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Income tax—U.S. foreign sales corporation tax practices—GATT Agreement on Subsidies and Countervailing Measures—GA TT Agreement on Agriculture—effect on appeal of failure to raise issue before WTO dispute settlement pane

Published online by Cambridge University Press:  27 February 2017

Stanley I. Langbein
Stanley I. Langbein*
Affiliation:
University of Miami School of Law
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Type
International Decisions
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American Journal of International Law , Volume 94 , Issue 3 , July 2000 , pp. 546 - 555
Copyright
Copyright © American Society of International Law 2000

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References

1 United States—Tax Treatment for “Foreign Sales Corporations,” WTO Doc. WT/DS108/AB/R (Feb. 24, 2000) [hereinafter Report], reprinted in 2000 Tax Notes Today 38–12 (Feb. 25, 2000). Reports issued under the WTO’s dispute settlement procedures are available online at <http://www.wto.org.

2 26 U.S.C. §§921–927 (1994).

3 Agreement on Subsidies and Countervailing Measures, Apr. 14, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1A, The Results of The Uruguay Round of Multilateral Trade Negotiations: The Legal Texts 264 (1994) [hereinafter ASCM].

4 Agreement on Agriculture, Apr. 14, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1 A, The Results of The Uruguay Round of Multilateral Trade Negotiations: The Legal Texts 39 (1994).

5 United States—Tax Treatment for “Foreign Sales Corporations,” WTO Doc. WT/DS108/R (Oct. 8, 1999), reprinted in 3 Law & Practice of the World Trade Organization (Joseph F. Dennin ed. 1999).

6 Agreement on Interpretation and Application of Articles VI, XVI, and XXIII of the General Agreement on Tariffs and Trade, opened for signature Apr. 12, 1979, GATT BISD (26th Supp.) at 56 (1979), 31 UST 513 [hereinafter Subsidies Code]. The Subsidies Code was adopted by the GATT parties as part of the Tokyo Round of agreements on nontariff barriers.

7 Tax Legislation (Dec. 7–8, 1981), GATT BISD (28th Supp.) at 114 (1982) [hereinafter Council action]. The Council action resolved disputes between the United States, on the one hand, and France, Belgium, and the Netherlands, on the other. Those disputes had concerned the domestic international sales corporation (DISC) provisions of U.S. law and the so-called “territorial tax systems” of the European states. See infra notes 9, 29. The Council action approved four panel reports that had been issued in 1976, one regarding the DISC provisions of United States law (Tax Legislation—United States Tax Legislation (DISC), adopted Dec. 7–8, 1981, GATT BISD (23d Supp.) at 98 (1976)) and the others involving the territorial tax systems of Belgium, France, and the Netherlands, and their failure to use the “arm’s-length” standard (Tax Legislation—Income Tax Practices Maintained by France, adopted Dec. 7–8, GATT BISD (23d Supp.) at 114 (1976); Tax Legislation—Income Tax Practices Maintained by Belgium, adopted Dec. 7–8, 1981.GATTBISD (23dSupp.) at 127 (1976); Tax Legislation—Income Tax Practices Maintained by the Netherlands, adopted Dec. 7–8, 1981, GATT BISD (23d Supp.) at 137 (1976)).

8 The full text of footnote 59 is as follows. For ease of reference to the text, a bracketed number gives the serial order of each sentence.

[1] The Members recognize that deferral need not amount to an export subsidy where, for example, appropriate interest charges are collected. [2] The Members reaffirm the principle that prices for goods in transactions between exporting enterprises and foreign buyers under their or under the same control should for tax purposes be the prices which would be charged between independent enterprises acting at arm’s length. [3] Any Member may draw the attention of another Member to administrative or other practices which may contravene this principle and which result in a significant saving of direct taxes in export transactions. [4] In such circumstances the Member shall normally attempt to resolve their differences using the facilities of existing bilateral tax treaties or other specific international mechanisms, without prejudice to the rights and obligations of Members under GATT 1994, including the right of consultation created in the preceding sentence.

[5] Paragraph (e) is not intended to limit a Member from taking measures to avoid the double taxation of foreign-source income earned by its enterprises or the enterprises of another Member.

9 Generally speaking, national income tax systems avoid double taxation under one of two methods—an exemption method or a credit method. An exemption method simply exempts income the source of which is “outside” the taxing jurisdiction. This method, employed by most continental countries, is called a “territorial” system of taxation. A credit method includes foreign-source income but allows a credit against the tax imposed by the home state for foreign taxes imposed on foreign-source income. The United States uses the credit method.

10 Article 1.1 (a) (1) (ii) of the ASCM, supra note 3, provides that a subsidy “exists” wherever “government revenue that is otherwise due is foregone or not collected.” The Body held, in effect, that if a country uses a credit method for avoiding double taxation, but substitutes an exemption method for certain income, it “subsidizes” that income. The Report recognizes that the international agreements do not require a member to impose tax. But the Report reasons that to determine whether revenue is “otherwise due” requires “some kind of comparison between the revenues due under the contested measure and revenues that would be due in some other situation,” and that the “basis of comparison must be the tax rules applied by the Member in question.” Report, supra note 1, para. 90. Thus, if the United States taxes foreign income generally, a measure forgoing the taxation of foreign income in particular circumstances is a subsidy of those circumstances.

11 Report, supra note 1, para. 97.

12 Understanding on Rules and Procedures Governing the Settlement of Disputes, Art. 17.6, Marrakesh Agreement Establishing the World Trade Organization, Annex 2, opened for signature Dec. 15, 1993 [hereinafter DSU], reprinted in 33 ILM 112 (1994).

13 Report, supra note 1, para. 103. The Body suggested that the United States sought to appeal from the failure of the panel to make a ruling with respect to the fifth sentence, and that this failure seemed to be due to “the failure of the respondent Member properly to litigate the matter before the Panel.” Id.

14 See Council action, supra note 7.

15 The Council action, id. at 114, stated in full:

The Council adopts these reports on the understanding that with respect to these cases, and in general, economic processes (including transactions involving exported goods) located outside the territorial limits of the exporting country need not be subject to taxation by the exporting country and should not be regarded as export activities in terms of Article XVI:4 of the General Agreement. It is further understood that Article XVI:4 requires that arm’s-length pricing be observed, i.e., price for goods in transactions between exporting enterprise and foreign buyers under their or the same control should for tax purposes be the prices which would be charged between independent enterprises acting at arm’s length. Furthermore, Article XVI:4 does not prohibit the adoption of measures to avoid double taxation of foreign source income.

16 Report, supra note 1, para. 108.

l7 Japan—Taxes on Alcoholic Beverages, WTO Doc. WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R, para. 16 (Nov. 1, 1996); Chile—Taxes on Alcoholic Beverages, WTO Doc. WT/DS87/AB/R, WT/DS/110/AB/R, paras. 59–60 (Jan. 12, 2000).

The Body rejected the United States’ argument that the words “in general” rendered the 1981 action an “authoritative interpretation” of the 1947 GATT. The Body relied upon the circumstances surrounding the adoption of the 1981 Council action, particularly a statement by the Council chairman, to determine that the action was not intended to bind all contracting parties to the GATT. Report, supra note 1, paras. 110–14.

18 The Body relied upon two differences between the GATT 1947 and GATT 1994 provisions: the provisions of Article XVI:4 applied only to export subsidies that resulted in the sale of the product at a price lower than the price in the domestic market, and GATT 1947 did not include an explicit definition of the term “export subsidy.” The Body also cited a statement by the chairman of the GATT Council with respect to the 1981 action, stating that the action interpreted only GATT 1947, not the 1979 Subsidies Code. The Body said it would be “incongruous” to extend the scope of the 1981 action to the 1994 ASCM. Report, supra note 1, para. 118.

19 Id., para. 120.

20 The subsidies listed in Article 9.1 include [a] direct subsidies contingent on export performance; [b] selling by the government of products at a below market price; [c] payments upon export financed by virtue of government action; [d] subsidies to reduce the costs of marketing exports; [e] government-mandated internal transport or freight charges below those charged on domestic shipments; and [f] subsidies on products contingent on their incorporation in exported products.

21 Report, supra note 1, paras. 130–32.

22 Id., para. 131.

23 Id., paras. 137–54. The Body declined to rule on two issues that the panel had not reached. The first involved the claim of the European Communities that the administrative pricing rules of the FSC provisions constitute an independent violation of the GATT. The second involved a claim by the European Communities against an aspect of the FSC provisions that limits the application of those provisions if more than 50% of the value of property is attributable to articles imported into the United States. In both cases, the European Communities made a conditional appeal with respect to the issue, to be considered only if the Body modified or reversed some aspect of the panel’s finding. Because the Body did not modify or reverse any aspect of the panel finding, however, the Body found no need to rule on the appeals. Id., paras. 172–76.

24 Canada—Measures Affecting the Importation of Milk and the Exportation of Dairy Products, WTO Doc. WT/DS103/AB/R, WT/DS113/AB/R, para. 87 (Oct. 27, 1999).

25 See supra note 10.

26 Report, supra note 1, para. 150.

27 Id.

28 See Kahn, Joseph, U.S. Loses Dispute on Export Sales, N.Y. Times, Feb. 24, 2000, at A1 Google Scholar. Among the hundreds of corporations that have been taking advantage of the FSC provisions are Boeing, General Motors, and Microsoft. Id.

29 Footnote 59 arose from three complaints filed by the United States in response to the complaint of Belgium, the Netherlands, and France against the domestic international sales corporation (DISC) practices of the United States. The United States charged that those nations’ territorial systems, coupled with their failure to enforce the “arm’s-length” principle, constituted an export subsidy in violation of Article XVI (4) of the GATT. In 1976, to the surprise of virtually everyone, the GATT panel upheld the three United States complaints, as well as the complaint against the United States, finding that both the DISC and the territorial practices of the three European nations violated Article XVI:4.

The 1979 Subsidies Code contains an illustrative list of subsidies. That list is carried forward in Annex I to the ASCM. Footnote 59 is based on a footnote set forth in connection with the list in Subsidies Code. The intention of the negotiators in adopting both the list and the footnote was to (1) all but concede the GATT-incompatibility of the DISC, and (2) concede the GATT-compatibility of the territorial tax systems, subject to the requirement that “arm’s-length pricing” be observed. The viscosity of the language used reflected the political circumstances surrounding the adoption of the Subsidies Code. The draftsmen knew that a code explicitly condemning the DISC while explicitly blessing the territorial systems would have difficulty securing congressional approval; Congress wanted the negotiators to “get something” in exchange for repeal of the DISC provisions. At the same time, the United States negotiators believed that the language in the footnote sanctioning the territorial systems could legitimate a more limited DISC-like program that approximated the effect of the European territorial systems on export activity.

In 1981, the parties, subject to their “understanding” regarding the effect on their domestic tax practices, moved to resolve the still-outstanding dispute before the GATT by means of the GATT Council action that adopted the reports. See supra note 7.

30 See supra note 18.

31 See supra note 10.

32 The FSC treats 32% of the foreign trade income of the FSC as exempt income. The income allocated to the FSC in the first place (the “foreign trade income”) is determined under generally applicable transfer-pricing principles. 26 U.S.C. §923 (a) (2). But the FSC provisions also permit the “foreign trade income” of the FSC to be determined under two essentially arbitrary methods. Id., §925(a). Under these methods, the “foreign trade income” of the FSC may be determined either as 23% of the combined income from the export transaction (that is, income attributable to both production and marketing activity), or as 1.83% of the gross receipts of the FSC; the exempt income is then calculated as 16/23 of the “foreign trade income” so determined. Id. §923(a)(3). These funny numbers (and confusing terms) may (and may be intended to) obscure the real nature of the FSC provisions, namely, that they represent the DISC provisions reduced by about one-third.

33 Id. §§922(a), 924(b)(1)(B).

34 Id. §924(e).

35 Id. §924(d)(1).

36 Id. §924(d)(2).

37 DSU Art. 21 (3) requires a member to inform the Dispute Settlement Board at a DSB meeting of its “intentions in respect of the implementation of recommendations and rulings of the DSB.” DSU, supra note 12. On April 7, 2000, the United States indicated that it intended to implement the recommendations “in a manner which respects our WTO obligations” but is “consistent with our goal of ensuring that U.S. exporters are not placed at a disadvantage in relation to their foreign competitors.” See U.S. Will Comply with WTO Ruling on FSCs, 2000 Tax Notes Today 70–3 (Apr. 10, 2000).

In early May, the United States offered to the European Communities a proposal that apparently would have (1) extended FSC benefits to foreign income earned from sales, rentals, and licenses without regard to whether the income was earned from export activity, (2) retained the features of the FSC that restrict benefits to property bearing too great a degree of “foreign content,” and (3) retained the administrative pricing rules to which the European Communities had objected. By late May, the European Communities had reportedly rejected the proposal. The administration nevertheless expressed an intention to work with Congress to adopt the proposal by October 1. See Statement by Deputy Secretary of the Treasury Stuart Eizenstat, May 29, 2000, reprinted in 2000 Tax Notes Today 106–21 (June 21, 2000).

38 Provisions of double-taxation conventions may suggest such limitations, but in the case of die United States, the conventions typically reserve the right of the United States to tax its citizens and corporations as if the convention were not in effect. Thus, any limitation that the double-taxation conventions impose on the United States’ right to define foreign-source income would apply principally to the taxation of nationals of convention partners with respect to their United States activities.

39 With respect to United States-based multinationals, characterizing income as foreign, rather than domestic, income can have the effect of exempting the income. The reason is that multinationals tend to be in an “excess credit” position, that is, they have available foreign tax credits in excess of what their current foreign-source income permits them to claim. Treating income that had been domestic-source as foreign-source thus has the consequence of permitting the corporation to claim additional foreign tax credits, offsetting the United States tax that would be collected if the income continued to be characterized as domestic-source.

40 One potential candidate for change would be the statutory rule that treats income from the sale of inventory property produced in the United States and sold abroad (or produced abroad and sold in the United States) as partly foreign- and partly domestic-source. 26 U.S.C. §863 (b). That rule could be eliminated, permitting the general rule for the sale of inventory property to govern these cases—which treats the income as foreign-source. 26 U.S.C. §§861 (a) (6), 862 (a) (6), 865 (b). This change would permit corporations to claim foreign tax credits for income that current law imputes (without any international norm requiring it to do so) to domestic activities. Other limited, but GATT-compliant, measures to achieve FSC effects without violating the ASCM have been suggested. See Bruce, Charles M., The WTO’s FSC Ruling: Let’s All Relax, 86 Tax Notes 1927 (Mar. 27, 2000)Google Scholar.

41 Value-added taxes involve “border tax adjustments” that rebate prior-stage taxes at the point goods are exported from the jurisdiction imposing the VAT, and that impose taxes on prior stages when goods are imported into a VAT jurisdiction. Border tax adjustments are permitted under the “destination principle,” a rule of international law that accords the right to impose indirect taxes to the jurisdiction in which the transaction subject to the indirect tax is completed—in most cases, the state into which goods are imported.

1 Vienna Convention on Consular Relations, Apr. 24, 1963, 21 UST 77, 596 UNTS 261.

2 See, e.g., Federal Republic of Germany v. United States, 526 U.S. 111 (1999); Republic of Paraguay v. Allen, 134 F.3d 622 (4th Cir.), aff’d sub nom. Breard v. Greene, 523 U.S. 371 (1998). See generally Aceves, William J., Case Report: Case Concerning the Vienna Convention on Consular Relations (Federal Republic of Germany v. United States) [LaGrand Case], 93 AJIL 924 (1999)CrossRefGoogle Scholar [hereinafter Aceves, Case Report: LaGrand]; Aceves, William J., Case Report: Application of the Vienna Convention on Consular Relations (Paraguay v. United States), 92 AJIL 517 (1998)Google Scholar [hereinafter Aceves, Case Report: Paraguayv. United States]; Agora: Breard, 92 AJIL 666 (1998).