US corporate gravy train held WTO illegal

by Chakravarthi Raghavan

Geneva, 26 July -- A United States tax-law device, the US Foreign Sales Corporations Law, that provides for an annual $2 billion subsidy on about annual $150 billion or 25% of US exports, mostly industrial but also some agricultural products, has been held WTO/GATT illegal by a dispute settlement panel.

The ruling, in the interim stage where the findings are given confidentially to the two parties for comments before the panel finalises its report and hands it down, was 'leaked' to the media in Brussels and Washington, and has since been confirmed in a European Community press release Monday in Brussels and comment to the media by former EC trade commissioner, Sir Leon Brittan.

Though interim, in practice WTO panels, even when making changes in their final report on reasoning, in the light of comments, do not change the findings and conclusions.

The panel, in the dispute brought by the EU against the United States, has held the US FSC law -- enacted in the 1980s to replace an earlier law, the 'Domestic International Sales Corporation' (DISC) law which had been held an illegal US subsidy under the old GATT -- to violate the GATT 1994 and its subsidies agreement, and has said the US should bring its legislation into conformity by 1 October 2000 -- said to be the earliest date in US tax and fiscal year calendar, by which the US could bring its law into conformity. In disputes involving the subsidies agreement, the panels decide on the time-frame within which the subsidy must be removed.

The final report is expected to be handed down in September. If the US takes it in appeal, the report of the appellate body would be due by December or early January. Unless the appellate body, on legal grounds, sets aside the panel ruling (and from what is known of the panel rulings and the EC case, it is difficult for this to happen), the US will be faced with an embarrassing trade issue in an election year when corporations, recipients of what US NGOs call 'Corporate welfare scheme', will feverishly lobby the US Congress against changes.

Officials of the EC, so long at the receiving end of some spectacular US 'wins' in the WTO are not disguising their satisfaction at the ruling, and further rulings they expect in 2- 3 more cases against the United States, including the case over Helms-Burton law, the copyright/trade mark violations, and the US S.301.

The modus operandi of the FSC is simple tax avoidance, sanctioned by the US law and costing the US treasury about annual $2 billion in tax foregone, and benefiting the corporations an annual $10 billion, according to the EC estimates.

Corporation A in the US sets up a subsidiary B, often, if not always, a mere 'name-plate' enterprise set up in a off-shore tax- haven, like the Virgin Islands or Barbados. Corporation A exports to say Netherlands, but not directly, but through its subsidary B, though it is only a book transaction and no actual work at B is involved. A exports product X to B at say $80 million value, and B exports the X to say Netherlands at $100 million. This $20 million dollar difference is tax-free in the US, and the cost to the US treasury in taxes foregone on profits (if A had exported $100 million of product directly to the Netherlands) is a subsidy to A.

According to an EC press release in Brussels, the export subsidy practice covers more than $150 billion worth of annual US exports or 25% of the US exports. Under the FSC scheme, some $10 billion of profits on these exports for the corporations is tax-free and the cost to the US tax-payer is $2 billion.

The original US law, DISC, was held to be a hidden subsidy by a GATT panel in 1976. After holding up adoption for quite some time, the US allowed the panel ruling to be adopted and, bilaterally agreed with the EC to enact a new law to eliminate the objectionable features.

The EC challenged the FSC law at WTO in 1998, after several bilateral consultations with the US failed to resolve the dispute. EC officials explain their delay in bringing up the dispute under the WTO (and its slightly stricter subsidies agreement and dispute settlement understanding) as due to the difficulties in piercing the arrangements between the US principals and the subsidiaries in the tax-havens, and estimating the extent of subsidy involved.

While the US, in statements before the DSB (on panel reference) had talked about the very small amounts involved, in terms of the very low tariffs in trade among industrialized countries, the subsidy does provide a competitive edge.

The EC complaint argued that the US tax law exemption is a subsidy in that the benefit is conditional on exports, and is available only if a large part of the exported item has bee manufactured in the US. As such, such a subsidy is disallowed in the GATT 1994 and the Subsidies Agreement. The EC has also contended that the subsidy allowed under this, when used for agricultural exports (an estimated $4.4 billion in grains and soybeans), it violates the subsidy commitments in the Agriculture Agreement.

US operates a system of worldwide taxation on the income of its corporations -- providing foreign tax credit if income taxes are paid on profits abroad. The EC explains that in the case of FSCs, foreign subsidiaries created to promote exports of parent US company products and services, 64 percent of the foreign trade income is exempt from US income tax. In addition, distributions made by the FSCs to parent corporations are not subject to any US tax either.

Such tax exemptions, in the EC view, cannot be justified for FSCs, typically established in tax havens where no income tax is paid at all. In 1992, some 66% of all FSCs were incorporated in the US Virgin Islands, 12% in Barbados and 7 percent in Guam. There is nothing in the FSC legislation that makes the benefits dependant on payment of foreign taxes by the FSC or the parent company.

In terms of total turnover of FSCs, the EC estimates that the largest exported manufactured product groups benefiting from the system are non-electrical machinery ($29.8 billion), chemicals ($29.3 billion), electrical machinery ($21.1 billion) and transportation equipment ($18.1 billion). The largest non- manufactured product or service group is grains and soybeans ($4.4 billion).

In a statement at Brussels over the weekend, Sir Leon Brittan was 'delighted' the WTO panel had supported the EC view. The FSC, he said, was blatantly contrary to US WTO obligations. This US export subsidy had created a major distortion of international trade by granting a huge unfair advantage to US products and that is paid by the US tax payer. Calling on the US to promptly comply within the time-frame specified by the panel, Sir Leon said the sums involved in the dispute were highly in excess of the trade in other current disputes between the US and the EU such as hormones and bananas.

Separately, the US and Canada were due to get from the WTO's Dispute Settlement Body Monday, authorization to withdraw equivalent trade concessions from the EC over its refusal to implement the ruling against it on beef hormone imports -- $117 million by US and about $8 million by Canada.

EC officials said after initial press reports about a "carousel" approach to retaliation (US shifting periodically the list of US products to be 'punished' for trade retaliation), the US had assured the arbitrators in the case that it would not adopt such an approach. EC officials said such an approach would be WTO illegal, and immediately there would be a complaint by the EC at the WTO.

Panel rulings, and authorization for withdrawal of concessions, a top EC official said, are not 'crime and punishments', but ways to restore the 'balance of rights and obligations' and any carousel approach would be totally illegal. The EC still favoured compensation until it was able to make a proper risk assessment, but the US has not accepted it, though talks with Canada based on such an approach was making progress. (SUNS4485)

The above article first appeared  in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

[c] 1999, SUNS - All rights reserved. May not be reproduced, reprinted or posted to any system or service without specific permission from SUNS. This limitation includes incorporation into a database, distribution via Usenet News, bulletin board systems, mailing lists, print media or broadcast. For information about reproduction or multi-user subscriptions please contact < >