japanese, Canadian, Danish, and other WTO-GPA-country-originating goods and services will have to review, under U.S. procurement law, the continued viability of its sales. However, because German, Japanese, Canadian, and Danish-incorporated direct USG vendors would continue to be exempt under Notice 2015-35, it seems doubtful that Section 5000C will present a significant additional barrier to their continued USG sales. Rather, Section 5000C liability would attach to German, Japanese, Canadian, and Danish-originating goods and services only in the perhaps less frequent case that such items are purchased and resold by a non-exempt foreign prime contractor to the USG.
That is, Section 5000C itself may not be a great motivator to the European Union, Japan, and Canada to enter into new FTAs or WTO-GPA renegotiations with the U.S. Rather, the European Union, Japan, and Canada would probably focus on weighing the additional USG procurement and other U.S. trade opportunities offered them by the U.S. in a new FTA or renegotiated WTO-GPA, against the concessions requested by the U.S. in that new agreement.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Author Information
Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.
