Foreign sales corporations - subsidies, sanctions, and trade wars.

• Author: Carmichael, Candace

ABSTRACT

The largest sanctions in the history of the World Trade Organization, the need to stabilize an ailing economy, and the need to maintain strong alliances in the face of a new global war on terrorism are all issues the United States currently faces in deciding how to resolve its dispute with the European Union regarding U.S. tax policy. In 1997, the European Union filed a complaint with the WTO claiming that the then-current U.S. tax regime violated U.S. international trade agreements. The European Union contended that the U.S. tax system gave rise to export-contingent subsidies, in violation of U.S. trade obligations.

Ultimately, the WTO found that the U.S. tax regime provided export-contingent subsidies and thus violated U.S. trade agreements. Although the United States appealed the decision, the European Union prevailed on appeal. This Note examines these WTO opinions and the bases for their findings.

After the U.S. tax framework was found to be in violation of international trade obligations, the United States drafted the Extraterritorial Income Exclusion Act of 2000, which replaced the U.S. tax laws found to be in violation of U.S. trade obligations. This Note describes the replacement law and how it differs from the past tax system.

Although Congress hoped the replacement law would resolve the tax dispute, the European Union was not satisfied that the replacement law remedied the trade violations. The European Union filed a claim with the WTO alleging that the replacement law continued to violate U.S. trade obligations. The WTO ultimately decided that the replacement law violated U.S. trade obligations. This Note examines the latest decision.

The United States filed a notification of appeal in response to the latest WTO decision. This Note concludes by addressing issues that the United States must consider in deciding how to resolve this dispute and possible solutions to the problem.

1. INTRODUCTION

   For the first time in its history, the United States has statutorily amended its domestic laws (1) in an attempt to comply with international trade obligations. In addition, the United States potentially faces sanctions for trade violations that would dwarf any sanctions previously imposed by the World Trade Organization. (2) Although the European Union (3) has complained about U.S. international tax laws for years, the European Union took official action in 1997 by filing a complaint against the United States with the WTO. The European Union claimed that the U.S. foreign sales corporation (FSC) tax structure was a breach of U.S. obligations under the Agreement on Subsidies and Countervailing Measures (SCM Agreement) (4) and the Agreement on Agriculture (AA) (5)

   The European Union challenged the U.S. laws regarding FSC taxation, claiming that the laws were export-contingent subsidies that placed the United States in violation of its international trade obligations. (6) Barbados, Canada, and Japan joined the European Union in the dispute as third parties to the disagreement. (7) On October 8, 1999, the WTO dispute settlement panel (DSP) ruled that the FSC tax regime did not comply with WTO obligations. (8) Both the United States and the European Union challenged certain aspects of the DSP's findings in the WTO Appellate Body. (9) Canada and Japan joined the European Union as third parties on appeal. (10) On February 24, 2000, the WTO Appellate Body essentially affirmed the DSP ruling. (11) In an attempt to comply with the WTO rulings, President Bill Clinton signed into law the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (EIEA or replacement law) on November 15, 2000. (12)

   After the enactment of the replacement law, the European Union continued to argue that the replacement law violated international trade obligations under the SCM Agreement and the AA, and challenged the replacement law. (13) The European Union again filed a petition with the WTO challenging the replacement law's compliance with U.S. trade obligations. On August 20, 2001, the DSP ruled that the replacement law failed to comply with WTO trade obligations. (14) Additionally, the DSP granted the European Union authorization to impose over four billion dollars in sanctions against the United States for past failures to comply with the DSP and Appellate Body recommendations and continuing violation of international trade obligations. (15) These potential WTO sanctions against the United States are the largest in the WTO's history. (16)

   On October 15, 2001, the United States appealed the August 20 WTO decision. Clearly, the outcome of this dispute will have a significant impact on both the United States and the European Union because the industries that benefit most from the FSC tax regime are those in which U.S. and EU companies compete most fiercely. (17) Furthermore, the outcome will affect millions of U.S. jobs, in addition to revenues brought in through taxation and exportation. (18)

   This Note will first explain the WTO's role in international trade disputes and the procedures that must be followed when filing a complaint with the WTO. A brief introduction to the WTO is provided in Part II. Part III depicts the long-standing dispute between the United States and the European Union regarding the U.S. tax structure. The different tax structures of the United States and European Union will also be introduced. Part IV sets forth the provisions of the original U.S. tax laws regarding FSCs that were found to be in violation of U.S. trade obligations. Part V presents the arguments made by the United States and the European Union regarding the validity of the FSC tax regime. The WTO's holdings are then discussed. The provisions of the "FSC Repeal and Extraterritorial Income Exclusion Act of 2000," which Congress enacted in an attempt to comply with the WTO ruling, are set forth in Part VI. Part VII describes EU criticisms of the replacement law, which resulted in the most recent WTO finding that the replacement law continues to violate U.S. foreign trade obligations. Finally, Part VIII discusses the latest U.S. appeal and potential responses.

2. INTRODUCTION TO THE WORLD TRADE ORGANIZATION

   The WTO was formed in 1995 to ensure that international trade flows as smoothly and freely as possible, to deal with the global rules of trade between nations, and to resolve international trade conflicts. (19) International trade disputes are resolved through the WTO's dispute resolution process, where the focus is on interpretation of agreements and commitments and determination of how to insure that each country's trade policies comply with the agreements it has signed. (2) For example, in the dispute between the United States and the European Union, the WTO will hear the arguments of both and suggest interpretations of the relevant international trade agreements. The WTO will then determine whether the U.S. tax regime is in compliance with the relevant agreements. Since the United States and European Union disagree about the validity of the U.S. FSC tax system, the WTO's role is to step in, at the request of the European Union, and interpret the related agreements to which the United States and European Union are parties.

   The WTO's founding members created the organization's dispute settlement scheme to provide an established system and forum for the mutual resolution of disputes. (21) To achieve this goal, Article 4 of the Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU) dictates that an application to create a DSP may only be made after consultations between the complaining party and the party allegedly in violation of its WTO obligations have failed to produce a mutually acceptable resolution. (22)

   If consultations or mediations do not produce a solution, the complaining party may request that a DSP be established to "rule" on the dispute. (23) Upon receipt of a request from the complaining party, the Dispute Settlement Body (DSB) will determine the "terms of reference." (24) Three persons are then selected to serve on the DSP. (25) However, panelists cannot be from the nations acting as principal or third parties to the disagreement. (26) Interestingly, unlike the standing requirements found in U.S. courts, there is no prerequisite in the DSU requiring parties to have a legal or economic interest in the disagreement. The DSPs have also refused to read such a condition into the DSU. (27)

   The DSU also permits third parties to participate in panel disputes. (28) Specifically, Article 10 of the DSU states that "any Member having a substantial interest in a matter before a panel and having notified its interest to the DSB ... shall have an opportunity to be heard by the panel[,] ... make written submissions to the panel," and receive submissions of the parties after theft first meeting with the panel. (29) Additionally, Article 4 of the DSU provides that a Member with a substantial interest (30) in an ongoing disagreement between other Members may request to be joined in consultations. (31)

   Once the DSP reviews the parties' arguments and third party submissions, it will issue an interim decision that sets forth each party's arguments and presents the panel's verdict. (32) Parties are allowed to make comments on the interim report, and the panel then considers the comments. (33) Final decisions are released first to the parties and third parties and then to all WTO Members and the public. (34)

   Parties may appeal the panel's decision to the Appellate Body within sixty days of its circulation to the public. (35) However, the Appellate Body review is restricted to issues of law and legal interpretation of the panel. (36) If a party is found to be in violation of its international trade obligations, then the complaining party may impose sanctions. (37)

3. BACKGROUND

   1. History Behind the Foreign Sales Corporation Dispute Between the United States and the European Union

      Due to increased global trade...