US Congress Promotes Anti-EU Tax Legislation

by Mike Godfrey, Tax-News.com, Washington

01 July 2002

In a move linked to the twin long-running Foreign Sales Corporation and Corporate Expatriation sagas, Bill Thomas, Chairman of the US House of Representatives Ways and Means Committee, is introducing a bill which would impose additional taxes on foreign-owned companies with US subsidiaries.

Mr Thomas says that his bill, the American Competitiveness Act of 2002, improves the incentive to a company to stay in the United States and reduces incentives to incorporate overseas. Specifically, the bill:

• Cracks down on earnings stripping arrangements, which allow US subsidiaries to deduct from their US taxable income most interest payments to a foreign parent, thus making US companies less attractive targets for foreign takeovers and shutting down a primary incentive for US companies to move overseas;
• Ensures that companies pay a tax when they transfer assets overseas; and
• Equalizes the treatment of corporate insiders (officers and directors) and common shareholders by imposing an excise tax on the stock options and stock based compensation held by corporate insiders at the time of an inversion.
  

It's estimated that the bill would increase taxes on foreign companies by up to $50bn over 10 years. This compares (and it's probably no coincidence) with the $4bn annual cost of the tax benefits which are given to the export subsidiaries of US corporations (known as foreign sales corporations) and which have been struck down by successive WTO rulings at the EU's behest.

The original Foreign Sales Corporation legislation was replaced last year with a broader scheme known as the Extraterritorial Income (ETI) regime, but this in turn was outlawed by the WTO. The EU is preparing a raft of punitive trade sanctions which will come into effect if the scheme is not replaced. European companies, which are the largest foreign investors in the US, are the primary targets of the new Thomas bill.

Says Mr Thomas: 'The current Extraterritorial Income (ETI) regime was designed to level the playing field between US companies and their foreign competitors. Both ETI and its predecessor, the Foreign Sales Corporation (FSC), have been repeatedly ruled to be “export subsidies” that violate our treaty obligations. If we repeal ETI, US businesses will be placed at an even greater competitive disadvantage relative to their foreign competitors. If we don’t repeal ETI, US companies may be hit with billions of dollars of retaliatory trade sanctions. An arbitration panel will set the level of authorized trade sanctions in July.

Mr Thomas says that, while he does not want to discourage foreign companies from investing in the US, "we just don't want them coming into this country with an advantage over US-owned companies".

In addition to raising taxes on foreign companies, the plan offers an array of tax breaks to US companies to offset loss of the FSC scheme. These include an end to rules that force some to pay taxes on overseas earnings before profits are repatriated to the US, and more favourable allocation of interest expenses.

The new bill is intended to provide a comprehensive solution to the acknowledged problems of the corporate tax code, but it's hard to see how it can be interpreted by the EU as anything other than a deliberate response to the threat of trade sanctions. Thus it is not a constructive solution to the problem, but merely another step in the bargaining process. It also has to be remembered that with Congressional elections approaching, domestic political considerations rank higher than exterior squabbles.

When US and EU leaders met in Washington for high-level talks in May, President Bush said his administration would begin overhauling the tax breaks for US exporters, and a senior EU official said later: "This is clearly a strong signal by the president that he is stepping into the compliance process; there is a commitment to establish a roadmap." But Congressional leaders warned Pascal Lamy, the EU's Trade Commissioner, that any change to US tax laws to comply with the WTO ruling would require a long legislative process that would carry well into next year. Bill Thomas said then that he was developing a list of options and planning further hearings on alternative approaches. "There are many, many options because there is no easy fix," said one of his assistants.

Expect a negative reaction from Pascal Lamy to Friday's announcement. Or will the EU be patient until elections are over?

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