World Trade
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14 January 2002 |
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(02-0152) |
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Edited ---
UNITED sTATES TAX TREATMENT FOR "FOREIGN SALES
CORPORATIONS"
RECOURSE TO ARTICLE 21.5 OF THE DSU BY THE EUROPEAN
COMMUNITIES
AB-2001-8
Report of
the Appellate Body
1.
The United States appeals certain issues of law and legal
interpretations in the Panel Report, United
States Tax Treatment for "Foreign
Sales Corporations" Recourse
to Article 21.5. of the DSU by the European Communities (the
"Panel Report").[1] The Panel was established to consider a
complaint by the European Communities concerning the consistency of the United
States FSC Replacement and Extraterritorial Income Exclusion Act (the "ETI
Act") [2] with the
Agreement on Subsidies and
Countervailing Measures (the "SCM
Agreement"), the Agreement
on Agriculture, and the General
Agreement on Tariffs and Trade 1994 (the "GATT
1994"). The ETI Act is a measure
taken by the United States with a view to complying with the recommendations
and rulings of the Dispute Settlement Body (the "DSB") in United States Tax Treatment for
"Foreign Sales Corporations" ("US FSC ").[3]
Pertinent aspects of the ETI Act are described in Section II below,
as well as in paragraphs 2.1-2.8 of the Panel Report.
2.
In US FSC,
the original panel concluded that the "FSC measure",
consisting of Sections 921-927 of the United States Internal Revenue Code
(the "IRC") and related measures establishing special tax treatment
for foreign sales corporations, was inconsistent with the United States'
obligations under the SCM
Agreement and under the Agreement
on Agriculture.[4]
The Appellate Body upheld the original panel's finding that the FSC
measure was inconsistent with United States' obligations under the SCM Agreement and modified the
Panel's findings under the Agreement
on Agriculture.
3.
On 20 March 2000, the DSB adopted the reports of the original panel
and the Appellate Body. The DSB
recommended that the United States bring the FSC measure into conformity with
its obligations under the covered agreements and that the FSC subsidies found
to be prohibited export subsidies within the meaning of the SCM Agreement be withdrawn without
delay, namely, "at the latest with effect from
1 October 2000."[5] At its meeting on 12 October 2000, the DSB
acceded to a request made by the United States to modify the time-period for
complying with the DSB's recommendations and rulings in this dispute so as to
expire on 1 November 2000.[6] On 15 November 2000, with a view
to such compliance, the United States promulgated the ETI Act.[7] The background of this dispute is set out in
further detail in the Panel Report.[8]
4.
The European Communities considered that the ETI Act did not comply with
the recommendations and rulings of the DSB and that it was not consistent with
the United States' obligations under the
SCM Agreement, the Agreement
on Agriculture, and the
GATT 1994. The European Communities
therefore requested that the matter be referred to the original panel pursuant
to Article 21.5 of the Understanding
on Rules and Procedures Governing the Settlement of Disputes (the
"DSU").[9] On 20 December 2000, in accordance with
Article 21.5 of the DSU, the DSB referred the matter to the original
panel.[10] The Panel Report was circulated to the
Members of the World Trade Organization (the "WTO") on 20 August
2001.
5.
The Panel concluded that:
(a)
the [ETI] Act is inconsistent with Article 3.1(a) of the SCM Agreement as it involves
subsidies "contingent
upon export performance" within the meaning of
Article 3.1(a) of the SCM Agreement
by reason of the requirement of "use outside the United States" and
fails to fall within the scope of the fifth sentence of footnote 59 of the
SCM Agreement
because it is not a measure to avoid the double taxation of foreign-source
income within the meaning of footnote 59 of the SCM Agreement;
(b)
the United States has acted inconsistently with its obligation under
Article 3.2 of the SCM
Agreement not to maintain subsidies referred to in paragraph 1 of
Article 3 of the SCM Agreement;
(c)
the [ETI] Act, by reason of the requirement of "use outside the
United States", involves export subsidies as defined in Article 1(e)
of the Agreement on
Agriculture for the purposes of Article 10.1 of the Agreement on Agriculture and the United
States has acted inconsistently with its obligations under Article 10.1 of
the Agreement on Agriculture by
applying the export subsidies, with respect to both scheduled and unscheduled
agricultural products, in a manner that, at the very least, threatens to
circumvent its export subsidy commitments under Article 3.3 of the Agreement on Agriculture and, by acting
inconsistently with Article 10.1, the United States has acted
inconsistently with its obligation under Article 8 of the Agreement on Agriculture;
(d)
the [ETI] Act is inconsistent with Article III:4 of the GATT 1994 by reason of the foreign
articles/labour limitation as it accords less favourable treatment
within the meaning of that provision to imported products than to like products
of US origin; and
(e)
the United States has not fully withdrawn the FSC subsidies found to
be prohibited export subsidies inconsistent with Article 3.1(a) of the SCM Agreement and has therefore failed
to implement the recommendations and rulings of the DSB made pursuant to
Article 4.7 SCM
Agreement.[11]
6.
The Panel also concluded that to the extent the United States had
acted inconsistently with the SCM Agreement, the Agreement on Agriculture and the GATT 1994, the United States had nullified or
impaired benefits accruing to the European Communities under those agreements.[12]
7.
On 15 October 2001, the United
States notified the DSB of its intention to appeal certain issues of law
covered in the Panel Report and legal interpretations developed by the Panel,
pursuant to paragraph 4 of Article 16 of the DSU, and filed a Notice
of Appeal pursuant to Rule 20 of the Working
Procedures for Appellate Review (the "Working Procedures").[13]
8.
By letter of 22 October 2001, the United States requested the
Appellate Body pursuant to Rule 16(2) of the Working Procedures to modify the timetable set out in the
Working Schedule for Appeal for the filing of the appellant's submissions by
the United States. The United States
stated that suspected bioterrorist attacks had compromised the ability of the
United States to conduct the necessary consultations with the United States
Congress with regard to this appeal.[14]
.. On 1 November 2001, the United States
filed its appellant's submission.[15] On 6 November 2001, the European
Communities filed its other appellant's submission.[16] On 16 November 2001, the European
Communities and the United States each filed an appellee's submission.[17] On the same day, Australia, Canada, India
and Japan each filed a third participant's submission.[18]
9.
The oral hearing in this appeal was held on 26 and 27 November
2001. The participants and third
participants presented oral arguments and responded to questions put to them by
the Members of the Division hearing the appeal.
10.
At the oral hearing, the Division requested the United States to reduce
to writing, by 28 November 2001, certain of its responses to questioning.[19] The Division also authorized the European
Communities and the third participants, if they wished, to respond in writing
by 30 November 2001.[20] In response to this request, the United
States filed an additional written memorandum on 28 November 2001. The European Communities filed a response to
this additional written memorandum on 30 November 2001.
11.
In our Report in US
FSC, we provided certain general background information relating to
United States rules of taxation. We
said:
For United
States citizens and residents, the tax laws of the United States generally
operate "on a worldwide basis".
This means that, generally, the United States asserts the right to tax
all income earned "worldwide" by its citizens and residents. A corporation organized under the laws of
one of the fifty American states or the District of Columbia is a "domestic",
or United States, corporation, and is "resident" in the United
States for purposes of this "worldwide" taxation system.
The United
States generally taxes any income earned by foreign corporations within the
territory of the United States. The
United States generally does not tax income that is earned by foreign
corporations outside the United States.
However, [under Section 882(a) IRC], such
"foreign-source" income of a foreign corporation generally will be
subject to United States taxation when such income is "effectively
connected with the conduct of a trade or business within the United
States".
[21]
(footnotes omitted)
12.
This statement continues to describe the United States tax system
and is relevant for the purposes of this appeal also. In addition, we note that, under Sections 1 and 11 IRC, the
United States imposes a tax on the "taxable income" of its citizens
and residents. According to Section
63(a) IRC, taxable income is equal to "gross income minus the deductions
allowed" under the IRC. Section 61(a) IRC
provides that gross income is "all income from whatever source
derived". When a United States
citizen or resident is subject to tax, in the United States, on income which
is also subject to tax in a foreign State, the United States grants the
taxpayer tax credits, subject to certain limitations, in respect of the amount
of foreign taxes paid.[22]
13.
The provisions of the IRC relating to these rules of taxation have
not been modified by the ETI Act, although the application of these rules has
been altered by the adoption of the ETI Act.
14.
A detailed description of the measure at issue in this appeal is
contained in paragraphs 2.2 to 2.8 of the Panel Report. Nevertheless, we consider it useful, at this
stage, to provide an overview of the fundamental aspects and key provisions of
the ETI Act.
15.
The ETI Act consists of five sections. At issue in this dispute are, first, certain
elements of Sections 2 and 5, which relate to foreign sales corporations
and, second, certain elements of Section 3.
Section 3, entitled "Treatment of Extraterritorial Income",
amends the IRC by inserting into it a new Section 114, as well as a new Subpart
E, which is in turn composed of new Sections 941, 942 and 943. The remaining sections of the ETI Act are
not relevant for purposes of this dispute.[23]
16.
As we have said, the ETI Act was promulgated by the United States
with a view to complying with the recommendations and rulings of the DSB in
US FSC. Section 2 of the ETI Act repeals the
provisions of the IRC relating to FSCs.[24] Section 5(b) prohibits foreign corporations
from electing to be treated as FSCs after 30 September 2000 and provides for
the termination of inactive FSCs.
Nevertheless, Section 5(c) creates a "transition period" for
certain transactions of existing FSCs.
Specifically, under Section 5(c)(1) of the ETI Act, the repeal of the
provisions of the IRC relating to FSCs "shall not apply" to transactions
of existing FSCs which occur before 1 January 2002 or to any other
transactions of such FSCs which occur after 31 December 2001, pursuant to a
binding contract between the FSC and an unrelated person which is in effect on
30 September 2000. These
provisions are the subject of the European Communities' claim that the
United States has not fully withdrawn the FSC subsidies, in accordance with
Article 4.7 of the SCM Agreement.
17.
Sections 114, 941, 942 and 943 IRC were inserted into the IRC by
virtue of Section 3 of the ETI Act, and create new rules under which certain
income is excluded from United States taxation. We refer to these new rules as the "ETI measure"
(or sometimes simply as the "measure"), which we outline below. In these proceedings, the claims brought by
the European Communities under Article 3.1 of the SCM Agreement, Articles 3.3,
8 and 10.1 of the Agreement on Agriculture and Article III:4 of
the GATT 1994 contest various elements of this measure.
18.
The tax treatment provided by the ETI measure is available to United
States' citizens and residents, including natural persons, corporations and
partnerships. In addition, the
provisions of the ETI measure also apply to foreign corporations which elect to
be treated, for tax purposes, as United States corporations.[25] The ETI measure permits all these taxpayers
to elect to have qualifying income taxed in accordance with the provisions of
that measure. This election may be made
by taxpayers on a transaction-by-transaction basis.
19.
Generally, income from specific transactions will qualify for
treatment in accordance with the provisions of the ETI measure if it is income
attributable to gross receipts: (i)
from specific types of transaction;
(ii) involving "qualifying foreign trade property"
("QFTP"); and (iii) if the
"foreign economic process requirement" is fulfilled with respect to
each such transaction.[26] Turning to the first of these conditions,
the rules contained in the ETI measure apply, in particular, to income
arising from sale, lease or rental transactions. The ETI measure also applies to income earned from the
performance of services "related or subsidiary to" qualifying
sales or lease transactions, as well as to income earned from the performance
of certain other services.[27]
20.
The second condition is that these transactions involve QFTP. Section 943(a)(1) IRC defines QFTP as
property which is: (A) manufactured,
produced, grown or extracted within or outside the United States; (B) held primarily for sale, lease or
rental, in the ordinary course of business, for direct use, consumption, or
disposition outside the United States;
and (C) not more than 50 percent of the fair market value of which is
attributable to: (i) articles
manufactured, produced, grown, or extracted outside the United States; and (ii) direct costs for labour performed
outside the United States.[28]
21.
The third condition is that the "foreign economic process
requirement" must be fulfilled with respect to each individual
transaction.[29] This requirement is fulfilled if the
taxpayer (or any person acting under contract with the taxpayer) participated
outside the United States in the solicitation, negotiation, or making of the
contract relating to the transaction.
Furthermore, a specified portion of the "direct costs" of the
transaction must be attributable to activities performed outside the
United States.[30]
22.
Section 942(a) IRC designates as "foreign trading gross
receipts" the receipts generated in transactions satisfying all three of
these conditions. Under Section 114(e)
IRC, "extraterritorial income" is the gross income
attributable to activities performed outside the United States.[31]
23.
Section 114(a) IRC provides that a taxpayer's gross income
"does not include extraterritorial income". Section 114(b) IRC adds that this exclusion of extraterritorial
income from gross income "shall not apply" to that portion of
extraterritorial income which is not "qualifying foreign trade
income" ("QFTI").
Accordingly, the only portion of extraterritorial income
which is excluded from gross income and, thereby, from United States taxation
is QFTI.
24.
QFTI is an amount which, if excluded from the taxpayer's gross
income, will result in a reduction of the taxable income of the taxpayer from
the qualifying transaction. Pursuant to
Section 941(a)(1) and (2) IRC, QFTI is calculated as the greatest of, or
the taxpayer's choice of, the following three options: (i) 30 percent of the foreign sale and
leasing income derived by the taxpayer from such transaction [32]; (ii) 1.2 percent of the
foreign trading gross receipts derived by the taxpayer from the transaction [33]; or (iii) 15 percent of the
foreign trade income derived by the taxpayer from the transaction.[34]
25.
This appeal raises the following issues:
(a) whether the Panel erred
in finding, in paragraphs 8.30 and 8.43 of the Panel Report, that the ETI measure
which is described in paragraphs 12-25 of this Report involves the
foregoing of revenue which is "otherwise due" and thus gives rise to
a "financial contribution" within the meaning of
Article 1.1(a)(1)(ii) of the SCM Agreement;
(b) whether the Panel erred
in finding, in paragraphs 8.75 and 9.1(a) of the Panel Report, that the ETI
measure includes subsidies "contingent
upon export performance"
within the meaning of Article 3.1(a) of the SCM Agreement;
(c) whether the Panel erred
in finding, in paragraphs 8.107 and 9.1(a) of the Panel Report that the ETI
measure, viewed as a whole, does not fall within the scope of
footnote 59 of the SCM Agreement as a measure taken to avoid
the double taxation of foreign-source income;
(d) whether the Panel erred
in finding, in paragraphs 8.122 and 9.1(c) of the Panel Report, that the ETI
measure involves export subsidies inconsistent with the United States'
obligations under Articles 3.3, 8 and 10.1 of the Agreement on Agriculture;
(e) whether the Panel erred
in finding, in paragraphs 8.158 and 9.1(d) of the Panel Report, that the ETI
measure is inconsistent with the United States' obligations under Article III:4
of the GATT 1994 because it accords less favourable treatment to imported products
as compared with like products of United States origin;
(f) whether the Panel erred
in finding, in paragraphs 8.170 and 9.1(e) of the Panel Report, that the United
States has not fully withdrawn the subsidies found, in US FSC, to be prohibited export
subsidies under Article 3.1(a) of the SCM Agreement,
and in finding that the United States has, therefore, failed to implement the
recommendations and rulings of the DSB made pursuant to Article 4.7 of the
SCM Agreement; and
whether the Panel erred in its interpretation of
Article 10.3 of the DSU in declining, in its decision
of 21 February 2001, reproduced in paragraph 6.3 of the Panel Report, to rule
that all the written submissions of the parties filed prior to the only meeting
of the Panel must be provided to the third parties
26.
For the reasons set out in this Report, the Appellate Body:
(a) upholds the
Panel's finding, in paragraphs 8.30 and 8.43 of the Panel Report, that the ETI
measure involves the foregoing of revenue which is "otherwise due"
and thus gives rise to a "financial contribution" within the meaning
of Article 1.1(a)(1)(ii) of the SCM Agreement;
(b) upholds the
Panel's finding, in paragraphs 8.75 and 9.1(a) of the Panel Report, that the
ETI measure includes subsidies "contingent
upon export performance"
within the meaning of Article 3.1(a) of the SCM upholds the Panel's finding, in paragraphs 8.107 and 9.1(a) of
the Panel Report, that the ETI measure, viewed as a whole, does not fall
within the scope of footnote 59 of the SCM Agreement as a
measure taken to avoid the double taxation of foreign-source income;
(d) upholds the
Panel's finding, in paragraphs 8.122 and 9.1(c) of the Panel Report, that the
ETI measure involves export subsidies inconsistent with the United
States' obligations under Articles 3.3, 8 and 10.1 of the Agreement on Agriculture;
(e) upholds the
Panel's finding, in paragraphs 8.158 and 9.1(d) of the Panel Report, that the
ETI measure is inconsistent with the United States' obligations under
Article III:4 of the GATT 1994 because it accords less favourable
treatment to imported products as compared with like products of United States
origin;
(f) upholds the
Panel's finding, in paragraphs 8.170 and 9.1(e) of the Panel Report, that the
United States has not fully withdrawn the subsidies found, in the Agreement;
finds that the Panel erred in its interpretation of Article 10.3 of the
DSU in declining, in its decision of 21 February
2001, reproduced in paragraph 6.3 of the Panel Report, to rule that all
the written submissions of the parties filed prior to the only meeting of the
Panel must be provided to the third parties.
27.
The Appellate Body recommends
that the DSB request the United States to bring the ETI measure, found in this
Report, and in the Panel Report as modified by this Report, to be inconsistent
with its obligations under Article 3.1(a) of the SCM Agreement, under Articles 3.3, 8 and 10.1 of the Agreement on Agriculture, and
under Article III:4 of the GATT 1994, into conformity with its obligations
under those Agreements, and that the DSB request the United States to implement
fully the recommendations and rulings of the DSB in US FSC, made pursuant to Article 4.7 of the SCM Agreement.
[1]WT/DS108/RW, 20 August 2001.
[2]United States Public Law 106-519, 114 Stat. 2423 (2000).
[3]The recommendations and rulings of the DSB resulted from the
adoption, by the DSB, of the Appellate Body Report in US FSC, WT/DS108/AB/R, adopted 20
March 2000 (the "original Appellate Body Report"). In this Report, we refer to the panel that
considered the original complaint brought by the European Communities as the
"original panel" and to its report as the "original panel
report".
[4]Original Panel Report, US FSC, WT/DS108/R, adopted 20 March 2000, as modified by the Appellate Body Report, WT/DS108/AB/R, para. 8.1.
[5]Ibid., para. 8.8.
[6]WT/DSB/M/90, paras. 6-7. See also Panel Report, para. 1.3.
[7]Panel Report, para. 1.5.
[8]Ibid., paras. 1.1-1.13.
[9]WT/DS108/16, 8 December 2000.
[10]WT/DS108/19, 5 January 2001.
[11]Panel Report, para. 9.1.
[12]Ibid., para. 9.2.
[13]WT/DS108/21, 15 October 2001.
[14]In its letter, the United States explained that, due to the delivery of the bacterium anthrax to the United States Congress, several buildings had been temporarily closed, including buildings housing the offices of United States Senate officials with jurisdiction over the issues arising in this appeal.
[15]Pursuant to Rule 21(1) of the Working Procedures.
[16]Pursuant to Rule 23(1) of the Working Procedures.
[17]Pursuant to Rules 22 and 23(3) of the Working Procedures.
[18]Pursuant to Rule 24 of the Working Procedures.
[19]Pursuant to Rule 28(1) of the Working Procedures.
[20]Pursuant to Rule 28(2) of the Working Procedures.
[21]Appellate Body Report, supra, footnote 3, paras. 6-7.
[22]Section 901(a) IRC.
[23]Section 1 relates to the short title of the ETI Act, while Section 4 sets forth a number of "technical and conforming" amendments.
[24]Subpart C of part III of Subchapter N of chapter 1, consisting of Sections 921-927 IRC.
[25]Section 3 of the ETI Act, Section 943(e) IRC.
[26]Under the ETI Act, the need to satisfy these three conditions is subject to a number of exceptions. We examine certain of these exceptions below, to the extent that they are pertinent to our analysis of the issues on appeal.
[27]The detailed rules of the ETI measure provide that foreign trading gross receipts may be earned through (i) any sale, exchange, or other disposition of qualifying foreign trade property; (ii) any lease or rental of qualifying foreign trade property; (iii) any services which are related and subsidiary to (i) and (ii); (iv) for engineering or architectural services for construction projects located (or proposed for location) outside the United States; and (v) for the performance of managerial services for a person other than a related person in furtherance of activities under (i), (ii) or (iii). (Section 3 of the ETI Act, Section 942(a) IRC) We will generally refer to sale and lease transactions as a shorthand reference to the transactions described in (i) and (ii) of this footnote.
[28]Section 3 of the ETI Act, Section 943(a)(1) IRC. Section 943(a)(3) and (4) IRC set forth specific exclusions from this general definition.
[29]Section 3 of the ETI Act, Section 942(b) IRC.
[30]The relevant activities
are: (i) advertising and sales
promotion; (ii) processing of customer
orders and arranging for delivery;
(iii) transportation outside the United States in connection with
delivery to the customer; (iv)
determination and transmittal of final invoice or statement of account or the
receipt of payment; and (v) assumption
of credit risk. A taxpayer will be
treated as having satisfied the foreign economic process requirement when at
least 50 percent of the total costs attributable to such activities is
attributable to activities performed outside the United States, or, for at
least two of these five categories of activity, when at least 85 percent of the
total costs attributable to such category of activity is attributable to
activities performed outside the United States. (Section 3 of the ETI Act,
Section 942(b)(2)(A)(ii), (b)(2)(B) and (b)(3) IRC)
[31]The relevant activities
are: (i) advertising and sales
promotion; (ii) processing of customer
orders and arranging for delivery;
(iii) transportation outside the United States in connection with
delivery to the customer; (iv)
determination and transmittal of final invoice or statement of account or the
receipt of payment; and (v) assumption
of credit risk. A taxpayer will be
treated as having satisfied the foreign economic process requirement when at least
50 percent of the total costs attributable to such activities is attributable
to activities performed outside the United States, or, for at least two of
these five categories of activity, when at least 85 percent of the total costs
attributable to such category of activity is attributable to activities
performed outside the United States. (Section 3 of the ETI Act, Section
942(b)(2)(A)(ii), (b)(2)(B) and (b)(3) IRC)
[32]Foreign sales and leasing income is defined in Section 941(c)(1) IRC.
[33]Foreign trading gross receipts are defined in Section 942(a) IRC.
[34]Foreign trade income is defined in Section 941(b) IRC.