VideoLast summer, Corporate America stood united before Congress to plead for the preservation of some $5 billion in export-tax benefits. Those benefits have been associated with the foreign sales corporation/extraterritorial income (FSC/ETI) exclusions, a government-approved regime of tax shelters for foreign earnings. Ruled illegal subsidies by the World Trade Organization twice in the past five years, the exclusions are slated for extinction, and executives trooped to Capitol Hill to ask not for clemency but for reincarnation.
"The loss of ETI without a suitable replacement could undermine the ability of U.S. exporters to compete in a global trade environment," warned F. Lynn McPheeters, CFO of Caterpillar Inc. "If the FSC/ETI were repealed...certainly it would be very detrimental," echoed Dan Kostenbauder, Hewlett-Packard's general tax counsel. Pierre Chao, a senior adviser at Credit Suisse First Boston, predicted that loss of the tax break would chop billions off the market capitalizations of key exporters like Boeing and United Technologies, thanks to lower earnings.
Now, with the European Union resting its finger on the trigger of $4 billion in retaliatory tariffs to force ETI repeal, Congress appears to be responding to those pleas for a replacement. While the Bush Administration has vowed to comply with the WTO directive, "it's very unlikely [FSC/ETI] would be repealed with nothing in its stead," says Rachelle Bernstein, director of Deloitte & Touche's tax-policy services group. In fact, not one but two bills with replacement tax breaks are being crafted in the House, and the Senate may add a third.
What constitutes a suitable replacement, however, has been the subject of bitter debate. Domestic manufacturers like Caterpillar are pushing for a tax break linked to U.S.-based production, currently embodied in a bill sponsored by Philip Crane (R-Ill.), Charles Rangel (D-N.Y.), and Don Manzullo (R-Ill.). Global operators like HP and Coca-Cola, though, are hoping to seize the opportunity to write more-favorable tax rules associated with overseas subsidiaries, an effort now headed by Committee on Ways and Means chair Bill Thomas (R-Calif.). While the two goals are not mutually exclusive, together they would cost the government about $80 billion over 10 years, reckons Gary Hufbauer, senior fellow at the Institute for International Economics in Washington, D.C., far exceeding the $50 billion 10-year FSC/ETI tab.
Double Trouble
At the heart of the matter is an effort to keep U.S. corporate tax burdens in line with what foreign-based firms face. In general, unlike their foreign competitors, U.S. companies must pay taxes on all income they bring back into the country, regardless of where it is earned. Since 1971, though, exporters have been allowed to funnel sales through so-called domestic international sales corporations and then FSCs, then deduct portions of those foreign earnings from their taxable income. That system, revised four times up to the current ETI regime, creates billions of dollars of savings for companies that primarily manufacture in the United States but sell overseas. It has also consistently been deemed an illegal export subsidy by the WTO.
To escape the "export subsidy" label, U.S.-based producers like Caterpillar, Boeing, and Microsoft are backing the Crane-Rangel-Manzullo bill, which would lower tax rates by up to 3.5 percentage points, depending on how high a percentage of a company's total production occurs in the United States, and regardless of where the goods are sold.
While few actually oppose the bill, many consider it too narrow for an increasingly global economy. "We like the Crane-Rangel-Manzullo approach," says Kimberly Pinter, director of corporate finance and tax for the National Association of Manufacturers, "but we don't think it should be a choice between manufacturing benefits and international tax reform. We would like to see something that addresses both."
A broader reform of international tax laws is expected from the Thomas bill, which was due out in July after several months of delay. His bill is expected to repeal FSC/ETI entirely, with a shorter transition period, and to include corporate tax favors like an expansion of research-and-development tax credits, a one-year tax holiday allowing companies to repatriate foreign earnings at a tax rate of only 5.25 percent, and a modification of Subpart F to allow U.S. companies to benefit from sales subsidiaries located in low-tax jurisdictions like Singapore and Switzerland.
The Thomas approach is favored by Procter & Gamble, Coca-Cola, EDS, and many others, often for reasons that have nothing to do with FSC/ETI. Procter & Gamble, for example, is "not a major exporter, and thus the elimination of FSC/ETI benefits would not have a major financial impact on us," says spokesperson Doug Shelton. But P&G is supporting the Thomas bill, since "it would make important progress toward eliminating double taxation of profits from our international business activities," says Shelton.
Subpart F reform is a particularly hot issue for companies with overseas operations. Tax payments on foreign income can generally be deferred by reinvesting it in those operations, rather than repatriating it. That advantage, though, is tempered by Subpart F, a complex 1962 provision that forces companies to pay current taxes on "passive" overseas income — including export-sales income — regardless of when it is repatriated. Even Treasury officials concede that Subpart F imposes unintended tax consequences and complexity.
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