Defense Contracting
Recent Law Has Impacted Contractor Use of Offshore Subsidiaries to Avoid Certain Payroll Taxes Gao ID: GAO-10-327 January 26, 2010Many federal contractors establish offshore subsidiaries to take advantage of labor and market conditions. GAO has found that they also use offshore subsidiaries to reduce their U.S. tax burdens. In 2008, Congress passed the Heroes Earnings Assistance and Relief Tax (HEART) Act which resulted in contractor offshore subsidiaries paying certain payroll taxes for U.S. personnel working abroad. Fiscal year 2009's National Defense Authorization Act required GAO to report on the rationales, implications, and costs and benefits of defense contractors' use of offshore subsidiaries. We (1) assessed trends and purposes for contractors' offshore subsidiaries; (2) identified how contractors use subsidiaries to support defense contracts; (3) assessed DOD's oversight of contractors' use of offshore subsidiaries. To conduct our work, we reviewed data for the 29 U.S. publicly traded contractors with at least $1 billion in DOD spending in fiscal year 2008, reviewed several illustrative contracts selected based on categories of DOD services most often performed overseas, reviewed audit documents, and interviewed DOD officials about oversight.
Many of the top 29 U.S. publicly traded defense contractors--those with $1 billion or more in DOD contracts in fiscal year 2008--have created offshore subsidiaries to facilitate global operations. Between fiscal years 2003 and 2008, they increased their use of these subsidiaries by 26 percent, maintaining at least 1,194 in 2008. We interviewed 13 of the 29 contractors based on a range of the amount of government work, locations of subsidiaries, and industry types; they reported that 97 percent of the subsidiaries generally supported global commercial and foreign government clients, while the remaining 3 percent supported DOD contracts performed overseas. These subsidiaries also helped the 29 contractors reduce taxes, with about one-third decreasing their effective U.S. corporate tax rates in 2008 in part through the use of foreign affiliates, lower foreign tax rates, and indefinite reinvestment of foreign income outside of the United States. For five of the DOD contracts we reviewed, companies principally used offshore subsidiaries to hire U.S. workers providing services overseas on U.S. government contracts in order to avoid Social Security, Medicare--known as Federal Insurance Contributions Act (FICA)--and other payroll taxes. This practice allowed contractors to offer lower bids when competing for certain services and thereby reduce costs for DOD. Our analysis of two contracts showed that the use of offshore subsidiaries saved DOD at least $110 million annually prior to the HEART Act, through payroll tax avoidance. While this practice provided contract cost savings for DOD, it resulted in these companies avoiding payroll taxes that would have contributed to the Social Security and Medicare Trust Funds. The 2008 HEART Act resulted in offshore subsidiaries of U.S. companies paying FICA taxes for U.S. workers performing services overseas on U.S. government contracts. As a result, in fiscal year 2009, four of the case study contractors using offshore subsidiaries to support DOD work requested reimbursement from DOD of at least $140 million for new FICA payments. Federal and state unemployment payroll taxes, however, were not covered by the HEART Act, and several contractors that used offshore subsidiaries have continued to avoid these taxes. In one state, we reviewed documentation for about 140 former employees of several contractors who were denied unemployment benefits in 2009. State workforce officials indicated these benefits were denied because the employees worked for a foreign subsidiary and not an American employer. DOD officials were aware of the roles offshore subsidiaries played in the DOD contracts we reviewed and stated that oversight mechanisms, such as the Defense Contract Audit Agency's reviews of incurred costs and oversight documents, inform them of the activities of offshore subsidiaries. In contracts we reviewed, evidence of offshore subsidiaries was present in contractor labor rates, cost accounting disclosures, and contractor price proposals. Contracting officials stated that the use of offshore subsidiaries did not negatively impact contract schedule or performance.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-10-327, Defense Contracting: Recent Law Has Impacted Contractor Use of Offshore Subsidiaries to Avoid Certain Payroll Taxes
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
January 2010:
Defense Contracting:
Recent Law Has Impacted Contractor Use of Offshore Subsidiaries to
Avoid Certain Payroll Taxes:
GAO-10-327:
GAO Highlights:
Highlights of GAO-10-327, a report to congressional committees.
Why GAO Did This Study:
Many federal contractors establish offshore subsidiaries to take
advantage of labor and market conditions. GAO has found that they also
use offshore subsidiaries to reduce their U.S. tax burdens. In 2008,
Congress passed the Heroes Earnings Assistance and Relief Tax (HEART)
Act which resulted in contractor offshore subsidiaries paying certain
payroll taxes for U.S. personnel working abroad.
Fiscal year 2009‘s National Defense Authorization Act required GAO to
report on the rationales, implications, and costs and benefits of
defense contractors‘ use of offshore subsidiaries. We (1) assessed
trends and purposes for contractors‘ offshore subsidiaries; (2)
identified how contractors use subsidiaries to support defense
contracts; (3) assessed DOD‘s oversight of contractors‘ use of
offshore subsidiaries.
To conduct our work, we reviewed data for the 29 U.S. publicly traded
contractors with at least $1 billion in DOD spending in fiscal year
2008, reviewed several illustrative contracts selected based on
categories of DOD services most often performed overseas, reviewed
audit documents, and interviewed DOD officials about oversight.
What GAO Found:
Many of the top 29 U.S. publicly traded defense contractors”those with
$1 billion or more in DOD contracts in fiscal year 2008”have created
offshore subsidiaries to facilitate global operations. Between fiscal
years 2003 and 2008, they increased their use of these subsidiaries by
26 percent, maintaining at least 1,194 in 2008. We interviewed 13 of
the 29 contractors based on a range of the amount of government work,
locations of subsidiaries, and industry types; they reported that 97
percent of the subsidiaries generally supported global commercial and
foreign government clients, while the remaining 3 percent supported
DOD contracts performed overseas. These subsidiaries also helped the
29 contractors reduce taxes, with about one-third decreasing their
effective U.S. corporate tax rates in 2008 in part through the use of
foreign affiliates, lower foreign tax rates, and indefinite
reinvestment of foreign income outside of the United States.
For five of the DOD contracts we reviewed, companies principally used
offshore subsidiaries to hire U.S. workers providing services overseas
on U.S. government contracts in order to avoid Social Security,
Medicare”known as Federal Insurance Contributions Act (FICA)”and other
payroll taxes. This practice allowed contractors to offer lower bids
when competing for certain services and thereby reduce costs for DOD.
Our analysis of two contracts showed that the use of offshore
subsidiaries saved DOD at least $110 million annually prior to the
HEART Act, through payroll tax avoidance. While this practice provided
contract cost savings for DOD, it resulted in these companies avoiding
payroll taxes that would have contributed to the Social Security and
Medicare Trust Funds. The 2008 HEART Act resulted in offshore
subsidiaries of U.S. companies paying FICA taxes for U.S. workers
performing services overseas on U.S. government contracts. As a
result, in fiscal year 2009, four of the case study contractors using
offshore subsidiaries to support DOD work requested reimbursement from
DOD of at least $140 million for new FICA payments. Federal and state
unemployment payroll taxes, however, were not covered by the HEART
Act, and several contractors that used offshore subsidiaries have
continued to avoid these taxes. In one state, we reviewed
documentation for about 140 former employees of several contractors
who were denied unemployment benefits in 2009. State workforce
officials indicated these benefits were denied because the employees
worked for a foreign subsidiary and not an American employer.
DOD officials were aware of the roles offshore subsidiaries played in
the DOD contracts we reviewed and stated that oversight mechanisms,
such as the Defense Contract Audit Agency‘s reviews of incurred costs
and oversight documents, inform them of the activities of offshore
subsidiaries. In contracts we reviewed, evidence of offshore
subsidiaries was present in contractor labor rates, cost accounting
disclosures, and contractor price proposals. Contracting officials
stated that the use of offshore subsidiaries did not negatively impact
contract schedule or performance.
What GAO Recommends:
Congress should consider whether further legislative action is needed
to address contractor avoidance of unemployment taxes for U.S. workers.
View [hyperlink, http://www.gao.gov/products/GAO-10-327] or key
components. For more information, contact John Needham at (202) 512-
4841 or needhamjk1@gao.gov.
[End of section]
Contents:
Letter:
Background:
Top Defense Contractors Increased Offshore Subsidiary Use to Support
Global Commercial Activities and Benefit from Reduced Liabilities:
Offshore Subsidiaries Supporting DOD Service Contracts Overseas Were
Principally Used to Avoid Payroll Taxes:
Contractors' Use of Offshore Subsidiaries Did Not Impede DOD's
Contract Oversight:
Conclusion:
Matter for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Related GAO Products:
Tables:
Table 1: Comparison of Top 25 Defense Contractors' Subsidiaries in
2003 and 2008:
Table 2: Contractor and Subsidiary Information for Six Case Study
Defense Contracts:
Table 3: Notional Comparison of Selected Payroll Taxes Paid by
Employer for an Employee Earning $100,000 in Wages:
Table 4: DOD Contractors Interviewed and Their Fiscal Year 2008 DOD
Contract Obligations:
Figure:
Figure 1: Example of Contractor Process for Hiring U.S. Personnel
through Offshore Subsidiaries for DOD Work Overseas Prior to the HEART
Act:
Abbreviations:
CAS: Cost Accounting Standards:
DCAA: Defense Contract Audit Agency:
DCMA: Defense Contract Management Agency:
DOD: Department of Defense:
FAR: Federal Acquisition Regulations:
FICA: Federal Insurance Contributions Act:
FPDS-NG: Federal Procurement Data System--Next Generation:
HEART Act: Heroes Earnings Assistance and Relief Tax Act:
SEC: Securities and Exchange Commission:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
January 26, 2010:
Congressional Committees:
Many federal contractors operate globally through offshore
subsidiaries to take advantage of favorable labor and market
conditions. GAO and others have found that contractors also use
offshore subsidiaries to reduce U.S. taxes and maintain subsidiaries
in tax haven and financial privacy jurisdictions.[Footnote 1] Congress
included a provision in the Heroes Earnings Assistance and Relief Tax
(HEART) Act of 2008 that addressed concerns about contractor use of
offshore subsidiaries to minimize U.S. taxes. This provision resulted
in foreign subsidiaries of U.S. companies working on U.S. government
contracts being required to pay certain payroll taxes.[Footnote 2] The
Department of Defense (DOD) relies heavily on federal contractors to
support its missions and in fiscal year 2008 spent approximately $396
billion on contracts for products and services. DOD uses thousands of
contractor employees to assist in operations around the world to
support U.S. forces deployed abroad with services ranging from
security details to transportation and facility management.
The Duncan Hunter National Defense Authorization Act for Fiscal Year
2009 directed GAO to report on the rationale, implications, and costs
and benefits for both the contractor and DOD in using offshore
subsidiaries, with respect to several issues, including: tax
liability; legal liability; compliance with cost accounting standards;
efficiency in contract performance; and contract management and
contract oversight.[Footnote 3] To fulfill our mandate we briefed your
staffs on the results of our review. This follow-on report (1)
assesses trends and purposes for defense contractors' offshore
subsidiaries; (2) identifies how selected defense contractors used
offshore subsidiaries to support ongoing defense contracts; and (3)
assesses DOD oversight and management of defense contractors using
offshore subsidiaries.
To conduct our work, we identified 29 U.S. publicly traded defense
contractors with $1 billion or more in DOD spending in fiscal year
2008, and reviewed information from Securities and Exchange Commission
(SEC) filings to determine which of these contractors had offshore
subsidiaries.[Footnote 4] From these 29 top defense contractors, we
selected 13 to interview based on a range of the amount of government
work in fiscal year 2008, location of identified subsidiaries, and
industry type. In addition, we interviewed three other defense
contractors as part of the case studies we conducted for a total of 16
contractors interviewed. We also interviewed knowledgeable attorneys,
academics, and tax professionals to obtain their views about the
rationale and implications of using offshore subsidiaries.
To identify examples of how contractors use subsidiaries and DOD
contractor management and oversight, we identified the categories of
DOD services most often performed overseas and selected six
illustrative contracts as case studies based on several factors
including the amount of contract dollars obligated, contracting
command, and services using large numbers of U.S. personnel. For each
of these contracts, we reviewed data on contractor performance and
interviewed DOD oversight staff, contracting commands, and company
officials responsible for these defense contracts. To determine
whether contractors using offshore subsidiaries selected for case
studies were subject to payroll taxes, including Social Security,
Medicare, and federal and state unemployment taxes for U.S. employees,
we reviewed contract file documents for the contractors and
interviewed Defense Contract Audit Agency (DCAA) officials. As an
illustrative example, we also selected one state, Texas, in which four
of the six selected contractors had a corporate presence, and reviewed
2009 unemployment benefit claims data. We interviewed state workforce
officials to determine the impact on the ability of U.S. personnel
working overseas for offshore subsidiaries to claim unemployment
benefits. We identified and assessed relevant laws, regulations, GAO
reports, and DOD policies applicable to contractor offshore
subsidiaries.
We conducted our review from February 2009 to January 2010 in
accordance with generally accepted government auditing standards.
These standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives. See appendix I
for more details on our scope and methodology.
Background:
Our prior work has found that U.S. multinational corporations engage
in offshore operations to reduce labor and administrative costs.
[Footnote 5] For example, many U.S. companies have found cost
efficiencies by outsourcing manufacturing jobs based in the U.S. to
countries with skilled labor available at lower cost. U.S. and foreign
tax regimes also influence decisions of U.S. multinational
corporations regarding how much to invest and how many workers to
employ in particular activities and in particular locations. Tax rules
also influence where corporations report earning income for tax
purposes.
We have reported on the conditions under which a federal contractor in
a low-tax jurisdiction--one that has no or nominal taxes and no
requirement for a substantive local presence--may have a tax cost
advantage when competing for federal contracts.[Footnote 6] The extent
of the advantage depends on the relative tax liabilities of the
contractor and its competitors. We also previously reported that 63 of
the 100 largest publicly traded federal contractors in terms of fiscal
year 2007 federal contract obligations reported having subsidiaries in
jurisdictions identified as tax haven or financial privacy
jurisdictions.[Footnote 7]
Defense contractors may contain a number of separate legal entities. A
parent corporation may directly own, either wholly or partially,
multiple subsidiary corporations. In turn, these subsidiaries may own
other corporate subsidiaries, and any of these corporations may own
stakes in partnerships. A domestic parent corporation--one that is
organized under U.S. laws--may head a group of affiliated businesses
that includes both domestic and foreign subsidiaries and partnerships.
Companies also consider payroll taxes in managing offshore operations.
Employers withhold these taxes from employee's wages for Social
Security and Medicare and match the employee's contribution for these
taxes.[Footnote 8] Workers make contributions to Social Security
through payroll taxes that the Treasury credits to the Social Security
Trust Fund. About 96 percent of the nation's workforce is in social
security-covered employment and pays tax on its annual earnings. When
workers pay social security taxes, they earn coverage credits, and 40
credits--equal to at least 10 years of work--entitle them to social
security benefits when they reach retirement age. Different
requirements govern the number of coverage credits necessary to
receive disability and survivors benefits for workers who become
disabled or die with relatively short work careers. Most employers
also pay both a federal and a state unemployment tax, which provide
unemployment compensation to workers who have lost their jobs.
Employees in most states do not contribute to unemployment taxes.
[Footnote 9]
DOD uses thousands of defense contractors to provide services ranging
from security details and interpreters to transportation and facility
management in support of U.S. forces in contingency operations around
the world. To oversee these contracts, the Defense Contract Management
Agency (DCMA) is responsible for monitoring contractors' performance
and management systems to ensure that cost, product performance, and
delivery schedules are in compliance with contract terms and
conditions. DCAA, under the authority of the DOD Comptroller, plays a
critical role in contractor oversight by providing auditing,
accounting, and financial advisory services for DOD and other federal
agency contracts. We have reported extensively on DOD contractor
management and oversight challenges in contingency operations and the
need for DOD to have better contract and contractor personnel
information.[Footnote 10] In part for these reasons, DOD contract
management issues, including sufficient oversight, have been a long-
standing GAO high-risk area.
Top Defense Contractors Increased Offshore Subsidiary Use to Support
Global Commercial Activities and Benefit from Reduced Liabilities:
From 2003 through 2008, defense contractors increasingly used offshore
subsidiaries. Our analysis of SEC filings found that in 2008, 29 of
the top defense contractors--accounting for 41 percent of DOD
contracting dollars in fiscal year 2008--had at least 1,194 offshore
subsidiaries.[Footnote 11] Of the total offshore subsidiaries, about
200 were located in tax haven or financial privacy jurisdictions such
as Singapore, Hong Kong, Ireland, or Luxembourg. Publicly traded
defense contractors[Footnote 12] increased their combined use of
foreign subsidiaries by 26 percent from 2003 through 2008. Of these
new subsidiaries, most were located in the United Kingdom and Canada,
while the largest rate of growth was in the British Virgin Islands and
Aruba. See table 1 for more information on the top 25 defense
contractor subsidiaries.
Table 1: Comparison of Top 25 Defense Contractors' Subsidiaries in
2003 and 2008:
Defense subsidiaries[A]: Offshore;
2003: 928;
2008: 1,169;
Percentage change: 26%.
Defense subsidiaries[A]: Domestic;
2003: 1,533;
2008: 1,472;
Percentage change: -4%.
Source: SEC 10-K filings.
[A] Four of the 29 top publicly traded defense contractors in 2008
were not publicly traded companies in 2003 and, therefore, were not
included in our analysis.
[End of table]
According to 13 of the top defense contractors we interviewed, 718 of
the 738 offshore subsidiaries--or 97 percent--that they reported to
the SEC in fiscal year 2008 were generally used to support global
commercial clients, and foreign government contracts rather than DOD
contracts. In some cases, contractors established offshore
subsidiaries for market presence and proximity to customers as they
thought it was important to establish a presence where they do
business overseas to be more responsive to customer needs. For
example, one defense contractor established subsidiaries in Singapore
to assist with equipment manufacturing and repairs of commercial
aircraft operating throughout Asia because it is more cost-efficient
than sending the aircraft back to the United States for repairs. Ten
of the 13 defense contractors told us they establish or acquire
offshore subsidiaries to take advantage of foreign government markets.
In one case, a defense contractor explained that it created a
subsidiary in the Netherlands to hire local nationals in order to win
a contract with the Dutch government. Contractors also noted that, in
certain circumstances, they are required to create offshore
subsidiaries to comply with foreign government requirements. For
example, one company told us it established a subsidiary in Bahrain to
comply with Bahrainian law for doing business in that country. In
another instance, one contractor said that it registered as a local
company in Iraq to conduct business in compliance with Iraqi law.
Aside from taking advantage of foreign government markets for
commercial work, a key benefit of using offshore subsidiaries cited by
contractors and other experts we spoke with was the ability to reduce
overall taxes. Several defense companies explained that the use of
offshore subsidiaries in foreign jurisdictions helps them lower their
U.S. taxes.[Footnote 13] For example, one defense contractor's
offshore subsidiary structure decreased its effective U.S. tax rate by
approximately 1 percent, equaling millions of dollars in tax savings.
Our review of 2008 SEC filings for the 29 publicly traded defense
companies found that approximately one-third reported decreasing their
2008 effective U.S. tax rates through the use of foreign affiliates,
lower foreign tax rates, and indefinite reinvestment of foreign income
outside of the United States.
Defense contractors also told us that creating subsidiaries, whether
based in the United States or offshore, protects U.S. parent companies
from certain legal liabilities, although company representatives said
this was not a primary reason for establishing offshore subsidiaries.
For example, defense companies and experts noted that subsidiary
structures limit U.S. parents from liabilities related to changes in
foreign law and practices. Defense contractors said an offshore
subsidiary can be used to focus liability in one place, thus shielding
the rest of the company from potential lawsuits because only the
assets of the subsidiary would be susceptible.
While almost all of the 738 offshore subsidiaries were used to support
commercial and foreign clients, 20--about 3 percent--were used to
support DOD contracts in fiscal year 2008. However, we do not know the
percentage of DOD contract dollars supporting activities of offshore
subsidiaries because contract data do not capture the use of offshore
subsidiaries specifically. Most of the 13 defense contractors we
interviewed directed work performed for DOD in a foreign country to a
company subsidiary in that country. For example, one defense
contractor's German subsidiary was the prime contractor for a facility
operations support services contract in Germany. Another contractor
used an Australian subsidiary to support a Navy research and
development contract performed in Australia. In contrast, we also
identified some defense contractors that used subsidiaries registered
outside the place of contract performance to support DOD service
contracts abroad. These offshore subsidiaries had no staff or business
activity where registered.
Offshore Subsidiaries Supporting DOD Service Contracts Overseas Were
Principally Used to Avoid Payroll Taxes:
The primary use of the offshore subsidiaries registered outside the
contract place of performance--many of those reviewed in our six case
studies--was to hire U.S. workers to perform services overseas and
thereby avoid Federal Insurance Contributions Act (FICA) taxes for
those employees.[Footnote 14] According to contractor officials, the
practice used in the cases we reviewed allowed the contractor to bid
lower labor costs when competing for labor-intensive DOD service
contracts performed abroad. Using offshore subsidiaries also permitted
contractors to avoid other payroll taxes, such as federal and state
unemployment insurance. Before the HEART Act took effect in August
2008, FICA tax payments were not required for U.S. personnel working
overseas on U.S. government contracts for foreign subsidiaries of U.S.
companies.[Footnote 15]Although this practice resulted in contract
cost savings for DOD, it meant that taxes were not paid into the
Social Security and Medicare Trust Funds as they would have been had
the services been provided by U.S. personnel employed by a domestic
entity. Additionally, because these payments were not made, employees
did not receive coverage credits--earned when workers pay social
security taxes--for this work.
DOD and defense contractor officials explained that the use of
offshore subsidiaries to hire U.S. workers to perform services
overseas was a practice used for labor-intensive service contracts,
often for work performed in countries such as Iraq, Afghanistan, and
Kuwait, because of the potential for FICA cost savings. Four of the
six contractors commonly used offshore subsidiaries when hiring U.S.
personnel to work on U.S. government contracts beyond the contracts we
reviewed.[Footnote 16] Defense contractor officials explained that the
need for security clearances for U.S. personnel working on certain DOD
contracts, as well export control provisions, limit the types of
defense work that can be conducted through offshore subsidiaries.
Typically, when contract functions required personnel with security
clearances, these personnel were hired through the contractor's U.S.
subsidiary, while personnel who did not require a security clearance
were hired though an offshore subsidiary. For one contract task order
we reviewed, more than 80 percent of the contractor's staff were
employed by its offshore subsidiary. See table 2 for information on
the six contracts selected for review.
Table 2: Contractor and Subsidiary Information for Six Case Study
Defense Contracts:
Contractor: Kellogg Brown and Root Services Incorporated;
Services provided: Logistics support;
FY2008 Contract obligation[A] (millions): $4,901;
Offshore subsidiary supports contract: [Check];
Offshore subsidiary supports other DOD contracts: [Check];
Offshore subsidiary awarded contract (prime contractor): [Empty];
Location (for contract reviewed): Cayman Islands;
Contract place of performance: Various countries, including Iraq;
Contract type: Primarily cost-plus.
Contractor: Combat Support Associates;
Services provided: Logistics support;
FY2008 Contract obligation[A] (millions): $487;
Offshore subsidiary supports contract: [Check];
Offshore subsidiary supports other DOD contracts: [Empty];
Offshore subsidiary awarded contract (prime contractor): [Empty];
Location (for contract reviewed): Cayman Islands;
Contract place of performance: Kuwait;
Contract type: Cost-plus/award fee.
Contractor: Fluor Intercontinental Incorporated;
Services provided: Architect - engineer services;
FY2008 Contract obligation[A] (millions): $196;
Offshore subsidiary supports contract: [Empty];
Offshore subsidiary supports other DOD contracts: [Empty];
Offshore subsidiary awarded contract (prime contractor): [Empty];
Location (for contract reviewed): Did not use an offshore subsidiary;
Contract place of performance: Iraq;
Contract type: Cost-plus/award fee.
Contractor: AECOM Government Services, Incorporated;
Services provided: Maintenance and repair of vehicles;
FY2008 Contract obligation[A] (millions): $143;
Offshore subsidiary supports contract: [Check];
Offshore subsidiary supports other DOD contracts: [Check];
Offshore subsidiary awarded contract (prime contractor): [Empty];
Location (for contract reviewed): Cayman Islands;
Contract place of performance: Iraq Afghanistan;
Contract type: Cost-plus/fixed fee.
Contractor: DynCorp International LLC;
Services provided: Construction of miscellaneous buildings;
FY2008 Contract obligation[A] (millions): $40;
Offshore subsidiary supports contract: [Check];
Offshore subsidiary supports other DOD contracts: [Check];
Offshore subsidiary awarded contract (prime contractor): [Empty];
Location (for contract reviewed): United Arab Emirates;
Contract place of performance: Afghanistan;
Contract type: Fixed-price.
Contractor: ITT Federal Services GMBH;
Services provided: Facilities operations and management;
FY2008 Contract obligation[A] (millions): $35;
Offshore subsidiary supports contract: [Check];
Offshore subsidiary supports other DOD contracts: [Check][B];
Offshore subsidiary awarded contract (prime contractor): [Check];
Location (for contract reviewed): Germany;
Contract place of performance: Germany;
Contract type: Cost-plus/award fee.
Source: GAO analysis.
[A] The contract dollars obligated value only includes the contract
actions for the specified service, per FPDS-NG. This value may not
reflect the contract's full obligation amount in cases where the
contract has actions under multiple FPDS-NG service categories.
[B] ITT Federal Services, the parent company of ITT Federal Services
GMBH, uses another offshore subsidiary to support DOD contracts.
[End of table]
Three of the six DOD contractors used subsidiaries registered, but
that did not have any staff or business activity, in the Cayman
Islands. Services were provided in locations near the contract place
of performance. For example, one company used two Cayman Islands
subsidiaries to hire and pay employees for logistics support contracts
performed in locations around the world, including the Middle East.
However, the subsidiaries' payroll processing work is conducted in
Dubai. According to DOD, these subsidiaries are registered in the
Cayman Islands to avoid payroll taxes. One company official explained
that the Cayman Islands are a popular choice for establishing offshore
subsidiaries because of the ease with which they can be registered due
to local laws. Furthermore, employees of Cayman Islands corporations
do not pay taxes in that country. Figure 1 provides an example of how
defense contractor subsidiaries were used to hire and pay U.S.
personnel for DOD work performed overseas prior to the HEART Act.
For five of the six cases we reviewed, DOD reduced contract costs as a
result of the use of offshore subsidiaries to provide payroll
functions. Most of the contracts were cost-reimbursement type
contracts, which authorize agencies to reimburse contractors for
allowable costs to the extent prescribed in the contract. Taxes are a
type of allowable cost prescribed in the Federal Acquisition
Regulation. Consequently, if defense contractors were required to pay
taxes such as FICA or state and federal unemployment insurance, DOD
would usually reimburse these costs. Our analysis of the two largest
service contracts with a combined total of more than $6 billion in
fiscal year 2008 obligations indicates that DOD saved at least $110
million per year by not having to provide reimbursement for FICA taxes.
Figure 1: Example of Contractor Process for Hiring U.S. Personnel
through Offshore Subsidiaries for DOD Work Overseas Prior to the HEART
Act:
[Refer to PDF for image: illustration]
DOD Statement of Work requires logistics support services for forces
in Iraq:
DOD awards the contract to a U.S.-based defense contractor. The
contractor needs U.S. employees for various positions supporting the
contract.
Does the position require a security clearance?
If yes:
Employee is hired through a U.S.-based subsidiary;
Contractor and employees pay FICA taxes.
If no:
Employee is hired through an offshore subsidiary;
Contractor and employees Do Not pay FICA taxes;
FICA cost savings provided to DOD.
Source: GAO analysis.
[End of figure]
HEART Act Resulted in Contractors Paying FICA Taxes and Impacted Use
of Offshore Subsidiaries:
After the HEART Act took effect, defense contractors that were not
paying FICA taxes on U.S. personnel working on DOD contracts outside
of the United States began to submit requests for equitable
adjustments to recover their newly increased tax costs. For the four
cost-reimbursement contracts we reviewed that used an offshore
subsidiary, the increased costs were negotiated with DOD officials and
were being processed as contract modifications at the time of our
review. DOD and company officials stated that total contract costs
have increased by approximately 8 to 10 percent in some cases due to
both FICA tax payments and increased contract award fees.[Footnote 17]
As a result, in fiscal year 2009, four of the five contractors using
offshore subsidiaries to support DOD work requested reimbursement of
at least $140 million from DOD for new FICA payments on the contracts
we reviewed as well as some others.
Several contractors stated that they initially used offshore
subsidiaries to hire U.S. workers to perform services overseas in
order to offer competitive prices when bidding for DOD contracts, and
as this practice grew, it became a competitive necessity. DOD
officials said they did not think that using an offshore subsidiary to
avoid FICA taxes provided a competitive advantage to companies since
each competitor was free to adopt the offshore structure if it chose.
With the enactment of the HEART Act, some defense companies have
reconsidered the use of offshore subsidiaries to hire U.S. workers.
One contractor said it established a subsidiary in 1993 to support a
DOD logistics contract because, at that time, company tax advisors
proposed using offshore subsidiaries to achieve cost savings that
could be passed on to DOD. This contractor is considering whether to
continue using this subsidiary now that the cost advantage from FICA
tax savings has been removed. Another contractor said that it had
transferred U.S. personnel from its Cayman Islands subsidiary to a
U.S.-based subsidiary and is evaluating whether to close the
subsidiary. A third contractor said that the HEART Act removed the
cost advantage when hiring U.S. citizens and residents to perform work
overseas, but it still uses the subsidiary to manage foreign workers.
Contractors noted that the requirement of the HEART Act that companies
hiring U.S. personnel overseas pay FICA taxes may have unintended
consequences, such as hiring fewer of these employees. Additionally,
they noted that foreign-based contractors now have a cost advantage in
competing for overseas DOD contracts because they are not required to
pay FICA taxes for their U.S. workers. Several company and DOD
officials also stated that a foreign subsidiary could continue to
avoid FICA taxes if the parent company changes its ownership stake in
the foreign subsidiary to 50 percent or less, which is below the
ownership threshold defined in the law.[Footnote 18] In fact, one
defense contractor adopted this practice and sold 50 percent of its
wholly owned subsidiary the day before the HEART Act took effect in
order for its foreign subsidiary to avoid paying FICA taxes for U.S.
workers performing DOD work abroad. According to DCAA, another defense
contractor proposed subcontracting U.S. workers who do not require
security clearances through a new offshore company to bypass the HEART
Act requirements.
Defense Contractors' Offshore Subsidiaries Continue to Avoid
Unemployment Taxes for Their U.S. Workers:
While five of the six contractors in our case studies said that
reducing FICA tax payments was the primary reason for using offshore
subsidiaries, this practice also allowed the contractors to reduce
costs by avoiding state and federal unemployment insurance taxes for
U.S. personnel working overseas. For U.S. citizens performing certain
work outside the United States, federal law requires only American
employers to pay unemployment taxes; foreign subsidiaries are not
defined as American employers under the law. The HEART Act did not
address unemployment payroll taxes for U.S. personnel working
overseas, and while these taxes are much lower than FICA taxes,
contractors have been able to continue to avoid them. Our analysis of
data from one contractor showed a savings of almost $6 million in 2009
by not paying state and federal unemployment insurance taxes for U.S.
workers on its federal government contract that were hired through its
offshore subsidiary. Table 3 provides a notional example of
differences in payroll taxes paid for U.S. workers of a domestic
subsidiary versus an offshore subsidiary.
Table 3: Notional Comparison of Selected Payroll Taxes Paid by
Employer for an Employee Earning $100,000 in Wages:
Employer[A]: Employee wages;
Offshore subsidiary, before the HEART Act: $100,000;
Offshore subsidiary, after the HEART Act: $100,000;
U.S. subsidiary: $100,000.
Employer[A]: FICA taxes: Social Security Old Age, Survivors, and
Disability Insurance (OASDI) (6.2%);
Offshore subsidiary, before the HEART Act: $0;
Offshore subsidiary, after the HEART Act: $6,200;
U.S. subsidiary: $6,200.
Employer[A]: FICA taxes: Medicare Hospital Insurance (1.45%);
Offshore subsidiary, before the HEART Act: $0;
Offshore subsidiary, after the HEART Act: $1,450;
U.S. subsidiary: $1,450.
Employer[A]: Unemployment taxes: Federal Unemployment Tax (0.8% on
first $7,000 in wages)[B];
Offshore subsidiary, before the HEART Act: $0;
Offshore subsidiary, after the HEART Act: $0;
U.S. subsidiary: $56.
Employer[A]: Unemployment taxes: State Unemployment Tax (1% on first
$9,000 in wages)[C];
Offshore subsidiary, before the HEART Act: $0;
Offshore subsidiary, after the HEART Act: $0;
U.S. subsidiary: $90.
Total employer payroll taxes:
Offshore subsidiary, before the HEART Act: $0;
Offshore subsidiary, after the HEART Act: $7,650;
U.S. subsidiary: $7,796.
Source: GAO Analysis:
[A] While both employers and employees pay equal shares of FICA taxes,
contributions to federal and state unemployment taxes are usually paid
by employers but not by employees.
[B] The federal unemployment tax rate is 6.2% on the first $7,000 of
annual wages, but this is typically reduced to 0.8% through an offset
credit for employers who pay the state unemployment tax, resulting in
a maximum tax of $56.00 per employee, per year (0.008 X $7,000 =
$56.00).
[C] Percentage based on average rate paid by Texas employers in 2009.
State unemployment tax rates vary by state and by employer, so that
employer rates are based on their experience with the unemployment
benefits system. The state tax wage bases also vary, from $7,000 in
several states to more than $30,000 in others.
[End of table]
In addition to offshore subsidiaries not owing unemployment taxes,
their U.S. workers may not be eligible for unemployment benefits
stemming from this employment. In one state where four of the six case
study contractors have a corporate presence, we reviewed documentation
for about 140 former employees of several contractors who were denied
unemployment benefits in 2009. State workforce officials indicated
that these benefits were denied because the employees worked for a
foreign subsidiary and not an American employer.
Contractors' Use of Offshore Subsidiaries Did Not Impede DOD's
Contract Oversight:
In the contracts we reviewed, DOD oversight officials were aware of
the roles that offshore subsidiaries played in supporting the
contracts. DOD officials said that oversight mechanisms, such as
DCAA's annual reviews of incurred costs, provide knowledge of the
activities of offshore subsidiaries in cost-reimbursement contracts.
For the contracts for which DCMA had oversight responsibilities,
officials said that they reviewed DCAA audits and approved company
disclosure statements, which included information about the
contractors' use of subsidiaries. Contracting officials said that the
use of offshore subsidiaries did not negatively affect contract
schedule or performance.
In the five contracts we reviewed that used offshore subsidiaries,
DCAA conducted audits or examined documents related to the specific
activities of the subsidiary. For example, for two of the contractors,
DCAA conducted on-site audits of the payroll processing activities
supported by the offshore subsidiaries. In one case, the contractors'
offshore subsidiaries are registered in the Cayman Islands, but its
payroll processing services are performed in Dubai and were audited on
location by DCAA. One DCAA office that monitors several contractors
using offshore subsidiaries has developed guidance to facilitate
reviewing the activities of payroll processing functions.
Contract file and oversight documents we reviewed, such as contractor
price proposals and cost accounting disclosure statements, disclosed
the use of offshore subsidiaries. For example, two of the contract
files included contractor labor rates, which specified the payroll
company (either onshore or offshore) assigned for each position. The
rates also indicate that the fringe benefits paid to employees of the
two offshore subsidiaries were less than benefits for U.S.-based
employees. In another case, one company's price negotiation memo
identified costs related to two offshore subsidiaries, but it did not
indicate that they were foreign companies or where they were
registered.
Although information on the offshore subsidiaries was disclosed in the
contract files, the clarity of information concerning the offshore
subsidiaries' role in the contracts we reviewed varied. For example,
for one of the contracts, a DCMA official said that information
identifying the contractor's offshore subsidiary was available, but it
took several months of working with the contractor to confirm the
subsidiary's purpose in avoiding FICA taxes. In other contracts we
examined, the role of the offshore subsidiary was more readily
apparent. For example, one contract file included documents in which
the defense contractor described the offshore subsidiary as a means of
saving DOD the cost of reimbursing FICA taxes. The contract file
indicated that contracting staff reviewed the company's information
with Army counsel before consenting to the subcontracting arrangement.
DCAA also has responsibility for reviewing contractor compliance with
federal cost accounting standards (CAS). For the six contracts in our
review, DCAA officials indicated that the contractors complied with
CAS. Contracts and subcontracts executed and performed entirely
outside of the United States, its territories, and possessions are
exempt from CAS requirements.[Footnote 19] Although performed
overseas, according to DCAA and contracting officials, most of the
contracts we examined were not CAS exempt because some costs were
incurred within the United States, and in each case the contractors
followed CAS. In general, defense companies said that even when their
contracts are CAS exempt, they comply with CAS because the accounting
system is already in place.
Conclusion:
While defense contractors have increased their offshore subsidiaries
used for commercial purposes, the practice of using offshore
subsidiaries to avoid certain payroll taxes on U.S. government
contracts has been addressed by the HEART Act. As a result,
contractors have begun to pay FICA taxes for U.S. workers hired
through offshore subsidiaries to support DOD contracts, thus
contributing to the Social Security and Medicare Trust Funds. This
requirement will likely lead to a change in corporate decisions to
create offshore subsidiaries for this purpose. DOD also continues to
monitor these contractor practices. Notwithstanding these changes, the
HEART Act did not address unemployment taxes for U.S. workers of
offshore subsidiaries, and some contractors continue to avoid these
taxes. While unemployment insurance taxes are much lower than those
for FICA, this continues to allow for a potential tax advantage for
contractors hiring U.S. workers through offshore subsidiaries for U.S.
government contracts performed overseas.
Matter for Congressional Consideration:
Congress should consider whether further legislative actions are
needed to require payment of unemployment taxes for U.S. workers hired
by offshore subsidiaries to perform services overseas.
Agency Comments and Our Evaluation:
We provided a draft of this report to the Departments of Defense and
Labor, the Internal Revenue Service, and the Securities and Exchange
Commission. Each agency generally agreed with our report and did not
provide additional comments. We also obtained third party views from
defense contractors selected as part of our case studies; they
generally agreed with our findings and provided technical comments,
which were incorporated as appropriate. Texas Workforce Commission
officials reviewed a portion of the draft report related to
unemployment benefits and agreed with our findings.
We are sending copies of this report to other interested congressional
committees and the Secretary of Defense. In addition, this report will
be available at no charge on GAO's Web site at [hyperlink,
http://www.gao.gov].
Should you or your staff have any questions on the matters covered in
this report, please contact John Needham at (202) 512-4841 or
needhamjk1@gao.gov. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
report.
Key contributors to this report were Amelia Shachoy, Assistant
Director; W. William Russell; Jennifer Dougherty; Emily Gruenwald; Ami
Ballenger; Noah Bleicher; Ken Patton; and Susan Neill.
Signed by:
John K. Needham:
Director:
Acquisition and Sourcing Management:
List of Committees:
The Honorable Carl Levin:
Chairman:
The Honorable John McCain:
Ranking Member:
Committee on Armed Services:
United States Senate:
The Honorable Ike Skelton:
Chairman:
The Honorable Howard P. McKeon:
Ranking Member:
Committee on Armed Services:
House of Representatives:
[End of section]
Appendix I: Scope and Methodology:
To understand the trends and purposes of defense contractors' offshore
subsidiaries, we identified 45 contractors with $1 billion or more in
2008 Department of Defense (DOD) spending, based on data from the
Federal Procurement Data System-Next Generation (FPDS-NG).[Footnote
20] Of the 45 contractors, we found 29 were publicly traded U.S.
companies and we corroborated this information with officials at the
Securities and Exchange Commission (SEC). We reviewed prior GAO
reports, performed literature searches, and conducted legal research
regarding DOD contractors' use of offshore subsidiaries.
To identify the 29 companies' subsidiaries, we reviewed the 2008 Form
10-K[Footnote 21] reports filed with the SEC, which require companies
to disclose their significant subsidiaries. SEC defines a subsidiary
as significant if (1) the parent corporation's and its other
subsidiaries' investments in and advances to the subsidiary exceed 10
percent of the consolidated total assets of the parent corporation and
its subsidiaries, (2) the parent corporation's and its other
subsidiaries' proportionate share of total assets (after intercompany
eliminations) of the subsidiary exceed 10 percent of the consolidated
total assets of the parent corporation and its subsidiaries, or (3)
the parent corporation and its other subsidiaries' equity in the
income from continuing operations exceeds 10 percent of the
consolidated income from continuing operations of the parent
corporation and its subsidiaries. The total number of subsidiaries
reported to the SEC is most likely understated. We also analyzed
offshore subsidiary data from 2003 and 2008 for 25 of the 29
contractors to determine differences in the numbers and locations of
offshore subsidiaries over a 5-year period. We excluded 4 of the 29
contractors that were not publicly traded in 2003 from our analysis.
To further understand the reasons companies use offshore subsidiaries,
we conducted interviews with tax specialists, senior international
procurement attorneys, as well as tax and legal professors. We
performed literature searches to find examples of legal cases
involving the contractors we selected for case studies and their
subsidiaries from 1980 to present. We specifically looked for cases
involving liability issues between a parent company and an offshore
subsidiary.
To learn more about how defense contractors use offshore subsidiaries,
we conducted interviews with 13 of the 29 DOD contractors. We selected
these contractors based on a range of the amount of government work in
fiscal year 2008, location of identified subsidiaries, and industry
type. In addition, we interviewed 3 other defense contractors for the
case studies we conducted, for a total of 16 contractors interviewed.
We identified the top service categories procured by DOD outside of
the United States based on fiscal year 2008 FPDS-NG data. The services
selected were logistics support, construction of miscellaneous
buildings, facilities operations, repair and maintenance of vehicles,
and architect and engineer services. From this data, we selected six
contracts for services overseas to provide illustrative examples of
services performed outside the United States based on several factors,
including the amount of contract dollars obligated, type of service
provided, contracting command, and the contract place of performance,
as well as services using large numbers of U.S. personnel. We compared
the FPDS-NG data to DOD Synchronized Pre-deployment and Operational
Tracker (SPOT) data to identify contracts that employed U.S. workers
abroad. We also identified contracts in which the prime contractor was
an offshore subsidiary of a U.S. defense company. For each contract
selected, we interviewed contractor officials, DOD contracting command
staff, as well as DOD officials responsible for oversight of the
contracts. Of the six contracts that met these selection criteria,
three of the associated contractors were among the 13 interviewed from
the top 29 defense contractors. Table 4 lists the 16 DOD contractors
interviewed.
Table 4: DOD Contractors Interviewed and Their Fiscal Year 2008 DOD
Contract Obligations:
DOD contractors: Lockheed Martin Corporation;
Fiscal Year 2008 DOD contract obligations: $28.9 billion;
Fiscal Year 2008 DOD service contract obligations: $12.6 billion.
DOD contractors: The Boeing Company;
Fiscal Year 2008 DOD contract obligations: $22.2 billion;
Fiscal Year 2008 DOD service contract obligations: $9.4 billion.
DOD contractors: General Dynamics Corporation;
Fiscal Year 2008 DOD contract obligations: $15.2 billion;
Fiscal Year 2008 DOD service contract obligations: $5.1 billion.
DOD contractors: L-3 Communications Holdings, Inc.;
Fiscal Year 2008 DOD contract obligations: $6.8 billion;
Fiscal Year 2008 DOD service contract obligations: $4.7 billion.
DOD contractors: KBR, Inc.;
Fiscal Year 2008 DOD contract obligations: $6.0 billion;
Fiscal Year 2008 DOD service contract obligations: $6.0 billion.
DOD contractors: ITT Corporation;
Fiscal Year 2008 DOD contract obligations: $4.6 billion;
Fiscal Year 2008 DOD service contract obligations: $2.0 billion.
DOD contractors: General Electric Company;
Fiscal Year 2008 DOD contract obligations: $3.5 billion;
Fiscal Year 2008 DOD service contract obligations: $1.0 billion.
DOD contractors: Computer Sciences Corporation;
Fiscal Year 2008 DOD contract obligations: $2.9 billion;
Fiscal Year 2008 DOD service contract obligations: $2.9 billion.
DOD contractors: Health Net, Inc.;
Fiscal Year 2008 DOD contract obligations: $2.4 billion;
Fiscal Year 2008 DOD service contract obligations: $2.4 billion.
DOD contractors: Harris Corporation;
Fiscal Year 2008 DOD contract obligations: $1.8 billion;
Fiscal Year 2008 DOD service contract obligations: $0.3 billion.
DOD contractors: Honeywell International, Inc.;
Fiscal Year 2008 DOD contract obligations: $1.7 billion;
Fiscal Year 2008 DOD service contract obligations: $0.7 billion.
DOD contractors: DynCorp International, Inc.;
Fiscal Year 2008 DOD contract obligations: $1.4 billion;
Fiscal Year 2008 DOD service contract obligations: $1.4 billion.
DOD contractors: Rockwell Collins, Inc.;
Fiscal Year 2008 DOD contract obligations: $1.2 billion;
Fiscal Year 2008 DOD service contract obligations: v0.3 billion.
DOD contractors: Fluor Corporation;
Fiscal Year 2008 DOD contract obligations: $0.7 billion;
Fiscal Year 2008 DOD service contract obligations: $0.4 billion.
DOD contractors: Combat Support Associates;
Fiscal Year 2008 DOD contract obligations: $0.5 billion;
Fiscal Year 2008 DOD service contract obligations: v0.5 billion.
DOD contractors: AECOM Technology Corporation;
Fiscal Year 2008 DOD contract obligations: $0.5 billion;
Fiscal Year 2008 DOD service contract obligations: $0.5 billion.
DOD contractors: Total;
Fiscal Year 2008 DOD contract obligations: $100.3 billion;
Fiscal Year 2008 DOD service contract obligations: $50.1 billion.
Source: USASpending and FPDS-NG, August 2009.
[End of table]
To assess the FPDS-NG data reliability for the contracts selected, we
corroborated the FPDS-NG data with DOD officials and the contract
files. We confirmed that contract information reported in FPDS-NG,
including the contract identification number, contract type, service
provided, contracted vendors, the contract place of performance, and
the fiscal year 2008 dollars obligated were sufficiently reliable for
our purposes.
To review DOD oversight and management of defense contractor's use of
offshore subsidiaries, for each of the six contracts selected, we
reviewed selected contract file documentation, including contracts and
task orders, price negotiation memorandums, requests for consent to
subcontract, and contractors' proposed pricing data. In addition, we
reviewed relevant Defense Contract Audit Agency (DCAA) audit reports
and documentation. We also reviewed available guidance from
contracting commands and estimates related to implementing the Heroes
Earnings Assistance and Relief Tax (HEART) Act of 2008 and interviewed
cognizant DOD officials, including contracting officers, DCAA and
Defense Contract Management Agency (DCMA) where delegated, as well as
the contractors. We reviewed the Federal Acquisition Regulation (FAR)
and the Defense FAR Supplement to identify any requirements regarding
DOD contractors' use of offshore subsidiaries as well as Cost
Accounting Standards (CAS) and reviewed DOD's public comments on the
CAS Board's review of the CAS exemption for contracts performed
entirely overseas.
To determine whether contractors using offshore subsidiaries selected
for case studies owed payroll taxes, we reviewed contract file
documents for the contractors and interviewed DCAA officials. With
regard to state and federal unemployment taxes, we analyzed contractor
proposed labor rate information in 2009 to determine the amount of
state and federal unemployment tax that was avoided on DOD contracts
through the use of offshore subsidiaries. We also selected one state,
Texas, in which four of the six selected contractors had a corporate
presence as an illustrative example. We reviewed data and interviewed
the state's workforce officials to determine whether employees of
those companies were denied unemployment benefits in 2009 because the
employees were hired through a company's offshore subsidiary. We
assessed the reliability of the state unemployment data and determined
it was sufficiently reliable for our purposes. In addition, we
reviewed guidance and interviewed Department of Labor officials about
federal and state unemployment insurance eligibility requirements.
We conducted this performance audit from February 2009 through January
2010 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit
to obtain sufficient, appropriate evidence to provide a reasonable
basis for our findings and conclusions based on our audit objectives.
We believe that the evidence obtained provides a reasonable basis for
our findings and conclusions based on our audit objectives.
[End of section]
Related GAO Products:
International Taxation: Large U.S. Corporations and Federal
Contractors with Subsidiaries in Jurisdictions Listed as Tax Havens or
Financial Privacy Jurisdictions. [hyperlink,
http://www.gao.gov/products/GAO-09-157]. Washington, D.C.: December
18, 2008.
U.S. Multinational Corporations: Effective Tax Rates are Correlated
with Where Income Is Reported. [hyperlink,
http://www.gao.gov/products/GAO-08-950]. Washington D.C.: August 12,
2008.
DCAA Audits: Allegations That Certain Audits at Three Locations Did
Not Meet Professional Standards Were Substantiated. [hyperlink,
http://www.gao.gov/products/GAO-08-857]. Washington D.C.: July 22,
2008.
Cayman Islands: Business and Tax Advantages Attract U.S. Persons and
Enforcement Challenges Exist. [hyperlink,
http://www.gao.gov/products/GAO-08-778]. Washington D.C.: July 24,
2008.
Defense Acquisitions: DOD's Increased Reliance on Service Contractors
Exacerbates Long-standing Challenges. [hyperlink,
http://www.gao.gov/products/GAO-08-621T]. Washington, D.C.: January
23, 2008.
Offshoring: U.S. Semiconductor and Software Industries Increasingly
Produce in China and India. [hyperlink,
http://www.gao.gov/products/GAO-06-423]. Washington D.C.: September 7,
2006.
Company Formations: Minimal Ownership Information Is Collected and
Available. [hyperlink, http://www.gao.gov/products/GAO-06-376].
Washington, D.C.: April 7, 2006.
International Trade: Current Government Data Provide Limited Insight
into Offshoring of Services. [hyperlink,
http://www.gao.gov/products/GAO-04-932]. Washington D.C.: September
22, 2004.
[End of section]
Footnotes:
[1] See GAO, International Taxation: Tax Haven Companies Were More
Likely to Have a Tax Cost Advantage in Federal Contracting,
[hyperlink, http://www.gao.gov/products/GAO-04-856], (Washington D.C.:
June 30, 2004).
[2] Pub. L. No. 110-245, § 302. See 26 U.S.C. § 3121(z) and 42 U.S.C.
§ 410(e).
[3] Pub. L. No. 110-417, § 844 (2008).
[4] Throughout this report we use the terms "offshore subsidiaries"
and "foreign subsidiaries" synonymously.
[5] GAO, International Trade: Current Government Data Provide Limited
Insight into Offshoring of Services, [hyperlink,
http://www.gao.gov/products/GAO-04-932] (Washington DC: September 22,
2004).
[6] [hyperlink, http://www.gao.gov/products/GAO-04-856].
[7] Financial privacy jurisdictions are jurisdictions that have strict
bank secrecy laws that persons can use to shield their wealth from
taxation in their home countries. See GAO, International Taxation:
Large U.S. Corporations and Federal Contractors with Subsidiaries in
Jurisdictions Listed as Tax Havens or Financial Privacy Jurisdictions,
[hyperlink, http://www.gao.gov/products/GAO-09-157] (Washington, D.C.:
December 18, 2008).
[8] GAO, Tax Compliance: Businesses Owe Billions in Federal Payroll
Taxes, [hyperlink, http://www.gao.gov/products/GAO-08-1034T]
(Washington DC: July 29, 2008).
[9] New Jersey, Pennsylvania, and Alaska withhold unemployment
insurance taxes directly from both employees and employers.
[10] GAO, Military Operations: High-Level DOD Action Needed to Address
Long-standing Problems with Management and Oversight of Contractors
Supporting Deployed Forces, [hyperlink,
http://www.gao.gov/products/GAO-07-145] (Washington, D.C.: Dec. 18,
2006).
[11] SEC requires companies to provide information on significant
subsidiaries as part of their annual filings. As a result, foreign
subsidiaries that do not meet the SEC reporting threshold may not be
listed, and the total number of subsidiaries reported may be
understated.
[12] Four of the 29 top publicly traded defense contractors in 2008
were not publicly traded companies in 2003 and, therefore, were not
included in our analysis.
[13] Tax avoidance, the act of using legally available tax planning
opportunities in order to minimize one's tax liability, is
permissible. Tax avoidance should be distinguished from tax evasion,
which is the willful attempt to defeat or circumvent the tax law in
order to illegally reduce one's tax liability.
[14] Federal Insurance Contributions Act (FICA) tax is a payroll tax
on both employers and employees to fund the Social Security and
Medicare Trust Funds. Employers are required to withhold 7.65 percent
of employees' covered salaries for FICA taxes, which include Social
Security and hospital insurance (Medicare) taxes. U.S. employees pay
FICA taxes as well. Consequently, after the HEART Act, the U.S.
personnel of these foreign subsidiaries working on U.S. government
contracts were also required to pay FICA taxes.
[15] The HEART Act amended the U.S Code to define a foreign subsidiary
of a U.S. company working on a U.S. government contract as a domestic
company for certain purposes, thus resulting in the foreign subsidiary
being required to pay certain payroll taxes for its U.S. workers
performing services abroad on the government contract as well as
requiring those U.S. workers to pay their share of the payroll taxes.
The HEART Act did not address the payment of state or federal
unemployment taxes for U.S. personnel working outside the United
States for foreign companies.
[16] One of the six case study contractors, Fluor Intercontinental,
did not use an offshore subsidiary to support the DOD contract we
selected for review. According to DOD and company officials, they also
did not use offshore subsidiaries to support other DOD contracts.
[17] Potential contract award fees are based on estimated total
contract costs.
[18] The HEART Act applies to foreign companies (and their U.S.
workers performing on U.S. government contracts) that are part of a
"controlled group of entities" whose common parent is a U.S.
corporation. For this purpose, the HEART Act revised the definition of
a "controlled group of entities" to lower the ownership threshold of a
parent-subsidiary from "at least 80 percent" to "more than 50
percent." See 26 U.S.C. § 1563(a)(1).
[19] 48 C.F.R. § 9903.201-1(b)(14).
[20] Selection of defense contractors was based on the obligation
amounts as of February 2009.
[21] Form 10-K is used for the annual reports or transition reports
that corporations file with the SEC according to the Securities
Exchange Act of 1934. 15 U.S.C. §§ 78m, 78o(d); 17 C.F.R. § 249.310.
[End of section]
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U.S. Government Accountability Office:
441 G Street NW, Room 7149:
Washington, D.C. 20548:
