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An Overview of the FSC Dispute (EU v. U.S.)

An Overview of the FSC Dispute (EU v. U.S.). ITRN 603 -- Professor Stuart S. Malawer By: Jim Ficaro, Lori Gavaghan, Chris Hartman, Mike Kalutkiewicz. Table of Contents. What is FSC; background Conflicting Views and Early Battles The WTO Case

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An Overview of the FSC Dispute (EU v. U.S.)

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  1. An Overview of the FSC Dispute (EU v. U.S.) ITRN 603 -- Professor Stuart S. Malawer By:Jim Ficaro, Lori Gavaghan, Chris Hartman, Mike Kalutkiewicz

  2. Table of Contents • What is FSC; background • Conflicting Views and Early Battles • The WTO Case • The U.S. Response • Issues and Recommendations

  3. What is FSC? • Foreign Sales Corporation • “Tax deferral” vehicle/concept introduced by 1984 legislation (actually replaced GATT violator, DISC of ‘71) • IRC Sections 921-927 established FSCs, which would be defined as “corporate entities in foreign jurisdictions through which US manufacturing companies could channel exports” • Implication: 15% of FSC sales would be exempt from corporate taxation • @ 35% rate, equates to keeping 5.25% more revenues

  4. Who Benefits? • Foreign subsidiaries of American companies • U.S. Virgin Islands, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, or other qualified foreign countries i.e. Bahamas, Barbados, Bermuda, etc. • Ex. Boeing, Caterpillar, Microsoft, IBM, Tyco • ~$5B of tax breaks annually

  5. Economic Process Requirements • FSC, or its agent, must participate, outside the U.S., in any of the following in export transactions: 1) solicitation (other than advertising), 2) negotiation, or 3) contracting • Specific percentages of the transaction costs must be "foreign direct costs," incurred by the FSC for activities it, or its agent, performs outside the U.S. The activities tested are: advertising and sales promotion; processing customer orders and arranging for delivery of the export property; transportation; assembling and transmission of a final invoice or statement of account and the receipt of payment; and assumption of credit risk

  6. Other Requirements • Must have at least one director who is not a U.S. resident • Must keep one set of books of account (including copies or summaries of invoices) at its main offshore office • Must have no more than 25 shareholders • No preferred stock • Must file a timely election to become a FSC with the IRS • Many others

  7. Why FSC? (US Perspective) • US only country with worldwide taxation system • FSC is a mechanism to protect American business and jobs, and a means to bolster US competitiveness • Otherwise US businesses would be double-taxed on foreign sales • EU has similar subsidies within various member countries’ tax codes as well.

  8. Why Not FSC (EU Perspective) • Amounts to a subsidy • Intentional manipulation of tax code is a violation of international trade obligations and also motivates US businesses to shift accounting practices to take advantage of code

  9. Result 1999: WTO ruled in favor of the EU, and determined that the FSC did in fact amount to illegal subsidy (three of the four findings came directly from the statement of the EU challenge) • Violation under SCM Agreement (3.1, 3.2, therefore 4.7); • From agricultural perspective, also violation under Agriculture Agreement (1.e, 3.3, 8, 10.1); • US nullified or impaired benefits accruing to EC under those agreements; • Violation of GATT Subsidies Code aka “National Treatment Principle”: prohibits favoring domestic products over foreign imports and prohibits export subsidies (Article III.4) • The U.S was given until 11/1/00 to comply

  10. American Response – 2000 ETI • Clinton’s Extra-Territorial Income Exclusion Act (ETI) • Allowed for transaction-by-transaction assessment and exemption • Actually widened benefit to all foreign sales (not just actions of foreign subs) • 50% US content minimum requirement also remained • Substance of original violating legislation remained, effectively creating same situation

  11. Back to the WTO • The EU noticed…and returned to the WTO • The US and EU agreed on a procedure to ensure U.S. compliance: • 1) Panel would determine if pursuant legislation (the ETI) was WTO compliant (U.S. or EU could still appeal) • 2) Only after appeal process was exhausted, and the legislation determined to be inconsistent with WTO agreements, was retaliation to occur

  12. Panel’s Findings • On August 21, 2001, the Panel determined the following: • The ETI Act did not bring the U.S. into compliance with WTO Agreements • The U.S. appealed, and the Appellate Body, on January 14, 2002, upheld the Panel’s Decision

  13. EU Response • EU makes a list of US products to apply sanctions against • May, 2003: WTO approves up to $4B of countervailing measures/tariffs • EU gives US until March, 2004 to comply, after which it would impose a 5% tariff against “the list” that would increase by 1% for each month of non-compliance, up to 17% • Applies to ~1,600 items; dairy, meat, sugar, cereal, toys, clothes and machinery • Tariffs officially took effect on March 1, 2004

  14. American Response • Tariffs reach 12% • US fails to pass Job Protection Bill • Senate bill (Rangel & Crane) would have repealed ETI and lowered US tax rate on all domestic manufacturers by 10% to 31.5% • House bill (Thomas) also cut rates, but cost more and included additional benefits • Many wanted neither and wanted to retain exclusive support of exporters rather than share tax breaks • October, 2004: finally passes American Jobs Creation Act of 2004 (JOBS)

  15. 2004 JOBS Act • The House of Representatives voted 280-141 on October 7 to pass the measure repealing FSC/ETI provisions. The Senate voted 69-17 in favor of the bill October 11, completing congressional action and sending the measure to the president for his signature. • Repealed FSC/ETI provisions • Provided other tax breaks instead and reformed tobacco subsidies program • Provided a 2-year transition to “wean” off prior FSC constituents • Would still be eligible for % of traditional benefits • Succeeded in temporarily halting EU tariffs

  16. EU Response • Agreed to remove retaliatory tariffs when new law took effect 1/1/05 • Contesting transition period

  17. Issues • Lack of expedience • Gamesmanship • Enforcement power of WTO appears weak • Issue of sovereignty • At what point does domestic policy making decisions become subject to international review and decision? • Does US code motivate “shady” dealings? • Is US code an impediment to growth? • Efficacy of worldwide taxation system

  18. Recommendations • Quit playing around • US legitimately accept findings and reverse tax breaks for American companies or reduce taxation of foreign earnings in US • Revamp entire tax code

  19. Resources Researched or Cited • http://www.useu.be/Categories/FSC/Index.htm • http://www.lectlaw.com/files/buo05.htm • http://www.lawandtax-news.com/html/us/juslatcorp.html • www.internationaltraderelations.com • Malawer, "International Tax & FSC /ETI CSE." (2002) • "U.S. Domestic Lobbying Battle." (Washington Post 7.6.03) • “Tax Fight.” (Wall Street Journal 9.17.03) • "Congress Stalls on Lifting Export Tax." Wall Street Journal (2.13. 04) • WTO FSC Case Abstract • http://www.cch.com/tax2004/QuickTaxFactsCard.pdf • http://waysandmeans.house.gov/Media/pdf/hr4520/hr4520summary.pdf

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