Menu
Tax Notes logo

The WTO Consistency of the Deduction for FDII

Posted on Feb. 25, 2019
[Editor's Note:

This article originally appeared in the February 25, 2019, issue of Tax Notes.

]

Grant D. Aldonas is the executive director of the Institute of International Economic Law at Georgetown University Law Center and the principal managing director of Split Rock International Inc. He served previously as the U.S. undersecretary of commerce for international trade and as majority chief international trade counsel to the Senate Finance Committee.

In this report, Aldonas examines allegations by European finance ministers that the deduction for foreign-derived intangible income violates WTO rules, and he explains why — based on the eligibility requirements of section 250 and the scope of the WTO subsidy disciplines — those concerns are misplaced.

I. Introduction

This report examines whether the section 250 deduction for foreign-derived intangible income introduced by the Tax Cuts and Jobs Act1 conflicts with the subsidy disciplines of the WTO’s Agreement on Subsidies and Countervailing Measures (SCM). In particular, it weighs the complaints raised by European finance ministers during the final congressional deliberations, who asserted that section 250 conferred a prohibited export subsidy in violation of the WTO rules.2

II. Another Trade Dispute Over U.S. Tax Policy?

The EU member country finance ministers’ focus on section 250 is unsurprising, if misplaced. The concerns they raised are, in their view, simply the latest stage in a decades-long conflict over U.S. tax policy. The proximate cause of the dispute lay in the disparate treatment of direct and indirect taxes under the original 1947 General Agreement on Tariffs and Trade.

Whereas indirect taxes (that is, sales taxes, excise taxes, and VATs applied directly to goods) could be rebated upon the export of the goods, the rules deemed the rebate of direct taxes on income an actionable export subsidy. Further, the rules allowed an importing country to impose on imports a charge equivalent to the indirect taxes borne by like products in its domestic stream of commerce, but they did not permit the levy of similar charges in relation to direct taxes on income.

The original GATT rules inherited that distinction from preparatory work dating back at least to the 1920s. The distinction was based on a flawed assumption regarding the incidence of direct and indirect taxes on income, but it persisted, as much by inertia as common assent, and is still reflected in the WTO rules today. The effect is best described in tax terms. The GATT/WTO rules have applied the destination principle to indirect taxes but applied a source and residence approach to direct taxes on income.

The distinction drawn between direct and indirect taxes became a source of friction in the early years of the GATT because of a gradual shift in tax policy by European GATT members that resulted in greater reliance on VATs than on income taxes. In trade terms, the shift toward VATs had the effect of expanding the share of domestic taxes that the European GATT members could rebate to exporters. The United States objected to what it viewed as an unfair advantage.

The United States raised its concerns about the distinction between direct and indirect taxes as early as 1960. It asserted that the disparate treatment created an unfair advantage for countries that relied on VATs, based on an erroneous assumption regarding the incidence of direct and indirect taxes. The United States asked the GATT membership to revisit the GATT rules, which led to the formation of a working group on border adjustability in 1968. The working group’s report, however, offered little more than a recapitulation of the views of the various GATT parties. It did not foster a consensus in support of changing the rules as the United States had hoped.3

Having seen no progress toward eliminating the disparate treatment of direct and indirect taxes in response to U.S. complaints, Congress in 1971 enacted the domestic international sales corporation provisions to offset the perceived advantage that the distinction created.4 The DISC provisions allowed for the indefinite deferral of tax on income derived from exporting, essentially treating income attributed to the DISC (a paper entity) as if it were earned abroad and exempt from the existing subpart F rules.5

The European Community responded to the DISC provisions by requesting the establishment of a formal GATT dispute settlement panel to determine whether they conferred an illegal export subsidy in violation of GATT Article XVI.6 The Community’s insistence on a formal dispute settlement panel led the United States to file what were, in effect, four counterclaims against the member countries’ tax policies, asserting that those policies resulted in tax rebates upon export that exceeded the taxes actually due.7

Under the final rulings of separate panels, both the DISC regime and the tax practices of various Community member countries were found to violate GATT rules.8 The rulings were not immediately adopted, as was customary under GATT practice. The United States proved willing to accept the finding against the DISC provisions if the findings regarding its counterclaims were adopted as well, but the Community member states remained recalcitrant, arguing for adoption of the DISC panel’s report alone. The reports remained pending for what would amount to five years.

The dispute was eventually resolved as part of the Tokyo Round GATT negotiations, which led to the first Subsidies Code. That code usefully reaffirmed the arm’s-length principle of taxation, the violation of which formed the substance of the United States’ GATT counterclaims. That code also expressed a preference for the resolution of tax issues in a tax policy forum rather than under GATT rules.

Yet the Subsidies Code didn’t eliminate the source of friction in the GATT rules that had led to the DISC case and the U.S. counterclaims. Instead, it reinforced the original distinction between direct and indirect taxes by specifically excluding the rebate of indirect taxes from the Illustrative List of Export Subsidies annexed to the agreement.

The United States and the European parties eventually reached an understanding, but only in 1981, after the Subsidies Code was adopted and implemented in U.S. law. The understanding reflected agreement on four points: (1) countries need not tax economic processes occurring outside their territory; (2) territorial tax systems did not alone contravene GATT; (3) tax authorities should apply the arm’s-length pricing principle in allocating income among related corporations; and (4) measures designed to alleviate the double taxation of foreign-source income do not violate the GATT rules.9

The United States took the position that the agreement provided cover for the measures Congress eventually adopted to replace the DISC.10 The alternative — the foreign sales corporation — at least as a matter of form, linked a share of a U.S. taxpayer’s income derived from exports to economic processes located abroad. The FSC provisions required a U.S. taxpayer to form an entity outside the United States to perform specific functions related to the taxpayer’s export sales. Taxpayers invariably formed their FSC affiliates in low-tax jurisdictions. When combined with the deferral allowed by the tax code for foreign-source income generated by the foreign affiliates of U.S. companies, the FSC allowed a U.S. taxpayer to avoid paying tax currently on a share of its export income.

The EU objected to the FSC when it was created, but otherwise took no action under GATT or, at least initially, under the WTO rules. The EU’s inaction lulled Treasury officials into believing that the gentleman’s agreement they claimed they had reached on the margins of the Subsidies Code negotiations would hold.

That status quo was left undisturbed until the late 1990s, after the conclusion of the Uruguay Round of multilateral negotiations that established the WTO. One of the central innovations of the Uruguay Round agreements was the establishment of a binding dispute settlement. Whereas the GATT rules on dispute settlement allowed any member, including the defendant, to block adoption of a dispute settlement decision and preempt any retaliation, the WTO Dispute Settlement Understanding (DSU) made rulings binding unless the entire WTO membership rejected it.11

The United States quickly filed a series of actions against the EU under the new rules. Each case involved a long-standing dispute in which the United States had either won before a GATT panel or had been blocked from pursuing dispute settlement by an EU objection. The eventual rulings vindicated the U.S. claims against the EU in a series of high-profile decisions. It was that string of losses that led the European Commission to propose that the EU member states lodge a WTO complaint against the FSC.

The complaint targeting the FSC led to one of the most contentious WTO disputes to date. In the end, the WTO panel found that the FSC provisions conferred an illegal export subsidy, and the Appellate Body affirmed.12

The United States responded by enacting the FSC Replacement and Extraterritorial Income Exclusion Act of 2000. The extraterritorial income regime eliminated the FSC but tried to achieve a similar result that would comply with a literal reading of the Appellate Body’s decision in the FSC case. In effect, the 2000 act inverted the tax code: Rather than allowing U.S. taxpayers to exclude a portion of their foreign-source income that was otherwise included under the section 61 definition of gross income (income from whatever source derived, which included taxpayers’ worldwide income), the ETI regime effectively defined gross income to exclude the export income.

The EU immediately asked the panel to reconvene to consider whether the United States had complied with the FSC ruling. Both the panel and (eventually) the Appellate Body found in the EU’s favor, holding that the ETI regime, too, violated the WTO rules.13

In compliance with the WTO ruling, Congress eventually eliminated the ETI regime. In so doing, it established one of the basic predicates of all the ensuing efforts to reform the tax code. Having had the WTO foreclose any mechanism by which it could achieve the effect of border adjustability and the perceived advantage it conferred within the framework of a system of worldwide taxation of corporate income, Congress was forced to consider a shift toward a territorial system.

The TCJA was the product of those deliberations. U.S. tax policymakers laid the groundwork in previous congresses for the reforms the TCJA made.14 In effect, those proposals conceded that the United States’ worldwide approach to taxing corporate income was out of step with the territorial approach adopted by other major trading partners and had harmful effects on U.S. competitiveness.15

To engineer the shift to a territorial approach, the earlier proposals would have created a participation exemption system for foreign income, akin to the system embodied in the TCJA.16 Like the TCJA, the earlier proposals included a significant reduction in the statutory corporate income tax rate and a series of anti-base-erosion rules. Both measures were intended to diminish any incentive the shift toward a territorial system might have created to move investment, and therefore income, offshore.17

Earlier tax reform proposals also included provisions analogous to section 250. One would have created a new category of subpart F income for intangible income derived by controlled foreign corporations and provided for a phased-in deduction for U.S. corporate taxpayers for income derived from their foreign exploitation of intangibles.18 The explicit justification for the measures was to inhibit the “erosion of the U.S. tax base through shifting intangible income” abroad.19 Once phased in, the deduction would have resulted in the taxation of income from the foreign exploitation of intangible property at a reduced tax rate of 15 percent.20

By adopting the territorial approach used by major U.S. trading partners, the TCJA negated the putative advantage that those partners previously received as a result of the GATT/WTO distinction between direct and indirect taxes. In part, the scrutiny the EU and its member states have focused on the TCJA reflects their concern that they will lose that advantage.

But as noted earlier, the Europeans’ concerns are also based on their perception that tax reform is simply cover for the United States to create an unfair competitive advantage for U.S. domestic producers at the expense of European trading partners, as they believe the United States did with the DISC, FSC, and ETI regimes. They have already begun to act on that impulse.

Much as it did for the FSC provisions, the commission has requested that the OECD review the TCJA to determine whether it contains “harmful tax practices.” One view is that the commission is using the OECD process as a way to engage in discovery before filing a WTO complaint — just as at it did with the FSC.

One way to defuse the potential dispute that the commission’s request to the OECD seems to foreshadow is to examine the possible grounds on which the EU might base its claim. The following analysis does so for the section 250 FDII deduction.

III. Tax Policy Rationale for the FDII Deduction

Building on the foundation laid by previous reform efforts, the TCJA introduced major changes to the way the code taxes the foreign-source income of U.S. corporate taxpayers — including, most importantly, the substantial shift from a worldwide system of taxation to a territorial approach. That shift takes the form of new section 245A, which provides a 100 percent deduction for dividends a U.S. taxpayer receives from foreign sources, including its foreign affiliates.21 The shift also eliminated the need for several provisions that were integral to the worldwide system, including the deferral of tax on foreign active business income earned by a U.S. taxpayer’s foreign affiliates.22

In engineering the shift to a territorial system, U.S. tax policymakers put a premium on ensuring that the separate components were internally consistent and offered a coherent response to the twin challenges of ensuring the global competitiveness of U.S. companies while at the same time protecting the U.S. tax base. The reforms Congress eventually adopted were the product of more than five months of policy discussions among the so-called Big Six Republican tax policymakers at the time: House Speaker Paul D. Ryan, Senate Majority Leader Mitch McConnell, House Ways and Means Committee Chair Kevin Brady, Senate Finance Committee Chair Orrin G. Hatch, Treasury Secretary Steven Mnuchin, and National Economic Council Director Gary Cohn. Those discussions produced a framework that served as the foundation for what became the TCJA.23 The drafters’ overview of the framework emphasized that it was designed “to prevent companies from shifting profits to tax havens” and “protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations,” while leveling “the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies.”24

The TCJA introduced several provisions to diminish the risk that the shift toward a territorial system would result in erosion of the U.S. tax base.25 The most significant of those provisions is section 951A, which requires U.S. corporate taxpayers to include in gross income in any tax year their global intangible low-taxed income.26 GILTI is defined as the excess of a taxpayer’s net tested income over its net deemed tangible income return.27 Section 951A deems that excess amount to be intangible income subject currently to U.S. tax.28

Under new section 250, however, the taxpayer is allowed to deduct 50 percent of any GILTI it is deemed to have earned from its gross income in any tax year.29 The taxpayer can also include any deemed dividend under section 78 to the extent that the amount is attributable to GILTI.30 The net effect is to lower the effective tax rate on GILTI from the new statutory rate of 21 percent to 10.5 percent.31 However, GILTI’s interaction with other provisions of the code, particularly the effect of the expense allocation rules on the calculation of the foreign tax credit, could result in an effective tax rate higher than 10.5 percent.

In effect, when the corporate rate and deduction are considered, section 951A imposes a 10.5 percent tax on intangible income to diminish the incentive otherwise created by the TCJA’s shift toward a territorial system.32 In that respect, the reforms introduced by the TCJA do not result in a fully territorial system of taxation. At least for intangible income, the amended code retains aspects of a worldwide system of taxation.

Thus, GILTI retains some of the problems associated with the full pre-TCJA worldwide system. For income from intangibles, which represent an increasingly important source of a corporate taxpayer’s income and profit, the GILTI minimum tax would reach intangible income earned abroad by U.S.-based entities but not that of foreign-based entities.

The section 250 deduction for FDII is designed to put intangible income earned by U.S. companies on their foreign sales on the same footing as intangible income earned by their foreign affiliates. The aim, once again, was to diminish any incentive for taxpayers to shift investment and profits outside the United States and thereby erode the U.S. tax base.

In concept, FDII is the portion of a U.S. corporation’s foreign-source income derived from intangible property. Given the complexity inherent in calculating actual returns on intangible assets, however, Congress opted to assume that income exceeding a 10 percent return on tangible assets is attributable to the corporation’s intangible assets. The concerns the EU finance ministers and various commentators have raised regarding section 250 stem from that assumption.

In practice, section 250 defines FDII in terms of two ratios: It represents the amount that bears the same ratio to the corporation’s deemed intangible income as the corporation’s foreign-derived deduction-eligible income (FDDEI) bears to its deduction-eligible income.33

The statute defines a taxpayer’s deemed intangible income as any excess of its deduction-eligible income over its deemed tangible income return.34 The corporation’s deemed tangible income return equals 10 percent of its qualified business asset investment, as defined in section 951A(d) (with some modifications), regardless of whether the corporation is a CFC.35

A taxpayer’s FDDEI includes any of its deduction-eligible income that is derived in connection with:

(A) property — (i) which is sold by the taxpayer to any person who is not a United States person, and (ii) which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use, or (B) services provided by the taxpayer which the taxpayer establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, not located within the United States.36

The term “deduction-eligible income” means, for any domestic corporation, any excess of gross income (with some adjustments) over the deductions (including taxes) properly allocable to that gross income.37

Taken together, that means that a taxpayer is eligible for the section 250 deduction only if its return on tangible assets exceeds 10 percent. If it does not exceed 10 percent, the calculation of the taxpayer’s FDDEI and its FDII is irrelevant.

Significantly, the source of the income that generates the taxpayer’s return on tangible assets — whether domestic or foreign — is immaterial to its ability to clear that hurdle. The section 250(b)(2)(B) definition of a taxpayer’s deemed tangible income return draws no distinction between the source of income or the activities that produce that return.38 More pointedly, nothing in section 250(b)(2)(B) mentions income from the export of goods, much less making access to the deduction contingent on exports or export performance.

When the return on tangible assets does exceed 10 percent, the taxpayer must then calculate the ratio of its FDDEI to its deduction-eligible income.39 As noted earlier, the statutory definition of a taxpayer’s FDDEI includes income “derived in connection with” the sale of property to foreign persons for foreign use or the sale of services to “any person, or with respect to property, not located within the United States.”40

The taxpayer then must calculate the ratio that its FDDEI bears to its total deduction-eligible income. The taxpayer multiplies its deemed intangible income by that ratio to determine its FDII.

Under section 250, the taxpayer may then deduct 37.5 percent of that amount from its taxable income, which results in an effective tax rate of 13.125 percent on FDII.41 As was the case with GILTI, the initial 37.5 percent rate applies only through the 2025 tax year; after that, the deduction falls to 21.875 percent of a taxpayer’s FDII, which will yield an effective tax rate of 16.406 percent.42

The TCJA’s shift toward a territorial approach, in tandem with anti-base-erosion measures like GILTI, represent a substantial response to the criticisms leveled against the previous tax code. Under the worldwide approach, U.S. tax was deferred on offshore income earned by the foreign affiliates of U.S. taxpayers until it was repatriated, usually in the form of dividends. That gave rise to claims of “stateless income” that “escaped” taxation.43

As a result, the U.S. rules on deferral became one of the primary targets of efforts to reform the international tax system. At the 2013 G-20 leaders’ meeting in St. Petersburg, Russia, the participating countries targeted deferral as one of the tax practices that needed to be addressed as part of any reform effort.44 The leaders’ declaration included explicit instructions to the tax officials of the participating countries to develop “recommendations regarding the design of domestic rules to neutralise the effect” of long-term deferral.45

In tandem with GILTI, the section 250 deduction for FDII represents a key part of the U.S. response. Taken together, the measures make a significant down payment on the U.S. commitment to implement the results of the OECD’s initiative on base erosion and profit shifting.46 Indeed, as the OECD has acknowledged, the TCJA constitutes the most comprehensive attempt to date by any OECD member to address the challenges identified in the BEPS action plan.47

Although intent is not dispositive in determining whether a particular tax measure violates the WTO rules, it does matter. The tax policy motivations behind the various elements of the TCJA, endorsed by the OECD, stand in sharp contrast to the motivation behind the DISC, FSC, and ETI regimes, which were tax provisions designed to achieve a trade outcome rather than a tax policy outcome.

IV. The Applicable WTO Rules

The WTO rules consist of a series of agreements that impose disciplines on trade in goods, trade in services, and the protection of intellectual property rights. Rules vary under each of the agreements, but they all build on the basic framework established by the WTO’s predecessor, GATT.

In broad outline, GATT aimed to eliminate all barriers other than tariffs and to encourage reductions in tariffs through successive rounds of multilateral trade negotiations as means to liberalizing world trade.48 The architecture of GATT — and now of the WTO — still conforms to that basic approach.

Not unlike a contract in domestic law, the agreements reached by WTO members consist of commitments to liberalize trade in specific goods or services.49 Regarding trade in goods, for example, WTO members agree to cap the tariffs they will apply to imports from other WTO members.50 Those bindings become a part of the member’s schedule of commitments.51 A member’s bindings are reinforced by rules designed to preserve the “balance of advantages” achieved at the negotiating table. Their goal is to prevent any erosion of commitments made by GATT and WTO members in previous rounds.52

With that framework in mind, the following sections explain the application of the WTO rules to direct taxes on income, the reach of those rules under various agreements, and the legal standard of review that would apply to any complaint targeting section 250.

V. Application to Direct Taxes on Income

The WTO rules, like those of GATT, undoubtedly extend to direct taxes on income and related measures like deductions and credits. The core provisions of GATT 1994 confirm that fact.

Article I of GATT 1994, the most favored nation clause, requires that any member immediately and unconditionally extend “any advantage, favour, privilege or immunity” it grants to any product to imports of all like products originating in the territories of all other contracting parties. The language was designed to reach any disparate treatment a WTO member might give to a product imported into its territory, regardless of the form that difference in treatment takes.

Some commentators have suggested that the Article I reference to “products” implies that the obligation extends only to taxes and other measures that apply in rem to the goods themselves.53 But the syntax of Article I doesn’t support that interpretation.

Strictly speaking, the word “product” does not limit the phrase “any advantage” as used in Article I. Properly parsed, the word “product” is the object or target of the advantage conferred, not a qualifier limiting the type of advantages to which the Article I proscription applies.

The remainder of Article I reinforces the conclusion that direct taxes on income fall within the scope of the WTO rules. Article I applies not only “with respect to customs duties and charges of any kind imposed on or in connection with importation” but also to “all matters referred to in paragraphs 2 and 4 of Article III.”54 Those referenced matters embody the GATT national treatment obligation as applied, respectively, to taxes and domestic regulation.55

The Article III national treatment obligation requires a WTO member to afford imports treatment no less favorable than that afforded to domestically produced goods. Article III:2 extends the obligation to “internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products.”56

Thus, Article III:2 bars the use of taxes to favor or protect domestic products, regardless of whether the taxes are applied directly or indirectly.57 The use of the word “indirectly” necessarily implies that Article III embraces more than sales taxes, excise taxes, or VATs, which apply directly to goods. Adopting a narrower construction — one that would exclude direct taxes on income — would either require reading the word “indirectly” out of the Article III:2 altogether or imputing a meaning to the term (that is, one that excludes direct taxes) that the language of Article III does not support.

The standard a WTO panel would apply in interpreting the provisions of the TCJA compels the same result. The WTO DSU obliges a panel to apply the “customary rules of interpretation of public international law.”58 Those rules, as reflected in the Vienna Convention on the Law of Treaties, provide that a “treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.”59

Applying the Vienna Convention’s rules of interpretation, the Appellate Body has consistently rejected attempts to find new requirements in well-worn provisions of the WTO agreements, which is what reading the word “indirectly” out of Article III:2 would do. The Appellate Body has explained that its duty is to examine the words of the treaty to determine the parties’ intentions, consistent with “the principles of treaty interpretation set out in Article 31 of the Vienna Convention,” and that those principles “neither require nor condone the imputation into a treaty of words that are not there or the importation into a treaty of concepts that were not intended.”60

The obligation embodied in Article III:2 is, moreover, subject to the Article III:1 injunction that “internal taxes and other internal charges . . . affecting the internal sale, offering for sale, purchase, transportation, distribution or use of products . . . should not be applied to imported or domestic products so as to afford protection to domestic production.”61

By its terms, Article III:1 applies to all forms of “internal taxes and other internal charges.” It neither distinguishes between direct and indirect taxes nor excludes direct taxes on income from its scope. The language it uses plainly reaches beyond those limited forms of tax (for example, “sales and excise taxes”) that apply to the goods themselves. The terms “internal taxes . . . affecting the internal sale” or “offering for sale” of goods imply more than taxes applied in rem on an ad valorem basis.

The same holds true of “taxes or other internal charges . . . affecting . . . transportation [or] distribution.” Significantly, both are services rather than goods. Yet Article III:1 includes them within the scope of its admonition because they can indirectly provide a means of affording “protection to domestic production.” That reference is fundamentally inconsistent with the assumption, however widely accepted it may once have been, that Article III applies to taxes on goods alone.

Given the Appellate Body’s reading of Article III:1, a narrow construction excluding direct taxes would be fundamentally inconsistent with Article III’s object and purpose. As explained earlier, the rules of the WTO, of which Article III forms a core part, are designed to ensure that members do not upset the balance of advantages or expectations accruing from previous negotiating rounds. Direct taxes on income can be as readily used as sales taxes, excise taxes, and VATs to frustrate the purpose of Article III.

The most telling example involves transfer pricing rules that fail to adhere to the arm’s-length standard. Those are the grounds on which the United States based its successful counterclaims against European tax practices in the DISC dispute. The U.S. complaint focused on the opportunity the European transfer pricing practices created to shift income and profits to lower-tax jurisdictions, providing a subsidy to the European countries’ exporters.

But the transfer pricing rules can be just as easily manipulated by governments to inflate the value of imported goods, with the effect of increasing the tax applicable to income derived from exporting into their markets. The resulting double taxation of the foreign exporter’s income operates like an additional tariff, creating a competitive advantage for domestic producers.

Income tax measures that create preferences for domestic products are in fact quite common. The leading example in WTO jurisprudence is the ETI regime — Congress’s replacement for the FSC — which was found by both the WTO panel and Appellate Body to violate the WTO rules. The same logic applies to the now-common attempts by tax authorities to impute a permanent establishment to an exporter where no PE exists under current norms of international taxation.

Finally, there is a more reasonable construction of Article III — one that is consistent with both its language and the provision’s object and purpose. That interpretation would include direct taxes within the scope of Article III to the extent that they affect the competitive conditions facing imported goods once they have entered the importing country’s domestic stream of commerce. Successive dispute settlement panels and the WTO Appellate Body, including, most authoritatively, the Appellate Body’s opinion on ETI, have reasoned their way toward that exact construction.62

Thus, the question is not whether the WTO rules apply to direct taxes on income, including measures like the section 250 deduction for FDII, but how they apply. For section 250, that depends on the reach of the WTO disciplines on subsidies.

VI. The Scope of WTO Subsidy Disciplines

Each of the core WTO agreements follows the same basic logic: a series of specific trade-liberalizing commitments reinforced by rules designed to preserve the balance of advantages achieved in previous negotiations. But each agreement differs in how it iterates that logic and in its scope, particularly regarding subsidy disciplines.

The differences in scope have important ramifications in analyzing the concerns raised by U.S. trading partners about the section 250 FDII deduction. Neither the General Agreement on Trade in Services (GATS) nor the agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), for example, imposes disciplines on subsidies.

GATS does contain a commitment to negotiate those disciplines at some undetermined point, but nothing more.63 It imposes no current bar to subsidizing exports of services.

For TRIPS, the limitation flows from the nature of the disciplines the agreement imposes, but the result is the same — the agreement imposes no specific disciplines on subsidies. The TRIPS disciplines apply solely to a WTO member’s enforcement of IP rights under its domestic law.64 The agreement establishes minimum standards of protection a member must provide for patents, copyrights, and other forms of IP it covers.65 The rules define the subject matter to be protected, the rights to be conferred, the permissible exceptions to those rights, and the minimum duration of protection a member must provide.66

What the TRIPS agreement does not do is create more general obligations regarding the treatment of IP (patents, copyrights, etc.) under other laws. The scope of the TRIPS national treatment obligation illustrates what that means in practice. That obligation requires members to “accord the treatment provided for in [TRIPS] to the nationals of other Members.”67 However, the “treatment provided for” in the agreement relates solely to the standards and administration of a member’s IP laws.68 The TRIPS national treatment requirement would not apply to a member’s revenue laws and its treatment of income derived from sale or licensing of that IP abroad as a consequence.

Given the absence of subsidy disciplines on services or IP, any point of friction that section 250 might create with the WTO rules must arise from GATT 1994 and the related SCM agreement, which apply solely to trade in goods. Suffice it to say, that sharply reduces the exposure of section 250 to any WTO complaint.

Section 250, by its terms, applies to income derived from intangibles. Because of the difficulty of defining and measuring income attributable to intangibles, however, the drafters of the TCJA opted to use high returns on specific assets as a surrogate for intangible income. That surrogate defines intangible income as a return of more than 10 percent on a QBAI.69

The use of that surrogate measure means income qualifying for the deduction need not be linked to a specific intangible asset and could flow from the sale of tangible, as well as intangible, property. For a taxpayer engaged in the sale of software and related services, that nuance is irrelevant. Any benefit it derived from the section 250 deduction would relate entirely to income from the sale of intangibles. Further, because the WTO subsidy disciplines apply solely to the export of goods, any benefit the taxpayer derived from section 250 as a result of its sales of services and licensing of IP would fall outside the scope of those disciplines.

What about a taxpayer that sells hardware as well as software and services? A share of the returns it generates from those sales would clearly flow from the sale of tangible property, potentially including the export of goods. Whether including the income from those sales in the base of a calculation designed to provide an estimate of intangible income is sufficient to deem section 250 an illegal export-contingent subsidy under the SCM agreement is analyzed in depth next. But even in that instance, the absence of subsidy disciplines on services and IP would plainly narrow the amount of any alleged subsidy to that benefiting the export of goods alone.

VII. Analysis of the FDII Deduction

There seems to be considerable confusion in tax circles over the application of the WTO subsidy rules to section 250. Much attention has been focused on the extent to which the FDII deduction falls within the SCM agreement’s definition of subsidy. That is an important step in the analysis, but the analysis does not end there.

What is critical to understand is that the SCM agreement does not enjoin all forms of subsidy. The disciplines focus solely on the forms of subsidy that distort trade and upset the balance of advantages reached in previous rounds of trade-liberalizing negotiations. For that reason, the analysis of section 250 under the SCM agreement requires an additional step. That step involves examining whether the FDII deduction represents one of the forms of subsidy the SCM agreement prohibits.

The analysis that follows examines, first, whether section 250 might fall within the scope of the SCM agreement’s definition of subsidy and then whether it represents a prohibited export subsidy barred by the accord.

A. The SCM Agreement’s Definition of Subsidy

In a tax context, article 1 of the SCM agreement defines a subsidy as “a financial contribution by a government” when “government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits).”70 As the Appellate Body observed in the FSC case, in practice that implies “some defined normative benchmark against which a comparison can be made between the revenue actually raised and the revenue that would have been raised ‘otherwise.’”71

With that in mind, the Appellate Body ruled that the “normative benchmark for determining whether revenue foregone is otherwise due must allow a comparison of the fiscal treatment of comparable income, in the hands of taxpayers in similar situations.”72 The clearest circumstance is one in which the measure at issue is an exception to a general rule but the effort is a practical one — a search for “the fiscal treatment of legitimately comparable income to determine whether the contested measure involves the foregoing of revenue which is ‘otherwise due.’”73

Identifying a benchmark in the context of the FDII deduction would not be particularly difficult. Under section 61, a taxpayer’s gross income is defined as “all income from whatever source derived.”74 Foreign-source income derived from a corporate taxpayer’s intangibles, wherever held, plainly falls within the scope of that definition.

By operation of the FDII deduction in section 250, that income is taxed at an effective rate of 13.125 percent through the 2025 tax year, after which it will rise to 16.406 percent.75 Both rates are substantially below the statutory rate of 21 percent otherwise applicable to the taxpayer’s non-FDII-eligible income. In short, it would not be all that difficult for a complaining WTO member to make a prima facie case that the FDII deduction falls within the scope of the SCM agreement’s definition of subsidy, as would any deduction, credit, or exclusion in the code.

Although there are substantive arguments that might be raised in opposition, let’s assume that a complaining party could establish a prima facie case. The question is whether that alone is enough to find section 250 in violation of the WTO rules. As the following discussion clarifies, it is not.

B. Prohibited Subsidies Under the SCM

As noted, the SCM agreement does not enjoin all forms of subsidy; its ambit is limited solely to subsidies that distort international trade in goods. For that reason, the SCM agreement divides subsidies that otherwise fall within its definition of subsidy into three categories: prohibited, actionable, and non-actionable.

Prohibited subsidies involve outright violations of the rules.76 Actionable subsidies are subsidies to which another WTO member might respond, either under the WTO rules or its domestic countervailing measures, when the subsidy seriously prejudices its trade interests.77 Non-actionable subsidies, as the name implies, are subsidies that are neither prohibited nor actionable under the WTO rules or under a member’s countervailing duty law.78

Only two types of measures fall within the category of prohibited subsidies: (1) subsidies contingent, in law or in fact, on export performance; and (2) subsidies contingent on the use of domestic goods over imported goods.79 Thus far, the concerns raised by U.S. trading partners and amplified by various commentators have focused exclusively on the assertion that section 250 confers an illicit export subsidy.80

Taking the European finance ministers’ allegations at face value, a WTO complaint predicated on those assertions would have to establish that a U.S. taxpayer’s eligibility for the FDII deduction is contingent on exports.81 Whether it is the sole condition or one of several, the subsidy must be tied to export performance by law or in fact.82

The complaint would also have to avoid the trap of assuming that a measure is an export subsidy simply because U.S. exporters might benefit from it. Footnote 4 to article 3 of the SCM agreement says that the “mere fact that a subsidy is granted to enterprises which export” is insufficient to draw a subsidy within article 3’s ambit.83

C. Subsidies Contingent on Export

The Appellate Body established the criteria for determining when a subsidy is contingent within the meaning of article 3 of the SCM agreement in its 1999 decision on alleged subsidies granted by Canada and Brazil to support the export of civilian aircraft (“Canada — Aircraft”).84 The Appellate Body ruled that the “legal standard expressed by the word ‘contingent’ is the same for both de jure or de facto contingency.”85 But it drew a distinction between the evidence needed to support a finding of contingency in either case: Whereas de jure export contingency must be “demonstrated on the basis of the words of the relevant legislation, regulation or other legal instrument,” for de facto export contingency, the “relationship of contingency, between the subsidy and export performance, must be inferred from the total configuration of the facts constituting and surrounding the granting of the subsidy, none of which on its own is likely to be decisive in any given case.”86

In light of the Appellate Body’s ruling in “Canada — Aircraft,” the obvious starting point is whether the words of section 250 demonstrate that the FDII deduction is de jure export-contingent. On its face, section 250 makes no mention of exports, export earnings, or export performance, much less a specific reference to the export of goods to which the SCM disciplines attach.

The provision allows a deduction for a portion of a taxpayer’s “foreign derived intangible income.”87 That term, as noted earlier, is defined in terms of two ratios. It is the “amount which bears the same ratio to the deemed intangible income of such corporation” as the “foreign-derived deduction eligible income of such corporation . . . bears to . . . the deduction eligible income of such corporation.”88

The term “foreign-derived deduction eligible income” includes:

any deduction eligible income of such taxpayer which is derived in connection with . . . property . . . which is sold by the taxpayer to any person who is not a United States person, and . . . which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use, or . . . services provided by the taxpayer which the taxpayer establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, not located within the United States.89

“Foreign use” is a defined term. It means “any use, consumption, or disposition which is not within the United States.”90 Property, on the other hand, is not defined.91 In its ordinary usage, it means anything owned by a person. That usage is, of course, clearly broad enough to cover what are conventionally thought of as goods. But even that conclusion requires an inference from the statutory language, rather than being reflected in the language itself.92

Just as important, the term is also broad enough to cover a wide range of other items, including IP rights, confidential business information, customer lists, and the whole range of things conventionally grouped under the term “intangibles.” In other words, it cannot be inferred that property means goods alone. For that reason, eligibility for the FDII deduction is not and cannot, on the basis of the statutory language, refer solely to income generated by the export of goods.93

Thus, for section 250, export contingency must be established on a de facto, rather than de jure, basis. Based on footnote 4 to article 3 of the SCM agreement, the Appellate Body outlined the elements a complaint must establish to justify a finding of de facto export contingency. The facts must demonstrate that the operation of the measure involves (1) the granting of a subsidy that (2) is tied to (3) actual or anticipated exportation or export earnings.94

The first element is not, according to the Appellate Body, simply a reiteration of the article 1 definition of subsidy. It involves “whether the granting authority imposed a condition based on export performance in providing the subsidy.”95

The second element requires that the facts demonstrate that the granting of a subsidy is tied to or contingent on actual or anticipated exports. It “does not suffice to demonstrate solely that a government granting a subsidy anticipated that exports would result.”96

The third element demands proof that exports were anticipated or expected to result from the grant of the subsidy.97 In effect, the exports must be the result of the subsidy because the “second sentence of footnote 4 precludes a panel from making a finding of de facto export contingency for the sole reason that the subsidy is ‘granted to enterprises which export.’”98

Applying that framework to the section 250 deduction for FDII reinforces the conclusion that the provision does not in fact provide a subsidy contingent on the export of goods, as the SCM agreement requires. First, nothing in section 250 obliges a U.S. taxpayer to export goods as a condition of qualifying for the deduction it provides.99 Although section 250 may include income from export sales as part of the calculation of the ratios that determine a taxpayer’s FDII, that is quite different from conditioning eligibility for the deduction on the export of goods. Indeed, as noted earlier, a U.S. taxpayer can clearly qualify for the deduction without income from the export of goods.

Second, far from demonstrating that the granting of a subsidy is tied to or contingent on actual or anticipated exports, the language of section 250 compels the opposite conclusion. Breaking the calculation of a taxpayer’s FDII down into its constituent parts helps explain why.

As noted earlier, section 250 defines FDII in terms of two ratios. It represents the amount that bears the same ratio to the corporation’s deemed intangible income as the corporation’s FDDEI bears to its deduction-eligible income.100

What that means is that a taxpayer’s FDII is a function of three factors: (1) its deemed intangible income; (2) its deduction-eligible income; and (3) its FDDEI. If those factors do not require the export of goods to satisfy their conditions, it cannot be said that the result — a taxpayer’s FDII — is contingent on the export of goods, as the SCM agreement requires.

Taking each of those in turn, a taxpayer’s deemed intangible income is defined as any excess of its deduction-eligible income over its deemed tangible income return.101 Its deemed tangible income return equals 10 percent of its QBAI, as defined in section 951A(d) (with some modifications), regardless of whether the corporation is a CFC.102 In other words, absent a showing that it has returns on tangible assets exceeding 10 percent, a taxpayer cannot establish that it has deemed intangible income and therefore cannot establish that it has FDII.

As noted earlier, the source of the income that generates the taxpayer’s return on tangible assets — whether domestic or foreign — is irrelevant to its ability to clear the hurdle of a 10 percent return on tangible assets. The section 250(b)(2)(B) definition of a taxpayer’s deemed tangible income return draws no distinction as to the source of income or the activities that produce that return.103 More pointedly, nothing in section 250(b)(2)(B) mentions income from the export of goods, much less making access to the deduction contingent on exports or export performance, as required by the SCM agreement and the WTO jurisprudence to date.

The analysis of what defines a taxpayer’s deduction-eligible income is similarly straightforward. Deduction-eligible income is defined as any excess of gross income (with some adjustments) over the deductions (including taxes) properly allocable to that gross income.104 As was true earlier, the definition draws no distinction as to the source — domestic or foreign — of either the income or deductions that determine whether a taxpayer has deduction-eligible income. Nor does the definition require the export of goods to satisfy the definition.

The same also holds true of the final element of the equation that determines a taxpayer’s FDII. The statute defines FDDEI as any deduction-eligible income that is derived in connection with property that is sold by the taxpayer to any person “who is not a United States person and which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use, or . . . services provided by the taxpayer which the taxpayer establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, not located within the United States.”105

To be clear, the provision’s use of the phrase “property . . . which is sold to a person who is not a United States person . . . for a foreign use” is broad enough to include the export of goods. But that does not imply the export of goods is necessary to establish that the taxpayer has FDDEI or that its ability to establish that it has income is contingent on the export of goods.

The phrase embraces a wide variety of other sources of income, including the sale to a foreign person of services, patents, trademarks, customer lists, and even sales of foreign real estate, plants, and equipment the taxpayer may hold abroad. The statute does not distinguish among those sources of income, much less reflect a preference for the export of goods over other sources of foreign income that would satisfy the definition of FDDEI. One thing it clearly does not do is require the export of goods to qualify.

Thus, none of the elements needed to establish a taxpayer’s eligibility for the section 250 deduction for FDII can be said to be contingent on the export of goods within the meaning of the SCM agreement.

Third, there is nothing in the operation of section 250 to suggest that any benefit it provides was offered in anticipation or expectation of exports. Like the other sources of foreign-derived income included in the section 250 calculation, export income is only one factor relevant to establishing an estimate of a taxpayer’s FDII. The fact that income derived from the export of goods might be included in the estimation of the intangible income the taxpayer derived from its overseas activities does not allow the inference that the deduction depends on or is tied to the export of goods from the United States.

To suggest otherwise ignores the actual conditions that section 250 imposes on eligibility. The most obvious example is the requirement to establish a rate of return on tangible assets exceeding 10 percent. Nothing in that requirement suggests that Congress created the deduction in anticipation or expectation of exports. To the contrary, even a U.S. taxpayer that derived almost all its earnings from the export of goods would fail to qualify for the section 250 deduction if it could not demonstrate returns on tangible assets exceeding 10 percent.

In other words, a U.S. corporate taxpayer’s eligibility for the section 250 deduction cannot be said to be either de jure or de facto contingent on export. It is undoubtedly a provision from which enterprises that export might benefit, but that alone is insufficient to draw a subsidy within the ambit of article 3 of the SCM agreement.106

VIII. Conclusion

Given the history of disputes between the United States and the EU over the trade effects of various U.S. tax measures, the concerns expressed by European finance ministers regarding the section 250 deduction for FDII are understandable. There is no doubt that the DISC, FSC, and ETI regimes were measures designed to achieve a trade policy result (that is, offsetting the perceived advantage created by the WTO’s disparate treatment of direct and indirect taxes in terms of their border adjustability).

In the case of section 250, however, those concerns are misplaced. The provision is clearly distinguishable from the measures involved in those prior disputes, both in terms of its purpose and its effect. Section 250 represents an important component of the anti-base-erosion measures Congress adopted to limit any incentive the shift toward a territorial system might create to move investment, assets, or income abroad. Given that the TCJA’s cut in the corporate rate still leaves the U.S. rate above the OECD median, the need for those measures as a matter of tax policy is clear.

That said, the far more important point is that an analysis of the eligibility requirements a taxpayer must satisfy to benefit from the section 250 deduction clarifies that the deduction for FDII is neither de jure nor de facto dependent on the export of goods, which is the limit of what the SCM agreement actually disciplines. For that reason, the section 250 deduction for FDII cannot be said to violate the WTO rules.

FOOTNOTES

1 As a technical matter, the conference report passed by both houses of Congress did not include the bill’s short title, the Tax Cuts and Jobs Act. See P.L. 115-97 (Dec. 22, 2017). Senate Democrats demanded that the bill’s title be stripped as a non-revenue measure under the Byrd rule. As a preventive measure, Senate Republicans were obliged to remove the table of contents as well.

2 Letter to Treasury Secretary Steven Mnuchin from the finance ministers of France, Germany, Italy, Spain, and the United Kingdom (Dec. 11, 2017). Later commentary by academics and tax practitioners elaborated on the EU member state allegations. See, e.g., Reuven S. Avi-Yonah and Martin Vallespinos, “The Elephant Always Forgets: U.S. Tax Reform and the WTO,” Law & Econ. Working Papers, art. 151 (Jan. 28, 2018).

3 GATT Working Party Report, “Border Tax Adjustments,” L/3464 (Nov. 20, 1970).

4 The DISC provisions were enacted as part of the Revenue Act of 1971.

5 See David L. Brumbaugh, “A History of the Extraterritorial Income (ETI) and Foreign Sales Corporation (FSC) Export Tax-Benefit Controversy,” Congressional Research Service, RL31660, at 3-4 (Sept. 22, 2006).

6 Id. at 5-6.

7 Id.

8 Id. at 6-7.

9 GATT, “Tax Legislation,” in Basic Instruments and Selected Documents (28th supp. Mar. 1982).

10 Brumbaugh, supra note 5, at 10-11.

11 WTO, “Understanding on Rules and Procedures Governing the Settlement of Disputes” (1994) (annex 2 of the WTO agreement) (DSU).

12 See Appellate Body Report, “US — FSC (Article 21.5 — EC II),” AB-1999-9 (Feb. 24, 2000); and Brumbaugh, supra note 5, at 11.

13 Brumbaugh, supra note 5, at 11.

15 More accurately, the international provisions of the previous code established a hybrid system that combined the worldwide taxation of all U.S. persons on all income, whether derived in the United States or abroad, with a territorial-based taxation of U.S.-source income of nonresident aliens and foreign entities. JCS-1-14, supra note 14, at 493. The negative effects of the U.S. hybrid system were well-summarized in comments submitted by the National Association of Manufacturers in response to a discussion draft of what became H.R. 1: “Comments of The National Association of Manufacturers on House Ways and Means Committee Chairman Dave Camp’s International Tax Reform Discussion Draft,” at 2 (Apr. 15, 2015).

16 Like the TCJA, H.R. 1 would have allowed a 95 percent deduction for the foreign-source portion of dividends received by a U.S. corporate taxpayer from some of its foreign affiliates. H.R. 1, section 4001.

17 See, e.g., H.R. 1, section 3001 (establishing a 25 percent corporate tax rate); section 3701 (designed to prevent tax avoidance through reinsurance with nontaxed affiliates); section 3704 (designed to limit the deduction for interest on some indebtedness between affiliates); and section 3705 (limiting treaty benefits for some deductible payments). JCS-1-14, supra note 14, at 141, 434, and 454-455.

18 H.R. 1, section 4211 (taxing some foreign intangible income at a reduced rate and treating some intangible income as subpart F income). JCS-1-14, supra note 14, at 530.

19 JCS-1-14, supra note 14, at 530.

20 Id.

21 Section 245A. See also PwC, “Tax Reform Readiness: Territorial Tax System and Anti-Deferral Rules” (Jan. 2018).

22 For a useful history of deferral of tax on unrepatriated offshore earnings and an understanding of why the shift toward a territorial system implied the need for its elimination, see Gary Clyde Hufbauer and Ariel Assa, U.S. Taxation of Foreign Income (2007).

23 “United Framework for Fixing Our Broken Tax Code” (Sept. 27, 2017).

24 Id. at 9.

25 See PwC, supra note 21.

26 Section 951A(a).

27 Section 951A(b)(1).

28 Section 951A includes several other adjustments designed to fit the new GILTI provision within the framework of the code’s existing international provisions. Those adjustments include adding the taxpayer’s GILTI into its basis in the shares of the CFC that was the source of the income, as well as treating GILTI as previously taxed income for subpart F purposes. A U.S. corporate taxpayer may also be eligible to credit 80 percent of the foreign taxes paid by its CFCs related to its GILTI income. Section 960(d)(1). Those adjustments are not germane to the WTO analysis here.

29 Section 250(a)(1).

30 Id.

31 The 50 percent deduction under section 250 applies for tax years 2018 through 2025. Section 250(a)(1)(B). The taxpayer can also include any deemed dividend under section 78 to the extent that the amount is attributable to GILTI. Section 250(a)(1)(B). For tax years after 2025, the deduction goes down to 37.5 percent of the deemed GILTI income, plus any related section 78 amount, which will raise the effective tax rate on GILTI income to 13.125 percent. Section 250(a)(3)(B).

32 The tax rate can reach 13.125 percent if FTCs related to GILTI are available because they are limited to 80 percent. Further, if expense allocation rules are applied to the FTC limitation, the effective rate can climb still higher, which would necessarily erode any subsidy the provision might be alleged to provide.

33 Section 250(b)(1).

34 Section 250(b)(2)(A).

35 Section 250(b)(2)(B).

36 Section 250(b)(4).

37 Section 250(b)(3)(A).

38 Section 250(b)(2)(B).

39 Section 250(b)(1).

40 Section 250(b)(4).

41 Section 250(a)(1)(A).

42 Section 250(a)(3)(A).

43 See, e.g., Edward D. Kleinbard, “Stateless Income’s Challenge to Tax Policy,” Tax Notes, Sept. 5, 2011, p. 1021; and Kleinbard, “The Lessons of Stateless Income,” 65 Tax L. Rev. 99 (2011).

45 Id.

46 The effort to reform the international tax system launched at the St. Petersburg G-20 summit coalesced into the OECD’s BEPS initiative. See generally OECD, “Action Plan on Base Erosion and Profit Shifting” (2013). See also OECD release, “OECD Presents Outputs of OECD/G20 BEPS Project for Discussion at G20 Finance Ministers Meeting” (Oct. 5, 2015). In acceding to the leaders’ communiqué at the G-20 Summit in Antalya, Turkey, in late 2015, President Obama effectively endorsed the package of measures developed under the BEPS project and agreed to their timely implementation. G-20 Leaders’ Communiqué Antalya Summit (Nov. 15-16, 2015).

47 The OECD applauded the passage of the TCJA, stating that the United States had “gone a long way in implementing BEPS measures,” and it expressly endorsed the U.S. effort to provide “a competitive tax system while at the same time protecting its tax base.” OECD, “Economic Surveys: United States,” at 47 (June 2018).

48 Id.

49 See Appellate Body Report, “Japan — Alcoholic Beverages II,” WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R (Oct. 4, 1996) (“The WTO Agreement is a treaty — the international equivalent of a contract. . . . In exchange for the benefits they expect to derive as Members of the WTO, they have agreed to exercise their sovereignty according to the commitments they have made in the WTO Agreement.”).

50 See GATT 1994 Art. II.

51 The same logic applies to the General Agreement on Trade in Services (GATS). Commitments to liberalize individual service sectors are similarly reflected in schedules, which, like their counterparts under GATT, form an integral part of the underlying agreement. See, e.g., GATS Art. XVI.

52 See Mitsuo Matsushita, Thomas Schoenbaum, and Petros Mavroidis, The World Trade Organization: Law, Practice, and Policy (3d ed. 2015). The disciplines the SCM agreement imposes on some subsidies affecting the export of goods offer a case in point. From an economic perspective, the protective effect of a subsidy is similar to that of a tariff. Imposing disciplines on subsidies prevent their use to offset the liberalization of tariffs achieved at the negotiating table.

53 See, e.g., John Jackson, World Trade and the Law of GATT 296 n.94 (1969) (suggesting that the most favored nation obligation applies solely to taxes on goods, not the enterprises that produce them). For a detailed summary of the arguments against including direct taxes within the scope of Article I, see Michael Schyle, “Most Favored Nation Treatment in Tax Matters in the GATT” in The Relevance of WTO Law for Tax Matters 73-102 (2006).

54 Schyle, supra note 53.

55 GATT 1994 Art. III:2 and III:4.

56 GATT 1994 Art. III:2.

57 Id.

58 DSU, supra note 11, at art. 3.2.

59 Vienna Convention, art. 31(1). The Appellate Body has relied on the convention as a reflection of the customary rules of treaty interpretation in its earliest rulings, and the principle that the convention’s rules of construction should be applied and upheld is by now firmly established. See, e.g., Appellate Body Report, “US — Gasoline,” WT/DS2/AB/R, at 16-17 (1996); and Appellate Body Report, “Japan — Alcoholic Beverages II,” supra note 49, at 104.

60 Appellate Body Report, “India — Patents (US),” WT/DS50/AB/R 19, at para. 45 (Dec. 1997).

61 GATT 1994 Art. III:1. In “Japan — Alcoholic Beverages II,” supra note 49, the Appellate Body made clear that the other provisions of Article III, including most particularly Article III:2 regarding taxes, must be read in light of Article III:1’s admonition against affording “protection to domestic production.” As the Appellate Body indicated, Article III:1 summarizes the “broad and fundamental purpose of Article III,” which is “to avoid protectionism in the application of internal tax and regulatory measures.” Appellate Body Report, Japan — Alcoholic Beverages II,” supra note 49, at 16.

62 See id. at 15 (indicating that the “broad and fundamental purpose of Article III is to avoid protectionism in the application of internal tax and regulatory measures” and, for that reason, “Article III obliges Members of the WTO to provide equality of competitive conditions for imported products in relation to domestic products”).

63 GATS Art. XV.

64 See, e.g., TRIPS, art. 3 (requiring national treatment solely “with regard to the protection of intellectual property”).

65 See, e.g., TRIPS, art. 2, Pt. II.

66 Id.

67 TRIPS, art. 1.3.

68 Id.

69 Section 951A(b)(2)(A). The same formulaic definition of intangible income applies for GILTI as well as for FDII. Compare sections 951(b), 951, 250(a), and 250(b).

70 SCM agreement, art. 1.1(a)(1)(ii).

71 Appellate Body Report, “US — FSC (Article 21.5 — EC),” supra note 12, at paras. 90-91.

72 Id. at paras. 91 and 98.

73 Id.

74 Section 61(a).

75 Section 250(a)(3)(A).

76 See SCM agreement, art. 3.2.

77 See SCM agreement, Pt. III.

78 See SCM agreement, Pt. IV.

79 SCM agreement, art. 3.1(a) and (b).

80 As noted, the SCM agreement also enjoins subsidies contingent on the use of domestic goods and makes some subsidies actionable under the WTO rules when they result in “serious prejudice” to another WTO member’s trade interests. Although this report doesn’t specifically address those two circumstances, the analysis outlined here would, to a significant extent, apply to those measures.

81 Panel Report, “Canada — Aircraft,” WT/DS70/R, para. 7.16 (Apr. 14, 1999).

82 DSU art. 21.5. See Appellate Body Report, “Canada — Aircraft,” WT/DS70/AB/R, at para. 171 (Aug. 2, 1999) (citing note 4 of article 3.1(a) of the SCM agreement).

83 SCM agreement, art. 3.1(a), n.4.

84 Appellate Body Report, “Canada — Aircraft,” supra note 82. The measures at issue involved various forms of financial support the Canadian government provided to its domestic civil aircraft industry. The Appellate Body upheld the panel’s findings that the Canadian programs were contingent on export within the meaning of article 3.1 of the SCM agreement because the financial support was provided in expectation of exports and export earnings.

85 Id. at para. 167

86 Id.

87 Section 250(a)(1).

88 Section 250(b)(1).

89 Section 250(b)(4).

90 Section 250(b)(5)(A).

91 The code lacks any single definition of the term “property.” Instead, it includes a variety of definitions of property, all of which are limited to the code sections in which they are used. See, e.g., section 614 (definition used in connection with the oil depletion allowance deduction).

92 The inference is plainly correct. The special rule section 250 provides for “property . . . provided to domestic intermediaries” supports that conclusion. The rule excludes property sold to “another person (other than a related party) for further manufacture or other modification within the United States” from the scope of property treated as “sold for a foreign use.” Section 250(b)(5)(B)(i). The reference to “further manufacture” implies that property includes components used in the manufacture of goods.

93 Id.

94 Appellate Body Report, “Canada — Aircraft,” supra note 82, at para. 169.

95 Id.

96 Id. at para. 171.

97 Id. at para. 172.

98 Id. at para. 173.

99 Id.

100 Section 250(b)(1).

101 Section 250(b)(2)(A).

102 Section 250(b)(2)(B).

103 Id.

104 Section 250(b)(3)(A).

105 Section 250(b)(4).

106 Appellate Body Report, “Canada — Aircraft,” supra note 82, at para. 172.

END FOOTNOTES

Copy RID