Afghanistan Compliance Advisory
2 July 2014
Half way through 2014 the political, economic and business climate in Afghanistan grows increasingly challenging. We are pleased to provide this analysis of risks that could impact your business operations in Afghanistan.
Afghan Presidential Elections. On June 14, 2014, Afghanistan’s second round of elections was held between the two top candidates from round one, former Finance Minister Dr. Ashraf Ghani and former Foreign Minister Dr. Abdullah Abdullah. In late June a crisis emerged when Abdullah announced that he no longer trusts the Independent Election Commission (IEC) and the Election Complaint Commission (ECC), the two institutions responsible for conducting and certifying the election. Abdullah alleged fraud had taken place in round two, and he further alleged a lack of neutrality on the part of the election bodies. As a result, Abdullah suspended his cooperation with IEC and ECC and vowed not to accept the election results as legitimate.
- Despite the protest from Abdullah, the Election Commission decided to continue with the process of counting votes and auditing ballots. The preliminary results are supposed to be announced on July 2, and the IEC is supposed to announce the final, certified results on July 22.
- President Karzai has announced that he is committed to transfer power on August 2, 2014.
- In order to overcome the impasse between Ghani and Abdullah, President Karzai has recommended that the two contenders turn to the United Nations or to the current Afghan Vice Presidents, one of whom favors Ghani and the other Abdullah, to mediate their dispute.
- An announcement of the preliminary election results on July 2, 2014 (today) is expected.
Impact of an election dispute on USG contractors in AFG. The fragile political situation in Afghanistan, the specter of violent protests in Kabul and elsewhere, and a protracted disagreement between the two candidates could lead to insecurity and instability that negatively impact USG contractor’s ability to execute their missions.
- Changes in government positions: Regardless of which candidate wins the presidency, USG contractors should reasonably expect wholesale changes at key security and finance posts in the government. To the extent that certain Afghan government officials and ministries have acted in a manner that violates the existing status agreement and has made execution of the USG contractor’s mission unreasonably and unjustifiably difficult, the expectation of change of such officials may create a more predictable and legally accommodating environment for USG contractors.
- Delays in filling key government positions. The next President will present the cabinet nominees to Parliament for approval, which is a time consuming process. Thus, until this new team is in place there will be uncertainty surrounding the policies, execution and enforcement of Afghan laws, regulations and interpretation of the current Status Agreement and the BSA once signed by the new president.
Bilateral Security Agreement (BSA). BSA approval and implementation remains on hold until a new president assumes office. Both candidates have clearly stated their intent to sign the BSA immediately upon assuming office. In the meantime, the existing status agreement will remain in effect; it does not “expire” on a given date.
- Even after the BSA is signed, adherence to the terms of the BSA by Afghan government ministries may be sketchy in the beginning, or even in the long term, in light of the track record of violations by multiple Afghan government agencies of certain provisions of the existing status agreement.
- Implementing regulations for the BSA continue to be developed between US and Afghan officials.
Tax Implications Bi-lateral Security Agreement (BSA). Relevant to the USG-MOF subcontractor tax dispute is Article 17, Paragraph 3, of the BSA that clearly states that USG contractors working as a sub-contract for the benefit of the US Forces are tax exempt:
3. United States contractors shall not be liable to pay any tax or similar or related charges assessed by the Government of Afghanistan within the territory of Afghanistan on their activities, and associated income, relating to or on behalf of United States forces under a contract or subcontract with or in support of United States forces. However, United States contractors that are Afghan legal entities shall not be exempt from corporate profits tax that may be assessed by the Government of Afghanistan within the territory of Afghanistan on income received due to their status as United States contractors.
Until the BSA is implemented, however, the dispute concerning the tax exempt status of USG sub-contractors remains a sensitive problem. Under the BSA, as is the case under the existing SOFA, USG contractors and sub-contracts are still required to register and obtain tax exempt ruling from the MOF.
U.S. Department of Defense (DoD) Afghanistan Contract Tax Reporting Requirement. On 23 May 2014, U.S. House of Representatives Passed the FY2015 National Defense Authorization Act, which included the following section:
SEC 1251215. Requirement to withhold Department of Defense assistance to Afghanistan in amount equivalent to 150 percent of all taxes assessed by Afghanistan to extent such taxes are not reimbursed by Afghanistan.
(a) Requirement to withhold assistance to Afghanistan.—An amount equivalent to 150 percent of the total taxes assessed during fiscal year 2014 by the Government of Afghanistan on all Department of Defense assistance in violation of the status of forces agreement between the United States and Afghanistan (entered in force May 28, 2003) shall be withheld by the Secretary of Defense from obligation from funds appropriated for such assistance for fiscal year 2015 to the extent that the Secretary of Defense certifies and reports in writing to the appropriate congressional committees that such taxes have not been reimbursed by the Government of Afghanistan to the Department of Defense or the grantee, contractor, or subcontractor concerned.
(b) Waiver authority.—The Secretary of Defense may waive the requirement in subsection (a) if the Secretary determines that such a waiver is necessary to achieve United States goals in Afghanistan.
(c) Report.—Not later than March 1, 2015, the Secretary of Defense shall submit to the appropriate congressional committees a report on the total taxes assessed during fiscal year 2014 by the Government of Afghanistan on any Department of Defense assistance.
Impact of DoD law on USG Contractors. DoD is already including a clause in contracts requiring the reporting requirement and warning that contractors may not charge Afghan taxes to the contract.
- USG prime and subcontractors have a reporting obligation to DOD regarding Afghan tax assessments so that DOD can report to the Congress what, if any, taxes were collected by the Afghan MOF in “violation of the status of forces agreement between the United States and Afghanistan (entered in force May 28, 2003)”. For any such taxes collected by the Afghan MOF, Congress intends to withhold 150% of that amount from assistance earmarked for Afghanistan.
- Under the existing Status of Forces Agreement (SOFA) and under the anticipated BSA, USG contractors must still comply with certain tax laws of Afghanistan (e.g., Afghan tax withholding requirements for rental payments, non-exempt employee wages, Afghan sub-contractors and penalty payments). These tax laws are not considered a violation of the SOFA. Additionally, commercial contracts not for the benefit of US forces are not covered by the SOFA.
- The current dispute between the USG and Afghanistan Ministry of Finance (MOF) revolves around whether USG subcontractors are tax exempt under the SOFA: DoD believes they are exempt and Afghan MOF believes they are not (despite the text of the current SOFA). This has created a sensitive situation for USG prime contractors that have hired USG Sub-contractors over the past 2 – 3 years. The enactment of the new legislation will 1) not permit USG contractors to charge any tax that violates the SOFA and 2) require the reporting to DoD of any taxes payments to Afghan MOF.
Blacklisting of Afghanistan by Financial Action Task Force – decision delayed 4 months. In 2012, Afghanistan, in partnership with the Financial Action Task force (FATF), an intergovernmental body that develops guidelines on anti-money laundering, took steps to address inadequacies regarding its effort to draft and implement laws focused on Anti-Money Laundering and Countering Financing of Terrorism (AML/CFT). After receiving several extensions, in May 2014 FATF gave Afghanistan a stern warning that if measures recommended by FATF were not passed then Afghanistan would be blacklisted. Thus, Afghanistan would be prevented from engaging in financial transactions with most international financial institutions, including US banks. In other words, USG Contractors would not be able to transfer funds between banks to pay local vendors.
Sensing the urgency of this issue, in early June the Afghan Government convened a meeting with representatives from the G-7 in order to seek yet another extension due to the political transition to a new government in August. However, the Afghan officials were informed that the AML/CFT regulations must be passed by FATF meeting in Paris on June 23-27, with all the provisions the international community deems essential. The Afghan Ministry of Justice had removed 34 provisions in total from the draft AML/CFT law citing conflict with local Afghan laws and sufficient coverage of certain provisions in other legislation implemented by Afghanistan. For example, in the draft regulations, the international community sought to empower FinTRACA on anti-money landing issues, and to provide them with the authority to act independently as they worked with international law enforcement to track financial assets of Afghan citizens or freeze their assets. However, this provision was removed by the Ministry of Justice citing conflict with local laws; under current Afghan regulations, the freezing of assets of an Afghan citizen that has funds in an Afghan financial institution regulated by FinTRACA, can only be authorized with the approval of President of Afghanistan. With all of the 34 provisions added back into the regulations, the draft AML/CFT was sent to the Afghan lower house of parliament in early June, and they passed it on June 16. The language was subsequently referred to the upper chamber of Parliament, approved on June 23, and sent to the Afghan President for signature.
The next day the President signed the Anti-Money Laundering regulations but not the Countering of Financing of Terrorism. In a June 27 statement, FATF declared that Afghanistan had made sufficient progress to avoid blacklisting, but since compliance is an ongoing process, the issue would be revisited in the next FATF meeting in October 2014, particularly since Afghanistan had passed both laws on June 23 but had only enacted the Anti-Money Laundering law.