A Comprehensive History of Foreign Sales Corporation Legislation and Related World Trade Organization Rulings

Article excerpt

U.S. export tax benefits have been disputed for the last twenty years, and the future of these benefits is currently being decided by the U.S. Congress. It is the intention of this article to provide a comprehensive history of U.S. legislation and GATT and WTO rulings concerning foreign sales corporations. While this issue is both historical and current, more detailed information is provided for more current events.

Introduction

U.S. export tax benefits have been disputed for the last twenty years, and the future of these benefits is currently being decided by the U.S. Congress. It is the intention of this article to provide a comprehensive history of U.S. legislation and GATT and WTO rulings concerning foreign sales corporations. While this issue is both historical and current, more detailed information is provided for more current events.

The DISC (1971-1984)

During the first half of the twentieth century, the United States enjoyed the benefits of a positive trade balance. But an increase in foreign competition in the late 1960s caused U.S. imports to exceed U.S. exports, producing larger and larger negative trade balances each year. U.S. tax policy was regarded as one means of reducing or eliminating this trade deficit. The domestic international sales corporation (DISC) legislation, passed in 1971, provided tax reduction incentives to stimulate U.S. exports of goods and services (Jacobs & Larkins, 1998).

A corporation that made a formal election to be designated as a DISC received a tax deferral for a portion of its income that was derived from exports. This tax deferral ranged between 47% and 94% (Jacobs & Larkins, 1998) and was indefinite as long as the DISC satisfied certain qualification requirements and did not distribute the deferred income to its shareholders (Mandell, 1998). The qualification requirements obliged DISCs to have 95% of gross receipts as

qualified export receipts, have 95% of all assets as qualified export assets, and have only one class of stock ( Internal Revenue Code, Section 992). Under the DISC regime, the profits of a DISC were not taxed to the DISC, but were taxed to the shareholders of the DISC when distributed or deemed distributed to them. Each year, a DISC was deemed to have distributed a portion of its income, and the recipient shareholders were required to pay applicable taxes. Tax could generally be deferred on the remaining portion of the DISC's taxable income until the occurrence of an event such as payment to shareholders or liquidation of the DISC (WT/DS 108/R).

The DISC was changed to an interest charge-domestic international sales corporation (IC-DISC) in 1984. No deferral is allowed to an IC-DISC on annual export receipts that exceed $10 million. IC-DISC tax deferrals are eventually paid to the U.S. government with interest based on a Treasury bill rate (Jacobs & Larkins, 1998). There were 1,700 IC-DISCs still active in 1998 (Mandell, 1998).

The change from DISC to IC-DISC was the result of objections to the DISC by the European Communities. The European Communities (EC) succeeded in having the DISC legislation declared an illegal export subsidy contrary to Article XVI:4 of the General Agreement on Tariffs and Trade (GATT) , the predecessor to the WTO. The EC's objections were adopted by the GATT in a report issued in December 1981. The GATT Council's report included a statement of understanding that made three clarifications of Article XVI:4: (1) economic processes 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; (2) arm's-length pricing must be observed between exporting enterprises and foreign buyers under the same control; and (3) this Article does not prohibit the adoption of measures to avoid double taxation of foreign source income (WT/DS108/R). While it may not have been the GATT's intention to lay out the requirements of an acceptable export tax benefit, these clarifications became the foundation of the U. …