Tax law changes are in the wind: a review of what's being considered in the wide-ranging Congressional package of business-law tax changes that could affect both domestic and international operations.

• Author: Merrill, Peter
• Position: Corporate Taxes

Trade disputes with European countries are nothing new, but the emergence of the European Union (EU) has brought new muscle to the European side--muscle the EU has been flexing over taxes and tariffs. Add to that the U.S. domestic furor over jobs going overseas and revenue creation offshore, and Congress is stepping in, taking decisive action to repeal, in some cases, and replace existing tax measures.

Both the U.S. House of Representatives and the Senate have passed legislation to repeal an existing export-oriented tax incentive and replace it with a domestic manufacturing incentive, international tax reforms and other business tax relief. Both bills also include revenue offsets, including new tax shelter penalties and a host of other provisions that address perceived tax abuses. While both bills have similarities, they also have differences, and negotiations are expected to be difficult.

The legislation responds to an on-going trade dispute with the EU. In 1998, the EU brought a case against the U.S. Foreign Sales Corporation (FSC) regime in the World Trade Organization (WTO). The FSC regime was a U.S. export tax incentive. In 2000, the WTO ruled the FSC regime was a prohibited export subsidy, and the U.S. enacted legislation replacing it with the Extraterritorial Income Exclusion (ETI) regime, which the EU immediately challenged. In 2002, the WTO held that the ETI regime--like the FSC regime it replaced--constituted a prohibited export subsidy, and authorized the EU to impose up to $4 billion a year in retaliatory trade sanctions on U.S. exports.

In March 2004, the EU imposed a tariff of 5 percent on a list of U.S. exports with an aggregate value of approximately $4 billion. The retaliatory tariff escalates by 1 percent per month until it reaches 17 percent in March 2005. Under WTO rules, the EU is not obliged to suspend retaliation until the U.S. repeals the FSC and ETI tax regimes.

The Bush Administration and congressional leaders are committed to complying with the WTO rulings. There is a general consensus to use the revenues generated by repealing the FSC and ETI provisions to provide tax relief to companies that benefit from these provisions. However, enactment of FSC-ETI replacement legislation has been delayed by disagreements on Capitol Hill and within the business community over what type of tax relief to provide to affected companies.

Some wanted to reform U.S. rules on the taxation of foreign-source income to improve the competitiveness of U.S. businesses operating abroad, while others wanted to protect U.S. manufacturing jobs by encouraging companies to maintain and expand their operations in the U.S. The debate reflected concerns about the loss of U.S. manufacturing jobs, the...