Tax Break, Trade Battle?

Congress wants to replace foreign sales corporations with new foreign income rules, but the European Union is crying foul.

Critics of the World Trade Organization (WTO) don’t always take to the streets, wearing turtle costumes and waving protest banners. Thanks to a long-simmering dispute over export tax breaks, some of the WTO’s biggest detractors can now be found in the executive suites of America’s largest companies.

The dispute centers on the U.S. tax code’s rules for foreign sales corporations (FSCs). Since their authorization in 1984, FSCs have enabled U.S. companies to collectively save billions of dollars on their export tax bills. But the European Union (EU) began complaining in November 1997 that the FSC regime amounted to an illegal export subsidy, and in October 1999, the WTO agreed. It set an October 1, 2000, deadline for the United States to either eliminate FSCs or change the rules according to the WTO’s terms. The ruling was upheld by a WTO appeals panel last February.

With significant input and support from business groups, the Clinton Administration and members of Congress drew up a plan that would replace the FSC regime with a completely new approach. On September 13, the U.S. House of Representatives passed a bill based on the proposal and sent it on to the Senate, where it was stalled at press time. On September 30, the United States and the EU agreed to extend the deadline for WTO compliance to November 1, giving the Senate the breathing room necessary to resolve the concerns of lawmakers on both sides of the aisle. The EU also said it would not impose sanctions without a WTO rejection of the replacement legislation, if passed.

The one-month extension gives the issue a chance to cool off. “The agreement … reflects our common desire to handle trade disputes in a pragmatic and nonconfrontational manner,” said Pascal Lamy, European trade commissioner in Brussels, when the extension was announced. But the delay won’t stave off the inevitable challenge of the new tax regime by the EU. “The new tax regime is still a subsidy and is still focused on exports,” complains one EU delegation official in Washington, D.C., who spoke on condition of anonymity.

Once requested to take up the dispute again by the EU, the WTO would have 90 days to rule on the replacement tax regime. Simultaneously, a separate panel would be asked to determine appropriate sanctions, which the EU will argue will be “at least $4 billion, the value of the current subsidies,” predicts the EU delegation official. Appeals would certainly follow the WTO ruling, and the United States would face any consequences by mid-2001 at the earliest.

A Fine Piece of Work

The EU may be dissatisfied, but the U.S. business community has good reasons to support the new rules. For one, the rules could provide even bigger tax savings, amounting to around $5 billion per year. The Joint Committee on Taxation, Congress’s in-house tax office, estimates that the changeover to the new rules should cost the federal government just $1.5 billion in lost revenue over five years.

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