A Taxing Dispute

The WTO ban on a U.S. export subsidy has pushed companies and Congress into a battle over tax bills.

Last summer, Corporate America stood united before Congress to plead for the preservation of some $5 billion in export-tax benefits. Those benefits have been associated with the foreign sales corporation/extraterritorial income (FSC/ETI) exclusions, a government-approved regime of tax shelters for foreign earnings. Ruled illegal subsidies by the World Trade Organization twice in the past five years, the exclusions are slated for extinction, and executives trooped to Capitol Hill to ask not for clemency but for reincarnation.

“The loss of ETI without a suitable replacement could undermine the ability of U.S. exporters to compete in a global trade environment,” warned F. Lynn McPheeters, CFO of Caterpillar Inc. “If the FSC/ETI were repealed…certainly it would be very detrimental,” echoed Dan Kostenbauder, Hewlett-Packard’s general tax counsel. Pierre Chao, a senior adviser at Credit Suisse First Boston, predicted that loss of the tax break would chop billions off the market capitalizations of key exporters like Boeing and United Technologies, thanks to lower earnings.

Now, with the European Union resting its finger on the trigger of $4 billion in retaliatory tariffs to force ETI repeal, Congress appears to be responding to those pleas for a replacement. While the Bush Administration has vowed to comply with the WTO directive, “it’s very unlikely [FSC/ETI] would be repealed with nothing in its stead,” says Rachelle Bernstein, director of Deloitte & Touche’s tax-policy services group. In fact, not one but two bills with replacement tax breaks are being crafted in the House, and the Senate may add a third.

What constitutes a suitable replacement, however, has been the subject of bitter debate. Domestic manufacturers like Caterpillar are pushing for a tax break linked to U.S.-based production, currently embodied in a bill sponsored by Philip Crane (R-Ill.), Charles Rangel (D-N.Y.), and Don Manzullo (R-Ill.). Global operators like HP and Coca-Cola, though, are hoping to seize the opportunity to write more-favorable tax rules associated with overseas subsidiaries, an effort now headed by Committee on Ways and Means chair Bill Thomas (R-Calif.). While the two goals are not mutually exclusive, together they would cost the government about $80 billion over 10 years, reckons Gary Hufbauer, senior fellow at the Institute for International Economics in Washington, D.C., far exceeding the $50 billion 10-year FSC/ETI tab.

Double Trouble

At the heart of the matter is an effort to keep U.S. corporate tax burdens in line with what foreign-based firms face. In general, unlike their foreign competitors, U.S. companies must pay taxes on all income they bring back into the country, regardless of where it is earned. Since 1971, though, exporters have been allowed to funnel sales through so-called domestic international sales corporations and then FSCs, then deduct portions of those foreign earnings from their taxable income. That system, revised four times up to the current ETI regime, creates billions of dollars of savings for companies that primarily manufacture in the United States but sell overseas. It has also consistently been deemed an illegal export subsidy by the WTO.

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