FAR 31.205-41: Allowable and Unallowable Taxes
Navigate the key distinctions in FAR 31.205-41. This guide explains the government's rules on tax costs for compliant and accurate contract management.
The Federal Acquisition Regulation (FAR) provides uniform policies for acquisition by all executive agencies. FAR 31.205-41 is a specific cost principle that dictates the treatment of tax-related expenses on government contracts. This regulation draws a clear line between tax costs that are recoverable from the government and those that are not. Understanding and correctly applying this standard ensures both compliance and financial accuracy, preventing billing errors that could lead to disputes, audits, and financial penalties.
Allowable Tax Costs
The general principle is that a tax is an allowable contract cost if the contractor is required to pay it and the cost is properly allocable to the government contract. This means the tax must be a necessary expense incurred in the performance of the contract. The regulation permits a range of federal, state, and local taxes to be charged, provided they are paid or accrued in accordance with Generally Accepted Accounting Principles (GAAP).
Among the most common allowable taxes are state and local income and franchise taxes, which are considered a normal cost of doing business in a particular jurisdiction. Property taxes on real and personal property used in the performance of government work are also allowable. If a property is used for both government and commercial work, the tax cost must be apportioned based on its use for each purpose.
Sales and use taxes paid on materials, supplies, and services purchased specifically for a contract are allowable. Federal, state, and local excise taxes are also allowable costs. Payroll taxes paid by the contractor are an allowable expense, which includes the employer’s share of Social Security (FICA) taxes and federal and state unemployment insurance taxes, as these costs are directly tied to the labor required to perform the contract.
Unallowable Tax Costs
The regulation explicitly lists several types of taxes that are unallowable as costs on government contracts. The primary unallowable costs are federal income taxes and excess profits taxes. The government’s rationale is that these taxes are based on a contractor’s overall profitability, not the cost of performing a specific contract, and are the responsibility of the business entity.
The regulation also disallows taxes associated with financing and corporate structuring. This includes taxes related to financing, refinancing, or refunding operations. These costs are considered part of the contractor’s capital management and are not directly tied to the performance of contract work. The government does not reimburse costs that a contractor incurs to manage its own financial structure or debt.
Another category of unallowable costs involves taxes from which the contractor is exempt. This applies to exemptions available directly to the contractor or those based on an exemption afforded to the U.S. Government. An exception exists if a contracting officer determines that the administrative effort to obtain the exemption would cost more than the tax itself.
Finally, any fines, penalties, and special assessments related to taxes are unallowable. This includes interest charges for late payment of taxes or penalties for noncompliance. Special assessments on land that represent capital improvements are also unallowable, as they are considered an increase in the value of the asset rather than an operating expense.
Treatment of Tax Refunds and Credits
The compliance obligations extend beyond simply identifying allowable and unallowable costs. The regulation specifies how to handle situations where a contractor receives a refund for a tax that was previously charged to a government contract. Any refund, credit, or rebate of a tax that was allowed as a contract cost must be credited back to the government.
The credit must be proportional to the amount the government originally contributed to the tax payment. For instance, if a property tax was allocated 50% to a government contract and 50% to commercial work, the government must receive 50% of any subsequent refund of that tax. This rule applies whether the contractor receives the refund directly or if it is passed down from a supplier or subcontractor.
This policy includes instances where a contractor might obtain a foreign tax credit that reduces its U.S. federal income tax liability because of a tax payment that was reimbursed by a foreign government on a U.S. contract. In such a case, the amount of the reduction must be paid to the U.S. Treasury.