Walking the tightrope in US tax dispute

Date: 21/09/00

Handling the transatlantic trade dispute over the US system of tax breaks for exporting firms is like trying to defuse a ticking bomb.

If Trade Commissioner Pascal Lamy and US Deputy Treasury Secretary Stuart Eizenstat make one wrong move, the whole thing could blow up in their faces.

Ever since the World Trade Organisation ruled earlier this year that the US system of foreign sales corporations (FSCs) - which saves companies such as Boeing, General Electric and Motorola around 5 billion euro a year in taxes - was an illegal subsidy, the two sides have been squaring up for a trade battle which will make all previous rows seem like arguments between two neighbours over a backyard fence.

It is not only that the value of the tax breaks dwarf those affected by any of the other trade rows over issues such as bananas and beef. If it is badly handled, the dispute could also seriously undermine the WTO's role as an multilateral body for settling market disagreements and set the US Congress off down the road towards unilateralism - something the Union fears deeply.

If the EU does decide to impose penalty duties on billions of euro worth of US exports or is seen to be trying to dictate tax policy to American legislators at election time, tit-for-tat trade retaliation could quickly escalate out of control.

Washington has already threatened to attack Dutch and French tax regimes systems if it loses the fight. Many also believe that the chances of getting a new world trade round off the ground - a key EU aim - would be next to zero. "It would be difficult for a new US administration to face this. It would lead to a new era of strained bilateral relations which would have a serious impact on the new WTO round," said one US corporate lawyer following the case closely.

It is this danger which has almost certainly prompted the EU to moderate its tactics and language in the dispute, with the European Commission exploring the possibility of preparing sanctions against the US over the FSC regime but then agreeing to suspend them immediately.

This has reinforced the impression that the Union is trying to walk a fine line, working to ensure that the WTO verdict kills off the tax breaks created by the FSC without provoking the US administration.

Such a conciliatory approach contrasts markedly with Washington's tactics as it prepares to apply 'carousel' sanctions to a new list of EU exports to the US, effectively doubling the harm done to European firms.

The Union has already challenged Washington's move, arguing it goes beyond the 350 million euro in sanctions which the WTO approved as punishment for the EU's failure to reform its banana import rules and lift its ban on imports of hormone-treated beef.

Even though US President Bill Clinton signed the sanctions bill into law in May, the administration has still not published its long-awaited list of which Union exports will be hit by the second round of penalties. Threats to include Scottish cashmere have been widely interpreted as an attempt to increase pressure on the UK to find a solution to the disputes - particularly that over bananas, where London plays a pivotal role because of its ties to Caribbean countries.

But it is difficult to see what can be done to prevent the FSC row coming to a head. "No one wants an all-out trade war over this, but it is very unclear how we are going to avoid just that," said one US corporate lawyer.

On the one hand, the EU feels compelled to raise the stakes in the dispute at the worst possible time, just before the US presidential elections on 7 November.

The Union insists that it has no option but to ask the dispute settlement body in Geneva for permission to introduce sanctions within 30 days of the 1 October deadline for the US to comply with the WTO ruling. If it does not, say officials, it would not be able to impose penalties at a later date if the revised FSC regime now making its way through Congress is eventually judged illegal under WTO rules.

The Union bases its argument on a precedent established by Washington in the banana dispute, when the US started the ball rolling on penalty duties before the WTO delivered its verdict on whether the EU's reformed regime was legal or not. As the Com-mission's head of trade policy Peter Carl said this week: "It is a case of your sins coming back to haunt you."

While Union governments agree that they need to start moves to win the right to impose sanctions, they are divided over how far the EU needs to go, with the UK and other member states arguing that WTO law does not require the Union to draw up a hit list of US exports.

This is where the option of applying to use the sanctions but then agreeing to suspend them pending the outcome of another ruling from Geneva comes in.

It would have the advantage of defusing the transatlantic tensions which would inevitably result from the Union asking for sanctions ahead of the closest presidential election race in years.

The only problem is finding a magic formula which will satisfy both sides. Industry representatives have confirmed that the US has been pushing for a deal under which there would be a trade-off between the tax rules and the carousel sanctions, which the Clinton administration has never liked. But US sources say Lamy has flatly ruled out a deal along these lines, insisting that each case should be judged on its merits. The Commissioner's tough stance may have prompted Eizenstat's remark last week that "negotiation rather than confrontation is the better way forward".

Unfortunately, the one issue on which the two sides cannot agree to disagree is how far the US needs to revise its FSC regime to bring it into line with WTO rules.

The Union argues that even 'Eizenstat II' - the deputy treasury secretary's second attempt at changing the legislation - would still give US firms an illegal export subsidy. "It is a wolf in sheep's clothing but it's still a wolf," insists Carl.

But Washington is adamant that the EU is demanding changes to the legislation which go beyond the scope of the WTO ruling. US officials maintain that the Union's objections to the initial and subsequent versions of the FSC rules hinge on two questions upon which the WTO did not pronounce: definitions of administrative pricing and domestic content.

The first is designed to prevent a multinational from using accountancy tricks to lower the tax charge on exports by reducing the cost of a product with 'cross-subsidies' from another part of its operations. The second relates to how much of a product intended for export - such as a pair of Levi jeans designed in the US but manufactured in China - is genuinely American and therefore eligible for tax breaks under the rules.

Washington argues that implementing the changes suggested by the Union would mean a fundamental shift in the US taxation system. This is the crux of the dispute. Even if the current US administration wanted to revise the system in the way the Europeans are demanding, it could hardly ask Congress to allow American tax policy to be dictated by a foreign power, even a friendly one.

Of course, if the US's interpretation of the WTO ruling is correct, the reconvened panel would let the administration off the hook by decreeing that the changes demanded by the EU go beyond the terms of its original complaint. But if the Union is right, it is hard to see how either side can prevent this dispute from spiralling into the all-out trade war which everyone fears.

Major analytical feature. Europe and the United States are struggling to prevent the argument over foreign sales corporations erupting into an all-out trade war.