Global Policy Forum

System for Exemptions Is Illegal,
Panel Says In Upholding Decision

By Barry James

Brussels - The United States suffered perhaps its biggest loss ever under international trade rules when the World Trade Organization announced Thursday that it had upheld a ruling that billions of dollars of tax breaks for U.S. corporations are illegal. In its ruling, the appellate body of the trade organization said the United States must end a system that allows U.S. multinational companies to avoid U.S. taxes by channeling sales through offshore subsidiaries, mostly in the Caribbean.

That arrangement, said Pascal Lamy, the trade commissioner of the European Union, ''had a major negative effect on international trade to the detriment of European companies.'' Although the United States has now lost both the original case and its appeal, U.S. officials made it clear that they would continue to contest the matter.

Treasury Secretary Lawrence Summers told The Associated Press that the U.S. government was ''clear in our commitment to finding a way to maintain the important incentives for U.S. exports that have been provided in the past.'' The United States has until Oct. 1 to change its laws, after which the European Union would be authorized to take retaliatory measures. Officials said the EU was not contemplating such measures at present.

The World Trade Organization has not ruled on the amount of possible damages. The European Union argued that the U.S. multinational companies were getting the equivalent of a multibillion-dollar subsidy in federal tax savings. Boeing Co. alone saved about $130 million in taxes in 1998, giving it a critical advantage against its European competitor Airbus Industrie, the EU contended.

The U.S. delegate to the World Trade Organization in Geneva, Rita Hayes, said the appellate panel was wrong to side with the European Union in the dispute and pledged, ''We will seek a solution that ensures that American firms and workers are not disadvantaged relative to their European counterparts.'' But it was unclear what sort of deal could be worked out. Though several European officials made conciliatory comments, others ruled out any agreement that would allow the United States to continue the tax system.

The dispute has lingered since domestic international sales corporations were created in 1971 to promote U.S. exports and reduce the trade deficit. The World Trade Organization's predecessor, the General Agreement on Tariffs and Trade, ruled in 1971 that these tax breaks were illegal, and the United States in 1984 introduced the legislation allowing exporters to set up the foreign sales subsidiaries. The legislation was justified as a response to the rebates on value-added tax that European companies receive when selling goods outside the European Union, although the world trade mechanism has ruled that this arrangement does not amount to a subsidy.

The European Union formally opposed the subsidiaries at the trade organization in 1997 after years of failed challenges. The European Union finally won its case in October 1999. It costs only about $2,000 to set up a foreign sales corporation, according to banking sources.

Such corporations enable U.S. companies to shield their foreign earnings from domestic taxes. As much as 65 percent of the subsidiary's income and all of its dividends are exempt from taxation. The benefits apply to industrial goods, including computer software as well as agricultural and mining products. According to U.S. Treasury estimates, the U.S. cost of the exemptions in 1999 amounted to at least $3.5 billion. The European Union estimates that the setup would save U.S. corporations $17.5 billion in taxes over the next five years if it were allowed to continue.

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