by Roger Russell

The failure of the House and Senate to pass legislation repealing the current export breaks for U.S. manufacturers in the tax code have resulted in the imposition of World Trade Organization sanctions on a variety of American goods.

Effective March 1, European Union members have imposed tariffs of 5 percent on over 1,600 U.S. products, including grain, timber, paper and manufactured goods. The tariffs will increase by 1 percent a month up to 17 percent, or until Congress acts to eliminate what the European Union calls “illegal export subsidies.”

The attempt to place U.S. corporations on an equal footing with those of other countries has taken a number of twists and turns since “domestic international sales corporations” were first conceived in the early 1970s.

Since European companies pay tax solely on income earned in Europe, U.S. companies, which are taxed on total income from domestic and foreign sales, are at a disadvantage. The DISCs were allowed to defer tax on a percentage of export profits, easing the tax gap with European companies.

The European Commission found fault with the DISC provisions, and brought an action under the General Agreement on Tariffs and Trade (the predecessor of the World Trade Organization) in 1976. Even though the U.S. replaced DISCs with the foreign sales corporation provisions pursuant to a 1981 GATT Council Understanding,  the European Union obtained a WTO ruling that the FSC provided an illegal export subsidy more than a decade later.

To comply with the WTO, the U.S. repealed the FSC provisions and enacted the Extraterritorial Income Exclusion Act in 2000. Once more, the EU charged that the ETI provisions violated WTO rules, and a WTO panel agreed. In a WTO arbitration proceeding, the EU was allowed to impose sanctions on U.S. exports.

The EU gave the U.S. a deadline of March 1, 2004, to repeal the ETI provisions from the tax code or face sanctions. Although both the House and the Senate have repeal bills on tap, neither has been passed yet.

“The principal purpose of all of these regimes was to give a tax break to U.S. taxpayers that export property,” said Jeff Hoops, president of the New York State Society of CPAs and a partner with Ernst & Young. “In every case, our trading partners told us the tax break is not in accord with our trade agreements, and we keep trying to fix it.”

“The WTO said in the last go-round, if we don’t fix it, our trade partners have the right to impose sanctions, and we didn’t, so they did,” Hoops explained. “Congress would like to fix it, but it has become a very difficult legislative initiative.”

Everybody’s business
This is an issue of interest to accountants and tax practitioners with clients of all sizes, according to Selva Ozelli, a CPA and international tax attorney with RIA, a Thomson business.

“International tax is not just the bailiwick of Fortune 500 firms,” she said. “A surprisingly large number of small businesses have interests overseas.”

While both the House and Senate each have their own version of a bill to correct the trade impasse, “the heart of both bills are extremely similar,” said Ozelli. “The Senate bill stalled, even though it was bipartisan, because a number of senators insisted on adding unrelated amendments.”

The Senate bill — the Jumpstart Our Business Strength Act — replaces the FSC-ETI provisions with an effective 3 percent tax cut for manufacturing income that is intended to preserve and create manufacturing jobs in the U.S. It also reforms international tax rules that undermine America’s ability to compete in the global marketplace, according to Senate Finance Committee chair Chuck Grassley, R-Iowa. “For example, the bill cleans up problems that cause foreign earnings to be double-taxed by both the United States and the foreign country where the profits are earned,” he stated.

While the Senate bill has broad bipartisan support, the House version might have a tougher time getting passed, according to Michael Mundaca, a partner in Ernst & Young’s Washington-based International Tax Services Group.

The House bill was voted out of the Ways and Means Committee on a straight party-line vote. “All the Democrats on the committee voted against it,” he said. “On the floor, there will be very little Democratic support. There’s a group of Republicans that don’t like it, as well. Part of the problem is tied in to the fact that it’s not quite revenue-neutral, and some say they don’t want to vote for further tax cuts.”

“The House version has broader international provisions involving subpart F and the foreign tax credit, which make it revenue non-neutral,” Mundaca continued.

The two bills are similar, but differ in structure, according to Kimberly Pinter, director of corporate finance and tax for the National Association of Manufacturers. “The manufacturing benefit is structured as a tax deduction in the Senate bill, while the House bill calls for a rate cut,” she said.

Pinter remains hopeful that the legislation will pass in one form or another before long. “We haven’t yet reached critical mass as far as people talking about sanctions,” she said. “A lot of people were in ‘hold your breath’ mode, thinking something would get done soon, but it didn’t happen. Being in a position where sanctions are imposed is beyond where we should be.”

Mark Luscombe, CPA and principal analyst for Riverwoods, Ill.-based CCH, agreed. “What we haven’t seen yet is industries being hurt by the sanctions mobilizing their lobbying groups. That’s what it will take to get Congress off the dime.”

“There’s been no real push and no real willingness to compromise. Even if it gets through the House and Senate, it will be a tough conference,” Luscombe predicted.

“They’ll come together sooner or later, but whether it’s before the elections, I’m not sure,” said Martin B. Tittle, an Ann Arbor, Mich.-based international tax attorney. “We thought it would be resolved last year, or by March 1 of this year. The fact that it’s an election year may be causing legislators to take a more vigorous stance for their positions.”

“Nobody thought it would last this long,” he said. “There are actually those who say to go ahead and pay the sanctions for awhile because we’re getting a $4 billion dollar benefit. With the tariffs increasing by one percent a month, the EU will collect about $350 million by the end of the year. If they cap the tariffs at 17 percent, the total will be between $600 and $700 million for 2005.”

“I believe they will get together this year, but it’s not a certainty,” said Mundaca. “A lot of tax bills appear to collapse before an agreement is reached. The administration will begin to ratchet up the pressure. Some industry groups are starting to speak up. I can’t believe that people won’t focus on this when the tariffs keep escalating.”

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