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International trade law - original DSB rulings apply to subsequent remedial measures.

INTERNATIONAL TRADE LAW--ORIGINAL DSB RULINGS APPLY TO SUBSEQUENT REMEDIAL MEASURES--United States--Tax Treatment for "Foreign Sales Corporations," Second Recourse to Article 21.5 of the DSU by the European Communities, WT/DS108/36 (March 14, 2006).

The World Trade Organization's (WTO) Agreement on Subsidies and Countervailing Measures (SCM Agreement) prohibits the creation or maintenance of subsidies that have a distorting effect on international trade. (1) Alleged violations of any WTO agreement may be brought before the Dispute Settlement Body (DSB) pursuant to the Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU). (2) In United States--Tax Treatment for "Foreign Sales Corporations," Second Recourse to Article 21.5 of the DSU by the European Communities (US-FSC), (3) the DSB upheld the findings of the Panel and Appellate Body that the United States created a form of prohibited subsidy in continued violation of the SCM Agreement and Article 21.5 of the DSU in its tax treatment of foreign sales corporations (FSCs). (4) Specifically, the Panel and Appellate Body considered whether a recommendation made under Article 4.7 of the SCM Agreement, in an original DSB proceeding, remained in effect until the implementing Member had fully complied with DSB rulings and recommendations, in addition to any subsequent DSU Article 21.5 proceedings. (5)

The European Community (EC) requested a consultation with the United States on November 18, 1997, to discuss sections 921-927 of the United States Internal Revenue Code (IRC) and related measures establishing special tax treatment for foreign sales corporations. (6) Specifically, the EC alleged that the IRC provided tax exemptions on income related to exports to U.S. parent companies in violation of the SCM Agreement by creating an export-contingent subsidy. (7) The EC also alleged that local content requirements of the exemption provided less favorable treatment to imported products than is accorded like products of the United States, violating the General Agreement on Tariffs and Trade (GATT) 1994 and the SCM Agreement. (8) Finally, the EC alleged that by maintaining the tax exemptions, the United States violated the Agreement on Agriculture. (9)

The original panel concluded that the FSC scheme was inconsistent with the United States' obligations under the Agreement on Agriculture and recommended the FSC scheme be brought into conformity with that agreement. (10) The panel further concluded that the FSC scheme was inconsistent with the United States' obligations under the SCM Agreement, and recommended that the United States withdraw the FSC subsidies without delay by October 1, 2000. (11) The Appellate Body affirmed the Panel's findings and both the Panel and Appellate Body reports were adopted by the DSB on March 20, 2000. (12)

The United States enacted the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (ETI Act) to implement the DSB's March 2000 recommendations and rulings. (13) The EC, however, asserted that the ETI Act continued to violate the SCM Agreement, the Agreement on Agriculture, and GATT 1994, and sought recourse to Article 21.5 of the DSU for the United States' failure to bring the IRC into compliance. (14) The DSB referred the matter to a Panel, which "concluded that the ETI Act was inconsistent with the United States' obligations under the SCM Agreement, the Agreement on Agriculture, and the GATT 1994." (15)The Panel further found that through section 5 of the ETI Act, the United States had not fully withdrawn the FSC subsidies that were prohibited by the original DSB rulings and recommendations. (16) The Appellate Body affirmed the Panel's findings and conclusions, and the DSB adopted these reports. (17)

The United States subsequently repealed the ETI Act through enactment of the American Jobs Creation Act of 2004 (Jobs Act). (18) Once again the EC argued this did not bring the U.S. tax scheme into conformity with its WTO obligations. (19) In this second recourse by the EC to Article 21.5 of the DSU, the DSB referred the matter to a panel, which found that "the inconsistencies with ... the SCM Agreement, ... the Agreement on Agriculture and ... GATT 1994 remain" and concluded that the United States continued to fail to fully implement DSB recommendations and rulings. (20) The United States then appealed some of the Panel's legal interpretations. The Appellate Body, in this second recourse, upheld the Panel's finding that Section 5 of the ETI Act was within the Panel's terms of reference and rejected the United States' argument that there was no DSB recommendation under the SCM Agreement with respect to tax exemptions of the ETI Act. (22) The Appellate Body also found the Panel's recommendations were not new recommendations under the SCM Agreement, instead holding that the Panel acted within the scope of its authority under the DSU in examining whether subsequent measures comply with earlier DSB rulings. (23)

The DSU governs disputes that arise between Member States related to covered agreements. (24) A Panel is established at the request of a complaining party, who must make the request in a writing that identifies the specific measures at issue and summarizes the legal basis of the complaint. (25) Compliance with this element of Article 6.2 of the DSU must be "demonstrated on the face of the request for the establishment of a panel." (26)

The SCM Agreement disciplines the use of subsidies and regulates the actions countries can take to counter the effects of subsidies. (27) Article 3 outlines a general prohibition on export subsidies based on performance or the use of domestic goods over imported goods. (28) Article 4.7 of the SCM Agreement provides the timeframe within which a prohibited subsidy must be removed. (29)

The foreign sales corporation was created through Title VIII of the Deficit Reduction Act of 1984 as an attempt to create a level playing field for U.S. companies in the global market. (30) Sections 921-927 of the United States Internal Revenue Code (IRC) provided a tax exemption for a portion of a foreign sales corporation's earnings from foreign trade income. (31) To the extent that the IRC was found to violate the United States' WTO obligations, it was amended by the ETI Act. (32) The IRC was amended again in 2004 through the Jobs Act in an effort to align the tax code with the United States' trade obligations by repealing the ETI Act; however, it continued to maintain similar transitional and grandfathering provisions. (33)

In United States--Tax Treatment for "Foreign Sales Corporations," the Appellate Body declined to embrace the United States' argument that under proper interpretation of the DSU and SCM Agreement the Jobs Act was not properly before the Panel or the Appellate Body. (34) The Appellate Body reasoned that while the EC panel request did not explicitly mention the Jobs Act, the request clearly included the ETI Act when it referenced the entirety of the prohibited United States subsidies, and thus the Jobs Act may be incorporated as a continued operation of the prohibited ETI Act provisions. (35) Further, compliance with the SCM Agreement is not fully achieved where an adopted measure replaces an original subsidy with another prohibited subsidy. (36)

The Panel and Appellate Body correctly concluded that rulings and recommendations of the DSB, whether original proceedings or recourses, form a continuum of events related to compliance with the original DSB proceedings. (37) To hold otherwise would be illogical and create a forum in which Member States could prolong disputes and avoid enacting truly remedial measures because review of any "new measures" would not be within the scope of review in later recourses to the DSU. (38) This decision attempts to force the United States to address the loophole in its tax structure, despite the possible consequences for the U.S. economy. (39)

Despite clarification of the authority the DSU vests in the Panel and proper interpretation of the SCM Agreement, it remains unclear whether this next step will be sufficient to motivate the United States to properly reform its tax structure. (40) Though this decision identifies why the current tax structure is problematic in light of the United States' WTO obligations, it is unclear how this case (as opposed to any of the earlier cases) will motivate the United States' "full withdrawal" of the originally prohibited FSC subsidies. (41) Resolution of this longstanding dispute will more likely be found in bilateral negotiations between the United States and the European Union (EU). (42)

It is foreseeable that, absent a bilateral agreement between the United States and the EU, the United States will counter with an attack on the EU tax structure. (43) Such an attack may serve to level the playing field, at least among these two trading partners, as each party may then be found holding the same negotiating chip of WTO authorized trade sanctions. (44) Despite earlier breakdowns in attempts to negotiate this sensitive matter, both parties may then be motivated to reach a resolution given the billions of dollars in trade sanctions at stake. (45)

In United States--Tax Treatment for "Foreign Sales Corporation," the Appellate Body considered whether remedial measures are within the scope of original DSB rulings and recommendations, or are instead separate measures that would require an independent review by formation of a new panel. The Appellate Body found that remedial measures operate on a continuum, stemming from an initial violation that would not be considered fully withdrawn until subsequent remedial measures were also in compliance with the agreement at issue. While this case solidifies and clarifies the authority of the Panel to examine all measures stemming from an initial DSU proceeding and makes inroads into the ability of Member States to use technicalities to avoid their WTO obligations, the ruling may not be enough to motivate large scale change of national laws.

(1.) Agreement on Subsidies and Countervailing Measures [hereinafter SCM Agreement], Marrakesh Agreement Establishing the World Trade Organization, Annex 1A, in WORLD TRADE ORGANIZATION, THE RESULTS OF THE URUGUAY ROUND OF MULTILATERAL TRADE NEGOTIATIONS--THE LEGAL INSTRUMENTS, Apr. 15, 1994, 33 I.L.M. 1167 (1994) [hereinafter WTO]. In 1947, the General Agreement on Tariffs and Trade (GATT) was established as the "forum for negotiating lower customs duty rates and other trade barriers." GATT, Oct. 30, 1947, 61 Stat. A-11, 55 U.N.T.S. 194. The WTO, established in 1995, is an international organization that replaced the original multilateral trading system established under GATT. The WTO in Brief: Part 1--The multilateral trading system--past, present and future, http://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr01_e.htm (last visited Dec. 14, 2007). The WTO includes approximately thirty multilateral trade agreements, including the SCM Agreement and GATT 1994, which Member States must adhere to as part of membership in the WTO. The WTO in Brief: Part 3--The WTO agreements, http://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr03_e.htm (last visited Dec. 14, 2007). The goal of GATT, and now the WTO, is to "ensure[] access to international markets, level[] the playing field among international competitors, and establish[] predictable law ... The core rationale for the GATT-WTO system is to open markets." Kevin C. Kennedy, The GATT-WTO System at Fifty, 16 WIS. INT'L L.J. 421, 421 (1998).

(2.) Understanding on Rules and Procedures Governing the Settlement of Disputes, Marrakesh Agreement Establishing the World Trade Organization, Annex 2, in WORLD TRADE ORGANIZATION, THE RESULTS OF THE URUGUAY ROUND OF MULTILATERAL TRADE NEGOTIATIONS--THE LEGAL INSTRUMENTS Apr. 15, 1994, 33 I.L.M. 1226 (1994) [hereinafter DSU]; See also Appellate Body Report, Brazil--Measures Affecting Desiccated Coconut, WT/DS22/AB/R (Feb. 21, 1997) (discussing scope of DSU and broadly defining agreements covered by DSU, including SCM Agreement).

(3.) Dispute Settlement Body Report, United States--Tax Treatment for "Foreign Sales Corporations," WT/DS108/36, (Mar. 17, 2006) [hereinafter FSC DSB Report].

(4.) See Appellate Body Report, United States--Tax Treatment for "Foreign Sales Corporations" Second Recourse to Article 21.5 of the DSU by the European Communities, [paragraph] 100, WT/DS108/AB/RW2 (Feb. 13, 2006) [hereinafter AB Second Recourse] (upholding Panel finding regarding amendments to U.S. Internal Revenue Code). This case has been ongoing since 1997. See Dispute Settlement: Dispute 108, United States--Tax Treatment for "Foreign Sales Corporations," http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds108_e.htm (last visited Dec. 14, 2007) (showing concise list of Panel, Appellate Body, and DSB reports); See also Foreign Sales Corporation-General Rules, 26 C.F.R. [section][section] 1.921-2(C)A-6 (1990). See generally Blake A. Bernet, Comment, The Foreign Sales Corporation Act: Export Incentive for U.S. Business, 25 INT'L LAW. 223 (1991) (defining scope of FSC and summarizing eligibility requirements). This legislation "created a new export entity called the Foreign Sales Corporation (FSC)," "a foreign corporation, created or organized in a foreign country or eligible U.S. protectorate, and maintaining a presence in that country or protectorate." Id. at 225-26. Use of the FSC allowed a U.S. corporation to exclude a portion of their income derived from export sales where certain conditions were met including foreign presence requirements and foreign economic processes. See generally Mark I. Siegal, Note, The Taxing of Foreign Sales Corporations: Original Legislation and Recent Developments, 24 GEO. WASH.J.INT'L L. & ECON. 353, 370 (1991) (discussing detailed requirements and issues related to whether any benefit would accrue relative to cost of establishing FSC). This tax exemption for U.S. exports was created to facilitate U.S. competition in the world marketplace. Id. at 353.

(5.) AB Second Recourse, supra note 4, [paragraph] 80. The report of the Dispute Settlement Body is very brief and incorporates the findings of the appellate body and those of the panel read in light of the appellate body's report. See FSC DSB Report, supra note 3. For this reason, throughout this comment citation will be made to the appellate body report and where relevant to the panel report.

(6.) Request for Consultations by the European Communities, United States Tax Treatment for "Foreign Sales Corporations," WT/DS108/1 (Nov. 28, 1997) [hereinafter EC Request for Consultations] (outlining specific problem areas of amended IRC); See also SARA DILLON, INTERNATIONAL TRADE AND ECONOMIC LAW AND THE EUROPEAN UNION 305 (2002) (describing FSC and manner in which tax exemption works); Bernet, supra note 4 (outlining requirements to qualify as FSC and when use is beneficial). See generally Marianne Kayan, The U.S. Response to the WTO Ruling Against Foreign Sales Corporations and the Extraterritorial Income Exclusion Act, FED. B.A. SEC. TAX'N REP. 7 (2004), available at 2004-WTR FEDBASTXR7 (summarizing history of FSC dispute and suggesting potential responses to WTO ruling). Suggested solutions include bilateral negotiation between the United States and EU, challenging the EU taxation system, and radial overhaul of the U.S. taxation system. Id.

(7.) EC Request for Consultations, supra note 6 (alleging continued violation of Article 3.1(a) of SCM Agreement); See also Candace Carmichael, Note, Foreign Sales Corporations--Subsidies, Sanctions, and Trade Wars, 35 VAND. J. TRANSNAT'L L. 151, 154-55, 203-09 (2002) (discussing developments in amendment of U.S. tax regime to comply with 2002 WTO rulings and recommendations).

(8.) EC Request for Consultations, supra note 6. GATT Article III:4 generally provides that imported products should be treated no less favorably than like domestic products on the internal market. See GATT, supra note 1, at art. III:4 (setting national treatment standard); DILLON, supra note 6, at 32 (outlining mechanics of Article III:4).

(9.) Panel Report, United States--Tax Treatment for "Foreign Sales Corporations," [paragraph][paragraph] 3.2(c)-(d), WT/DS108/R (Oct. 8, 1999) (alleging U.S. tax law violated Agreement on Agriculture by granting export subsidies in excess of reduction commitments).

(10.) Id. [paragraph][paragraph] 8.1, 8.4.

(11.) Id. [paragraph] 8.8; See also World Trade Organization, Understanding the WTO, Chapter 2: The Agreements, p. 45, available at http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap2_e.pdf (last visited Dec. 14, 2007) (providing overview of SCM Agreement).

(12.) Panel Report, Second Recourse to Article 21.5 of the DSU by the European Communities, United States--Tax Treatment for "Foreign Sales Corporations," [paragraph] 1.1, WT/DS108/RW2 (Sept. 30, 2005) [hereinafter Panel Second Recourse].

(13.) Id. [paragraph][paragraph] 1.1, 1.2.

(14.) AB Second Recourse, supra note 4, [paragraph] 4.

(15.) AB Second Recourse, supra note 4, [paragraph][paragraph] 4-5.

(16.) AB Second Recourse, supra note 4, [paragraph] 5.

(17.) AB Second Recourse, supra note 4, [paragraph] 5.

(18.) H.R. 4520-6, 108th Cong. (2004); American Jobs Creation Act of 2004, Pub. L. No. 108-357, [section] 101, 118 Stat. 1423 [hereinafter Jobs Act]; See also AB Second Recourse, supra note 4, [paragraph] 6 (summarizing amendments of United States law attempting conformity with WTO obligations). The ETI Act is repealed in Section 101 of the Jobs Act. AB Second Recourse, supra, [paragraph] 6. Despite the Jobs Act's transition provisions phasing out the prohibited exemptions, under Section 101(f), it still provides a grandfather provision under which the ETI tax scheme remains available indefinitely in certain cases, and does not repeal section 5 of the ETI Act, which allows for the grandfathering of the prohibited FSC subsidies in certain instances. Id.

(19.) AB Second Recourse, supra note 4, [paragraph] 7.

(20.) AB Second Recourse, supra note 4, [paragraph][paragraph] 9-10 (enacting section 101 of Jobs Act maintains prohibited subsidies through transitional and grandfathering provisions).

(21.) AB Second Recourse, supra note 4, [paragraph] 11. The United States appealed the Panel's findings and conclusions as they applied to Section 5 of the ETI Act because, the United States argued, the ETI Act was not within the Panel's terms of reference and thus was not a measure at issue under Article 21.5 of the DSU. Id. [paragraph][paragraph] 12-19. The United States further argued that the Panel could not find that the United States had failed to comply with the original DSB rulings and recommendations regarding the SCM Agreement because there were no DSB recommendations related to the ETI Act. Id. [paragraph][paragraph] 20-26. Instead, the United States asserted, the measures in question are isolated to each DSB ruling--in this instance the first DSB rulings would apply only to FSCs and not to any subsequent legislation. Id. [paragraph][paragraph] 20-26.

(22.) AB Second Recourse, supra note 4, [paragraph][paragraph] 72-87.

(23.) AB Second Recourse, supra note 4, [paragraph][paragraph] 93 (discussing proper scope of Panel tasks); See also Appellate Body Report, Mexico--Anti-Dumping Investigation of High Fructose Corn Syrup (HFCS) From the United States (Article 21.5--US), [paragraph][paragraph] 121-24, WT/DS132/AB/RW (Oct. 22, 2001) [hereinafter Mexico--Corn Syrup] (addressing authority to incorporate prior original proceedings during subsequent dispute settlement).

(24.) DSU, supra note 2, at Art. 21.5. In relevant part, Article 21.5 provides that: "[w]here there is disagreement as to the existence or consistency with a covered agreement of measures taken to comply with the recommendations and rulings such dispute shall be decided through recourse to these dispute settlement procedures, including wherever possible resort to the original panel." Id. The word "existence" suggests that
 as part of its assessment of whether a measure taken to comply
 exists, a panel may need to take account of facts and circumstances
 that impact or affect such existence. The word "consistency"
 implies that panels acting pursuant to Article 21.5 must
 objectively assess whether new measures are, in fact, consistent
 with relevant obligations under the covered agreements.


Appellate Body Report, United States--Softwood Lumber IV, [paragraph] 67, WT/DS257/AB/RW (Dec. 5, 2005).

(25.) DSU, supra note 2, at Art. 6 (outlining how complaining party requests establishment of panel).

(26.) Appellate Body Report, United States--Countervailing Duties on Certain Corrosion-Resistant Carbon Steel Flat Products From Germany, [paragraph] 127, WT/DS213/AB/R (Nov. 28, 2002) (noting requirement of specificity on face of document requesting panel). However, submissions and statements made by the complaining party in the first written submission may also be used by the panel to clarify the DSU Article 6.2 request originally made. Id.

(27.) See Understanding the WTO, supra note 11, at 45 (providing overview of SCM Agreement).

(28.) See SCM Agreement, supra note 1, at Art. 3 (articulating prohibited subsidies). Subsection (e) of Annex 1 to the SCM Agreement is most illustrative of the IRC's tax exemption schemes at issue here: "[t]he full or partial exemption remission, or deferral specifically related to exports, of direct taxes or social welfare charges paid or payable by industrial or commercial enterprises." Id. at Annex 1.

(29.) See SCM Agreement, supra note 1, at Art. 4.7 (suggesting prohibited subsidy's removal without delay and specified time period for withdrawal).

(30.) See Carmichael, supra note 7, at 158-60 (discussing motivation behind tax structure allegedly designed to equalize disadvantages faced by U.S. exporters).

(31.) 26 U.S.C. [section][section] 921-27 (1984), repealed by FSC Repeal and Extraterritorial Income Exclusion Act of 2000, Pub. L. No. 106-519, 114 Stat. 2423, 2423 (repealed 2004) [hereinafter ETI Act]. To qualify as foreign trade income, certain requirements of foreign presence and foreign economic processes had to be met. See 26 U.S.C. [section] 922(a) (1984) (repealed 2000).

(32.) See ETI Act, Supra note 31, at 2433 (discussing purpose of ETI Act). While section 5(b) of the ETI Act no longer allowed formation of FSCs, section 5(c) allowed for both a transition period and a grandfather clause for certain transactions of then existing FSCs. See Id. [section][section] 5(b) and (c).

(33.) See Jobs Act, supra note 18 (repealing ETI Act). However, sections 101(d) and (f) maintain transition and grandfathering provisions, which in relevant part provides: "(d) TRANSITIONAL RULE FOR 2005 AND 2006 ... ( f) BINDING CONTRACTS.--The amendments made by this section shall not apply to any transaction in the ordinary course of a trade or business which occurs pursuant to a binding contract--... (2) which is in effect on September 17, 2003, and at all times thereafter." Id. [section][section] 101(d) and (f); See also Carmichael, supra note 7, at 203-08 (discussing possible measures to remedy defects in IRC). However, there is no clear winning solution that would allow the United States to amend its statutes without risking detriment to the United States economy. See Carmichael, supra, at 203-08. The best possible scenario would involve a compromise between the EU and United States that would best facilitate the large scale trade that these trading partners engage in. See Id. at 209-10 (outlining potential EU--U.S. compromise and factors motivating cooperation).

(34.) See AB Second Recourse, supra note 4, [paragraph] 68 (concluding EC panel request gave United States sufficient notice issue with continued operation of ETI Act).

(35.) See AB Second Recourse, supra note 4, [paragraph][paragraph] 66-69 (expounding steps logically leading to application of DSU and SCM to Jobs Act).

(36.) See AB Second Recourse, supra note 4, [paragraph] 83 (explaining complete withdrawal not achieved where prohibited measure continues under guise of new legislation). A Member State's original obligation to fully withdraw a prohibited subsidy continues where the Member State leaves an originally prohibited subsidy in place, either in its entirety or in part, or by replacing it with another subsidy prohibited by the SCM Agreement, as was the case here. Id. [paragraph][paragraph] 84-86.

(37.) See Mexico--Corn Syrup, supra note 23, [paragraph][paragraph] 121-22 (declaring subsequent compliance measures operate on continuum).

(38.) See AB Second Recourse, supra note 4, [paragraph][paragraph] 47-50 (discussing concerns of Australia and Brazil regarding legal effect of adopting United States' position).

(39.) See Carmichael, supra note 7 (discussing reality of what compliance could mean for U.S. economy).

(40.) See Carmichael, supra note 7, at 159-60 (discussing history of FSC beginning with 1971 United States enactment of Domestic International Sales Corporation).

(41.) See Carmichael, supra note 33 and accompanying text (recognizing difficulties inherent in overhauling tax structure).

(42.) See Kayan, supra note 6 (noting possible resolutions to FSC dispute); Carmichael, supra notes 7 & 33 (discussing why bilateral negotiations are most likely solution).

(43.) See supra notes 6, 7 & 33 and accompanying text (discussing possible U.S. retaliation through grievance before WTO).

(44.) See supra note 33 and accompanying text (discussing political bargaining power of attacking EU taxation system).

(45.) See Kayan, supra note 6 (noting 2002 WTO panel award of $4.042 billion in trade sanctions).
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Title Annotation:Dispute Settlement Body
Author:Levy, Leah
Publication:Suffolk Transnational Law Review
Date:Dec 22, 2007
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