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Going Bananas Over the FSC

5 min readBy: J. D. Foster, Ph.D.

Most Americans have never heard of Foreign Sales Corporations (FSC). Even many trade and taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. people had only a general notion about FSCs before the World Trade Organization (WTO) ruled the FSC violated the anti-subsidy provisions of the WTO and the ruling was upheld by an appellate body.

Briefly, the FSC is a device built into the tax code to reduce some of the U.S. corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. burden on U.S. exports. One way to think about the FSC is that it operates as a modest rebate of income tax akin to the Value-Added Tax (VAT) export rebates many of our trading partners enjoy.

Many U.S. trading partners, and particularly many Europeans, have groused for years that the FSC was not really kosher tax policy and probably violated the international trading rules as laid out in the General Agreement on Tariffs and Trade and, subsequently in the WTO. However, the problem was modest enough as the Europeans saw it not to warrant a major trade row. They were also somewhat concerned that if they raised a stink over the FSC, the U.S. might try to put the VAT’s border tax adjustments (BTAs), i.e. its export rebates and import levies, on the table in a future trade round.

What happened? Why did the Europeans suddenly raise the issue? One reason is they got the acceptability of their BTAs codified in the last WTO round, putting them in a very strong defensive position on that score.

But the real reason seems to be all about bananas, with a touch of beef hormone. The U.S. won the last two trade disputes with the Europeans brought before the WTO. These dealt with beef hormones, (the Europeans don’t like them), and bananas, about which the Europeans proved to be quite discriminating. The problem was not that the U.S. won these cases, but that after winning the banana case the U.S. Administration pounded its chest in loud self congratulation like the louts that infest British soccer stadiums. Bad form.

No one likes to be shown up, least of all Sir Leon Brittain, the European Union Trade Commissioner. Sir Leon lost the beef and banana cases and wanted revenge after the Americans behaved so badly. Acting largely on his own initiative, which is supposed to be a no-no in EU circles, Sir Leon launched his challenge against the FSC. Not wanting to appear out of the loop the European governments quickly fell in line in support of the challenge.

For its part, the U.S. thought it had a gentleman’s agreement dating back two decades and re-affirmed during negotiations to create the WTO that the FSC would not be challenged. Apparently no one thought to have the gentleman’s agreement included in the official WTO agreement. Thus, initially, the FSC challenge surprised the U.S. government, and it was stunned when the decision went for the Europeans. Now the U.S. is scrambling to decide what to do to avoid trade sanctions against U.S. exports that could easily run in the tens of billions of dollars.

Interestingly, most Americans involved with the issue quickly decided the Europeans really weren’t all that interested in FSC. Americans presumed the Europeans wanted leverage for something else. Perhaps they wanted the U.S. to give way on beef and bananas. In fact, most people involved were hoping a little horse trading was all the Europeans were after because they did not see a sure-fire way to create a FSC-like device that would pass WTO muster.

The crux of the ruling against the FSC is that it is an export subsidy because a taxpayer only qualifies for the FSC benefit to the extent goods and services sold through an FSC contain U.S. content. In response to the WTO ruling, the U.S. Treasury came up with a very clever solution. The U.S. would allow any U.S.-owned foreign corporation to qualify for the benefit if it made the appropriate election and if it the goods and services contained a sufficient amount of U.S. content. In effect, they expanded the universe of companies that could qualify for the benefit to include those foreign companies that purchased U.S. content-bearing goods abroad and resold them, possibly after some additional processing.

The Europeans said publicly they were quite surprised the Yanks came up with a proposal so quickly. In other words, they thought the U.S. was boxed in with nowhere to go. Deputy Treasury Secretary Stu Eizenstadt, the Administration’s FSC point man, went over to present the proposal to his counterpart, EU Trade Commissioner Pascal Lamy. Unfortunately, Eizenstadt also let on that the U.S. attitude was “take it or leave it,” which Mr. Lamy indicated was fine because they would leave it, thank you very much. Eizenstadt then backtracked, indicating there might be some wiggle room. Nothing like drawing a line in the sand and then erasing it as quickly as you can.

After a week of discussions with EU officials and other European government officials it is quite clear the EU wants only one thing – for the U.S. to be WTO compliant. They are not looking for a deal and they would rather not have to retaliate. For Europeans their attitude is remarkably direct: We expect the U.S. to comply with the WTO ruling. We are happy to discuss anything you like, but we are not negotiating anything despite Mr. Lamy’s indication that the “door remains open.” We think Treasury’s proposed solution is a non-starter, but if you think it is WTO compliant take it to the WTO and let’s find out.

It’s anybody’s guess whether the Administration’s proposal will pass WTO muster. What is certain is the Congress has precious little time to act in any case. It is also certain that if the Congress does pass the Administration’s proposal, the Europeans will challenge it under expedited review. Finally, it is certain that if the U.S. loses the challenge it is going to be in a very weak position, the Europeans will retaliate as long as the FSC remains in effect, and Sir Leon Brittain is going to be insufferably and deservedly smug.