Decisions of the Appellate Body of the World Trade Organization

United States: Tax Treatment for `Foreign Sales Corporations'

2. Facts

This decision related to the provisions of the US Internal Revenue Code relating to `Foreign Sales Corporations' (FSC).¹ These provisions replaced provisions dealing with Designated International Sales Corporations (DISC), which were found in 1981 to confer illegal export subsidies under GATT 1947.

The FSC provisions must be understood in light of the general structure of US international taxation. The following description is a sketch of extremely detailed provisions with many exceptions; it is provided only to give the basic and general facts necessary to the trade law analysis.

Under US principles, US persons, including US corporations, are taxed on their worldwide income. Non-US companies are, very broadly speaking (and with important exceptions), subject to US taxation on their US source income, but not on their foreign-source income. However, if the foreign source income of a foreign company is found to be `effectively connected' with a `US trade or business', it is subject to US taxation. The FSC programme deems certain export income of FSCs not to be `effectively connected' income, and thereby ensures that it will not be subject to US taxation. Foreign companies that are subsidiaries of US companies are treated the same way, but when they pay dividends to a US parent, the dividend is normally taxable in the hands of the parent. The FSC provisions permit US firms to establish foreign subsidiaries, and to pass a portion of their export sales of goods or services through these foreign subsidiaries, so as to attribute a specified portion of their income to these foreign subsidiaries. A second important provision of the FSC programme allows the US parent generally to deduct the amount of dividends received from FSCs from their income, to the extent the dividend is made from certain foreign trade income of the FSC. The net result is that this specified portion of their foreign trade income is not subject to US taxation.

1 Sections 921-927 of the US Internal Revenue Code.

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