Hello, 

This is a wide ranging topic and I will try to share what I know.

A significant difference between Offsets and the VAT is that offsets are exclusively negotiated and agreed to between the contractor and the purchaser (pertaining to your question, we are talking about the FMS country). The US government does not encourage nor participate in these types of agreements (DFARS 225.7306), nor does it assume any obligation to satisfy or administer the offset agreement or to bear any associated costs (225.7303-2(a)(iii)). It is the contractor's responsibility to inform the IA (FMS purchasing agent) when estimated offset costs are included in the FMS pricing, and this should be included prior to LOA transmittal or acceptance - otherwise, a modificaiton or ammendment is required (Def. Security Cooperation Agency Security Assistance Manual (DSCA) 5105.38-M, ch. 6, para. 6.3.9). Indirect offset costs are deemed reasonable for purposes of FAR parts 15 and 31 with no further analysis necessary on the part of the contracting officer, provided the contractor submits a signed offset agreement. Contractors may not recover costs incurred for offset agreements unless the LOA is financed wholly with foreign government or int'l organization customer funds or repayable FMS finance credits (US govt funds shall not pay toward offset agreements). (225.7303-2(a)(3)(i)). 

The VAT is a form of sales tax used in many industrialized foreign countries which seeks to tax products incrementally along the supply chain as value is added throughout the process. The US does not employ a VAT, and so such taxes are always foreign. IAW DFARS 229.170-2, by law, bilateral agreements with foreign governments must include a provision that commodities acquired under contract funded by US assistance programs shall be exempt from taxation by the foreign government. If taxes or customs duties are imposed, the foreign government must reimburse the amount of such taxes to the US govt. (Sec 579 of Div E of the Consolidated Appropriations Act, 2003 (Pub L. 108-7). This exemption applies to contract/subcontract for commodities when funds are appropriated by the annual foreign operations appropriation; and the value of the contract is $500 or more. It does not apply to acq of services. This is generally implemented through LOAs, country-to-country agreements, or Fed interagency agreements. Clauses for solicitations and contracts are found in 229.170-4. 

DFARS PGI 229.101 provides guidance on resolving tax problems with foreign governments. PGI 229.7002-1 and -3 specifically adresses the VAT exemption for the United Kingdom. 

I hope this if helpful.  

Curtis Cummings, Professor of Contract Management, DAU - West Region