Decisions of the Appellate Body of the World Trade Organization United States - Tax Treatment for Foreign Sales Corporations--Recourse To Article 21.5 of the DSU by the European Communities 3. Analysis of the Appellate Body Report (a) Financial Contribution under Article 1.1(a) of the SCM Agreement Article 1.1(a) provides a "threshold" test to determine whether a subsidy is provided, thereby giving rise to other responsibilities under other provisions of the SCM Agreement. The main question in the FSC and ETI litigation, indeed, has been whether the U.S. "measure" constitutes a subsidy by virtue of Article 1.1(a)(1)(ii), by forgoing government revenue that is otherwise due. The Appellate Body recalled its decision in the FSC case,1 to the effect that in order to apply the "otherwise due" standard, it is necessary to establish a "normative benchmark."2 This problem is extremely difficult, and the U.S. formulation of the ETI statute was intended to establish a different "normative benchmark" from the one that was found in the FSC case: it was intended to establish for the U.S. an exclusion of a category of income from taxation, rather than to have that category of income constitute an exception from a "normative benchmark." Such a comparison enables panels and the Appellate Body to reach an objective conclusion, on the basis of the rules of taxation established by a Member, by its own choice, as to whether the contested measure involves the foregoing of revenue that would be due in some other situation or, in the words of the SCM Agreement, "otherwise due".3 Legal realists and critical legal studies scholars know that it is often difficult to discern between the general rule and the exception, and vice-versa, and the Appellate Body also sees this difficulty. Given the variety and complexity of domestic tax systems, it will usually be very difficult to isolate a "general" rule of taxation and "exceptions" to that "general" rule. Instead, we believe that panels should seek to compare the fiscal treatment of legitimately comparable income to determine whether the contested measure involves the foregoing of revenue which is "otherwise due", in relation to the income in question.4 This "legitimately comparable income" test might be compared to the "like products" test applied in GATT Article III jurisprudence, and is subject to some of the same difficulties. In the final analysis, it involves panels and the Appellate Body in determining whether to respect or disrespect regulatory categories established by government, with few guiding principles. The U.S. tried to establish a different "normative benchmark" by showing that it was merely excluding from taxation certain foreign source income, similarly to the practice of a number of foreign countries with "schedular" tax systems. Thus, the U.S. suggested that by restructuring its system so that the target income is not excluded from an initial or tentative rule of taxation, but is instead excluded, ab initio, from the tax base, it could not be viewed as giving rise to taxes "otherwise due." In response, the Appellate Body found, without substantial analysis, that the "normative benchmark" is simply the U.S. worldwide system of taxation: its taxation of U.S. citizens and residents with respect to all income from whatever source derived.5 Based on this "normative benchmark," the ETI provisions forego revenue "otherwise due." The Appellate Body found the fact that the application of the ETI provisions is based on an election to confirm its views: taxpayers presumably would not elect ETI treatment except in circumstances where it reduced the overall tax bill. Of course, on this basis, all taxpayer elections, which the U.S. uses in many circumstances, would constitute subsidies.6 The Appellate Body emphasized later in its report that the taxpayer could elect between the normal tax system, including a tax credit for foreign taxes on foreign source income, and the ETI system.7 (b) Export Contingency under Article 3.1(a) The U.S. argued that since ETI treatment is not only contingent on export performance, but can be achieved through other means, it cannot satisfy the requirements of Article 3.1(a). The Appellate Body approved the panel's separation of treatment of goods exported from goods produced outside the U.S.8 The Appellate Body found that the fact that in order to qualify, the goods must be used outside the U.S., causes the measure to be export contingent.9 The fact that a "subsidy" is also available where goods are produced outside the U.S. does not diminish the export contingency of the measure as it relates to goods produced within the U.S. (c) Footnote 59 and Measures to Avoid Double Taxation of Foreign Source Income The Appellate Body found that the fifth sentence of footnote 59, attached to item (e) of the Illustrative List of Export Subsidies, constitutes an exception to the prohibition of export subsidies, not an exception from the definition of export subsidies.10 Accordingly, this provision amounts to an "affirmative defense," with the burden of proof on the defending state. The Appellate Body, in interpreting the fifth sentence of footnote 59, recognized the fact that "foreign source income" and "double taxation" are terms of art in international taxation law. While these meanings may not be directly applicable in the WTO legal system, they may be useful in determining the "ordinary meaning" of these terms, or in finding that the parties intended a special meaning for these terms. The Appellate Body examined the U.S. requirement for foreign economic process, finding that some portion of the income covered by ETI might be construed, by some states under some circumstances, as foreign source income (income sourced for tax purposes in non-U.S. states). However, the Appellate Body determined that not all such income would be foreign source income.11 The Appellate Body does not seem to take into account that each state has its own sourcing rules, and that double taxation occurs largely because two or more states claim that the same income is sourced in their jurisdictions. It seems that these complexities of international tax law may challenge the ability of the Appellate Body to produce firm definitions of terms like "foreign source income" and "double taxation," and that perhaps the member states did not intend to provide in the trade context fixed definitions of these terms, but merely to refer to the activities of member states in response to their own definitions of these terms. This is an interesting example of international trade law importing legal concepts from other areas of international law and seeking to provide greater clarity than may exist in those other areas. The Appellate Body found that not all of the income benefited by the ETI is foreign source, as the ETI uses "rules of thumb" in terms of fixed percentages to calculate the amount of income excluded from taxable income. These percentages would not be expected to conform to the actual proportion of U.S.-source income. In other words, some U.S.-source income would be expected to benefit from the ETI. The Appellate Body found that "income generated by activities that do not have a link with a "foreign" State is not properly regarded as "foreign-source income" within the meaning of footnote 59, but as domestic-source income."12 The Appellate Body objects to the artificiality of these U.S. rules, but it should recognize that many rules determining the source of income in international taxation are equally artificial. The Appellate Body appears to assume, incorrectly, that there is a clear and recognized method of determination or allocation of source with which to compare the U.S. formulae.13 The Appellate Body concluded that the ETI measure would in some cases exempt U.S.-source income, and so the U.S. did not satisfy its burden of proof that the affirmative defense under the fifth sentence of footnote 59 of the SCM Agreement applied.14 (d) Article III:4 The EC claimed that the "foreign articles/labour limitation" of the ETI, whereby exported goods qualifying for ETI benefits are subject to a limitation on imported content, violated Article III:4 of GATT. The Appellate Body agreed that the U.S. measure conferred "less favourable treatment" on imported products by virtue of the fact that imported products would be less desirable in the market.15 (e) Obligation to Withdraw Export Subsidies Under Article 4.7 of the SCM Agreement The Dispute Settlement Body had recommended that the U.S. conform its law to its WTO obligations by November 1, 2000. The ETI, however, contained transition provisions allowing U.S. companies that had already elected FSC status to continue to receive FSC treatment until the end of 2001, and beyond that with respect to transactions contracted earlier than September 30, 2000. The Appellate Body interpreted Article 4.7 of the SCM Agreement strictly, finding no reason to extend the period for compliance for the reasons cited by the U.S. relating to ease of transition. 1 Appellate Body Report, United States - Tax Treatment for "Foreign Sales Corporations" ("US - FSC "), WT/DS108/AB/R, adopted 20 March 2000. 2 Appellate Body Report, para. 87-89. 3 Appellate Body Report, para. 89. 4 Appellate Body Report, para. 91 (footnote omitted). 5 Appellate Body Report, paras. 101-105. 6 Appellate Body Report, paras. 103-104. 7 Appellate Body Report, para. 171. 8 Appellate Body Report, para. 115. 9 Appellate Body Report, para. 117. 10 Appellate Body Report, para. 132. 11 Appellate Body Report, para. 154. 12 Appellate Body Report, para. 165. 13 See Appellate Body Report, para. 54, footnote 133, citing II Joseph Isenbergh, International Taxation - U.S. Taxation of Foreign Persons and Foreign Income (2nd ed.1999). 14 Appellate Body Report, paras. 185-186. 15 Appellate Body Report, para. 221.
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