An Analysis of Foreign Sales Corporations and the European Communities' Four Billion-Dollar Retaliation
Shallue, James Joseph, Denver Journal of International Law and Policy
Located in Geneva, Switzerland, the World Trade Organization (1) is comprised of over 140 members. (2) Since its inception in 1994, (3) the WTO has provided its members a forum for trade negotiations and disputes. (4) Through the use of this dispute resolution process, the WTO's ultimate goal is to ensure free trade and fair pricing throughout the world. (5)
Disputes in the WTO currently range from the European Communities' dispute with India over anti-dumping violations (6) to violations of Chilean alcohol taxation. (7) One dispute currently before the WTO is particularly important because it involves over four billion dollars in compensatory measures. (8)
In a dispute entitled the "United States: Tax Treatment for Foreign Sales Corporations," (9) the European Communities allege that the Unites States is illegally subsidizing exporters through the use of the Internal Revenue Code, (10) in violation of its WTO obligations, (11) The United States counters that the Code's provisions are not subsidies, and that its tax legislation is currently meeting all WTO obligations. (12)
This dispute is the culmination of a long and heated battle between the United States and the European Communities over the exact definition of the term subsidy. A subsidy can generally be defined as a "non-tariff measures utilized by governments either to inhibit imports (so-called 'domestic subsidies') or to enhance exports (so-called 'export subsidies'). Subsidies typically constitute direct or indirect economic benefits granted by governments to an industry or group of industries." (13) The United States and the European Communities, however, vehemently disagree over an exact definition of the term subsidy.
This disagreement, currently in its fourth decade, began in 1971 with the advent of Domestic International Sales Corporations (DISCs). (14) At the time, American corporations were losing the export battle because double taxation and value added taxation caused their prices to be much higher than those of their foreign competition. (15) In order to be competitive abroad, DISCs were developed so that American exporters could lower their overall prices. This was accomplished by deferring part of their tax liability through the use of a tax-free commission. Because exporters had lower tax liabilities through the use of DISCs, they could lower their prices and still maintain the same profit margins. These lower prices on exports eventually translated into a more competitive environment between American and foreign corporations.
Foreign countries affected by DISCs, however, felt that they were an illegal subsidy rather than a tax deferral. The United States argued that because DISCs mirrored territorial and value added taxation systems, they could not be considered subsidies. Eventually, under the General Agreement on Tariffs and Trade, (16) DISCs were held to be subsidies.
In 1984, because DISCs could no longer be used as intended, the United States implemented the Foreign Sales Corporation (FSC) as a vehicle to increase competition between American and foreign corporations. (17) Unlike a DISC, a FSC was designed to be a foreign corporation that operated on a dividend-basis with its domestic parent corporation. The United States felt that FSCs complied with GATT, and were not an illegal subsidy because they mirrored territorial and value added taxation systems used by others in Europe and throughout the world.
Many foreign countries, however, argued that FSCs, like DISCs before them, were an illegal subsidy under GATT and other international trade agreements, including the Agreement on Subsidies and Countervailing Measures (18) and the Agreement on Agriculture. (19) These foreign countries, now formally known as the European Communities, again argued that FSCs provided an illegal subsidy rather than a tax deferral. They also argued that because FSCs were export-contingent, they were also an illegal subsidy under various other WTO agreements. …