By Tom Bergin
LONDON (Reuters) - The sweeping tax bill awaiting President Donald Trump's signature includes a tax break for U.S. exporters that appears to contravene World Trade Organization rules and is likely to spark a major trade dispute with Europe, legal experts said.
For some U.S. companies, the provision in the Tax Cuts and Jobs Act that passed both houses of Congress this week could be twice as generous as the Foreign Sales Corporation scheme, which was abolished around 2006 after causing one of the biggest transatlantic trade disputes of recent decades.
The provision taxes earnings from exports of "intangibles" at around a 13 percent rate against a 21 percent corporate tax rate overall. The bill does not define intangible but it is understood in business terms to include patents, trademarks, copy-righted material and know-how.
A Reuters analysis of past corporate filings suggests the measure on "foreign-derived intangible income", or FDII, could save U.S. companies like Microsoft (NASDAQ:MSFT), Walt Disney, Starbucks (NASDAQ:SBUX), Oracle (NYSE:ORCL) and Bank of America (NYSE:BAC) billions of dollars.
Legal experts and the European Commission said it appears to amount to an export subsidy, which effectively allows U.S. companies to undercut European competitors on their own turf.
"We seem to be facing another, repackaged, version of the Foreign Sales Corporation saga. The United States seems to have not learned," said Folkert Graafsma, a WTO expert with law firm VVGB in Brussels.
"The newly proposed rule seems prima facie manifestly inconsistent with standing WTO law and practice," he said.
U.S. companies export hundreds of billions of dollars worth of software, technology, patent rights and other intangible goods each year, trade data shows.
The European Commission, the European Union’s executive arm, wrote U.S. Treasury Secretary Steven Mnuchin before the bill was passed to say the measure appeared to be at odds with the WTO treaty, which governs how signatories tax cross-border trade.
"... the draft U.S. tax bill as it currently stands contains elements that risk seriously hampering trade and investment flows between our two economies," said the letter, dated Dec. 12. "We believe it is in our joint interest to avoid this."
A study of the bill released on Monday by a dozen U.S. tax and legal academics said the FDII provision "likely violates WTO obligations".
Four legal experts consulted by Reuters shared their view.
"A WTO complaint by the EU seems to be very likely," Prof. Ernst-Ulrich Petersmann, a trade law expert with the European University Institute in Florence, Italy, told Reuters.
Microsoft, Bank of America, Starbucks and Oracle declined to comment. Disney did not respond to requests for comment.
The House Committee on Ways and Means, which helped write up the tax bill, said it was drafted to be "consistent with WTO requirements".
"This bill simply levels the playing field – so American businesses can compete and win anywhere around the world – including here at home," a committee spokesperson said in answer to Reuters questions.
EXAMINING THE IMPLICATIONS
Most of the European business groups contacted by Reuters said they were still examining the implications of the measure. Britain’s largest business lobbying group, the Confederation of British Industry (CBI), said it saw risks.
"The risk of retaliatory action from other governments to the proposals in the U.S. is a real one," said Annie Gascoyne, CBI's Head of Economic Policy.
WTO rules clearly state that lower tax rates on profits from exports constitute an unlawful subsidy, Petersmann said.
"If a U.S. sales or income tax is reduced on condition of the exportation of the goods or intangibles concerned, it seems to be a subsidy 'contingent upon export performance' as prohibited by Article 3.1(a)," he said.
Article 3.1(a) was the rule which led to a WTO judgment against the United States over the Foreign Sales Corporation regime in 2000.
The scheme, which ran in various forms from 1984 until around 2006, allowed U.S. companies to structure their earnings in such a way as to benefit from an effective reduction in tax of around 15 percent on the export of physical products as well as intangible goods and services.
Big manufacturers like Boeing (NYSE:BA) and General Electric (NYSE:GE) were the best-known beneficiaries of the regime.
The exact benefit to U.S. companies of the FDII tax break will depend on what tax planning strategies they already have in place and how much of a company's export earnings will be classified as "intangible income".
Reuters went through the annual reports and presentations to analysts of more than 100 U.S. companies, randomly picked, going back 20 years, and found 26 firms that noted that they benefited from the Foreign Sales Corporation scheme.
Of those 26, half were businesses whose exports were mainly of intangible goods, including drugmaker Merck (NYSE:MRK), coffee chain Starbucks, software group Oracle and technology giant IBM (NYSE:IBM).
The 13 companies either declined to comment or did not respond to requests for comment for this story. But a Reuters analysis of their past corporate filings showed the regime offered big benefits.
Walt Disney Co., the vast majority of whose exports are intangibles such as movies and video games, said in annual reports between 2002 and 2005 that the regime allowed it to reduce its overall effective tax rate by around 3 percentage points annually.
If the new export tax break generated similar savings as the old one, and Disney remained as focused on exports as it has in the past, it could save the company more than $250 million a year, based on its $9 billion annual earnings.
The company could end up even better off than under the Foreign Sales Corporation scheme, however, even without all its exports covered.
That's because paying a 13 percent tax rate rather than 21 percent on foreign-derived intangible income would allow U.S. companies to reduce the tax they pay on qualifying exports by 38 percent – more than twice the 15 percent reduction effectively offered under the older tax break.
Jeffrey Korenblatt, a tax attorney with law firm Reed Smith in Washington D.C., said companies will now begin to examine how much of the profit on their exported goods and services can be ascribed to intangibles.
Even for manufacturers of heavy equipment, a considerable amount of value can be linked to patents and trademarks, he said.
"People will be doing the modelling," he said.