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Tax breaks to US companies: trade war looms?

A continuing $6bn subsidy maybe isn't quite what the WTO had in mind...

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A major trade war may be looming between the US and the European Union over billions of dollars of tax breaks for exports by major US companies like Microsoft and Intel.

Yesterday the US Senate Finance Committee gave the nod to proposed new legislation that would transform the vexed Foreign Sales Corporation export tax break scheme. earlier, the World Trade Organisation (WTO) had decided the scheme was illegal under its rules. The decision was the result of a complaint to the WTO from the EU - with the US losing the subsequent appeal.

The US legislation was passed by the Senate before the 1 October WTO deadline (it has already received approval in the House), but it will need to get agreement from the European Commission. This is in some doubt because major US exporters will still get some $6 billion of export subsidies, albeit not through the former off-shore corporations in tax havens. The EU does not think that the proposed new law meets the WTO requirements, since broadly the same amount of subsidy is being given by the US government for export sales, just by a different mechanism. At present the US is proposing that certain categories of foreign income would not be subject to US tax, thus avoiding the use of tax havens.

The EU could well make another complaint to the WTO in an effort to get fairer treatment. It has however indicated that it would not act heavy-handedly on 1 October and impose sanctions immediately against US exports to the EU, but first try to seek an amicable agreement for compensation. For its part, during the banana and hormone-infested beef wars, the US jumped the gun and imposed sanctions on a variety of EU exports to the US, before it was authorised to do so by the WTO.

Microsoft had some related bad news last week: the royalties it receives from exporting software master copies will not get tax breaks under the FSC rules. The decision was made by the US Tax Court, following an action by the US Internal Revenue Service. The court decided that the code was not export property and remained the property of Microsoft: it was just copyrighted material. Curiously, copyrights on films and sound recordings are given this favourable tax treatment because such material may not be copied.

The cost to Microsoft will be small change - some $7 million for 1990 and 1991 - but this does give an interesting insight into the slowness of the US judicial system. The timing of the decision suggests that the US wanted to be seen to be enforcing its FSC rules, which came about as a counter to what the US regards as EU subsidies for the common agricultural policy, as well as state aid, when for example France bailed out some of its present or former state-owned organisations like Bull, Air France and semi-bankrupt banks.

In another significant trade development yesterday, the US Senate agreed to grant China permanent normal trade relations, which is widely expected to be a final step before China is admitted to the WTO. Microsoft has been an active supporter of China's desire to join the WTO, principally because it hopes that as a result of the WTO TRIPS (Trade Related Aspects of Intellectual Property Rights) rules, China can be forced to get tough over software piracy.

The US government has already said it will be proposing that China accepts help from the US Patent and Trademark Office - but US corporations could find the Chinese challenging them over some existing software patents if the US companies try to enforce them in China.

Microsoft estimates that more than 90 per cent of its software in China is pirated. It is also important for Microsoft to compete with the rise of Linux in China, but this may prove to be difficult in view of the cost of Windows and the difficulty it has in trying to get Windows pre-loaded. ®

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