Lessons Learned from DISC/FSC/ETI Disputes: Reshaping the Quest Towards a GATT/WTO Friendly Corporate Tax Reform in the United States

Abstract

The Corporate Tax Policy of the United States has long been considered to be disadvantageous to U.S manufacturers and exporters, who allege that adoption of the world-wide taxation policy has affected their competitiveness. The tax legislative measures introduced by the United States to address this criticism such as the Domestic International Sales Corporations (DISC), Foreign Sales Corporation (FSC) and the Extraterritorial Income Act (ETI), however, have failed the GATT/WTO scrutiny. Although the American Job Creation Act, 2004 has almost resolved the matter between the U.S and EU, the dispute is far from settled. The FSC/ETI disputes were considered as an opportunity to introduce fundamental tax reforms in the U.S. Among the various proposals made so far, the proposal to introduce a progressive consumption type taxation replacing the current corporate income tax has gained significant popularity. Most academic writings suggest that a progressive two-tiered consumption tax such as a destination basis X tax could be treated as a direct tax under the GATT/WTO in view of the wage tax element. But prejudging the WTO legality of destination basis X-tax would not be appropriate on the basis of a pure textual interpretation of a footnote in an Annex in the SCM Agreement, which predated the current treaty provisions. Before classifying a measure as a prohibited illegal subsidy, it needs to be examined whether such tax legislation is based on - neutral or - objective criteria and whether it otherwise meets the definition of subsidy. A broad based and functional interpretation of destination basis X-tax could establish that it is not a trade distorting export subsidy within the meaning of the GATT/WTO. It will be unwise to preempt discussions on this topic assuming its inconsistency with the GATT/WTO.The other proposal is to implement a territorial income tax. Although such a tax scheme is WTO-compatible, if administered under the guidelines provided by the WTO dispute panels, it will face other difficulties such as significant transition problems and interference with a number of 3 bilateral treaties. Again, it is uncertain whether such a tax system could improve the competitiveness of the U.S industry.