World Trade Organisation Rules Against US Foreign Sales Corporations

On 24 February the Appellate Body of the World Trade Organisation (WTO) affirmed the earlier finding of the Dispute Settlement Panel on a complaint made by the European Union that the US Foreign Sales Corporation (FSC) régime constitutes an illegal export subsidy under the Agreement on Subsidies and Countervailing Measures and the Agreement on Agriculture. It also recommended that the WTO require the US to comply with its obligations under those agreements by 1 October 2000.

If the US fails to act by this deadline the EU could seek to impose countervailing sanctions on the US; but whether it would in fact do so is uncertain.

Under the current régime an FSC set up by a US corporation obtains the benefit of a partial exemption from US tax on income from exports. The FSC provisions were enacted in 1984 in response to a similar series of actions under the General Agreement on Tariffs and Trade (GATT) that challenged the legality of the predecessors to FSCs, Domestic International Sales Corporations (DISCs).

Now it seems that the US may once again be faced with the prospect of creating a new régime for the taxation of exports. It may well attempt to negotiate the terms of any replacement régime with the EU, but a number of other outstanding trade disputes between the US and the EU may add further tension to negotiations.

Relief from double taxation ensures that the profits of overseas subsidiaries, taxed once in the country in which profits are generated, are not also taxed a second time in the UK; eg, when dividends are paid back to the UK parent company.

On 17 March 1998 the Chancellor announced that the Inland Revenue would be consulting business on opportunities to modernise the system of double tax relief for companies. Following a period of preliminary discussions, a consultative paper was published on 12 March 1999, with comments invited by 30 September 1999.

UK multinationals are now expecting two years' worth of consultation to bear fruit in the forthcoming Budget, resulting in a simplification of the way in which UK companies obtain relief for foreign taxes.

The Inland Revenue has indicated that it does not favour an exemption from UK tax for overseas dividends - a system used by many EU countries such as Germany. It is likely therefore that the existing system, giving credit for withholding taxes and for 'underlying tax' on the profits of the overseas company, will be maintained but modified to remove some of the traps and pitfalls which can currently prevent companies gaining the expected benefit.

Joy Svasti-Salee, partner in charge of KPMG's International Tax Group, said: 'It is also likely that the Inland Revenue will want to tighten up some areas where it perceives the current system to be open to abuse. If past experience is anything to go by, multinationals will need to beware that they do not fall foul of detailed provisions which can easily penalise legitimate transactions.

As smaller companies become more involved in international trade the pressure is on the Inland Revenue to provide a simple method for obtaining relief from double taxation for smaller companies, so that they can have the relief without the need to maintain complex group structures. However the Inland Revenue has indicated that a price may have to be paid for any such simplification. This may take the form of the disallowance of losses incurred in overseas branches, thus increasing the costs of overseas investment for entrepreneurial companies. We would view such a measure as a retrograde step.'

Multinationals will also be expecting to see measures to improve the operation of the single market from a corporation tax perspective. Some significant changes are expected to deal with the ramifications of the landmark ICI v Colmer case (which ruled that the UK law on group relief discriminated against non-UK companies) and with other European Court of Justice rulings - the long reach of EU law may well be seen throughout the Budget. The danger for the Government is that if it does not go far enough it will place UK companies at a competitive disadvantage in the EU and risk an avalanche of litigation.

David Evans, a Director in KPMG's International Tax Group, said: 'One change we do expect as a result of the ICI case concerns the transfer of losses between members of a group of companies. Legislation currently covers the situation when a group has a UK parent but not when the parent is an EU (non-UK) company. The Inland Revenue has already announced that the relief will be extended to cover this situation. However, EU banks which operate through branches in the UK are at a disadvantage because the relief does not extend to the transfer of losses between a branch and a subsidiary. The Inland Revenue is under great pressure in this area and may face litigation if it does not change its view.

Another area concerns the capital gains review for companies. We consider that current UK law, which can result in tax charges on transfers of assets within a UK/EU group, is contrary to EU law. We hope that legislation is introduced in this area to pre-empt litigation and ensure that UK companies can benefit more from the single market and not be at a competitive disadvantage.'

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28 February 2000 - Inland Revenue - Tax treatment of compensation for mis-sold Free-Standing Additional Voluntary Contribution Schemes (FSAVCS)

Lump sum compensation for mis-sold FSAVCS under the current review ordered by the Financial Services Authority and the Personal Investment Authority will be exempt from tax under an extra-statutory concession.

The Court of Appeal has held in the Victor Chandler case that advertising in the UK of offshore betting, using electronic media such as teletext, is illegal.

Under a new Double Contributions Convention (not yet in force) individuals going to work in Japan from the UK, or coming to the UK from Japan, will only be liable to social security contributions in their home country.

The Tax Law Rewrite Project has published its ninth exposure draft, dealing with capital allowances. For further details, see last week's Weekly Tax Briefing.

New editions of IR1 'Extra-Statutory Concessions' and IR131 'Statements of Practice' have been issued. Certain concessions relating to loan and money societies and to holiday clubs and thrift funds are being withdrawn from April 2001.

For further information about any of the items mentioned, please get in touch with your usual KPMG Tax Advisers contact.

This Briefing is intended to provide a general guide to the subject matter and should not be regarded as a basis for ascertaining the liability to tax or determining investment strategy in specific circumstances. In such instances separate advice should be taken.