DSB adopts FSC ruling, US says it will comply

A WTO dispute settlement decision which found a US law to be in violation of the trade body’s subsidy rules has been adopted by the membership, amid reports that the US may strike a deal which could keep intact the offending legislation.

by Chakravarthi Raghavan

GENEVA: The WTO’s Dispute Settlement Body (DSB) on 29 January adopted the ruling of its panel, as modified by the Appellate Body, on US compliance with a previous ruling about its Foreign Sales Corporation Act, found to provide prohibited export subsidies, with the US announcing that it was working with the EC to resolve the issue in a responsible and non-confrontational manner and that progress was being made.

Some media reports suggest that the US and the EC, the two parties to the dispute, were looking for solutions in terms of “compensation” rather than changing the law. Free-trade ideologue Jagdish Bhagwati, in an op-ed article in the Financial Times (29 January 2002), while endorsing the ruling and the principles behind it and chiding US critics, has also advocated the compensation route.

The EC Trade Commissioner Pascal Lamy and the US Trade Representative Robert Zoellick have reportedly had talks in Washington on this, among other subjects, but it is not clear what kind of a deal or compensation the two might seek or accept.

However, though it was the EC which brought the case against the US and has chalked up a huge trade damage claim, other countries which had intervened in the panel processes said the US law affected them too, in terms of both subsidized US exports to their markets (including agricultural products) and unfair competition in third markets.

In an intervention, India, which had been a third-party intervenor in the dispute, told the DSB that the issues raised by it and the ruling had an impact on all Members and not just the US and the EC.

“Given the pervasive nature of the measure, which has been found to be inconsistent with the WTO covered agreements, and its adverse effect on all trading partners, the only way the DSB rulings in this case could be given effect to by the US is through removal of the subsidies found to be inconsistent with their (US) obligations under the WTO,” India added in an intervention the text of which was made available to the media.

Illegal subsidy

The Appellate Body ruling said that countries are free to choose their own tax systems, including on double-taxation issues and the use of tax exemptions to deal with double taxation, and these are protected in terms of prohibited subsidies and the qualifications in footnote 59 in the Subsidies and Countervailing Measures (SCM) Agreement, but provided that the tax methods they choose do not conflict with the WTO obligations. The AB also agreed that in choosing the method and in deciding on the foreign income to be exempt to avoid double taxation, a country’s tax system and the exemption need not exactly reflect the tax paid or payable in the foreign jurisdiction.

Nevertheless, the AB found that the three alternative (rule of thumb) methods provided in the US law to calculate the foreign source income to be exempt (methods that can be chosen by the taxpayer) would enable both domestic source and foreign source income to be exempt if the goods and services were used abroad, and thus constituted a prohibited subsidy not justified in terms of footnote 59.

The US in its intervention found fault with the AB ruling that while the tax exclusion for foreign source income could qualify to be covered by the footnote (enabling measures that a country could take to exempt double taxation), the specific exclusions did not qualify (in relation to the ‘foreign source’ income, as defined by the US law) “primarily because it (the AB) found that the Act’s arithmetic formulas (the ‘rule of thumb’) may permit exemption for some domestic source income.”

Complained the US, “This leaves us with several important questions unanswered. First, the status of ‘rules of thumb’ (set in the law for the revenue authorities/taxpayers to determine tax-exempt foreign source income). Certain portions of the AB report could be interpreted as precluding the ‘rules of thumb’ altogether. If so, tax authorities around the world would be shocked by such a proposition. Rules of thumb have a legitimate place in the administration of tax laws of many countries, as well as other types of laws, and WTO bodies should think twice before imposing an undue level of administrative precision.

“On the other hand,” concluded the US, “different portions of the AB report suggest that ‘rules of thumb’ may be acceptable as long as they generate results within some acceptable range. While this is a more reasonable approach, the AB provided no guidance as to what might be considered an acceptable range, or what standards should be used to identify one. This lack of guidance makes it difficult for Members to avail themselves of the right provided in footnote 59.”

In its intervention, the EC said that contrary to the US claims, the panel and the AB have given clear indications as to the legal issues raised by the US legislation, and “there is absolutely no more room for further requests for clarification and guidance.” They were asked to rule on the WTO compatibility of the US law and have done so in a precise, comprehensive and legally sound manner. The AB has not reversed any of the panel’s findings nor criticized the panel’s reasoning. It has fully confirmed them or has developed a new reasoning in view of the extra arguments brought by the US. “The EC expects that these rulings will put a definite end to this long-lasting dispute between the two parties.”

The EC announced that in the light of the rulings and adoption, and in terms of the US-EC procedural agreement, the arbitration proceedings to assess the amount of countermeasures and suspension of concessions requested by the EC would be “automatically reactivated today.”

In its statement, India noted that the Indian position before the panel and the AB found that the “extraterritorial income” (ETI) measure set in the FSC Replacement Act was not a compliance measure; that the restrictive conditions set in that law for calculating ETI led to the same subsidy, foregone revenue which was “otherwise due” in terms of the SCM Agreement. The AB had also found that extending the subsidy to both exporting and non-exporting firms would not absolve the ETI measure of the element of prohibited export subsidy. And while avoiding double taxation in terms of footnote 59 was legitimate, the link between the measure at issue and avoiding double taxation had to be clearly established by the US.

The ruling was a salutary decision with a “far-reaching effect on the global trading environment”, said India. The dispute and ruling had brought out that “the trade majors have continued to use the prohibited measures to promote their trade while at the same time penalizing through CVD (countervailing duty) action even the legally permissible subsidies given by developing countries for their legitimate development objectives.”

The dispute, said India, had an impact on all Members, not just the two parties, and given the pervasive nature of the measure found WTO-inconsistent and its  adverse effects on all trading partners, the only way the DSB ruling could be given effect to by the US was through removal of the subsidies found inconsistent with the US obligations. (SUNS5050)