US Fails To Shield Contractors From $920M In Afghan Taxes

By Dietrich Knauth

Law360, New York (May 14, 2013, 9:09 PM EDT) — The U.S.’ failure to enforce nontaxation agreements has allowed Afghanistan to collect more than $920 million in improper taxes from U.S. contractors, according to a new report that experts say highlights the persistent challenge of coordinating federal agencies to ensure war spending isn’t wasted.

The Special Inspector General for Afghanistan Reconstruction, or SIGAR, reported Tuesday that his office examined $921 million in business taxes and penalties levied against 43 contractors supporting U.S. rebuilding efforts in Afghanistan, in spite of agreements meant to ensure that U.S. contractors aren’t taxed. Those agreements “appear to be failing in their purpose,” in part because the U.S. Department of Defense, Department of State and the U.S. Agency for International Development have failed to make a coordinated effort to push back against improper taxes, often leaving contractors to fend for themselves.

“It’s disturbing that the Afghan government is targeting American contractors with unjust taxes and intimidation,” Special Inspector General John F. Sopko said. “It’s even more disturbing that U.S. agencies are letting it happen — all at the expense of American taxpayers, who have already shouldered a heavy burden on Afghan reconstruction. This needs to end.”

Of the $921 million examined by SIGAR, $93 million falls clearly under a tax category that both the U.S. and the Afghan government agreed should be exempt, and SIGAR believes that many of the remaining taxes are also illegitimate.

Congress took quick notice of SIGAR’s report, and Rep. Peter Welch, D-Vt., on Tuesday reintroduced legislation that would block all U.S. taxpayer assistance to Afghanistan until a new bilateral agreement on taxes is reached.

“It is incomprehensible that the government of Afghanistan, with its abysmal track record of corruption, would actually think it is a good idea to tax assistance provided by the American taxpayer,” Welch said. “We shouldn’t give another dime to the Afghan government until they agree to stop ripping off the American taxpayer.”

Experts say that SIGAR’s report is just further evidence of the difficulties that the U.S. faces in getting USAID, DOD and the State Department on the same page when it comes to wartime contracting issues. The recently closed office of Sopko’s counterpart in Iraq, the Special Inspector General for Iraq Reconstruction, has recommended creating a new federal agency to oversee rebuilding efforts in future contingency operations, but the agencies have resisted those recommendations, and some contractors have also opposed the plan as creating another layer of bureaucracy.

Charles Tiefer, a law professor at the University of Baltimore and a former member of the Commission on Wartime Contracting, said the U.S. agencies need to present a more unified front on wartime contracting, whether or not a new agency is introduced.

“There needs to be some structural change,” Tiefer said. “If the agencies coordinated and presented a strong and unified stance to the Afghan government, they could at least reduce the scale of improper Afghan taxing of American efforts.”

Fragmented planning for rebuilding contracts greatly increases the risk of waste and fraud, and that’s especially true in Afghanistan, where corruption is part of the culture, and where President Hamid Karzai’s government has tried to maximize its share of the U.S. and international cash that supports its institutions, Tiefer said. Afghanistan’s tax collectors don’t respect the tax exemption agreements signed by its diplomats, and the tax issues seem to be an echo of previous efforts to force contractors to hire a new Afghan security force in place of private guards, Tiefer said.

“The strategy here on the Afghan side may appear chaotic but in fact comes from the Karzai administration, which treats American contract funding in several ways as its very own piggy bank,” Tiefer said. “The U.S. taxpayer puts up money to build schools and infrastructure in Afghanistan, and the Afghan government turns around and engages in double dipping, getting both the U.S. funded project and skimming extorted taxes as well.”

Contractors say the report simply adds concrete data to the reality they’ve been facing for some time. The Professional Services Council, a contractor trade group, agreed with SIGAR’s calls for better coordination between agencies and more training on the tax exemption agreements for U.S. contracting officers, to prevent representatives of the Afghan government from exploiting inconsistencies in an effort to “shake down” contractors.

“The report confirms what PSC has long argued in letters, white papers and meetings with government officials: The U.S. government’s lack of a unified position in resolving the Afghan government’s inappropriate taxation of U.S.-funded contracts has hindered contractors’ efforts to support the U.S. government in Afghanistan,” said Alan Chvotkin, general counsel and executive vice president of PSC. “As the IG found, the lack of response increases the costs of U.S. government projects in Afghanistan and diverts U.S. funding from program objectives specifically defined by Congress and the contracting agencies.”

Because of tax disputes, the Afghan Ministry of Finance has restricted contractors’ freedom of movement, hurting the ability of contractors to support U.S. missions, and has even arrested at least one contractor because of unresolved tax issues, SIGAR reported.

Some U.S. agencies’ contracting officers do not appear to understand Afghanistan’s tax laws and have improperly reimbursed contractors for taxes paid to the Afghan government, and contractors have begun billing the U.S. government for the tax costs, or adjusting their bids to account for increased costs due to the Afghan taxes, according to SIGAR. The U.S. agencies have paid improper taxes, through contractor reimbursement, without helping contractors fight the taxes or helping contractors obtain tax-exemption certification ahead of time, the report found.

The contractors caught in the middle may face additional trouble down the road, since billing the government for improper taxes may go against federal regulations, Tiefer said.

“These contractors may be violating the rules on reimbursement when they pass on taxes that they shouldn’t have paid,” Tiefer said. “They’re getting away with it now, and that means that in some ways they’re happier avoiding friction with the Afghan government, at the cost of milking the American taxpayer through reimbursement.”

SIGAR recommends that the secretary of state take the lead in developing a consistent, unified position on what the U.S. government deems appropriate taxation of contractors, and make efforts to recover any improper tax payouts. But while the DOD concurred with SIGAR’s recommendations, State resisted, saying it “did not explicitly agree or disagree,” while arguing that the agencies already have a unified position. State also said it “neither agreed nor disagreed” on recommendations to recover tax payments.

The State Department also questioned SIGAR’s authority to examine issues related to the tax treatment of contracts, causing SIGAR to write that it is “concerned that State chose to focus initially on the bureaucratic question of which oversight agency is the appropriate one to examine this issue, rather than turning its attention to devising solutions to the problems we identified in this report.”

While the tax issue is serious on its own, it also points to a larger pattern of the Afghan government trying to maximize what it can take from U.S. and internationally funded rebuilding efforts, Tiefer said. Afghanistan previously banned contractors from hiring foreign-owned private security companies, forcing them to hire a new Afghan government agency, the Afghan Public Protection Force, at a higher price than the contractors were originally paying.

The focus on maximizing short-term payouts doesn’t bode well for the future, Tiefer said, especially as U.S. forces plan to exit Afghanistan and turn over the country’s security to its fledgling armed forces in 2014.

“Supplying their treasury by extorting tax payments from the US treasury is a very short-term strategy, and they are materially diminishing their country’s prospect for surviving after American troops pull out and some of the reconstruction effort drops off,” Tiefer said. “This report shows that the Afghan government is sucking only too much from the teat of the American treasury, and needs to be weaned off its rich diet.”

Foreign aid projects make up an enormous part of Afghanistan’s economy — 97 percent, according to a Senate Foreign Relations Committee report from 2011. Since 2002, Congress has appropriated over $89 billion to U.S. government agencies, including DOD, State and USAID, for humanitarian and reconstruction programs and projects in Afghanistan, according to SIGAR.

Published by Law360

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