On Foreign Soil

Congress is moving ahead with legislation to amend a tax law that allows U.S. exporters to establish foreign sales corporations (FSCs) abroad. With FSCs, companies can lower their income tax rate on the profits made from selling products in other countries. (For more details, see February 2000's "Tax Talk.")

The legislative push is in response to a recent ruling from the World Trade Organization (WTO) indicating that the 1982 law allowing FSCs provides unfair subsidies to U.S. companies. The European Union brought the complaint to the WTO.

Because of the FSC tax law, U.S. exporters receive an estimated $4 billion in tax breaks per year. The U.S. government contends these breaks help maintain U.S. companies' price competitiveness in world markets.

In February, the WTO upheld a preliminary ruling against the United States and recommended that it bring the law into conformity with the WTO rules. Countries can ignore rulings, but then they must compensate their trading partners or accept sanctions.

Congress is considering legislation designed to preserve the financial benefits that companies receive when setting up FSCs and at the same time address the EU complaint. The legislation would amend the law so it applies to exports or to goods made by companies' affiliates in foreign countries.

The EU isn't satisfied with Congress' effort. It says the legislation not only preserves the tax break available to U.S. companies but also extends to it other types of businesses.

The United States' solution is unusual, sources say. Normally, case-losing countries compromise. In this case, however, Congress feels the FSC law provides a benefit to U.S. companies that needs to be preserved.

If you operate an FSC, don't panic, says Saul B. Brenner, a tax partner in charge of international taxation for the New York City accounting firm David Berdon & Co. LLP. While there may be some modification in the FSC law, he says, U.S. companies are not likely to lose the tax break altogether.

Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 13 years.