Taxes, When There is a Question on Allowability

Back in 2010, we posted a discussion on the allowability of taxes under FAR 31.205-41 (click here to read that post). The standard lists a number of taxes that are allowable under Government contracts and some that are not. One type of tax that is not allowable under Government contracts are taxes from which exemptions are available directly, or available based on an exemption afforded the Government, except when the contracting officer determines that the administrative burden incident to obtaining the exemption outweighs the corresponding benefits accruing to the Government.

After we posted our initial write-up, the ASBCA (Armed Services Board of Contract Appeals) issued a decision that helps clarify the "exemptions afforded the Government" provision of the FAR cost principle. (see ASBCA No. 5796, Westech International, Inc.).

The State of Arizona imposes a transaction privilege tax (TPT) on certain tangible personal property purchases. For several years leading up to the time of the appeal, Westech and the Government had been working to determine whether there was an exemption for TPT taxes for Government contracts.
The Government was not willing to reimburse the Contractor until such time as the applicability of the tax was resolved.

The Government attorney advising the contracting officer advised that Arizona's TPT tax was a legitimate expense and no exemption appeared to be applicable. However, the attorney also advised that the contractor should continue to seek ways to avoid the tax if possible. In 2009, the contracting officer, in turn, authorized the contractor to pay the tax but also, to continue to seek ways to avoid the tax if possible.

Evidently, authorizing the contractor to pay the tax and reimbursing the contractor for the taxes under a cost reimbursable contract are two different things. The contracting officer refused to reimburse the contractor for the paid taxes "until further direction is received". The contractor paid the taxes, the Government refused to reimburse, so the contractor appealed to the ASBCA.

The Board ruled in favor of the contractor. It ruled that FAR establishes a procedure for determining whether taxes are due in case of doubt. If the Government really believed such an exemption was available (despite its agency attorney's advice to the contrary, it could have instructed the contractor to litigate that issue in Arizona. The contracting officer did not do so. The Government evidently seeks to have the Board independently determine whether the Arizona exemption was available, but that is a matter for the Arizona taxing authorities and courts.

Further, the Government was on the hook for the penalties and interest on back taxes because the contractor did not pay the taxes on time at the contracting officer's direction. That made such costs specifically allowable under FAR 31.205-41(a)(3) which states:

Interest or penalties incurred by the contractor for non-payment of any tax at the direction of the contracting officer or by reason of the failure of the contracting officer to ensure timely direction after a prompt request is allowable.

Whenever there is a question regarding the applicability of taxes levied by a State, county, municipality or other taxing authority, contractors should engage their contracting officers right away for help in determining the propriety of those taxes charged to Government contracts.