THE U.S. INTERNATIONAL TAX RULES:

BACKGROUND, DATA, AND SELECTED ISSUES

RELATING TO THE COMPETITIVENESS OF

U.S.-BASED BUSINESS OPERATIONS

Scheduled for a Public Hearing

Before the

SENATE COMMITTEE ON FINANCE

on July 8, 2003

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

July 3, 2003

JCX-67-03
i

CONTENTS

Page

INTRODUCTION .......................................................................................................................... 1

I. BACKGROUND: THE U.S. INTERNATIONAL TAX SYSTEM............................................ 2

A. Tax Treatment of Foreign Activities of U.S. Persons......................................................... 2

B. Tax Treatment of U.S. Activities of Foreign Persons......................................................... 6

C. Transfer Pricing................................................................................................................... 6

D. Treaties................................................................................................................................ 6

II. BACKGROUND AND DATA RELATING TO INTERNATIONAL TRADE AND 

INVESTMENT............................................................................................................................... 8

A. Trade Deficits and Cross-Border Capital Flows................................................................. 8

B. Trends in the United States' Balance of Payments............................................................ 14

C. Trends in the United States' Financial Account ................................................................ 29

D. Background Data Relating to Foreign Sales Corporations ............................................... 59

III. SELECTED ISSUES .............................................................................................................. 78

A. The FSC-ETI Dispute ....................................................................................................... 78

B. Base Erosion Through Earnings Stripping and Offshore Reinsurance Transactions ....... 87

APPENDIX................................................................................................................................. A-1
1

INTRODUCTION

The Senate Committee on Finance has scheduled a public hearing for July 8, 2003, on the 

effects of the U.S. international tax rules on the competitiveness of U.S.-based business 

operations. This document, 1 prepared by the staff of the Joint Committee on Taxation, provides 

general background and data relating to these rules, and specific discussions of the FSC-ETI 

controversy and certain base-erosion issues.

 

1

 This document may be cited as follows: Joint Committee on Taxation, The U.S. 

International Tax Rules: Background, Data, and Selected Issues Relating to the Competitiveness 

of U.S.-Based Business Operations (JCX-67-03), July 3, 2003.
2

I. BACKGROUND: THE U.S. INTERNATIONAL TAX SYSTEM

A. Tax Treatment of Foreign Activities of U.S. Persons

In general

The United States employs a “worldwide” tax system, under which domestic corporations 

generally are taxed on all income, whether derived in the United States or abroad. Income 

earned by a domestic parent corporation from foreign operations conducted by foreign corporate 

subsidiaries generally is subject to U.S. tax when the income is distributed as a dividend to the 

domestic corporation. Until such repatriation, the U.S. tax on such income generally is deferred. 

However, certain anti-deferral regimes may cause the domestic parent corporation to be taxed on 

a current basis in the United States with respect to certain categories of passive or highly mobile 

income earned by its foreign subsidiaries, regardless of whether the income has been distributed 

as a dividend to the domestic parent corporation. The main anti-deferral regimes in this context 

are the controlled foreign corporation rules of subpart F2

 and the passive foreign investment 

company rules.3 A foreign tax credit generally is available to offset, in whole or in part, the U.S. 

tax owed on foreign-source income, whether earned directly by the domestic corporation, 

repatriated as an actual dividend, or included under one of the anti-deferral regimes.4

Foreign tax credit

The United States generally provides a credit for foreign income taxes paid or accrued.5 

In the case of foreign income taxes paid or accrued by a foreign subsidiary, a U.S. parent 

corporation is generally entitled to a “deemed paid” credit for such taxes when it receives an 

actual or deemed distribution of the underlying earnings from the foreign subsidiary.6 The 

foreign tax credit generally is limited to the U.S. tax liability on a taxpayer’s foreign-source 

income, in order to ensure that the credit serves its purpose of mitigating double taxation of 

foreign-source income without offsetting the U.S. tax on U.S.-source income.7 

Due to this limitation, a taxpayer must allocate gross income and expenses between U.S. 

and foreign sources in order to determine the amount of allowable foreign tax credits. Under 

present law, interest expense that a U.S.-based multinational corporate group incurs in the United 

States is allocated to U.S. and foreign sources based on the gross assets located in the United 

 

2

 Secs. 951-964.

3

 Secs. 1291-1298.

4

 Secs. 901, 902, 960, 1291(g).

5

 Sec. 901.

6

 Secs. 902, 960.

7

 Secs. 901, 904. 
3

States relative to those located abroad (measured either by basis or by fair market value).8 Thus, 

a U.S.-based multinational with a significant portion of its assets overseas must allocate a 

significant portion of its U.S. interest expense to foreign-source income, which reduces the 

foreign tax credit limitation and thus the credits allowable (even though the interest expense 

incurred in the United States is not deductible in computing the actual tax liability under 

applicable foreign law). 

The foreign tax credit limitation is applied separately to different types of foreign-source 

income, in order to reduce the extent to which excess foreign taxes paid in a high-tax foreign 

jurisdiction can be “cross-credited” against the residual U.S. tax on low-taxed foreign-source 

income. For example, if a taxpayer pays foreign tax at an effective rate of 45 percent on certain 

active income earned in a high-tax jurisdiction, and pays little or no foreign tax on certain 

passive income earned in a low-tax jurisdiction, then the earning of the untaxed (or low-taxed) 

passive income could expand the taxpayer’s ability to claim a credit for the otherwise 

uncreditable excess foreign taxes paid to the high-tax jurisdiction, by increasing the foreign tax 

credit limitation without increasing the amount of foreign taxes paid. This sort of cross-crediting 

is constrained by rules that require the computation of the foreign tax credit limitation on a 

category-by-category basis.9 Thus, in the example above, the rules would place the passive 

income and the active income into separate limitation categories (or “baskets”), and the lowtaxed passive income would not be allowed to increase the foreign tax credit limitation 

applicable to the credits arising from the high-taxed active income. Present law provides nine 

separate baskets as a general matter, and effectively many more in situations in which various 

special rules apply.10

If a taxpayer generates an overall foreign loss (“OFL”) for the year -- whether as the 

result of business losses or expense allocations under U.S. tax rules -- it will not be able to claim 

foreign tax credits for that year, since it will have no foreign-source income and thus will have a 

foreign tax credit limitation of zero. Moreover, if the taxpayer does generate foreign-source 

income in later years, some portion of such income will be “recaptured,” or recharacterized as 

U.S.-source, thus reducing the foreign tax credit limitation in later years.11 The rationale for 

OFL recapture is that the foreign-source losses offset U.S.-source income in the year generated, 

thereby reducing the U.S. tax collected with respect to U.S.-source income. The U.S. fisc would 

not be made whole when the taxpayer subsequently earns foreign-source income if the U.S. taxes 

on such income were completely offset by foreign tax credits.

 

8

 Sec. 864(e); Temp. Reg. sec. 1.861-11T.

9

 Sec. 904(d).

10

 Id.

11 Sec. 904(f). These rules also operate on a category-by-category basis.
4

Anti-deferral regimes

In general

Generally, income earned indirectly by a domestic corporation through a foreign 

corporation is subject to U.S. tax only when the income is distributed to the domestic 

corporation, because corporations generally are treated as separate taxable persons for Federal 

tax purposes. However, this deferral of U.S. tax is limited by anti-deferral regimes that impose 

current U.S. tax on certain types of income earned by certain corporations, in order to prevent 

taxpayers from avoiding U.S. tax by shifting passive or other highly mobile income into low-tax 

jurisdictions. Deferral of U.S. tax is considered appropriate, on the other hand, with respect to 

most types of active business income earned abroad.

Subpart F

Subpart F,12 applicable to controlled foreign corporations and their shareholders, is the 

main anti-deferral regime of relevance to a U.S.-based multinational corporate group. A 

controlled foreign corporation generally is defined as any foreign corporation if U.S. persons 

own (directly, indirectly, or constructively) more than 50 percent of the corporation’s stock 

(measured by vote or value), taking into account only those U.S. persons that own at least 10 

percent of the stock (measured by vote only).13 Under the subpart F rules, the United States 

generally taxes the U.S. 10-percent shareholders of a controlled foreign corporation on their pro 

rata shares of certain income of the controlled foreign corporation (referred to as “subpart F 

income”), without regard to whether the income is distributed to the shareholders.14 

Subpart F income generally includes passive income and other income that is readily 

movable from one taxing jurisdiction to another. Subpart F income consists of foreign base 

company income,15 insurance income,16 and certain income relating to international boycotts and 

other violations of public policy.17 Foreign base company income consists of foreign personal 

holding company income, which includes passive income (e.g., dividends, interest, rents, and 

royalties), as well as a number of categories of non-passive income, including foreign base 

company sales income, foreign base company services income, foreign base company shipping 

income and foreign base company oil-related income.18 

 

12 Secs. 951-964.

13 Secs. 951(b), 957, 958.

14 Sec. 951(a).

15

 Sec. 954.

16 Sec. 953.

17 Sec. 952(a)(3)-(5).

18 Sec. 954.
5

In effect, the United States treats the U.S. 10-percent shareholders of a controlled foreign 

corporation as having received a current distribution out of the corporation's subpart F income. 

In addition, the U.S. 10-percent shareholders of a controlled foreign corporation are required to 

include currently in income for U.S. tax purposes their pro rata shares of the corporation's 

earnings invested in U.S. property. 19

Passive foreign investment companies

The Tax Reform Act of 1986 established an anti-deferral regime for passive foreign 

investment companies. A passive foreign investment company generally is defined as any 

foreign corporation if 75 percent or more of its gross income for the taxable year consists of 

passive income, or 50 percent or more of its assets consists of assets that produce, or are held for 

the production of, passive income.20 Alternative sets of income inclusion rules apply to U.S. 

persons that are shareholders in a passive foreign investment company, regardless of their 

percentage ownership in the company. One set of rules applies to passive foreign investment 

companies that are “qualified electing funds,” under which electing U.S. shareholders currently 

include in gross income their respective shares of the company’s earnings, with a separate 

election to defer payment of tax, subject to an interest charge, on income not currently 

received.21 A second set of rules applies to passive foreign investment companies that are not 

qualified electing funds, under which U.S. shareholders pay tax on certain income or gain 

realized through the company, plus an interest charge that is attributable to the value of 

deferral.22 A third set of rules applies to passive foreign investment company stock that is 

marketable, under which electing U.S. shareholders currently take into account as income (or 

loss) the difference between the fair market value of the stock as of the close of the taxable year 

and their adjusted basis in such stock (subject to certain limitations), often referred to as 

“marking to market.”23

Coordination

Detailed rules for coordination among the anti-deferral regimes are provided to prevent 

U.S. persons from being subject to U.S. tax on the same item of income under multiple regimes. 

For example, a corporation generally is not treated as a passive foreign investment company with 

respect to a particular shareholder if the corporation is also a controlled foreign corporation, and 

the shareholder is a “U.S. shareholder” as defined in section 951(b). Thus, subpart F is allowed 

to trump the passive foreign investment company rules. 

 

19 Secs. 951(a)(1)(B), 956.

20 Sec. 1297.

21 Sec. 1293-1295.

22 Sec. 1291.

23 Sec. 1296.
6

B. Tax Treatment of U.S. Activities of Foreign Persons

The United States asserts taxing jurisdiction over nonresident alien individuals and 

foreign corporations (“foreign persons”) only with respect to income that has a sufficient nexus 

to the United States. Foreign persons are subject to U.S. tax on income that is “effectively 

connected” with the conduct of a trade or business in the United States. Effectively connected 

income generally is taxed in the same manner and at the same rates as the income of a U.S. 

person.

Foreign persons are also subject to a gross-basis U.S. tax at a 30-percent rate on certain 

categories of non-effectively-connected income derived from U.S. sources (interest, dividends, 

rents, royalties, and other similar types of income), subject to a few exceptions. One major 

exception is that certain types of interest (for example, interest from certain bank deposits and 

from certain portfolio obligations) are not subject to the tax. The tax generally is collected by 

means of withholding by the person making the payment to the foreign person receiving the 

income.

C. Transfer Pricing

Due to the variation in tax rates and tax systems among countries, a multinational 

enterprise, whether U.S.-based or foreign-based, may have an incentive to shift income, 

deductions, or tax credits among commonly controlled entities in order to arrive at a reduced 

overall tax burden. Such a shifting of items between commonly controlled entities could be 

accomplished by establishing artificial, non-arm’s-length (i.e., non-market) prices for 

transactions between group members.

Under section 482, the Secretary of the Treasury is authorized to redetermine the income 

of an entity subject to U.S. taxation when necessary to prevent an improper shifting of income 

between that entity and a commonly controlled entity. The statute generally does not prescribe 

any specific reallocation rules that must be followed, other than establishing the general 

standards of preventing tax evasion and clearly reflecting income. Treasury regulations adopt 

the concept of an arm's length standard as the method for determining whether reallocations are 

appropriate. Thus, the regulations generally attempt to identify the respective amounts of taxable 

income of the related parties that would have resulted if the parties had been uncontrolled parties 

dealing at arm's length. Special transfer pricing rules apply to transactions involving intangible 

property and services. These transactions present particular challenges to the administration of 

the arm’s length standard, since intangibles and services may be unique, thus rendering a 

comparison with third-party market transactions difficult or impossible. 

D. Treaties

In addition to the U.S. and foreign statutory rules for the taxation of foreign income of 

U.S. persons and U.S. income of foreign persons, bilateral income tax treaties limit the amount 

of income tax that may be imposed by one treaty partner on residents of the other treaty partner. 

For example, treaties often reduce or eliminate withholding taxes imposed by a treaty country on 

certain types of income (e.g., dividends, interest and royalties) paid to residents of the other 

treaty country. Treaties also contain provisions governing the creditability of taxes imposed by 
7

the treaty country in which income was earned in computing the amount of tax owed to the other 

country by its residents with respect to such income. Treaties further provide procedures under 

which inconsistent positions taken by the treaty countries with respect to a single item of income 

or deduction may be mutually resolved by the two countries.
8

II. BACKGROUND AND DATA RELATING TO INTERNATIONAL

TRADE AND INVESTMENT

This part presents background data relating to the scope of the international trade sector 

in the United States economy. This part discusses the economic relationship between trade 

deficits, capital inflows, investment, and savings in the economy. It briefly reviews trends in 

both the current account (the trade surplus or deficit) and the financial account24 (U.S. 

investment abroad and foreign investment in the United States). It also provides some evidence 

on the extent to which U.S. business have utilized FSCs and descriptive statistics of corporations 

that have utilized FSCs.

A. Trade Deficits and Cross-Border Capital Flows

National income accounting

In popular discussion of trade issues, much attention is given to the trade deficit or 

surplus, that is, the difference between the exports and imports of the economy. In the late 

1980s, there was also attention given to inflows of capital from abroad. Capital inflows can take 

the form of foreign purchases of domestic physical assets, of equity interests, or of debt 

instruments. These two phenomena, trade balances and capital inflows, are not independent, but 

are related to each other. Trade deficits, capital inflows, investment, savings, and income are all 

connected in the economy. The connection among these economic variables can be examined 

through the national income and product accounts, which measure the flow of goods and services 

and income in the economy.25

 

24 Prior to 1999, the U.S. Department of Commerce, Bureau of Economic Analysis 

reported and described international transactions by reference to the “current account” and the 

“capital account.” Beginning in June 1999 the Bureau of Economic Analysis adopted a threegroup classification to make U.S. data reporting more closely aligned with international 

guidelines. The three groups are labeled: current account; capital account; and financial 

account. Under this regrouping, the “financial account” encompasses all transactions that used 

to fall into the old “capital account,” that is, the financial account measures U.S. investment 

abroad and foreign investment in the United States. Under the new system, the “current 

account” is redefined by removing a small part of the old measure of unilateral transfers and 

including it in the newly defined “capital account.” The newly defined capital account consists 

of capital transfers and the acquisition and disposal of non-produced, non-financial assets. For 

example, the newly defined capital account includes such transactions as forgiveness of foreign 

debt, migrants’ transfers of goods and financial assets when entering or leaving the country, 

transfers of title to fixed assets, and the acquisition and disposal of non-produced assets such as 

natural resource rights, patents, copyrights, and leases. In practice, the Bureau of Economic 

Analysis believes that newly defined “capital account” transactions will be small in comparison 

to the current account and financial account.

25 The national income and product accounts measure the flow of goods and services 

(product) and income in the economy. The most commonly reported measure of national 
9

The value of an economy's total output must be either consumed domestically (by private 

individuals and government), invested domestically, or exported abroad. If an economy 

consumes and invests more than it produces, it must be a net importer of goods and services. If 

the imports were all consumption goods, in order to pay for those imports, the country must 

either sell some of its assets or borrow from foreigners. If the imports were investment goods, 

foreign persons would own the investments. Thus, an economy that runs a trade deficit will also 

experience foreign capital inflows as foreign persons purchase domestic assets, make equity 

investments or lend funds (purchase debt instruments).

 

economic income is gross domestic product (GDP). Related to GDP is gross national product 

(GNP). GNP is GDP plus the net factor income received by residents of United States from 

abroad. Thus, wages earned by a U.S. resident from temporary work abroad constitutes part of 

GNP but not GDP. Similarly, the returns from investment abroad constitute part of GNP but not 

GDP. To help understand the connection between trade deficits and cross border capital flows, 

in the following it is useful to use GNP, which includes cross border returns to investment, rather 

than the more commonly reported GDP concept. The GNP of the economy is the total annual 

value of goods and services produced by the economy and may be measured in several ways. 

One way to measure GNP is by expenditures on final product. By this measure, 

(1) GNP = C + I + G + (X-M) + NI. 

Equation (1) is an accounting identity which states that gross national product equals the 

sum of private consumption expenditures (C), private investment expenditures on plant, 

equipment, inventory, and residential construction (I), government purchases of goods and 

services (G), net exports (exports less imports of goods and services and net interest payments to 

foreigners, or X-M), plus net investment income (the excess of investment income received from 

abroad over investment income sent abroad or NI). 

An alternative is to measure GNP by the manner in which income is spent. By this 

measure, 

(2) GNP = C + S + T. 

Equation (2) is another accounting identity which states that gross national product equals 

the sum of private consumption expenditures (C), saving by consumers and businesses (S), and 

net tax payments to the government (T) (net tax payments are total tax receipts less transfer, 

interest, and subsidy payments made by all levels of government). 

Because both measures of GNP are simple accounting identities, the right hand side of 

equation (1) must equal the right hand side of equation (2). From this observation can be derived 

an additional national income accounting identity: 

(3) I = S + (T - G) + (M - X) - NI 

Equation (3) states that private investment equals private saving (S), plus public saving 

(T-G) and net imports (M - X), less net investment income.
10

For example, when the United States imports more than it exports, the United States pays 

for the imports with dollars. If foreigners are not buying goods with the dollars, then they will 

use the dollars to purchase U.S. assets. (An alternate way of viewing these relationships is that 

dollars flowing out of the U.S. economy in order to purchase goods or to service foreign debt 

must ultimately return to the economy as payment for exports or as capital inflows.)

The previous discussion focuses on the disposition of the economy's output. If the 

economy is a net importer, it must attract capital inflows to pay for those imports. If the 

economy is a net exporter, it must have capital outflows to dispose of the payments it receives 

for its exports. Another way of looking at the connection between capital flows and the goods 

and services in the economy is to concentrate on the sources of funds for investment. Because 

domestic investment must be financed either through saving or foreign borrowing, net capital 

inflows must also equal the difference between domestic investment and saving.

These relationships can be summarized as follows (the equation ignores relatively small 

unilateral transfers such as foreign aid and assumes, without loss of generality, that the 

government budget is balanced):

Net Foreign Borrowing = Investment - Saving

= (Imports - Exports) - Net Investment Income

For this purpose, imports and exports include both goods and services, and net 

investment income is equal to the excess of investment income received from abroad over 

investment income sent abroad.26 The excess of imports over exports is called the trade deficit in 

goods and services. Net investment income can be viewed as payments received on previouslyacquired foreign assets (foreign investments) less payments made to service foreign debt.

If the investment in an economy is larger than that country's saving, the country must 

either be running a trade deficit or the economy is increasing its foreign borrowing. Similarly, a 

country cannot run a trade surplus without also exporting capital, either by increasing its foreign 

investments, or by servicing previously-acquired foreign debt. Because the level of net 

investment income in any year is fixed by the level of previous foreign investment (except for 

changes in interest rates), changes in investment or saving that are associated with capital 

inflows will have a negative impact on a country's trade balance.

Economic implications of trade deficits

A trade deficit is not necessarily undesirable. What is important is the present and future 

consumption possibilities of the economy. That will depend in part on whether the trade deficit 

is financing consumption or investment. For example, if a country uncovers profitable 

investment opportunities, then it will be in that country's interest to obtain funds from abroad to 

 

26 This equation in the text can be seen from equation (3) in footnote 14 above if the 

government budget is assumed to be balanced, that is, if G = T. It follows that if the government 

runs a deficit, that is, if G>T, for a given level of investment, saving, and net investment income, 

net foreign borrowing must be greater. 
11

invest in these profitable projects.27 If the economy currently does not have enough domestic 

savings to invest in these projects, it could reduce its consumption (generating more domestic 

saving) or look to foreign sources of funds (thus allowing investment without reducing current 

consumption). For example, suppose new oil reserves that could be profitably recovered through 

increased investment are discovered in the United States. The investment may be financed by 

foreigners. In order to invest in U.S. assets, foreigners will have to buy dollars, thus increasing 

the value of the dollar. This dollar appreciation makes U.S. goods more expensive to foreigners, 

thereby reducing their demand for U.S. exports. At the same time, the dollar appreciation makes 

foreign goods cheaper for U.S. residents, increasing the demand for imports and resulting in a 

trade deficit. Eventually, the flow of capital will be reversed, as the U.S. demand for new 

investment falls, and foreigners receive interest and dividend payments on their previous 

investments.

The foreign borrowing in the above example was used to finance investment. This 

borrowing did not reduce the living standards of current or future U.S. residents, because the 

interest and dividends that were paid to foreigners came from the return from the new 

investment. If foreign borrowing finances consumption instead of investment, there are no new 

assets created to generate a return that can support the borrowing. When the debt eventually is 

repaid, the repayments will come at the expense of future consumption. For instance, consider a 

situation in which the domestic supply of funds for investment decreases because domestic 

saving rates fall. Foreign borrowing in this case is not associated with increased investment, but 

instead is devoted to investment that was previously financed with domestic savings. Because 

the foreign borrowing is not associated with increased investment, future output does not 

increase, and interest and dividends on the investment will be paid to foreign persons at the 

expense of future domestic consumption. In this case, there may be an increase in the standard 

of living for current U.S. residents at the expense of a decrease in the standard of living of future 

residents.

During the period that foreign borrowing finances U.S. consumption, the United States 

runs a trade deficit. Although the United States could service its growing foreign debt by 

increased borrowing, and hence larger trade deficits, in the long run trade deficits cannot keep 

growing. In fact, the United States must eventually run a trade surplus. If the United States 

imported more goods than it exported every year, there also would be an inflow of foreign 

capital every year. This capital inflow would be growing with the increasing costs of servicing 

the foreign debt. Eventually, foreigners would be unwilling to continue lending to the United 

States, and the value of the dollar would fall. The fall in the dollar would eliminate the trade 

deficit, and the United States would eventually run a trade surplus, so that the current account 

deficit (the sum of the trade deficit in goods and services and the net interest on foreign 

obligations) would be small enough for foreigners to be willing to lend again to the United 

States.

Even when foreign investment finances domestic consumption, trade deficits and capital 

inflows themselves should not necessarily be viewed as undesirable, because the foreign capital 

 

27 This scenario describes the experience of the United States in the mid to late 1800s, 

when foreign capital inflows financed much of the investment in railroads and other assets. 
12

inflows help to keep domestic investment, and hence labor productivity, from falling. For 

instance, the large inflow of foreign capital to the United States in the 1980s is widely viewed to 

be a result of low U.S. saving rates. If the mobility of foreign capital had been restricted 

(through capital or import controls, for example), then the low saving rate could have led to 

higher domestic interest rates and lower rates of investment. That decreased investment would 

have led to decreases in future living standards because the lower growth rate of the capital stock 

would have resulted in lower growth rates of U.S. labor productivity. The fact that foreign 

capital was not restricted and did finance U.S. investment helped mitigate the negative effects on 

economic growth of low domestic saving.

The above observations support the argument that the trade deficit does not in itself 

provide a useful measure of international competitiveness, since trade deficits and trade 

surpluses can be either good or bad for the United States. The example of oil discovery 

discussed above shows that even increases in a country's stock of exportable goods can have 

ambiguous effects on the trade deficit. If the discovery of oil also increases the demand for 

investment, then the trade deficit may actually increase in the short run. Increases in natural 

resources, advances in technology, increases in worker efficiency, and other wealth-enhancing 

innovations have ambiguous effects on the trade deficit in the short and medium run. Because 

these innovations increase the productivity of U.S. workers and lower production costs, they 

increase the attractiveness of U.S. goods, and may result in increased exports. To the extent 

these innovations increase the demand for investment, however, they can have the opposite 

effect on the trade deficit. Nonetheless, each of these innovations increases the output of the 

economy, and hence the incomes of U.S. residents.

The balance of payments accounts, presented in Table 1, are analogous to a sources and 

uses of funds statement of the United States with the rest of the world. As demonstrated above, 

the current account balance, which consists primarily of the trade balance, should be exactly 

offset by the capital account and financial account balances, which measure the net inflow or 

outflow of capital to or from the United States. The difference between the current account 

surplus or deficit and the capital and financial accounts deficit or surplus is recorded as a 

statistical discrepancy. Problems of measurement, which have been large in some years, cause 

the accounts to be somewhat mismatched in practice, but basic patterns are unlikely to be 

significantly distorted by these problems. The subsequent sections examine trends in the current 

account and financial account in more detail.
13

Table 1 – International Transactions of the United States, Selected Years,

1975-2000

($ Billions nominal)

1975 1985 1995 2000

Current Account Balance

Exports of Goods and Services

Merchandise

Services

Receipts from U.S. assets abroad

Imports of Goods and Services

Merchandise

Services

Payments on foreign-owned U.S. assets

18.1

157.9

107.1

25.5

25.4

132.7

98.2

22.0

12.6

-118.2

387.6

215.9

73.2

98.5

483.8

338.1

72.9

72.8

-109.9

1,005.9

575.2

219.2

211.5

1,081.8

749.4

141.4

191.0

-444.7

1,418.6

772.2

293.5

352.9

1,809.1

1,224.4

217.0

367.7

Unilateral Transfers 7.1 22.0 34.1 54.1

Financial Account Balance

Foreign Investment in the United States

Direct Investment

Private non-direct investment

Official

-22.5

17.2

2.6

7.5

7.0

101.3

146.1

19.7

127.5

-1.1

113.3

465.7

57.8

298.0

109.9

443.2

1,024.2

287.7

700.2

37.6

U.S. Investment Abroad

Direct Investment

Private non-direct investment

Increase in governme nt assets

39.7

14.2

21.1

4.3

44.8

18.9

19.1

6.7

352.4

98.8

242.9

10.7

581.0

152.4

427.3

1.2

Capital Account Transactions, net n.a. 0.3 0.4 0.7

Statistical Discrepancy 4.4 16.5 3.8 0.7

Source: Douglas B. Weinberg, “U.S. International Transactions, First Quarter 2001,” Survey of Current Business, 

81, July 2001, pp. 37-81.

n.a. - not applicable
14

B. Trends in the United States' Balance of Payments

Overview of U.S. balance of payments (current account)

Foreign trade has become increasingly important to the United States economy. Figure 1

presents the value of exports from the United States and imports into the United States as a 

percentage of GDP for the period 1960-2001.28 As depicted in Figure 1, exports and imports 

each have risen from less than six percent of GDP in 1960 to more than 12 percent in 2001. 

Figure 1 also shows that the United States generally was a net exporter of goods and services 

prior to 1982. Since that time, the United States has been a net importer of goods and services.

Figure 1

Source: Department of Commerce, Bureau of Economic Analysis.

 

28 Data for Figure 1 are from the U.S. Commerce Department, Bureau of Economic 

Analysis and are reprinted in Appendix 1and Appendix 2.

Exports and Imports as a Percentage of United States GDP, 1960-2001

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage of GDP

Imports

Exports
15

The net trade position of a country is commonly summarized by its current account. The 

U.S. current account as a whole, which compares exports of goods and services and income 

earned by U.S. persons on foreign investments to imports of goods and services and income 

earned by foreign persons on their investments in the United States (plus unilateral remittances), 

generally was positive from 1960 through 1981, but generally has been in deficit by over $90 

billion per year 13 times since 1984. Figure 2 reports the current account balance of the United 

States for the period 1960 through 2001 in nominal (non-inflation-adjusted) dollars.29 Figure 3

presents the same data as a percentage of GDP to eliminate the effect of inflation on reported 

nominal figures. Figure 2 and Figure 3, like Figure 1, show the United States' change in status 

from net exporter to net importer since the early 1980s. Figure 2 and Figure 3 reflect a 

substantial reduction in the current account deficit for 1992. In that year, the United States 

received substantial payments from abroad related to the Persian Gulf War. 

Figure 2

Source: Department of Commerce, Bureau of Economic Analysis.

 

29 Data for Figure 2 and Figure 3 are from the U.S. Commerce Department, Bureau of 

Economic Analysis and are reprinted in Appendix 1. 

United States Current Account Balance, 1960-2001

[millions nominal dollars]

-500,000

-400,000

-300,000

-200,000

-100,000

0

100,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Millions of Dollars
16

Figure 3

Source: Department of Commerce, Bureau of Economic Analysis.

United States Current Account Balance as a Percentage of GDP, 1960-2001

(percent)

-5.00

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Percentage
17

Components of the current account

Merchandise trade, trade in services, and income from investments

The aggregate data reported in Figure 1, Figure 2, and Figure 3 mask differences in the 

trade position of various sectors of the economy. As explained above, the current account 

compares exports of goods and services and payments of income earned by U.S. persons on 

foreign investments to imports of goods and services and payments of income earned by foreign 

persons on their investments in the United States. Figure 4 and Figure 5 separately chart the 

nominal dollar value of exported and imported goods referred to as “merchandise trade” (Figure 

4) and merchandise trade as a percentage of GDP (Figure 5). Figure 6 and Figure 7 separately 

chart exported and imported services in nominal dollars and as a percentage of GDP. Figure 8

and Figure 9 separately chart investment income earned by U.S. and foreign persons in nominal 

dollars and as a percentage of GDP.30 The sum of the export curves in, Figure 4, Figure 5, 

Figure 6, Figure 7, Figure 8, and Figure 9 less the sum of the import curves (plus unilateral 

remittances) equals the current account balance curves of Figure 2 and Figure 3.

Figure 4, Figure 5, Figure 6, Figure 7, Figure 8, and Figure 9 reveal different trends. As 

has been widely reported, the merchandise (goods only) trade deficit has been over $100 billion 

per year since 1984 and over $500 billion per year since 1996. On the other hand, the United 

States has been a net exporter of services since the mid-1970s (Figure 6 and Figure 7). Only 

since 1998 have payments of income to foreign persons on their U.S. investments exceeded U.S. 

receipts of income on investments abroad (Figure 8 and Figure 9).

 

30 Data for Figure 4, Figure 5, Figure 6, Figure 7, Figure 8, and Figure 9 are from the 

U.S. Commerce Department, Bureau of Economic Analysis and are reprinted in Appendix 1.
18

Figure 4

Source: Department of Commerce, Department of Economic Analysis.

U.S. Merchandise Trade, 1960-2001

[millions nominal dollars]

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Millions of Dollars

Exports

Imports
19

Figure 5

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Merchandise Trade as a Percentage of GDP, 1960-2001

(percent)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage

Merchandise Exports

Merchandise Imports
20

Figure 6

Source: Department of Commerce, Bureau of Economic Analysis.

Trade in Services, 1960-2001

[millions nominal dollars]

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Year

Millions of Dollars

Service Exports

Service Imports
21

Figure 7

Source: Department of Commerce, Bureau of Economic Analysis.

Trade in Services as a Percentage of GDP, 1960-2001

(percent)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage

Service Exports

Service Imports
22

Figure 8

Source: Department of Commerce, Bureau of Economic Analysis.

Receipts of Income from Abroad and U.S. Payments to Foreign Persons, 1960-2001

[millions nominal dollars]

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Millions of Dollars

U.S. receipts from abroad

U.S. payments to foreigners
23

Figure 9

Source: Department of Commerce, Bureau of Economic Analysis.

Intra-firm trade

These aggregate data also do not reveal the extent to which growing trade flows result 

from trade between related parties. For example, a domestic company might ship components 

manufactured in the United States to its foreign subsidiary for final assembly and sale. Such 

shipments would be counted as exports from the United States. A domestic company might 

produce components abroad and ship them to the United States for final assembly and sale. Such 

shipments would be counted as imports to the United States. Likewise, a foreign parent 

company might ship components from abroad to its U.S. affiliate for final assembly and sale in 

the United States. Such shipments would be counted as imports into the United States. The 

foreign affiliate might ship components to another country for assembly and sale. Such 

shipments would be counted as exports from the United States.

Receipts of Income from Abroad and U.S. Payments to Foreign Persons

as a Percentage of GDP, 1960-2001

(percent)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage

U.S. receipts from abroad

U.S. payments to foreigners
24

The preceding paragraph suggests that intra-firm trade involves the shipment of 

components across borders. Other intra-firm trade may involve the shipment of raw materials 

abroad for manufacture abroad or shipment of finished goods to a foreign sales affiliate. The 

data do not permit such distinctions to be drawn. Nevertheless, the extent of this intra-firm 

cross-border trade is large. In 1996, large foreign-owned domestic corporations reported sales of 

tangible goods to related foreign persons (exports) of $68.6 billion, a figure representing 11.2 

percent of total U.S. merchandise exports in 1996. Large foreign-owned domestic corporations 

reported purchases of tangible goods from related foreign persons (imports) of $181.9 billion, a 

figure representing 22.6 percent of total U.S. merchandise imports in 1996.31 Similarly, in 1996, 

U.S. multinational enterprises shipped $162.4 billion of goods to their foreign affiliates, a figure 

representing 26 percent of U.S. merchandise exports in 1996. Foreign affiliates of U.S. 

multinational enterprises shipped $136.1 billion of goods to their U.S. parent enterprise, a figure 

representing 16.9 percent of U.S. merchandise imports in 1996.32 Thus, in total, in 1996 intrafirm trade accounted for at least 37 percent of U.S. merchandise exports and 39 percent of U.S. 

merchandise imports.

Merchandise trade data by industry and geographic region

Intra-firm trade helps explain two other aspects of merchandise trade. First, sectors that 

are important sources of U.S. exports are often also substantial import sectors. For example, a 

U.S. manufacturer of computer equipment may produce some components in the United States 

and ship the components abroad for assembly before re-importing the product for sale in the 

United States. Such a business arrangement would produce exports from the computer and 

computer components sector and imports into the computer and computer component sector. 

Beyond intra-firm trade, competition in the market place also would result in the same sector 

being the source of exports and the recipient of imports. Figure 10 and Figure 11 detail the 

composition, by industry, of U.S. merchandise exports (Figure 10) and U.S. merchandise imports 

(Figure 11) for 2000. To highlight the example above, the data show that seven percent of U.S. 

exports were from the computer and peripherals industry and similarly seven percent of U.S. 

imports were in the computer and peripherals industry. 

 

31 Michael G. Seiders and Heather R. Duffy, “Transactions Between Large ForeignOwned Domestic Corporations and Related Foreign Persons, 1996,” SOI Bulletin, 19, Fall 1999, 

pp. 192-213. The data are from 545 foreign-owned domestic corporations, each with total 

receipts of $500 million or more in 1996 or a prior year. The figures reported in the text are the 

sum of reported “sales of stock in trade” and “sales of other tangible property.” In 1991, such 

inter-affiliate trade by large foreign-owned domestic corporations represented 11 percent of 

merchandise exports and 24 percent of merchandise exports. In 1994, such inter-affiliate trade 

by large foreign-owned domestic corporations represented 14 percent of merchandise exports 

and 27 percent of merchandise imports.

32 Raymond J. Mataloni, Jr. “U.S. Multinational Companies: Operations in 1996,” 

Survey of Current Business, 78, September 1998, p. 54. Unlike the data cited above for foreignowned U.S. corporations, these data are more inclusive of U.S. foreign affiliates, not being 

restricted by the size of the foreign affiliate.
25

Intra-firm trade also is a factor in understanding why countries or areas that are important 

export markets also often are significant points of origin of imports. Figure 12 and Figure 13

show the destinations of U.S. merchandise exports and the areas of origin of U.S. merchandise 

imports in 2000.33

Figure 10

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

 

33 Data for Figure 10 through Figure 13 are found in Douglas B. Weinberg, “U.S. 

International Transactions, First Quarter 2001,” Survey of Current Business, 81, July 2001, pp. 

37-81.

Composition, by Industry of U.S. Merchandise Exports, 2000

[Billions of Dollars and Percentage]

Other

$29.8 - 4%

Automobiles & parts

$80.2 - 10%

Other capital goods

$162.1 - 21%

Other industrial supplies and 

materials

$80.5 - 10%

Computers & peripherals

$55.5 - 7%

Semiconductors

$60.1 - 8%

Metals & nonmetallic 

products

$39.2 - 5%

Chemicals

$52.2 - 7%

Foods, feeds,

& beverages

$47.5 - 6%

Consumer durable

goods

$43.3 - 6%

Consumer nondurable goods

$42.6 - 6%

Telecommunications 

equipment

$31.3 - 4%

Civilian aircraft

& parts

$48.1 - 6%
26

Figure 11

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

Composition, by Industry of U.S. Merchandise Imports, 2000

[Billions of Dollars and Percentage]

Other capital goods

$150.2 - 12%

Automobiles & parts

$195.6 - 17%

Consumer nondurable goods

$130.4 - 11%

Energy products

$138.4 - 11%

Computers & peripherals

$89.8 - 7%

Chemicals

$34.4 - 3%

Telecommunications equipment

$31.9 - 3%

Civilian aircraft & parts

$26.4 - 2%

Semiconductors

$48.6 - 4%

Consumer durable goods

$136.3 - 11%

Other industrial supplies and 

materials

$70.3 - 6%

Metals & nonmetallic products

$59.8 - 5%

Foods, feeds,

& beverages

Other $32.8 - 3%

$62.6 - 5% 
27

Figure 12

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

Destination of U.S. Merchandise Exports, 2000

[Billions of Dollars and Percentage]

Latin America

$170.3 - 22%

Other Asia

$152.0 - 20%

Japan

$63.6 - 8%

Canada

$179.0 - 23%

Western Europe

$178.8 - 23%

Eastern Europe

$5.9 - 1%

Africa

$10.1 - 1%

Australia

$12.2 - 2%
28

Figure 13

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

Areas of Origin of U.S. Merchandise Imports, 2000

[Billions of Dollars and Percentage]

Latin America

$210.2 - 17%

Other Asia

$340.3 - 28%

Japan

$146.5 - 12%

Canada

$233.7 - 19%

Western Europe

$243.4 - 20%

Eastern Europe

$16.1 - 1%

Africa

$27.5 - 2%

Australia

$6.4 - 1%
29

C. Trends in the United States' Financial Account

Overview of the United States' financial account

As explained above, when the United States imports more than it exports, the dollars the 

United States uses to buy the imports must ultimately return to the United States as payment for 

U.S. exports or to purchase U.S. assets. As Figure 2, Figure 3, and Table 1 document, the United 

States' current account has been in deficit since the early 1980s. Figure 14 plots gross (before 

depreciation) U.S. investment and gross U.S. saving as a percentage of GDP for the period 1960-

2000.34 Figure 14 also plots net foreign investment as a percentage of GDP. In Figure 14, when 

the United States is a net exporter of capital, net foreign investment is measured as a positive 

number, and when the United States is a net importer of foreign capital net foreign investment is 

measured as a negative number. Net foreign investment became a larger proportion of the 

economy since 1982. At the same time, the United States changed from being a modest exporter 

of capital in relation to GDP to being a large importer of capital. Net foreign investment has 

become a larger proportion of the economy and a more significant proportion of total domestic 

investment than in the past. In 2000, gross investment in the United States was $1,741 billion 

and net foreign investment was $428 billion, or 24.6 percent of gross domestic investment. In 

1993, net foreign investment comprised 8.9 percent of gross domestic investment.

 

34 Data for Figure 14 are from the U.S. Department of Commerce, Bureau of Economic 

Analysis and are reprinted in Appendix 2. 
30

Figure 14

Source: Department of Commerce, Bureau of Economic Analysis.

Saving, Investment, and Net Foreign Investment as a Percentage of GDP,

1960-2000

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage of GDP

Savings

Investment

Net foreign
31

The net foreign investment in the United States is measured by the United States' 

financial account. The financial account measures the increase in U.S. assets abroad compared 

to the increase in foreign assets in the United States. Figure 15 plots the annual increase of U.S. 

assets abroad and of foreign assets in the United States in constant dollars for the period 1960-

2001.35 Foreign assets in the United States increased by $814 billion in 1999, $1,024 billion in 

2000, and $895 billion in 2001 in nominal dollars. At the same time, foreign assets owned by 

U.S. persons increased by $437 billion in 1999, $581 billion in 2000, and $400 billion in 2001 

(nominal dollars).

Figure 15

Source: Department of Commerce, Bureau of Economic Analysis.

 

35 Data for Figure 15 are from the U.S. Department of Commerce, Bureau of Economic 

Analysis and are reprinted in Appendix 3.

Annual Increase in U.S. Assets Abroad and in Foreign Assets in U.S.,

1960-2001, in Constant 1996 Dollars

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Dollars in Millions

U.S.-owned assets abroad

Foreign-owned assets in the U.S.
32

Growth in foreign-owned assets in the United States and U.S.-owned assets abroad

Overview

Measured in nominal dollars, the amount of foreign-owned assets in the United States 

grew more than 700 percent between 1975 and 198836 and by nearly 400 percent between 1980 

and 2000. The total amount of foreign-owned assets in the United States exceeded $8 trillion by 

the end of 2000.37 The recorded value of U.S.-owned assets abroad grew less rapidly during the 

same period. The Department of Commerce reports that in 1975 the amount of U.S.-owned 

assets abroad exceeded foreign-owned assets in the United States by $74 billion. By the end of 

1988, however, the situation had reversed, so that the amount of foreign-owned assets in the 

United States exceeded U.S.-owned assets abroad by $162 billion. By 2000, the amount of 

foreign-owned assets in the United States exceeded U.S.-owned assets abroad by $1.8 trillion.38 

These investments are measured at their so-called “current cost.”39 Some argue that the market 

value of U.S.-owned assets abroad is similar to, or greater than, the market value of foreignowned assets in the United States, if market values were measured accurately. 40

 Figure 16 and 

Figure 17 display the value of U.S.-owned assets abroad and foreign-owned assets in the United 

States for selected years measured under both current cost and based on estimates of current 

market values. Whether this argument is correct with respect to the current net investment 

position, it is clear that foreign-owned U.S. assets are growing more rapidly than U.S.-owned 

assets abroad, as depicted in Figure 15.

 

36 Russell B. Scholl, “The International Investment Position of the United States in 

1988,” Survey of Current Business, U.S. Department of Commerce, Bureau of Economic 

Analysis, June 1989, p. 43. 

37

 Ibid.

38

 Ibid.

39 The Bureau of Economic Analysis estimates the values of U.S. foreign direct 

investment abroad and foreign direct investment in the United States using three different bases: 

historical cost, current cost, and market value. Using the historical cost base, assets are 

measured according to values carried on taxpayers’ books. Thus, investments reflect the price 

level of the year in which the asset was acquired. Under the current cost measure, a parent’s 

share of its affiliates’ tangible assets (property, plant, and equipment and inventories) is revalued

from historical cost to replacement cost. Under the market value measure, an owner’s equity in 

foreign assets is revalued to current market value using indexes of stock prices.

40 The distinction between book valuation and market valuation is only relevant for the 

category of investment labeled “direct investment,” not for “portfolio investment.” The 

distinction between direct and portfolio investment is explained in the text below.
33

Figure 16

Source: Department of Commerce, Bureau of Economic Analysis.

International Investment Position of the United States,

1982, 1990, and 2000 in Constant 1996 Dollars

(direct investment at current cost)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

1982 1990 2000

Year

Billions of dollars

U.S. assets abroad

Foreign assets in the U.S.
34

Figure 17

Source: Department of Commerce, Bureau of Economic Analysis.

International Investment Position of the United States,

1982, 1990, 2000 in Constant 1996 Dollars

(direct investment at market value)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

1982 1990 2000

Year

Billions of dollars

U.S. assets abroad

Foreign assets in the U.S.
35

Direct investment, non-direct (portfolio) investment, and official investment

Foreign assets in the United States (and U.S. assets abroad) can be categorized as direct 

investment, non-direct investment, and official assets. Direct investment constitutes assets over 

which the owner has direct control. The Department of Commerce defines an investment as 

direct when a single person owns or controls, directly or indirectly, at least 10 percent of the 

voting securities of a corporate enterprise or the equivalent interests in an unincorporated 

business. Foreign persons held direct investments of $1.37 trillion in the United States in 2000, 

having grown from $127 billion in 1980.41 

The largest category of investment is non-direct investment held by private (nongovernmental) foreign investors, commonly referred to as portfolio investment. For most of the 

past decade foreign portfolio investment annually has exceeded foreign direct investment, 

making portfolio investment responsible for the majority of growth in foreign ownership of U.S. 

assets. (See Figure 18) Foreign portfolio investment consists mostly of holdings of corporate 

equities, corporate and government bonds, and bank deposits. The portfolio investor generally 

does not have control over the assets that underlie the financial claims. In 2000, portfolio assets 

of foreign persons in the United States were more than triple the recorded value of direct 

investment, $4.74 trillion compared to $1.37 trillion, respectively.42 Bank deposits account for 

approximately one-quarter of this total, and reflect, in part, the increasingly global nature of 

banking activities. Figure 19 reports the dollar value of foreign holdings of selected U.S. assets, 

both portfolio investment and direct investment, for 1982, 1990, and 2000.43 Foreign investment 

in bonds, corporate equities, and bank deposits, like other types of financial investment, provide 

a source of funds for investment in the United States but also represent a claim on future U.S. 

resources.

The final category of foreign-owned U.S. assets is official assets: U.S. assets held by 

governments, central banking systems, and certain international organizations. The foreign 

currency reserves of other governments and banking systems, for example, are treated as official 

assets. Levels of foreign-held official assets have grown more slowly than foreign-held direct 

and portfolio investment of private investors.

The value of investments by private U.S. persons abroad has grown from $693 billion in 

1980 to $5.95 trillion in 2000.44 This growth has not been as rapid as the growth in the value of 

investments by foreign persons in the United States. As has been the case for foreign investors 

in U.S. assets, over the past decade U.S. investors portfolio holdings of foreign assets has 

increased more rapidly than U.S. foreign direct investment. (See Figure 20.)45 At year-end 

 

41 King, “The International Investment Position of the United States at Yearend 2000.”

42

 Ibid.

43 See Appendix 4.

44 King, “The International Investment Position of the United States at Yearend 2000.”

45 See Appendix 5.
36

2000, U.S. foreign direct investment constituted approximately one-quarter of U.S. ownership of 

foreign assets (with direct investment measured at current cost).46 Measured at current cost, the 

value of U.S. direct investment abroad has remained above the value of foreign direct investment 

in the United States. (See Figure 21.) Measured at market value, the value of foreign direct 

investment in the United States has modestly surpassed the value of U.S. direct investment 

abroad since 1998. (See Figure 22.)

Figure 18

Source: Department of Commerce, Bureau of Economic Analysis.

 

46 King, “The International Investment Position of the United States at Yearend 2000.”

Annual Increase in Foreign Direct Investment in the United States and Foreign

(Non-Treasury Security) Portfolio Investment, 1960-2001,

In Constant 1996 Dollars

(50,000)

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Millions 1996 Dollars

Direct Investment

Portfolio Investments
37

Figure 19

Source: Department of Commerce, Bureau of Economic Analysis.

Selected Nongovernmental Foreign Holdings of United States' Assets, Both Portfolio and Direct Investments,

1982, 1990, 2000 in Constant 1996 Dollars

(direct investment at current cost)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1982 1990 2000

Year

Billions of dollars

U.S. Treasury securities

Corporate and other bonds

Corporate equity

Direct investment
38

Figure 20

Source: Department of Commerce, Bureau of Economic Analysis.

 Selected United States' Holdings of Foreign Assets, Both Portfolio

and Direct Investments, 1982, 1990, 2000, in Constant 1986 Dollars

(direct investment at current cost)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1982 1990 2000

Year

Billions of dollars

Corporate bonds

Corporate equity

Direct investment
39

Figure 21

Source: Department of Commerce, Bureau of Economic Analysis.

Year-End Value of Foreign Direct Investment in the United States

and U.S. Direct Investment Abroad, 1982-2000

[Billions of Nominal Dollars at Current Cost]

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Billions of dollars

Foreign Direct Investment

U.S. Direct Investment
40

Figure 22

Source: Department of Commerce, Bureau of Economic Analysis.

Year-End Value of Foreign Direct Investment in the United States

and U.S. Direct Investment Abroad, 1982-2000

[Billions of Nominal Dollars at Market Value]

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Billions of dollars

Foreign Direct Investment

U.S. Direct Investment
41

Cross border investment by geographic region and industry47

Most cross border investment by developed countries is located in other developed 

countries. Measured on an historical cost basis, more than 50 percent of U.S. direct investment 

abroad is located in Europe and more than 10 percent is located in Canada. (See Figure 23.) 

Similarly, European persons account for more than 70 percent of foreign direct investment in the 

United States on an historical cost basis, and Canadian persons account for more than eight 

percent of foreign direct investment in the United States. (See Figure 24.) The single largest 

country hosting U.S. foreign direct investment abroad is the United Kingdom, followed by 

Canada, the Netherlands, and Germany. The United Kingdom is the single largest source 

country for foreign direct investment in the United States, followed by Japan, the Netherlands, 

and Germany. (See Figure 25 and Figure 26.) More than one quarter of U.S. direct investment 

abroad has been devoted to manufacturing. More than 40 percent of foreign direct investment in 

the United States is in the manufacturing sectors. Other significant sectors in which U.S. persons 

make direct investments abroad and in which foreign persons make direct investments in the 

United States are finance, insurance, and petroleum. (See Figure 27, Figure 28 and Figure 29).

 

47 The data in the text below and accompanying figures is from Maria Borgo and 

Raymond Mataloni, Jr., “Direct Investment Positions for 2000: Country and Industry Detail,” 

Survey of Current Business, 81, July 2001, pp. 16-29.
42

Figure 23

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Direct Investment Abroad, 2000

[Billions of Dollars]

Middle East

$11.9

Africa

$15.8

Europe

$648.7

Latin America & Other 

Western Hemisphere

$239.4

Asia & Pacific

$199.6

Canada

$126.4
43

Figure 24

Source: Department of Commerce, Bureau of Economic Analysis.

Foreign Direct Investment in the United States, 2000 Historial Cost Basis

[Billions of Dollars]

Latin America & Other 

Western Hemisphere

$42.7

Middle East

$8.4

Africa

$2.1

Canada

Asia & Pacific $100.8

$194.0

Europe

$890.6
44

Figure 25

Source: Department of Commerce, Bureau of Economic Analysis.

15 Largest Host Countries of U.S. Direct Investment Abroad, 2000

[Billions of Dollars]

$233.3

$126.4

$115.5

$55.6

$54.8

$54.1

$53.6

$39.0

$35.5

$35.4

$35.4

$35.3

$33.3

$23.6

$23.3

0 50 100 150 200 250

United Kingdom

Canada

Netherlands

Japan

Switzerland

Bermuda

Germany

France

Brazil

Mexico

Panama

Australia

Ireland

Italy

Hong Kong

Countries

Billions of Dollars
45

Figure 26

Source: Department of Commerce, Bureau of Economic Analysis.

10 Largest Home Countries of Foreign Direct Investment

in the United States, 2000

[Billions of Dollars]

$229.8

$163.2

$152.4

$122.8

$119.1

$100.8

$83.3

$81.7

$27.4

$23.0

0 50,000 100,000 150,000 200,000 250,000

United Kingdom

Japan

Netherlands

Germany

France

Canada

Luxembourg

Switzerland

Sweden

Ireland

Countries

Billions of Dollars
46

Figure 27

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Direct Investment Abroad at Year-End 2000

by Industry on an Historical Cost Basis

[Billions of Dollars]

Finance, insurance, and real 

estate

$497.3

Depository institutions

$37.2

Wholesale trade

$88.9

Petroleum

$105.5

Manufacturing

$344.0

Services

$79.9

Other

$92.8
47

Figure 28

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Direct Investment in Manufacturing Abroad at

Year-End 2000 by Manufacturing Industry on an

Historical Cost Basis

[Billions of Dollars]

Other manufacturing

$75.3

Transportation equipment

$41.1

Electronic and other electrical 

equipment

$43.4 Industrial machinery and 

equipment

$42.5

Primary and fabricated metals

$18.7

Chemicals and alied products

$86.1

Food and kindred products

$36.8
48

Figure 29

Source: Department of Commerce, Bureau of Economic Analysis.

Foreign Direct Investment in the United States by Industry, 2000

[Billions of Dollars]

Manufacturing

$496.6

Petroleum

$92.9

Wholesale Trade

$109.6

Depository Institutions

$68.6

Finance

$88.1

Insurance

$106.4

Real Estate

$42.3

Services

$103.0

Other

$99.1
49

Cross-border merger activity

Cross-border merger activity is one means by which changes occur in the financial 

account. Figure 30 below details the dollar value of foreign investor acquisitions of U.S. 

companies and the U.S. investor acquisitions of foreign companies via merger or acquisition. 

All of these mergers would represent direct, rather than portfolio, investment, as all involve 100-

percent acquisitions.48 Figure 30 shows that the dollar value of such cross-border acquisitions 

was comparable with U.S. acquisitions slightly lower for the period 1991 through 1997. 

Subsequent to 1997 foreign acquisitions of U.S. companies has more than doubled U.S. 

acquisitions of foreign companies, although throughout the entire period U.S. acquisitions 

generally have exceeded foreign acquisitions in terms of number of companies purchased.49

The greatest plurality of cross-border mergers and acquisitions has involved U.S. 

companies and companies of the United Kingdom, consistent with the data presented above 

showing the extent of U.K. direct investments in the United States and U.S. direct investments in 

the United Kingdom. In 2000, the investors domiciled in the United Kingdom accounted for 

nearly 34 percent of foreign acquisitions of U.S. companies (valued at $114.3 billion).50 

Approximately 35 percent of U.S. investor acquisitions of foreign companies involved 

companies domiciled in the United Kingdom (valued at $47.9 billion).51 The next four largest 

foreign acquirers of U.S. companies in 2000 were France ($39.8 billion, 11.7 percent of the 

total), Switzerland ($35.6 billion, 10.5 percent of the total), the Netherlands ($31.8 billion, 9.4 

percent of the total), and Canada ($29.2 billion, 8.6 percent of the total). After the United 

Kingdom the next largest sites of U.S. investor acquisitions in 2000 were Canada ($13.8 billion, 

10.2 percent of the total), Italy ($11.8 billion, 8.7 percent of the total), Japan ($10.7 billion, 7.9 

percent of the total), and Germany ($6.7 billion, 5.0 percent of the total).52 Measured by dollar 

value, approximately 17 percent of foreign acquisitions were of U.S. firms engaged in 

investments and commodities and another 15 percent of foreign acquisitions were of U.S. firms 

engaged in providing business services.53 The foreign industry receiving the greatest U.S. 

investor purchases was telecommunications, accounting for nearly 13 percent of U.S. foreign 

 

48 An investment is considered a “direct investment,” rather than a “portfolio 

investment,” if at least a 10-percent interest is acquired. 

49 See Appendix 6.

50

 Mergers & Acquisitions Almanac, February 2001, pp. 38. 

51

 Ibid.

52

 Ibid.

53

 Ibid. U.S. firms in the oil and gas industry accounted for nearly 12 percent of year 

2000 foreign acquisitions and U.S. firms in the food industry accounted for nine percent of 

foreign acquisitions. No other industry accounted for more than five percent of foreign 

acquisitions measured in dollars.
50

acquisitions. Foreign utilities constituted nearly 10 percent of U.S. acquisitions of foreign 

companies in 2000.54

Table 2, Table 3, Table 4, and Table 5, below, list the 25 largest foreign acquisitions of 

U.S. companies in 2000 (Table 2) and 1999 (Table 4) and the 25 largest U.S. acquisitions of 

foreign companies in 2000 (Table 3) and 1999 (Table 5). The tables list the target company, the 

acquiring company, the domicile of the companies, the line of business of the target company, 

and estimated dollar value of the merger or acquisition.

 

54

 Ibid. Acquisitions of foreign investment and commodity companies comprised 9.5 

percent of U.S. acquisitions abroad in 2000. Acquisitions of foreign radio and television 

companies comprised 7.5 percent of U.S. acquisitions abroad, acquisitions of foreign business 

service companies comprised 6.4 percent, acquisitions of foreign metal and metal product 

companies comprised 6.1 percent, acquisitions of foreign oil and gas companies comprised 5.3 

percent, and acquisitions of foreign electronic and electrical equipment companies comprised 

five percent of U.S. acquisitions abroad in 2000. No other sector accounted for more than three 

percent of U.S. acquisitions of foreign companies in 2000.
51

Figure 30

Source: Mergers and Acquisitions Almanac, see Appendix 6.

Dollar Value of Cross Border Mergers and Acquisitions, 1991-2000

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

$350.0

$400.0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Billions of Dollars

Foreign Acquisition

of U.S. Firms

U.S. Acquisitions of

Foreign Firms
Table 2 – Top 25 Foreign Acquisitions of U.S. Companies – 2000

Acquirer

Domicile of

Acquirer Target

Target

Industry

Price

($ Billions)

BP Amoco PLC United Kingdom Atlantic Richfield Co. Oil and gas $27.2

Unilever PLC United Kingdom Bestfoods Food products 25.1

UBS AG Switzerland PaineWebber Group Inc. Investment banking 16.5

Credit Suisse Group Switzerland Donaldson, Lufkin & Jenrette Inc. Investment banking 13.5

Cap Gemini SA France Consulting business of Ernst & 

Young LLP

Consulting services 11.8

ING Groep NV Netherlands Financial services and international 

businesses of Aetna Inc.

Insurance financial services 7.6

Nortel Networks Corp. Canada Alteon Websystems Inc. Internet infrastructure products 7.1

Terra Networks SA Spain Lycos Inc. Internet search engine 6.2

ING Groep NV Netherlands ReliaStar Financial Corp Insurance 6.0

Nippon Telephone & 

Telegraph Corp. 

Japan Remaining 90% of Verio Inc. Internet service provider 5.7

France Telecom SA France 25% of NTL Inc. Cable TV systems, radio stations, 

telecom services

5.5

PowerGen PLC United Kingdom LG&E Energy Corp. Electric and gas utility 5.4

WPP Group PLC United Kingdom Young & Rubicam Inc. Advertising agency 5.0

Tyco International Ltd. Bermuda Mallinckrodt Inc. Diagnostic products 4.4

France Telecom SA France Remaining 71% of Global One Co. Telecommunications 4.3

Sema Group PLC United Kingdom LHS Group Inc. Billing and customer care services 4.3

National Grid Group PLC New England Electric System Electric utility; oil and gas 4.2

Stora Enso Oyj Finland Consolidated Papers Inc. Paper products 4.0

BASF AG Germany Agricultural products business of 

American Home Products Corp

Crop protection products 3.9

Koninklijke Ahold NV Netherlands US Foodservice Inc. Grocery products wholesaling 3.6

Rodamco North America NV Netherlands Urban Shopping Centers Inc. Mall development and management 3.4

Nortel Networks Corp. Canada Xros Inc. Fiber-optic network switching 

equipment

3.3

Nortel Networks Corp. Canada Otera Corp. Fiber-optic telecommunication 

equipment

3.3

Cia Cementos Mexicanos SA Mexico Southdown Inc. Cement; limestone mining 2.8

Global Crossing Ltd. Bermuda IPC Communications Inc. unit of 

Citigroup Inc.

Integrated communication systems and 

services

2.8

52
Table 3 – Top 25 U.S. Acquisitions of Foreign Companies – 2000

Acquirer Target Domicile of

Acquirer

Target

Industry

Price

($ Billions)

NTL Inc. CWC Consumer Co unit of Cable 

and Wireless Communications 

PLC

United Kingdom Telecommunication, cable TV, and 

internet services

11.0

Chase Manhattan Corp. Robert Fleming Holdings Ltd. United Kingdom Merchant banking 7.7

NTL Inc. Cablecom Holding AG Switzerland Cable TV services 3.7

Corning Inc. 90% of the optical components and 

device business of Pirelli SpA

Italy Optical network components 3.6

Callahan Associates 

International LLC et al

55% of the North Rhine 

Westphalia cable network of 

Deutsche Telekom AG

Germany Telecommunication services 2.8

Ford Motor Co. Land Rover business of BMW AG United Kingdom Motor vehicles 2.7

General Motors Corp. 20% of the Fiat Auto SpA unit of 

Fiat SpA

Italy Automobiles 2.4

General Electric Co. Toho Mutual Life Japan Insurance 2.3

Citigroup Inc. Worldwide investment banking 

business of Schroders PLC

United Kingdom Investment banking 2.2

Cisco Systems Inc. Fiber-optic networking operations 

of Pirelli SpA

Italy Fiber-optic network development 2.2

AES Corp. Additional 80.2% of Ca La 

Electricidad de Caracas SACA

Venezuela Electric utility 1.7

Nationwide Mutual Insurance 

Co.

Ganmore Investment Management 

PLC unit of Royal Bank of 

Scotland Group PLC

United Kingdom Investment management services 1.6

Corning Inc. Optical fiber, cable and related 

equipment businesses of Siemens 

AG

Germany Fiber-optic cables 1.4

Smurfit-Stone Container 

Corp.

St. Laurent Paperboard Inc. Canada Paperboard products 1.4

Intel Corp. Giga A/S unit of NKT Holding Denmark Telecommunication network 

components

1.3

Reliant Energy Inc. Remaining 48% of 

Energieproduktiebedrijf UNA NV

Netherlands Electric utility 1.2

Kohlberg, Kravis Roberts & 

Co.

Non-speciality organics operations 

of Laporte PLC

United Kingdom Pigments, additives, chemical 

compounds

1.2

AES Corp. Additional 35.6% of Electopaulo Brazil Electric utility 1.1

53
Acquirer Target Domicile of

Acquirer

Target

Industry

Price

($ Billions)

Metropolitena Electricidade de San 

Paulo SA

Diamond Technology 

Partners, Inc.

Cluster Consulting Spain Business consulting services 1.1

General Motors Corp. 17.7% of Fuji Heavy Industries 

Ltd.

Japan Motor vehicles 1.1

Microsoft Corp. MediaOne Group Inc.'s 60% stake 

in Titus Communications Corp.

Japan CableTV networks 0.9

ADC Telcommunications, 

Inc.

Altitun AB Sweden Semiconductor laser modules 0.9

Delphi Automotive Systems 

Corp.

Lucas Diesel Systems unit of TRW 

Inc.

France Diesel fuel-injection systems 0.9

Siebel Systems Inc. Janna Systems Inc. Canada Electronic systems services 0.9

54
Table 4 –Top 25 Foreign Acquisitions of U.S. Companies – 1999

Acquirer Domicile of

Aquirer

Target Target

Industry

Price 

($ Billions)

Merger: Vodadone Group PLC United Kingdom AirTouch Communications Mobile telecom and 

paging services

$60.3

Scottish Power PLC United Kingdom PacificCorp Electric utility company 12.6

Aegon NV Netherlands TransAmerica Corp. Insurance 10.6

Global Crossing Ltd. Bermuda Frontier Corp. Telecommunications 10.1

Deutsche Bank AG Germany Bankers Trust New York Corp. Bank holding company 9.1

HSBC Holdings PLC United Kingdom Republic New York Corp. Bank holding company 7.7

Vivendi SA France United States Filter Corp. Water and wastewater 

treatment systems

6.3

New Holland MV Netherlands Case Corp. Farm machinery 6.3

Roche Holding AG Switzerland Remaining 33% of Genentech Inc. Drugs based on DNA and 

gene, technology

4.8

General Electric Co. P.L.C United Kingdom FORE Systems Inc. Network interfaces and 

LAN products

4.2

Suez Lyonnaise des Eaux-Dumez SA France Nalco Chemical Co. Water treatment 

compounds, lubricants, 

chemicals

4.1

ACE Ltd. Bermuda U.S. and international property and 

casualty units of CIGNA Corp.

Insurance 3.5

Quebecor Printing Inc. Canada World Color Press Inc. Printing services 2.9

Fortis AG Belgium American Bankers Insurance Group 

Inc.

Insurance 2.8

Verengigd Bezit VNU Netherlands Nielsen Media Research Inc. TV audience 

measurement services

2.8

Koninklijke Numico NV Netherlands General Nutrition Cos. Vitamin and nutrition 

supplement stores

2.5

Buhrmann NV Netherlands Corporate Express Inc. Office supplies 2.3

General Electric Co. PLC United Kingdom Reltec Corp. Telcommunication 

systems

2.1

Stagecoach Holdings PLC United Kingdom Coach USA Inc. Motorcoach sightseeing 

services

1.8

Alcatel SA France Xylan Corp. High-bandwidth 

switching systems

1.8

News Corp Ltd. Australia Remaining 50% of Fox/Liberty 

Networks

Sports TV network 1.8

55
Acquirer Domicile of

Aquirer

Target Target

Industry

Price 

($ Billions)

Kensington Acquisition Sub Inc. Italy and Germany joint 

venture

Cellular Communications 

International

Cellular communication 

services

1.7

Atlas Copco AB Sweden Rental Service Corp. Equipment rental services 1.6

EMAP PLC United Kingdom Petersen Cos. Magazine publishing 1.5

Accor SA France Red Roofs Inns. Inc. Hotels 1.1

Dyckerhoff AG Germany Lone Star Industries Inc. Cement 1.1

Thyssen AG Germany Elevator business of Dover Corp. Elevators 1.1

56
Table 5 –Top 25 U.S. Acquisition of Foreign Companies – 1999

Acquirer Target Domicile of

Aquirer

Target

Industry

Price

($ Billions)

Wal-Mart Stores Inc. ASDA Group PLC United Kingdom General-merchandise 

retailing

$10.8

TRW Inc. LucasVarity PLC United Kingdom Engineering services; 

motor vehicle equipment

6.8

General Electric Co. Japan Leasing Corp. Ltd. Japan Business credit services 6.6

Ford Motor Co. Worldwide passenger vehicle 

business of Volvo AB

Sweden Automobiles, trucks, and 

parts

6.5

Texas Pacific Group Inc. U.K. retailing business of Allied 

Domecq PLC 

United Kingdom Pubs 4.3

Ameritech Corp. 20% of Bell Canada Canada Telecommunications 3.4

Uniphase Corp. JDS Fitel Inc. Canada Fiber-optic connectors 

polishing machinery

3.1

AES Corp. National Power Drax Ltd. unit of 

National Power PLC

United Kingdom Electricity generation 3.0

Huntsman Corp. Polyurethane, titanium dioxide, and 

selected petrochemical businesses of 

Imperial Chemical Industries PLC 

United Kingdom Industrial organic 

chemicals

2.85

CIT Group Inc. Newcourt Credit Group Inc. Canada Equipment financing and 

leasing services

2.7

Burlington Resources Inc. Poco Petroleums Ltd. Canada Oil and gas 2.5

US West Inc. 9.02% of Global Crossing Ltd. Bermuda Internet and 

telecommunication services

2.5

Weyerhaeuser Co. MacMillan Bloedel Ltd. Canada Paper, pulp products; 

freight transportation 

services

2.3

Edison International Corp. Two power stations of PowerGen 

PLC

United Kingdom Electricity-generating 

power stations

2.1

Du Pont Co. Herberts Paints GmbH unit of 

Hoechst AG 

Germany Automobile paints; 

chemical preparations

1.9

NTL Inc. Diamond Cable Communications United Kingdom Cable TV services 1.9

Electronic Data Systems Corp. MCI Systemhouse Inc. unit of MCI 

WorldCom Inc.

Canada Computer systems 1.7

Ford Motor Co. Kwik-Fit Holdings PLC United Kingdom Auto parts and repair shops 1.6

Gannett Co. Inc. Newsquest PLC United Kingdom Publish newspapers 1.4

Principal Financial Group BT Funds Management, BT Australia Investment banking 1.4

57
Acquirer Target Domicile of

Aquirer

Target

Industry

Price

($ Billions)

Portfolio Services, BT Margin 

Lending, and BT Investment 

Banking Business units of Deutsche 

Bank AG

services

Energy Partnership Group Ikon Energy/Multinet Gas Australia Natural gas distribution 1.3

Tyco International Inc. Siemens Electromechanical 

Components AG unit of Siemens 

AG

Germany Relays and 

electromechanical 

components

1.1

Global TeleSystems Group Inc. Esprit Telecom Group PLC United Kingdom Telcommunications 0.9

General Electric Co. Heavy-duty gas turbine business of 

Alstom SA

Netherlands Gas turbines 0.9

General Motors Corp. Arriva Automotive Solutions unit of 

Arriva PLC

United Kingdom Vehicle leasing; fleet 

management

0.8

58
59

D. Background Data Relating to Foreign Sales Corporations

Foreign sales corporations and U.S. exports

Data on the role of foreign sales corporations in U.S. trade is limited. Figure 31 details 

foreign sales corporation (“FSC”) and domestic international sales corporation (“DISC”) 

dividends as a percentage of the profits of all U.S. corporations. While trending upwards over 

the last several years, FSC profits constitute less than 1.5 percent of total corporate profits. 

While a relatively small part of the overall profits of U.S. corporations, sales of goods and 

services through FSCs may represent a substantial share of U.S. exports. Figure 32 below 

reports the “foreign trade gross receipts” of FSCs as a percentage of total U.S. exports of goods 

and services for 1987, 1992, and 1996. “Foreign trade gross receipts” represent the receipts from 

the sale of export property, the lease payments on qualifying export property, and payments for 

services related to qualifying sales and leases. In general, these data measure the receipts 

derived from qualified export sales.55 Figure 32 reports that qualifying FSC exports comprised 

one third of U.S. merchandise and service exports in 1996. These data give a picture of the 

scope of FSCs in U.S. exports but should not be over emphasized. On one hand, these data may 

overstate somewhat the role of FSCs as foreign trade gross receipts include the value of 

marketing and sales service performed abroad which would not normally be included as an 

export. On the other hand, the Statistics of Income Division of the Internal Revenue Service 

report that not all FSC tax returns report foreign trade gross receipts56 and the imputation of the 

missing data is likely to understate the value of foreign trade gross receipts. Another factor to 

consider is that approximately 90 percent of FSC returns represent FSCs related to 

manufacturing industries. The percentages reported in Figure 32 compare FSC sales to exports 

of goods and services. FSC sales of manufactured goods is likely to constitute a higher 

percentage of merchandise exports than the percentages reported in the figure.

 

55 “Foreign trade gross receipts also include payments for engineering and architectural 

services on foreign construction projects. In the case of a commission FSC, the foreign trade 

gross receipts of the related supplier are included in these data. FSCs reported $84.3 billion in 

foreign trade gross receipts in 1987, $152.3 billion in 1992, and $185.9 billion in 1996. Cynthia 

Belmonte, “Foreign Sales Corporations, 1996, SOI Bulletin, 19, Spring 2000, pp. 87-122.

56 A foreign sales corporation need not report “foreign trade gross receipts” in order to 

determine its tax liability.
60

Figure 31

Source: Statistics of Income, Internal Revenue Service and JCT staff calculations.

FSC and DISC Dividends as a Percentage of Corporate Profits,

1983-1998

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Year

Percent
61

Figure 32

Source: Statistics of Income, Internal Revenue Service and JCT staff calculations. 

FSC Exports of Goods and Services as a Percentage of Total U.S. Exports of Goods and 

Services, 1987, 1992, and 1996

33.6%

24.7% 24.2%

0

5

10

15

20

25

30

35

40

1987 1992 1996

Percent
62

Distribution of FSC Dividends Across Corporations

Among the 4.9 million corporate returns filed in 1999, 1,886 corporations (0.04 percent 

of corporations) reported a FSC dividend. Table 6 ranks FSC beneficiaries by decile according 

to the size of their FSC benefit for 1999. That is, Table 6 divides those corporations that 

reported FSC dividends into ten equal groups of 188 corporations, from the 188 corporations that 

reported the least FSC dividends to the 188 corporations that reported the most FSC dividends. 

Table 6 reports that among the 1,886 corporations reporting a FSC dividend in 1999, 10 percent 

accounted for 87 percent of the total dollar value of claimed FSC benefits. Table 6 also shows, 

by decile, how the average size of the FSC dividend correlates with average taxable income, 

average assets, and average sales. 

Table 7 groups all corporate tax returns for 1999 by industry classification and shows, for 

each category, the number of returns on which FSC dividends were not claimed, the number of 

returns on which FSC dividends were claimed, and the average and total amounts of FSC 

dividends for each category. Table 7 shows that the manufacturing sector accounts for the bulk 

of the overall FSC benefit (76 percent of the number of corporations reporting FSC dividends 

and 89 percent of the dollar value of dividends reported in 1999). It is important to note that 

Table 7 is based on the industry classifications reported by the corporations themselves, using 

the North American Industrial Classification System (“NAICS Code”) system. These selfreported classifications are not audited or verified in any way. In addition, consolidated groups 

report a single classification for these purposes, which may provide a distorted view of some 

companies -- e.g., a large conglomerate may have lines of business in several different

categories, but it would report only a single category for the entire consolidated group. 

Table 6.–All Corporations Reporting a FSC Dividend in 1999, By Decile

(188 Firms Per Decile)

Decile by Size of 

FSC Dividend

Average FSC 

Dividend

Percentage of 

Total FSC 

Dividend

Average Taxable 

Income Average Assets Average Sales

(thousands) (percent) (thousands) (thousands) (thousands)

lowest 10 percent $25 0.03% $4,297 $154,861 $65,336 

11 - 20th percentile $66 0.09% $2,258 $1,000,279 $64,793 

21 - 30th percentile $124 0.17% $5,388 $91,434 $107,238 

31 - 40th percentile $231 0.32% $13,755 $204,210 $267,977 

41 - 50th percentile $361 0.49% $9,564 $163,106 $167,581 

51 - 60th percentile $545 0.75% $21,155 $587,752 $270,579 

61 - 70th percentile $980 1.34% $81,294 $1,495,840 $904,679 

71 - 80th percentile $1,980 2.72% $97,506 $7,344,215 $1,254,670 

81 - 90th percentile $5,035 6.94% $171,370 $4,143,671 $2,130,158 

largest 10 percent $63,564 87.14% $716,194 $31,133,400 $9,274,154 

Source: JCT staff calculations from IRS data.
63

Table 7.–Returns of Corporations Reporting FSC Dividends by Industry, 1999

Number of Percentage

Corporations of Firms Number Percentage Total

Not Not of Corp. of Firms Average Industry Percentage

Claiming Claiming Claiming Claiming FSC FSC of Total

FSC FSC FSC FSC Dividend Dividends FSC

Industry Dividends Dividends Dividends Dividends ($ Millions) ($ Millions) Dividends

Manufacturing 296,288 6.0% 1,426 75.6% $8.52 $12,156.15 88.6%

Information 107,573 2.2% 55 2.9% $13.58 $746.81 5.4%

Professional,

Scientific, and

Technical

Services 657,099 13.3% 54 2.9% $3.32 $179.17 1.3%

Mining 30,829 0.6% 20 1.1% $7.46 $149.18 1.1%

Wholesale Trade 349,684 7.1% 190 10.1% $0.71 $135.66 1.0%

Retail Trade 596,339 12.1% 19 1.0% $5.87 $111.47 0.8%

Holding

Companies 43,223 0.9% 23 1.2% $3.16 $72.62 0.5%

Finance and

Insurance 217,766 4.4% 14 0.7% $4.92 $68.92 0.5%

Agriculture,

Forestry, 

Fishing

and Hunting 141,645 2.9% 33 1.7% $0.91 $30.13 0.2%

Construction 580,278 11.8% 24 1.3% $0.25 $5.93 0.0%

Transportation and

Warehousing 160,189 3.2% (1) (1) (1) (1) (1)

Utilities 7,038 0.1% (1) (1) (1) (1) (1)

Real Estate and

Rental and Leasing 521,442 10.6% (1) (1) (1) (1) (1)

Accommodation

and Food Services 252,111 5.1% (1) (1) (1) (1) (1)

Health Care and

Social Services 303,498 6.2% (1) (1) (1) (1) (1)

Other Services 305,723 6.2% (1) (1) (1) (1) (1)

Arts,

Entertainment, and

Recreation 93,920 1.9% (1) (1) (1) (1) (1)

Administrative and

Support and Waste

Management and

Remediation

Services 205,009 4.2% (1) (1) (1) (1) (1)

Educational

Services 35,195 0.7% (1) (1) (1) (1) (1)

Wholesale and

Retail Trade not

Allocable 2,139 0.0% 0 0.0% - $0 0.0%

Not Allocable 27,031 0.5% 0 0.0% - $0 0.0%

TOTAL 4,934,018 100.0% 1,886 100.0% $7.27 $13,713.70 100.0%

(1) – Data not disclosed to protect taxpayer confidentiality.

Industry classification self-reported on a consolidated return basis.

Note: Totals may not add due to rounding.

Source: JCT staff calculations from IRS data.
64

Because of the predominance of the manufacturing sector among those corporations 

reporting FSC dividends, Table 8 and Table 9 present the same information as Table 6 and Table 

7 for the manufacturing sector only. Among 296,000 manufacturing corporations, 1,427 (0.48 

percent) reported FSC dividends in 1999. Table 8 reports that among the 1,427 manufacturing 

corporations reporting a FSC dividend in 1999, 10 percent accounted for 88 percent of the total 

dollar value of claimed FSC benefits. Table 9 reports that three industries accounted for more 

than 70 percent of FSC benefits: transportation equipment (32.2 percent); computer and 

electronic products (25.7 percent); and chemicals (14.0 percent). 

Table 8.–All Manufacturing Corporations Reporting a FSC Dividend in 1999,

By Decile

(143 Firms Per Decile)

Decile by Size of 

FSC Dividend

Average FSC 

Dividend

Percentage of 

Total FSC 

Dividend

Average Taxable 

Income Average Assets Average Sales

(thousands) (percent) (thousands) (thousands) (thousands)

lowest 10 percent $29 0.04% $4,192 $51,640 $64,461 

11 - 20th percentile $76 0.08% $2,522 $82,747 $78,378 

21 - 30th percentile $151 0.18% $6,206 $109,784 $114,843 

31 - 40th percentile $270 0.32% $6,234 $105,024 $120,099 

41 - 50th percentile $390 0.46% $8,311 $146,073 $143,072 

51 - 60th percentile $616 0.72% $12,680 $374,127 $250,463 

61 - 70th percentile $1,089 1.28% $60,325 $762,213 $647,588 

71 - 80th percentile $2,247 2.63% $57,707 $1,751,720 $1,123,782 

81 - 90th percentile $5,540 6.52% $165,002 $2,811,985 $1,726,259 

largest 10 percent $75,160 87.78% $687,862 $21,892,107 $10,191,067 

Source: JCT staff calculations from IRS data.
65

Table 9.–Returns of Manufacturing Corporations Reporting FSC Dividends

Dividends by Type of Manufacturing, 1999

Number of Percentage Percentage

Corporations of Firms Number of of Total Percentage

not not Corporations Firms Average Industry of

Claiming Claiming Claiming Claiming FSC FSC Total

Type of FSC FSC FSC FSC Dividends Dividends FSC

Manufacturing Dividends Diviends Dividends Dividends ($ Millions) ($ Millions) Dividends

Transportation 

Equipment 10,708 3.6% 81 5.7% $48.30 $3,912.47 32.2%

Computer & 

Electronic Products 15,437 5.2% 288 20.2% $10.87 $3,129.52 25.7%

Chemicals 10,380 3.5% 130 9.1% $13.08 $1,699.80 14.0%

Machinery 25,936 8.8% 196 13.7% $5.20 $1,018.24 8.4%

Electrical Equipment, 

Appliance, and 

Components 9,624 3.2% 104 7.3% $3.90 $405.11 3.3%

Beverage & Tobacco 2,341 0.8% 14 1.0% $13.08 $364.27 3.0%

Misc. Manufacturing 37,842 12.8% 136 9.5% $2.61 $354.42 2.9%

Food 16,636 5.6% 61 4.3% $4.46 $272.03 2.2%

Fabricated Metal 

Products 57,044 19.3% 132 9.3% $1.94 $255.93 2.1%

Paper 3,089 1.0% 33 2.3% $7.11 $234.47 1.9%

Primary Metals 5,191 1.8% 35 2.5% $3.71 $129.92 1.1%

Plastics & Rubber 

Products 13,043 4.4% 60 4.2% $1.49 $89.41 0.7%

Nonmetallic Mineral 

Products 8,627 2.9% 18 1.3% $4.27 $76.82 0.6%

Textile Mills & 

Textile Mills 

Products 5,788 2.0% 38 2.7% $1.19 $45.20 0.4%

Furniture & Related 

Products 10,966 3.7% 19 1.3% $1.29 $24.60 0.2%

Wood Products 13,345 4.5% 52 3.6% $0.37 $19.27 0.2%

Printing & Related 

Support 32,814 11.1% 10 0.7% $0.74 $7.40 0.1%

Petroleum & Coal 

Products 1,390 0.5% (1) (1) (1) (1) (1)

Leather & Allied 

Products 1,695 0.6% (1) (1) (1) (1) (1)

Apparel 14,393 4.9% (1) (1) (1) (1) (1)

TOTAL 296,287 100.0% 1,427 100.0% $8.52 $12,158.11 100.0%

(1) – Data not disclosed to protect taxpayer confidentiality.

Industry classification self-reported on a consolidated return basis.

Note: Totals may not add due to rounding

Source: JCT staff calculations from IRS data
66

Characterization of FSC beneficiaries

In general

It is not really possible to describe a “generic” corporation that has utilized the FSC (or 

ETI) benefits of the Code. As detailed above, fewer than 200 corporations claimed most of the 

FSC benefits in 1999. These corporations generally were large when measured by assets, sales, 

or income. Moreover, in general, these corporations apply substantial amounts of physical (i.e., 

plant and equipment) and intangible capital (e.g., patents, trademarks, proprietary information 

and processes, and goodwill) in their business and also have substantial amounts of non-FSC 

foreign income. Yet there are numerous exceptions to this generalization of FSC beneficiaries. 

It also is the case that there are a number of large corporations that apply substantial amounts of 

physical and intangible capital in their business and also have substantial amounts of non-FSC 

foreign income that did not claim FSC benefits in 1999.

It is difficult to bring data to bear to characterize those corporations that claimed FSC 

benefits in 1999 as capital intensive or not capital intensive, to assess the extent to which such 

businesses earn returns from intangible capital, or to measure the extent to which FSC 

beneficiaries have non-FSC foreign source earnings. The source of data reported in the 

following tables is tax return data. These data are not perfectly suited to the task of 

characterizing those businesses that claim FSC benefits because items reported on the tax return 

may only offer crude approximations for the information necessary to describe the corporation’s 

business activity. For example, tax return information does not report the value of patents or 

copyrights that a taxpayer may be employing to earn income. Likewise tax return information 

does not report the value of a taxpayer’s investment in plant and equipment outside of the United 

States. The tables below report data drawn from the sample of corporate returns for 1999 

prepared by the Internal Revenue Service’s Statistics of Income Division.

FSC beneficiaries and investments in physical capital

Table 10 and Table 11 sort all corporations (Table 10) that reported a FSC dividend in 

1999 and all manufacturing corporations (Table 11) that reported a FSC dividend in 1999 by the 

size of the FSC dividend reported. These tables display the average assets and average 

depreciation reported by decile, from those ten percent of firms reporting the smallest FSC 

dividends to the ten percent of firms reporting the largest FSC dividends. 
67

Table 10.–The Average FSC Dividend, Average Assets, and Average Depreciation

Reported by All Corporations Reporting a FSC Dividend in 1999,

by Decile Based on the Size of the FSC Dividend

(188 firms per decile)

FSC Decile

Average FSC 

Dividend

($ thousands)

Average Assets

($ thousands)

Average 

Depreciation

($ thousands)

Smallest to 10th percentile $25 $154,861 $4,505

11th to 20th percentile 66 1,000,279 3,648

21st to 30th percentile 124 91,434 3,704

31st to 40th percentile 231 204,210 7,227

41st to 50th percentile 361 163,106 4,270

51st to 60th percentile 545 587,572 13,172

61st to 70th percentile 980 1,495,840 44,758

71st to 80th percentile 1,980 7,344,215 44,697

81st to 90th percentile 5,035 4,143,671 74,333

Largest 10 percent of FSC 

dividends reported 63,564 31,133,400 639,211

Note: JCT staff tabulations of IRS Statistics of Income data.
68

Table 11.–The Average FSC Dividend, Average Assets, and Average Depreciation 

Reported by Manufacturing Corporations Reporting a FSC Dividend in 1999,

by Decile Based on the Size of the FSC Dividend

(143 firms per decile)

FSC Decile

Average FSC 

Dividend

($ thousands)

Average Assets

($ thousands)

Average 

Depreciation

($ thousands)

Smallest to 10th percentile $29 $51,640 $2,151

11th to 20th percentile 76 82,747 3,588

21st to 30th percentile 151 109,784 4,659

31st to 40th percentile 270 105,024 4,049

41st to 50th percentile 390 146,073 4,131

51st to 60th percentile 616 374,127 8,750

61st to 70th percentile 1,089 762,213 27,788

71st to 80th percentile 2,247 1,751,720 44,935

81st to 90th percentile 5,540 2,811,985 74,192

Largest 10 percent of FSC 

dividends reported 75,160 21,892,107 607,354

Note: JCT staff tabulations of IRS Statistics of Income data.
69

As reported above, manufacturing firms comprise the vast majority of FSC beneficiaries. 

However, obviously, not all manufacturing firms utilized an FSC. Table 12 displays, by firm 

size as measured by firm assets, the average depreciation reported by manufacturing firms that 

did not report any FSC dividends in 1999 and also displays the average depreciation reported by 

those manufacturing firms that did report a FSC dividend in 1999. Table 12 also reports the 

average FSC dividend reported by those manufacturing firms that reported a FSC dividend in 

1999. 

For manufacturing corporations with less than $1 billion in assets, the average 

depreciation claimed in 1999 by FSC beneficiaries and by manufacturing corporations that 

claimed no FSC benefits was comparable. Among the largest manufacturing corporations (those 

with assets of $1 billion or more), FSC beneficiaries reported nearly three times as much 

depreciation expense as did non-FSC beneficiaries.

Table 12.–Number of Manufacturing Firms Not Reporting a FSC Dividend, Number

of Manufacturing Firms Reporting a FSC Dividend, Average Depreciation

Claimed by Manufacturing Firms Not Reporting a FSC Dividend, Average

Depreciation Claimed by Manufacturing Firms Reporting a FSC Dividend,

and Average FSC Dividend Reported, by Asset Size of Firm

Number of Firms

Average Depreciation

($ thousands)

Size of Firm by Total 

Assets

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

Average FSC 

Dividend

($ thousands)

Zero or missing.............. 11,665 n.d. $263 n.d. n.d.

$1 to $999,999............... 213,029 n.d. 16 n.d. n.d.

$1 million to less than

$10 million.................... 57,941 195 168 $265 $179

$10 million to less than

$50 million.................... 9,881 349 996 1,113 288

$50 million to less than 

$250 million .................. 2,721 323 4,591 5,292 926

$250 million to less than

$1 billion....................... 710 234 19,811 19,007 2,619

$1 billion or more .......... 341 287 137,571 363,819 38,592

All firms ....................... 296,288 1,426 336 77,899 8,526

n.d. – not disclosed to protect confidentiality.
70

FSC beneficiaries and investments in intangible capital

As noted above, it is difficult to assess the extent to which a corporation employs 

intangible capital in its business activities. Two potential items reported on the corporation’s tax 

return that are related to intangible capital are research credits claimed and royalty income 

earned. Table 13 and Table 14 are similar to Table 10 and Table 11 except that, instead of 

reporting assets and depreciation by FSC dividend decile, they report average research credit 

amount claimed and the average royalty income reported by FSC beneficiaries. 

Table 13.–The Average FSC Dividend, Average Research Credit Claimed,

and Average Royalty Income Reported by All Corporations Reporting a

FSC Dividend in 1999, by Decile Based on the Size of the FSC Dividend

(188 firms per decile)

FSC Decile

Average FSC 

Dividend

($ thousands)

Average Research

Credit Claimed

($ thousands)

Average Royalty

Income Reported

($ thousands)

Smallest to 10th percentile $25 $49 $397

11th to 20th percentile 66 75 125

21st to 30th percentile 124 62 229

31st to 40th percentile 231 95 2,698

41st to 50th percentile 361 78 936

51st to 60th percentile 545 161 4,081

61st to 70th percentile 980 393 10,579

71st to 80th percentile 1,980 780 16,454

81st to 90th percentile 5,035 1,112 19,583

Largest 10 percent of FSC 

dividends reported 63,564 10,505 191,518

Note: JCT staff tabulations of IRS Statistics of Income data.
71

Table 14.–The Average FSC Dividend, Average Research Credit Claimed, and

Average Royalty Income Reported by Manufacturing Corporations Reporting a

FSC Dividend in 1999, by Decile Based on the Size of the FSC Dividend

(143 firms per decile)

FSC Decile

Average FSC 

Dividend

($ thousands)

Average Research

Credit Claimed

($ thousands)

Average Royalty

Income Reported

($ thousands)

Smallest to 10th percentile $29 $75 $604

11th to 20th percentile 76 35 51

21st to 30th percentile 151 72 372

31st to 40th percentile 270 67 363

41st to 50th percentile 390 54 763

51st to 60th percentile 616 121 1,950

61st to 70th percentile 1,089 435 10,697

71st to 80th percentile 2,247 814 18,831

81st to 90th percentile 5,540 1,269 18,838

Largest 10 percent of FSC 

dividends reported 75,160 12,718 214,173

Note: JCT staff tabulations of IRS Statistics of Income data.
72

Table 15 and Table 16 restrict the presentation to corporations that report themselves as 

predominantly engaged in manufacturing. Table 15 sorts manufacturing firms that did not report 

any FSC dividends and those that did report FSC dividends by asset size and for each size class 

reports the average research credit claimed in 1999. Table 16 sorts manufacturing firms that did 

not report any FSC dividends and those that did report FSC dividends by asset size and for each 

size class reports the average royalty income reported in 1999. On average, for each asset size 

classification, manufacturing corporations that claimed FSC benefits in 1999 claimed twice as 

much research credit as did manufacturing corporations that did not claim FSC benefits. 

Likewise, on average, for each asset size classification, manufacturing corporations that claimed 

FSC benefits in 1999 reported at least 50 percent more royalty income than did manufacturing 

corporations that did not claim FSC benefits. As reported in Table 9, three industries accounted 

for more than 70 percent of FSC benefits: transportation equipment; computer and electronic 

products; and chemicals. Given the technical nature of these industries, the indication of 

potentially greater reliance on intangible capital by FSC beneficiaries reported in Table 15 and 

Table 16 may be expected.

Table 15.–Number of Manufacturing Firms Not Reporting a FSC Dividend, Number

of Manufacturing Firms Reporting a FSC Dividend, Average Research Credit

Claimed by Manufacturing Firms Not Reporting a FSC Dividend,

Average Research Credit Claimed by Manufacturing Firms Reporting a

FSC Dividend, and Average FSC Dividend Reported, by Asset Size of Firm

Number of Firms

Average Research Credit 

Claimed

($ thousands)

Size of Firm by Total 

Assets

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

Average FSC 

Dividend

($ thousands)

Zero or missing.............. 11,665 n.d. $4 n.d. n.d.

$1 to $999,999............... 213,029 n.d. 0 n.d. n.d.

$1 million to less than

$10 million.................... 57,941 195 2 $12 $179

$10 million to less than

$50 million.................... 9,881 349 15 30 288

$50 million to less than 

$250 million .................. 2,721 323 64 129 926

$250 million to less than

$1 billion....................... 710 234 285 408 2,619

$1 billion or more .......... 341 287 3,057 7,220 38,592

All firms ....................... 296,288 1,426 6 1,561 8,526

n.d. – not disclosed to protect confidentiality.
73

Table 16.–Number of Manufacturing Firms Not Reporting a FSC Dividend, Number

of Manufacturing Firms Reporting a FSC Dividend, Average Royalty

Income Reported by Manufacturing Firms Not Reporting a FSC Dividend,

Average Royalty Income Reported by Manufacturing Firms Reporting a

FSC Dividend, and Average FSC Dividend Reported, by Asset Size of Firm

Number of Firms

Average Royalty Income 

Claimed

($ thousands)

Size of Firm by Total 

Assets

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

Average FSC 

Dividend

($ thousands)

Zero or missing.............. 11,665 n.d. $64 n.d. n.d.

$1 to $999,999............... 213,029 n.d. 0 n.d. n.d.

$1 million to less than

$10 million.................... 57,941 195 1 $2 $179

$10 million to less than

$50 million.................... 9,881 349 23 47 288

$50 million to less than 

$250 million .................. 2,721 323 301 557 926

$250 million to less than

$1 billion....................... 710 234 1,904 2,819 2,619

$1 billion or more .......... 341 287 88,858 129,051 38,592

All firms ....................... 296,288 1,426 6 26,576 8,526

n.d. – not disclosed to protect confidentiality.
74

FSC beneficiaries and other foreign operations

Corporations that claimed FSC benefits in 1999 generally were large enterprises. Many 

large U.S. corporations have established subsidiaries or branches overseas to increase their sales 

and income. Table 17 and Table 18 are similar to Table 10 and Table 11 and Table 13 and Table 

14 except that they report, by decile, the average foreign tax credit claimed in 1999 and the 

average non-FSC foreign dividends reported in 1999 by FSC beneficiaries. These two variables 

reported on the corporation’s tax return may serve as an indicator of the extent to which the 

corporation has a presence outside of the United States. As before, Table 17 presents data for all 

1,885 FSC beneficiaries and Table 17 presents data for the 1,426 manufacturing firms who were 

FSC beneficiaries in 1999. Across all deciles of FSC beneficiaries, on average, the 

corporation’s non-FSC foreign dividends exceed the FSC dividend reported in 1999.

Table 17.–The Average FSC Dividend, Average Foreign Tax Credit Claimed, and

Average non-FSC Foreign Dividends Reported by All Corporations Reporting

a FSC Dividend in 1999, by Decile Based on the Size of the FSC Dividend

(188 firms per decile)

FSC Dividend Decile

Average FSC 

Dividend

($ thousands)

Average Foreign

Tax Credit 

Claimed

($ thousands)

Average Non-FSC

Foreign Dividends 

Reported

($ thousands)

Smallest to 10th percentile $25 $48 $33

11th to 20th percentile 66 231 4,519

21st to 30th percentile 124 125 185

31st to 40th percentile 231 124 278

41st to 50th percentile 361 160 138

51st to 60th percentile 545 1,912 1,616

61st to 70th percentile 980 5,620 12,005

71st to 80th percentile 1,980 10,307 6,209

81st to 90th percentile 5,035 12,567 32,993

Largest 10 percent of FSC 

dividends reported 63,564 83,609 70,226

Note: JCT staff tabulations of IRS Statistics of Income data.
75

Table 18.–The Average FSC Dividend, Average Foreign Tax Credit Claimed, and

Average non-FSC Foreign Dividends Reported by Manufacturing Corporations

Reporting a FSC Dividend in 1999, by Decile Based on the Size of the FSC Dividend

(143 firms per decile)

FSC Dividend Decile

Average FSC 

Dividend

($ thousands)

Average Foreign

Tax Credit 

Claimed

($ thousands)

Average Non-FSC

Foreign Dividends 

Reported

($ thousands)

Smallest to 10th percentile $29 $26 $19

11th to 20th percentile 76 45 199

21st to 30th percentile 151 223 321

31st to 40th percentile 270 38 91

41st to 50th percentile 390 110 153

51st to 60th percentile 616 1,78 418

61st to 70th percentile 1,089 6,878 14,825

71st to 80th percentile 2,247 4,881 5,385

81st to 90th percentile 5,540 13,851 39,911

Largest 10 percent of FSC 

dividends reported 75,160 92,390 85,778

Note: JCT staff tabulations of IRS Statistics of Income data.
76

Table 19 and Table 20 restrict the presentation to corporations that report themselves as 

predominantly engaged in manufacturing. Table 19 sorts manufacturing firms that did not report 

any FSC dividends and those that did report FSC dividends by asset size and for each size class 

reports the average foreign tax credit claimed. Table 20 sorts manufacturing firms that did not 

report any FSC dividends and those that did report FSC dividends by asset size and for each size 

class reports the average non-FSC foreign dividends reported in 1999. 

For manufacturing corporations with less than $1 billion in assets, the average FSC 

dividend claimed in 1999 exceeded the average non-FSC foreign dividend reported by FSC 

beneficiaries. Among the largest manufacturing corporations (those with assets of $1 billion or 

more), FSC beneficiaries reported non-FSC foreign dividends nearly twice as large as FSC 

dividends on average. 

Table 19.–Number of Manufacturing Firms Not Reporting a FSC Dividend, Number

of Manufacturing Firms Reporting a FSC Dividend, Average Foreign

Tax Credit Claimed by Manufacturing Firms Not Reporting a FSC Dividend,

Average Foreign Tax Credit Claimed by Manufacturing Firms Reporting a

FSC Dividend, and Average FSC Dividend Reported, by Asset Size of Firm

Number of Firms

Average Foreign Tax 

Credit Claimed

($ thousands)

Size of Firm by Total 

Assets

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

Average FSC 

Dividend

($ thousands)

Zero or missing.............. 11,665 n.d. $99 n.d. n.d.

$1 to $999,999............... 213,029 n.d. 0 n.d. n.d.

$1 million to less than

$10 million.................... 57,941 195 0 $0 $179

$10 million to less than

$50 million.................... 9,881 349 4 12 288

$50 million to less than 

$250 million .................. 2,721 323 60 205 926

$250 million to less than

$1 billion....................... 710 234 522 1,340 2,619

$1 billion or more .......... 341 287 21,697 57,404 38,592

All firms ....................... 296,288 1,426 31 11,826 8,526

n.d. – not disclosed to protect confidentiality.
77

Table 20.–Number of Manufacturing Firms Not Reporting a FSC Dividend, Number

of Manufacturing Firms Reporting a FSC Dividend, Average non-FSC Foreign

Dividend Reported by Manufacturing Firms Not Reporting a FSC Dividend,

Average non-FSC Foreign Dividend Reported by Manufacturing Firms Reporting

a FSC Dividend, and Average FSC Dividend Reported, by Asset Size of Firm

Number of Firms

Average Non-FSC Foreign 

Dividend Reported

($ thousands)

Size of Firm by Total 

Assets

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

No FSC 

Dividend 

Reported

FSC 

Dividend 

Reported

Average FSC 

Dividend

($ thousands)

Zero or missing.............. 11,665 n.d. $59 n.d. n.d.

$1 to $999,999............... 213,029 n.d. 0 n.d. n.d.

$1 million to less than

$10 million.................... 57,941 195 0 $0 $179

$10 million to less than

$50 million.................... 9,881 349 12 20 288

$50 million to less than 

$250 million .................. 2,721 323 106 359 926

$250 million to less than

$1 billion....................... 710 234 1,029 1,490 2,619

$1 billion or more .......... 341 287 25,311 68,308 38,592

All firms ....................... 296,288 1,426 35 14,686 8,526

n.d. – not disclosed to protect confidentiality.
78

III. SELECTED ISSUES

A. The FSC-ETI Dispute

Overview

Like many other countries, the United States has long provided export-related benefits 

under its tax law. In the United States, for most of the last two decades, these benefits were 

provided under the FSC regime. In 2000, the European Union (“EU”) succeeded in having the 

FSC regime declared a prohibited export subsidy by the WTO. In response to this WTO ruling, 

the United States repealed the FSC rules and enacted the ETI regime under the FSC Repeal and 

Extraterritorial Income Exclusion Act of 2000 (the “ETI Act”). The EU immediately challenged 

the ETI regime in the WTO, and in January of 2002 a WTO Appellate Body held that the ETI 

regime also constituted a prohibited export subsidy under the relevant trade agreements. 

In August 2002, a WTO arbitration panel ruled that the EU could impose trade sanctions 

of $4.04 billion against U.S. exports to the EU as a countermeasure to the prohibited export 

subsidy provided through the ETI Act. In September 2002, the European Commission published 

an initial list of approximately $12 billion worth of potentially targeted U.S. exports to EU 

member states. EU companies were given a 60-day consultation period to appeal the inclusion 

of items on the sanctions list (e.g., if they relied on a particular item as an input to production). 

In March 2003, EU member states approved a shortened list of U.S. exports to the EU that 

matched the $4 billion retaliation amount authorized by the WTO.57 The list includes more than 

1,600 products listed by their eight-digit codes under the EU customs classification system.

Early statements by European Commission officials indicated that the EU would refrain 

from imposing sanctions against the United States as long as it was evident that progress was 

being made toward complying with the WTO rulings. In May 2003, EU Trade Commissioner 

Pascal Lamy indicated that the European Commission will review the situation this fall, and if 

there is no sign that compliance is forthcoming at that time, the European Commission will begin 

the legislative procedure for the adoption of countermeasures by January 1, 2004.

Background and History of the Trade Dispute Over the FSC and ETI Regimes

The “DISC” dispute and enactment of the FSC regime

Prior to the enactment of the FSC regime, the United States provided a different system 

of export-related tax benefits, which applied to certain export-intensive corporations known as 

“domestic international sales corporations” (“DISCs”).58 Under this regime, DISCs were 

 

57

 European Commission Proposed Retaliatory Duties List in World Trade Organization 

Dispute Over U.S. Tax Treatment for Foreign Sales Corporations, available in BNA Daily Tax 

Report, April 28, 2003, G-7.

58 Another export incentive in turn preceded the DISC regime -- under provisions 

enacted in 1962, controlled foreign corporations that qualified as “export trade corporations” 

were permitted to reduce their subpart F income by the amount of certain export trade income.
79

incorporated as domestic corporations, but DISC income was exempt from corporate income tax, 

and the shareholder-level tax on that income was in part deferred. Shortly after the DISC 

regime’s enactment in 1971, certain signatories to the General Agreement on Tariffs and Trade 

(“GATT”) challenged the regime as a prohibited export subsidy. In 1976, a GATT panel 

sustained these challenges, as well as U.S. challenges to certain export tax incentives provided 

by France, Belgium, and the Netherlands. These rulings of the panel proved controversial and 

remained unadopted by the relevant signatory countries for a number of years. 

In 1981, without conceding that the DISC regime violated the GATT, the United States 

agreed to adopt the general findings of the GATT panel, subject to a 1981 GATT Council 

Decision (the “1981 Understanding”), which was understood to qualify those findings. The 1981 

Understanding had three main components: (1) GATT signatories are not required to tax export 

income that is attributable to economic processes occurring outside their territorial limits; (2) 

“arm’s length” transfer pricing principles should be observed in transactions between exporting 

enterprises and related foreign buyers; and (3) the GATT does not prohibit the adoption of 

measures to avoid the double taxation of foreign-source income. 

A debate subsequently ensued as to whether the DISC regime violated the GATT, as 

interpreted in light of the 1981 Understanding. The European Communities (“EC”) argued that 

the DISC regime constituted an illegal export subsidy because it provided tax benefits for export 

income earned within the United States. The United States defended the regime on the grounds 

that, as applied to exports, it merely approximated the effect of a territorial tax system of the kind 

commonly used by European countries, which in turn was considered acceptable under the 1981 

Understanding. A majority of GATT Council members sided with the EC and urged the United 

States to bring the DISC regime into compliance with the GATT. In addition, the EC took steps 

toward seeking approval for the imposition of trade sanctions against the United States, and other 

signatories indicated that they would seek compensation from the United States. In late 1982, 

the United States made a commitment to the GATT Council to develop legislation that would 

address these concerns, and in early 1983, the President set forth a proposal to replace the DISC 

regime with a new system that was thought to be GATT-compliant (without conceding that the 

DISC regime was not GATT-compliant).

In 1984, the Congress enacted legislation along the general lines proposed by the 

President, creating the FSC regime. Unlike the DISC regime, the FSC regime provided tax 

benefits for export-related income earned by foreign corporations that were required to have a 

foreign presence and to perform export-related activities outside the United States. Transfer 

pricing principles were also set forth for the measurement of FSC income. In light of these 

features, which caused the FSC regime to emulate more closely certain aspects of an exemptionmethod territorial tax system, the FSC regime was thought to fall directly within the terms of the 

1981 Understanding. 

The FSC regime had been in existence for approximately 14 years when the EU brought 

a case against it in the WTO in mid-1998. 
80

The FSC dispute and enactment of the ETI regime

In 1999, a WTO panel agreed with the EU that the FSC regime constituted a prohibited 

export subsidy under the relevant WTO agreements, and in early 2000 a WTO Appellate Body 

upheld that finding. The rulings held that the FSC rules constituted a subsidy because under 

those rules the government refrained from collecting revenue that was “otherwise due”; the 

rulings held that this subsidy was prohibited because it was export-contingent. The EU also 

expressed additional objections to the FSC regime that were not addressed by the WTO --

specifically, that the FSC transfer pricing rules were not “arm’s length,” and that the FSC regime 

encouraged the use of tax havens. 

In an effort to comply with these rulings (and to address the additional concerns raised by 

the EU), in late 2000 the United States repealed the FSC regime and enacted the ETI regime. 

Under the ETI regime, an exclusion from gross income applies with respect to 

“extraterritorial income,” which is a taxpayer’s gross income attributable to “foreign trading 

gross receipts.” This income is eligible for the exclusion to the extent that it is “qualifying 

foreign trade income.” Qualifying foreign trade income is the amount of gross income that, if 

excluded, would result in a reduction of taxable income by the greatest of: (1) 1.2 percent of the 

foreign trading gross receipts derived by the taxpayer from the transaction; (2) 15 percent of the 

“foreign trade income” derived by the taxpayer from the transaction;59 or (3) 30 percent of the 

“foreign sale and leasing income” derived by the taxpayer from the transaction. 60 

Foreign trading gross receipts are gross receipts derived from certain activities in 

connection with “qualifying foreign trade property” with respect to which certain economic 

processes take place outside of the United States. Specifically, the gross receipts must be: (1) 

from the sale, exchange, or other disposition of qualifying foreign trade property; (2) from the 

lease or rental of qualifying foreign trade property for use by the lessee outside the United States; 

(3) for services which are related and subsidiary to the sale, exchange, disposition, lease, or 

rental of qualifying foreign trade property (as described above); (4) for engineering or 

architectural services for construction projects located outside the United States; or (5) for the 

performance of certain managerial services for unrelated persons. A taxpayer may elect to treat 

gross receipts from a transaction as not foreign trading gross receipts. As a result of such an 

election, a taxpayer may use any related foreign tax credits in lieu of the exclusion.

 

59 “Foreign trade income” is the taxable income of the taxpayer (determined without 

regard to the exclusion of qualifying foreign trade income) attributable to foreign trading gross 

receipts. 

60 “Foreign sale and leasing income” is the amount of the taxpayer's foreign trade income 

(with respect to a transaction) that is properly allocable to activities that constitute foreign 

economic processes. Foreign sale and leasing income also includes foreign trade income derived 

by the taxpayer in connection with the lease or rental of qualifying foreign trade property for use 

by the lessee outside the United States.
81

Qualifying foreign trade property generally is property manufactured, produced, grown, 

or extracted within or outside the United States that is held primarily for sale, lease, or rental in 

the ordinary course of a trade or business for direct use, consumption, or disposition outside the 

United States. No more than 50 percent of the fair market value of such property can be 

attributable to the sum of: (1) the fair market value of articles manufactured outside the United 

States; and (2) the direct costs of labor performed outside the United States. With respect to 

property that is manufactured outside the United States, certain rules are provided to ensure 

consistent U.S. tax treatment with respect to manufacturers.

Even before Congress enacted the ETI regime, the EU informed the United States that it 

intended to challenge the regime before the WTO. 

The Appellate Body decision in the ETI dispute

In general

Two days after the President signed the FSC Repeal and Extraterritorial Income 

Exclusion Act of 2000 into law, the EU brought its case against the ETI regime in the WTO. In 

August of 2001, a WTO panel (the “Panel”) held that the ETI regime constituted a prohibited 

export subsidy under the relevant WTO agreements,61 and a WTO Appellate Body (the 

“Appellate Body”) later affirmed the Panel’s findings (but modified the Panel’s reasoning in 

part).62 

The Appellate Body reviewed and upheld several findings of the Panel, including the 

findings that the ETI legislation: (1) involves the forgoing of revenue which is otherwise due and 

thus gives rise to a “financial contribution” (i.e., a subsidy); (2) includes subsidies contingent on 

export performance; (3) does not qualify for the exception from treatment as a prohibited export 

subsidy as a measure to avoid double taxation of foreign-source income; (4) is inconsistent with 

other U.S. trade obligations because it accords less favorable treatment to imported products as 

compared with like products of U.S. origin; and (5) did not fully withdraw the FSC rules that 

were previously found to constitute a prohibited export subsidy. 63

 

61 United States -- Tax Treatment for “Foreign Sales Corporations” -- Recourse to 

Article 21.5 of the DSU by the European Communities, WT/DS108/RW, Report of the Panel, 

August 20, 2001.

62 United States -- Tax Treatment for “Foreign Sales Corporations” -- Recourse to 

Article 21.5 of the DSU by the European Communities, WT/DS108/RW, Report of the Panel, as 

modified by the Appellate Body, January 14, 2002, adopted January 29, 2002 (the “Appellate 

Body Decision”).

63 The Appellate Body also reviewed and upheld other findings of the Panel, including a 

finding that the ETI rules involve prohibited export subsidies under the Agreement on 

Agriculture.
82

Subsidy

The Panel found that the ETI rules constitute a subsidy under the Agreement on Subsidies 

and Countermeasures (the “SCM Agreement”). Under that agreement, a subsidy is deemed to 

exist if there is a financial contribution by a government, and a benefit is thereby conferred. A 

financial contribution by a government exists where government revenue that is otherwise due is 

forgone or not collected.

The Appellate Body reviewed the Panel’s finding that the ETI rules involve the forgoing 

of revenue that is otherwise due and thus give rise to a financial contribution. The Appellate 

Body stated that the term “otherwise due” implies a comparison with a “defined, normative 

benchmark,” to distinguish situations where revenue forgone is “otherwise due” and situations 

where such revenue is not “otherwise due.” The Appellate Body further stated that the 

normative benchmark for the ETI rules consists of the other rules of taxation applicable to the 

foreign-source income of U.S. citizens and residents earned through the sale or lease of property, 

or through the performance of related services. 

The Appellate Body stated that the United States taxes U.S. citizens and residents, in 

principle, on all foreign-source income, subject to permissible deductions and allowable foreign 

tax credits. The Appellate Body further stated that, under the ETI rules, certain extraterritorial 

income (i.e., “qualifying foreign trade income”) is excluded from U.S. taxation, and that 

taxpayers may elect to apply this exclusion or be subject to tax under the other rules applicable to 

such income. The Appellate Body further stated that where a taxpayer elects to apply the ETI 

rules, “the amount of tax paid by the taxpayer will very likely be less than the tax which the 

taxpayer would have paid, on that income, under the rules ‘otherwise’ applicable to foreignsource income, if the taxpayer did not elect to use the ETI measure.”64 The Appellate Body 

concluded that “the definitive exclusion from tax of [qualifying foreign trade income], compared 

with the taxation of other foreign-source income, and coupled with the right of election for 

taxpayers to use the rules of taxation most favourable to them, means that, under the contested 

measure, the United States foregoes revenue on [qualifying foreign trade income] which is 

otherwise due.”65

Export contingency

The Appellate Body upheld the Panel’s finding that the ETI rules include subsidies 

contingent on export performance. The SCM Agreement prohibits “subsidies contingent, in law 

or in fact, whether solely or as one of several conditions, upon export performance.” The Panel 

found that the ETI rules involve subsidies contingent in law upon exports in relation to property 

produced in the United States. 

The Appellate Body concluded that the ETI rules grant a tax exemption as to certain 

transactions involving two different types of property: (1) property that is produced within the 

United States and held for use outside the United States, and (2) property that is produced 

 

64 Appellate Body Report at 32.

65 Id.
83

outside the United States and held for use outside the United States. The Appellate Body 

reasoned that the division of the ETI rules into these two separate circumstances is supported by 

provisions in the ETI rules themselves, each addressing a particular factual situation: 

specifically, certain foreign-source limitation rules that apply only to property produced in the 

United States and certain consistency rules that apply only to property produced outside the 

United States. The Appellate Body concluded that the portion of the ETI rules that provides a 

tax exemption for property produced in the United States and held for use outside the United 

States is export-contingent.66

Exception for measures to avoid double taxation

Under the SCM Agreement, even a subsidy that is contingent on exports is not prohibited 

if it is found to be a measure designed to avoid the double taxation of foreign-source income 

(often referred to as the “Footnote 59” exception, after its location in the SCM Agreement). The 

Appellate Body rejected the U.S. argument that the ETI regime qualified for the Footnote 59 

exception, because it found that the regime applied not only to foreign-source income that could 

potentially be subjected to double taxation, but also to a broad class of U.S.-source income that 

faced no such threat of double taxation (e.g., income attributable to manufacturing activities in 

the United States). 

While the Appellate Body acknowledged that countries must be given latitude to develop 

their own definitions of foreign-source income, it held that, at a minimum, such income must 

have some functional connection to a foreign country sufficient to create some possibility of 

taxation in that foreign country. While the ETI regime’s foreign economic processes 

requirement ensures that transactions qualifying for benefits under the ETI regime involve some 

link to activities conducted abroad, the Appellate Body held that that requirement was 

insufficient to ensure that all of the income generated in those transactions (and benefited by the 

ETI regime) possessed such a link. In particular, the Appellate Body examined the three main 

methods for calculating “qualifying foreign trade income” under the ETI regime and noted that, 

of the three methods, only the one applicable to “foreign sale and leasing income” includes any 

allocation rule to distinguish income connected with foreign activities from income connected 

with domestic activities. The other two methods employ formulas based on flat percentages (1.2 

percent of “foreign trading gross receipts” or 15 percent of “foreign trade income”) and thus, in 

the Appellate Body’s view, do not sufficiently distinguish between foreign-source and domesticsource income in providing the ETI benefit. In addition, the foreign economic processes 

requirement does not apply at all to “small” taxpayers (i.e., those with $5 million or less of 

“foreign trading gross receipts”), and thus, according to the Appellate Body, no effort at all is 

made to distinguish foreign-source and domestic-source income with respect to these taxpayers.

The Appellate Body further noted that the ETI regime is elective, and that taxpayers are 

allowed to choose between the ETI regime and the foreign tax credit regime generally provided 

under U.S. law to mitigate double taxation, making it difficult in the Appellate Body’s view to 

 

66 The Appellate Body did not opine on the issue of whether the portion of the ETI rules 

that applies to property produced outside the United States and held for use outside the United 

States is export-contingent.
84

maintain that the United States designed and enacted the ETI regime with a view toward 

avoiding double taxation.

Limitation on foreign content

The Appellate Body upheld the Panel’s finding that the ETI rules accord less favorable 

treatment to imported products as compared with like products of U.S. origin and thus violate the 

GATT 1994, which broadly prohibits discrimination against imports. The ETI rules require that 

not more than 50 percent of the fair market value of qualifying foreign trade property may be 

attributable to articles produced or direct labor performed outside the United States. In the 

Appellate Body’s view, this foreign-content limitation on the ETI tax benefit constitutes 

discrimination against imports in violation of the GATT 1994, because taxpayers seeking ETI 

benefits have an incentive to use U.S. inputs instead of foreign inputs in order to ensure that they 

comply with the foreign-content limitation.

Withdrawal of FSC rules

The Appellate Body upheld the Panel’s finding that the United States has not fully 

withdrawn the FSC rules previously found to be prohibited export subsidies. In the FSC dispute, 

the WTO panel recommended that the United States withdraw the FSC subsidies by October 1, 

2000; the WTO Dispute Settlement Body acceded to a U.S. request to modify the time period in 

that dispute to expire on November 1, 2000. Although the FSC rules have been largely repealed, 

transition rules apply to certain existing FSCs and to certain pre-existing binding contractual 

arrangements involving FSCs. The Appellate Body concluded that the FSC rules were required 

to be fully withdrawn without delay, and that there was no basis to extend the time period for the 

United States to fully withdraw the FSC rules.

Arbitration proceedings on trade sanctions

WTO rules allow complaining countries to impose countermeasures against countries that 

are found to violate their WTO obligations. In this dispute, the EU requested authorization from 

a WTO arbitration panel to impose trade sanctions in the amount of $4.04 billion per year against 

U.S. exports. The EU based this figure on estimates of the total cost to the United States of 

providing the subsidy, not on any estimate of actual trade harm to the EU itself. The United 

States argued in its submission to the arbitration panel that the EU figure was disproportionate to 

any possible harm to the EU itself and is therefore inappropriate, and that the maximum level of 

permissible sanctions in this case is $956 million per year. 

The parties filed their initial submissions on the sanctions issue in early February of 

2002. In August 2002, a WTO arbitration panel ruled that the EU could impose trade sanctions 

of $4.04 billion against U.S. exports to the EU as a countermeasure to the prohibited export 

subsidies provided by the United States through the ETI Act. In September 2002, the European 

Commission published an initial list of approximately $12 billion worth of potentially targeted 

U.S. exports to the EU member states. EU companies were given a 60-day consultation period 

to appeal the inclusion of items on the sanctions list (e.g., if they relied on a particular item as an 

input to production). In March 2003, EU member states approved a shortened list of U.S. 
85

exports to the EU that matched the $4 billion retaliation amount authorized by the WTO.67 The 

list includes more than 1,600 products listed by their eight-digit codes under the EU customs 

classification system. 

Authorization of trade sanctions

In May 2003, the WTO Dispute Settlement Body granted final authorization to the EU to 

impose sanctions against the United States. The legislative procedure for adopting 

countermeasures against the United States would require an agreement of the 15 EU member 

states, voting by a qualified majority in the EU Council, upon recommendation by the European 

Commission to impose sanctions. 

Proposed alternatives to FSC-ETI

H.R. 5095 (107th Congress)

H.R. 5095, the “American Competitiveness and Corporate Accountability Act of 2002,” 

was introduced by Chairman William Thomas of the House Ways and Means Committee on July 

11, 2002. The bill would repeal the ETI regime and replace it with international competitiveness 

provisions relating to income from foreign business operations and investment. The bill includes 

several proposals relating to subpart F (e.g., repeal of the foreign base company sales and 

services income rules, look-through treatment of certain payments between related controlled 

foreign corporations under the foreign personal holding company rules) and the foreign tax credit 

(e.g., allocation of interest expense using a worldwide fungibility approach, recharacterization of 

overall domestic losses, reduction to three foreign tax credit baskets, extension of carryforward 

period for foreign tax credits).68 The bill also includes provisions relating to corporate tax 

shelters and inversion transactions. 

H.R. 1769

H.R. 1769, the “Job Protection Act of 2003,” was introduced by Representatives Philip 

Crane and Charles Rangel, the House Ways and Means Trade Subcommittee chairman and the 

committee’s ranking member, respectively, on April 11, 2003. The bill would repeal the ETI 

regime and replace it with a percentage deduction for domestic manufacturing income. The bill 

generally allows a corporation a deduction equal to 10 percent of its taxable income related to 

domestic production activities for the taxable year. However, the amount of this deduction is 

reduced for taxpayers with foreign production activities, in proportion to the relative value of 

such activities. The bill also provides transition relief to current FSC/ETI beneficiaries. The bill 

allows current FSC/ETI benefits to remain in effect for transactions between unrelated parties 

pursuant to a binding contract and allows a deduction equal to a percentage of the taxpayer’s 

 

67

 European Commission Proposed Retaliatory Duties List in World Trade Organization 

Dispute Over U.S. Tax Treatment for Foreign Sales Corporations, available in BNA Daily Tax 

Report, April 28, 2003, G-7.

68 For a more detailed analysis of the provisions contained in H.R. 5095, see Joint 

Committee on Taxation, Technical Explanation of H.R. 5095, (JCX-78-02), July 2002.
86

FSC/ETI benefit accrued in 2001 (indexed for inflation). The deduction is phased out over a 

period of five years and does not apply to the extent that the binding contract transition relief 

applies to the taxpayer. 
87

B. Base Erosion Through Earnings Stripping and

Offshore Reinsurance Transactions

Earnings stripping

Background

A U.S. corporation with a foreign parent may reduce the U.S. tax on its U.S.-source 

income through the payment of deductible amounts such as interest, rents, royalties and 

management service fees to the foreign parent or other foreign affiliates that are not subject to 

U.S. tax on the receipt of such payments. These transactions are commonly referred to as 

“earnings stripping” transactions. Although foreign corporations generally are subject to a grossbasis U.S. tax at a flat 30-percent rate on the receipt of payments like interest, rents, royalties, 

and certain similar types of income derived from U.S. sources, this tax may be reduced or 

eliminated under an applicable income tax treaty. Consequently, U.S. corporations may use 

certain treaties to facilitate earnings stripping transactions without having the benefit of their 

deductions offset by U.S. withholding taxes. 

Section 163(j) addresses earnings stripping involving interest payments, by limiting the 

deductibility of interest paid to certain related parties if no income tax is imposed on the interest 

(“disqualified interest”),69 if: (1) the payor’s debt-to-equity ratio exceeds 1.5 to 1 (the so-called 

“safe harbor”); and (2) the payor’s net interest expense exceeds 50 percent of its “adjusted 

taxable income” (generally taxable income computed without regard to deductions for net 

interest expense, net operating losses, and depreciation, amortization, and depletion). Interest 

amounts disallowed under these rules can be carried forward indefinitely. In addition, excess 

limitation (i.e., any excess of the 50-percent limit over a company’s net interest expense for a 

given year) can be carried forward three years. 

More generally, section 482 and the regulations thereunder require that all transactions 

(regardless of whether the transactions involve the payment of interest, royalties, rents, 

management service fees or other payments) between related parties be conducted on terms 

consistent with an “arm's length” standard, and permit the Secretary of the Treasury to reallocate 

income and deductions among such parties if that standard is not met.

Questions regarding the efficacy of the current earnings stripping rules were raised in the 

course of recent public discussion and legislative activity regarding corporate “inversion” 

transactions. It appears that the main benefit of certain recent inversion transactions was the 

reduction of U.S. taxes that otherwise would be incurred on income from U.S. operations, 

through the use of various earnings stripping strategies. 70 This provided some evidence that the 

 

69 This interest also may include interest paid to unrelated parties in certain cases in 

which a related party guarantees the debt. 

70

 See, e.g., Department of the Treasury, Office of Tax Policy, Corporate Inversion 

Transactions: Tax Policy Implications, May 17, 2002, Part VII.A (“Treasury study”); Joint 

Committee on Taxation, Background and Description of Present-Law Rules and Proposals 

Relating to Corporate Inversion Transactions (JCX-52-02), June 5, 2002, 3-4.
88

earnings stripping rules were not fully achieving their intended purposes and led some to 

conclude that these rules needed to be strengthened.71

Legislative proposals

H.R. 2

The Senate amendment to H.R. 2, the “Jobs and Growth Tax Relief Reconciliation Act of 

2003” would tighten the current earnings stripping rules, but only for certain inverted 

corporations. With respect to such corporations, the provision would eliminate the debt-equity 

threshold generally applicable under section 163(j) and would reduce the 50-percent thresholds 

for “excess interest expense” and “excess limitation” to 25 percent.

Generally, these rules would apply to transactions in which, pursuant to a plan or a series 

of related transactions: (1) a U.S. corporation becomes a subsidiary of a foreign-incorporated 

entity or otherwise transfers substantially all of its properties to such an entity; (2) the former 

shareholders of the U.S. corporation hold (by reason of holding stock in the U.S. corporation) 

greater than 50 percent but less than 80 percent (by vote or value) of the stock of the foreignincorporated entity after the transaction; and (3) the foreign-incorporated entity, considered 

together with all companies connected to it by a chain of greater than 50 percent ownership (i.e., 

the “expanded affiliated group”), does not have substantial business activities in the entity’s 

country of incorporation, compared to the total worldwide business activities of the expanded 

affiliated group. The proposal would apply to all inversion transactions meeting the above test 

that are completed after 1996. 

In addition, the proposal would apply to a transaction in which, pursuant to a plan or a 

series of related transactions completed after 1996 but before March 20, 2002: (1) a U.S. 

corporation becomes a subsidiary of a foreign-incorporated entity or otherwise transfers 

substantially all of its properties to such an entity; (2) the former shareholders of the U.S. 

corporation hold (by reason of holding stock in the U.S. corporation) 80 percent or more (by vote 

or value) of the stock of the foreign-incorporated entity after the transaction; and (3) the foreignincorporated entity, considered together with all companies connected to it by a chain of greater 

than 50 percent ownership (i.e., the “expanded affiliated group”), does not have substantial 

business activities in the entity’s country of incorporation, compared to the total worldwide 

business activities of the expanded affiliated group. With respect to such transactions completed 

on or after March 20, 2002, other provisions of the bill would eliminate the benefit of the 

inverted structure by deeming the foreign parent to be a domestic corporation, thus rendering 

earnings stripping concerns irrelevant.

 

71

 See, e.g., Department of the Treasury, General Explanations of the Administration’s 

Fiscal Year 2004 Revenue Proposals, February 2003, 104 (“Treasury explanation”) (“Under 

current law, opportunities are available to reduce inappropriately the U.S. tax on income earned 

from U.S. operations through the use of foreign related-party debt. Tightening the rules of 

section 163(j) is necessary to eliminate these inappropriate income-reduction opportunities.”); 

Treasury study, Part VII.A. (“The prevalent use of foreign related-party debt in inversion 

transactions is evidence that [the rules of section 163(j)] should be revisited”).
89

HR 5095

H.R. 5095, the “American Competitiveness Act of 2002,” was introduced by Chairman 

William Thomas of the House Ways and Means Committee on July 11, 2002. H.R. 5095 would 

strengthen the earnings stripping provisions of section 163(j) in two ways. The first involves 

modifications to the existing interest disallowance rule, based on net interest expense as a 

percentage of adjusted taxable income. The debt-equity threshold of this rule would be 

eliminated, and the percentage threshold would be lowered from 50 percent to 35 percent of 

adjusted taxable income. Carryovers of interest disallowed under this rule would be limited to 

five years, and the carryover of excess limitation would be eliminated. 

The proposal also would strengthen section 163(j) by adding a new interest disallowance 

rule, which would disallow related-party interest to the extent that the U.S. subsidiaries of a 

foreign parent are more highly leveraged than the overall worldwide corporate group. For 

purposes of applying this new test, financial corporations would be treated as a separate subgroup. Interest amounts disallowed under this new rule would not be eligible for carryover, nor 

would any excess limitation. The modified present-law disallowance rule and the new 

disallowance rule would be coordinated by providing that the rule yielding the greater amount of 

interest disallowed would determine the overall disallowance. 

The new disallowance rule would require a series of calculations. First, the total assets of 

the U.S. subsidiary (or U.S. affiliated group) would be divided by the total assets of the 

worldwide group, yielding a fraction. Debt of the U.S. subsidiary (or U.S. affiliated group) then 

would be defined as "disproportionate" to the extent that such debt exceeded the product of this 

fraction and the total external debt of the worldwide group. To the extent that disproportionate 

debt is attributable to related-party debt, the interest on this debt (determined using a blended 

average interest rate on all related-party debt) would be disallowed. For this purpose, 

disproportionate debt would be attributed first to related-party debt. Thus, in the calculation, 

disproportionate debt would be divided by the total related-party debt of the U.S. subsidiary (or 

U.S. affiliated group), to yield a "disproportionate domestic related party indebtedness 

percentage" (not to exceed 100 percent), and then the interest disallowed under the rule would be 

the product of this percentage and the U.S. subsidiary's (or U.S. affiliated group's) related-party 

interest. 72

 

72 For example, if a worldwide group had $ 500 of total external debt and $ 1,000 of total 

assets, for a debt-assets ratio of 50 percent, and the U.S. affiliated group had $ 75 of total debt ($ 

45 unrelated and $ 30 related, all at a 10 percent interest rate) and $ 100 of total assets, for a 

debt-assets ratio of 75 percent, then the U.S. affiliated group would be regarded as overleveraged 

by 25 percentage points, or $ 25. Using a related-party-first ordering rule, the entire $ 2.50 of 

interest on this $ 25 would be disallowed under the rule. More specifically, under the calculation 

provided in the new rule, the U.S. affiliated group would have $ 75 -[($ 100 / $ 1,000) x $ 500] = 

$ 25 of disproportionate debt. The disproportionate domestic related party indebtedness 

percentage would be $ 25/$ 30 = 83.33 percent. Of the U.S. affiliated group's $ 3 of interest 

incurred on its $ 30 of related-party debt, 83.33 percent of this interest, or $ 2.50, would be 

disallowed. If the U.S. affiliated group's $ 30 of related-party debt had consisted of three $ 10 

loans at interest rates of 8, 9, and 10 percent, for total related-party interest of $ 2.70, then the 
90

The proposal would continue the present-law rules in the case of taxable REIT 

subsidiaries. 

The proposal generally would be effective for taxable years beginning after December 

31, 2003. However, the proposal would be effective for taxable years ending after July 10, 2002, 

for debt incurred after that date. In addition, for taxpayers involved in certain inversion 

transactions completed after 1996, the proposal would be effective for taxable years ending after 

March 20, 2002. For purposes of applying the five-year limit on carryovers of interest 

disallowed under the adjusted taxable income rule, amounts carried to any taxable year 

beginning after December 31, 2003 would be treated as having been first disallowed for the most 

recent taxable year beginning on or before such date. The effective date of the elimination of 

excess limitation carryovers would be governed by the effective date generally applicable to the 

relevant debt of the taxpayer. 

Fiscal Year 2004 Budget Proposal

The President’s fiscal year 2004 budget proposal was submitted to the United States 

Congress on February 3, 2003. The proposal would change the earnings stripping provisions of 

section 163(j) by: (1) modifying the safe harbor provision; (2) reducing the adjusted taxable 

income threshold; (3) adding a new disallowance provision based on a comparison of domestic 

to worldwide indebtedness; and (4) limiting carryovers.

Modified safe harbor

The proposal would replace the present-law debt-to-equity safe harbor with a safe harbor 

based on a series of debt-to-assets ratios. Under the proposal, a safe-harbor debt amount for an 

interest-paying U.S. corporation would be computed by: (1) categorizing all of the corporation’s 

assets into specified classes; (2) multiplying the asset value in each class by a stated debt-toassets ratio for such class; and (3) totaling such amounts.73 A corporation would face interest 

disallowance under section 163(j) only if its debt exceeded this safe harbor amount. The 

proposal is intended to make the safe-harbor more sensitive to the ability of different types of 

assets to support debt.

 

amount disallowed would be 83.33 percent of $ 2.70, or $ 2.25 (thus effectively applying the 

average related-party interest rate of 9 percent to $ 25 of disproportionate related-party debt).

73 Equity investments in foreign related parties (other than investments in subsidiaries) 

would not be taken into account. For example, if a U.S. subsidiary of a foreign parent 

corporation owned some stock of the foreign parent, this stock would be disregarded for 

purposes of determining the U.S. subsidiary’s safe-harbor amount.
91

Reduced adjusted taxable income threshold

The proposal would reduce the present-law threshold of 50 percent of adjusted taxable 

income to 35 percent. 

Domestic-foreign indebtedness comparison

The proposal would also add a new interest disallowance rule, which disallows relatedparty interest to the extent that a U.S. subsidiary of a foreign parent is more highly leveraged 

than the overall worldwide corporate group. For purposes of applying this new test, financial 

corporations are treated as a separate sub-group. The amount of interest disallowed under this 

rule would be the amount of interest attributable to the excess U.S. indebtedness, determined by 

a comparison of U.S. to worldwide debt-to-assets ratios. For purposes of this rule, excess U.S. 

indebtedness would not be able to exceed the amount (if any) by which a corporation’s U.S. 

indebtedness exceeds its safe-harbor debt amount. Thus, this rule would only apply to 

corporations that exceed the safe harbor, and only to interest attributable to such excess.

The modified present-law disallowance rule and the new disallowance rule would be 

coordinated by providing that the rule yielding the greater amount of interest disallowed 

determines the overall disallowance. 

Carryovers

The proposal would limit the carryforward of interest disallowed under the “adjusted 

taxable income” limitation to five years. The proposal would allow no carryover of interest 

disallowed under the domestic-foreign indebtedness test. The proposal would eliminate the 

carryover of excess limitation.

The proposal would be effective for taxable years beginning after December 31, 2003.

Analysis

As discussed above, recent corporate inversion transactions led some to raise questions 

regarding the efficacy of the current earnings stripping rules. Some concluded that these rules 

were not achieving their intended purposes and thus needed to be strengthened.74 The proposals 

described above generally would further limit the ability to engage in earnings stripping 

transactions involving the payment of interest. Some may argue that the proposals do not go far 

enough in combating earnings stripping, as they do not address stripping transactions involving 

the payment of other deductible amounts, such as royalties and management service fees. 

 

74

 See, e.g., Department of the Treasury, General Explanations of the Administration’s 

Fiscal Year 2004 Revenue Proposals, February 2003, 104 (“Treasury explanation”) (“Under 

current law, opportunities are available to reduce inappropriately the U.S. tax on income earned 

from U.S. operations through the use of foreign related-party debt. Tightening the rules of 

section 163(j) is necessary to eliminate these inappropriate income-reduction opportunities.”); 

Treasury study, Part VII.A. (“The prevalent use of foreign related-party debt in inversion 

transactions is evidence that [the rules of section 163(j)] should be revisited”).
92

Others argue that there is no need to strengthen the current earnings stripping rules at all, 

because there is no empirical evidence of abuse outside the narrow context of inversion 

transactions. In addition, they argue that the recent proposals are overly broad and penalize 

legitimate business transactions. For example, the capital structures of multinational companies 

often vary by line of business and the amount of leverage the market permits. Some have argued 

that the proposals are not sufficiently sensitive to these differences. More broadly, some have 

argued that the proposals would increase the cost of U.S. direct investment for some foreignbased multinationals and thus may cause these companies to reduce such investment in the 

future. In addition, because income tax treaties are typically relied upon to achieve earnings 

stripping, some have argued that the United States should reexamine certain of its income tax 

treaties to determine whether reductions in withholding taxes are appropriate in light of the treaty 

partner’s tax treatment of the foreign recipient of the relevant deductible payments. Finally, it is 

widely recognized that the latter two proposals would introduce considerable additional 

complexity into the Code.

Reinsurance transactions 

Background 

Under a reinsurance agreement, an insurer that has underwritten risks (the “ceding 

company”) transfers all or a portion of the risks to a reinsurer. In the transaction, a premium may 

be paid or credited to the reinsurer, and assets may be transferred to the reinsurer, on which the 

reinsurer earns investment income. The transfer of a risk can take several forms. For example, 

the entirety of the risk ma y be transferred, or only a portion (e.g., the portion exceeding a 

particular dollar amount of coverage). The ceding company may retain a residual liability to pay 

claims or may transfer the responsibility for claims payment to the reinsurer.

Some have expressed a concern that reinsurance transactions are being used to erode the 

U.S. tax base. The issue first arose when foreign-based insurance companies began acquiring 

U.S. affiliates that insured U.S. risks. Subsequent to these acquisitions, the U.S. companies often 

transferred large amounts of the gross premiums earned from insuring U.S. risks to their foreign 

affiliates through reinsurance transactions with their foreign affiliates. As a result of these 

reinsurance transactions, some U.S. insurance companies argue that they are at a competitive 

disadvantage relative to their foreign-based competitors.75

U.S. taxation of domestic insurance companies

In general

A life insurance company is subject to tax on its life insurance company taxable income, 

which is its life insurance gross income reduced by life insurance deductions (sec. 801). In 

determining life insurance gross income, a life insurance company may deduct premiums and 

other consideration arising out of indemnity reinsurance from the gross amount of premiums and 

other consideration on insurance and annuity contracts (sec. 803(a)). Similarly, a property and 

casualty insurance company is subject to tax on its taxable income, which is determined as the 

 

75 Some of these U.S. insurance companies have responded by reincorporating offshore.
93

sum of its underwriting income and investment income (as well as gains and other income items) 

(sec. 831). In determining underwriting income, a property and casualty insurance company may 

deduct premiums paid for reinsurance from its premiums earned (sec. 832(b)(4)). 

U.S. insurance companies are taxable on their worldwide income. As in the case of other 

types of domestic corporations, an insurance company's income derived from operations of its 

foreign subsidiaries generally is subject to U.S. tax when the income is repatriated as a dividend 

to the domestic corporation. Until repatriation, the U.S. tax on this income generally is deferred. 

However, under the rules of subpart F of the Code (sections 951-964), the domestic insurance 

company may be taxed on a current basis in the United States with respect to certain income 

earned by its foreign insurance subsidiaries, generally those in which it has a greater than 10-

percent interest. Such income could include premiums on reinsurance transactions and the 

investment income earned on premiums and reserves for the reinsured risks. Generally, a foreign 

insurance company may elect to be taxed as a domestic insurance company on its worldwide 

income (sec. 953(d)), rather than under the rules of subpart F. 

Reinsurance transactions between related persons 

In the case of a reinsurance agreement between two or more related persons, section 845 

provides the Treasury Secretary with authority to allocate among the parties or recharacterize 

income (whether investment income, premium, or otherwise), deductions, assets, reserves, 

credits and any other items related to the reinsurance agreement, or make any other adjustment, 

in order to reflect the proper source and character of the items for each party. For this purpose, 

related persons are defined as in section 482. In addition, the provision also permits such 

allocation, recharacterization, or other adjustments in a case in which one of the parties to a 

reinsurance agreement is, with respect to any contract covered by the agreement, in effect an 

agent of another party to the agreement, or a conduit between related persons.76 

U.S. taxation of foreign insurance companies

The United States taxes foreign corporations only on income that has a sufficient nexus to 

the United States. Thus, a foreign corporation is generally subject to U.S. tax only on income 

that is “effectively connected” with the conduct of a trade or business in the United States. Such 

foreign corporation’s insurance income that is “effectively connected income” generally is taxed 

under subchapter L in the same manner and at the same rates as the income of a U.S. insurance 

company. An applicable income tax treaty may limit the imposition of U.S. tax on business 

operations of a foreign corporation to cases in which the business is conducted through a 

“permanent establishment” in the United States.

In addition, foreign corporations generally are subject to a gross-basis U.S. tax at a flat 

30-percent rate on the receipt of interest, dividends, rents, royalties, and certain similar types of 

income derived from U.S. sources, subject to certain exceptions. The tax generally is collected 

 

76 These rules may apply may apply even if one of the related parties is not a domestic 

company. See S. Rep. No. 97-494, 97th Cong., 2d Sess. 337 (1982) (describing provisions 

relating to the repeal of modified coinsurance provisions). 
94

by means of withholding by the person making the payment. This tax may be reduced or 

eliminated under an applicable income tax treaty. 

Reinsurance excise tax

An excise tax applies to premiums paid to foreign insurers and reinsurers covering U.S. 

risks (secs. 4371-4374). Under this rule, a gross-basis excise tax is imposed at the rate of one 

percent on reinsurance and life insurance premiums. Similarly, a tax of four percent is imposed 

on property and casualty insurance premiums. The excise tax does not apply to premiums that 

are effectively connected with the conduct of a U.S. trade or business or if an applicable income 

tax treaty provides an exemption from the tax. Thus, the excise tax arguably provides some 

protection from the erosion of the U.S. tax base through reinsurance transactions. However, the 

frequent exemption from the tax by treaty eliminates such protection. 

Legislative proposals

H.R. 2

The Senate amendment to H.R. 2, the “Jobs and Growth Tax Relief Reconciliation Act of 

2003” would provide a rule clarifying the treatment of certain reinsurance transactions. 77 The 

proposal would clarify the rules of section 845, relating to the authority of the Treasury Secretary 

to allocate items among the parties to a reinsurance agreement, recharacterize items, or make any 

other adjustment, in order to reflect the proper source and character of the items for each party. 

The proposal would authorize such allocation, recharacterization, or other adjustment, in order to 

reflect the proper source, character or amount of the item. It is intended that this authority be 

exercised in a manner similar to the authority under section 482 of the Treasury Secretary to 

make adjustments between related parties. It is intended that this authority be applied in 

situations in which the related persons (or agents or conduits) are engaged in cross-border 

transactions that require allocation, recharacterization, or other adjustments in order to reflect the 

proper source, character or amount of the item or items. 

The proposal would be effective for any risk reinsured after April 11, 2002.

H.R. 1755

H.R. 1755, the “Reinsurance Tax Equity Act of 2001,” was introduced by 

Representatives Johnson and Neal on May 8, 2001. The proposal would amend section 

832(b)(4) to deny a deduction for premiums paid for direct or indirect reinsurance of U.S. risks 

with a “related insurer” in certain circumstances. However, under the proposal, an insurance 

company would generally deduct reinsurance recovered from a related insurer, when calculating 

its taxable income, to the extent a deduction for the premium paid for the reinsurance was 

disallowed as a result of the proposal. A U.S. risk would include any risk related to property in 

the United States, or liability arising out of the activity in, or in connection with the lives or 

 

77 Sec. 343 of the Senate amendment to H.R. 2. The provision was not adopted in the 

conference agreement for H.R. 2. This proposal has been approved by the Senate Finance 

Committee in connection with corporate inversion legislation passed by the Committee. 
95

health of residents of, the United States. A “related insurer” would mean a reinsurer owned or 

controlled directly or indirectly by the same interests (within the meaning of section 482) as the 

person making the premium payment. 

The deduction would not be denied if: (1) the income attributable to the reinsurance to 

which such premium relates is includible in the gross income of such reinsurer or one or more 

domestic corporations or citizens or residents of the United States; or (2) the related insurer 

establishes to the satisfaction of the Treasury Secretary that the taxable income (as determined 

under section 832) attributable to the reinsurance is subject to an effective rate of income tax 

imposed by a foreign country greater than 20 percent of the maximum rate specified in section 

11. A related insurer may elect to treat income from the reinsurance of U.S. risks, which is not 

otherwise includible in gross income, as income that is effectively connected with the conduct of 

a U.S. trade or business.

The proposal would be effective with respect to premiums paid after the House Ways and 

Means Committee votes to report this proposal. 

H.R. 4192

H.R. 4192 was introduced by Representatives Johnson and Neal on April 5, 2000. Under 

the proposal, if a domestic person directly or indirectly reinsures a United States risk with a 

related foreign reinsurer, then the investment income of the domestic person would be increased 

each year by an amount equal to the product of (1) the average of the applicable federal mid-term 

rates determined under section 1274(d)(1) and (2) the sum of the reserves and liabilities related 

to the U.S. risks ceded to the foreign reinsurer as shown on the national statement approved by 

the National Association of Insurance Commissioners. A U.S. risk would include any risk 

related to property in the United States, or liability arising out of the activity in, or in connection 

with the lives or health of residents of, the United States. An insurer would be a “related foreign 

insurer” with respect to any domestic person if such person and foreign insurer are owned or 

controlled directly or indirectly by the same interest (within the meaning of section 482). 

Generally, this rule would not be applicable if: (1) the foreign reinsurer retaining the 

reinsurance includes the income attributable to the reinsurance of the U.S. risks on its U.S. tax 

return either as a result of having made an election to be taxed as a domestic insurance company 

under section 953(d) or because such income is effectively connected with the foreign reinsurer’s 

U.S. trade or business; (2) the foreign reinsurer elects to file a tax return and pay tax on income 

from the reinsurance of U.S. risks ceded to it by related domestic persons as if such income were 

effectively connected to a U.S. trade or business; (3) one or more domestic corporations or U.S. 

individuals include the income attributable to the reinsurance of the U.S. risks ceded to the 

related foreign reinsurer on its tax return under subpart F; or (4) the foreign reinsurer establishes 

to the satisfaction of the Treasury Secretary that the taxable income (as determined under section 

832) attributable to the reinsurance is subject to an effective rate of income tax imposed by a 

foreign country greater than 20 percent of the maximum rate specified in section 11 of the Code. 

The one-percent excise tax on premiums paid to foreign reinsurers would not apply to 

premiums to which the proposal applies. 
96

This proposal would apply to taxable years ending after the date of enactment of the 

proposal. 

Analysis

Some have expressed a concern that reinsurance transactions are being used to erode the 

U.S. tax base. Foreign-based reinsurers may not be subject to U.S. tax on either the reinsurance 

premiums or the investment income earned on such premiums, while the U.S. ceding company 

receives a deduction for reinsurance premiums paid. In contrast, a U.S.-based insurance 

company that reinsures a risk with a foreign affiliate may be subjected to U.S. tax with respect to 

both the reinsurance premiums and the investment income earned on such premiums by reason 

of subpart F. Thus, some have argued that, with respect to foreign-based insurance companies, 

reinsurance transactions between related domestic and foreign parties may be used to shift 

income to foreign parties, subject neither to U.S. tax nor to any significant level of foreign tax. 

Others argue that these reinsurance transactions are on terms equivalent to arms-length and 

therefore do not provide an opportunity to inappropriately erode the U.S. tax base. 

Because some foreign-based reinsurers are not subject to a significant level of foreign tax 

on either the reinsurance premiums or the investment income earned on these premiums, some 

U.S.-based insurance companies have argued they are at a competitive disadvantage relative to 

their foreign-based competitors that are subject to a lower overall effective tax rate. Others argue 

that, as long as these reinsurance transactions are conducted on terms equivalent to arms-length,

no unfair advantage is obtained. In addition, they may argue that the benefits of operating a 

reinsurance company in a jurisdiction that does not impose income tax (in contrast to the United 

States) are overstated, because the relevant transactions are still subject to a one-percent U.S. 

excise tax. However, the excise tax may be difficult to collect in certain instances involving 

multiple-step reinsurance transactions. Some also have argued that the principal benefit of 

operating an insurance company in these jurisdictions is the relative simplicity of these 

jurisdictions’ regulatory regimes.

The proposals introduced by Representatives Johnson and Neal are limited to reinsurance 

transactions covering U.S. risks and between related parties. Insurance transactions covering 

U.S. risks arguably have a greater nexus to the United States than those transactions that do not 

cover U.S. risks. In addition, third-party reinsurance transactions do not provide the same 

opportunity to allocate income, deductions, or other items inappropriately between U.S. and 

foreign related persons as do related-party reinsurance transactions. Nevertheless, some have 

argued that these proposals inappropriately extend the United States’ taxing jurisdiction, because 

the proposals may act as a U.S. tax on foreign insurers’ foreign-source investment income. 

Others might assert that proposals limiting base erosion through reinsurance do nothing to 

remove the competitive disadvantage faced by U.S.-based insurers relative to certain foreignbased reinsurers that do not engage in reinsurance transactions with related parties with respect 

to U.S. risks. The proposal related to section 845 raises similar issues, although it is not limited 

to transactions covering U.S. risks.
APPENDIX

DATA ON U.S. INTERNATIONAL TRANSACTIONS

Appendix Table 1.–U.S. International Transactions, 1960-2001

($ millions of nominal dollars)

Year

Exports

of Goods

Services

and

Income

Receipts

Merchandise

Adjusted

Excluding

Military Services

Income

Receipts

on U.S.

Assets

Abroad

Imports of

Goods

Services

and

Income

Payments

Merchandise

Adjusted

Excluding

Military Services

Income

Payments

on Foreign

Assets in

the U.S.

Unilateral

Transfers

Net

1960 30,556 19,650 6,290 4,616 23,670 14,758 7,674 1,238 4,062 

1961 31,402 20,108 6,295 4,999 23,453 14,537 7,671 1,245 4,127 

1962 33,340 20,781 6,941 5,618 25,676 16,260 8,092 1,324 4,277 

1963 35,776 22,272 7,348 6,157 26,970 17,048 8,362 1,560 4,392 

1964 40,165 25,501 7,840 6,824 29,102 18,700 8,619 1,783 4,240 

1965 42,722 26,461 8,824 7,437 32,708 21,510 9,111 2,088 4,583 

1966 46,454 29,310 9,616 7,528 38,468 25,493 10,494 2,481 4,955 

1967 49,353 30,666 10,667 8,021 41,476 26,866 11,863 2,747 5,294 

1968 54,911 33,626 11,917 9,367 48,671 32,991 12,302 3,378 5,629 

1969 60,132 36,414 12,806 10,913 53,998 35,807 13,322 4,869 5,735 

1970 68,387 42,469 14,171 11,748 59,901 39,866 14,520 5,515 6,156 

1971 72,384 43,319 16,358 12,707 66,414 45,579 15,400 5,435 7,402 

1972 81,986 49,381 17,841 14,765 79,237 55,797 16,868 6,572 8,544 

1973 113,050 71,410 19,832 21,808 98,997 70,499 18,843 9,655 6,913 

1974 148,484 98,306 22,591 27,587 137,274 103,811 21,379 12,084 9,249 

1975 157,936 107,088 25,497 25,351 132,745 98,185 21,996 12,564 7,075 

1976 172,090 114,745 27,971 29,375 162,109 124,228 24,570 13,311 5,686 

1977 184,655 120,816 31,485 32,354 193,764 151,907 27,640 14,217 5,226 

1978 220,516 142,075 36,353 42,088 229,870 176,002 32,189 21,680 5,788 

1979 287,965 184,439 39,692 63,834 281,657 212,007 36,689 32,961 6,593 

1980 344,440 224,250 47,584 72,606 333,774 249,750 41,491 42,532 8,349 

1981 380,928 237,044 57,354 86,529 364,196 265,067 45,503 53,626 11,702 

1982 366,983 211,157 64,079 91,747 355,975 247,642 51,749 56,583 16,544 

1983 356,106 201,799 64,307 90,000 377,488 268,901 54,973 53,614 17,310 

1984 399,913 219,926 71,168 108,819 473,923 332,418 67,748 73,756 20,335 

1985 387,612 215,915 73,155 98,542 483,769 338,088 72,862 72,819 21,998 

A-1
Year

Exports

of Goods

Services

and

Income

Receipts

Merchandise

Adjusted

Excluding

Military Services

Income

Receipts

on U.S.

Assets

Abroad

Imports of

Goods

Services

and

Income

Payments

Merchandise

Adjusted

Excluding

Military Services

Income

Payments

on Foreign

Assets in

the U.S.

Unilateral

Transfers

Net

1986 407,098 223,344 86,689 97,064 530,142 368,425 80,147 81,571 24,132 

1987 457,053 250,208 98,661 108,184 594,443 409,765 90,787 93,891 23,265 

1988 567,862 320,230 110,919 136,713 663,741 447,189 98,526 118,026 25,274 

1989 648,290 359,916 127,087 161,287 721,607 477,665 02,479 141,463 26,169 

1990 706,975 387,401 147,832 171,742 759,287 498,435 17,659 143,192 26,654 

1991 727,557 414,083 164,261 149,214 734,563 491,020 18,459 125,084 -10,752 

1992 748,603 439,631 176,916 132,056 762,105 536,528 16,476 109,101 35,013 

1993 777,044 456,943 185,941 134,159 821,930 589,394 122,281 110,255 37,637 

1994 869,328 502,859 201,031 165,438 949,312 668,690 131,878 148,744 38,260 

1995 1,005,935 575,204 219,229 211,502 1,081,776 749,374 141,447 190,955 34,057 

1996 1,077,966 612,113 240,007 225,846 1,158,822 803,113 150,850 204,859 40,081 

1997 1,195,538 678,366 256,614 260,558 1,294,553 876,485 166,260 251,808 40,794 

1998 1,191,932 670,416 262,278 259,238 1,364,962 917,112 182,410 265,440 44,427 

1999 1,242,655 684,553 272,800 285,302 1,518,106 1,029,987 189,204 298,915 48,913 

2000 1,418,568 772,210 293,492 352,866 1,809,099 1,224,417 217,024 367,658 54,136 

2001 1,298,397 720,831 283,758 293,808 1,665,325 1,147,446 204,953 312,926 50,501 

Source: U. S. Department of Commerce, Bureau of Economic Analysis, May 2001, and U.S. Department of Commerce, news release, "U.S. International Transactions: 

Fourth Quarter and Year 2001," March 14, 2002.

Note: Dollar figures in millions of current year dollars. Figures for 2001 are preliminary.

A-2
A-3

Appendix Table 2.–U.S. Gross Domestic Product, Gross Saving, Gross Investment,

and Net Foreign Investment, 1960-2000

(billions of nominal dollars)

Gross Net foreign

Year GDP Gross Saving Investment investment

1960 527.4 110.9 110.4 3.2

1961 545.7 113.9 113.8 4.3

1962 586.5 124.6 125.3 3.9

1963 618.7 132.8 132.4 5.0

1964 664.4 143.0 144.2 7.5

1965 720.1 158.1 160.0 6.2

1966 789.3 169.1 175.6 3.9

1967 834.1 171.1 175.9 3.5

1968 911.5 183.3 187.6 1.7

1969 985.3 199.8 202.7 1.8

1970 1,039.7 194.3 201.2 4.0

1971 1,128.6 211.4 222.7 0.6

1972 1,240.4 241.6 250.3 -3.6

1973 1,385.5 294.6 302.6 8.7

1974 1,501.0 304.0 314.0 7.1

1975 1,635.2 298.4 316.1 21.4

1976 1,823.9 342.7 367.2 8.9

1977 2,031.4 398.2 419.8 -9

1978 2,295.9 481.6 502.6 -10.4

1979 2,566.4 544.9 580.6 1.4

1980 2,795.6 555.5 589.5 11.4

1981 3,131.3 666.5 684.0 6.3

1982 3,259.2 625.7 628.2 -0.2

1983 3,534.9 608.0 655.0 -32.0

1984 3,932.7 769.4 787.9 -87.0

1985 4,213.0 772.5 784.2 -110.9

1986 4,452.9 735.9 779.8 -140.6

1987 4,742.5 810.4 813.8 -152.0

1988 5,108.3 936.2 894.0 -113.2

1989 5,489.1 967.6 983.9 -86.7

1990 5,803.2 977.7 1008.2 -69.2

1991 5,986.2 1015.8 1035.4 14.9

1992 6,318.9 1007.4 1051.1 -38.7

1993 6,642.3 1039.4 1103.2 -72.9

1994 7,054.3 1155.9 1214.4 -108.3

1995 7,400.5 1257.5 1284.0 -98.0

1996 7,813.2 1349.3 1382.1 -110.7

1997 8,318.4 1502.3 1532.1 -123.1

1998 8,790.2 1654.4 1629.6 -199.1

1999 9,299.2 1717.6 1645.6 -313.2

2000 9,963.1 1825.1 1741.3 -427.9

Source: U.S. Department of Commerce, Bureau of Economic Analysis.
A-4

Appendix Table 3.–Increase in U.S. Assets Abroad and

Foreign Assets in the United States, 1960-2001

(millions of nominal dollars)

Year

Increase in U.S.

Assets Abroad

Increase in Foreign

Assets in U.S.

1960 4,099 2,294 

1961 5,538 2,705 

1962 4,174 1,911 

1963 7,270 3,217 

1964 9,560 3,643 

1965 5,716 742 

1966 7,321 3,661 

1967 9,757 7,379 

1968 10,977 9,928 

1969 11,585 12,702 

1970 8,470 6,359 

1971 11,758 22,970 

1972 13,787 21,461 

1973 22,874 18,388 

1974 34,745 35,341 

1975 39,703 17,170 

1976 51,269 38,018 

1977 34,785 53,219 

1978 61,130 67,036 

1979 64,915 40,852 

1980 85,815 62,612 

1981 113,054 86,232 

1982 127,882 96,589 

1983 66,373 88,694 

1984 40,376 117,752 

1985 44,752 146,115 

1986 111,723 230,009 

1987 79,296 248,634 

1988 106,573 246,522 

1989 175,383 224,928 

1990 81,234 141,571 

1991 64,388 110,808 

1992 74,410 170,663 

1993 200,552 282,040 

1994 176,056 305,989 

1995 352,376 465,684 

1996 413,923 586,038 

1997 487,599 759,290 

1998 359,632 504,464 

1999 437,067 813,744 

2000 580,952 1,024,218 

2001 439,563 895,459 

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Note: Data for 2001 are preliminary.
A-5

Appendix Table 4.–Selected Nongovernmental Foreign Holdings

of U.S. Assets, Both Portfolio and Direct Investment, 1982-2000

(billions of nominal dollars)

Year

U.S.

Treasury

Securities

Corporate

and Other

Bonds

Corporate

Equity

Direct

Investment

1982 25,758 16,709 76,279 184,842 

1984 62,121 32,421 96,056 223,538 

1986 96,078 140,863 168,940 284,701 

1988 100,877 191,314 200,978 401,766 

1990 152,452 238,903 221,741 505,346 

1992 197,739 299,287 300,160 540,270 

1994 235,684 368,077 371,618 617,982 

1996 502,562 588,044 611,417 745,619 

1998 729,738 902,153 1,110,276 912,187 

2000 639,684 1,374,259 1,589,714 1,369,505

Source: Harlan W. King, "The International Investment Position of the United States at Year end 2000,

"Survey of Current Business, 81, July 2001, pp. 7-29.

Note: Direct investment at current cost.
A-6

Appendix Table 5.–Selected United States Holdings of Foreign Assets,

Both Portfolio and Direct Investment, 1982-2000

(billions of nominal dollars)

Year

Foreign

Corporate

Bonds

Foreign

Corporate

Equity

Direct

Investment

1982 56,604 17,442 374,059 

1984 62,810 25,994 348,342 

1986 85,724 72,399 404,818 

1988 104,187 128,662 513,761 

1990 144,717 197,596 616,655 

1992 200,817 314,266 663,830 

1994 321,208 627,460 786,565 

1996 465,057 1,002,928 989,810 

1998 576,745 1,476,184 1,196,765 

2000 577,694 1,828,810 1,445,177

Source: Harlan W. King, "The International Investment Position of the United States

at Yearend 2000," Survey of Current Business, 81, July 2001, pp. 7-29.

Note: Direct investment at current cost.
A-7

Appendix Table 6.–Cross Border Mergers and Acquisitions, 1991-2000

Foreign Acquisitions of United States Acquisitions

U.S. Companies of Foreign Companies

Year

Number of 

Transactions

Dollar Value 

(billions)

Number of 

Transactions

Dollar Value 

(billions)

1991 539 $30.8 482 15.3

1992 406 16.1 548 15.6

1993 394 21.0 635 18.2

1994 513 48.2 762 23.4

1995 634 55.2 1,032 46.8

1996 684 79.7 1,160 62.0

1997 837 80.9 1,401 79.8

1998 982 234.0 1,688 119.7

1999 1,151 266.5 1,617 153.8

2000 1,196 340.0 1,502 135.2

Source: Mergers and Acquisitions Almanac, February 2001, p.3