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WTO Dispute Settlement United States - Tax Treatment for Foreign Sales Corporations.

WTO Dispute Settlement United States - Tax Treatment for Foreign Sales Corporations. Tanya Bathiche Marcia Banda Samrawit Aragie ITRN 603 – International Trade Relations Professor Malawar. Outline. Overview History Main WTO Issue U.S. laws involved with this case WTO Agreement

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WTO Dispute Settlement United States - Tax Treatment for Foreign Sales Corporations.

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  1. WTO Dispute SettlementUnited States - Tax Treatment for Foreign Sales Corporations. Tanya Bathiche Marcia Banda Samrawit Aragie ITRN 603 – International Trade Relations Professor Malawar

  2. Outline • Overview • History • Main WTO Issue • U.S. laws involved with this case • WTO Agreement • Complainant (E.U.) & Respondent (U.S.) Position • Panel Decision • Appellate Body Decisions • Implementation of Sanctions • National and International Interests • Proposal for Resolution

  3. OverviewHistoryMain WTO IssueU.S. laws involved- Tanya Bathiche

  4. Overview • Complainant: European Communities • Respondent: United States • Third Parties: Australia, Barbados, Brazil, Canada, China, India, Jamaica, Japan • Current Status: The WTO Appellate Body, on 13 February 2006, issued its report regarding the last compliance panel report on the European Communities’ complaint against “United States: Tax treatment for ‘Foreign Sales Corporations’” (DS108).

  5. The beginning… • The Domestic International Sales Corporation (DISC) provisions – roots of the FSC controversy • Enacted as part of the Revenue Act of 1971 and went into effect on January 1, 1972 • Provided a tax incentive to export • Tax incentive for exports was desirable to stimulate the US economy • The European Community (EC; the precursor of the European Union) began proceedings against the provision under GATT almost immediately. • Foreign Sales Corporation provision (FSC) was enacted in 1984 to replace the DISC • Extraterritorial income (ETI) provision enacted in 2000 in response to a WTO panel ruling against the FSC • American Jobs Creation Act enacted in 2004 to repeal FSC/ETI regime

  6. DISC and GATT • DISC was intended both to stimulate U.S. exports and to encourage U.S. firms to locate their production for foreign markets in the United States rather than abroad • European countries complained under the General Agreement on Tariffs and Trade (GATT, the WTO's predecessor) that DISC was a prohibited export subsidy • The US argued that a parallel existed between the U.S. export tax benefits and the territorial systems maintained by several European countries. • A GATT panel ruled against DISC, and the United States did not concede DISC's illegality but replaced DISC in 1984 with the Foreign Sales Corporation (FSC) provisions, • Designed to achieve GATT- legality while still providing an export benefit

  7. FSC and WTO • Foreign Sales Corporation provision (FSC) was enacted in 1984 to replace the DISC • Under FSC: • Exporters obtained a tax benefit by selling their exports through a specially qualified subsidiary corporation, in this case, an FSC. • The EU argued that the FSC rules provided special tax exemptions where export income would otherwise be taxed. The EU also argued that FSC's administrative pricing rules constituted an export subsidy. • The United States, in turn, argued that territorial taxation was WTO-legal and that FSC was similar to territorial taxation. • WTO’s ruling in favor of the EU posed a dilemma for the US: achieve WTO-legality or maintain the "competitiveness" of U.S. exports.

  8. ETI and WTO • Extraterritorial income (ETI) provision enacted in 2000 in response to a WTO panel ruling against the FSC • ETI provision extended the tax benefit beyond exports to income from foreign operations, thus attempting to provide a tax benefit that included exports but that was not "export contingent.” • ETI provisions do not require a firm to sell its exports through a foreign-chartered corporation to qualify for the benefit (unlike the FSC) • The United States argued that ETI was broader than FSC, and revised the general U.S. method of taxing overseas income because the provisions could be applied to income from foreign operations as well as exports • ETI provisions imposed enough special conditions on their use that they were an exception to the general U.S. tax practice, and was therefore a subsidy

  9. Main WTO Issue • Provisions of U.S. tax law provide impermissible “subsidies” because business income from exports is sometimes not taxed at the same rate as other forms of corporate income • American Jobs Creation Act (AJCA) enacted in 2004 to repeal FSC/ETI regime • According to the E.C., the Jobs Act was intended to implement the DSB recommendations and rulings in the case but… • It failed to do so properly and was inconsistent with the provisions of the WTO Agreement as did the predecessor legislation. • E.C. concern about Section 101 of the Jobs Act • Although the AJCA repealed the ETI measures it conserved payments to previous beneficiaries under a two year ‘transitional period’ and through permanent “grandfathering” of some payments. The WTO has now ruled that these clauses preserve illegal benefits.

  10. US laws involved with this case… • The Domestic International Sales Corporation (DISC) provisions • Foreign Sales Corporation (FSC) portion of the tax code (EU contends that it violates trade rules) • Extraterritorial Income Act (ETI) (Congress had replaced FSC with ETI) • Jobs Creation Action of 2004, section 101 in particular (also referred to as the JOBS Act)

  11. ConsultationsPanel DecisionsAppellate Body Decisions- Marcia Banda

  12. Second First Third 1997 2004 Consultation 2000 Original Panel Compliance Panel 2 Compliance Panel 1 Panel Appellate Body 2000 ETI 2004 JOBS 2006 ? Action This can help before start….

  13. First Phase(1997-2000) Consultation Panel #1 (Original) Appellate Body Implementation

  14. 1997: Consultation • On November 18 1997, the EC request for consultations with the US in respect of Sections 921-927 of the Internal Revenue Code. The exemptions from the United States direct (income) taxes of a portion of FSC income constitute export subsidies contrary to Article XVI GATT 1994 and Article 3.1(a) (b) of the ASCM. The requirement that the tax exemption under the FSC scheme provides treatment less favorable to imported products than is accorded to like US products contrary to Article III:4 GATT 1994

  15. Agreements and provisions: GATT 1994 • Article III:4, National Treatment on Internal Taxation and Regulation:The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favorable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use. The provisions of this paragraph shall not prevent the application of differential internal transportation charges which are based exclusively on the economic operation of the means of transport and not on the nationality of the product. • Article XVI, Subsidies: A.I. Subsidies in general, If any contracting party grants or maintains any subsidy, including any form of income or price support, which operates directly or indirectly to increase exports of any product from, or to reduce imports of any product into, its territory, it shall notify the contracting parties in writing of the extent and nature of the subsidization, of the estimated effect of the subsidization on the quantity of the affected product or products imported into or exported from its territory and of the circumstances making the subsidization necessary. In any case in which it is determined that serious prejudice to the interests of any other contracting party is caused or threatened by any such subsidization, the contracting party granting the subsidy shall, upon request, discuss with the other contracting party or parties concerned, or with the contracting parties, the possibility of limiting the subsidization.

  16. Agreements and provisions (Cont.) • Agreement on subsidies on Countervailing Measures (ASCM): • Article 3.1 Except as provided in the Agreement on Agriculture, the following subsidies, within the meaning of Article 1, shall be prohibited: (a) subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex I; (b) subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods. • Agreement on Agriculture • Article 3.3,Incorporation of Concessions and Commitments: A member will not provide export subsidies in excess of the budgetary outlay and quantity commitment levels specified therein and shall not provide such subsidies in respect of any agricultural product not specified in that Section of the Schedule. • Article 8,Export Competition Commitments: Each Member undertakes not to provide export subsidies otherwise than in conformity with this Agreement and with the commitments as specified in that Member’s Schedule. • Article 10.1, Prevention of Circumvention of Export Subsidy Commitments: • Export subsidies not listed in paragraph 1 of Article 9 shall not be applied in a manner which results in, or which threatens to lead to, circumvention of export subsidy commitments;  nor shall non-commercial  transactions be used to circumvent such commitments. 

  17. 1998: Panel #1 (Original) • On September 22, 1998 the DSB established a panel. • On October 8, 1999 the Panel Report circulated. • The panel found that, through the FSC scheme, the US acted inconsistently with its obligations under Article 3.1(a) of the Subsidies Agreement as well as with its obligations under Article 3.3. of the Agreement on Agriculture (and consequently with Article 8).

  18. 2000: Appellate Body #1 & Action #1On November 26 1999, the US appealed; On February 24 2000, the AB ruled • It upheld the panel’s finding that the FSC measure constituted a prohibited subsidy under Article 3.1(a) of the SCM Agreement. • It reversed the panel’s finding that the FSC measure involved “the provision of subsidies to reduce the costs of marketing exports” of agricultural products under Article 9.1(d) of the Agriculture Agreement and, in consequence, reversed the panel’s findings that the US had acted inconsistently with its obligations under Article 3.3 of the Agriculture Agreement. • It found that the US acted inconsistently with its obligations under Articles 10.1 and 8 of the Agriculture Agreement by applying export subsidies, through the FSC measure, in a manner which results in, or threatens to lead to, circumvention of its export subsidy commitments with respect to agricultural products._____________________________________________________ • November 15, 2000: US action #1.Extraterritorial Income Exclusion Act of 2000 (ETI) The ETI Act was a measure taken by the U.S. to comply with the recommendations and rulings of the Dispute Settlement Body (DSB) in “US-FSC”, however did not modify the export subsidy scheme.

  19. Second Phase(2000-2004) Consultation Panel #2 (Compliance Panel #1) Appellate Body Implementation

  20. 2000: Compliance (Consultation & Panel #2)On November 17, 2000 the EC stated that, the US had failed to comply with the DSB. • On December 7, 2000 the EC notified the DSB that consultations had failed to settle the dispute and requested the establishment of a panel. • On January 5, 2001 the Panel was composed. On August 20, 2001, the compliance panel report was circulated: • The ETI Act confers a prohibited subsidy under the WTO Subsidies Agreement; • The ETI Act confers an export subsidy which violates U.S. obligations under the WTO Agriculture Agreement; • The ETI Act violates the national treatment provisions of Article III:4 of the GATT 1994; and • The ETI Act’s transition rules violate the panel’s report recommendation to withdraw the FSC subsidy with effect from November 1, 2000. • The Panel concluded that the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 was still inconsistent with WTO.

  21. 2002: Appellate Body #2, Sanctions, and Action #2. On October 15, 2001 the US appealed On January 14, 2002 the Appellate Body ruled • Upheld the Panel’s findings that the US acted inconsistently with its obligations under the SCM Agreement, the Agreement on Agriculture, and the GATT 1994 through the FSC amended legislation, a measure taken by the United States to implement the recommendations and rulings made by the DSB in the original proceedings in the United States — FSC dispute. • On August 30, 2002 sanctions against US were authorized (additional charge for imports from US in a maximum of $4,043 billion per year) ____________________________________________ • October 22, 2004: US action #2.American JOBS Creation Act of 2004

  22. Third Phase(2004-2006) Consultation Panel #3 (Compliance Panel #2) Appellate Body Implementation

  23. 2004: Compliance (Consultation &Panel #3)On November 15, 2004 the EC requested the US to enter consultations with respect to the American Jobs Creation Act • In particular, the European Communities considers that Section 101 of the JOBS Act contains transitional provisions which will allow US exporters to continue to benefit from the WTO incompatible FSC Replacement and Extraterritorial Income Exclusion Act (a) in the years 2005 and 2006 with respect to all export transactions and (b) for an indefinite period with respect to certain binding contracts, thus failing to withdraw the subsidy and implement the DSB’s recommendations and rulings. • January 1, 2005 EC suspended sanctions (Consultation fails) • On 13 January 2005, the EC notified the DSB that consultations had failed to settle the dispute and that it was requesting the establishment of a panel. • On 30 September 2005, the Panel Report was circulated to Members. The Panel found that the United States has failed to implement fully the DSB recommendations and rulings arising from the original dispute and first compliance proceedings.

  24. Arguments of the Parties: European Communities • The EC asserts that two provisions of the Jobs Act continue inconsistencies with the United States' WTO obligations. These two provisions are: • the "transition provision 44”, which provides for a two-year continuation of a percentage of ETI benefits (80 per cent in 2005 and 60 per cent in 2006); and • the "grandfathering provision"45, which exempts certain transactions indefinitely from the repeal of the ETI scheme. • Moreover, the EC submits that, as the Jobs Act is silent as to the prohibited FSC subsidies grandfathered through section 5 of the ETI Act, the United States persists in failing to withdraw fully these prohibited subsidies.

  25. Arguments of the Parties: U.S. • According to the United States, the purpose of fiscal transition provisions contained in sections 101(d) and (f) of the Jobs Act is to provide a smooth and orderly transition in order to prevent the repeal of tax legislation from having a retroactive effect on taxpayers who entered into arrangements in reliance on pre-repeal law. Such transition rules are typically included in major US tax legislation.

  26. 2005: Appellate Body #3. On November 24 2005, the US appealed On January 26 2006, the Appellate Body ruled • Upholds the Panel's finding, in paragraph 7.87 of the Panel Report, that Section 5(c)(1)(B) of the FSC Repeal and Extraterritorial Income Exclusion Act of 2000, grandfathering prohibited FSC subsidies, was within its terms of reference176; and • Upholds the Panel's finding and conclusion, in paragraphs 7.65 and 8.1 of the Panel Report, that "to the extent that the United States, by enacting Section 101 of the American Jobs Creation Act of 2004, maintains prohibited FSC and ETI subsidies through [the] transitional and grandfathering measures, it continues to fail to implement fully the operative DSB recommendations and rulings to withdraw the prohibited subsidies and to bring its measures into conformity with its obligations under the relevant covered agreements."

  27. 2006: Action #3 ?

  28. U.S. Implementation of new policiesImplementation of Sanctions EU InterestsProposal for Resolution- Samrawit Aragie

  29. ETI ACT - November 15, 2000 • President Clinton signed the Extra Territorial Income (ETI) Act to replace the FSC • Extended the tax break to all types of entities with qualifying foreign sales • Provided some relief from double taxation both for exports and foreign production • Established that foreign tax credits on goods concerned were not available to a participating entity • Set forth requirements for : Proportion of US-manufactured content (actual manufacture could take place outside US); and proportion of foreign costs • After the passing of ETI, the EU began to consider sanctions on the US

  30. EU countermeasures on US goodsFebruary 2004 • Selected products would have an additional customer duty of 5% as of March 1, 2004 • Followed by a 1% increase monthly up to a ceiling of 17% to be reached on March 1, 2005

  31. Expected Customs Duties on Specific Products

  32. Estimated Impact in 2004

  33. JOBS ACT - March 2004 • Senate approved 19 to 2 a bill called the Jumpstart Our Business Strength (JOBS) Act • Over three years this Act would repeal FSC/ETI and reduce the tax rate for all US based companies • JOBS would also reform the US international tax regime • This would cut corporate taxes by $100 billion over a ten year period and eliminate $56 billion in export subsidies.

  34. American Jobs Creation Act - 2004 • Passed by House Ways and Means Committee on June 17th and by the Senate in a 69-17 vote • Cut corporate taxes by $142 billion over a ten year period and eliminate $40 billion in export subsides • Three year transitional period

  35. Australia Barbados Brazil Canada China India Jamaica Japan Third Parties

  36. US Need For Tax Provision • US exporters would have to pay value added tax (VAT) on sales into the EU, Canada, Mexico, and other countries • Exporters will also have to pay full corporate income tax on their earnings • Competitors will export goods into US market free of VAT and take advantage of selling subsidiaries located in low-tax jurisdictions

  37. Underlying EU Interests • FSC case might be used to resolve WTO disputes already lost by the EU (beef hormone and potential biotechnology claims, restrictions on steel imports, and agricultural subsidies) • May stall US from bringing forth challenges against the EU (trade barriers against genetically modified organisms, Airbus subsidies)

  38. Others Implicated • Export processing zones mostly in developing countries • US export source rule • Territorial tax systems used in Europe and other countries (Netherlands and Belgium)

  39. Proposals • Creation of Committee in Security Exchange Commission for oversight • Elimination of three year transitional period • High penalties for corporations that continue to take advantage of loophole tax subsidy of FSC

  40. Conclusion • Proposal for Compliance with WTO Ruling: Removal of Section 101 of the Jobs Act • Will this be enough to satisfy the EU? • What political underpinnings will this have in the United States? • How will this change effect the US economy?

  41. Questions & Answers

  42. References • www.iie.com/publications/papers/paper.cfm?ResearchID=451 • www.iie.com/publications/pb/pb02-10.pdf • www.state.gov/e/eb/rls/othr/13210.htm • www.eurunion.org/news/press/2004/20040032.htm • www.lawandtax-news.com/html/us/juslatcorp.html • http://usinfo.state.gov.ei/archive/2004/Mar/04-845697.html • http://tax.cchgroup.com/tax-briefings/2004-Jobs-Creation-Act.pdf • http://www.wto.org/english/news_e/news06_e/news06_e.htm

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