Tax Deduction for Payment to Foreign Government

The U.S. Securities and Exchange Commission and U.S. Department of Justice continue to prioritize enforcement of the Foreign Corrupt Practices Act of 1977, or FCPA, regarding payment to a foreign official. While some payments to foreign government officials are illegal and some are legal, many people question whether payments from a taxpayer to a foreign government official are tax deductible.

The FCPA term foreign official is construed broadly. For example, an owner of a financial services company who also serves as minister of finance is considered a foreign official. Doctors at government-owned or -managed hospitals are considered foreign officials. The same holds true for any employee of a government-owned or -managed institution or enterprise.

Basic Rules Under the FCPA

Similarly, a rebate, discount, allowance, or other payment that is an illegal bribe, kickback, or payment is not deductible as an ordinary and necessary business expense. However, it may be subtracted from gross sales when determining gross income.

A taxpayer doesn't have to be convicted of making an illegal payment to be prohibited from deducting that payment. Simply violating the FCPA bars an otherwise deductible payment from becoming deductible. However, the IRS has the burden of proving that such a payment was an illegal bribe or kickback.

A taxpayer can deduct a payment made to a foreign government official to facilitate routine administrative, non-discretionary action if the payment does not violate the FCPA. Note that if the payment is not illegal under the FCPA, it may be deductible even if it violates other federal laws. This only applies when such a payment falls within the parameters of an ordinary and necessary business expense.

Illegal Activity

A taxpayer may deduct a legal payment connected to an illegal activity. The prohibition on deduction applies only when the payment itself is illegal, not if it is connected to other activity.

There is a significant difference between bribery and a grease payment. Bribery, which Merriam-Webster defines as "money … given or promised in order to influence the judgment or conduct of a person in a position of trust," is illegal under the FCPA and therefore non-deductible. In contrast, a grease payment, which is money that is paid to influence an official to expedite otherwise routine duties, is not illegal under the FCPA and may be deductible.

Taxpayers who make ordinary and necessary business payments to foreign officials may be able to deduct those payments on their federal tax returns as long as the FCPA does not ban those payments.