The measure comes amid continued debate in the United States and Iraq over the involvement of security contract workers from the U.S. firm Blackwater in a Sept. 16 shooting in Baghdad that left 17 Iraqis dead.
Iraqi Prime Minister Nouri al-Maliki has pledged to push through the legislation amid growing public anger over the Blackwater shooting incident and other Iraqi civilian deaths allegedly suffered at the hands of foreign contractors.
Iraqi government spokesman Ali al-Dabbagh said the draft law would cancel Order 17, a U.S.-led Coalition Provisional Authority decree issued in 2004 that protects foreign contractors from being prosecuted in local Iraqi courts.
Security companies also would have to register, and employees would have to carry weapons licenses and could be searched at Iraqi security checkpoints.
Complicating the issue of accountability, the Associated Press and other media organizations revealed earlier this week that the State Department offered Blackwater bodyguards limited immunity during the investigation into the shootings last month.
The immunity deal was not for full protection, but kept the bodyguard's statements sealed so that prosecutors could not use any information from the statements when pursuing criminal charges.
State Department spokesman Sean McCormack refused to answer questions on the immunity reports.
"If there are individuals who broke rules, laws or regulations, they must be held to account," he told reporters.
The FBI took control of the investigation from the State Department early this month, and has re-interviewed some of the Blackwater employees. Several Blackwater bodyguards have refused to be interviewed by the FBI, claiming they were promised immunity, reported the Washington Post.
Blackwater has claimed its employees acted lawfully after being attacked, but witnesses and the Iraqi government claim the contractors fired on civilians and deliberately killed them.
The FBI will turn over its investigation results to the Justice Department, which will decide whether or not to prosecute.
It is unclear whether any U.S. law actually applies to the contractors. The House passed a bill last month that would expand laws that currently apply only to Pentagon contractors to State Department contractors as well.