It is hard to envy the Bush administration. After weathering denunciations for its actions on the Kyoto Protocol and withdrawing from an OECD-led initiative to limit tax havens, it now finds itself locked in a dispute with the EU over the US Foreign Sales Corporation Tax.
Prior to recent revisions, the US Internal Revenue Service code allowed American exporters to establish Foreign Sales Corporations (FSC) as offshore subsidiaries to receive favorable treatment of corporate income taxes. The foreign earnings of US exporters were shielded from tax for sales made through offshore shell companies.
This tax break was granted to about 7,000 American companies whose exports are worth US$150 billion. For example, General Electric saved US$746 million from 1991 to 1998 by relying upon FSCs and Motorola saved US$378 million over the same period.
In its original form, companies would be exempt from US corporate taxes if they routed revenues from overseas sales through an offshore sales subsidiary. The US Congress made changes last year to bring the tax scheme into compliance with WTO rules and bring it more closely in line with the territorial tax systems used by most EU states. The new system provided for the elimination of some corporate income earned abroad as long as foreign taxes were paid on those earnings. However, the EU claimed that the amended form did not eliminate the injury.
Unimpressed by American offers to scale back the program, the European Commission took action. For its part, the EU sought approval from the World Trade Organization (WTO) to impose sanctions worth US$4 billion against US exports. The WTO dispute settlement panel found that the tax law gave US exporters an unfair advantage over foreign competitors in violation of world-trade rules since it acts as a prohibited export subsidy. According to EU data, the scheme reduces the potential federal tax burden of almost half of all US exporters by between 15 percent and 30 percent.
A final ruling is scheduled for August this year and further appeals by the US could postpone sanctions until December. If the US does not comply with the final ruling, the EU would be entitled to retaliate with up to US$4 billion in countervailing tariffs and duties.
This is good news for corporations that compete openly and rely upon their competitive advantage instead of turning to meddling governments. Now it will be up to American export powerhouses such as Boeing and Microsoft to show their mettle without relying upon subsidies to boost their bottom line.
Most of the FSCs are set up in Caribbean tax havens to handle the foreign sales of US exporters. According to EU estimates, a conservative approximation is that these tax breaks are worth more than US$4 billion to American exporters this year and as much as to US$25 billion over the next five years.
In force since 1984, it allows US corporations to operate in tax havens like the Virgin Island and Barbados so that profits from exports funneled through these corporations are exempt from American taxes. About US$1 in every US$4 of US exports come from firms that have registered foreign sales corporations under this scheme. (Interestingly, many European companies with subsidiaries in the US also take advantage of this tax concession.)
An earlier precedent, arising from a complaint initiated by the US government against an Australian firm, is the basis for requiring companies that received funds from this scheme to make retrospective repayment for these subsidies.
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