U.S. Must Rewrite Tax Law, WTO Says

The U.S. must rewrite a controversial law that saves Boeing Co., Microsoft Corp. and other multinationals billions of dollars a year in taxes or risk as much as $4 billion in penalties, the World Trade Organization said Monday.

The law--which allows U.S. exporters to shield much of their overseas earnings from taxes--was challenged by the European Union as an illegal export subsidy. The Geneva-based WTO upheld the charge Monday, finalizing a preliminary decision first reported in June.

The ruling threatens transatlantic ties already frayed by disputes over global warming and missile defense, imperils efforts to launch a new round of trade talks and could lead to costly new headaches for U.S. multinationals. It also could trigger calls for tax changes here.

Under WTO rules, the U.S. government has 60 days to appeal the decision, revise its tax law or face a penalty of as much as $4 billion in additional duties on U.S. exports to Europe. The potential hit list includes aircraft, chemicals, toys, electronic equipment, soap and beef.

“The implications are potentially enormous for a lot of major U.S. exporters,” said Clyde Prestowitz, president of the Washington-based Economic Strategy Institute. “This could be a big hit.”

With the frail state of the global economy, a multibillion-dollar trade war could do tremendous damage to already weakened exporters on both sides of the Atlantic.

Trade and investment between the United States and the EU countries have boomed in recent years, increasing the interdependency of the two regions. Many EU firms depend on U.S. suppliers and customers, and vice versa.

Most observers believe the stakes are too high for the U.S. and EU not to find a face-saving compromise to this dispute, which has been festering for three decades.

Some speculate U.S. Trade Representative Robert Zoellich and EU Trade Commissioner Pascal Lamy might postpone the day of reckoning by agreeing to include tax issues in a new round of trade talks the WTO hopes to launch in November in Doha, Qatar.

“It is not clear to me how the EU would propose to go forward with penalties, because the implications to their own trade could be so severe,” said Tracy Hollingsworth, a senior tax attorney with Manufacturers Alliance/MAPI, a trade group in Arlington, VA.

Earlier this month, the chief executives of Boeing Co., General Motors Corp. and 70 other leading U.S. firms sent a letter urging President Bush to negotiate a “mutually acceptable” solution to the messy dispute over conflicting tax policies.

The U.S. contends that the European tax system provides benefits to its exporters through a rebate of its value-added tax, which puts U.S. competitors at a disadvantage. U.S. firms argue that the tax law under attack by the EU levels the playing field.

Rick Fuller, a Boeing spokesman, said his company is “disappointed” with the WTO ruling. In recent years, the aerospace giant has received $79 million to $230 million in annual tax breaks from the targeted law.

Zoellich said Monday that he is working closely with Congress, U.S. firms and the EU to find a solution that will “promote U.S. economic interests” while “fulfilling our WTO obligations.” Richard Mills, Zoellich’s spokesman, said the office has not yet decided whether it will file an appeal.

But the European Commission said it is “fully satisfied” with Monday’s ruling and expects the U.S. to comply with the WTO decision.

Some on Capitol Hill agree. Rep. William M. Thomas (R-Bakersfield), chair of the House Ways and Means Committee, which writes tax policy, said the WTO ruling is evidence that America’s tax system is “antiquated” and needs a major overhaul to lessen the burden on U.S. multinationals without violating international trade rules.

For example, under present U.S. law a company’s global earnings are subject to taxation in the U.S. This puts firms at risk of being taxed twice--at home and in the country where they made the money.

Monday’s WTO ruling can be traced back to the Foreign Sales Corporation program, which was created in 1971 to boost ailing U.S. firms by allowing them to ship overseas profits to offshore tax havens. The EU complained that the FSC violated trade rules and the WTO ruled in its favor in 1999.

Last year, Congress did away with the FSC and created a new program that still allowed U.S. firms to shield much of their overseas earnings. That sparked a new complaint by the EU, which led to the latest WTO decision.