Afghanistan's push to tax U.S. contractors could renew tensions

By Karen DeYoung and Joshua Partlow
Washington Post Staff Writers
Monday, January 17, 2011; 12:48 AM

The Afghan government is ramping up efforts to tax U.S. contractors operating there - an effort that could raise millions for the cash-strapped government but could also provoke fresh confrontation with the United States, according to U.S. and Afghan officials.

Taxation of U.S. government assistance is barred by U.S. law, as well as by a number of bilateral accords between Afghanistan and the United States. But the wording in the documents is vague, and the two governments disagree on what "tax-exempt" means.

Non-Afghan contractors who have recently received tax bills for work done under U.S. government programs say they have appealed to the Defense and State departments to clarify the matter with the Afghans. But they have been told simply to ignore the bills and "stand up for our rights," said one official of an American company that has multiple U.S defense contracts in Afghanistan.

The Afghan government says no clarification is needed. It has started to send out what it says are overdue tax bills and has threatened some U.S. companies with arrests, loss of licenses and confiscation of aid goods.

"I don't need any new plan [to require a] foreign company to pay tax," Afghan Finance Minister Omar Zakhilwal said in a text message in response to questions. "Whatever is not exempted by law and treaties will not be exempted." Afghanistan, he said, is "serious against tax evasion."

The simmering controversy is the latest in a series of run-ins between the Afghan government and the U.S.-led coalition that spends up to $10 billion a year on private contractors in Afghanistan, more than five times the $1.8 billion in total revenue the Afghan government expects to take in by the end of the fiscal year in March.

The most recent public disagreement, over the fate of private security companies, remains unresolved.

Earlier this month, President Hamid Karzai approved a plan to require all new foreign development projects to employ government security guards rather than those from private Afghan and foreign companies. But the government guards - known as the Afghan Public Protection Force - still don't exist except on paper. NATO's new development projects would require an estimated 25,000 guards.

'Issue for quite a while'

The Afghan government has long urged foreign donors to funnel their billions through government ministries, rather than paying for projects directly to contractors. Karzai has regularly complained about what he calls "parallel structures," such as the coalition-run provincial reconstruction teams, which dole out vast sums to build roads, dams or other projects that are not always aligned with Afghan priorities.

The effort to collect more taxes appears in line with other attempts by the government to assert more control as well as feed its feeble coffers.

As part of its anti-corruption efforts, the Obama administration certifies Afghan ministries as eligible to receive direct funding. Only a handful of about two dozen ministries have received certification.

The tax question "has been an issue for quite a while," a senior Afghan official said, but only in the past several months has the government become aggressive. One prominent Afghan businessman, familiar with the government's intentions, saw it as yet another intentional confrontation with the West and said it could become a "bombshell" in relations with the United States.

Most government and contractor officials who agreed to discuss the taxation situation refused to speak on the record about what they described as a subject of growing tension.

"Many companies, especially if there are agreements with USAID or ISAF or donors, they are not paying taxes," said Ahmad Shah Zamanzai, director general of revenue for the Finance Ministry. "Companies profit, why don't they pay tax for the profit they make? We don't tax the donation," he said, "we tax the company that is gaining from this donation."

Zamanzai said the government has drafted a plan to regularize rules for all donor countries, based on an analysis by the British consulting firm Adam Smith International. He said he expects the ministry to approve the plan by the end of the month.

In the meantime, the government's current focus appears to be on subcontractors - those hired by the major or "prime" contractors who have signed agreements directly with the United States or other donor governments. The "primes" contract the "subs" for specific tasks and "there is no contract of any magnitude that doesn't have a bevy of subs," the company official said.

The government's position is that the various accords regulating the foreign presence in Afghanistan, including taxation, do not cover anyone without a direct government contract. According to a recent Finance Ministry letter to primes on the taxation issue, "a contractor can only be identified as a U.S. government contractor if there is a legally binding agreement between this person and the U.S. Government." Subs are not exempt, the government asserts, because their contracts are with the primes.

The accords themselves are overlapping and incomplete, reflecting the initial ad hoc nature of the U.S. presence in Afghanistan. They include a "military technical agreement" signed in January 2002 between the then-interim government of Afghanistan and the NATO International Security Assistance Force, or ISAF, authorized by the United Nations.

U.S. forces have also been governed by a series of U.S.-Afghan diplomatic notes signed in 2002, 2003 and 2006. USAID has also issued regular notices to U.S. contractors confirming their tax-exempt status.

All use different wording to outline the tax situation. Some refer to contractors, while others mention goods and services funded by the United States. None directly mention subcontractors.

The Defense Department, in response to questions, said that its interpretation of the 2002 and 2003 agreements is that they provide tax exemptions "to both prime and subcontractors, even though the word 'subcontractor' does not appear."

USAID issued a similar statement, saying that "typically, we interpret these provisions to apply to any entity funded by USAID, including non-local primes and non-local subs."

Concern about precedent

Taxation has rarely, if ever, been a problem with worldwide U.S. foreign assistance programs, and some officials expressed concern that any possible concessions made in Afghanistan would set a precedent for other recipient countries.

In its 2008 State Department appropriation, Congress mandated that no new aid agreement be signed with any country without unambiguous tax exemption language. The law called on the secretary of state to "expeditiously" renegotiate existing agreements to include such provisions.

There is widespread agreement that Afghan subcontractors paid with foreign funds are not exempt from domestic Afghan taxes. The senior Afghan official said that the fact that "many well-connected Afghan contractors [are] paying no tax to the government" was a separate issue. U.S. prime contractors maintain that they regularly withhold income tax - set at 2 percent - from payments to Afghan subs and turn it over to the government.

But the Afghan government, the American contract company official said, is "coming after" his firm's foreign subs, "claiming they are not tax exempt and saying . . . they will take away their business licenses, not allow them to fly in and out, and not allow them to bring goods in."

Although customs officials have occasionally held incoming contract goods hostage for duty payments, he said, such incidents have so far been worked out on the scene. U.S. officials have told the primes, he said, that they will act forcefully if there is any substantive confiscation.

"DOD and State and the primes are telling them, 'No, you're subs, don't pay taxes,'" the company official said. But "the Afghan government has become so hard to work with on so many fronts that I'm not sure whether this issue is still in the embassy's top-10 list of things."

Another contracting executive said there was "tension in the embassy" between those officials who work on helping the Afghan government collect more revenue so it can pay its own way, and those "responsible for working on behalf of U.S. business."

"We know we're going to have to pay at least $8 billion to $10 billion a year for the next 10 years to keep these guys running," the executive said. "The International Monetary Fund and the World Bank are putting heat on the government to create a tax base. Some of the biggest cash flow into the country is Western aid."

Under Afghanistan's new regulations, Zamanzai said, foreign prime and subcontractors will both be eligible for taxation in certain circumstances. The United States is supporting Afghanistan's transformation, he said, and "if you do not have a good tax system, how can you finance your other reforms?"

Partlow reported from Kabul.

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