A History of the Extraterritorial Income (ETI) and Foreign Sales Corporation (FSC) Export Tax-Benefit Controversy
CRS Report for Congress
A History of the Extraterritorial Income (ETI)
and Foreign Sales Corporation (FSC)
Export Tax-Benefit Controversy
Updated September 22, 2006
David L. Brumbaugh
Specialist in Public Finance
Government and Finance Division
Congressional Research Service ˜ The Library of Congress
A History of the Extraterritorial Income (ETI) and
Foreign Sales Corporation (FSC)
Export Tax- Benefit Controversy
Prior to 2004, the U.S. tax code’s extraterritorial income (ETI) provisions
provided a tax benefit for exports. However, ETI and several statutory predecessors
embroiled the United States in a three-decade controversy with the European Union
(EU) over their legality under the World Trade Organization (WTO) agreements.
The EU complained that the U.S. export tax benefits were prohibited subsidies, and
a succession of WTO panels supported that view. A WTO panel also ruled that the
EU could impose retaliatory tariffs on U.S. products. Initially, the EU indicated that
it would not impose tariffs while the United States was making progress in bringing
its laws into WTO-compliance. However, while Congress began deliberations on
ETI in 2002, it had not repealed the measure by 2004, and the EU began a phased-in
implementation of tariffs in March 2004.
The controversy began with the 1971 enactment of the Domestic International
Sales Corporation (DISC) export tax benefit. European countries complained under
the General Agreement on Tariffs and Trade (GATT, the WTO’s predecessor) that
DISC was a prohibited export subsidy. A GATT panel ruled against DISC, and the
United States did not concede DISC’s illegality but replaced DISC in 1984 with the
Foreign Sales Corporation (FSC) provisions, designed to achieve GATT-legality
while still providing an export benefit. In 1997, however, the EU began proceedings
against FSC. A WTO panel ruled against FSC, leading the United States to enact the
ETI provisions in 2000; the EU began WTO proceedings against ETI in November
of that year.
After consideration of several alternative approaches to ending the controversy,
Congress repealed ETI in 2004 as part of the American Jobs Creation Act (AJCA;
P.L. 108-357). The measure coupled ETI’s repeal with enactment of a deduction
generally applicable to all domestic manufacturing production — not just exports.
The EU suspended its tariffs beginning in January 2005, but at the same time lodged
a new WTO complaint about several transition rules included with AJCA’s repeal.
The WTO supported the EU’s complaint, and in May 2006 provisions included in the
Tax Increase Prevention and Reconciliation Act (P.L. 109-222) repealed the
transition rules, apparently ending the decades-long controversy.
U.S. exporters argued that ETI was necessary to protect U.S. competitiveness,
but traditional economic theory questions the efficacy of export benefits. Theory
suggests that exchange rate adjustments reduce most of any increase the tax benefits
may cause in exports while at the same time triggering an increase in imports; the net
result is no change in the balance of trade. Theory also suggests that export subsidies
reduce the economic welfare of the subsidizing country in two ways. First, part of
the subsidy’s benefit flows abroad, transferring welfare from U.S. taxpayers to
foreign consumers. Second, the benefit likely distorts the U.S. economy, inducing
it to trade more than is economically efficient.
Domestic International Sales Corporations (DISCs) and Their Rationale.......1
DISC and the General Agreement on Tariffs and Trade....................5
The Advent of Foreign Sales Corporations (FSCs)........................8
FSC and the World Trade Organization................................9
The Extraterritorial Income Benefit...................................11
The EU Response.................................................17
A History of the Extraterritorial Income (ETI)
and Foreign Sales Corporation (FSC)
Export Tax-Benefit Controversy
A long-running dispute between the United States and the European Union (EU)
over U.S. export tax benefits may have reached a conclusion. For more than 30
years, U.S. tax law provided a tax benefit to exporters: first, as the Domestic
International Sales Corporation (DISC) provisions; then, with the Foreign Sales
Corporation (FSC) benefit; and finally with the Extraterritorial Income (ETI)
provisions. The EU maintained for virtually the entire period that the U.S. export
benefits violated international trade agreements’ prohibitions of export subsidies,
arguing that DISC violated the General Agreement on Tariffs and Trade (GATT), and
later complaining that FSC and the ETI provisions violated the World Trade
Organization (WTO) agreements that replaced GATT. Successive attempts by the
United States to redesign its export tax benefits so as to achieve legality under GATT
and the WTO were not successful; GATT and WTO panels without exception ruled
against the U.S. provisions. WTO rulings against the U.S. export benefits culminated
in 2002 with the approval of up to $4.03 billion in retaliatory tariffs by the EU.
Congress began consideration of legislation to repeal ETI, and initially, the EU
deferred application of its tariffs. By early 2004, however, the United States had not
enacted repeal legislation, and the EU began to phase in its tariffs in March of that
In October 2004, the U.S. Congress repealed ETI with enactment of the
American Job Creation Act (AJCA; Public Law 108-357). The act provides for the
phase out of ETI over two years and also implemented a number of tax benefits for
domestic U.S. production in general (i.e., for exports and non-exports alike) as well
as tax cuts for overseas operations. The EU suspended its tariffs, effective January
2005, but also lodged a WTO complaint regarding the transition provisions of ETI’s
repeal, arguing that AJCA’s phaseout (rather than immediate repeal) contravened the
WTO agreements. In May 2006, Congress repealed the transition provisions as part
of the Tax Increase Prevention and Reconciliation Act (P.L. 109-222), apparently
ending the decades-long controversy.
Domestic International Sales Corporations (DISCs)
and Their Rationale
The Domestic International Sales Corporation (DISC) provisions were enacted
as part of the Revenue Act of 1971 (P.L. 92-178). DISC was a small part of a
broader economic package announced in August 1971 by the Nixon Administration,
a program designed to alleviate a range of economic problems that included a
deteriorating U.S. balance of payments.1 In contrast to the current regime of flexible
exchange rates, international exchange rates at the time were fixed, and the U.S.
balance of payments problem was highlighted by a current account deficit and large
outflows of capital from the United States, leading to a balance of payments deficit
that placed severe pressure on the U.S. dollar. The major aspects of the curative
program were suspension by the United States of the dollar’s convertibility into gold
and a 10% surcharge on imports. For its part, DISC was intended both to stimulate
U.S. exports and to encourage U.S. firms to locate their production for foreign
markets in the United States rather than abroad.2
DISC was designed, in part, to counter the effect of another tax code provision,
a still-existing tax benefit known as “deferral,” under which U.S. firms can
indefinitely postpone U.S. tax on their overseas operations. By providing a tax
benefit for income earned abroad, deferral poses a tax incentive for U.S. firms to
invest and produce in countries with relatively low tax rates. DISC was designed to
counter deferral’s incentive with an incentive of its own for investment in U.S.-based
production of exports. Instead of building factories abroad to serve their foreign
markets, U.S. firms could obtain a tax benefit by producing in the United States and
shipping their goods overseas. Indeed, the DISC benefit’s statutory design mirrored
the mechanics of deferral in many respects.
To see how the 1971 DISC provisions were designed to provide preferential tax
treatment to exports, it is useful to take a brief look at the overall U.S. tax structure
in its international setting. In broad terms, the United States bases its tax jurisdiction
on the residence of a corporation or individual, not on the source of the taxpayer’s
income. Under this so-called “residence” system of taxation, U.S. taxes apply to both
the foreign and U.S.-source income of corporations chartered in the United States
(U.S. corporate “residents”). Thus, without a special provision such as DISC or its
successors, a U.S.-chartered corporation that sells exports directly to its foreign
customers is taxed in full on its export income, regardless of whether export income
is considered to have a U.S. or a foreign source.
The aforementioned deferral benefit complicates this picture. Deferral works
like this: while the United States taxes its residents on their worldwide income, it
taxes foreign-chartered corporations only on income from the conduct of a U.S. trade
1 Thomas W. Anninger, “DISC and GATT: International Aspects of Bringing Deferral
Home,” Harvard International Law Journal, vol. 13, Summer 1972, p. 392.
2 DISC was first proposed in 1969, and was championed by the Treasury Department before
its ultimate inclusion in the 1971 economic proposals: John H. Jackson, “The Jurisprudence
of International Trade: The DISC Case in GATT,” American Journal of International Law,
vol. 72, Oct. 1978, p. 752. For an overview of the 1971 economic package, see the
testimony by Treasury Secretary John Connally in U.S. Congress, House Committee onnd
Ways and Means, Tax Proposals Contained in the President’s New Economic Policy, 92st
Cong., 1 sess., Sept. 8, 1971 (Washington: GPO, 1971), pp. 7-8. For the congressional
rationale for DISC, see U.S. Congress, Joint Committee on Taxation, General Explanation
of the Revenue Act of 1971 (Washington: GPO, 1971) , p. 86. For a discussion of the
balance of payments problems, see Barry Eichengreen, Globalizing Capital: A History of
the International Monetary System (Princeton, NJ: Princeton Univ. Press, 1996), pp. 128-
or business. To use the deferral benefit, a U.S. firm with multinational operations
arranges to earn its foreign income through a subsidiary corporation chartered in a
foreign country. Since the foreign subsidiary is exempt from U.S. tax (at least to the
extent it does not earn U.S. income), U.S. taxes can be postponed until the
subsidiary’s income is paid to the U.S.-chartered parent firm as dividends, a deferral
that constitutes a tax benefit as long as the subsidiary’s income is subject to low
foreign taxes in the interim. (Note here that U.S. corporations can normally deduct
some or all of dividends received from U.S.-chartered corporations as a means of
alleviating multiple applications of corporate-level tax. However, dividends received
from foreign corporations are not deductible.)
Even without DISC (and later FSC and ETI), certain tax planning opportunities
are available to exporters using the deferral benefit. Conceivably, a U.S. exporter can
avoid at least some amount of U.S. tax by selling its exports to a foreign subsidiary
corporation which then sells the U.S.-made products to foreign customers. To the
extent income from the export can be attributed to the foreign subsidiary, it can
achieve deferral of U.S. tax. Two aspects of the U.S. tax code, however, limit this
technique. First, the Internal Revenue Service (IRS) is empowered by the tax code
to reallocate income among related taxpayers so as to accurately reflect each entity’s
actual production of income. And, in general, the IRS allocates income on the basis
of hypothetical “arm’s-length” prices that are assigned to transfers of goods and
services between related firms as though the firms were, in fact, unrelated. Since the
bulk of an export’s value is, by definition, added by the home-country exporter,
presumably little in the way of export income can be allocated to a foreign sales
subsidiary, and little export income can thus benefit from deferral.
A set of tax code rules known as Subpart F also limits deferral’s benefit for
exports. Subpart F is generally designed to restrict U.S. taxpayers from concentrating
foreign income in low-tax foreign “tax havens,” the better to take advantage of
deferral. To that end, Subpart F identifies certain types of income that are subject to
current U.S. taxation, even if earned through a foreign subsidiary, generally income
from passive investment (i.e., interest, dividends, and similar income) and a variety
of income types whose source is thought to be easily manipulated. Included in this
latter category is what Subpart F terms “foreign base company sales income,”
income from sales transactions between related entities. Thus, even if a tax-planning
exporter were to successfully allocate export profits to a foreign subsidiary, Subpart
F potentially denies the deferral benefit.
The DISC provisions carved an export benefit into this structure by establishing
an indefinite tax deferral for income from exporting, emulating certain aspects of the
deferral benefit that was already on the books. A firm availed itself of the DISC
benefit by setting up a subsidiary through which it sold its exports, a “DISC” in this
case meaning a corporation chartered domestically rather than abroad. DISCs
themselves were tax exempt under special tax code provisions; any income attributed
to the DISC could thus be deferred until remitted to the parent firm as intra-firm
dividends. And while a DISC could be simply a paper corporation performing few
economic activities of its own, the DISC provisions contained special income
allocation rules under which specified portions of a firm’s export income could be
attributed to the DISC rather than the parent corporation.3 These allocation rules
departed from the arm’s-length pricing method of dividing income that U.S. tax rules
normally applied. As a result of the various rules governing income allocation and
other aspects of DISC, firms could use the benefit to indefinitely defer taxes on
somewhere between 16% and 33% of their export income from taxation.4
In addition to countering deferral, DISC was designed to offset what were
perceived to be tax advantages provided by foreign countries to their own exporters.
Some countries, then as now, operate “territorial” rather than residence-based tax
systems under which tax jurisdiction is based on the source of income rather than the
identity of the taxpayer. Territorial systems generally tax only domestic-source
income and exempt income attributed to foreign sources. The structure of territorial
tax systems can provide export subsidies under certain circumstances, for example,
if arm’s-length pricing is not rigorously applied so that a large fraction of export
income can be concentrated in exempt offshore branches.
Another perceived advantage for foreigners was the “border tax adjustments”
provided by countries that make extensive use of value-added taxes (VATs).
Countries that use VATs, including those in the EU, commonly rebate the VAT that
has been paid on exports while applying the VAT to imports. These adjustments are
intended to ensure that products made in VAT-utilizing countries do not face a price
disadvantage in competing against goods from other countries. However, some U.S.
businesses argued (and some still argue today) that VAT rebates give foreign goods
an advantage over U.S. exports; a provision such as DISC was thought necessary to
place U.S. and foreign products on an even footing, tax-wise.
Again, DISC was designed to address a balance of payments deficit, both by
reducing outflows of capital and the U.S. trade deficit. Shortly after DISC was
enacted, however, the U.S. abandoned the gold standard, and the world’s major
trading countries ultimately adopted a regime of flexible exchange rates. According
to economic theory, the new regime neutralized any impact DISC may have had on
exports. Under flexible exchange rates, an export subsidy such as DISC drives up
the price of the exporting country’s currency (in this case, the dollar), making its
exports more expensive for foreigners and its own imports cheaper. Any initial
export expansion from the tax benefit is reduced, while imports increase. Ultimately,
the export benefit has no impact on the balance of trade although it does increase the
overall level of trade. (According to economists, these same adjustments refute the
argument that VAT rebates provide an advantage to foreigners; exchange rate
adjustments offset any effect the rebates may have.)
3 For a detailed description of how DISC worked, see U.S. Congress, Joint Committee on
Taxation, General Explanation of the Revenue Act of 1971, 92nd Cong., 2nd sess.
(Washington: GPO, 1972), p. 86. An economic analysis of both DISC and deferral is in
CRS Report 78-20 E, Deferral and DISC: Two Targets of Tax Reform, by Jane G. Gravelle
and Donald W. Kiefer (an out of print report available from the author).
4 CRS Report 83-69, DISC: Effects, Issues, and Proposed Replacements, by David L.
Brumbaugh, p. 7 (an out of print report available from the author).
More importantly, economic theory also questions the efficacy of export
subsidies regardless of their impact on the balance of trade. According to theory,
export subsidies reduce the economic welfare of the subsidizing country in two ways.
First, any expansion in exports is likely accomplished by a reduction in prices that
foreign consumers pay for the exports: a price reduction that is financed by the
subsidizing country’s taxpayers. Second, an export subsidy reduces economic
welfare by distorting resource use in the subsidizing and subsidized countries alike;
it induces countries to trade more than is economically efficient. However, in the
case of DISC, FSC, and ETI alike, these deleterious effects were probably not large,
in part because of exchange rate adjustments.
DISC and the General Agreement on
Tariffs and Trade
DISC was enacted on December 10, 1971, and went into effect on January 1,
1972. Almost immediately, the European Community (EC; the precursor of the
European Union) began proceedings against the provision under GATT.
GATT was created in 1947 as an agreement among the major trading countries
that would govern acceptable commercial policy in the conduct of trade. GATT’s
purpose was to reduce the tariffs and other trade barriers as well as discriminatory
trade practices that had grown up in the inter-war years and that had contributed to
the worldwide economic collapse that preceded World War II. In promoting free
trade, it was believed that GATT would promote rising standards of living and full
GATT did not have autonomous power and was not a formally constituted
organization like the World Bank or International Monetary Fund. Further, decisions
required a consensus among the contracting countries, effectively giving each country
veto power. Nonetheless, the Agreement included a prohibition against subsidies for
exports of manufactured goods, and procedures were developed within GATT for
settling trade disputes. Under the procedures, an aggrieved country would first
request consultations with the country it believed to be in violation of the Agreement.
If the differences remained unresolved, the GATT Council could appoint a panel that
would issue a report on the dispute. The GATT Council could either adopt, reject,
or take no action on the panel report. In cases where a country was found to have
violated GATT, the complaining country could request permission to apply
The EC took the first step in this process in February 1972, by requesting
consultations with the United States on DISC.5 The United States, in turn, requested
consultations under GATT with the Netherlands, France, and Belgium, each of which
5 European doubts about DISC’s legality were expressed before the provision was actually
enacted. The U.S. Treasury, however, was prepared to maintain that DISC was GATT-
compatible. Thomas W. Anninger, “DISC and GATT: International Aspects of Bringing
Deferral Home,” Harvard International Law Journal, vol. 13, Summer 1972, p. 393;
Jackson, “The Jurisprudence of International Trade,” p. 761.
maintained “territorial” tax systems. The consultations produced no solution to the
dispute, and in May 1973, both the EC and the United States took the next step in the
dispute process by filing formal complaints with GATT. The GATT Council, as set
forth under its procedures, established independent panels to examine and report on
The European complaint against DISC relied on the conclusions of a 1960
GATT Working Party report containing an illustrative list of subsidies, a report that
had been adopted by the major GATT countries. The report’s list included the
“remission” of direct taxes on exports as well as the “exemption” of export income
from tax, although it did not specifically list tax deferrals. The EC argued that
because the DISC deferral was, in principle, unlimited, it was the economic
equivalent of an outright remission or exemption.6 In response, the United States
pointed out the omission of tax deferrals as an explicit item on the 1960 list.7
The U.S. response struck an additional theme to which the United States was to
return in future episodes of the controversy: that a parallel existed between the U.S.
export tax benefits and the territorial systems maintained by the several European
countries. The United States argued that since income of foreign sales branches is
not taxed under territorial systems, and because the EC countries did not rigorously
apply arm’s-length pricing, territorial systems subsidized exports. (Indeed, this was
exactly the argument the United States mounted against the EC territorial systems in
its own GATT complaint.) At the same time, however, the United States argued that
GATT had, by custom, always considered territorial systems acceptable. DISC, the
United States maintained, simply removed the distortion introduced by the territorial
systems by introducing another; if the first distortion (the territorial systems) was
legal, so too was the other.8
The GATT panel report was issued in November 1976; it found elements of
subsidy in both the U.S. and territorial systems. In the first place, the panel
concluded that DISC was a prohibited export subsidy notwithstanding its deferral
rather than exemption of income from taxes. The subsidy was conferred, the panel
reasoned, because no interest charge was assessed by the U.S. tax authorities on the
deferred tax liability. With respect to the U.S. defense of DISC as a counterweight
6 General Agreement on Tariffs and Trade, “United States Tax Legislation (DISC): Report
of the Panel Presented to the Council of Representatives on 12 November 1976,” Basicrd
Instruments and Selected Documents, 23 Supp., Jan. 1977, p. 103.
7 Ibid., p. 104.
8 Ibid., p. 106. The belief that there was linkage between DISC and territorial systems was
apparently not confined to DISC’s defense before GATT. See the assessment by Robert
Hudec, who cites U.S. officials’ “conviction that the European tax systems were not merely
permitting tax-haven operations, but were actively helping exporters to enlarge that tax
advantage by adopting very generous ... pricing rules for tax haven transactions. United
States tax officials, who took some pride in their own fairly rigorous arm’s length pricing
rules, found it particularly irritating to be accused of subsidizing by tax officials who, they
believed, were actively promoting even worse practices at home.” Robert E. Hudec,
“Reforming GATT Adjudication Procedures: The Lessons of the DISC Case,” Minnesota
Law Review, vol. 72, June 1988, p. 1459.
to the territorial systems, the panel concluded that one distortion (i.e., the territorial
systems) does not justify another, and that mere custom, furthermore, did not
necessarily make territorial systems GATT-legal. As for the U.S. complaint against
the territorial systems, the panel report concluded that the territorial systems in
question provided a tax subsidy for export sales through low-tax countries and that
lenient intra-firm pricing and cost allocation rules amplified the benefit.9
Following the issuance of the panel reports, the next step in the dispute-
resolution process would normally have been for the GATT Council to consider
whether or not to adopt the reports. However, the United States and the EC were at
an impasse. The United States was willing to accept the finding against DISC, but
only if the findings against the three territorial systems were also adopted; the three
European countries were only willing to adopt the finding against DISC.10 A GATT
Council decision remained in abeyance for nearly five years. In part, the hiatus was
due to the increased opposition to DISC within the United States itself. In 1978, the
Carter Administration initially proposed repealing DISC, before withdrawing its
proposal in the face of strong opposition; in the face of a possible unilateral repeal
of DISC by the United States, the controversy lost its urgency. In addition,
negotiation of a new GATT Subsidies Code occurred during GATT’s Tokyo Round,
and appeared to point to a resolution of the dispute. The Code explicitly included tax
deferrals as subsidies, casting doubt on DISC’s legality, while affirming the
importance of using arm’s-length pricing in intra-firm transfers — again, a key
element of the United States complaint against territorial systems. At the same time,
the Subsidies Code appeared to countenance the legality of territorial systems in
ge n e r a l . 11
In December 1981, the four DISC panel reports were finally adopted by the
GATT Council, subject to an Understanding. The Understanding, which later
assumed an important role in the U.S. defense of FSC before the WTO, was an
agreement on three points. First, countries need not tax economic processes
occurring outside their territory. Notwithstanding the panel reports, territorial tax
systems did not, in other words, generally contravene GATT. Second, arm’s-length
pricing should be followed in allocating income among related firms. Third, GATT
does not prohibit measures designed to alleviated double-taxation of foreign-source
The Understanding and adoption of the reports, however, did not end the
9 General Agreement on Tariffs and Trade, “United States Tax Legislation (DISC),” p. 126.
10 Hudec, “Reforming GATT Adjudication Procedures,” pp. 1488-1489. As a testament to
the growing intractability of the dispute, Hudec points out that the failure to adopt the
reports was almost unprecedented. Before 1976, there had been 20 GATT legal rulings and
all but one had been adopted by the GATT Council.
11 Ibid., p. 1492.
12 The Understanding is reprinted in General Agreement on Tariffs and Trade, “Tax
Legislation,” Basic Instruments and Selected Documents, 28th Supp., March 1982, p. 114.
The Advent of Foreign Sales Corporations (FSCs)
The meaning of the 1981 Understanding itself shortly became an item of
contention, and during 1982 a debate occurred in the GATT Council over how the
Understanding applied to DISC. The EC continued to argue that DISC was an illegal
export subsidy, while the United States maintained that every export involves at least
some extraterritorial income, and that DISC was a reasonable means of13
approximating the extraterritorial portion. However, policymakers in the United
States noted that the dispute was becoming more serious and “threatened breakdown
of the dispute resolution process” and that the United States had become isolated
over the issue.14 The U.S. Treasury thus proposed what ultimately were enacted as
the 1984 Foreign Sales Corporation (FSC) provisions.
The FSC provisions were designed to achieve GATT legality by providing an
export tax benefit incorporating elements of the territorial tax system countenanced
by the 1981 Understanding. The FSC provisions worked as follows: in a manner
similar to DISC, exporters obtained a tax benefit by selling their exports through a
specially qualified subsidiary corporation, in this case, an FSC. But in contrast to
DISCs, FSCs were required to be incorporated outside the United States. And also
in contrast to DISCs, FSCs were required to conduct certain management activities
or economic processes abroad. Examples of management activities included
maintaining a bank account abroad, having a board of directors that included at least
one person who was not a U.S. resident, and holding all shareholder meetings outside
the United States. “Foreign economic process” requirements were met if an FSC at
least participated in activities such as advertising, arrangement of transportation,
transmittal of invoices and receipt of payment, processing of orders, and assumption
of credit risk.15 Notwithstanding these requirements, an FSC, like DISCs before it,
could be little more than a paper corporation.
As with DISC, the FSC itself was the entity that received special tax status, in
this case a partial tax exemption. The tax code granted the partial exemption by
classifying qualifying FSC income as foreign-source income not connected with the
conduct of a U.S. trade or business; because foreign firms are subject to U.S. tax only
on U.S. income, this placed FSC income outside the U.S. tax jurisdiction. Further,
U.S. parents of FSC subsidiaries were permitted a 100% dividends-received
deduction, despite the fact that FSCs were foreign-chartered corporations. And to
rule out possible U.S. taxation under Subpart F’s foreign base company sales income
rules, FSC income was exempted from Subpart F’s anti-deferral rules.
Since the FSC was the tax-favored entity, the size of the benefit (as with DISC)
depended heavily on how much income a firm was permitted to allocate to its tax-
favored subsidiary. As with DISC, the FSC provisions contained “administrative”
income allocation rules that assigned more income to the subsidiary than generally
13 Hudec, “Reforming GATT Adjudication Procedures,” p. 1497.
14 U.S. Congress, Joint Committee on Taxation, General Explanation of the Deficit
Reduction Act of 1984, committee print, 2nd sess. (Washington: GPO, 1984), p. 1041.
15 A detailed explanation of the FSC provisions is available at Ibid., pp. 1037-1070.
could be allocated under arm’s-length pricing, although firms could use the latter
method if they wished. Under these “administrative pricing” rules, a firm could
choose to allocate either a flat 23% of taxable income from exporting to the FSC or
an amount equal to 1.83% of gross receipts. The portion of income allocated to the
FSC that was tax exempt depended on the income allocation method the firm used:
15/23 was exempt if either of the administrative pricing methods was used; 30% if
arm’s-length pricing was used. As a final element, a parent firm was permitted to
deduct 100% of dividends received from its FSC subsidiary, thus setting the
treatment of FSC dividends apart from that of the fully-taxable dividends received
from other foreign corporations.16 The combination of specified exemptions and
pricing rules resulted in a total tax exemption that ranged from 15% to 30% of export
income, a benefit very slightly smaller than that available under DISC.17
FSC and the World Trade Organization
The adoption of FSC in 1984 dampened the export-benefit controversy for a
period; the EC did not formally bring the matter of U.S. export tax benefits before
GATT for almost 15 years, although there were some indications of European18
dissatisfaction with the redesigned benefit. In the meantime, the ability of GATT
to maintain compliance with its own rules was increasingly being criticized.
Subsidies in general and the DISC controversy in particular were cited as problem
areas.19 The outlines of what was to become the World Trade Organization were
developed during GATT’s Uruguay Round of trade negotiations during the early
1990s. GATT was supplanted by the WTO on January 1, 1995. In general, the WTO
continued the principles of GATT: reduction of trade barriers and non-
discrimination in trade practices. However, in contrast to GATT, the WTO was a
formally constituted organization rather than just an agreement. Also, its underlying
agreements included a strengthened dispute-settlement process contained in its
Dispute Settlement Understanding, or DSU. Further, a new Subsidies and
Countervailing Measures (SCM) agreement was negotiated during the Uruguay
Round and subsumed in the WTO agreements; the SCM clarified the definition of
16 Note that domestic corporations are permitted to deduct some or all of dividends received
from other domestic corporations, as a means of preventing multiple layers of corporate-
level tax. In general, however, dividends received from foreign corporations are not eligible
for the dividends-received deduction.
17 CRS Report RL30684, The Foreign Sales Corporation (FSC) Tax Benefit for Exporting:
WTO Issue and an Economic Analysis, by David L. Brumbaugh, p. 5.
18 The EC expressed doubts about FSC’s GATT-legality even before the new benefit was
adopted, and held consultations (outside the GATT settlement process) with the United
States in 1985. During the early 1990s, representatives of the European aerospace industry
complained that FSC gave U.S. aircraft exports an unfair advantage. For complaints of
Airbus Industrie, see Journal of Commerce, Sept. 9, 1992, p. 1A.
19 Jackson, “The Jurisprudence of International Trade,” pp. 747-781.
20 George Kleinfeld and David Kaye, “Red Light, Green Light?: The 1994 Agreement on
The WTO’s dispute settlement process generally followed the same procedures
that had grown up under GATT, but with the addition of a standing Appellate Body
to hear appeals of panel decisions. An important strengthening of the process under
the WTO, however, is this: under GATT, a consensus was required for decisions,
meaning, for example, that the “loser” of a panel decision could, in effect, veto the
report. Under the WTO, however, consensus is required for a decision not to be
approved at each stage in the process, thus, for example, requiring the “loser” of a
case to persuade the “winner” to overturn a panel decision.21
The hiatus in the dispute ended on November 18, 1997, when what had become
the European Union (EU) took the first step in the WTO’s dispute settlement process
by formally requesting consultations with the United States over FSC.22 The
consultations failed to produce a solution, and in July, 1998, the EU requested the
establishment of a dispute settlement panel, which the WTO formed in September.
The heart of the EU’s complaint was that FSC violated Article 3.1(a) of the
SCM Agreement, which prohibits provision of subsidies that are “contingent on
export performance.” Article 1.1, in turn, defines subsidies as a “financial
contribution” by a government where “government revenue that is otherwise due is
foregone or not collected.” In general, the EU argued that the FSC rules provided
special tax exemptions where export income would otherwise be taxed, for example,
under Subpart F or as income from the conduct of a U.S. business. The EU also
argued that FSC’s administrative pricing rules constituted an export subsidy.
The United States, in turn, argued that territorial taxation was WTO-legal and
that FSC was analogous to territorial taxation. More specifically, the United States
maintained that the 1981 GATT Understanding together with the SCM Agreement
provided that countries need not tax income from “foreign economic processes,”
which established the acceptability of territorial taxation.23 The United States then
argued that FSC’s various foreign economic presence and management requirements
Subsidies and Countervailing Measures, Research and Development Assistance, and U.S.
Policy,” Journal of World Trade Law, vol. 28, Dec. 1994, p. 43.
21 For an explanation of the WTO dispute settlement procedures, see CRS Report RS20088,
Dispute Settlement in the World Trade Organization: An Overview, by Jeanne J. Grimmett.
See also: Gilbert R. Winham, “World Trade Organisation: Institution-Building in the
Multilateral Trade System,” World Economy, vol. 21, May 1998, p. 351-352. Winham
interprets the differing consensus requirements between the WTO and GATT in terms of
national sovereignty, with GATT’s consensus requirement being consistent with sovereignty
and the WTO’s “reverse consensus” placing constraints on unilateral action.
22 In 1993, the EC was subsumed into the European Union. Although the complaint was
technically filed by the EC as a component of the EU, this report nonetheless uses the term
EU in describing events in 1993 and after.
23 The relevant part of the SCM Agreement is contained in the Agreement’s Annex I, which
presents an illustrative list of practices that do and do not constitute export subsidies.
Paragraph (e) of Annex I generally provides that exemption, remission, or deferral of direct
taxes on exports are export subsidies. Footnote 59 qualifies the paragraph by allowing that
countries need not tax income from foreign economic processes.
linked the tax benefit to foreign economic processes. The United States further
maintained that the SCM Agreement gives countries considerable latitude in setting
required intra-firm pricing methods, and FSC’s administrative pricing rules merely
identified the portion of income attributable to foreign economic processes.
The WTO panel issued its report on October 8, 1999. In general, the report
concluded that FSC was indeed a “subsidy contingent on exporting,” and so violated
the SCM Agreement. In reaching its conclusion, the panel rejected the U.S. analogy
between FSC and territorial taxation. Although the panel accepted that countries
need not tax income from foreign economic processes, whether a provision forgives
taxes “otherwise due” — and thus whether a subsidy exists — depends on how the
provision in question compares to a country’s own general method of taxation. In the
we consider that the United States has made an unwarranted leap of logic from
the proposition that “income arising from foreign economic processes may be
exempted from direct taxes” to the proposition that “if countries are under no
obligation to tax income from foreign economic processes, then they should be24
free to exempt all such income or just part of it” (emphasis added).
In short, because FSC carved out an exception from the way the United States
normally taxed exports, it was, the panel concluded, an export subsidy.
The United States appealed the panel’s decision almost immediately, generally
arguing again that the WTO rules hold that a country need not tax income from
foreign economic processes and that FSC was therefore permissible. However, on
February 22, 2000, the WTO Appellate Body concluded that, having decided to tax
foreign source income in general, the United States provided a subsidy by carving out
an exception to that treatment, thus again rejecting the analogy between FSC and
The Extraterritorial Income Benefit
As described above, the advent of flexible exchange rates called into question
the ability of export benefits such as FSC and DISC to reduce the U.S. trade deficit.
Nonetheless, many in the United States believed that the decision against FSC
confronted the United States with a dilemma: achieve WTO-legality or maintain the
“competitiveness” of U.S. exports. Some prominent U.S. policymakers, including
then-Chairman of the House Ways and Means Committee Bill Archer, suggested the
dilemma could be solved by adopting relatively broad tax reforms rather than making
small adjustments in the benefit’s design. For example, some suggested the United
States adopt a form of consumption tax, thus foregoing taxation of business profits
altogether; another suggested alternative was adopting a pure territorial tax system
24 World Trade Organization, United States — Tax Treatment for Foreign Sales
Corporations, Report of the Appellate Body, Feb. 24, 2000, AB-1999-9 p. 273.
25 World Trade Organization, United States — Tax Treatment for ‘Foreign Sales
Corporations,’ p. 59.
as maintained by several European countries and apparently countenanced under
The Clinton Administration, however, did not rule out the possibility of a
narrower approach: finding a reformulation of just the FSC benefit that would
nonetheless be WTO-compatible. In April 2000, the United States informed the
WTO that it would comply with the panels’ rulings, but would do so in a way that
would ensure that “U.S. exports are not disadvantaged in relation to their foreign
counterparts.”27 In May, the United States briefed EU representatives on a planned
replacement for FSC. The plan contained the basics of what were later enacted as the
ETI provisions. The general approach it took was to attempt WTO-legality by
extending the tax benefit beyond exports to income from foreign operations, thus
attempting to provide a tax benefit that included exports but that was not “export
contingent,” as prohibited by the SCM Agreement.28 However, after examining the
plan EU representatives stated their belief that it, too, was not WTO-compliant
because its benefit was still export-contingent. EU officials indicated that the
measure, if enacted, would be challenged under WTO rules.29
Notwithstanding the EU’s objections, Congress passed the ETI provisions in
November 2000, and President Clinton signed them into law on November 15 (P.L.
106-519). In general, the ETI provisions begin by exempting what they term
“extraterritorial income” from U.S. tax, but continue by defining “extraterritorial
income” and a chain of other concepts in a way that confines the exemption to a
firm’s U.S. exports and, at most, a matching amount of income from foreign
operations. The initial link in the chain of definitions is “qualifying foreign trade
property,” which is generally products manufactured, produced, grown, or extracted
within or outside the United States. Unlike the parallel FSC concept of export
property, qualifying foreign trade property can be partly manufactured outside the
United States. However, not more than 50% of the value of qualified property can
be added outside the United States.
The next link in the chain is “foreign trading gross receipts,” which the
provisions define as income from the sale or lease of qualifying foreign trade
26 Ryan J. Donmoyer, “Legislative Fix for FSCs Needed ‘This Year or Soon,’ Archer Says,”
Tax Notes, March 13, 2000, p. 1524.
27 U.S. Ambassador to the World Trade Organization Rita Hayes, as quoted in BNA Daily
Tax Report, April 10, 2000, p. G-1.
28 Joe Kirwin, et al., “U.S. Outlines FSC Fix to Europeans, Offers Elective Regime for
Foreign Sales,” BNA Daily Tax Report, May 3, 2000, p. GG-1.
29 Joe Kirwin and Daniel Pruzin, “Europeans, U.S. Officials to Face Off Following EU
Rejection of FSC Proposal,” BNA Daily Tax Report, May 31, 2000, p. GG-1. The United
States and the EU, however, worked out a procedural agreement under which the EU would
not ask the WTO for permission to impose sanctions related to FSC until the WTO had ruled
on the compatibility of FSC’s replacement with WTO rules. Further, the EU agreed to
relax an October 1, 2000, deadline for the United States to comply with WTO rules that
would otherwise have applied under normal WTO procedures. Joe Kirwin et al., “U.S., EU
Reach Procedural Pact in FSC Case; U.S. Loss Could Still Lead to Huge Sanctions,” BNA
Daily Tax Report, Oct. 3, 2000, p. G-7.
property, and which parallels the FSC concept of gross receipts. As with FSC, a firm
would only be treated as earning foreign trading gross receipts if it conducts
economic processes abroad. However, FSC’s foreign management requirements
would be dropped.
The provisions next define “foreign trade income” as taxable income
attributable to foreign trading gross receipts. The provisions term a specified part of
this foreign trade income “qualifying foreign trade income,” and grant such income
a tax exemption. The bill sets qualifying foreign trade income (and thus the
exclusion) equal to either 1.2% of foreign trading gross receipts, 15% of foreign
trade income, or 30% of the income attributable to the foreign economic processes
undertaken under the foreign trading gross receipts requirements. (The rule
exempting 30% of income is similar in its effect to the FSC rule that applies to firms
that use arm’s-length pricing.) As with FSC and the May 2000 proposal before it, the
arithmetic result of these rules is that a firm can exempt somewhere between 15%
and 30% of qualified income from U.S. tax.30
As noted above, in contrast to FSC, the ETI provisions do not require a firm to
sell its exports through a foreign-chartered corporation to qualify for the benefit.
Since a U.S. corporation could qualify for the exemption directly, the special
dividends-received deduction language in the FSC provisions is not necessary. The
provisions also contain language providing that a foreign corporation that uses the
benefit can elect to be taxed like a U.S. corporation. This mechanism rules out the
possible application of Subpart F, which applies only to income earned by firms that
are foreign corporations, for tax purposes.
On November 17, 2000, the EU formally requested consultations with the
United States over the ETI provisions. The consultations failed, and on December
7, the EU requested that the WTO establish a panel to determine ETI’s legality. The
panel was appointed on December 20, and issued its report on August 20, 2001.
In defending ETI, the United States first argued that the provision addressed the
previous (FSC) panel’s finding that FSC created an exception to the general U.S. tax
practice and was thus a subsidy. The United States argued that ETI was broader, and
revised the general U.S. method of taxing overseas income because the provisions
could be applied to income from foreign operations as well as exports. Thus,
according to the U.S. argument, ETI is neither an exception to the general U.S.
practice (and is therefore not a subsidy) nor contingent on exporting. A second U.S.
argument held that, even if ETI were an export subsidy, it is a means of alleviating
double taxation of foreign income and is therefore permissible under WTO rules by
virtue of language contained in footnote 59 of the SCM Agreement.
But the WTO panel ruled against the United States, finding that the ETI
provisions imposed enough special conditions on their use that they were an
30 A firm can always choose to exempt 15% of income from tax. Alternatively, if its return
on sales is sufficiently high, it could use the gross receipts method to exempt up to twice that
amount from tax. The range of exemption, in other words, is 15%-30%.
exception to the general U.S. tax practice, and was therefore a subsidy.31 The panel
also concluded that the subsidy was “contingent on export performance.” According
to the panel, the fact that the benefit could apply to exports made the benefit export
contingent despite the fact that the benefit could also apply to income from foreign
operations (i.e., non-export income).32 Finally, the panel rejected the U.S. argument
that ETI was intended to avoid double-taxation, concluding that the scope of the
benefit was considerably broader than the type of income that would ordinarily be at
risk of double-taxation.33 (For example, nations do not usually include foreigners’
income from home-country exports within their own tax base.)
On October 10, 2001, the United States announced it would appeal the panel’s
decision on ETI, asking the WTO Appellate Body to reverse the panel’s findings that
ETI is a subsidy, that the subsidy is contingent on exporting, and that it is not a
measure to alleviate double taxation. However, on January 14, 2002, the Appellate
Body issued a report upholding the panel’s ruling on each of the three main
arguments advanced by the United States.34
WTO procedures permit a complaining country (in this case, the EU) to ask the
WTO for permission to impose sanctions if the non-compliant country (in this case,
the United States) does not take action to come into compliance. WTO procedures
also permit the level of sanctions to be arbitrated at the defending county’s request.
In the case of ETI, the EU asked the WTO to authorize imposition of $4.043 billion
in sanctions on its imports from the United States, an amount based on the EU’s
estimate of the full value of the U.S. subsidy to all countries. The United States, in
turn, argued before WTO arbitrators that the authorized tariffs should be only $956
million, based on the United States’ estimate of the impact of the U.S. export benefit35
on European producers alone. On August 30, 2002, WTO arbitrators ruled that the
EU could impose the full $4.043 billion it requested.36
Following the Appellate Body’s decision, the U.S. Congress again began active
consideration of the export benefits. The House Committee on Ways and Means held
31 World Trade Organization, United States — Tax Treatment for “Foreign Sales
Corporations”: Report of the Panel, WT/DS108/RW, Aug. 20, 2001, p. 23.
32 Ibid., p. 32.
33 Ibid., p. 43.
34 The Appellate Body’s report was published as World Trade Organization, United States
— Tax Treatment for “Foreign Sales Corporations”: Report of the Appellate Body,
WT/DS108/AB/RW, Jan. 14, 2002, p. 79.
35 For a description of the disagreement over retaliatory measures, see Daniel Pruzinand
Myrna Zelaya-Quesada, “Punitive Damages in FSC/ETI Dispute Should Not Exceed $1
Billion, U.S. Says,” BNA Daily Tax Report, Feb. 15, 2002, pp. G-1 - G-2.
36 Alison Bennett et al., “WTO Gives EU Green Light for $4 Billion in Sanctions Against
United States over FSCs,” BNA Daily Tax Report, Sept. 3, 2002, p. GG-1.
a series of hearings, designed, according to Committee Chairman William Thomas,
to “carefully and thoroughly address the problems created at the intersection of our
Tax Code, and our international trade obligations.”37 The chairman also voiced
skepticism about the merits of additional efforts to redesign the tax benefit as had
been done with FSC and ETI, stating: “Our corporate tax structure is in need of major
restructuring, not another attempt at a short-term fix. More fundamental reform is
required.”38 During the hearings, Administration officials also expressed the view
that mere redesigns of the ETI provisions would likely not be a workable solution,
but expressed their intention to work closely with Congress to find a solution.39 For
its part, the EU indicated its willingness to postpone applying sanctions to U.S. goods
as long as it perceived that Congress was making progress toward a solution.40
On July 11, 2002, Chairman Thomas introduced H.R. 5095, a bill that proposed
outright repeal of the ETI provisions rather than their redesign. At the same time, the
bill proposed a broad range of tax cuts for U.S. firms operating abroad, reductions
designed to improve the competitiveness of U.S. firms in international markets. The
tax cuts included changes in foreign tax credit rules and in Subpart F. In addition,
the bill contained revenue-raising provisions designed to restrict “earnings stripping”
and corporate “inversions,” the former being the artificial shifting of U.S.-source
income from U.S. subsidiary corporations to foreign parents and the latter, a tax-
motivated corporate reorganization whereby U.S. corporations would reincorporate
in a foreign country.
H.R. 5095 encountered criticism from several sources. Business groups such
as the National Foreign Trade Council argued that the tax cuts in the bill did not
make up for repeal of the ETI provisions. Congressional Democrats and several
Republicans argued that the bill penalized firms that manufacture in the United States
while benefitting those operating abroad. In the 108th Congress, Representatives
Crane and Rangel introduced H.R. 1769, a bill that would phase out ETI while
phasing-in a special tax deduction linked with income from domestic (but not
foreign) production activities. Senator Hollings subsequently introduced S. 970, an
identical bill. On July 25, 2003, Chairman Thomas introduced H.R. 2896, consisting
of provisions similar to those contained in H.R. 5095, his bill in the 107th Congress,
but with the addition of several substantial tax benefits for domestic investment; the
bill thus contains a mix of tax incentives for domestic and foreign investment. In the
Senate, Senator Hatch introduced S. 1475, containing a somewhat different mix of
37 Statement at the hearings of the Committee on Ways and Means, Feb. 27, 2002. Available
on the committee’s website at [http://waysandmeans.house.gov/hearings.asp?formmode=
39 See, for example, the statement by the U.S. Treasury Department’s International Tax
Counsel Barbara Angus: “We do think that significant change in the system would be
necessary and that legislation that simply replicates the FSC or ETI provisions would be
unlikely to pass muster.” In U.S. Congress, House Committee on Ways and Means, hearing,thnd
107 Cong., 2 sess., Feb. 27, 2002. Available on the Committee’s website at
[http://waysandmeans.house.gov/ hearings .asp?formmode=archive&hearing=42].
40 Alison Bennett, “EU Satisfied with Export Regime Progress, But Pressing for Swift
Action, Lamy Says,” BNA Daily Tax Report, June 24, 2002, p. G-9.
benefits for foreign and domestic investment.41 On October 1, the Senate Finance
Committee approved S. 1637 (Senators Grassley and Baucus), which would also
replace ETI with a mix of investment incentives both for domestic and overseas
investment. On October 28, the House Ways and Means Committee approved a
modified version of H.R. 2896. Several other bills were introduced in the Senate
that, like the Crane/Rangel/Hollings bill, would repeal ETI and implement a tax
benefit restricted to domestic investment. These bills included S. 1688 (Senator
Rockefeller), S. 1922 (Senators Smith and Breaux), and S. 1964 (Senators Stabenow
In the meantime, the EU moved towards adoption of a deadline for U.S.
compliance. In May 2003, EU officials stated that the EU would review the situation
in the fall of 2003 and, if necessary, begin procedures that would impose tariffs by
January 1, 2004. In November, EU officials stated that if compliance was not
achieved by March 1, 2004, the EU would begin a phase in of retaliatory tariffs.42
ETI legislation had not been enacted by March, and the EU began to phase in its
tariffs on March 1.
In the United States, some suggested that an alternative approach to the ETI
dispute might be negotiations, possibly coupled with some manner of tax law change.
At the opening of hearings conducted by the Senate Finance Committee on July 30,
624) on the 2002 Trade Promotion Authority bill (H.R. 3009; P.L. 107-210) directed
U.S. negotiators to address the disparate treatment of border tax adjustments under
the WTO, which permits the rebate of indirect taxes (such as the value-added taxes
imposed by EU countries) but not income tax exemptions for exports, as with the
ETI.43 Also, an op-ed article in the Financial Times on September 16 by Ways and
Means Committee ranking minority member Charles Rangel and Republican
committee member Philip Crane voiced a similar view, that the goal of WTO
compliance “can be accomplished through changes in our tax law and/or changes to
trade rules negotiated within the new round of negotiations that was launched in
Doha, Qatar.”44 In response, however, U.S. Trade Representative Robert Zoellick
stated that “if the EU determines that [negotiation] is the course Congress has chosen,
we are likely to trigger earlier trade retaliation against U.S. exporters.”45
41 For a description and analysis of the bills in the 108th Congress, see CRS Report RL32066,
Taxes, Exports, and International Investment: Proposals in the 108th Congress, by David
42 Joe Kirwin, “EU Sets March 1 Deadline for ETI Repeal, Details Plan to Phase in
Sanctions Otherwise,” BNA Daily Tax Report, Nov. 6, 2003, p. GG-1.
43 Statement of Chairman Max Baucus in U.S. Congress, Senate, Committee on Finance,
hearing, 107th Cong., 2nd sess., July 30, 2002, on the role of the extraterritorial income
exclusion act in the international competitiveness of U.S. companies. Available on the
Committee’s website at [http://finance.senate.gov/hearings/statements/073002mb.pdf].
44 Financial Times (London), Sept. 16, 2002, p. 23.
45 Letter by U.S. Trade Representative Robert B. Zoellick to Representative Philip M. Crane,
dated Sept. 23, 2002. Reprinted in BNA TaxCore, Sept. 23, 2002.
In Congress, legislation to repeal ETI gradually gained momentum in 2004. The
Ways and Means Committee bill was not taken up by the full House during the first
months of 2004, but the Senate began floor consideration of the Finance Committee
bill in March. The bill initially encountered difficulties, with opponents objecting to
those portions of the bill’s tax cuts accruing to foreign-source income. On May 11,
however, the Senate approved a slightly modified version of the Finance Committee
bill, after rejecting amendments that would have removed the bill’s international
In the House, Chairman Thomas in June introduced a somewhat modified
version of his earlier bills as H.R. 4520. The new bill had the same general thrust as
S. 1637 and H.R. 2896 before it; it proposed to repeal ETI while enacting a mix of
domestic and international benefits while offsetting part of the cost with assorted
revenue-raising provisions. Prominent among H.R. 4520’s differences from the
earlier Thomas bills were the addition of an optional individual income tax deduction
for state sales taxes and a tobacco “buyout” provision which would compensate
tobacco growers for the end of federal price-support and quotas. On July 15, the
Senate approved a version of H.R. 4520, amended to include the tax provisions of its
earlier bill (S. 1637) and its own tobacco buyout provision. On October 7, the House
approved a conference agreement on the bill, and the full Senate approved the
measure on October 11. The President signed the bill on October 22, and it became
law (P.L. 108-357).
The EU Response
By October, 2004, the EU’s phased-in tariffs had reached 12% (a five percent
initial rate in March, followed by seven monthly one-percentage-point increases).
However, in response to the benefit’s repeal, EU Trade Commissioner Lamy stated
that he would recommend to the EU Council of Ministers that the sanctions be
suspended on January 1, 2005, the beginning date of ETI’s phaseout.
At the same time, however, the EU indicated its intention of lodging a WTO
complaint against the transition provisions of ETI’s repeal. If the complaint is
upheld, re-imposition of part of the tariffs is a possibility. One aspect of the
transition rules is ETI’s phase out over two years. The provisions permit firms to
claim 80% of their otherwise applicable ETI benefit in 2006 and 60% in 2007 before
ending in 2008.
However, EU officials are apparently more concerned about a second transition
provision, which “grandfathers” existing contracts. Under the provision, the full ETI
benefit applies to exports made under contracts entered into before September 17,
2003. EU officials have argued that the “grandfather” provisions favor producers of
large capital goods that have long delivery times and would favor large U.S.
exporters such as Boeing, Microsoft, Intel, Motorola, and Caterpillar.46 Some U.S.
46 Joe Kirwin, et al. “Extraterritorial Income: EU to End Sanctions in Wake of Export Bill
But Plans Appeal of Grandfather Provisions,” BNA Daily Tax Report, Oct. 26, 2004, p. G-1.
observers have suggested that the EU appeal is linked to a separate WTO complaint
lodged by the United States against Airbus.47
On November 5, the EU announced it had taken the first step in the WTO
process by requesting consultations with the United States over the transition
provisions. In August 2005, a WTO panel supported the EU’s complaint, and the
EU announced it would resume the phase in of its tariffs if the United States had not
fully repealed ETI by mid-May 2006. On May 9, Congress repealed the ETI
transition rules as part of the Tax Increase Prevention and Reconciliation Act (P.L.
47 Alison Bennett, “Extraterritorial Income: Transition, Grandfather Relief in Export Bill
Reasonable, Finance Democratic Memo Says,” BNA Daily Tax Report, Oct. 27, 2004, p.