UNITED STATES  - TAX TREATMENT FOR "FOREIGN SALES CORPORATIONS"
Document: Recourse to Article 21.5 of the DSU by the European Communities Report of the Panel
Date: 20 August 2001
Document codes: WT/DS108/RW
Complainant: EU
Respondent: U.S.
Third parties: Australia, Barbados, Brazil, Canada, China, India, Jamaica, Japan
Dispute stage: Retaliation & Arbitration
Agreements cited: Art. 1, 3, 8  AgricultureArt. 3.1(a), 3.1(b)  Subsidies and Countervailing Measures (SCM)Art. 9, 10  Agriculture

UNITED STATES - TAX TREATMENT FOR
"FOREIGN SALES CORPORATIONS"
Recourse to Article 21.5 of the DSU
by the European Communities
Report of the Panel
The report of the Panel on United States - Tax Treatment for "Foreign Sales Corporations"- Recourse
to Article 21.5 of the DSU by the European Communities is being circulated to all Members, pursuant
to the DSU. The report is being circulated as an unrestricted document from 20 August 2001 pursuant
to the Procedures for the Circulation and Dere striction of WTO Documents (WT/L/160/Rev.1).
Members are reminded that in accordance with the DSU only parties to the dispute may appeal a panel
report. An appeal shall be limited to issues of law covered in the Panel report and legal interpretations
developed by the Panel. There shall be no ex parte communications with the Panel or Appellate Body
concerning matters under consideration by the Panel or Appellate Body.
Note by the Secretariat: This Panel Report shall be adopted by the Dispute Settlement Body (DSB) within
60 days after the date of its circulation unless a party to the dispute decides to appeal or the DSB decides by
consensus not to adopt the report. If the Panel Report is appealed to the Appellate Body, it shall not be
considered for adoption by the DSB until after the completion of the appeal. Information on the current status
of the Panel Report is available from the WTO Secretariat.

I. PROCEDURAL BACKGROUND
1.1 On 20 March 2000, the Dispute Settlement Body (the "DSB”) adopted the Appellate Body
Report in and the Panel Report in as modified by the Appellate Body
Report in the United States - Tax Treatment for "Foreign Sales Corporations" dispute. In its
recommendations and rulings, the DSB requested the United States to bring the FSC measure that was
found, in the Appellate Body Report and in the Panel Report as modified by that Report, to be
inconsistent with its obligations under Articles 3.1(a) and 3.2 of the Agreement on Subsidies and
Countervailing Measures (the "SCM Agreement") and under Articles 10.1 and 8 of the Agreement on
Agriculture, into conformity with its obligations under those Agreements.
1 The DSB specified that
the FSC subsidies had to be withdrawn “at the latest with effect from 1 October 2000”.2
1.2 In its Report, the Appellate Body, inter alia, upheld the Panel's finding, in paragraph 7.130 of
the original Panel Report, that the FSC measure constitutes a prohibited export subsidy under
Article 3.1(a) of the SCM Agreement; reversed the Panel's finding, in paragraph 7.159 of the original
Panel Report, that the FSC measure involves "the provision of subsidies to reduce the costs of
marketing exports" of agricultural products under Article 9.1(d) of the Agreement on Agriculture and,
in consequence, reversed the Panel's findings, in paragraphs 7.165 and 7.176 of the original Panel
Report, that the United States has acted inconsistently with its obligations under Article 3.3 of the
Agreement on Agriculture ; and found that the United States acts inconsistently with its obligations
under Articles 10.1 and 8 of the Agreement on Agriculture by applying export subsidies, through the
FSC measure, in a manner which results in, or which threatens to lead to, circumvention of its export
subsidy commitments with respect to both scheduled and unscheduled agricultural products.
3
1.3 On 29 September 2000, the Chairman of the DSB received a communication from the
United States in which the United States “propo se[d] that the DSB modify the time-period in this
dispute so as to expire on 1 November 2000”. 4 The United States asked “that the DSB approve this
proposal and, to that end, request[ed] a meeting of the DSB on 12 October 2000 to consider this
matter.”5 On 12 October 2000, the DSB, given that there was no opposition to the US request, agreed
to accede to the request of the United States as formulated in its letter of 29 September 2000 and
circulated in document WT/DS108/11.
6
1.4 On 2 October 2000, the parties informed the DSB of their Understanding on "Agreed
procedures under Articles 21 and 22 of the Disp ute Settlement Understanding and Article 4 of the
SCM Agreement applicable in the follow-up to the 'Unite d States - Tax Treatment for "Foreign Sales
Corporations' dispute", concluded between the parties on 29 September 2000.7
1.5 On 15 November 2000, the President of the United States signed into law an Act of the United
States Congress entitled the “ FSC Repeal and Extraterritorial Income Exclusion Act of 2000 ”8 (the
“Act"). With the enactment of this legislation, the United States considered that it had implemented
the DSB's recommendations and rulings in the dispute and that the legislation was consistent with the
United States' WTO obligations.9

1 Original Appellate Body Report, WT/DS108/AB/R, adopted 20 March 2000, para. 178.
2 Original Panel Report, WT/DS108/R, adopted 20 March 2000 as modified by the original Appellate
Body Report, WT/DS108/AB/R, para. 8.8.
3 Original Appellate Body Report, supra, note 1, para. 177 (a), (b) and (d).
4 WT/DS108/11, 2 October 2000.
5 Ibid.
6 See Minutes of the DSB meeting held on 12 October 2000, WT/DSB/M/90, paras. 6-7.
7 Circulated as document WT/DS108/12, 5 October 2000.
8 United States Public Law 106-519, 114 Stat. 2423 (2000), Exhibit EC-5; Exhibit US-1.
9 Minutes of the DSB meeting held on 17 November 2000, WT/DSB/M/92, para. 143.

1.6 On 17 November 2000, the European Communities requested the United States to enter into
consultations under Articles 4 and 21.5 of the Understanding on Rules and Procedures Governing the
Settlement of Disputes (the "DSU"), Article 4 of the SCM Agreement, Article 19 of the Agreement on
Agriculture and Article XXIII:1 of the GATT 1994 with respect to the Act. The European
Communities considered that the United States ha d failed to comply with the DSB recommendations
and rulings by 1 November 2000. Furthermore, the European Communities alleged that the Act
“appears to replicate the violations of the WTO Agreement found in the original dispute rather than
remove them.”10
1.7 Consultations were held between the parties on 4 December 2000 in Geneva, but the
consultations failed to settle the dispute.
1.8 On 7 December 2000, the European Communities requested the establishment of a panel as
"there is a disagreement as to the existence or consistency with a covered agreement of measures
taken to comply with the recommendations and rulings" of the DSB. The European Communities
made the request pursuant to Article 6 and Article 21.5 of the DSU, Article 4 of the SCM Agreement,
Article 19 of the Agreement on Agriculture and Article XXIII of the GATT 1994, and as envisaged in
the "Agreed procedures under Articles 21 and 22 of the Dispute Settlement Understanding and
Article 4 of the SCM Agreement applicable in the follow-up to the United States - Tax Treatment for
'Foreign Sales Corporations' WTO dispute" between the European Communities and the
United States of 29 September 2000”.
11
1.9 At its meeting on 20 December 2000, the DSB decided, in accordance with Article 21.5 of the
DSU, to refer to the original Panel the matter ra ised by the European Communities in document
WT/DS108/16. At that DSB meeting, it also was agreed that the Panel should have standard terms of
reference as follows:
12
“To examine, in the light of the relevant provisions of the covered agreements cited
by the European Communities in document WT/DS108/16, the matter referred to the
DSB by the European Communities in that document and to make such findings as
will assist the DSB in making the recommendations or in giving the rulings provided
for in those agreements.”
1.10 The Panel was composed as follows:
13
Chairman: Mr. Crawford Falconer
Members: Mr. Didier Chambovey
Professor Seung Wha Chang
1.11 Australia, Canada, India, Jamaica and Japan reserved their rights to participate in the Panel
proceedings as third parties.
1.12 The Panel met with the parties on 13-16 March 2001 and with third parties on
14 March 2001.
1.13 The Panel submitted its interim report to the parties on 22 June 2001. On 2 July 2001, both
parties submitted written requests that the Panel review precise aspects of the interim report. On

10 WT/DS108/14 and Corr. 1., 21 November 2000.
11 WT/DS108/16, 8 December 2000.
12 See document WT/DS108/19, 5 January 2001.
13 Ibid.

9 July 2001, each party submitted written comments on the other party's written request. The Panel
submitted its final report to the parties on 23 July 2001.
II. FACTUAL ASPECTS
2.1 On 15 November 2000, the United States enacted the Act 14, which repeals the provisions in
the United States Internal Revenue Code ("IRC") relating to taxation of foreign sales corporations 15,
subject to certain transitional provisions. In particular, the Act specifies that, in general, the
amendments made by the Act “shall apply to transactions after September 30, 2000”. 16 In addition,
no new FSCs may be created after that date. 17 However, in the case of a FSC in existence on
30 September 2000, the amendments made by the Act shall not apply to any transaction in the
ordinary course of trade or business involving a FSC which occurs: (A) before 1 January 2002; or (B)
after 31 December 2001, pursuant to a binding contract between the FSC (or any related person) and
any unrelated person that is in effect on 30 September 2000. 18 The original FSC scheme is described
in paras. 2.1-2.8 of our original Panel Report.19
2.2 The Act amends the IRC by, inter alia, inserting a new section 114, entitled “extraterritorial
income”. Under the heading “exclusion”, the Act 20 provides that “gross income does not include
extraterritorial income”. Under the heading “exception”, the Act21 provides that this exclusion “shall
not apply to extraterritorial income which is not qualifying foreign trade income…”.
2.3 Under the Act, certain income of a United States "taxpayer"22 may be excluded from taxation.
Such income -- "extraterritorial income" that is "qualifying foreign trade income" -- may be earned
with respect to goods only in transactions involving qualifying foreign trade property.23
2.4 The Act defines “extraterritorial income” as the gross income of a taxpayer attributable to
foreign trading gross receipts, i.e. gross receipts generated by certain qualifying transactions involving
the sale or lease of “qualifying foreign trade property” not for use in the United States.24

14 FSC Repeal and Extraterritorial Exclusion Act of 2000 , United States Public Law 106-519, 114 Stat.
2423 (2000), Exhibit EC-5; Exhibit US-1.
15 See section 2 of the Act, repealing subpart C of part III of subchapter N of chapter 1 of the IRC.
16 Act, section 5(a).
17 Act, section 5(b)(1).
18 Act, section 5(c)(1).
19 See supra, note 2.
20 Act, section 3; section 114(a) IRC.
21 Act, section 3; section 114(b) IRC.
22 Including a foreign corporation that has elected to be treated as a US corporation for the purposes of
the Act. See Act, section 3; section 943(e) IRC.
23 And, outside the goods area, such income may be earned in relation to services which are: related
and subsidiary to (i) any sale, exchange, or other disposition of qualifying foreign trade property, or (ii) any
lease or rental of certain qualifying foreign trade pr operty; for engineering or architectural services for
construction projects located (or proposed for location) outside the United States; or for the performance of
managerial services for a person other than a related person in furtherance of the production of certain foreign
trading gross receipts. Act, section 3; section 942 IRC. The only way to earn qualifying foreign trade income
that does not involve qualifying foreign trade property is through certain engineering or architectural services.
24 Act, section 3; sections 114(e) and 942 IRC. We no te that the term foreign trading gross receipts also
includes the gross receipts of the taxpayer which are for certain services, some of which must involve qualifying
foreign trade property, as indicated supra, note 23. Section 942(a)(2)(A)(i) IRC, relating to the definition of
"foreign trading gross receipts", states that such receipt s shall not include receipts from a transaction if the
qualifying foreign trade property or services are for ultimate use in the United States.

2.5 "Qualifying foreign trade income" means, with respect to any transaction, the amount of gross
income which, if excluded, will result in a reduction of the taxable income of the taxpayer from such
transaction equal to the greatest of:
• 30 per cent of the foreign sale and leasing income 25 derived by the taxpayer from such
transaction,
• 1.2 per cent of the foreign trading gross receipts 26 derived by the taxpayer from the
transaction, or
• 15 per cent of the foreign trade income27 derived by the taxpayer from the transaction.28
2.6 Qualifying foreign trade property means property –
"(A) manufactured, produced, grown or extracted within or
outside the United States,
(B) held primarily for sale, lease or rental, in the ordinary course
of trade or business for direct use, consumption, or disposition
outside the United States, and
(C) not more than 50 per cent of the fair market value of which is
attributable to -
(i) articles manufactured, produced, grown, or extracted
outside the United States, and
(ii) direct costs for labour (determined under the
principles of Section 263A) performed outside the
United States."
29 […]
Certain property is excluded from "qualifying foreign trade property", including oil or gas (or any
primary product thereof)30, any unprocessed timber that is a softwood31 and any property the President
may designate as in “short supply”.32

25 The Act defines "foreign sale and leasing income" as foreign trade income properly allocable to
certain foreign economic processes performed outside the United States or derived in connection with the lease
or rental of qualifying foreign trade property outside the United States. Act, section 3; section 941(c)(1) IRC.
The term "foreign sale and leasing income" includes "any foreign trade income derived by the taxpayer from the
sale of property described in paragraph (1)(B)". Act, section 3, section 941(c)(2) IRC, dealing with "special
rules for leased property", also contains certain "limitations" in sub-paragraph (B), and section 941(c)(3) IRC
contains certain "special rules".
26 I.e. with respect to goods, gross receipts generated by certain qualifying transactions involving the
sale or lease of “qualifying foreign trade property” not for use in the United States. Act, section 3; section 942
IRC. The term "foreign trading gross receipts" also in cludes certain gross receipts for certain services, some of
which must involve qualifying foreign trade property. See supra, note 23.
27 The Act defines "foreign trade income" as the taxable income attributable to foreign trading gross
receipts (Act, section 3; Act, section 941(b)(1) IRC).
28 Act, section 3; section 941(a)(1) IRC. Under section 941(a)(2) IRC, a taxpayer may compute its
qualifying foreign trade income under one of these three methods other than the one that results in the greatest
amount of such income.
29 Act, section 3; section 943(a)(1) IRC.
30 Act, section 3; section 943(a)(3)(C) IRC.
31 Act, section 3; section 943(a)(3)(E) IRC.
32 Act, section 3; section 943(a)(4) IRC.

2.7 The Act's definitions of qualifying foreign trade property and foreign trading gross receipts --
which determine income that qualifies as extraterritorial income, foreign trade income and qualifying
foreign trade income -- thus contain at least two requirements that must be satisfied in order for a
taxpayer to qualify for the exclusion from taxation: (i) a requirement that a good produced within or
outside the United States must be held primarily for sale, lease or rental, in the ordinary course of
trade or business for direct use, consumption, or disposition outside the United States
33 (referred to in
this Report as the requirement of "use outside the United States"); and (ii) a requirement that no more
than 50 per cent of the fair market value of such property can be attributable to articles manufactured,
produced, grown, or extracted outside the United States, and direct costs for labour performed outside
the United States (referred to in this Report as the "foreign articles/labour limitation").
2.8 Foreign trading gross receipts arise from any transaction only if certain foreign economic
process requirements are fulfilled in respect of a transaction.34 This requirement is met if the taxpayer
(or any person acting under contract with such taxpayer) has participated outside the United States in
the solicitation (other than advertising), the negotiation, or the making of the contract relating to such
transaction, and the foreign direct costs (i.e. attributable to specified activities performed outside the
United States) incurred meet a certain proportion of the total direct costs 35 (i.e. attributable to
specified activities performed anywhere). The specif ied activities relating to qualifying foreign trade
property are:
• advertising and sales promotion;
• processing of customer orders and arranging for delivery;
• transportation outside the United States in connection with delivery to the customer;
• determination and transmittal of final invoice or statement of account or the receipt of
payment; and
• assumption of credit risk.36
III. FINDINGS REQUESTED BY THE PARTIES
3.1 The European Communities requests the Panel to find that37:
(a) The FSC Replacement scheme created by the FSC Replacement Act gives rise to
subsidies within the meaning of the SCM Agreement and the Agreement on
Agriculture.
(b) The FSC Replacement scheme provides subsidies contingent upon export
performance contrary to Article 3.1(a) of the SCM Agreement. This prohibition is
supported and confirmed by the fact that these subsidies are specifically related to
exports within the meaning of item (e) to the Illustrative List in Annex I to the SCM
Agreement.

33 See supra, para. 2.6.
34 Act, section 3; section 942(b) IRC, except where a taxpayer’s foreign trading gross receipts do not
exceed US$5 million, see section 942(c) IRC.
35 The foreign direct costs attribut able to the transaction generally must exceed 50 per cent of the total
direct costs attributable to the transaction, but the requir ement will also be satisfied if, with respect to at least
two categories of direct costs, the foreign direct cost s equal or exceed 85 per cent of the total direct costs
attributable to each category (Act, section 3; section 942(b)(2)(A)(ii) and (B)).
36 Act, section 3; section 942(b)(3) IRC. Section 942(b)(4) states that a taxpayer "shall be treated as
meeting the requirements of this subsection with respect to any sales transaction involving any property if any
related person has met such requirements in such tr ansaction or any other sales transaction involving such
property".
37 EC first written submission, Annex A-1, paras. 29 and 259.

(c) The foreign content limitation in the FSC Replacement scheme renders the basic FSC
Replacement subsidy (and the extended FSC Replacement subsidy, if this is not
contrary to Article 3.1(a)) contingent upon the use of US over imported goods
contrary to Article 3.1(b) of the SCM Agreement.
(d) Consequently, the FSC Replacement scheme grants and maintains subsidies contrary
to Article 3.2 of the SCM Agreement.
(e) The FSC Replacement scheme accords more favourable treatment to US than to like
imported products in relation to the use of such products for the production of goods
for export under the scheme, contrary to Article III:4 of GATT 1994.
(f) The FSC Replacement scheme is inconsistent with Articles 10.1 and 8 of the
Agreement on Agriculture or, in the alternative, with Articles 3.3 and 8 of the
Agreement on Agriculture in conjunction with Article 9.1 of the Agreement on
Agriculture.
(g) By maintaining the availability of FSC subsidies after 30 September 2000, for
transactions effected by existing FSCs until 31 December 2001 (and, under certain
conditions, for an indefinite period) the US has failed to withdraw the FSC subsidies
as required by Article 4.7 SCM Agreement and the recommendations and rulings of
the DSB and has also failed to comply with its obligations under Article 21 DSU.
(h) By failing to withdraw the FSC subsidies and to comply with the rulings and
recommendations of the DSB by the end of the period of time allowed by the DSB,
the US has also failed to comply with its obligations under Article 21 DSU.
3.2 In addition, the European Communities "requests the Panel to make a preliminary ruling to
the effect that third parties are entitled to receive all written submissions of the parties submitted prior
to the meeting of the Panel and to make this prel iminary ruling and communicate it to the parties and
the third parties as soon as possible after receipt of the US first written submission and before the date
for the presentation of the second written submissions."38
3.3 The United States requests that the Panel find that39:
(a) The Act’s exclusion of extraterritorial income from US taxation does not constitute a
prohibited subsidy contingent upon export performance within the meaning of
Article 3.1(a) of the SCM Agreement.
(b) The Act’s exclusion of extraterritorial income from US taxation does not constitute a
prohibited subsidy contingent upon the use of domestic over imported goods within
the meaning of Article 3.1(b) of the SCM Agreement.
(c) The Act does not result in less favourable treatment being provided to imported goods
in comparison to the treatment afforded to like domestic goods within the meaning of
Article III:4 of GATT 1994.
(d) The Act’s exclusion of extraterritorial income from US taxation is not inconsistent
with US obligations under Articles 10.1 and 8, or Article 3.3 and 8, of the Agreement
on Agriculture.

38 EC first written submission, Annex A-1, para. 260.
39 US first written submission, Annex A-2, para. 239.

(e) The United States complied with the DSB’s recommendations and rulings in the
original FSC dispute.
(f) The third parties in this proceeding do not have a right to the parties’ rebuttal
submissions.
IV. ARGUMENTS OF THE PARTIES
4.1 The arguments of the parties are set out in their submissions to the Panel. The parties'
submissions are attached to this Report as Annexes (see List of Annexes, page iii).
V. ARGUMENTS OF THE THIRD PARTIES
5.1 The arguments of the third parties, Australia, Canada, India and Japan, are set out in their
submissions to the Panel and are attached to this Report as Annexes (see List of Annexes, page iii).
One third party, Jamaica, made no written or oral submissions to the Panel.
VI. PROCEDURAL MATTERS
A. THIRD PARTY ACCESS TO REBUTTAL SUBMISSIONS
6.1 In its first written submission, the European Communities requested "the Panel to make a
preliminary ruling to the effect that third parties ar e entitled to receive all written submissions of the
parties submitted prior to the meeting of the Panel and to make this preliminary ruling and
communicate it to the parties and the third parties as soon as possible after receipt of the US first
written submission and before the date for the presentation of the second written submissions."40
6.2 In response, the United States requested that we find that the third parties in this proceeding
do not have a right to the parties’ rebuttal submissions.41
6.3 On 21 February 2001, the Panel issued the following decision to the parties:42
Panel decision concerning the request by the European Communities
relating to third party access to parties' rebuttal submissions
1. The working procedures adopted by the Panel provide that third parties "shall
receive copies of the parties' first written submissions" and that "[a]ny party may
decide to provide the third parties with a copy of its rebuttal or other submissions."
The European Communities contends that the working procedures conflict with
Article 10.3 DSU as they do not require that third parties receive all of the parties'
submissions preceding the one substantive Panel meeting in an accelerated panel
process under Article 21.5 DSU. The European Communities requests that the Panel
rule that third parties be allowed to receive all the main parties’ submissions
preceding the single Panel meeting.1 The United States asks us to deny this request.2
2. For the reasons stated below, we do not consider that Article 10.3 DSU
requires that third parties receive all pre-meeting submissions of the parties (including

40 EC first written submission, Annex A-1, para. 260. See paras. 247-258 for EC arguments in support
of this request.
41 US first written submission, Annex A-2, para. 239(f). See paras. 234-238 for US arguments in
response to the EC request.
42 We have made certain technical changes to the text of the decision.

rebuttal submissions) in the context of an accelerated proceeding under Article 21.5
DSU that involves only one meeting of the parties and third parties with the panel.
Accordingly, we deny the EC request.
3. The EC argument is based upon Article 10.3 DSU, which provides: "Third
parties shall receive the submissions of the parties to the dispute to the first meeting
of the panel."
4. In reaching our decision, we took note of the weight placed by the EC
argument on the text of Article 10.3 DSU
3, as well as on certain perceived
considerations in the DSU.4 We were mindful also of the Vienna Convention rules on
treaty interpretation, including the need to avoid isolating the words of a treaty from
their context.5
5. We note, to begin with, the express reference in Article 10.3 to the "first"
meeting of the panel. In our view, this reference in Article 10.3 to "submissions … to
the first meeting of the panel" (emphasis added) cannot be interpreted in such a way
as to render the word “first” devoid of meaning. Its use clearly presupposes a context
where there is more than one meeting of a Panel. This reflects the fact that the
reference at issue is made in the context of standard panel procedures.
6. Under such procedures, a panel ordinarily holds two meetings.
Documentation is submitted prior to each of these meetings.6 Third parties ordinarily
do not have a right to hear the oral statements of the parties at any panel meeting
(including the first meeting). Rather, they attend a single special third party session
set aside for this purpose and held subsequent to the first panel meeting with the
parties.
7 In that context, it should be emphasized, the manifest effect of Article 10.3
DSU is to limit third party rights to receive only the parties' first written submissions
(submitted to the first meeting); not the parties' written rebuttals (presented to the
second meeting).
7. A panel under Article 21.5 must follow DSU panel procedures. But it must
do so in a particular context, namely in the context of a much stricter timeframe. As a
result, this Panel decided to hold only one meeting, rather than two, as would usually
be the case (i.e. in the context of a proceeding with a lengthier timeframe). Our
working procedures maintained the practice of obtaining from the parties two sets of
documentation in the form of first written submissions and written rebuttals (both,
however, prior to the single Panel meeting). We note, further, that such arrangements
received the concurrence of the parties. It was, indeed, their declared preference.
8. In our view, the plain language of Article 10.3 DSU does not expressly
address the extent of third party access to submissions in a situation where there is
only one meeting pursuant to the constraints imposed by Article 21.5 DSU. This is
manifest from the plain language which, as noted above in paragraph 5, refers to a
“first” meeting. However, it is incumbent upon us to construe Article 10.3 DSU
“…in good faith in accordance with the ordinary meaning to be given to the terms of
the treaty in their context and in the light of its object and purpose".8
9. In this regard, the Panel is of the view that in order to give effect to
Article 10.3 DSU, this provision must be understood as limiting third party rights in
these proceedings to access to the first written submissions only, and as not including
access to the written rebuttals. In the absence of any explicit or express provision to
the contrary in an Article 21.5 proceeding involving only one panel meeting, we can

find no basis to warrant a contrary approach. The drafters of the DSU restricted third
party rights. It is not this Panel's task to extend them in Article 21.5 procedures.9
10. Nor, for that matter, can we see that there is any other reason why such an
approach could be construed to be an ything other than most consonant with
Article 10.3 DSU. In our view, it is an arrangement that ensures that the situation of
all parties is most consistently applied. As noted, had the Panel decided to hold two
meetings with the parties -- the more frequent situation envisioned in Article 10 and
Appendix 3 DSU -- third parties would have received the written submissions made
prior to the first meeting, but not rebuttals or other subsequent submissions. Thus, in
a more frequent procedure, third parties would be in precisely the same position as
they are here with respect to their ability to present views to the Panel. Therefore, in
our view, the procedures we have adopted more closely parallel the degree of access
foreseen by Article 10.3 DSU than if they required that third parties receive the
rebuttals. They are thus, in our view, in keeping with Article 10.3 DSU in a
proceeding involving only one substantive meeting.
11. Moreover, we gave the parties an opportunity to comment on draft working
procedures and timetable, and at no time did either party make any comment with
respect to any modification of this aspect of the working procedures.
12. Finally, while we recognize that an extension of third party rights would not
be precluded were special circumstances to arise, we note that no third party has
requested any third party rights other than those referred to in our working procedures
and see no special reason why any third party to this case would need extended third
party rights.
13. While we decline the EC request to rule that third parties be allowed to
receive all the main parties’ submissions preceding the single Panel meeting, we
recall that pursuant to our working procedures, "[a]ny party may decide to provide the
third parties with a copy of its rebuttal or other submissions."
1EC first written submission, Annex A-1, paras. 247 ff.
2US first written submission, Annex A-2, para. 237.
3e.g. EC first written submission, Annex A-1, paras. 251-252.
4Ibid., paras. 253-254.
5Pursuant to Article 31 of the Vienna Convention on the Law of Treaties (23 May 1969, 1155
U.N.T.S. 331; 8 I.L.M. 679) to the extent it reflects customary international law, the Panel is
required to interpret Article 10.3 DSU "in good faith in accordance with the ordinary meaning
to be given to the terms of the treaty in their context and in the light of its object and purpose".
6Appendix 3 to the DSU, paras. 4-7.
7Ibid., paras. 5 and 6.
8See supra, note 5.
9 We note that at least two other Article 21.5 panels were of a similar view. See Article 21.5
Panel Report, Australia - Subsidies Provided to Producers and Exporters of Automotive
Leather, Recourse to Article 21.5 of the DSU by the United States , WT/DS126/RW, adopted
11 February 2000, para. 3.9. See Article 21.5 Panel Report, Australia - Measures Affecting
Importation of Salmon, Recourse to Article 21.5 by Canada; WT/DS18/RW, adopted
20 March 2000, para. 7.5.

B. TIMING OF REBUTTAL SUBMISSIONS
6.4 On 12 February 2001, the United States sent a written communication to the Panel requesting
that we revise the schedule for this proceeding in order to provide for consecutive, rather than
simultaneous, filing of the second written submissions by the parties. The United States stated that
the existing schedule meant that any response by the United States to the EC second submission
would have to be presented by the United States in its oral statement at the Panel meeting. The
United States was of the view that consecutive filing would be of more assistance to the Panel in its
work. The United States asserted that while the European Communities had new material from the
United States to rebut in its rebuttal submission, the United States did not. The United States further
argued that the European Communities has the opportu nity to file two written submission, while the
United States was limited to one.
6.5 On 14 February 2001, the European Communities sent a written communication to the Panel,
asking that we “reject this request” and expressing surprise that the United States was trying to reopen
this matter at this late stage in the proceeding, after the deadline for requesting preliminary rulings.
The European Communities asserted that “[s]imultaneous rebuttals are required by Article 12.6 DSU”
and that this rule had also been followed in previous panel proceedings under Article 21.5 DSU. The
European Communities stated that these considerations had presumably led the Panel to reject the
United States request at the organizational meeting with the parties in December 2000.
6.6 On 21 February 2001, the Panel issued the following decision to the parties:
Panel decision concerning the request by the United States
relating to the timing of rebuttal submissions
1. We have carefully considered the request by the United States of
12 February 2001 that the Panel provide for consecutive, rather than simultaneous,
filing of the parties' second written submissions, as well as the responding
communication of the European Communities dated 14 February 2001.
2. We recall that we adopted our working procedures after having heard the
views of the parties, including their views on the issue of the timing of the filing of
their rebuttal submissions. We do not believe that any development or consideration
has since arisen that would require us to reconsider this aspect of our working
procedures, particularly given the current advanced stage of the proceedings and the
difficulties inherent in adjusting other aspects of the Panel's schedule that such a
change would necessitate.
3. We therefore deny this request by the United States to change the Panel's
schedule with respect to the timing for filing the parties' second written submissions.
We note that the United States, as well as the European Communities, if they wish,
would be able to respond to, or comment on, the other party's rebuttals in their oral
statements at the substantive meeting.
VII. INTERIM REVIEW
7.1 The Panel submitted its interim report to the parties on 22 June 2001. On 2 July 2001, both
parties submitted written requests that the Panel review precise aspects of the interim report. On
9 July 2001, each party submitted written comments on the other party's written request.

A. ORIGINAL COMMENTS BY THE EUROPEAN COMMUNITIES
7.2 The European Communities suggests that we insert references to the panel report in
Canada-Autos43 in footnotes relating to paras. 8.148 and 8.157. The Panel has inserted such a
reference in footnote 262 and clarified our reasoning in paragraph 8.157.
7.3 The European Communities asserts that we inaccurately reflected its argument concerning
the treatment afforded by the Act to imported goods vis-à-vis domestic goods in paragraph 8.151 (and
footnote 264). The Panel has adjusted the drafting in this paragraph (and footnote 264).
7.4 The European Communities further argues that the formulation that originally appeared in
paragraph 8.164 suggested that the DSB had changed an adopted panel report, by referring to a date
contained in the our original Report and then stating that the DSB had subsequently extended that
date. In the EC view, the DSB agreed to accede to the request of the United States as formulated in
document WT/DS108/11, which referred to a time- period set (implicitly) by the DSB for the
"necessary measures" to be adopted by the United States; the DSB did not affect the explicit
recommendation that the FSC subsidies "must be withdrawn at the latest with effect from
1 October 2000." The European Communities submits that paragraph 8.171 was also inaccurate as to
the DSB specification in this dispute. The United States disagrees with the EC's "mischaracterization
of the US request that was granted" at the 12 October 2000 meeting of the DSB. According to the
United States, at that meeting, the United States requested, and was granted, an extension of the time-
period within which the United States was to withdraw the measure. The Panel has made changes to
paragraphs 8.164 and 8.171 in order to reflect more clearly our understanding of the US request
acceded to by the DSB. We have, as well, made changes to paragraph 8.169 in order to maintain
consistency.
7.5 The European Communities submits that it is not appropriate for us to make a
recommendation in this case, as our mandate under Article 21.5 DSU is to decide a disagreement. In
the EC view, this replaces the normal rule in Articles 7 and 11 DSU that a panel makes findings so as
to assist the DSB in making recommendations and rulings. The European Communities argues that
we have already made the recommendation referred to in Article 19 DSU in our original Report. The
Panel, noting that the United States did not respond to this EC comment and that practice in this area
has not been entirely consistent in Article 21.5 DSU proceedings
44, is of the view that the original
recommendation adopted by the DSB on 20 March 2000 remains operative. We have therefore
deleted what was originally paragraph 9.3 of the interim report (and made a consequential change in
the title of Section IX of the Report).

43 Infra, para. 231.
44 Certain Article 21.5 DSU panels have made recommendations (e.g. Article 21.5 Panel Report,
European Communities - Regime for the Importation, Sale And Distribution of Bananas - Recourse To
Article 21.5 By Ecuador , WT/DS27/RW/ECU, adopted 6 May 1999; Article 21.5 Panel Report, Australia –
Measures Affecting Importation of Salmon - Recourse to Article 21.5 by Canada , WT/DS18/RW, adopted
20 March 2000; Article 21.5 Panel Report, Mexico-Anti-Dumping Investigation of High Fructose Corn Syrup
(HFCS) from the United States , WT/DS132/RW, circulated 22 June 2001), while others have not (e.g.
Article 21.5 Panel Report, Australia - Subsidies Provided to Producers and Exporters of Automotive Leather -
Recourse to Article 21.5 of the DSU by the United States, WT/DS126/RW, adopted 20 March 2000; Article 21.5
Panel Report, Brazil – Export Financing Programme for Aircraft - Recourse By Canada To Article 21.5 of the
DSU, WT/DS46/RW, adopted 4 August 2000; Article 21.5 Panel Report, Canada – Measures Affecting the
Export of Civilian Aircraft , Recourse by Brazil to Article 21.5 of the DSU , adopted 4 August 2000,
WT/DS70/RW).

B. ORIGINAL COMMENTS BY THE UNITED STATES
7.6 The United States argues that we had omitted a reference in Section II to the fact that foreign
tax credits are not allowed in respect of excluded extraterritorial income, as well as an indication that
the "legislative history" of the Act "makes clear that because the Act's exclusion was intended to
avoid double taxation, tax credits are not allowed on excluded income in order to avoid double relief
of double taxation." The United States requests the insertion of a new paragraph to this effect. The
European Communities considers that the new paragraph proposed by the United States is
misleading and unnecessary, but that if we consider including a reference to the Act, section 3;
section 114(d) IRC, we should also include a reference to the Act, section 3, section 943(d) IRC. The
Panel notes that we refer to and elaborate upon certain of these elements in our examination under
footnote 59 of the SCM Agreement , infra, paragraphs 8.76-8.108. We have therefore made
modifications to footnote 197 to ensure that the text of the Senate and House Reports referred to by
the United States are appropriately reflected in the substantive part of our analysis.
7.7 The United States submits that paragraph 2.3 is inaccurate as it states that certain income
"may be" rather than "is" excluded from taxation, and that paragraph 2.7 was inaccurate as it stated
that the definitions of qualifying foreign trade property and foreign trading gross receipts determine
income that "may" qualify as extraterritorial income (rather than "income that qualifies as
extraterritorial income"). The European Communities understands us to have used the word "may"
in paragraph 2.3 because, pursuant to the Act
45, a taxpayer may elect to exclude certain receipts from
foreign trading gross receipts so that the corres ponding income will not be qualifying foreign trade
income. The European Communities has no objection to the proposed change in paragraph 2.7. The
Panel has maintained the term "may be" in paragraph 2.3. In our view, this term more accurately
characterizes the situation, not least because, pursuant to the Act 46, the term "foreign trading gross
receipts" shall not include receipts of a taxpayer from a transaction if the taxpayer elects not to have
such receipts taken into account. Noting that the European Communities does not object to the
change proposed by the United States in paragraph 2.7, and recalling the fact that income that
"qualifies" as qualifying foreign trade income need not necessarily be excluded from taxation, we
have made the requested change in paragraph 2.7.
7.8 The United States argues that our Report inaccurately indicated -- in paragraphs 2.3, 2.4 and
2.5 (footnote 26) -- that qualifying foreign trade income could be generated only by the sale or lease
of qualifying foreign trade property, and submits that such income may also be generated by certain
services, including engineering or architectural services without regard to qualifying foreign trade
property. The European Communities agrees that qualifying foreign trade income may be earned
from architectural or engineering services performed outside the United States. The European
Communities submits that this is the only case in which foreign trading gross receipts may be earned
that does not involve qualifying foreign trade property, but that this has not been considered relevant
for the debate and is nowhere discussed in the Report. The Panel has made certain insertions in
footnotes 23, 24, and 26, to clarify that foreign trading gross receipts may be generated in certain
transactions relating to services involving qualifying foreign trade property, as well as engineering or
architectural services for construction projects located (or proposed for location) outside the United
States and not involving qualifying foreign trade property. We note that, with respect to goods,
qualifying foreign trade income may be generated only in certain transactions involving qualifying
foreign trade property and that we had originally been referring to the Act only in respect of goods,
and had not originally elaborated upon the Act in respect of services.
7.9 The United States further submits that we had inaccurately omitted an element of the
definition of "foreign sale and leasing income" in paragraph 2.5, footnote 25. The

45 Act, section 3; section 942(a)(3).
46 Act, section 3; section 942(a)(3).

European Communities submits that a complete definition of foreign sale and leasing income would
have to take into account all of the provisions of section 941(c) IRC. The Panel has inserted the
additional element set out in the Act (section 3; section 941(c)(2) IRC), as identified by the
United States, as well as referring to the remaining paragraphs of the provision concerned.
7.10 The United States suggests that we incorporate the precise wording of the Act in our
description of the requirement of use outside the United States in paragraph 2.7. The
European Communities does not object to this suggestion. The Panel has reflected the full wording
of the text of the Act47 in our description of the requirement in paragraph 2.7.
7.11 The United States submits that the list of findings it had requested was incomplete in
paragraph 3.3, as it omitted the requested finding that third parties in this proceeding did not have a
right to parties' rebuttal submissions. The European Communities submits that we deal with this US
request in paragraph 6.2. The Panel, while noting that we deal with such procedural matters in
Section VI of our Report, and that we already specifically refer to this US request in paragraph 6.2,
has inserted the finding requested by the United States in paragraph 3.3. In order to maintain
consistency, we have also inserted, in paragraph 3.2, the procedural finding requested by the
European Communities.
7.12 The United States objects to our citation, in paragraph 8.38, of section 941(a)(1) IRC as
support for our conclusion that the text of the Act is inconclusive on the question of whether
extraterritorial income is excluded from gross income. In the US view, this citation is inaccurate and,
as the United States submits it had explained during the proceedings 48, the rule set forth in this
provision functions as a computational mechanism for determining the amount of the gross income
exclusion. The European Communities considers that no change need be made to this paragraph,
and that even if section 941(a)(1) IRC includes a "computational mechanism", the presence of such
mechanism confirms that it is not the "extraterritor ial income" as such that is excluded, but only a
portion of it (and then only upon fulfilment of certain conditions). The European Communities
submits that the reference to section 941(a)(1) IRC merely confirms the conclusion already drawn by
referring to section 114 IRC, a provision making clear that only a fraction of the "category"
"extraterritorial income" -- qualifying foreign tr ade income -- can actually be "excluded" (if the
relevant conditions are met). The Panel takes note of these comments and has maintained the
reference to the provision in question. It is the structure of the provision, read in conjunction with the
other relevant provisions of the Act, that provides the basis for our analysis in paragraph 8.38.
7.13 The United States contends that in paragraph 8.40 (and elsewhere), we appear to attach
significance to the fact that the exclusion of extraterritorial income is (according to the Panel) based
on “highly selective qualitative conditions and quantitative requirements.” We repeat this phrase
several times, so, presumably, the US argues, we must consider this fact significant. In the view of
the United States, however, the relevance of this fact is not readily apparent, and is not clarified by
our analysis. Indeed, the United States submits that there is an inherent contradiction between our
"repudiation of the relevance of the concept of specificity" in footnote 108, and our "repeated
invocation of the “highly selective qualitative conditions and quantitative requirements” as a reason
for finding the Act’s exclusion to constitute the foregoing of revenue that is otherwise due". It seems
to the United States that we are saying one of two things: (1) the exclusion for extraterritorial income
constitutes foregone revenue that is otherwise due because the exclusion is “highly selective”; or
(2) any exclusion from gross income, regardless of how broad it might be, constitutes foregone
revenue that is otherwise due. In the view of the United States, it is essential that we clarify our
analysis on this point. The European Communities submits that our reference to the “highly
selective conditions” for obtaining the tax benefit is not contradictory with our "rejecting the

47 Act, section 3; section 943(a)(1)(B) IRC:
48 The United States refers here to US response to Panel Question 7, Annex F-3, paras. 10-13.

relevance of the notion of “specificity”". According to the European Communities, our view on the
specificity notion is clearly explained in footnote 108. For the European Communities, excluding the
relevance, in interpreting Article 1 of the SCM Agreement, of a notion which becomes relevant under
Article 2 of the Agreement (that is, once it is established that a subsidy exists), by no means takes
away our duty to evaluate the structure of a measure in order to assess whether there is revenue
foregone which is “otherwise due” in the sense of Article 1.1. The European Communities sees no
reason to change this paragraph and notes that the United States makes no precise proposal. The
Panel perceives no contradiction in our analytical approach. As we state infra, paragraph 8.26, "[b]y
treating as "non-taxable" certain income on the basis of highly selective qualitative conditions and
quantitative requirements, the Act effectively carves such income out from another situation….".
This selective "carve-out" under the Act that we address in our Article 1.1(a) analysis is conceptually
distinct from the notion of specificity within the meaning of Articles 1.2 and 2 of the SCM Agreement.
We have, however, made certain clarifications of our reasoning in the text of Section VIII(B)(1)(b)(i)
of our Report, including in footnote 108.
7.14 The United States argues that, in paragraphs 8.67 and 8.72, we state that a differentiation in
treatment – i.e., that domestically sold products may not be given less favorable treatment than export
products – constitutes export contingency within the meaning of Article 3.1(a) of the SCM
Agreement. In the view of the United States, our discussion of this point fails to connect the rule we
articulate to the actual text of Article 3.1(a). In the view of the United States, we should fill in this
gap in our analysis in order to add clarity to our re solution of a critical issue in this dispute. In the
European Communities’ view, the reference to “differentiation in treatment” is easily “connected”
to the actual text of Article 3.1(a), contrary to the US suggestion. According to the European
Communities, we make this perfectly clear in paragraph 8.72. The European Communities submits
that if we wish to make the text of paragraph 8.67 even clearer for the United States, we could insert
language clarifying that the differentiation in treatment is as regards eligibility or non-eligibility for
the tax exemption. The Panel does not concur with the US view that we fail to connect the rule we
articulate to the text of Article 3.1(a) of the SCM Agreement . In this context, we recall that an
examination of de jure contingency under Article 3.1(a) calls for an examination of whether export
contingency is apparent from the words of the Act, or can be derived by necessary implication ( infra,
paras.8.55-8.56). We then find that the words of the Act make clear that the subsidy is not available
in relation to goods produced within the United States sold for use within the United States ( infra,
para. 8.60). It is the differential treatment provided for in the Act -- that is, if US-produced goods are
exported, the subsidy is available, while if they are sold in the domestic market, it is not -- that renders
the Act contingent upon export performance within the meaning of Article 3.1(a).
7.15 With respect to paragraphs 8.76-8.108, the United States submits that the parties disagreed
during the proceedings as to which party bore the burden of proof with respect to footnote 59.
However, the United States submits, in our discussion of footnote 59 and the status of the Act as a
"double taxation avoidance measure", nowhere do we articulate which party bore the burden of
proof.
49 In the view of the United States, our analysis of the footnote 59 issue is inadequate and
incomplete without an explanation as to how we allocated the burden of proof. The
European Communities does not agree that we are required to “articulate which party bore the
burden of proof” as requested by the United Stat es, and that the Appellate Body has confirmed on
several occasions that this is not necessary. 50 The European Communities reads the interim report as

49 The United States notes that we also refrained from addressing the burden of proof with respect to
other issues, as well. However, the United States note, with respect to these other issues there was no serious
disagreement that the EC, as the complainant, bore the burden of proof.
50 The European Communities cites Appellate Body Report, Korea – Definitive Safeguard Measure on
Imports of Certain Dairy Products (“Korea – Dairy Safeguards”) , WT/DS98/AB/R, adopted 12 January 2000,
para. 145; Appellate Body Report, India – Patent Protection for Pharmaceutical and Agricultural Chemical
Products, WT/DS50/AB/R, adopted 16 January 1998, para. 74; and, more recently, Appellate Body Report,

indicating that we did not need to consider the issue of burden of proof because we had all the
information we needed to come to the conclusions we did. In the EC view, a detailed consideration of
the issue of burden of proof is only really necessary when the evidence is incomplete or is in
equipoise. According to the European Communities, the absence of a specific consideration of the
burden of proof is also consistent with the Panel’s approach of not considering, and therefore not
prejudicing, the question of whether the last sentence of footnote 59 is an exception to Article 3.1(a)
or not. The European Communities submits that we could explain in response to the United States
request that, even if the European Communities were to have the burden of proof that the conditions
of the last sentence of footnote 59 were not met, we consider that the European Communities had
satisfied this burden. The Panel agrees with the United States that it is appropriate for us to identify
who bears the burden of proof on this issue.
51 Accordingly, we have clarified infra, paragraph 8.90,
that, in our view the United States bears the burden of proof in this context. In any event, we consider
that the evidence and argumentation adduced by both parties was sufficient to enable us properly to
weigh this evidence and argumentation in reaching our finding. Moreover, even if the European
Communities bore the burden of proving that the Act was not within the scope of the last sentence of
footnote 59, we consider that the European Communities discharged this burden.
7.16 The United States submits that the last sentence in paragraph 8.102 appeared to have
disregarded the first element of the “foreign sales and leasing income” prong of the Act, which
excludes income attributable to foreign economic processes. 52 In the view of the United States, the
last sentence of paragraph 8.102, as well as our analysis related thereto, was inaccurate and
incomplete to the extent that it failed to take this element of the “foreign sales and leasing income ”
prong into account. According to the European Communities, these US comments appear to be a
rather artificial attempt to have us include in the Report consideration of an argument that the
United States raised for the first time in its co mments on the European Communities’ answers to the
Panel’s questions (and that did not appear to bear any real connection therewith) and which had not
been debated during the proceeding. The European Communities submits that the United States
appears to argue that there may be a relationship between the extent of “foreign economic processes”
conducted and the amount of the excluded income where qualifying foreign trade income is calculated
on the basis of foreign sale and leasing income in accordance with Act, section 3;
section 941(c)(1)(A) IRC. While the European Communities is of the view that it cannot be expected
to deal with this complex issue at this stage of the proceedings, it made several brief points to
demonstrate that the arguments are unmeritorious. The European Communities asserts that Act,
section 3; section 941(c)(1)(A) IRC constitutes only one of two ways of calculating “foreign sales and
leasing income” which in turn is only one out of three ways of calculating “qualifying foreign trade
income”. The alternative way of calculating “foreign sales and leasing income” is set out in Act,
section 3; section 941(c)(1)(B) IRC, from which the “attributable” or “properly allocable” language
on which the United States appears to rely is absent. According to the European Communities, the
method for calculating qualifying foreign trade income based on “foreign sale and leasing income” in
Act, section 3; section 941(a)(1) IRC in fact corresponds to the calculation of FSC income based on

Thailand – Anti-Dumping Duties on Angles, Shapes and Sections of Iron or Non-Alloy Steel and H-Beams from
Poland (“Thailand – H-Beams”) , WT/DS122/AB/R, adopted 5 April 2001, para. 134.
51 By contrast, we understand that a panel is not required to make an explicit ruling on whether a prima
facie case has been established before proceeding to examine the evidence submitted with a view to rebuttal.
See, for example, Appellate Body Report, Korea- Dairy Safeguards, supra, note 50, para. 145: "We find no
provision in the DSU … that requires a panel to make an explicit ruling on whether the complainant has
established a prima facie case of violation before a panel may proceed to examine the respondent's defence and
evidence." See also Appellate Body Report, Thailand - H-Beams, supra , note 50, para. 134: "…a panel is not
required to make a separate and specific finding, in each and every instance, that a party has met its burden of
proof in respect of a particular claim, or that a party has rebutted a prima facie case."
52 The United States refers to Act, section 3, s ection 941(c)(1)(A) IRC; US first written submission,
Annex A-2, para. 33, note 39; and US comments on EC Answers to Questions from the Panel, Annex F-6,
paras. 64-68.

arm’s length pricing under the original FSC scheme (which is why the exclusion is 30 per cent). Just
as in the case of the FSC scheme, this provision cannot serve to justify the FSC Replacement scheme
since taxpayers are always able to use the most favourable basis for calculating the exemption. In this
connection, the European Communities observes that the definition of foreign trading gross receipts
also covers lease income (Act, section 3; section 942(a)(1)(B) and (C)(ii) IRC). According to the
European Communities, by raising this argument, the United States is effectively asking us to rule on
a hypothetical scheme that does not at present exist by asking us to imagine a system where the
amount of qualifying foreign trade income (that is “foreign sales and leasing income” calculated
under Act, section 3; section 941(c)(1)(A) IRC) may arguably bear some relationship to the amount of
the foreign activity. There are many reasons why such a hypothetical scheme based on Act, section 3;
section 941(c)(1)(A) IRC would also not be a “measure to avoid the double taxation of foreign-source
income.” However, the European Communities submits, we may simply refuse to rule on such a
hypothetical scheme, just as we refused to rule on a hypothetical scheme involving only wholly
foreign transactions in paragraph 8.163 of the Report (even though, the EC submits, we had the
benefit of a proper debate between the parties on the issue of wholly foreign transactions). The
European Communities made certain drafting suggestions if we did wish to make changes to our
Report. In light of the comments of the parties, the Panel has made certain clarifications in the text of
paragraph 8.102 and inserted footnote 204.
7.17 The United States argues that the thrust of paragraph 8.104 appears to be that a measure to
avoid double taxation within the meaning of footnote 59 must be general in nature. In the view of the
United States, nothing in the text of footnote 59 suggests that a broad measure is necessary. Likewise,
nothing in the text of footnote 59 suggests that a Member is precluded from using tax credits as a
double taxation avoidance measure with respect to some products or some types of transactions and
the exemption method with respect to other products or other types of transactions. Similarly, the
United States submits, there is nothing in the text of footnote 59 which suggests that a Member is
precluded from using a combination of tax credits and the exemption method with respect to a single
transaction. It is an undisputed fact in this case that the exemption method results in more favorable
tax treatment for exports. Therefore, a “reasonable legislature” – the role, the United States argues,
that "the Panel has assigned to itself" – might very well decide to “draft legislation, such as the Act”,
which uses a combination of methods to avoid double taxation. Accordingly, in the view of the
United States, we should clarify our discussion of f ootnote 59 by explaining why a measure to avoid
double taxation, within the meaning of the footnote, must be of a general nature. Alternatively, if the
United States has misunderstood our position, we should explain why we find the Act’s perceived
lack of uniformity relevant, or, to use our term, “striking.” The European Communities does not
understand us to be saying that measures relevant under footnote 59 must be general in nature, or that
they must be “broad”. If we are minded to further develop our reasoning to respond to the
United States request, the European Communities submits that we may wish to consider the following
comments. In the European Communities’ view, we correctly weighed the “overall structure and
design” of the specific measure before it and, based on its specific features, decided on the issue of
whether it was a measure “to avoid” double taxation. As regards specifically the reference to
legislative history, the European Communities submits, as observed by the Appellate Body in Japan –
Alcoholic Beverages , and reiterated in Chile – Alcoholic Beverages (to which, the European
Communities argues, we could also usefully refer), one has to proceed to "an examination of the
design, architecture and structure of a tax measure precisely to permit identification of a measure's
objectives or purposes as revealed or objectified in the measure itself " (emphasis added by EC).
53
For the record and in order to avoid any possible misunderstanding, the European Communities
reiterates that it does not accept the United States’ contention that the exemption method results in a
more favourable tax treatment for exports – which is not, therefore, an undisputed fact – and refers us

53 Appellate Body Report, Chile – Taxes on Alcoholic Beverages (“Chile – Alcoholic Beverages”) ,
WT/DS87/AB/R, WT/DS110/AB/R, adopted 12 January 2000, para. 71.

to the EC explanation of its position. 54 The Panel has taken note of these comments of the parties.
We disagree with the US characterization of our finding as requiring that a measure be "broad" or
"general" to fall within the scope of the fifth sentence of footnote 59. We recall our statements infra,
paragraph 8.97, that the Act is unusually broad for a measure whose purpose is to avoid double
taxation, and at the same time, the Act is unusually narrow for a measure whose asserted purpose is to
avoid double taxation. Further, we note there "that the Act overlaps with an extensive system of
bilateral agreements designed to avoid double taxation through foreign tax credits, and its application
is not designed to cover situations where such agre ements did not exist." In particular, we reiterate
that no single one of these elements, taken separately, would necessarily lead us to the conclusion that
the Act is not a measure taken to avoid the double taxation of foreign-source income; taken together,
however, they lead us to the conclusion that the Act is not a measure taken to avoid the double
taxation of foreign-source income within the mean ing of footnote 59. As to the alternative US
argument that we should explain why we find the Act’s perceived lack of uniformity relevant, or
“striking”, we recall our statement infra, paragraph 8.95, that "we consider that the relationship
between the measure and its asserted purpose -- i.e. "to avoid the double taxation of foreign-source
income …" -- must be reasonably discernable". As indicated there, we seek to ascertain whether the
Act is a measure "to avoid" the double taxation of foreign-source income by concentrating our
examination on a review of the overall structure, design and operation of the Act in the context of the
broader United States tax system. Taken together, the Act's breadth -- in certain respects -- and its
narrowness -- in other respects, in conjunction with the other aspects of the Act's structure and design
that we examine lead us to find that the relation ship between the measure and its asserted purpose is
not reasonably discernable. We have therefore maintained our original language while making an
insertion in footnote 197.
7.18 We have also made certain technical revisions and clarifications in paragraphs 1.13, 8.60,
8.66, 8.80, 8.91, 8.94, 8.95, 8.97, 8.104, 8.105, 8.107, 8.108, 8.163 and 9.1, including in certain
footnotes linked to those paragraphs.
VIII. FINDINGS
A.
PANEL'S APPROACH TO EXAMINATION OF EC CLAIMS IN THIS DISPUTE
8.1 We note that the European Communities has confirmed that, in its view, “there would no
longer be a prohibited subsidy within the meaning of Article 3 of the SCM Agreement ” if the
United States eliminated the requirements that the property be held for use outside the United States
and the 50 per cent “foreign content limitation”. 55 Therefore, we will focus our examination of the
European Communities' claims on these two aspects of the Act.
B. REQUIREMENT OF "USE OUTSIDE THE UNITED STATES"
1. Claims under Article 3.1(a) of the SCM Agreement
(a) analytical approach
8.2 In examining the European Communities' Article 3.1(a) claims in the original dispute, we first
considered issues arising under Articles 1 and 3 of the SCM Agreement, rather than issues arising
under footnote 59 attached to item (e) of the Illustrative List of Export Subsidies in Annex I to the
SCM Agreement . The Appellate Body found that there was no "legal error" in this analytical

54 The European Communities refers to EC Responses to Panel Questions, Annex F-1, paras. 54 to 57,
and, in particular, para. 56.
55 EC response to Panel Question 39, Annex F-1, para. 148.

approach.56 The parties also do not expressly contest this approach in these Article 21.5 proceedings.
Accordingly, we will adopt the same analytical approach in this Article 21.5 proceeding.
(b) whether a subsidy exists within the meaning of Article 1 of the SCM Agreement
(i) financial contribution
8.3 The first issue we address in this dispute is whether the Act's "exclusion" from "gross
income" of certain "extraterritorial income" gives ri se to a "financial contribution" in the form of a
foregoing of "government revenue that is otherwise due" within the meaning of Article 1.1(a)(1)(ii) of
the SCM Agreement.
8.4 The European Communities submits that the Act gives rise to a "financial contribution" in the
form of a foregoing of "government revenue that is otherwise due" within the meaning of
Article 1.1(a)(1)(ii) of the SCM Agreement. In the EC view, there is no general US taxation rule
excluding extraterritorial income from taxation. The majority of extraterritorial income -- that is, the
part that is not qualifying foreign trade income -- is subject to the normal rate of tax.
57 The European
Communities argues that the Act does not qualitatively define a class or category of income that is
excluded from the tax base, but rather lays down conditions for the non-taxation of a part of
extraterritorial income (i.e. qualifying foreign trade income) that would otherwise be taxed.58
8.5 In the EC view, section 114(a) of the IRC is a "limited exclusion or exemption" that confirms
the general rule of world-wide taxation of income of US natural or legal persons. 59 With respect to
"corporate income from a commercial activity" 60, the European Communities asserts that the US
"prevailing domestic standard" is that such income ma y be taxed, if it is earned by a US corporation,
under section 11, in conjunction with section 61, IRC. If such income is earned by a foreign
corporation, it may be taxed under section 881 IRC if it is US-source income; or under section 882
IRC if it is "effectively connected" with a US trade or business.
61 The European Communities also
argues that the "benchmark" for assessing the "extended" 62 FSC Replacement scheme under
Article 1.1(a)(1)(ii) would be the situation prevailing if the conditions (notably sale “not for use
within the United States” and the "foreign content limitation") were not fulfilled. Except in the case

56 Original Appellate Body Report, supra, note 1, para. 89.
57 EC first written submission, Annex A-1, para. 51.
58 EC first written submission, Annex A-1, paras. 57, 61.
59 EC response to Panel Question 37, Annex F-1, para. 135.
60 EC second written submission, Annex C-1, para. 68.
61 EC second written submission, Annex C-1, para. 68; EC response to Panel Question 37, Annex F-1,
para. 124 ff. In response to Panel Question 36, Annex F-1, paras. 118-121 ff, the European Communities
submits that "the foreign-source income of a foreign cor poration that is not effectively connected with a trade or
business in the US is not directly taxable in the US. If the foreign corporation is a subsidiary of a US
corporation, the income would be taxable when remitted to the US as dividends (section 61(a)(7)) makes
dividends received part of gross income). The divide nds received deduction in section 243 of the IRC does not
apply to dividends received from non-taxpayers such as the foreign subsidiary. The parent corporation may
even have to pay tax earlier on deemed dividends if the anti-deferral provisions of sub-part F of the IRC are
applicable. The corporation may however, under the gene rally applicable US rules, claim a foreign tax credit
for the tax borne outside the US but this is limited to foreign source income (section 904 of the IRC)".
62 The European Communities contends that there are two distinguishable subsidies in the Act. In its
first written submission, the European Communities explains that it "will refer to the subsidy granted in respect
of the export of US produced goods as the “basic FSC Replacement subsidy” and that accorded to transactions
involving foreign produced goods as the “extended FSC Replacement subsidy” in order to distinguish them.
When there is no need to distinguish the two cases, the EC will refer to them generally as the “FSC Replacement
subsidy” or the “FSC Replacement subsidies”." See EC first written submission, Annex A-1, para. 64. We use
these terms in describing the EC argument, but do not ourselves adopt this terminology.

of a foreign corporation that is not a subsidiary of a US corporation 63, the Act, therefore, in the EC
view, gives rise to a foregoing of revenue that is "otherwise due" and thus to a financial contribution
within the meaning of Article 1.1(a)(1)(ii) SCM Agreement.
8.6 The United States asserts that the new measure is not a "financial contribution" within the
ordinary meaning of the language of Article 1.1(a)(1)(ii) of the SCM Agreement. The United States
submits that, taking the ordinary meaning of the terms in Article 1.1(a)(1)(ii) together, "the foregoing
of revenue otherwise due means that a government has refrained from collecting income that in
another circumstance would be legally owed to the government".64 The United States asserts that the
Act redefines the concept of gross income and that the revised definition of gross income is the
"prevailing domestic standard" for US taxation. As the United States lacks the statutory authority to
tax outside the definition of "gross income", there is no general rule of taxation that would apply "but
for" the definition of gross income. 65 Taxes on extraterritorial income are thus not "foregone" or
"otherwise due".66 The United States submits that absent the Act, income defined as extraterritorial
income may not be subject to tax at all, or taxed to a lesser extent. 67 The "exception" concerning
extraterritorial income that is not qualifying fore ign trade income is a revenue-raising exception, i.e.
without it, all extraterritorial income would be excluded from gross income and revenues would be
less.68 The United States contends that the exclusion of extraterritorial income from US taxation
represents a shift in US taxing jurisdiction and the "normative benchmark" for US taxation of "foreign
income".69
8.7 The United States submits that section 61 IRC can be understood only in light of the other
provisions of the IRC that define its terms and application and that section 114 IRC is an integral part
of section 61 IRC. The US submits that the European Communities is, in effect, asking the Panel to
assume that the United States normative benchmark is to tax all income earned by parties that may be
subject to US tax. However, in the US system, “gross income” applies only as defined by the IRC
and does not apply to all income.
70 According to the United States, the approach in the Act "is one
that is faithful to the text of the Agreement and to the findings of the Panel and the Appellate Body [in
the original dispute]".71
8.8 In commencing our analysis as to whether the Act involves a financial contribution, we first
recall that Article 1.1 of the SCM Agreement provides, in relevant part:
"For the purpose of this Agreement, a subsidy shall be deemed to exist if:
(a)(1) there is a financial contribution by a government or any public body within
the territory of a Member (referred to in this Agreement as "government"), i.e. where:

63 EC response to Panel Question 36, Annex F-1, para. 122. The EC submits: "If a foreign corporation
that is not a subsidiary of a US corporation conducts the transaction, the income would not be taxable in the US
either directly or indirectly. In this case, the application of the FSC Replacement scheme would not give rise to
a subsidy because no revenue would be forgone." Subsequently, however, the European Communities states:
"…the extended FSC Replacement scheme is elective and it is clear that companies will only invoke it where it
gives rise to a reduction in taxation. That is why it is a subsidy no matter how rarely it may be used." EC
response to Panel Question 36, Annex F-1, para. 123.
64 US first written submission, Annex A-2, para. 61.
65 US first written submission, Annex A-2, para. 77.
66 US first written submission, Annex A-2, para. 79.
67 US first written submission, Annex A-2, paras. 101-105.
68 US first written submission, Annex A-2, para. 81.
69 US first written submission, Annex A-2, paras. 71-72.
70 US comments on EC response to Panel Question 36, Annex F-6, para. 51.
71 US closing oral statement, Annex D-4, para. 8.

…
(ii) government revenue that is otherwise due is foregone or not collected (e.g.
fiscal incentives such as tax credits)[footnote omitted]; ….
8.9 As indicated above, the issue before us is whether the Act gives rise to "revenue forgone that
is otherwise due" within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.
8.10 We recall that, in the original dispute, the Appellate Body largely agreed with our analytical
approach under Article 1.1 of the SCM Agreement. The Appellate Body stated,
"…the " foregoing" of revenue " otherwise due" implies that less revenue has been
raised by the government than would have been raised in a different situation, or, that
is, "otherwise". Moreover, the word "foregone" suggests that the government has
given up an entitlement to raise revenue that it could "otherwise" have raised. This
cannot, however, be an entitlement in the abstract, because governments, in theory,
could tax all revenues. There must, therefore, be some defined, normative
benchmark against which a comparison can be made between the revenue actually
raised and the revenue that would have been raised "otherwise". We, therefore, agree
with the Panel that the term "otherwise due" implies some kind of comparison
between the revenues due under the contested measure and revenues that would be
due in some other situation. We also agree with the Panel that the basis of
comparison must be the tax rules applied by the Member in question. To accept the
argument of the United States that the comparator in determining what is "otherwise
due" should be something other than the prevailing domestic standard of the Member
in question would be to imply that WT O obligations somehow compel Members to
choose a particular kind of tax system; this is not so. A Member, in principle, has the
sovereign authority to tax any particular categories of revenue it wishes. It is also
free not to tax any particular categories of revenues. But, in both instances, the
Member must respect its WTO obligations. What is "otherwise due", therefore,
depends on the rules of taxation that each Member, by its own choice, establishes for
itself.
72
8.11 We further recall that the Appellate Body upheld our use of a "but for" analysis as to whether
there was revenue foregone that was "otherwise due" in the original dispute. In the Appellate Body's
view, that legal standard provided a "sound basis for comparison" as it was not difficult in that dispute
to establish in what way the foreign-source income of a FSC would otherwise be taxed ("but for" the
contested measure).73 The Appellate Body opined, however, that it had,
"… certain abiding reservations about applying any legal standard, such as this "but
for" test, in the place of the actual treaty language. Moreover, we would have
particular misgivings about using a "but for" test if its application were limited to
situations where there actually existed an alternative measure, under which the
revenues in question would be taxed, absent the contested measure. It would, we
believe, not be difficult to circumvent such a test by designing a tax regime under
which there would be no general rule that applied formally to the revenues in
question, absent the contested measures…"
74

72 Original Appellate Body Report, supra, note 1, para. 90.
73 Original Appellate Body Report, supra, note 1, para. 91.
74 Original Appellate Body Report, supra, note 1, para. 91.

8.12 As both parties used certain of the terminology referred to in the original Appellate Body
Report in their argumentation before us, and as the United States asserts that its approach under the
Act "is one that is faithful to the text of the Agreement and to the findings of the Panel and the
Appellate Body…[in the original dispute]", 75 we consider the text of Article 1.1 of the SCM
Agreement, coupled with the above citations from the Appellate Body decision, is a useful -- although
not necessarily the only possible -- starting-point for our analysis of the measure before us.
8.13 In particular, we continue to be of the view that the basis of comparison in an analysis under
Article 1.1(a)(1)(ii) SCM Agreement as to whether revenue "otherwise due" is foregone must be the
tax rules applied by the Member in question.
8.14 In so approaching the matter, we emphasize our view that in order to discern whether revenue
is “otherwise due”, we are not assuming that this can only be ascertainable where a purely mechanical
exercise of inspection is feasible. Clearly, a defendant Member would have an incentive to argue that
what is argued by a complainant to be the foregoing of revenue otherwise due was never due in the
first place. Indeed, one might reasonably surmise that any Member applying such a contested regime
could have every reason to ensure that there was no automatic or explicit link to the situation of what
would be otherwise due. The Appe llate Body itself has been mindful of this circumstance when it
observed, a propos of the concept of a “but for” test that:
"It would, we believe, not be difficult to circumvent such a test by designing a tax
regime under which there would be no general rule that applied formally to the
revenues in question, absent the contested measures.
76"
8.15 Indeed, it is worth underlining that the same may be said of the actual terms of the SCM
Agreement when it comes to the term “otherwise due” itself. Were this term to be construed in an
equivalent narrow and formalistic manner, the practical consequence would be precisely the same. It
would effectively ensure that any Member that was careful enough to sever any self-evident formal
link between a measure at issue and its default regime would thereby insulate itself from effective
discipline under the SCM Agreement. The Member would be in a position to assert that what was
claimed to be foregoing of revenue otherwise due was simply never due in the first place. Asserted
compliance by a defendant Member would be tantamount to a definitive defence. This is manifestly
absurd and would render the provisions of the SCM Agreement operationally ineffective.
8.16 Of course, this does not mean that one can run to the other extreme. As the Appellate Body
has also observed:
"…the word "foregone" suggests that the government has given up an entitlement to
raise revenue that it could "otherwise" have raised. This cannot, however, be an
entitlement in the abstract, because governments, in theory, could tax all
revenues...."
77
8.17 Thus, one cannot simply assert that revenue is otherwise due in the abstract. It cannot be
presumed. The key is to apply critical judgement to the facts of the matter. In so doing, we follow
the reasoning of the Appellate Body viz that the comparison to be made involves revenues due under
the contested measure and those that would be due in some other situation and that the basis of the
comparison must be the tax rules applied by the Member in question.
78

75 US closing oral statement, Annex D-4, para. 8.
76 Original Appellate Body Report, supra, note 1, para. 91.
77 Original Appellate Body Report, supra, note 1, para. 90.
78 Original Appellate Body Report, supra, note 1, para. 90.

8.18 In following this reasoning, we underline that while the inquiry cannot be inherently
presumptive or speculative, neither can it be so exac ting or confining that it is necessary to attain the
level of establishing a mathematical deductive relationship between the contested measure and the
default situation. To interpret the SCM Agreement in the latter manner would expose a panel to
precisely the manifestly absurd consequence referred to in paragraph 8.15 above. The key point is
that the tax rules applied by the Member in question are the basis for the comparison. Thus, any
finding that revenue has been foregone must be securely grounded on that foundation.
8.19 That, in our view, provides a sound basis for exercising reasonable judgement as to whether
or not a defending Member’s assertion that no revenue was due in the first place is, in fact, valid or
whether the contested measure in effect masks the substance of what is actually the foregoing of
revenue that is otherwise due.
8.20 Against that background, we therefore turn to the tax rules of the Member in question, in this
case, the United States, in order to identify a basis for comparison for the purposes of our inquiry as to
whether a "financial contribution" exists within the meaning of Article 1.1(a) of the SCM Agreement.
In so doing, we look first to the Act.
8.21 Under the Act, certain income is "excluded" from taxation. In order to qualify as such
"excluded" "extraterritorial income"
79, income must satisfy several stringently selective qualitative
conditions and quantitative requirements.80 The qualitative conditions include, first and foremost, the
requirements relating to use outside the United States81 and the foreign articles/labour limitation.82 In
addition, the Act stipulates, for example, that certain property is "excluded property" 83, and not
included in the term "qualifying foreign tr ade property". Such property includes, inter alia, "oil and
gas (or any primary product thereof)” and "any unprocessed timber which is a softwood". 84
Furthermore, the Act provides that the President may designate property that might otherwise
constitute qualified foreign trade property as property in "short supply". 85 During the period that it is
so designated, the property shall not be treated as "qualifying foreign trade property" and income
derived in transactions relating to such property is therefore not eligible for the tax treatment available
under the Act.
8.22 As we discuss further below, where income fails to qualify as excluded extraterritorial income
within the meaning of the Act it remains subject to taxation.
8.23 Consistent with the approach outlined in paragraph 8.17 above, our task is to assess whether,
in essence, this "exclusion" of “extraterritorial income” can properly be characterized as a situation in

79 The Act defines “extraterritorial income” as the gross income attributable to foreign trading gross
receipts, i.e. derived from the sale of "qualifying foreign trade property" for ultimate use outside the
United States. Act, section 3; sections 114(e) and 942 IRC. The Act defines "foreign trade income" as the
taxable income attributable to fore ign trading gross receipts. Act, s ection 3; sections 941(b)(1) and 942 IRC.
Supra, paras. 2.4-2.6.
80 The Act defines qualifying foreign trade income as the amount of gross income which, if excluded,
will result in a reduction of taxable income by certain amounts defined in the Act. See Act, section 3;
section 941(a)(1) IRC, described supra, para. 2.5.
81 See Act, section 3; section 943(a)(1)(B) IRC rela ting to the definition of "qualifying foreign trade
property", as well as, for example, section 942(a)(2)(A)(i) IRC relating to the definition of "foreign trading gross
receipts".
82 Act, section 3; section 943(a)(1)(C) IRC relating to the definition of "qualifying foreign trade
property".
83 Act, section 3; section 943(a)(3)(C) IRC.
84 See Act, section 3; section 943(a)(3)(E) IRC.
85 See Act, section 3; section 943(a)(4) IRC.

which no revenue is inherently due, or whether it is a situation in which revenue otherwise due is
foregone. In doing so, we look at the overall situation as an integrated whole.
8.24 In this regard, we take note of the US assertion that the concept of "gross income" in
section 61 IRC can be understood only in light of the other provisions of the IRC that define its terms
and application and that section 114 ("excluding" fr om gross income extraterritorial income with the
"exception" of non-qualifying foreign trade income) "is "an integral part" of section 61 IRC". 86
However, we consider significant the EC statement endorsed by the United States -- that section 114
IRC is one of several, specific exclusions from the section 61 definition of gross income.
87
8.25 On this basis, it is clear to us that where income does not qualify for the "exclusion" from
"gross income" upon the fulfilment of the Act's stringently selective conditions, it is not shielded from
taxation. It is part of gross income and is subject to taxation88 under otherwise applicable US taxation
rules. Reaching this view is not a matter of speculation or invention of an entitlement to tax where it
is manifestly absent. This is not a matter of mere presumption or assertion of a hypothetical
possibility in the abstract severed from the context of applicable US tax rules. On the contrary, it is
grounded in the actual way in which the US tax regime functions. Based on this, it is clear to us that
there is a “prevailing” domestic standard 89 and that the measure at issue functions, indeed, as an
effective departure from it. In this respect, we understand, for example, that the income earned by a
US corporate taxpayer in transactions not involv ing foreign trading gross receipts or qualifying
foreign trade property would ordinarily be subject to taxation, under section 11 of the IRC, in
conjunction with sections 61 and 63 of the IRC.
 90 Foreign corporations pay tax in the United States
on income "from sources within the United States" under section 881 of the IRC and on income
"effectively connected with a United States trade or business" under section 882 of the IRC.
8.26 By treating as "non-taxable" certain income on the basis of highly selective qualitative
conditions and quantitative requirements, the Act effectively carves such income out from another
situation. The Act's demarcation -- in a negative manner through a number of qualitative (and
quantitative) conditions -- of income that may be eligible for "exclusion" from "gross income" cannot
be rationally understood as a self-standing autonomous construct, but rather only by comparison with
another situation to which the Act itself explicitly re fers. This other situation is the one that prevails
where the Act's conditions for obtaining the "exclusion" are not fulfilled, most particularly, for
example, where goods are for use within the United States or where they do not satisfy the foreign
articles/labour limitation. That leads us to the conclusion that this is to be rightly characterized as the
foregoing of revenue otherwise due.

86 US comments on EC response to Panel Question 36, Annex F-6, para. 51.
87 US comments on EC response to Panel Question 37, Annex F-6, para. 58, referring to EC response
to Panel Question 37, Annex F-1, para. 132.
88 We note that, in order to avail itself of the tax "exclusion", a foreign corporation must make
domestication election, while a foreign branch of a US corporation need not make a domestication election (see
US first written submission, Annex A-2, para. 139 ("…the Act applies to foreign branches of US businesses
manufacturing outside the United States without the need for an election. This is because, under US law, a
foreign branch of a US business is not treated as a separate entity for tax purposes"). We further note the
European Communities' assertion that in the case where a foreign corporation that is not a subsidiary of a US
corporation conducts the transaction, the income would not be taxable in the US either directly or indirectly, and
the Act "would not give rise to a subsidy because no revenue would be forgone" (EC response to Panel
Question 36, Annex F-1, para. 122).
89 See original Appellate Body Report, supra, note 1, para. 90.
90 Exhibit EC-21 and Exhibit US-4. Section 11 IRC stat es: "a tax is hereby imposed for each taxable
year on the taxable income of every corporation". Sectio n 61 states in pertinent part that: "Except as otherwise
provided in this subtitle, gross income means all income from what ever source derived... ". Section 63 IRC
provides in general that "taxable income means gross income minus the deductions allowed by this chapter."

8.27 Moreover, we do not see any other, countervailing, features that could reasonably lead us to
conclude otherwise. Even if one seeks to discern some kind of overall rationale and coherence to the
“extraterritorial income” “exclusion” that might even hypothetically (and we make no presumption
that it would) lead one to modify the view that this is revenue that is “otherwise due”, no such
rationale is apparent here.
8.28 For instance – and without prejudice to what the status of such a measure might be under the
SCM Agreement – the Act manifestly does not represent a coherent approach to corporate earnings
derived from offshore activities only. The conditionality is such that the eligibility is, in fact,
circumscribed carefully to render it only effectiv e, for example, with respect to goods, only with
respect to certain goods -- i.e. certain "qualifying foreign trade property" -- produced within or
outside the United States, where those goods are for "use outside the United States" and where those
goods fulfil the foreign articles/labour limitation included in the definition of qualifying foreign trade
property. In short, one is left with the perspective simply of certain carve-outs being provided for in
relation to what would otherwise be the prevailing regime of revenue liability in respect of the income
concerned.
8.29 We add that while, in our view, the terms of the SCM Agreement are clear enough, their
application to the facts of the multiplicity of Members’ regimes will not necessarily be self-evident.
Indeed, discerning what might be described as “the prevailing domestic standard” for a particular tax
regime may be a particularly exacting exercise. In more common usage, it might be rather difficult to
discern what is the exception, as it were, and what is the rule. But the terms of the SCM Agreement
are clearly of general application: there is nothing which states that they are only to be applied when
the results are self-evident. Be that as it may, we are not, in this dispute, presented with a situation of
such complexity. This dispute does not involve a de batable call as to whether the glass is half-full or
half-empty. As outlined above, we have looked at the essential shape and the rationale that is
exhibited. In examining that, we have weighed such considerations as the degree of conditionality,
the range of limitations and the manner in which the measure at issue relates to the overall regime.
Taken together, they enable us to assess the nature of the relationship of the measure at issue and the
overall regime. That is precisely how one is in a position to arrive at the judgement required by the
terms of the SCM Agreement.
8.30 In light of these considerations, we are of the view that, through the tax "exclusion" provided
by the Act, the United States government foregoes revenue that is otherwise due within the meaning
of Article 1.1(a)(1)(ii). In our view, a "financial contribution" thereby arises within the meaning of
Article 1.1 SCM Agreement.
8.31 We recall that in its Report in the original dispute, the Appellate Body referred on several
occasions to the concept of "categories" of revenue and indicated that a Member is "free not to tax any
particular categories of revenues".
91 Before us, the parties had divergent views on the utility and
meaning of the term "categories" of revenue used by the Appellate Body. The parties disagreed on
the nature of "categories" that could be excluded in a WTO-consistent manner from taxation, and on
whether extraterritorial income (or foreign trade income or qualifying foreign trade income)
constitutes such a “category”.
8.32 We turn now to whether utilization of the term "category" would in any way alter the nature
of our analysis to this point. However, before considering these issues, we first observe that the
concept of "categories" of revenue to which the Appellate Body referred is not actual treaty language.

91 Original Appellate Body Report, supra, note 1, e.g. paras. 90, 98-99, 120.

We further note that the Appellate Body also emphasized that, regardless of any "category" of revenue
that may be under consideration, a Member is bound at all times to respect its WTO obligations.92
8.33 According to the United States, the rationale for the Act's exclusion is "to treat all foreign
transactions alike regardless of where goods are manufactured". 93 The United States asserts that the
Act excludes extraterritorial income from gross inco me and that this constitutes a defined, normative
benchmark for taxing income earned on foreign transactions. 94 The United States contends that the
exclusion of extraterritorial income from gross income was an exercise of the United States sovereign
right not to tax a particular category of revenue and that extraterritorial income is a "category" that
may be excluded from taxation in a WTO consistent manner.95 The European Communities contends
that while foreign-source income may be a general "category" that WTO Members are free not to tax,
"extraterritorial income" is not foreign-source income. 96 For the European Communities,
"extraterritorial income" (and even less qualifying foreign trade income) is not a general category of
income that a Member may choose not to tax in conformity with the SCM Agreement.
97 According to
the European Communities, the Act does not qualitatively define a class or category of income that is
excluded from taxation. Rather, it lays down conditions for the partial non-taxation of a quantity of
income that would otherwise be taxed.98
8.34 Based on the facts of the situation, we understand the United States to be arguing in effect
that it can simply exclude certain income from gross income and that, when it does so, the "excluded
income" is, by definition, not "otherwise due" within the meaning of Article 1.1(a)(1)(ii) of the SCM
Agreement.99 It follows from this US argument that the United States may exclude any "category" of
income100 from "gross income" in this manner, and that there would never be a foregoing of revenue
otherwise due within the meaning of Article 1.1 of the SCM Agreement. We further understand the
United States to argue that, in any event, the exclusion of "extraterritorial income" excludes a
"category" of income (income derived from "foreign transactions") that may be excluded consistently
with the United States' WTO obligations.
8.35 In our view, although the terminology of “categories” is particular, we see no reason why the
analysis utilized above is not just as applicable, even if one views the nexus of tax measures under this
particular descriptor.
8.36 In this way, we turn first to the US argument that it can simply exclude certain income from
gross income and that, when it does so, the "excluded income" is, by definition, not "otherwise due"
within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.
101 This is, in substance, just as
subject to the reasoning we applied above. 102 The situation is linguistically different, but the
underlying substance remains the same. Here again, this effectively amounts to no more than the
assertion that what is claimed to be otherwise due was never due in the first place, albeit that this is
clothed in language which presents it as a “category”.
8.37 In this context, we consider the US argument that the Act's revised definition of gross income
is the "prevailing domestic standard" for US taxation and that once income is "excluded" from "gross

92 See original Appellate Body Report, supra, note 1, para. 90.
93 US first written submission, Annex A-2, para. 116.
94 US first written submission, Annex A-2, para. 79.
95 US first written submission, Annex A-2, para. 83.
96 EC first written submission, Annex A-1, para. 59.
97 EC first written submission, Annex A-1, para. 60.
98 EC first written submission, Annex A-1, paras. 57, 61.
99 We refer also to our summary of US arguments supra, paras. 8.6-8.7.
100 US oral statement, Annex D-3, para. 77.
101 Supra, paras. 8.33-8.34.
102 Supra, para. 8.23 ff.

income", there is no general rule of taxation that would apply "but for" the definition of gross income
-- and therefore no foregoing of revenue that is "otherwise due" under Article 1.1 SCM Agreement --
to be a highly formalistic construct that is difficult to reconcile with the text and context of
Article 1.1(a)(1)(ii) in light of the object and purpose of the SCM Agreement. To give due meaning
and effect to Article 1.1 of the SCM Agreement , our examination as to whether there is revenue
foregone that is "otherwise due" must be based on actual substantive realities and not be restricted to
pure formalism.
8.38 That said, we observe that even under the highly formalistic approach advocated by the
United States before us, the Act is inconclusive on it s face. Looking to section 114(a) of the Act, we
read that "gross income does not include extraterritorial income". In section 114(b), we read that this
"exclusion" does not apply to certain extraterritorial income. Looking then to section 114(e), we see
that "extraterritorial income" is defined as "…the gross income of the taxpayer attributable to foreign
trading gross receipts" (emphasis added). In addition, the Act defines the term ‘qualifying foreign
trade income’ as "the amount of gross income which, if excluded, will result in a reduction of the
taxable income of the taxpayer…". 103(emphasis added) Thus, the text of the Act itself appears to
indicate variously that extraterritorial income is excluded from gross income, while it also forms part
of gross income that may or may not be excluded. We do not consider that it is discernable from the
text of the Act itself whether extraterritorial income is actually "excluded" from gross income or is
rather "gross income" that may become "excluded" upon fulfilment of certain conditions.104
8.39 More importantly, we point out the perilous systemic implications inherent in the approach
advocated by the United States in these proceedings and the corrosive effect such an approach would
have upon the legal foundations of the SCM Agreement. Particularly revealing in this regard was the
US response to Panel questioning as to whether the United States believed that there would be
revenue foregone that was "otherwise due" within the meaning of Article 1.1 of the SCM Agreement if
the US legislation provided that "gross income does not include income generated from export
activities". The United States was of the view that "…the ordinary meaning of the terms of
Article 1.1(a)(ii) suggests that in such a situati on there would not be a financial contribution within
the meaning of Article 1.1(a)(1), as the "tax revenue on export activities would not be "otherwise due"
under the law of the Member, which is the normative benchmark for an Article 1 analysis". 105 Taken
to its logical extreme, this US argument would be that a government could opt to bestow financial
contributions in the form of fiscal incentives simply by modulating the "outer boundary" of its "tax
jurisdiction" or by manipulating the definition of the tax base to accommodate any "exclusion" or
"exemption" or "exception" it desired, so that there could never be a foregoing of revenue "otherwise
due". This would have the effect of reducing paragraph (ii) of Article 1.1(a)(1) of the SCM
Agreement to "redundancy and inutility"106 and cannot be the appropriate implication to draw from the
stipulation as to what constitutes one of the enumerated forms of "financial contribution" under
Article 1.1 of the SCM Agreement . Furthermore, the consequences of this reasoning would also
entirely undermine Article 3.1(a) of the SCM Agreement, as there could never be, in this situation, a
subsidy contingent upon export in the form of a financial contribution involving of a foregoing of
revenue that is otherwise due. As such, it is inhe rently contradictory to what may be viewed as the
object and purpose of the SCM Agreement in terms of disciplining trade-distorting subsidies in a way

103 Act, section 3; section 941(a)(1).
104 Furthermore, "foreign trade income" -- which the Act defines as "taxable income" derived from
foreign trading gross receipts (Act, s ection 3; section 941(b)(1)) -- may be, in part, "excluded" as "qualifying
foreign trade income". See Act, section 3; section 941(a)(1)(C). We also see in the Act (section 3,
section 943(b)(4) IRC) that "Section 114 shall not be taken into account in determining the amount of gross
income or foreign trade income from any transaction".
105 US response to Panel Question 20, Annex F-3, para. 62.
106 It is well-established that an interpreter is not free to adopt a reading that would reduce whole
clauses of a treaty to redundancy or inutility. See, for example, Appellate Body Report, Brazil - Export
Financing Programme for Aircraft, WT/DS46/AB/R, adopted 20 August 1999, para. 179 and note 110.

that provides legally binding security of expectations to Members. In this regard, it is evident that the
interpretation advanced by the United States would be irreconcilable with that object and purpose,
given that it would offer governments " carte-blanche" to evade any effective disciplines, thereby
creating fundamental uncertainty and unpredictability.107 In short, such an approach would eviscerate
the subsidies disciplines in the SCM Agreement.108
8.40 We turn next to the argument of the United States that, in any event, the exclusion of
"extraterritorial income" excludes a "category" of income (income derived from "foreign
transactions") that may be excluded consistently with the United States' WTO obligations. 109 E v en
assuming that income attributable to "foreign tr ansactions" might be a "category" of income that
might be excluded in a WTO-consistent manner (an issue which we need not and do not decide here),
the United States is not in fact excluding -- or giving up an entitlement to raise revenue that it could
"otherwise" have raised with respect to -- all of the income attributable to "foreign transactions", but
rather only a portion of certain income defined by highly selective qualitative conditions and
quantitative requirements and attributable only to certain qualifying "foreign" transactions (as it itself
characterizes the Act).110 For example, we note that income derived from "foreign" transactions not
involving qualifying foreign trade property or foreign trading gross receipts would not qualify for the
Act's exclusion. Thus, income derived from transactions involving property for ultimate use within
the United States (regardless of where it is manufac tured or produced) and property not satisfying the
foreign articles/labour limitation would not qualify. The Act contains additional restrictions with
respect to the types of property and transaction that would give rise to income qualifying for the
exclusion.111

107 In this respect, the panel in Canada – Measures Affecting the Export of Civilian Aircraft noted that
"…the object and purpose of the SCM Agreement could more appropriately be summarised as the establishment
of multilateral disciplines "on the premise that some forms of government intervention distort international
trade, [or] have the potential to distort [international] trade." WT/DS70/R, adopted 20 August 1999,
para. 9.119. We also find support for our view of the object and purpose of the SCM Agreement in the
Appellate Body Report in Canada - Measures Affecting the Export of Civilian Aircraft , WT/DS70/AB/R,
adopted 20 August 1999, para. 157, where the Appellate Body referred to "the trade-distorting potential of a
"financial contribution"".
108 In response to the same Panel Question 20, the United States also submitted that, "a broader reading
of the text could find that an exclus ion incorporated into a general rule would constitute a financial contribution
if the exception were expressly applicable to only a specifi c group …. If the Panel were to apply our alternative
broader principle to this case, we do not believe that the Act’s exclusion would be specific within the meaning
of Article 2.3, because, for the reasons previously artic ulated, the exclusion is neither export contingent nor
contingent upon the use of domestic over imported goods" (US response to Panel Question 20, Annex F-3,
para. 60). We also do not consider this approach -- which amounts to determining whether there is a financial
contribution for the purposes of Article 1.1 on the basis of whether or not there is export-contingency under
Article 3.1 of the SCM Agreement -- to be an acceptable interpretation of the relationship between these
provisions. We note, however, that even on the basis of its own theory, the United States' argument would fail.
As we note in our examination below under Article 3.1(a) of the SCM Agreement (infra, para. 8.64 ff), we
consider that the fact that the subsidy is available only in respect of transactions involving goods for use outside
the US renders the subsidy export-contingent within the meaning of Article 3.1(a). We recall that, pursuant to
Article 2.3 of the SCM Agreement, any subsidy falling under the provisions of Article 3 "shall be deemed to be
specific". Thus, following the US logic, this would be specific within the meaning of Article 2 and, as such,
would constitute a financial contribution within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement .
However, we certainly do not endorse the US approach.
109 Supra, para. 8.33.
110 US first written submission, Annex A-2, para. 114. In its oral statement, Annex D-3, para. 48, the
United States similarly states that the exclusion of extraterritorial income applies to income earned in " a wide
range of foreign transactions" (emphasis added).
111 See supra, paras. 2.6-2.7.

8.41 Thus, even if one applies the term of “category” to the measure at issue, this linguistic or
formal distinction in no way alters the underlying substance of the actual relationship between the
measure at issue and the default tax regime as outlined above. Employment of the terminology in no
way substantively modifies that relationship. Nor does it introduce any new elements or rationale to
the measure at issue that change its essential character.
8.42 Irrespective of whether one simply denies that revenue is otherwise due, or describes what is
"excluded" as a “category”, in both guises, this am ounts to an asserted view that ignores, almost by
definition, the actual context in which the measure occurs. Both arguments are effectively flawed, in
our view, for the same reasons.
8.43 We therefore conclude that the exclusion from taxation by the United States of certain income
on the basis of the Act's highly selective qualitative conditions and quantitative requirements relating
to the definitions of "qualifying foreign trade prop erty" and "foreign trading gross receipts" -- which
define what income may become "extraterritorial income", "foreign trade income" and "qualifying
foreign trade income" -- results in the foregoing of revenue which is "otherwise due" and thus gives
rise to a financial contribution with the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.112
(ii) benefit
8.44 Having found that the tax "exclusion" under the Act gives rise to a financial contribution
within the meaning of Article 1.1(a) of the SCM Agreement, we must also examine whether a benefit
is thereby conferred within the meaning of Article 1.1(b) of the SCM Agreement.
8.45 We recall that the term "benefit" has been found to imply "some kind of comparison", and
that:
"This must be so, for there can be no "benefit" to the recipient unless the "financial
contribution" makes the recipient "better off" than it would otherwise have been,
absent that contribution."113

112 We wish to emphasize that we do not base our finding on whether or not the United States
Constitution or the IRC may or may not require or permit the establishment or maintenance by the United States
of a world-wide taxation system, nor do we make any pronouncement as to the US view that the scheme created
by the Act introduces "territorial" aspects into its system of taxation. See e.g. US comments on EC responses to
Panel Questions, Annex F-6, para. 56. Indeed, we do not believe it is necessary to presume in the abstract that,
or opine on whether or to what extent, the United States "taxes all income" (see e.g. US oral statement,
Annex D-3, para. 12) or is required or permitted to do so by its domestic law, to reach this finding. With respect
to the issue whether or not the United States maintains a "world-wide" tax system, we recall that the European
Communities cites several treatises on US taxation an d a study prepared by the United States Treasury in
December 2000 for the proposition that the United States itself has recognized the maintenance of the world-
wide taxation system, even following the enactment of the Act (EC response to Panel Question 37, para. 131,
referring to Exhibit EC-22). The United States challenges this evidence and alleges that it either predates the
Act or contains citations not mentioned by the European Communities that serve to refute the EC arguments US
comments on EC responses to Panel Questions, Annex F-6, paras. 53-60.
We also do not rely on the evidence cited by the European Communities concerning a US
Congressional budget report
 (EC first submission, Annex A-1, para. 21; EC rebuttal submission, Annex C-1,
paras. 88-95) indicating that the measure will result in lost tax revenues, while noting the US response that the
EC's reference to the Congressional budget report is misleading as it compares revenues under the Act versus
the FSC and the former worldwide tax system (US first submission, Annex A-2, para. 106), and that "…the
estimated revenue loss for the Act is independent of and greater than the revenue loss for the former FSC
regime." (US response to EC question 2, Annex F-4).
113 Appellate Body Report, Canada-Measures Affecting th e Export of Civilian Aircraft ( "Canada-
Aircraft"), WT/DS70/AB/R, adopted 20 August 1999, para. 157.

8.46 Under the Act, a taxpayer involved in a qualifying transaction may exclude qualifying foreign
trade income from its gross income and therefore need not pay a certain amount of tax that it would
otherwise have to pay to the United States government . It is therefore "better off" than it would have
been absent the contribution, that is, if it had been in another situation, where the conditions for
obtaining the tax treatment under the Act were not fu lfilled and it was therefore subject to otherwise
applicable US taxation rules. We are of the view that the tax treatment in the Act confers a benefit.
8.47 Furthermore, the United States' arguments regarding the existence of a subsidy are limited to
the contention that there is no foregoing of revenue that is "otherwise due". The United States does
not specifically contest that, in the event that there is a foregoing of revenue "otherwise due", a benefit
would be conferred by these rules of taxation.
8.48 We therefore find that there exists a financial contribution conferring a benefit, and that a
subsidy therefore exists within the meaning of Article 1.1 of the SCM Agreement.114
(c) whether the subsidy is contingent upon export performance within the meaning of
Article 3.1(a) of the SCM Agreement
8.49 Having determined that a subsidy exists within the meaning of Article 1 of the SCM
Agreement, we next consider whether the subsidy is contingent upon export, that is, whether the
"exclusion" from taxation is "contingent… upon export performance" under Article 3.1(a) of the SCM
Agreement.115
8.50 The European Communities asserts that the "basic" 116 subsidy, relating to US-produced
goods, is prohibited under Article 3.1(a) of the SCM Agreement because it is only applicable to profits
arising from export transactions. In the EC view, the fact that there are other ways to earn the
exclusion – e.g., by manufacturing and selling abroad, or by selling services abroad -- does not vitiate
the export-contingency of the subsidy in respect of US-produced goods.
117
8.51 The United States argues that, in order to be inconsistent with Article 3.1(a) of the SCM
Agreement, export performance must be a condition that must be satisfied in order to obtain the
subsidy.118 The Act's exclusion of extraterritorial income is therefore, in the US view, not export-
contingent, either on its face 119 , or in operation. 120 The United States contends that under the Act,
there is a single exclusion that applies to different types of foreign transactions, and that covers
different situations. 121 The rationale for the exclusion was to treat all foreign transactions alike,
regardless of where goods are manufactured. 122 According to the United States, the exclusion of

114 A subsidy is subject to the provisions of the SCM Agreement only if it is specific within the meaning
of Article 2. Article 2.3 provides, however, that "[a]ny subsidy falling under the provisions of Article 3 shall be
deemed to be specific". Thus, we pro ceed directly to our analysis of whether the Act is contingent upon export
performance and upon the use of domestic over imported goods within the meaning of Article 3 of the SCM
Agreement.
115 We recall the rationale underlying the sequence of our analysis under Article 3.1(a), supra,
para. 8.2, that is, commencing with Articles 1 and 3 of the SCM Agreement, rather than with the issues arising
under footnote 59 attached to item (e) of the Illustrative List of Export Subsidies in Annex I to the SCM
Agreement.
116 See supra, note 62, for the EC arguments as to the "basic" and "extended" subsidies under the Act.
117 E.g. EC written rebuttal submission, Annex C-1, paras. 101-102.
118 US first written submission, Annex A-2, para. 109, 135. The United States cites Appellate Body
Report, Canada - Certain Measures Affecting the Automotive Industry ("Canada-Autos"), WT/DS139/AB/R,
WT/DS142/AB/R, adopted 19 June 2000, para. 100.
119 US first written submission, Annex A-2, paras. 112-114.
120 US first written submission, Annex A-2, paras. 115-127.
121 US comments on EC responses to Panel Questions, Annex F-6, para. 1.
122 US first written submission, Annex A-2, para. 116.

extraterritorial income is not export-contingent because it applies to income earned in a broad range of
foreign transactions wholly unrelated to exporting US goods.123 In particular, US taxpayers may earn
such income by manufacturing and selling abroad. 124 The United States asserts that there are even
certain domestic transactions (e.g. domestic sales of products that are to be used outside of the
United States) for which the exclusion is available. 125 Thus, the United States contends, while
exporters are plainly among those taxpayers who can utilize the exclusion, the exclusion does not
meet the ordinary meaning of the contingency test set out in the text of Article 3.1(a).126
8.52 The heart of the disagreement between the pa rties is, therefore, that the United States
contends that the exclusion of "extraterritorial" income is not export-contingent because such income
can be earned in many ways besides exporting US goods, while the European Communities asserts
that the subsidy is export-contingent in respect of US-produced goods because it is conditioned upon
exportation.
8.53 We must therefore consider whether the Act involves subsidies contingent upon export
performance within the meaning of Article 3.1(a) SCM Agreement by reason of the requirement
contained in the definition of "qualifying foreign trade property" and of "foreign trading gross
receipts" that goods be held primarily for sale, lease or rental, in the ordinary course of trade or
business for direct use, consumption, or disposition outside the United States. The precise issue that
confronts us here is whether the export of US goods is a “condition” for satisfying the requirement of
“use outside the United States”, and therefore, for receiving the subsidy. As always, the starting-point
of our analysis is the text of the SCM Agreement. Article 3.1(a) provides, in relevant part, that:
"Except as provided in the Agreement on Agriculture, the following subsidies, within
the meaning of Article 1, shall be prohibited:
(a) subsidies contingent, in law or in fact 4, whether solely or as one of several
other conditions, upon export performance, including those illustrated in
Annex I5;
------------------------------------------------------------------------------------------------------------------------------------------------------------------
4 This standard is met when the facts demonstrate that the granting of a subsidy,
without having been made legally contingent upon export performance, is in fact tied
to actual or anticipated exportation or export earnings. The mere fact that a subsidy is
granted to enterprises which export shall not for that reason alone be considered to be
an export subsidy within the meaning of this provision.
5 Measures referred to in Annex I as not constituting export subsidies shall not be
prohibited under this or any other provision of this Agreement."
8.54 In examining whether the exclusion of qualifying foreign trade income from gross income is
"contingent … upon export performance" within the meaning of Article 3.1(a), we recall that the
meaning of "contingent" in that provision is "conditional" or "dependent for its existence upon". 127
We further recall that the legal standard expressed by the word ‘contingent’ is the same for both
de jure or de facto contingency.
128 There is a difference, however, in what evidence may be employed

123 US first written submission, Annex A-2, paras. 118-120.
124 US oral statement, Annex D-3, paras. 88-89.
125 US closing oral statement, Annex D-4, para. 9.
126 US closing oral statement, Annex D-4, para. 9.
127 Appellate Body Report, Canada-Aircraft, supra, note 113, para. 166.
128 Appellate Body Report, Canada-Aircraft, supra, note 113, para. 167.

to establish that a subsidy is export-contingent. 129 We understand the European Communities to be
making a claim of de jure contingency, challenging the legislation "as such". 130 We will conduct our
examination accordingly.
8.55 We recall the Appellate Body's statement that " de jure export contingency" is demonstrated
on the basis of the words of the relevant legislation, regulation or other legal instrument131, as opposed
to the "total configuration of the facts constituting and surrounding the grant of the subsidy." 132 The
Appellate Body has also recently stated,
"that a subsidy is also properly held to be de jure export contingent where the
condition to export is clearly, though implicitly, in the instrument comprising the
measure. Thus, for a subsidy to be de jure export contingent, the underlying legal
instrument does not always have to provide expressis verbis that the subsidy is
available only upon fulfilment of the condition of export performance. Such
conditionality can also be derived by necessary implication from the words actually
used in the measure."
133
8.56 Applying these principles to the case at hand, we will examine whether export-contingency is
apparent from the words of the Act, or can be derived by necessary implication from the words
actually used in the Act.
8.57 We first turn to the text of the Act. We note that under the Act, "extraterritorial income"
means "the gross income of the taxpayer attributable to the foreign trading gross receipts … of the
taxpayer."134 "Foreign trade income" is the taxpayer's ta xable income attributable to foreign trading
gross receipts.135 "Foreign trading gross receipts" means generally: "the gross receipts of the taxpayer
which are -- (A) from the sale, exchange, or ot her disposition of qualifying foreign trade property,
[or] (B) from the lease or rental of qualifying foreign trade property for use by the lessee outside the
United States, …". 136 The term "foreign trading gross receipts" does not include receipts of the
taxpayer from a transaction if the qualifying foreign trade property (or services) are for ultimate use in
the United States.137 The Act defines the term ‘qualifying foreign trade property’ to mean property:
"(A) manufactured, produced, grown or extracted within or
outside the United States,
(B) held primarily for sale, lease or rental, in the ordinary course
of trade or business for direct use, consumption, or disposition
outside the United States, and
(C) not more than 50 per cent of the fair market value of which is
attributable to -

129 Appellate Body Report, Canada-Aircraft, supra, note 113, para. 167.
130 EC response to Panel Question 2, Annex F-1, para. 6. We note the EC statement that "[a] complaint
against a mandatory law that is not yet fully applied can in any event only be judged on the basis of the text and
evident facts." See EC response to Panel Question 2, Annex F-1, para. 10.
131 Appellate Body Report, Canada-Aircraft, supra, note 113, para. 167.
132 Ibid.
133 Appellate Body Report, Canada-Autos, supra, note 118.
134 Act, section 3; section 114(e) IRC.
135 Act, section 3; section 941(b) IRC.
136 Act, section 3; section 942(a)(1) IRC.
137 Act, section 3; section 942(a)(2)(A)(i) IRC.

(i) articles manufactured, produced, grown, or extracted
outside the United States, and
(ii) direct costs for labour (determined under the
principles of Section 263A) performed outside the United
States."138
8.58 We observe that the text of the Act limits the definitions of "foreign trading gross receipts"
and "qualifying foreign trade property" -- which determine what income will qualify as
"extraterritorial income", “foreign trade income” and "qualifying foreign trade income" -- to property
that is for ultimate use outside the United States. The subsidy is therefore only available in respect of
income derived from transactions relating to such property.
8.59 The definition of qualifying foreign trade property applies to goods manufactured, produced,
grown or extracted within or outside the United States. The fact that the definition of the term
"qualifying foreign trade property" refers to property manufactured, produced, grown or extracted
within or outside the United States is, according to the United States "the most significant aspect of
the definition of "qualifying foreign trade property"". 139 In the United States’ view, this reference
shows that the Act applies equally to all foreign transactions irrespective of whether goods are
produced in the United States or abroad 140 and, we understand the United States to argue, essentially
means that tax treatment under the Act is not export-contingent under Article 3.1(a).
8.60 We disagree. We consider that the words of the Act make clear that the subsidy is not
available in relation to goods produced within the United States sold for use within the United States
and that the following can be derived by necessary implication from the words actually used in the
Act:
• goods produced outside the United States are eligible for the tax exclusion under the Act only
if they are, inter alia, for use outside the United States.
• goods produced within the United States are eligible for the tax exclusion under the Act only
if they are, inter alia, for use outside the United States.
Thus, in relation to US-produced goods, the words of the statute itself make it clear that exporting is a
necessary precondition to qualify for the subsidy. In respect of US-produced goods, the existence and
amount of the subsidy depends upon the existence of income arising from the exportation of such
goods. In relation to US-produced goods, the existence of such income is clearly conditional, or
dependent upon, the exportation of such goods from the United States. We are therefore of the view
that by necessary implication the scheme is de jure dependent or contingent upon export in relation to
US-produced goods.
8.61 We take note of the US argument that US manufacturers may earn extraterritorial income
without exporting, as they have the option to produce and sell outside the United States.
141 T h a t
entities effecting transactions relating to goods in the United States could opt to source their goods
from outside the United States and to engage in w holly non-US transactions does not, in our view,
alter the fundamental reality that for US-produced goods, export is a necessary precondition for
benefitting from the subsidy under the Act due to the requirement of "use outside the United States".

138 Act, section 3; section 943(a)(1) IRC.
139 US comments on EC response to Panel Question 35, Annex F-6, para. 46.
140 US comments on EC response to Panel Question 35, Annex F-6, para. 44.
141 US oral statement, Annex D-3, paras. 88-89.

8.62 The United States emphasizes that the subsidy is also available under the scheme with respect
to goods produced outside the United States, prov ided the transactions involve qualifying foreign
trade property, and asserts that the subsidy is not export-contingent because it is available to other
than exporters. By contrast, the European Communities argues that it is not necessary to show that all
subsidies under the Act are export-dependent 142, and that a subsidy that is export-contingent in some
situations does not cease to be so if it can also be obtained in other situations which do not require
export.
8.63 For the purpose of our analysis, and consistent with the stated view of both parties 143, we
assume for the sake of argument that there may be a subsidy within the meaning of Article 1 of the
SCM Agreement even in the case where a financial contribution confers a benefit exclusively in
respect of production outside the territory of the Member providing the financial contribution. Given
that a resolution of this question is not necessary to resolve this dispute, we need not decide this
issue.
144
8.64 We do not believe that it is necessary that the Act involves exclusively subsidies that are
export-dependent in order to make a finding that the Act involves a defined segment of subsidies – i.e.
in respect of US-produced goods -- that are prohibited export subsidies because, in respect of this
defined segment, the Act is inevitably and invariably conditioned on exportation.145 The fact that the
Act also involves subsidies with respect to goods produced outside the United States -- that need not
be exported from the United States by reason of the foreign use requirement alone in order to qualify
for the subsidy -- does not, in our view, vitiate the export-contingency of the Act that we find in
respect of US-produced goods. We find support for our view that export-contingent subsidies may
exist in the context of a broader subsidies scheme in the reasoning of the Appellate Body in Canada-
Aircraft. There, the Appellate Body stated that,
"the fact that some of TPC's contributions, in some industry sectors, are not
contingent upon export performance, does not necessarily mean that the same is true
for all of TPC's contributions. It is enough to show that one or some of TPC's
contributions do constitute subsidies "contingent ... in fact … upon export
performance".
146
There, the export-contingency of the subsidy vis-à-vis regional aircraft was not vitiated by the fact
that it did not depend on exports vis-à-vis other products/sectors.

142 EC first written submission, Annex A-1, para. 96.
143 See EC response to Panel Question 43, Annex F-1, paras. 149 ff; US response to Panel Question 43,
Annex F-3, paras. 101 ff.
144 If, however, a subsidy within the meaning of Article 1 were limited to a financial contribution
provided by a Member only in respect of production inside its territory, then the availability of the exclusion
provided by the Act to income derived from the sale or lease of foreign-produced goods would not constitute a
subsidy within the meaning of Article 1. This would invalidate the United States argument that the "subsidy" is
not export-contingent by reason of the requirement of "use outside the United States" on the grounds that it is
also available in respect of goods that are produced and sold outside the United States and thus are not exported
from the United States.
145 In our view, the following analogy supports our conclusion. Assume that "goods produced outside
the United States" may be referred to as "good A" (for example, toasters), and that "goods produced within the
United States" may be referred to as "good B" (for example, aircraft). On this basis, the Act's requirement of
use outside the United States is tantamount to a stipulation that "good A" (toasters) need not be exported from
the United States, while "good B" (aircraft) must be for use outside the United States (i.e. be exported from the
United States) in order to become eligible for the subsidy under the Act. In our view, this amounts to a
provision making exportation a condition for receiving the subsidy with respect to "good B" (e.g. aircraft),
although not with respect to "good A" (e.g. toasters).
146 Appellate Body Report, Canada-Aircraft, supra, note 113, para. 179.

8.65 We recall that, in response to Panel questioning, the United States drew an analogy between
export contingency and specificity under the SCM Agreement, arguing that just as "the conventional
way of making a specific subsidy non-specific is to expand the universe of users or beneficiaries" 147,
"the way to cure an export subsidy is to ensure that the benefit is provided to a larger group than just
exporters; that is, to a non-specific group". 148 While it may be that an expansion of the group of
eligible recipients may be a way to eliminate the sp ecificity of a subsidy, we do not consider that this
logic can be extended to export contingency.
8.66 The analogy drawn by the United States with specificity does not, in our view, hold here at
all. In the case of specificity, what might be loosely described in purely formal terms as an
"expansion" cannot blind one to the fact that, as a matter of substance, this "expansion" of the subsidy
itself thereby actually, inherently and invariably changes the nature of the subsidy at issue. A specific
subsidy is, by definition, a subsidy that is only granted to a specific enterprise or industry or group of
enterprises or industries.
149 In "expanding" the granting of the subsidy to a broad group of users or
beneficiaries sufficient to achieve the standard of non-specificity, a Member is at the same time
necessarily ceasing to grant it as a specific subsidy. The specificity and the non-specificity cannot in
any manner objectively co-exist. The act of granting a non-specific subsidy in and of itself precludes
specificity. Specificity is simply eliminated.
8.67 This is not at all the case we are dealing with here. In the case at hand, we are dealing with
an "expansion" which does not inherently eliminate the objective existence of export-contingency.
The fact that some other form of economic activity which relates to goods produced outside the
territory of the Member concerned also obtains a subsidy does not in any way thereby eliminate the
contingency of a subsidy on exports. The two can perfectly conceivably co-exist. This reflects the
fundamental fact that "exports" here only have meaning in the context of sale or consumption of
goods that are produced within the territory of the Member. In common usage, such goods can be
either exported or sold domestically. That exhausts the alternative possibilities for their sale or
consumption. As long as there is differentiation between the treatment of those domestically-
produced goods depending on whether they are, respectively, either exported (subsidy provided) or
sold domestically (subsidy not provided), the provision of such a subsidy is contingent on export.
This is the defining contrast.
8.68 One can hardly "cure" a situation that essentially arises from -- and is essentially related to --
differential treatment of the sale of products that are domestically produced by providing subsidies in
respect of economic activities that do not even involve those goods produced in the territory of a
Member in the first place. Indeed, when conducting an analysis from the perspective of the Member
granting the subsidy, the very concept of "exporting" does not even arise in the context of goods that
are themselves not produced within the territory of the Member itself.
150 In effect, the United States
seems to argue that a subsidy to economic activity that is entirely irrelevant to export activity --
indeed, is precluded from involving such exports -- can effectively remove export contingency. This

147 US response to Panel Question 21, Annex F-3, para. 72.
148 Ibid., para. 73.
149 See SCM Agreement, Article 2.1.
150 We consider that the use of the term "export" in Article 3.1(a) of the SCM Agreement indicates that
goods must be moved from the territory of one Member to that of another Member. For the purposes of this
dispute, we consider that it is sufficient for us to clarify our view that this involves movement of a good from
the territory of the Member granting the subsidy to the territory of another Member. We also consider that the
treatment of domestically-produced goods sold domestically in the territory of the Member granting the subsidy
is a useful basis for comparison for the purposes of an Article 3.1(a) analysis. We find contextual support for
this approach in, for example, the text of Article XVI of the GATT 1994, which refers to granting "directly or
indirectly any form of subsidy which operates to increase the export of any primary product from its territory…"
(para. 3) and to subsidies resulting in the sale of a product for export "at a price lower than the comparable price
charged for the like product to buyers in the domestic market" (para. 4).

seems to be a manifestly unreasonable interpretation. Be that as it may, it would also have the
practical effect of reducing the disciplines of the SCM Agreement to ineffectiveness and inutility.
8.69 This can be readily seen. If the provision of such a subsidy -- that does not even relate to
goods that can be, in principle, exported -- coul d "cure" export-contingency, where would the line be
drawn demarcating the parameters of such an approach? Manifestly, there could not be any such line.
One could just as readily argue that the provision of subsidies in realms entirely unrelated to the sale
or consumption of domestically-produced goods would eliminate export subsidies otherwise deemed
to exist in respect of such domestically-produced goods.
8.70 Thus, the application here by the United States of a subsidy to offshore economic activity is,
at most, the provision of a supplemental feature or an additional subsidy. But the fundamental
differentiation that existed in the first place has s till not thereby been eliminated. This contrast in
respect of domestically-produced goods irrevocably remains. The analogy that more readily springs
to mind is that a Member does not eliminate an export subsidy on apples by also granting a subsidy on
oranges that is not contingent upon export performance.
8.71 In fact, the specificity analogy, if anything, actually implies the reverse of the US argument.
The only way to eliminate an export subsidy in the manner equivalent to eliminating specificity is to
eliminate the essential basis of the differentiation in the first place viz grant the equivalent subsidy
also to the goods for sale or consumption on the dom estic market. It would not then be contingent on
export because it would be available in respect of goods produced in the US territory irrespective of
whether or not they are exported . THAT would be the comparable case to the conversion from
specificity to general availability.
8.72 Thus, in our view, a way to cure export-contingency in this case would be to eliminate the
conditionality on export by making the subsidy available irrespective of whether a product of national
origin is sold in the domestic market or abroad. It is the differential treatment provided for in the Act
-- that is, if US-produced goods are exported, the subsidy is available, while if they are sold in the
domestic market, it is not -- that renders the Act contingent upon export performance within the
meaning of Article 3.1(a).151 The addition of other circumstances or products in respect of which the
subsidy may be available -- i.e. foreign-produced goods -- does not eliminate the conditionality of the
subsidy upon export, and thus does not cure the inconsistency with Article 3.1(a) of the SCM
Agreement.152

151 We note that the United States argues that such an approach to contingency (i.e. for owners of US
produced goods, export is a condition for obtaining the benefits under the scheme for those goods, see e.g. EC
rebuttal submission, para. 102), would mean that "territorial exemptions in most European countries provide
export-contingent subsidies…" (US oral statement, Annex D-3, para. 91) and that most tax systems worldwide
were inconsistent with the SCM Agreement , which could not have been intended by the drafters of the
Agreement. The EC responds that “a territorial system taxes income from economic activity -- the final
destination of the product is irrelevant" (EC response to Panel Question 35, Annex F-1, para. 89).
152 In this respect, we do not rely upon the phrase "solely or as one of several other conditions" in
Article 3.1(a) of the SCM Agreement . Nor would our ruling mean, as the United States argues, that the
application of Article 3.1(a) extends "to essentially an y measure that has any relationship to exportation or that
might result in exportation" (see US first written submission, Annex A-2, para. 133). We are not dealing here
with a situation where a subsidy may be earned in respect of particular goods either through export or through
sale in the domestic market. Nor is this a situation where a subsidy might be earned in respect of US-produced
goods if one of several alternative conditions was met (e.g. export or generation of employment). Thus, we do
not address, and reserve our position on, the issue whether "one of several other conditions" in Article 3.1(a)
refers to "additional" conditions beyond export-contingency or to conditions "alternative" to export contingency.

8.73 We also take note of the US argument that the tax exclusion is even available for certain
domestic transactions (domestic sales of products that are to be used outside of the United States). 153
In response to questioning from the Panel, the United States submits that “[a] manufacturer of goods
can earn excluded income by sales to domestic buyers, provided that the goods in question are used
outside the United States".
154 The United States contends, further, that:
"Use outside the United States could occur, for example, if the good in question is a
fishing boat sold to a United States person for use outside the territorial waters of the
United States. In that case, income from the sale of the boat could qualify
notwithstanding that the boat was not “consumed” within a foreign jurisdiction. Use
outside the United States also could occur in certain circumstances if the article is
incorporated into a good that is sold for use outside the United States. Thus, for
example, extraterritorial income could be earned if a US manufacturer sells an aircraft
engine to a US aircraft manufacturer for incorporation into a finished aircraft to be
used outside the United States."
155
8.74 These US statements do not change our view of the nature of the scheme in relation to US-
produced goods. Since, in order for a transaction involving US-produced goods to qualify for the tax
exclusion under the Act, the goods must not be "for use in the United States", it follows that these
goods must be sent across the US border and moved outside US territory, generally, and in the usual
case not involving questions of territorial waters, in to another country. In our view, this means that,
in respect of US-produced goods, the subsidy is conditioned upon export. The factual situation
identified by the United States in these proceedings where a good could re-enter the United States –
e.g. a US manufacturer of car tires may earn excluded extraterritorial income from the sale of tires to
an unrelated US car manufacturer with a plant in Canada, even if the tires are installed on cars for sale
in the US domestic market”
156 – still requires that the goods leave US territory and cross the US
border (entering into another country) before they re-enter upon US territory. That the requirement of
"use outside the United States" may require only " predominant foreign use"157 still means that some
extent of foreign use is a requirement, immaterial whether this is entire or predominant. 158 In short,
for US-produced goods, the subsidy is available only upon the condition of exportation.
8.75 We therefore find that the Act involves subsidies "contingent … upon export performance" by
reason of the requirement of “use outside the United States” and is therefore inconsistent with
Article 3.1(a) of the SCM Agreement.159

153 US closing oral statement, Annex D-4, para. 9. US response to Panel Question 11, Annex F-3,
paras. 22-26.
154 US response to Panel Question 11, Annex F-3, para. 22.
155 US response to Panel Question 11, Annex F-3, para. 22. In respect of these hypothetical situations it
raises, the US states that "these examples follow from the language of the statute but the precise scope of these
rules will be the subject of proposed regulations to be issued in the future" (US response to Panel Question 11,
Annex F-3, para. 22).
156 US response to Panel Question 11, Annex F-3, para. 24.
157 US response to Panel Question 11, Annex F-3, para. 25.
158 In this connection, we note that the requirement of "use outside the United States" can be met under
the Act if, with other conditions being satisfied, property is held primarily for use outside the United States.
Act, section 3, section 943(a)(1) IRC. Moreover, the Act, section 3, section 942(a)(2)(A)(i), relating to the
definition of "foreign trading gross receipts" states that such receipts shall not include receipts from a
transaction if the qualifying foreign trade property is for ultimate use in the United States.
159 Having made this finding, we do not consider that it is necessary for us to further examine whether
the Act also involves the full or partial exemption, remission or deferral "specifically related to exports", of
direct taxes paid or payable by industrial or commercial enterprises within the meaning of item (e) of the
Illustrative List of Export Subsidies in Annex I of the SCM Agreement.

2. Footnote 59
(a) analytical approach
8.76 The United States contends that, even if the Act's exclusion were an export-contingent
subsidy, it would not be prohibited because the fifth sentence to footnote 59, when read in conjunction
with footnote 5, provides that measures to avoid the double taxation of foreign-source income are not
prohibited by the SCM Agreement .
160 In the view of the United States, the fifth sentence of
footnote 59, which provides that "[p]aragraph (e) is not intended to limit a Member from taking
measures to avoid the double taxation of foreign-source income earned by its enterprises or the
enterprises of another Member", falls within the scope of footnote 5, which provides that,
"[m]easures referred to in Annex I as not constituting export subsidies shall not be prohibited under
this or any other provision of this Agreement". The United States refers in this respect to the Brazil –
Aircraft panel report, which opined that footnote 5 "could extend more broadly to cover cases where
the Illustrative List contained some other form of affirmative statement that a measure is not subject
to the Article 3.1(a) prohibition", and referred by way of example to the first and fifth sentences of
footnote 59.161
8.77 The European Communities "sees no reason to contest that that the last sentence of
footnote 59 may be an exception to Article 3.1(a)"162, but, in response to a Panel question, asserts that
it "was not stating that it considers that the last sentence of footnote 59 is an exception to
Article 3.1(a)".163 The European Communities submits that as the scheme is not a measure to avoid
the double taxation of foreign-source income, the conditions of the last sentence of footnote 59 are not
met. Accordingly, the European Communities asserts, the Panel need not reach the issue of whether
the last sentence to footnote 59 is an exception to item (e) and thus within the scope of footnote 5.164
8.78 We recall that the fifth sentence of footnote 59 to item (e) of the Illustrative list of Export
Subsidies in Annex I of the SCM Agreement states:
"Paragraph (e) is not intended to limit a Member from taking measures to avoid the
double taxation of foreign-source income earned by its enterprises or the enterprises
of another Member".
8.79 Footnote 5 of the SCM Agreement states:
"Measures referred to in Annex I as not constituting export subsidies shall not be
prohibited under this or any other provision of this Agreement".
8.80 In order for the United States to prevail, on the basis of footnotes 59 and 5 of the SCM
Agreement, with respect to the claims of the European Communities under Article 3.1(a), we must
determine that:
• the Act is a measure to avoid the double taxation of foreign-source income within the
meaning of the fifth sentence of footnote 59 of the SCM Agreement, and

160 US first written submission, Annex A-2, para. 154.
161 US first written submission, Annex A-2, para. 175, citing Article 21.5 Panel Report , Brazil - Export
Financing Programme for Aircraft - Recourse by Canada to Article 21.5 of the DSU , WT/DS46/RW, adopted as
modified by the Appellate Body, 4 August 2000.
162 EC written rebuttal submission, Annex C-1, para. 181.
163 EC response to Panel Question 3, Annex F-1, para. 12.
164 Ibid.

• the fifth sentence of footnote 59 falls within the scope of footnote 5 of the SCM
Agreement.165
(b) whether the Act is a measure to avoid the double taxation of foreign-source income under
footnote 59 of the SCM Agreement
8.81 We first turn to an examination of the United States argument that the Act is a measure to
avoid the double taxation of foreign-source income within the meaning of footnote 59 of the SCM
Agreement.
8.82 The United States contends that the language in the fifth sentence of footnote 59 is
“particularly flexible, imposing no limit on WTO Members in fashioning double tax relief
measures.”166 The United States submits that the last sentence of footnote 59 suggests that WTO
Members are not prevented by the SCM Agreement from taking “prophylactic steps to prevent their
taxpayers from being subjected to taxation both at home and in a foreign jurisdiction.” 167 T h e
United States submits that the Act is a measure to avoid double taxation of foreign-source income and
that the Act provides a partial exclusion from tax for foreign-source income (i.e. income derived from
non-domestic sources). The United States points to legislative history that it contends indicates that
the Act “was intended and designed” to serve as " a measure to avoid double taxation", and that the
structure of the Act demonstrates this.168
8.83 The United States submits that while the terms “double taxation” and “foreign-source
income” are terms widely used in the tax area, it is not clear that they have obtained universally
agreed-upon “special meanings”, and no such “special meanings” have been accepted by the WTO.169
For the United States, the ordinary meaning of the terms in the fifth sentence of footnote 59 is readily
ascertainable and there is no need for recourse to supplemental means of interpretation for these
terms.
170
8.84 In the US view, the term “foreign-source income”, as used in footnote 59, is not limited solely
to income attributable to foreign economic activities. 171 The United States argues that there is no
international consensus that a permanent establishment is necessary to tax income. The United States
asserts that income covered by the Act’s exclusion is income that faces the legitimate possibility of
taxation outside the United States.
172 In the US view, the issue that arises is whether the Act does not
constitute a measure to avoid double taxation under footnote 59 because it does not limit its exclusion
to the amount of foreign taxes paid.173

165 Footnote 59 of the SCM Agreement is linked to item (e) of the Illustrative List in Annex I of the
SCM Agreement . Footnote 5 is linked to Article 3.1(a) of the SCM Agreement . As footnote 5 of the SCM
Agreement relates to situations where a measure is referred to as not constituting an export subsidy in Annex I, it
would thus be necessary for us to determine whether a measure found to fall within the scope of footnote 59,
fifth sentence -- which provides that "[p]aragraph (e) is not intended to limit a Member from taking measures to
avoid the double taxation of foreign-source income…" -- constitutes a measure referred to in Annex I as not
constituting an export subsidy for the purposes of footnote 5.
166 US oral statement, Annex D-3, para. 143.
167 US oral statement, Annex D-3, para. 22.
168 US oral statement, Annex D-3, paras. 138-139.
169 US oral statement, Annex D-3, para. 111.
170 US oral statement, Annex D-3, paras. 120-121.
171 US first written submission, Annex A-2, para. 190-192, US written rebuttal submission, Annex C-2,
paras. 56-59: US oral statement, Annex D-3, para. 133.
172 US closing oral statement, Annex D-4, para. 15.
173 US oral statement, Annex D-3, para. 8.

8.85 The United States submits that the exemption (non-taxation) of foreign-source income is a
widely accepted method of avoiding double taxation (along with foreign tax credits). 174 While the
United States continues to use foreign tax credits, it asserts that nothing prevents it from using
alternative means (tax credits and exclusions) to avoid double taxation.175 The United States relies on
the OECD Model Tax Convention on Income and Capital solely as an example, and does not consider
it to be a substitute for the text of the relevant WTO provisions. 176 The United States refers to the
OECD Commentary as relevant only in that it reflects that many countries are like the United States
and offer a mix of exemptions and exclusions as well as foreign tax credits. 177 The United States
asserts that there is no "double relief from double taxation" as "[f]oreign tax credits may not be used
with respect to excluded extraterritorial income".178
8.86 For the European Communities, it is not necessary in this case to establish the exact status and
meaning of footnote 59, but it is rather sufficient to note that the Act is not a measure for the
avoidance of double taxation and is not limited to foreign-source income.
179 T h e E u r o p e a n
Communities submits that “whether one considers that this is a reference to a WTO standard or must
be assessed, like revenue foregone, by a reference to the tax system of the country concerned, the Act
does not satisfy this condition". 180 The European Communities contests US assertions that the
legislative history shows that the purpose of the Act was to avoid double taxation.181
8.87 The European Communities argues that the provisions of the OECD Model Tax Convention
apply only where income may, in accordance with its provisions, be taxed in another state, and the
Convention provides evidence of the rule that business profits may only be taxed where an enterprise
carries on business through a "permanent establishment". 182 The European Communities contends
that under the Act, income may be excluded in respect of transactions where the taxpayer does not
maintain a permanent establishment abroad and is thus not subject to taxation in another state. As the
Act excludes from tax income which could not legitimately be taxed in any other country, it provides
"single taxation relief".
183
8.88 The European Communities contends that the s ource of income is the place in which the
activities giving rise to these profits have taken place. The United States treats income as
"extraterritorial" if the money or assets originate outside the United States. Thus, the income
excluded by the Act is not foreign-source income. Nor is "extraterritorial income" foreign-source
income within the meaning of US law.
184 In the EC view, the scheme allows what is claimed to be
double taxation relief on both foreign-source income and domestic-source income. The availability of

174 US first written submission, Annex A-2, paras. 178, 180, citing to Articles 23A and 23B of the
Model Tax Convention on Income and Capital (“ OECD Model Tax Convention ”) (Exhibit US-7; Exhibit
EC 12).
175 US written rebuttal submission, Annex C-2, paras. 35-38.
176 US oral statement, Annex D-3, para. 117.
177 US oral statement, Annex D-3, para. 142, referring to the Commentary to Article 23 of the OECD
Model Tax Convention (Exhibit US-7)
178 US first written submission, Annex A-2, paras. 188-189; US oral statement, Annex D-3, para. 139;
US comments on EC response to Panel Question 16, Annex F-6, para. 17, referring to ss. 114(c)-(d) IRC.
179 EC closing oral statement, Annex D-2, paras. 29-30.
180 EC closing oral statement, Annex D-2, paras. 29-30.
181 EC written rebuttal submission, Annex C-1, paras. 41-42.
182 Eg EC closing oral statement, Annex D-2, para. 22.
183 EC written rebuttal submission, Annex C-1, paras. 186 – 198.
184 EC written rebuttal submission, Annex C-1, paras. 199-208. The European Communities states that
the United States deals with taxation of income from sources without the United States in section 862 IRC,
submitted as part of Exhibit EC-21. See e.g. EC response to Panel Question 36, Annex F-1, para. 118.

double taxation relief on domestic-source income under the FSC Replacement scheme is also not
covered by the last sentence of footnote 59.185
8.89 Finally, the European Communities argues that the United States has no need of the Act to
relieve double taxation, because it has a comprehensive system of foreign tax credits. Nor does the
Act solve the problem of double taxation because, the amount of excluded income being limited,
companies may still need to claim foreign tax credits to avoid double taxation. On the other hand, the
Act in some cases permits an enterprise to take a foreign tax credit with respect to excluded income,
thus providing "double relief from double taxation". Nor do the "formulaic" rules for calculating the
amount of excluded income correspond to the arm's length apportionment of the profits which another
country would seek to tax. Thus, the European Communities asserts, avoidance of double taxation
cannot be the "real objective" of the Act.
186
8.90 In considering this issue, we first recall that a party asserting the affirmative of a particular
claim or defence bears the burden of proof with respect to that claim or defence. 187 It appears to us
that the nature of the last sentence of footnote 59 is such that the party asserting that its measure falls
within the scope of that sentence bears the burden of establishing that the measure fulfils the
conditions set out in that sentence. We do not believe that it would be incumbent upon a party to
assert that a measure was not a measure to avoid the double taxation of foreign-source income within
the meaning of footnote 59 before the party imposing the measure had invoked the last sentence of
footnote 59 as a justification for its measure.188
8.91 We observe that the fifth sentence of footnote 59 contains several elements relating to the
type of measure that item (e) "is not intended to limit a Member from taking". In this regard,
footnote 59 refers to "measure[s] to avoid the double taxation of foreign-source income". Thus,
item (e) "is not intended to limit a Member from taking measures: (i) "to avoid"; (ii) "the double
taxation"; (iii) "of foreign-source income" earned by the enterprises of the Member concerned or of
another Member. In order for a measure to fall within the scope of the fifth sentence of footnote 59, it
must satisfy each of these three elements.
8.92 We do not understand the parties to disagree that the term "double taxation" refers to the
situation where the same income is taxed in more than one jurisdiction. However, the parties have
diverging views on the nature and scope of the justification provided by the fifth sentence of the
footnote, on the meaning of the term “foreign-source income” as used in the footnote and on whether
the Act is a measure "to avoid" double taxation. We therefore consider each of these other elements
in turn.
8.93 We turn first to the term “foreign-source income". We recognize that this term in footnote 59
refers to a taxation concept. However, it is not clear to us that the term has obtained a universally
agreed upon special meaning. Even if such a definition or special meaning existed, no such definition

185 EC comments on US responses to Questions, Annex F-5, paras. 29-30.
186 EC written rebuttal submission, Annex C-1, paras. 209-220.
187 Appellate Body Report, United States - Measure Affecting Imports of Woven Wool Shirts and
Blouses form India, WT/DS33/AB/R, adopted 23 May 1997, p. 15.
188 We consider the original Appellate Body Report in this dispute to be instructive here. The
Appellate Body stated that "… the United States did not indicate that, in its substantive arguments to the Panel,
it had justified the FSC measure as a measure "to avoid double taxation" under footnote 59. Nor do we find any
indication in the Panel Record th at the United States ever invoked this justification . We, therefore, conclude
that the United States did not assert, far less argue, before the Panel that the FSC measure is a measure "to avoid
double taxation of foreign-source income" under footnote 59 (emphasis added)." Original Appellate Body
Report, supra, note 1, para. 101. We consider that this supports our view that it is for the Member seeking to
justify its measure under the last sentence of footnote 59 to invoke this provision and to bear the burden of proof
by establishing an affirmative prima facie case that the conditions in that sentence of the footnote are fulfilled.

or meaning has been included in the SCM Agreement as a common understanding among WTO
Members. Therefore, in our examination of the Act under footnote 59, we do not impose a single
rigid definition or interpretation of the term “f oreign-source income”, as that term is used in
footnote 59, nor do we import into the WTO Agreement any definition of the term that may exist in
other international instruments or fora. 189 Nor are we of the view that the meaning of the term
"foreign-source" as used in footnote 59 need necessarily be determined purely by reference to the
domestic laws of the Member invoking the footnote, in this case, the United States. 190 We note,
however, that footnote 59 refers to measures taken to avoid "the double taxation of foreign-source
income". We understand the term "foreign-source inco me" as used in footnote 59 to refer to certain
income susceptible to "double taxation".
8.94 We turn next to the term "to avoid" in footnote 59, fifth sentence. The term "avoid" is defined
inter alia as "[t]o empty out; remove…to get rid of, put an end to…" and as "[t]o escape, evade; … To
prevent, obviate".191 The use of the term "to avoid", rather than, for example, measures "that avoid",
indicates to us that the purpose of the measure (or at least one of its purposes) must be to avoid (i.e.
"prevent" or "obviate") the double taxation of foreign-source income.192 Thus, the fact that a measure
may incidentally prevent certain income from being subject to double taxation in a particular set of
circumstances would not, in and of itself, be sufficient to bring the measure within the scope of
footnote 59. We note, in any event, that virtually any subsidy provided through relief from income
taxation might have such an incidental effect in certain circumstances. For example, a provision that
income derived from exportation was not subject to income taxes would have at least an incidental
effect in avoiding the double taxation of certain foreign-source income. We observe that such a broad
interpretation of the term "to avoid" in footnote 59, fifth sentence would render item (e), and possibly
all of Article 3 of the SCM Agreement
193, devoid of all meaning and do not believe that such an
interpretation could have been intended. We note that the text also does not, for example, state that
item (e) is not intended to limit Members from taking measures "that happen to avoid"; "in relation to
avoiding"; "in respect of avoiding"; or "in regard to avoiding" the double taxation of foreign-source
income. All of these might be seen as phrasings which are more consistent with the interpretative
approach posited by the United States. But the language in the fifth sentence of footnote 59 is far
more targeted than that.
8.95 We have a degree of sympathy for the US statement that “precision” in the relief of double
taxation is "“probably impossible” given the many differences in taxation systems from one country

189 We note that to the extent that it might be releva nt to this proceeding as an example of international
tax practice, the OECD Model Tax Convention refers to the concept of "source" but does not, in any event,
contain such a definition. See also infra, note 195.
190 Section 862 of the IRC refers to and describes "Income from sources without the United States".
The European Communities contests the US assertion in its response to Panel Question 15 (Annex F-3, para. 51)
that "excluded extraterritorial income would be forei gn-source income under US sourcing rules, as set forth in
section 862(a)(4) and 863(b) of the IRC" and offers explanation as to why "foreign-source income and
extraterritorial income are entirel y unconnected concepts". See EC comments on US response to Panel
Question 15, Annex F-5, paras. 7-8. We do not consider the US definition of foreign-source income contained in
the IRC decisive here. We observe that footnote 59 doe s not contain any statements analogous to the statement
in footnote 6 to Article XIV of the General Agreement on Trade in Services , which reads: "Tax terms or
concepts in paragraph (d) of Article XIV and in this f ootnote are determined according to tax definitions and
concepts, or equivalent or similar definitions and concepts, under the domestic law of the Member taking the
measure."
191 The Shorter Oxford English Dictionary , 3rd ed. (Oxford University Press, 1965).
192 We note that this term appears in the French text of the footnote as: "en vue d'éviter" and in the
Spanish text as "destinadas a evitar". We consider that these translations are consistent with our view.
193 We note the US argument that a measure falling under the fifth sentence of footnote 59 is "not
prohibited" not only in respect of item (e), but also in respect of the SCM Agreement as a whole (including
Article 3 thereof). See e.g. US first written submission, Annex A-2, para. 154. As noted infra, para. 8.108, we
do not decide this issue here.

to another and the many different ways that international commerce can be structured.”194 Indeed, we
do not view footnote 59 as requiring that a measure "to avoid" the double taxation of foreign-source
income must avoid double taxation entirely, exclusively or precisely. 195 However, we consider that
the relationship between the measure and its asserted purpose -- i.e. "to avoid the double taxation of
foreign-source income …" -- must be reasonably discernable. 196 We seek to ascertain whether the Act
is a measure "to avoid" the double taxation of foreign-source income by concentrating our
examination on a review of the overall structure, design and operation 197 of the Act in the context of
the broader United States tax system.

194 US response to Panel Question 19, Annex F-3, para. 61.
195 We recognize that the United States itself is not contending that the Act is a “narrowly-tailored,
dollar-for-dollar offset of foreign taxes paid" (US oral statement, Annex D-3, para. 23), and we are not of the
view that this would necessarily be the only type of measure that might qualify for justification under the
footnote. To the contrary, such an interpretation would imply that only a system of foreign tax credits, and not a
mechanism to exempt foreign-source income, would fall within the scope of footnote 59. Such an approach
would be inconsistent with a broadly-held view, reflected in the OECD Model Tax Convention , that both the
credit and exemption methods are appropriate means to avoid double taxation.
We want to be clear that when we refer to the OECD Model Tax Convention here and elsewhere in this
Report, we are not suggesting that its provisions are somehow controlling of our interpretation of the WTO
Agreement. Rather, we consider that the OECD Model Tax Convention can be relevant to the extent it is
reflective of tax practices of certain WTO Members. We note that the United States itself has relied upon the
OECD Model Tax Convention for this purpose (US oral statement, Annex D-3, para. 117).
196 We note the US assertion that the language in footnote 59 is "particularly flexible, imposing no limit
on WTO Members in fashioning double tax relief measures" (US oral statement, Annex D-3, para. 143). While
we agree with the United States that the language of the footnote may accommodate a certain degree of
flexibility, we do not view this flexibility as extending entirely beyond the words and concepts actually used in
the text of the provision.
197 We find support for our approach in previous WTO dispute settlement reports. For example, in the
context of an examination under Article III:2 of the GATT 1994, the Appellate Body has stated "[a]lthough it is
true that the aim of a measure may not be easily ascer tained, nevertheless its protective application can most
often be discerned from the design, the architecture, and the revealing structure of a measure." See Appellate
Body Report, Japan - Taxes on Alcoholic Beverages , WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R,
adopted 1 November 1996, pp. 29-30 (" Japan-Alcoholic Beverages "). In its Report in Chile-Taxes on
Alcoholic Beverages , supra, note 53, para. 71, the Appellate Body characterized its approach in Japan -
Alcoholic Beverages as calling "for examination of the design, architecture and structure of a tax measure
precisely to permit identification of a measure's objectives or purposes as revealed or objectified in the measure
itself." As well, in the context of an examination under Article XX(g) of the GATT 1994, the Appellate Body
examined "the relationship between the general structure and design of the measure" at stake "and the policy
goal it purports to serve". United States - Import Prohibition of Shrimp and Shrimp Products , WT/DS58/AB/R,
adopted 6 November 1998, para. 137. See also infra, note 217.
In this context, we do not place great weight in our examination on the asserted intent of the
United States legislators prior to enactment of the Act. We recall that the Act (section 3; section 114(d) IRC)
disallows foreign tax credits that might otherwise be a llowed with respect to excluded extraterritorial income
(and that the Act, section 3; section 943(d) IRC contains rules relating to the treatment of "withholding taxes"
for purposes of section 114(d) IRC). We note, in this regard, the references identified by the United States in
the US House of Representatives Report on the FSC Repeal and Extraterritorial Income Exclusion Act , H.R.
Rep. No. 106-845 (2000) (" House Report")(Exhibit US-3), (see e.g. US first written submission, Annex A-2,
paras 188-189) as demonstrating that the Act was intended and designed to avoid double taxation of foreign-
source income. We further note that the Reports of the United States Senate and House of Representatives
relating to the Act state that,
"Because the exclusion of such extraterritorial income is a means of avoiding double taxation,
no foreign tax credit is allowed for income taxes paid with respect to such excluded income.
An exception from this general rule is provid ed for extraterritorial income that is not
qualifying foreign trade income."

8.96 Examining the overall structure, design and operation of the Act, we consider that the
parameters of the Act do not even roughly approximate the parameters of a measure to avoid the
double taxation of foreign-source income. With the Act, the United States has not approximated the
boundaries relating to the type of income that might be subject to tax by another tax authority, but has
rather drawn a distinct line demarcating what it refers to as "extraterritorial income” (and then
provided for an exclusion from "gross income" of a portion thereof, i.e., qualifying foreign trade
income).
8.97 As discussed in more detail below, the Act includes as "extraterritorial income" that is
excluded from taxation income which would, in our view, not necessarily be treated as taxable in
other jurisdictions. In this respect, the Act is unusually broad for a measure whose purpose is to avoid
double taxation. At the same time, the "extraterritorial income" excluded from taxation does not
include a range of income which is potentially subject to taxation in other jurisdictions. It is thus, in
certain respects, unusually narrow for a measure whose asserted purpose is to avoid double taxation.
Finally, we note that the Act overlaps with an extensive system of bilateral agreements to avoid
double taxation through foreign tax credits, and its application is not designed to cover situations
where such agreements did not exist. No single one of these elements, taken separately, would
necessarily lead us to the conclusion that the Act is not a measure taken to avoid the double taxation
of foreign-source income; taken together, however, they lead us to the conclusion that the Act is not a
measure taken to avoid the double taxation of foreign-source income within the meaning of
footnote 59.
8.98 First, we note that the Act is exceedingly broad in that it excludes income which would rarely
be taxable in another jurisdiction.
8.99 We recall that a defining feature of the tax exclusion provided for by the Act is that it is only
available in respect of income derived from the sale or lease of goods held primarily "for direct use,
consumption or disposition outside the United States".
198 We consider it clear, however, that income
is not necessarily subject to taxation outside the United States merely because the money originated
outside the United States. 199 Rather, many countries impose limits on the extent to which they will
seek to tax business income relating to transactions on their territory. One such approach, as
evidenced in Articles 5 and 7 of the OECD Model Tax Convention, is to tax business profits of an
enterprise only where that enterprise carries on business through a permanent establishment, and only
to the extent those profits are attributable to that permanent establishment.
8.100 The parties have debated at length the issue of "permanent establishment". The United States,
in particular, has argued that "[a] number of nations have broader jurisdiction under their tax laws to
reach income of non-residents than that prescribed by the concept of 'permanent establishment'..." 200
We do not dispute this contention. Nevertheless, we observe that many countries appear to have rules
concerning the taxation of certain earnings of foreign entities that are based on the "permanent

(US Senate Report on the FSC Repeal and Extraterritorial Income Exclusion Act , S. Rep. No. 106-416 (2000)
("Senate Report ") (Exhibit US-2), page 2; and House Report , Exhibit US-3, page 10. Also see, for example,
House Report , page 18.) These references are not, in our view, decisive or conclusive here. They appear
primarily to explain why foreign tax credits are disallowed, that is, to avoid a situation where foreign tax credits
would be granted in respect of taxes on income that was, in any event, excluded from taxation in the
United States. We further note that the stated purpose of the Act was, according to the House Report, "to
comply with decisions of a World Trade Organization dispute panel and Appellate Body". Id., p. 9.
198 Act, section 3; section 943(a) IRC.
199 We note, in any event, the US contention that "a manufacturer of goods can earn excluded income
by sales to domestic buyers, provided that the goods in question are used outside the United States." (US
response to Panel Question 11, Annex F-3, para. 22). Thus, even if we were to accept this US view, the Act
would nevertheless be overbroad in this respect as a measure to avoid double taxation.
200 US oral statement, Annex D-3, para. 127.

establishment" principle or on an analogous basis. In fact, we note that the bilateral tax treaties of the
United States and a number of other countries largely rely on this approach. 201 Thus, in cases where
the United States maintains either a bilateral ta x treaty reflecting the "permanent establishment"
approach or the country in question has incorporated the concept of "permanent establishment" in its
legislation, there is no potential for double taxation in the absence of a permanent establishment. The
Act, however, contains no requirement that excluded income be derived from a permanent
establishment. It may thus be anticipated that the Act will, in a range of situations, exclude from
taxation income that could not, in any event, be taxed in the foreign jurisdiction in question.
8.101 We note the United States' contention that the foreign economic processes requirement in
section 942(b) IRC is an indication that extraterritorial income must involve some foreign economic
activity, as well as the US statement that "the Act requires that transactions giving rise to
extraterritorial income must have a variety of foreign attributes that can result in a sufficient nexus to
a foreign taxing regime so as to render US taxpayers subject to foreign taxation".
202 We further note
that, while the foreign economic processes referred to and required by the Act must be performed
outside the United States, the Act allows the solicitation or negotiation of a given contract to be
conducted by the taxpayer or any person acting under a contract with such a taxpayer and that a
taxpayer is treated as meeting the requirements with respect to activities relating to qualifying foreign
trade property if any related person has met the requirements in a given transaction. 203 We take these
as further indications that the Act does not require that excluded income be derived from a permanent
establishment, and this indicates that the Act would exclude from taxation income that could not, in
any event, be taxed in many of the foreign jurisdictions in question. Moreover, the foreign economic
process requirements are not applicable to entities earning less than $5 million, thus indicating that for
US taxpayers with earnings under this threshold no foreign economic processes creating any degree of
"nexus" whatsoever with any foreign taxing regime need occur.
8.102 We recall our observation above that many countries impose limits on the extent to which
they will seek to tax business income relating to transactions on their territory, and the OECD Model
Tax Convention is reflective of one approach that contemplates taxation of business profits of an
enterprise only where that enterprise carries on business through a permanent establishment, and only
to the extent those profits are attributable to that permanent establishment. We understand the
concept of profits "attributable to" a permanent establishment to refer to income bearing some
relationship to the level of economic activity conducted through the permanent establishment. In this
regard, we note that the costs incurred in conducting the foreign economic processes required by the
Act need not bear any direct proportional relationship to the amount of "extraterritorial" income that
may ultimately be excluded under the Act.
204

201 See e.g. US oral statement, Annex D-3, para. 127; United States Model Tax Convention, Exhibit
EC-13.
202 eg US response to EC Question 20, Annex F-4, para. 31.
203 Act, section 3; section 942(b)(2)(A)(i) and 942(b)(4) IRC.
204 We note that one of the three bases for calculating qualifying foreign trade income under the Act is
30 per cent of "foreign sale and leasing income" (Act, section 3; section 941(a)(1)(A) IRC). Under the Act,
"foreign sale and leasing income" is defined as foreign trade income "properly allo cable" to certain enumerated
foreign economic processes or as foreign trade income derived by the taxpayer in connection with the lease or
rental of certain qualifying foreign trade property, and also includes any foreign trade income derived from the
sale of such property (Act section 3; section 941(c) IRC). The other two bases for calculating qualifying foreign
trade income under the Act contain no reference to any relationship between the foreign economic processes and
the amount of income that may ultimately be "excluded" (that is, provided the "threshold" requirements of Act,
section 3; section 942(b) IRC relating to foreign economic processes are fu lfilled). We recall that a taxpayer
may compute its qualifying foreign trade income on one of the three enumerated bases other than the one
resulting in the greatest amount of such income (Act, section 3; section 941(A)(2) IRC). We consider that these
elements support the proposition that the foreign economi c processes need not bear any direct proportional

8.103 We do not mean to suggest that the absence of a permanent establishment requirement in the
Act in itself means that the Act is not a measure to avoid double taxation within the meaning of
footnote 59. We are conscious of the fact that "there are differing views and practices among
countries as to what brings a non-resident enterprise within a country's taxing authority".205 While we
believe that the Act probably pushes close to the outer limit of the income that might be subject
somewhere by some other jurisdiction to taxation, we do not preclude that the broad scope of the Act
might nevertheless be justified as a "prophylactic", "preventive" measure to avoid double taxation.
206
We find it difficult, however, to reconcile the asserted desire of the United States to take such a
prophylactic, preventive approach with the fact that the Act is in key respects quite narrow, excluding
from "extraterritorial income" a wide range of income that could be subject to double taxation. It is to
this issue that we now turn.
8.104 It is in our view striking that "extraterritorial income" does not include a range of income
which is potentially subject to taxation in other jurisdictions. In this respect, we first note that the Act
excludes entirely from "extraterritorial income" income related to sales within the United States or to
sales outside the United States not meeting the foreign articles/labour limitation.
207 Furthermore, the
Act makes access to the special tax treatment subject to several highly selective conditions. These are
the conditions relating to ultimate use outside the United States 208 and the foreign articles/labour
limitation. In addition, for example, Section 943(a)(3) of the Act stipulates that certain property is
"excluded property", and not included in the term "qualifying foreign trade property". Such property
includes, inter alia , "oil and gas (or a primary product thereof"); 209 and "any unprocessed timber
which is a softwood". 210 Moreover, the Act provides that the President may designate property that
might otherwise constitute qualified foreign trade property as property in "short supply". 211 During
the period that it is so designated, the property shall not be treated as "qualifying foreign trade
property" and is therefore not eligible for the tax treatment. These additional narrowing conditions
are manifestly and entirely unrelated to the source of the income or the potential for double taxation
and seem to relate to other policy concerns of the United States government. 212 Indeed, the range of
selective conditions in the Act is inconsistent with the US characterization of the Act as constituting a
“prophylactic step[] to prevent [its] taxpayers from being subjected to taxation both at home and in a
foreign jurisdiction.”213

relationship to the amount of income ultimately excluded. We underline that it is not this element of our
examination, in isolation, that leads us to reach our fi ndings, but rather this element taken together with other
elements of our examination, see e.g. supra, para. 8.97.
205 US oral statement, Annex D-3, para. 128.
206 US oral statement, Annex D-3, para. 22.
207 As the European Communities argues in its response to Panel Question 5, Annex F-1, para. 21, even
for foreign-produced goods, some of the income could be US-source income (i.e. a US company distributing
foreign-made goods).
208 We note that the tax exclusion is available in respect of income derived from certain transactions
involving qualifying foreign trade property, as well as from certain services (see supra, note 23). We observe
that the structure and design of the Act relating to the treatment of services is similar to that of the treatment of
goods in that access to the tax exclusion is subject to highly selective conditions. For example, the Act limits
the definition of "foreign trading gross receipts"-- which may give rise to excluded extraterritorial income -- so
as not to include qualifying foreign trade property or se rvices for ultimate use in the United States. See Act,
section 3; section 942(a)(2)(A)(i) IRC.
209 Act, section 3; section 943(a)(3)(C) IRC.
210 Act, section 3; section 943(a)(3)(E) IRC.
211 See Act, section 3; section 943(a)(4) IRC.
212 We note that the United States submitted, in response to questions from the EC, that "[n]either the
Act nor the legislative history of the Act … articulates the legislative intent behind…" these sections of the IRC.
See US responses to Questions from the EC, Annex F-4, para. 8.
213 US oral statement, Annex D-3, para. 22.

8.105 Finally, we observe that the United States has numerous bilateral tax treaties with other
countries that rely upon the foreign tax credit approach to avoiding double taxation. 214 The scope of
the Act is not designed to cover, in particular, situations where such a tax treaty is not in place.215 We
are cognizant that some countries may utilize several means to avoid double taxation
simultaneously216, and do not mean to suggest that the last sentence of footnote 59 only applies to
measures that are "necessary" 217 to avoid double taxation. We do consider, however, that the
existence of this extensive system of bilateral agreements addressing double taxation, combined with
the fact that the Act does not target those situations where such bilateral agreements were not in place,
represents an additional element relevant to our consideration as to whether the Act was "intended and
designed" to serve as a measure to avoid the double taxation of foreign-source income.
8.106 Put simply, the question we have posed is whether legislators concerned with avoiding the
double taxation of foreign-source income might reasonably have been expected to draft legislation
such as the Act. In our view, and for the reasons set forth above, the answer is no.
8.107 In light of these considerations, we find that the Act fails to fall within the scope of the fifth
sentence of footnote 59 because it is not a measure to avoid the double taxation of foreign-source
income within the meaning of the fifth sentence of footnote 59.
8.108 As we have found that the Act does not fall within the scope of the fifth sentence of
footnote 59, we do not believe that it is necessary to reach the issue of whether the fifth sentence of
footnote 59 also falls within the scope of footnote 5 of the SCM Agreement.
3. Claim under Article 3.2 of the SCM Agreement
8.109 The European Communities alleges that the Act grants and maintains subsidies contrary to
Article 3.2 of the SCM Agreement.
218 The United States does not specifically contest that if it were
found to be in violation of its obligations under Article 3.1, it would also be in violation of its
obligations under Article 3.2. That provision states:
"A Member shall neither grant nor maintain subsidies referred to in paragraph 1".

214 US oral statement, Annex D-3, para. 127.
215 We note that section 3 of the Act, section 942(a)(3) IRC, allows taxpayers the option to exclude any
transaction from giving rise to fore ign trading gross receipts and thus fr om the exclusion for extraterritorial
income. We recall that the United States cites "legislative history" to the effect that: “A taxpayer may elect to
treat gross receipts from a transaction as not foreign trading gross receipts. As a consequence of such an
election, the taxpayer could utilize any related foreign tax credits in lieu of the exclusion as a means of avoiding
double taxation” (US response to EC Question 5, Annex F-4, citing Senate Report (Exhibit US-2), supra,
note 197, page 8; and House Report, (Exhibit US-3), supra, note 197, page 21. We further note that tax credits
are not available for excluded extraterritorial income, pursuant to Act, section 3; Article 114(d) IRC. See supra,
note 197.
216 The United States points to the Commentary to Article 23 of the OECD Model Tax Convention for
the proposition that countries may "offer a mix of exemptions and exclusions as well as foreign tax credits" (US
oral statement, Annex D-3, para. 122). Although it is not dispositive to our analysis, we note that the
Commentary (para. 31) merely states that "Contracting States may use a combination of the two methods". It
does not explicitly state that Contracting States may offer taxpayers a choice between two alternative methods
with respect to particular income.
217 US oral statement, Annex D-3, para. 144. We observe that the term "necessary" appears in other
provisions of the GATT 1994 , for example, paragraphs (a), (b) and (d) of Article XX. The term "necessary"
does not appear in the fifth sentence of footnote 59. As we have discussed above, supra, paras. 8.94 ff., the fifth
sentence of footnote 59 refers to measures taken "to avoid" the double taxation of foreign source income.
218 EC first written submission, Annex A-1, para. 186.

8.110 The parties submitted no additional or separate argumentation on this claim relating to any
independent violation of this provision. We therefore view this claim as wholly dependent upon our
resolution of the claims under Article 3.1 of the SCM Agreement. Recalling our finding that the Act
involves prohibited export subsidies in breach of Article 3.1(a) of the SCM Agreement by reason of
the requirement of "use outside the United States", we find that by maintaining the subsidies under the
Act, the United States has acted inconsistently with its obligation under Article 3.2 of the SCM
Agreement not to maintain subsidies referred to in paragraph 1 of Article 3 of the SCM Agreement.
4. Claims under the Agreement on Agriculture
8.111 We turn to consider the claim by the European Communities that, by reason of the
requirement of use outside the United States, the Act gives rise to export subsidies within the meaning
of the Agreement on Agriculture, and that the subsidies it provides are contrary to Articles 10.1 and 8
thereof.
8.112 The European Communities submits that, as export subsidies are conferred within the
meaning of the SCM Agreement, there is no reason that they are not also conferred within the meaning
of the Agreement on Agriculture. The European Communities argues, on the basis of the Appellate
Body's reasoning in the original dispute, that the Act involves export subsidies and also creates a legal
entitlement for companies to receive these subsidies. This must “at the very least” threaten to lead to
circumvention of export subsidy commitments. In the EC view, it is therefore inconsistent with
Articles 10.1 and 8 of the Agreement on Agriculture.219
8.113 The United States contends that, as the Act's exclusion of extraterritorial income does not
constitute an export subsidy within the meaning of Articles 1 and 3.1(a) of the SCM Agreement, it also
does not constitute an export subsidy under Article 1(e) of the Agreement on Agriculture. Thus, the
United States argues, there is no violation of the Agreement on Agriculture.
8.114 Article 1(e) of the Agreement on Agriculture states:
"(e) "export subsidies" refers to subsidies contingent upon export performance,
including the export subsidies listed in Article 9 of this Agreement;"
Article 10.1 of the Agreement on Agriculture provides:
"1. Export subsidies not listed in paragraph 1 of Article 9 shall not be applied in
a manner which results in, or which threatens to lead to, circumvention of
export subsidy commitments; nor shall non-commercial transactions be used
to circumvent such commitments."
Article 8 of the Agreement on Agriculture reads:
"Each Member undertakes not to provide export subsidies otherwise than in
conformity with this Agreement and with the commitments as specified in
that Member's Schedule."

219 The European Communities did not assert that the Act involved subsidies listed in Article 9.1 of the
Agreement on Agriculture . It did, however, make an alternative claim under Articles 3.3, and 8 in conjunction
with Article 9.1, of the Agreement on Agriculture , which claim was only applicable in the event that the
United States so asserted. See EC first written submission, Annex A-1, para. 231. As neither party asserts that
the Act involves export subsidies listed in Article 9.1 (see also US first written submission, Annex A-2,
note 210) we do not address this alternative argument.

8.115 The question for determination is thus whether, for the purposes of the anti-circumvention
provisions of Article 10.1 of the Agreement on Agriculture, the subsidies to which the Act gives rise
constitute subsidies contingent on export performance (other than those listed in Article 9.1 of the
Agreement) as defined in Article 1(e) of the Agreement on Agriculture.
8.116 In line with the decision of th e Appellate Body in the original dispute concerning the scope
and application of Article 10.1 of the Agreement on Agriculture220, we consider that our reasoning and
conclusions with respect to Articles 1.1 and 3.1(a) of the SCM Agreement221, are also applicable as
regards whether the Act gives rise to subsidies contingent upon export performance within the
meaning of Article 1(e) of the Agreement on Agriculture for the purposes of Article 10.1 of the
Agreement on Agriculture . Consequently, we find in the circumstances of the present case that the
Act also involves subsidies contingent upon export performance within the meaning of Article 1(e) of
the Agreement on Agriculture for the purposes of Article 10.1 of the Agreement on Agriculture. 222
8.117 Turning to the issue of whether the export subsidies are "applied in a manner which results in,
or which threatens to lead to, circumvention of export subsidy commitments" within the meaning of
Article 10.1 of the Agreement on Agriculture, we derive guidance from the approach of the Appellate
Body in the original dispute and consider the structure and other characteristics of the measure.223 We
recall that the term "export subsidy commitments", de fining the obligations that are to be protected
under Article 10.1 of the Agreement on Agriculture, "… covers commitments and obligations relating
to both scheduled and unscheduled agricultural products".224
8.118 We note that the Act creates a legal entitlement for recipients to receive export subsidies, not
listed in Article 9.1 225, with respect to both scheduled and unscheduled agricultural products. Upon
fulfilment by the taxpayer of the conditions stipulated in the Act, the United States government must
provide the tax exclusion. As there is no limitation on the amount of extraterritorial income, and thus
on the amount of qualifying foreign trade income, that may be claimed in respect of eligible
transactions, the amount of export subsidies is unqualified.
226
8.119 Thus, with respect to unscheduled agricultural products, we believe that the Act involves the
application of export subsidies, not listed in Article 9.1, in a manner that, at the very least, "threatens
to lead to circumvention" of that "export subsidy commitment" in Article 3.3.
8.120 With respect to scheduled agricultural products, we observe that the measure allows for the
provision of an unlimited amount of subsidies, and scheduled agricultural products may, therefore,

220 Original Appellate Body Report, supra, note 1, paras. 133-154.
221 Supra, paras. 8.43, 8.75.
222 The parties disagree as to whether the subsidy under the Act could ever in practice be available in
respect of agricultural products produced abroad. While the United States contends that an agricultural product
produced abroad could satisfy the 50 per cent limit on certain foreign value, and, thus, could be eligible for the
Act’s exclusion, the European Communities underlines the obstacles to the availability of the subsidy in respect
of an agricultural product produced abroad, and argues that taxpayers will be "well advised to turn to US
production if they wish to be able to rely on the benefits of the FSC Replacement scheme." EC comments on
US response to EC Question 19, Annex F-5, para. 80 ff. In this context, we recall our finding supra, para. 8.64
that the fact that the subsidy is also available with respect to goods produced outside the United States -- that do
not necessitate export -- does not, in our view, vitiate the export-contingency of the scheme that we find in
respect of US-produced goods and thus does not cure the inconsistency of the Act with Article 3.1(a) of the
SCM Agreement by reason of the requirement of "use outside the United States". Thus, we need not resolve this
issue.
223 Original Appellate Body Report, supra, note 1, para. 149.
224 Original Appellate Body Report, supra, note 1, paras. 144-147.
225 See supra, note 219.
226 See also original Appellate Body Report, supra, note 1, para. 149.

benefit from those subsidies even after the reduction commitment levels specified in the United States'
Schedule for those agricultural products have been reached. Thus, we find that the Act is applied in a
manner that, at the very least, threatens to lead to circumvention of the export subsidy commitments
made by the United States, under the first clause of Article 3.3, with respect to scheduled agricultural
products. 227
8.121 We note that, in these proceedings, the United States does not contest that, if the measure
gives rise to subsidies contingent upon export performance under the Agreement on Agriculture, then
these subsidies would violate its obligations under Articles 10.1 and 8 of the Agreement on
Agriculture.
8.122 We therefore conclude that the United States has acted inconsistently with its obligations
under Article 10.1 of the Agreement on Agriculture by applying the export subsidies, with respect to
both scheduled and unscheduled agricultural products, in a manner that, at the very least, threatens to
circumvent its export subsidy commitments under Article 3.3 of the Agreement on Agriculture .
Furthermore, by acting inconsistently with Articl e 10.1, the United States has acted inconsistently
with its obligation under Article 8 of the Agreement on Agriculture "not to provide export subsidies
otherwise than in conformity with this Agreement…".
C.
FOREIGN ARTICLES/LABOUR LIMITATION
1. Claim under Article III:4 of the GATT 1994
8.123 We recall that, under the Act, certain extraterritorial income derived from the sale or lease of
"qualifying foreign trade property" is excluded fro m taxation. “Qualifying foreign trade property” is
property made within or outside the United States, and sold for ultimate use outside the United States,
no more than 50 per cent of the fair market value of which is attributable to "articles manufactured,
produced, grown or extracted outside the United States" and "direct costs for labour . . . performed
outside the United States". Thus, the exclusion from taxation provided by the Act is not available in
respect of income derived from the sale or lease of property more than 50 per cent of the fair market
value of which is attributable to articles made, or costs of direct labour performed, outside the United
States.
8.124 The European Communities submits that the foreign articles/labour limitation described
above is inconsistent with Article III:4 of the GATT 1994 as it is a requirement (contained in a law)
that provides less favourable treatment to imported parts and materials than to like domestic goods
with respect to their internal use in the production of goods within the United States.
228
8.125 The United States contends, in general, that the European Communities mischaracterizes the
Act, and emphasizes that the Act does not require the use of domestic rather than imported goods:
goods can meet the foreign articles/labour limitation even if 100 per cent of the fair market value of
their inputs is foreign.
229 The United States submits that the Act does not on its face violate
Article III:4, and that the European Communities has failed to proffer adequate factual evidence in
support of its claim.
8.126 Article III:4 of the GATT 1994 provides in relevant part:

227 Original Appellate Body Report, supra, note 1, para. 152.
228 EC first written submission, Annex A-1, para. 188; EC response to Panel Question 30, Annex F-1,
para. 75. The European Communities does not claim that the foreign articles/labour limitation is inconsistent
with Article III:4 of the GATT 1994 as it relates to the production of goods outside the United States (EC
response to Panel Question 27, Annex F-1, para. 66).
229 US first written submission, Annex A-2, paras. 213-215.

“The products of the territory of any Member imported into the territory of any other
Member shall be accorded treatment no le ss favourable than that accorded to like
products of national origin in respect of all laws, regulations and requirements
affecting their internal sale, offering for sale, purchase, transportation, distribution or
use.”
8.127 In our examination of the merits of the EC claim under Article III:4, we will examine the
following issues: (a) whether the imported and domestic products at issue are "like products";
(b) whether the measure at issue is a "law, regulation, or requirement affecting their internal sale,
offering for sale, purchase, transportation, distribution, or use"; and (c) whether the imported products
are accorded "less favourable" treatment than that accorded to like domestic products."230
8.128 We recall the essence of the Article III:4 obligation that will guide our examination of the EC
claim under Article III:4 of the GATT 1994, as follows231:
"The "no less favourable treatment obligation" in Article III:4 has been consistently
interpreted as a requirement to ensure effective equality of opportunities between
imported products and domestic products. In this respect, it has been held that, since
a fundamental objective of Article III is the protection of expectations on the
competitive relationship between imported and domestic products, a measure can be
found to be inconsistent with Article III:4 because of its potential discriminatory
impact on imported products.
842 The requirement of Article III:4 is addressed to
""relative competitive opportunities created by the government in the market, not to
the actual choices made by enterprises in that market". 843 Both in relation to
Article III:2 and Article III:4 it has been established that the actual trade effects of a
disputed measure are not a decisive criterion in determining whether the requirements
of these provisions are met in a given case.
844 Finally, as stated by the Appellate
Body, a determination of whether there has been a violation of Article III:4 does not
require a separate consideration of whether a measure affords protection to domestic
production.845
Affecting Imports of Fresh, Chilled and Frozen Beef , (" Korea -Beef "), WT/DS161/AB/R, WT/DS169/AB/R,
adopted 10 January 2001, para. 133. We note that our approach is materially similar to that outlined by the
Appellate Body.
231 Panel Report, Canada-Certain Measures Affecting the Automotive Industry ("Canada-Autos") ,
WT/DS139/AB/R, WT/DS142/AB/R, para. 10.78, adopted 19 June 2000 as modified by Appellate Body
Report, supra, note 118. The findings of that panel under Article III:4 of the GATT 1994 were not appealed.

8.129 With these considerations in mind, we turn to the first element of our examination of the EC
claim under Article III:4 of the GATT 1994.
(i) whether the imported and domestic products at issue are "like products"
8.130 The parties differ on the nature of the "like product" analysis required in this case. The
European Communities asserts that the distinction operated by the foreign articles/labour limitation
relates to the origin of the product and that the mere fact of having US origin is not, as such, apt to
confer upon goods any quality that makes them, by definition, "unlike" any imported goods.
232 The
European Communities cites the European Communities – Parts and Component s233 panel report for
the proposition that it need not, in respect of a measure of general application, compare a certain class
of domestic products with the same class of imported products.234
8.131 The United States contends that there must be evidence that any particular class of imported
goods will be accorded less favourable treatment than a class of domestic like products, and that, as
this case involves a generally applicable measure, there is a greater evidentiary burden than in the case
of a measure of specific application and evidence must be introduced to establish a "meaningful
nexus" between the measure and adverse effects on competitive conditions for a like class of imported
goods.
235
8.132 We view the principal purpose of the "like product" inquiry under Article III:4 of the
GATT 1994 as ascertaining whether any formal differentiation in treatment between an imported and a
domestic product could be based upon the fact that the products are different -- i.e. not like -- rather
than on the origin of the products involved. We find support for this view in the recent statement by
the Appellate Body that under "Article III:4 of the GATT 1994, the term "like products" is concerned
with competitive relationships between and among products."236
8.133 On this basis, we note that the distinction made between imported and domestic products in
the Act's foreign articles/labour limitation concerning the limitation on fair market value attributable
to “articles” is solely and explicitly based on origin. We do not believe that the mere fact that a good
has US origin renders it "unlike" an imported good. We further note that the Act is a measure of
general application. It applies horizontally to all possible products that can be used for the production
of goods that might eventually be qualifying foreign trade property. Thus, in our view, there is no
need to demonstrate the existence of actually traded like products in order to establish a violation of
Article III:4.
237 Furthermore, where there are no like US goods, the issue of less favourable treatment
of imported goods would not even arise.

232 EC first written submission, Annex A-1, paras. 196-197.
233 Panel Report, EEC – Regulation on Imports of Parts and Components , BISD 37S/132, adopted
16 May 1990.
234 EC written rebuttal submission, Annex C-1, paras. 240-241.
235 US first written submission, Annex A-2, paras. 216-219; US oral statement, Annex D-3, paras. 167,
171.
236 See Appellate Body Report, European Communities - Measures Affecting Asbestos and Asbestos-
Containing Products, WT/DS135/AB/R, adopted 6 April 2001, para. 103.
237 We find support, for example, in Panel Report, Indonesia - Measures Affecting the Automotive
Industry, WT/DS54/R, WST/DS55/R, WT/DS59/R, WT/DS64/R, adopted 23 July 1998, para. 14.113 ("…an
origin-based distinction in respect of internal taxes suffi ces in itself to violate Article III:2, without the need to
demonstrate the existence of actually traded like products"). See also Panel Report, Canada-Autos, supra,
note 231, para. 10.74. That panel stated: “It has not been contested that the distinction made between domestic
products and imported products in the definition of Canadian value-added is based solely on origin and that,
consequently, there are imported products which must be considered to be like the domestic products the costs
of which are included in the definition of Canadian value-added.”

8.134 Thus, we do not believe that it is necessary, as the United States argues, that there must be
evidence that any particular class of imported goods will be accorded less favourable treatment than a
class of like products of national origin. Nor -- as far as the "like product" analysis is concerned -- do
we believe that evidence must be introduced to establish a "meaningful nexus" between the measure
and adverse effects on competitive conditions for a like class of imported goods just because this case
involves a generally applicable measure.
238 Nor do we endorse the US assertion that laws of general
applicability have, at most, an indirect impact on imported products and thus engender a greater
evidentiary burden than laws of specific application.239
8.135 For these reasons, we consider that the "like product" element of Article III:4 is satisfied in
this case.
(ii) whether the Act is a "law, regulation or requirement affecting the internal … use" of imported
and like domestic products by reason of the foreign articles/labour limitation
8.136 The parties disagree on whether or not, by reason of the foreign articles/labour limitation, the
Act is a "law, regulation or requirement affecting the internal … use” of imported and like domestic
products within the meaning of Article III:4 of the GATT 1994.
8.137 The European Communities states that its claim under Article III:4 of GATT 1994 is focusing
on the "foreign content limitation, which affects the sale or use of products on the US market and
discriminates against foreign products", and is not claiming that the "tax exemption" as such is a
"requirement affecting internal sale" within the meaning of Article III:4.
240 With respect to the term
“affecting”, the European Communities argues that actual trade effects of the measure need not be
established. Rather, according to the European Communities, it is sufficient that the limitation
"affects" the competitive position of the imported product on the market. 241 The European
Communities states that the Act provides an incentiv e to source inputs domestically because this will
enhance the chances that a US producer will qualify for the tax benefit, and that this is sufficient to
violate Article III:4 which guarantees equality of competitive opportunities. 242 For the European
Communities, this is the case even if the measure allows for other means to obtain the advantage.243
8.138 For the United States, it is difficult to consider how imports could be "affected" by a generally
applicable measure like the one at issue. 244 According to the United States, the Act does not affect
competitive conditions between imported and like domestic products as it does not require the use of
any US-origin goods for a transaction to earn excluded extraterritorial income; goods can meet this
requirement even if 100 per cent of the fair market value of their inputs is foreign.245
8.139 In considering these issues, we first consider the form of the measure in question. We agree
with the views expressed in previous GATT and WTO panel reports that Article III:4 applies also to

238 US first written submission, Annex A-2, paras. 216-219; US oral statement, Annex D-3, para. 167.
239 US oral statement, Annex D-3, para. 171.
240 EC response to Panel Question 18, Annex F-1, paras. 47-48.
241 EC first written submission, Annex A-1, paras. 198-205.
242 EC written rebuttal submission, Annex C-1, para. 231.
243 EC written rebuttal submission, Annex C-1, para. 237, citing Panel Report, Canada - Autos , supra,
note 231, paragraph 10.82.
244 e.g. US first written submission, Annex A-2, para. 218.
245 US first written submission, Annex A-2, para. 214; also e.g. US oral statement, Annex D-3,
para. 166 ff.

measures in the form of conditions 246 that must be satisfied in order to obtain an "advantage" 247 from
the government.
8.140 While we endorse the view of the European Communities that the measure at issue here falls
within the scope of the phrase "laws, regulations and requirements" in Article III:4, we are inclined to
believe that the three separate elements identified in this phrase in Article III:4 deal with the form
rather than the content of the measure under examination. We observe that the foreign articles/labour
limitation is a statutory provision, that is, a requirement included in the Act, which is a generally
applicable "law". At any rate, regardless of whether the measure at issue is a "law" or a
"requirement", we agree with the view expressed by the European Communities that the "standard
laid down in Article III:4 of GATT 1994 is the same both for "laws" and "requirements"".248
8.141 We recall the European Communities' statement that its claim under Article III:4 of
GATT 1994 is focusing on the "foreign content limitation, which affects the sale or use of products on
the US market and discriminates against foreign products". 249 The European Communities clarifies
that it is not claiming that the "tax exemption" as such is a "requirement affecting internal sale" within
the meaning of Article III:4 of the GATT 1994. 250 In this regard, we note that the measure in question
in an Article III:4 examination may condition acce ss to an advantage or incentive bestowed by the
government. We consider that the nature of the "advantage" ultimately sought from (or "incentive"
ultimately bestowed by) the government when a certain "requirement" is voluntarily accepted in order
to obtain the "advantage" or "incentive" is not relevant for the purposes of an enquiry under
Article III:4 of the GATT 1994. In particular, it is not relevant that we are dealing here with a
measure that conditions access to an income tax advantage to a "firm".
8.142 In this connection, we can see no specification or limitation in the text of Article III:4
concerning the type of advantage linked to the measure under examination under Article III:4 of the
GATT 1994. Thus, nothing in the plain language of the provision specifically excludes requirements
conditioning access to income tax measures from the scope of application of Article III, which deals
with "national treatment on internal taxation and regulation".
8.143 In terms of context, we note that Article XIV(d) of the General Agreement on Trade in
Services (the "GATS"), entitled "General Exceptions", stipulates that nothing in that Agreement shall
be construed to prevent the adoption or enforcement by any Member of measures inconsistent with
the "national treatment" obligations in Article XVII , "provided that the difference in treatment is
aimed at ensuring the equitable or effective imposition or collection of direct taxes in respect of
services or service suppliers of other Members." This implies to us that a direct income tax measure
would generally be covered by Article XVII of the GATS. We base this view on the following
reasoning: unless a direct income tax measure were within the ambit of that provision, the Uruguay
Round negotiators would not have deemed it necessary to create such an explicit "exception" when
drafting the relevant provisions of the GATS. Clearly, provisions relating to national treatment under
the GATS were modelled after Article III of the GATT and reflect jurisprudence developed thereunder.
This contextual element, therefore, supports our view that the obligation in Article III:4 of the
GATT 1994 is not so circumscribed.

246 See e.g. Panel Report, Canada – Administration of the Foreign Investment Review Act , BISD
30S/140, adopted 7 February 1984, paras. 5.4-5.6; Panel Report, EC – Parts and Components , supra, note 233,
247 The term "advantage" has been used in this context in previous GATT and WTO dispute settlement
reports: see Panel Report, Canada – Autos , supra, note 231, para. 10.73; Panel Report, EC – Parts and
Components, supra, note 233, para. 5.21. The term "incentive" is used in the context of the Article III:4
examination by the Appellate Body in Appellate Body Report, EC - Bananas, supra, note 251, para. 213.
248 See EC response to Panel Question 31, Annex F-1, para. 79.
249 EC response to Panel Question 18, Annex F-1, paras. 47-48.
250 Ibid.

8.144 Furthermore, the terms "law, regulation or requirement affecting…" in Article III:4 are
general terms that have been interpreted as having a broad scope. 251 If measures conditioning access
to income tax advantages in respect of certain products were excluded from the scope of Article III:4,
a wide range of trade-distortive measures with enormous economic and commercial implications
would, in effect, be given a safe haven, while measures not linked to income tax advantages and
perhaps associated with a lesser extent of trade distortion would be subject to the disciplines of
Article III:4. It seems to us that such a interpretation runs counter to the object and purpose of the
GATT and the WTO Agreement (including the "elimination of discriminatory treatment" in
international trade
252) and can hardly have been what the drafters intended. On the basis of the text
and context of Article III:4 in light of the object and purpose of the GATT and the WTO Agreement,
we therefore consider that Article III:4 of the GATT 1994 applies to measures conditioning access to
income tax advantages in respect of certain products.
8.145 We take note of the preparatory work for the Havana Charter referred to by the United States
in these proceedings. In response to Panel questioning, the United States states that "there is support
in the history of the GATT that Article III:4 was never intended to apply to income taxes". According
to the United States, the Reports of the Havana Convention at which Article 18 of the Havana
Charter253 was drafted, specify that “neither income taxes nor import duties fall within the scope of
Article 18 which is concerned solely with internal taxes on goods". 254 This statement in the
preparatory work of the Havana Charter does not change our view that the scope of Article III:4 of the
GATT 1994 includes measures conditioning access to income tax advantages in respect of certain
products. While seemingly framed in general terms, this statement appears 255 in a section containing
comments on paragraphs 1, 2 and 3 of Article 18 and thus seems to relate to what would later become
Article III:2 of the GATT. It therefore would not be decisive concerning the scope of Article III:4, in
any event. Moreover, the statement was made in relation to the withdrawal of a specific proposal by
Peru dealing with a situation materially different th an the one currently before us (not deeming as "in
opposition to" Article 18 the exemption of import duties on equipment or materials and exemption
from income taxes granted for a limited time to enterprises created for the establishment of
"economically sound industries").
256 However, even if the statement was meant to refer more
generally to what would later become Article III as a whole (including Article III:4), if taken literally,
it would entirely exclude an area that was explicitly covered by Article 18 of the Havana Charter, and
now Article III:4 of the GATT: i.e., internal regulation (it suffices here to recall that Article III of the
GATT 1994 is entitled: "National Treatment on Internal Taxation and Regulation"), which would
amount to a result that clearly runs counter to the object and purpose of Article III and of the
GATT 1994 in general. Therefore, the statement in the preparatory work of the Havana Charter does

251 Appellate Body Report , European Communities - Measures Affecting the Importation, Sale and
Distribution of Bananas , adopted 25 September 1997, WT/DS27/AB/R, para. 220. See also Panel Report,
Canada-Autos, supra, note 231, para. 10.80; Panel Report, Italian Agricultural Machinery , BISD 7S/60,
adopted 23 October 1958, para. 12.
252 See preamble to the GATT 1947 and the Marrakesh Agreement Establishing the World Trade
Organization.
253 Final Act of the United Nations Conference on Trade and Employment , March 24, 1948.
254 In its response to Panel Question 18, the United States cites to the Interim Committee for the
International Trade Organization, Report of Committees and Principal Sub-Committees, Report of
Sub-Committee A of the Third Committee on Articles 16, 17, 18 and 19, E/CONF.2/C.3/59, para 44, page 63,
Geneva, 1948.
255 See ibid.
256 See Third Committee: Commercial Policy, Revised Annotated Agenda for Chapter IV, Proposed
Amendment by Peru, E/Conf.2/C.3/6/Add. 2, 17 December 1947.

not change our view that Article III:4 of the GATT 1994 applies to measures conditioning access to
income tax advantages in respect of certain products.257
8.146 Finally, we observe that previous panels have been of the view that the scope of Article III:4
extended to measures conditioning access to income tax advantages in respect of certain products.
Indeed, one WTO panel has observed that, “subsidies granted in respect of direct taxes are generally
not covered by Article III:2, but may infringe Article III:4 to the extent that they are linked to other
conditions which favour the use, purchase, etc. of domestic products."
258 We also note that provisions
relating to eligibility for an import duty exemption (an area also referred to in the preparatory work
cited by the United States as not falling within the scope of Article 18 of the Havana Charter) were at
issue in the Article III:4 inquiry by the panel in Canada-Autos.259
8.147 We next examine whether the measure at issue is one "affecting" the internal sale or use of
the products concerned. We recall here the Appellate Body's observation that the ordinary meaning of
the word "affecting" implies a measure that has "an effect on" and thus indicates a broad scope of
application.
260 Further, we observe that the term "affecting" in Article III:4 of the GATT 1994 has
been interpreted to cover not only laws and regulations which directly govern the conditions of sale or
purchase but also any laws or regulations which might adversely modify the conditions of competition
between domestic and imported products.261
8.148 We consider that a measure pursuant to which the use of domestic -- but not imported --
products contributes to obtaining an advantage has an impact on the conditions of competition
between domestic and imported products and thus "affects" the internal "use" of imported products,
even if the measure allows for other means to obtain the advantage, such as the use of domestic inputs
other than products. 262 Under the Act, by reason of the foreign articles/labour limitation, the use of
US-origin products contributes to obtaining the exclusion while the use of imported products does not.
Thus, we consider that it is a measure which "affects" the internal use of imported products even if
ways -- other than the use of goods -- exist to impute permissible fair market value.
8.149 For these reasons, we find that, by reason of the "foreign articles/labour limitation", the Act is
a "law, regulation or requirement" that affects the internal "use" in the United States of imported
goods and like domestic products for use in the production of qualifying foreign trade property.

257 Furthermore, we note that in accordance with the customary rules of interpretation of public
international law as codified in Articles 31 and 32 of the Vienna Convention on the Law of Treaties,
"Recourse may be had to supplementary means of interpretation, including the preparatory
work of a treaty … in order to confirm the meaning resulting from the application of article
31, or to determine the meaning when the interpretation according to article 31:
(a) leaves the meaning ambiguous or obscure; or
(b) leads to a result which is manifestly absurd or unreasonable."
Here, we do not consider that the ordinary meaning of the text of Article III:4, in its context and in light
of the object and purpose of the GATT 1994 and the WTO Agreement to be "ambiguous or obscure" or that our
interpretation of that provision "leads to a result which is manifestly absurd or unreasonable". We are therefore
of the view that it is not even necessary to refer at all to the preparatory work.
258 Panel Report, Indonesia - Certain Measures Affecting the Automobile Industry, WT/DS54/R,
WT/DS55/R, WT/DS59/R, WT/DS64/R, adopted 23 July 1998, para. 14.38.
259 Supra, note 231.
260 Appellate Body Report , European Communities - Bananas , supra, note 251 ,para. 220. See also
Panel Report, Canada-Autos, supra, note 231, para. 10.80.
261 Panel Report, Italian Agricultural Machinery , supra, note 251, para. 12; see also Panel Report,
262 See Panel Report, Canada-Autos, supra, note 231, para. 10.82.

(iii) whether the Act accords imported products "less favourable" treatment than that accorded to
like domestic products by reason of the foreign articles/labour limitation
8.150 The parties disagree as to whether or not the Act accords less favourable treatment than that
accorded to like domestic products by reason of the foreign articles/labour limitation.
8.151 The European Communities argues that in all cases, the "foreign articles/labour limitation"
will act as an incentive to source inputs domestically because this will enhance the chances of a US
producer intending to export its goods to qualify for the tax benefit. 263 According to the European
Communities, this is sufficient to violate Article III:4, which guarantees equality of competitive
opportunities. While the European Communities recognizes that the Act does not oblige a US
producer to use US inputs, the European Communities argues that this is in many cases one of the
necessary conditions for obtaining the advantage, and in all other cases the scheme encourages the use
of US goods over foreign goods. 264 Thus, the Act gives "less favourable treatment" to imported
goods. In any event, the European Communities considers that, under Article III:4, "[a]ny individual
product must be treated no less favourably than a like domestic product -- and this in all cases, for all
transactions".265
8.152 The core of the US response to this claim hinges on its argument that no less favourable
treatment is afforded to imported goods because the foreign articles/labour limitation does not change
or affect the conditions of competition. According to the United States, taxpayers are under no
obligation to use domestic content.
266 The United States contends that the Act does not require the
use of any US-origin goods for a transaction to earn excluded extraterritorial income 267, but rather
provides that up to 50 per cent of the fair market value of the goods involved in a transaction may be
attributable to articles produced outside the United States and direct labour costs incurred outside the
United States. The US underlines, and deems it fundamental, that goods can meet this requirement
even if 100 per cent of the fair market value of their inputs is foreign.
268
8.153 With these considerations in mind, we examine the text of the foreign articles/labour
limitation in the Act to see whether it adversely affects the equality of competitive opportunities of
imported products in relation to like domestic products and thus affords less favourable treatment to
imported products than to like domestic products within the meaning of Article III:4 of the
GATT 1994.
8.154 We observe that we are dealing here with a statutory requirement that is expressly and
explicitly origin-based: there is an explicit reference in the Act to articles manufactured or produced
"outside", as opposed to within, the United States . We are well aware, however, that any distinction
that is based exclusively on criteria relating to the nationality or origin of the product will not

263 EC first written submission, Annex A-1, paras. 205, 207, 208; EC written rebuttal submission,
Annex C-1, para. 231.
264 EC first written submission, Annex A-1, paras. 191-195; EC second written submission, Annex C-1
para. 231; EC oral statement, Annex D-1, para. 82; EC closing oral statement, Annex D-2, paras. 32-34.
265 EC first written submission, Annex A-1, para. 211.
266 US oral statement, Annex D-3, para. 166.
267 US first written submission, Annex A-2, para. 214.
268 The United States submits that the foreign articles/labour limitation takes into account only the
value of foreign articles and direct labour costs in producing a finished product, but does not limit other foreign
value. Thus, the United States submits, the remaining 50 per cent of fair market value of the finished product
can be attributed to non-tangible elements, including intellectual property rights, goodwill, capital, marketing,
distribution and other services, which may be of either US or foreign origin. According to the United States, the
articles used in manufacturing, whatever their origin, account for only part of the total value. See e.g.
United States first written submission, Annex A-2, para. 201.

necessarily be incompa tible with Article III. 269 Article III:4 requires rather that a measure accord
treatment to imported products that is “no less favourable than” that accorded to like domestic
products. Therefore, we do not halt our examination here.
8.155 We further observe that the foreign articles/labour limitation explicitly places a limit on the
proportion of the fair market value of a product that can be derived from imported products (and
foreign labour) only, and places no similar constraint on the proportion of the fair market value of a
product that can be derived from domestic products (and labour).
8.156 We note that the use of imported products by a manufacturer in the US cannot contribute to
the fulfilment of the foreign articles/labour limitation -- a condition necessary to obtain the advantage
in the form of the exclusion from tax of the portion of extraterritorial income that is qualifying foreign
trade income available under the Act -- whereas the use of domestic products can. Thus, an advantage
is conferred upon the use of domestic products that is not conferred upon the use of imported
products. This constitutes a formal differentiation of treatment between imported and like domestic
products which, in our view, affords less favourable treatment to imported products than to like
domestic products.
8.157 At the heart of the US argument in response to this claim is its assertion that the foreign
articles/labour limitation does not necessarily require the use of US-origin goods. Thus, more than
50 per cent of the fair market value of "qualifying foreign trade property" could be attributable to US
or foreign intellectual property, goodwill, capital, marketing, distribution or other services. However,
we are of the view that the existence of other ways to impute value does not change the fundamental
fact that, as far as goods are concerned, the foreign articles/labour limitation creates an incentive to
use domestic rather than imported goods. That there may exist other ways to impute permissible fair
market value in order to obtain qualifying foreign trade property does not vitiate the fact that this
incentive inherently advantages domestic goods and that less favourable treatment is thereby accorded
to imported goods than to domestic goods.
8.158 In light of these considerations, we consider that, by reason of the foreign articles/labour
limitation, the Act accords less favourable treatment within the meaning of Article III:4 of the
GATT 1994 to imported products than to like products of US origin because, by conferring an
advantage upon the use of products of US origin but not upon the use of imported products, it
adversely affects the equality of competitive opportunities of imported products in relation to like
products of United States origin.
8.159 We wish to point out that the United States argument that the European Communities has
presented insufficient factual evidence in support of its claim of inconsistency of the Act, by reason of
the foreign articles/labour limitation, with Article III:4 of the GATT 1994 is not germane to our
examination. In order to reach our finding of de jure violation of Article III:4, we take note of, but
need not rely on, the evidence submitted by the Eu ropean Communities indicating that in certain
cases, the foreign articles/labour limitation would appear to require the use of a certain amount of US
articles. The "less favourable treatment" we have found arises by necessary implication from the
words actually used in the text of the foreign articles/labour limitation in the Act. We recall that
Article III:4 of the GATT 1994 is an obligation addressed to governments requiring that they ensure
equality of competitive opportunities to domestic and like imported products. It does not require a
demonstration of trade effects, nor proof that the sourcing decisions of private firms have actually
been impacted by the requirement in question.
270

269 See Appellate Body Report, Korea-Beef, supra, note 230, paras. 137-138.
270 We find support for this view in Panel Report , Canada-Autos , supra, note 231, para. 10.84 and
para. 10.78, Appellate Body Report, Japan – Alcoholic Beverages, supra, note 197, pp. 16-17.

2. Other claims
8.160 We note that the European Communities has also alleged that the "extended" subsidy, in
respect of goods produced outside the United States, is prohibited because it will often be necessary to
use US articles (and therefore exports) in order to satisfy the "foreign articles/labour limitation "271,
and that "[t]he foreign content limitation in the FSC Replacement scheme renders the basic FSC
Replacement subsidy (and the extended FSC Replacement subsidy, if this is not contrary to
Article 3.1(a)) contingent upon the use of US over imported goods contrary to Article 3.1(b) of the
SCM Agreement."
272
8.161 We recall that we need not examine all legal claims before us. Rather, we need only address
those claims that must be addressed in order to resolve the matter in issue in the dispute 273, provided
that we address those claims on which a finding is necessary in order to enable the DSB to make
sufficiently precise recommendations and rulings so as to allow for prompt compliance by a Member
in order to ensure effective resolution of disputes to the benefit of all Members.
274
8.162 In light of our finding that the Act is inconsistent with Article III:4 of the GATT 1994 by
reason of the "foreign articles/labour limitation" in respect of US-produced goods 275, we do not
consider it necessary to also address the EC claim that the Act is inconsistent with Article 3.1(b) of
the SCM Agreement by reason of the foreign articles/labour limitation in respect of US-produced
goods.
8.163 With respect to the elements of the Act challenged by the European Communities in its claim
under Article 3.1(a) of the SCM Agreement in respect of foreign-produced goods, we understand the
European Communities to allege, in effect, that US-produced inputs that are used to produce
qualifying foreign trade property outside the United States receive a subsidy contingent upon export
performance. Under the current scheme, to the extent that a supplier of such inputs may be seen as
receiving a "subsidy", it would be entitled to receive that subsidy irrespective of whether the inputs
were used to produce qualifying foreign trade property within the United States or outside the
United States. In order to decide the EC claim, we would be required to assume a different scheme,
that is, where an input supplier might be seen as entitled to a "subsidy" only where the inputs were
supplied for use in production of qualifying foreign trade property outside the United States (i.e. a
scheme devoid of a foreign articles/labour limitation in respect of qualifying foreign trade property
produced within the United States, which currently constitutes an integral part of the measure).
However, such a significantly transformed measure would be manifestly different from the measure
that is currently before us, and, as such, we consider that it would be neither necessary or appropriate
to rule on it. With respect to the European Communities' alternative claim under Article 3.1(b) of the
SCM Agreement , the European Communities asks us "to consider the application of the foreign
content limitation in the case of non-US producers only if [we are] of the view that this limitation
does not make the extended FSC Replacement subsidy contingent upon export performance contrary
to Article 3.1(a)."
276 As we have not ruled on the EC claim under Article 3.1(a), it would therefore be
inappropriate for us to rule on the alternative EC claim under Article 3.1(b) of the SCM Agreement.

271 EC response to Panel Question 1, Annex F-1, paras. 1-4.
272 EC first written submission, Annex A-1, para. 259.
273 Appellate Body Report, United States - Measure Affecting Imports of Woven Wool Shirts and
Blouses from India , WT/DS33/AB/R, adopted 23 May 1997, p. 19. See also e.g. Appellate Body Report ,
Canada - Autos, supra, note 118, paras. 112-117, where the Appellate Body refers to and endorses that panel's
exercise of the "discretion" implicit in the principle of judicial economy.
274 Appellate Body Report, Australia-Measures Affecting Importation of Salmon , WT/DS18/AB/R,
adopted 6 November 1998, para. 223.
275 supra, para. 8.158.
276 EC first written submission, Annex A-1, para. 184.

D. TRANSITIONAL ISSUES
8.164 In our Report in the original dispute, we recommended "that the DSB request the
United States to withdraw the FSC subsidies without delay"277, and specified that "FSC subsidies must
be withdrawn at the latest with effect from 1 October 2000". 278 These elements formed part of the
DSB recommendations and rulings arising upon adoption, on 20 March 2000, of the original Panel
and Appellate Body Reports. On 12 October 2000, the DSB acceded to the United States' request
"that the DSB modify the time-period in this dispute so as to expire on 1 November 2000”.
279
8.165 The European Communities argues that by maintaining the availability of FSC subsidies after
30 September 2000, for transactions effected by existing FSCs until 31 December 2001 (and, under
certain circumstances, for an indefinite period), the United States has failed to withdraw the FSC
subsidies as required by Article 4.7 SCM Agreement and the recommendations and rulings of the DSB
and has also failed to comply with its obligations under Article 21 DSU.280
8.166 In the US view, the "limited transition relief" available under the Act provides foreign and
domestic businesses with an opportunity to adjust and protect people who might have altered their
conduct in reliance on the tax treatment provided by the earlier law, and is reasonable in the particular
circumstances of this case. The United States contends that WTO panels have excused procedural
violations in the absence of prejudice to the complaining party, essentially taking into account
equitable considerations in issuing their decisi ons. According to the United States, a limited
adjustment period is particularly appropriate given the EC's 13-year delay in challenging the FSC and
the United States' reasonable reliance on the 1981 decision and understanding of the GATT 1947
Council.
281 Thus, the United States argues that the Act's limited transition rules constitute "reasonable
implementation of the DSB's recommendations".282
8.167 We recall that the Act provides that "amendments made by this Act shall apply to transactions
after 30 September 2000" 283, and that no new FSCs may be created after 30 September 2000. 284
However, in the case of a FSC in existence on 30 September 2000, the amendments made by the Act
shall not apply to any transaction in the ordinary course of trade or business involving a FSC which
occurs: (A) before 1 January 2002; or (B) after 31 December 2001, pursuant to a binding contract
between the FSC (or any related person) and any unrelated person that is in effect on
30 September 2000.
285
8.168 Thus, for FSCs in existence as of 30 September 2000, the FSC subsidies continue in operation
for one year and, with respect to FSCs that entered into long-term, binding contracts with unrelated
parties before 30 September 2000 the Act does not alter the tax treatment of those contracts for an
indefinite period of time. We recall the statement of the Appellate Body in Brazil - Export Financing
Programme for Aircraft, Recourse by Canada to Article 21.5 of the DSU that, "to continue to make

277 Original Panel Report, supra, note 2, para. 8.3.
278 Original Panel Report, supra, note 2, para. 8.8.
279 WT/DS108/11, 2 October 2000. See supra, para. 1.3 and WT/DSB/M/90, paras. 6-7.
280 EC first written submission, Annex A-1, para. 241.
281 Tax Legislation, BISD 28S/114, 7-8 December 1981.
282 US first written submission, Annex A-2, paras. 223-229.
283 Act, section 5(a).
284 Act, section 5(b)(1).
285 Act, section 5(c)(1). The Act specifies that a binding contract shall include a purchase option,
renewal option or replacement option whic h is included in such contract and which is enforceable against the
seller or lessor.

payments under an export subsidy measure found to be prohibited is not consistent with the obligation
to "withdraw" prohibited export subsidies, in the sense of "removing" or "taking away"."286
8.169 We also observe that the United States does not dispute that prohibited FSC subsidies
continue to be available after the time-period set for compliance in this dispute.287
8.170 In light of these considerations, we find that the United States has not fully withdrawn the
FSC subsidies found to be prohibited export subsidies inconsistent with Article 3.1(a) of the SCM
Agreement and has therefore failed to implement the recommendations and rulings of the DSB made
pursuant to Article 4.7 SCM Agreement.
8.171 Having found that the United States has not fully withdrawn the FSC subsidies as required by
the recommendations and rulings of the DSB made pursuant to Article 4.7 SCM Agreement, we do not
believe that it is necessary to also determine whet her the United States “failed to comply with the
DSB recommendations and rulings within the period of time specified by the DSB and has therefore
also failed to comply with Article 21 DSU"
288 due to its enactment of the Act repealing the FSC on
15 November 2000. We therefore exercise judicial economy with respect to this claim.
IX. CONCLUSION
9.1 In light of the findings contained in Section VIII above, we therefore conclude that:
(a) the Act is inconsistent with Article 3.1(a) of the SCM Agreement as it involves
subsidies "contingent… upon export performance" within the meaning of
Article 3.1(a) of the SCM Agreement by reason of the requirement of “use outside the
United States” and fails to fall within the scope of the fifth sentence of footnote 59 of
the SCM Agreement because it is not a measure to avoid the double taxation of
foreign-source income within the meaning of footnote 59 of the SCM Agreement;
(b) the United States has acted inconsistently with its obligation under Article 3.2 of the
SCM Agreement not to maintain subsidies referred to in paragraph 1 of Article 3 of
the SCM Agreement;
(c) the Act , by reason of the requirement of “use outside the United States”, involves
export subsidies as defined in Article 1(e) of the Agreement on Agriculture for the
purposes of Article 10.1 of the Agreement on Agriculture and the United States has
acted inconsistently with its obligations under Article 10.1 of the Agreement on
Agriculture by applying the export subsidies, with respect to both scheduled and
unscheduled agricultural products, in a manner that, at the very least, threatens to
circumvent its export subsidy commitments under Article 3.3 of the Agreement on
Agriculture and, by acting inconsistently with Article 10.1, the United States has
acted inconsistently with its obligation under Article 8 of the Agreement on
Agriculture;
(d) the Act is inconsistent with Article III:4 of the GATT 1994 by reason of the foreign
articles/labour limitation as it accords less favourable treatment within the meaning of
that provision to imported products than to like products of US origin; and

286 Appellate Body Article 21.5 Report, Brazil - Export Financing Programme for Aircraft, Recourse
by Canada to Article 21.5 of the DSU, WT/DS46/AB/RW, adopted 4 August 2000, para. 45.
287 See US first written submission, Annex A-2, para. 224.
288 EC first written submission, Annex A-1, paras. 242-246.

(e) the United States has not fully withdrawn the FSC subsidies found to be prohibited
export subsidies inconsistent with Article 3.1(a) of the SCM Agreement and has
therefore failed to implement the recommendations and rulings of the DSB made
pursuant to Article 4.7 SCM Agreement.
9.2 Since Article 3.8 of the DSU provides that "[i]n cases where there is an infringement of the
obligations assumed under a covered agreement, the action is considered prima facie to constitute a
case of nullification or impairment", we conclude that to the extent the United States has acted
inconsistently with the SCM Agreement, the Agreement on Agriculture and the GATT 1994 it has
nullified or impaired the benefits accruing to the European Communities under those agreements.

ANNEX A
First Submission by the Parties
Contents Page
Annex A-1 First Written Submission of the European Communities A-2
Annex A-2 First Written Submission of the United States A-51

1. INTRODUCTION
1. The FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (the “FSC Replacement
Act”), adopted on 15 November 2000 as US Public Law No 106-519, is the measure taken by the US
ostensibly to comply with the recommendations and rulings of the DSB following the earlier
proceedings before the Panel. 1 It does not however bring the US into compliance with those
recommendations and rulings for the reasons the EC will explain in detail below. Although the FSC
Replacement Act states that it repeals the FSC scheme, this scheme will continue to be available to all
existing FSC scheme until 1 January 2002 and to apply to certain of their transactions for an indefinite
period. Also, for those transactions where the FSC scheme no longer applies, the FSC Replacement
Act makes available an alternative scheme that increases and extends the subsidies that were available
under the FSC scheme without removing the contingency on export performance or on the use of
domestic over imported goods.
2. The description of the factual background (Section 2) is limited to the essential information.
More detail about the US measure is provided as and when needed during the legal analysis
(Section 3). Before concluding, the EC will ask the Panel to clarify the rights of third parties in this
proceeding by means of a request for a preliminary ruling (Section 4).
2. FACTUAL BACKGROUND
3. The Panel is well aware of the background of this dispute through its work on the original
Panel Report, which was upheld by the Appellate Body in virtually all respects except for a change in
the reasoning relating to the violation of the Agreement on Agriculture. The recommendations of the
Panel were adopted by the Dispute Settlement Body on 20 March 2000.
2
4. Initial US proposals for complying with the recommendations of the DSB, for example by
reducing the level of the tax deductions, were rejected by US business groups that lobbied vigorously
to maintain their benefits. According to Inside US Trade of 24 March 2000:
Large companies that stand to lose billions of dollars in tax benefits if the FSC were
changed have taken a very hard line on rolling back FSC benefits. They hope the EU
will agree to a cosmetic change of the FSC …
3
5. Accordingly, the US decided to attempt to comply with the DSB recommendations by
replacing the FSC scheme with other tax provisions that would maintain the same benefits.
6. The first official communication of US intentions came on 2 May 2000 when the US Deputy
Secretary of the Treasury, Mr Eizenstat, came to Brussels to outline a proposal to the EC
Commission.
7. This initial US proposal would have involved a repeal of the current FSC scheme and its
replacement by an elective tax regime that would tax the “qualifying foreign income” of “eligible
corporations” at a rate of 12.17 per cent or 24.5 per cent. The text of this proposal is Exhibit EC-2.
8. This new elective tax regime would have been very similar in effect to the FSC scheme. The
tax rate of 12.17 per cent applied only if the “safe haven method” for calculating “qualifying foreign

1 United States – Tax Treatment for “Foreign Sales Corporations.” Reports of the Panel
(WT/DS108/R, 8 October 1999) and by the Appellate Body on (AB-1999-9, WT/DS108/AB/R,
24 February 2000) adopted by the DSB on 20 March 2000.
2 Doc. WT/DS108/10 of 24 March 2000.
3 The relevant extract is Exhibit EC-1.

income” was used and corresponded to the FSC benefit using administrative pricing rules (12.17 per
cent being equivalent to 8/23 of 35 per cent) and the rate of 24.5 per cent, applied in other cases
(24.5 per cent being about double 12.17 per cent).
9. Also, an “eligible corporation” would have been defined as a foreign corporation that
(i) is managed outside the United States, and
(ii) conducts economic activity outside the United States with respect to its "qualifying
foreign income."
 4
and “qualifying foreign income” would have had to be earned by an "eligible corporation," from the
sale, lease, or rental of goods
(i) manufactured by an "eligible manufacturing corporation,"
(ii) sold, leased, or rented for use, consumption, or disposition outside the United States,
and
(iii) not more than 50 per cent of the fair market value of which is attributable to foreign
content.
5
10. The main change compared with the FSC scheme was that the benefit of the new scheme
would also have become available to foreign sale s of certain foreign manufactured goods (of which
not more than 50 per cent of the fair market value was attributable to foreign content).
11. In the view of the US, the enlarged applicati on of the elective regime to both export foreign
sales (involving US manufacturing) and non-export foreign sales (involving foreign manufacturing)
would have rendered this scheme non export contingent.
12. On 26 May 2000, by a letter of Commissioner Lamy to Mr Eizenstat, the EC made clear its
view that this proposal was unacceptable as it did not fulfil the conditions for WTO compatibility
(Exhibit EC-3).
13. On 28 July 2000, US Deputy Secretary of St ate Eizenstat wrote to Commissioner Lamy to
inform him about the passage by the House Ways and Means Committee on 27 July of the legislation
to replace the FSC scheme. The bill submitted to Congress removed some of the ancillary elements of
the 2 May proposal, like the need to create a foreign corporation to channel sales, but the US
nonetheless persisted with the same basic scheme, developing its form to make it, in the US view,
more easily defendable within the WTO, while still maintaining equivalent benefits for FSC
beneficiaries.
14. Commissioner Lamy wrote to US Deputy Secr etary of State Eizenstat on 31 August 2000 to
express his concerns about the content of the bill as according to him it failed to remove the WTO
violations that were present in the FSC scheme (Exhibit EC-4).
15. The bill was ultimately signed into law on 15 November 2000 as an Act of the US Congress
entitled FSC Repeal and Extraterritorial Income Exclusion Act of 2000 . The text of this Act is
attached as Exhibit EC-5. An explanation of its provisions is contained in the US Congress Joint
Committee on Taxation, Technical Explanation of the Senate Amendment to H.R. 4986, the “FSC

4 See page 2 of the US proposal in Exhibit EC-1.
5 See page 2 of the US proposal in Exhibit EC-1.

Repeal and Extraterritorial Income Exclusion Act of 2000 (JCX-111-00) of 1 November 2000
(Exhibit EC-5A).
16. The intent to continue the effect of the FSC scheme is apparent in particular through the
statement6 in the Joint Committee on Taxation explanation that during the “gap period” pending the
issuance of administrative guidance on the application of the new scheme, taxpayers may apply the
principles of present law regulations and other administrative guidance under the FSC scheme.
17. The title of this law is misleading in a number of ways. First, it does not entirely repeal the
FSC scheme, but allows it to continue for an indefinite period, as the EC will explain in more detail in
Section 3.9 below. Second, it does not concern “extraterritorial” income in any real of that word. The
income to which it relates can be earned entirely in the US. It seems that the US is using the word
“extraterritorial” to mean “export” or “derived from sales for foreign consumption”. Finally, the word
“exclusion” is confusing because the Act does nothing other than exempt a certain amount of income
from tax, in a manner that is different in form but not in substance from the FSC scheme. For these
reasons the EC will refer to the Act as the “FSC Replacement Act”.
18. The nature of the new scheme introduced by the FSC Replacement Act (and which the EC
will refer to as the “FSC Replacement scheme” to distinguish it from its predecessor) is well
summarised in a Congressional Research Service Report on Foreign Sales Corporation Tax Benefit
for Exporting and the World Trade Organization as follows:7
H.R 4986 begins by exempting "extraterritorial income" from US tax, and continues
by defining "extraterritorial income" and a chain of other concepts in a way that
confines its exemption to a firm's US exports and a matching amount of income from
foreign operations. The initial link in the chain of definitions is "qualifying foreign
trade property", which is generally pr oducts manufactured, produced, grown, or
extracted within or outside the United States. Generally, this is the full range of US
exports, but the bill explicitly excludes the same items as FSC: certain intangibles, oil
and gas, raw timber, prohibited exports, and property in short supply. Unlike FSC,
however, military products would apparently qualify for the same benefit as other
exports. And unlike the parallel FSC concept of export property, qualifying foreign
trade property can be partly manufactured outside the United States. However, not
more that 50 per cent of the value of qualified property can be added outside the
United States.
The next link in the chain is "foreign trade gross receipts", which the bill defines as
income from sale or lease of qualifying trade property, and which parallels the FSC
concept of gross receipts. As with FSC, a firm would only be treated as earning
foreign trading gross receipts if it conducts economic processes abroad. However,
FSC's foreign management requirements (see page 4, above) would be dropped.
The bill next defines "foreign trade income" as taxable income attributable to foreign
trading gross receipts. The bill terms a specified part of this foreign trade income
"qualifying foreign trade income", and gran ts such income a tax exemption. The bill
sets qualifying foreign trade income (and thus the exclusion) equal to either 1.2 per
cent of foreign trading gross receipts, 15 per cent of foreign trade income, or 30 per

6 Exhibit EC-5A, p. 20.
7 Congressional Research Service Report on Foreig n Sales Corporation Tax Benefit for Exporting and
World Trade Organization The Foreign Sales Corporation FSC Tax Benefit for Exporting and the WTO David
L. Brumbaugh Specialist in Public Finance. Government and Finance Division (Updated 22 September 2000) -
Exhibit EC-6.

cent of the income attributable to the foreign economic processes undertaken under
the foreign trading gross receipts requirements. (The rule exempting 30 per cent of
income is similar in its effect to the FSC rule that applies to firms that use arm's
length pricing.) As with FSC and the May proposal before it, the arithmetic result of
the rules is that a firm can exempt somewhere between 15 per cent and 30 per cent of
qualified income from US tax.
19. The main features of the FSC Replacement scheme compared with the FSC scheme to which
the EC would draw attention at this point are:
8
• The FSC Replacement scheme preserves the tax benefits available under the FSC scheme and
envisaged in the initial US proposal in May 2000, that is an exemption of between 15 per cent
and 30 per cent of export income. The formulae for calculating the exclusion from income are
arithmetically equivalent to those available under the FSC scheme (as the EC will explain
below).
• The FSC Replacement scheme is however simpler and easier to use than the FSC scheme.
The need for a separate foreign corporation to earn the exempted income has been removed
and the maximisation of tax benefits by using the most favourable method for calculating
qualifying foreign trade income can now be conducted by the US tax authorities;
• The FSC Replacement scheme is available under certain circumstances for income earned
from the sale of goods by foreign corporations that elect to be treated as domestic US
corporations;
• The 50 per cent foreign content limitation that exists under the FSC scheme has been adapted
to the features of the new law so as to include foreign direct labour costs.
20. The FSC Replacement Act therefore does nothing to meet the concerns of the EC, the Panel,
the Appellate Body or the DSB about the export subsides granted by the US tax system. It is an
attempt to disguise them. Indeed its purpose is, as US Deputy Secretary of State Eizenstat intimated
when urging the US Senate to pass the bill, to prevent immediate retaliation and to give the US “a
chance to ‘re-litigate’ the dispute”.
9
21. The Congressional Budget Office estimated that the FSC Replacement Act would increase tax
expenditures compared to the existing FSC scheme by the following amounts:
10
Estimated Budget Effects of H.R. 4986, The ‘‘FSC Repeal And Extraterritorial
Income Exclusion Act of 2000,’’ as Reported by the Committee on Finance
[Fiscal Years 2001– 2010, in millions of dollars]
Provision Effective 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001-
05
2001-
10
Extra-
territorial
income
Generally
ta
-141 -305 -340 -378 423 -466 -514 -566 -623 -687 -1,587 -4,443
8 For a fuller explanation of the differences between the FSC scheme and the FSC Replacement
scheme, the Panel is referred to the annexed documents. The EC will describe the provisions of the Act in more
detail as and when necessary below.
9 US Deputy Secretary of State Eizenstat speaking during the Senate Finance Committee passing of the
bill on 19 September 2000 and reported in Inside US Trade, 22 September 2000, page 26 (Exhibit EC-7).
10 Taken from the Senate Report of 20 September 2000. The Congressional Budget Office Cost
Estimate of 13 September 2000 (Exhibit EC-8) contained slightly higher estimates.

Exclusion: FSC Repeal 9/30/00
Legend for ‘‘Effective’’ column: ta = transaction after.
Note: Details may not add to totals due to rounding.
Source: Joint Committee on Taxation.
22. Despite its disappointment with the fact th at the US has refused to comply with the
recommendations of the DSB, the EC has endeavoured to de-escalate this dispute in the hope that a
calm political environment would facilitate the task of the US in ultimately coming into compliance.
For this reason, it has entered into a procedural agreement with the US, which it has notified to the
WTO11 and which underlines the importance that the EC attaches to the multilateral character of the
WTO dispute settlement system.
23. On 17 November 2000 the EC initiated the procedures under Article 21.5 of the
Understanding on Rules and Procedures Governing the Settlement of Disputes (“DSU”) by requesting
the US to enter into consultations.12
24. Consultations were held with the US on FSC Replacement scheme in Geneva on
4 December 2000 Act. They allowed a better understanding of the respective positions of the parties
but failed to resolve the dispute.
25. Accordingly, the EC requested that the Panel be reconvened to examine this issue under
Article 21.5 DSU.
13 The Panel was established on 20 December 2000.
3. LEGAL ANALYSIS
3.1. Introduction
26. In the view of the EC, the FSC Replacement Act fails to bring the US into compliance with
the DSB recommendations and rulings and is inconsistent with the covered agreements. The FSC
Replacement scheme provides equally prohibited subsidies to US exporters as does the FSC scheme
and introduces further prohibited subsidies to certain foreign corporations.
27. There is disagreement both as to the existence and the consistency with covered agreements
of measures taken to comply with the recommendations and rulings of the DSB within the meaning of
Article 21.5 DSU. The US has even refused at the consultations to accept that no measures taken to
comply with the recommendations and rulings of the DSB “existed” on the date by which the DSB
had fixed for them to be taken.
28. Accordingly, the mandate of the Panel pursuant to Article 21.5 of the DSU and in the light of
Article 4 of the Agreement on Subsidies and Countervailing Measures (“ SCM Agreement ”) is to
determine whether the US has withdrawn the subs idy and complied with the recommendations and
rulings of the DSB by the due dates and whether the US measures (the FSC Replacement Act and its
related provisions) are consistent with the covered agreements.
29. The EC will set out in the following order the reasons why it considers that the FSC
Replacement Act is inconsistent with the obligations of the US under the covered agreements and that
by failing to withdraw the subsidies found to be inconsistent with the SCM Agreement and to bring its

11 Understanding between the European Communities an d the United States Regarding Procedures
under Articles 21 and 22 of the DSU and Article 4 of the SCM Agreement, WT/DS108/12, 5 October 2000.
12 The request was circulated in document WT/DS108/14 of 21 November 2000.
13 WT/DS108/16, 8 December 2000.

law into conformity with its obligations under the SCM Agreement and the Agreement on Agriculture,
the US has also failed to comply with the DSB recommendations and rulings in this dispute:
• that the FSC Replacement scheme results in the foregoing of tax revenue that is otherwise
due, thereby conferring a benefit upon recipients. Therefore, the FSC Replacement Act
provides subsidies within the meaning of Article 1 of the SCM Agreement and under the
Agreement on Agriculture;
• that the FSC Replacement scheme provides subsidies which are contingent upon export
performance contrary to Article 3.1(a) of the SCM Agreement and specifically related to
export contrary to item (e) of Annex 1 of the SCM Agreement;
• that the FSC Replacement scheme provides subsidies which are contingent upon the use of
domestic over imported goods contrary to Article 3.1(b) of the SCM Agreement;
• that consequently, the FSC Replacement scheme grants and maintains subsidies contrary to
Article 3.2 of the SCM Agreement;
• that the FSC Replacement scheme provides treatment less favourable to products imported
into the US that is accorded to like US products, contrary to Article III:4 of GATT 1994;
• that the subsidies provided by the FSC Replacement scheme are contrary to Articles 10.1 and
8 of the Agreement on Agriculture , or in, the alternative, Articles 3.3 and 8 in conjunction
with Article 9.1 of the Agreement on Agriculture;
• that the FSC Replacement Act contains transitional provisions which allow companies to
continue to benefit from the WTO incompatible FSC scheme beyond 30 September 2000;
• that the US has failed to comply with the DSB recommendations and rulings in United States
- Tax Treatment for "Foreign Sales Corporations", WT/DS108 by 1 November 2000, as
specified by the DSB on 12 October 2000.
3.2. The FSC Replacement scheme continues to provide subsidies
3.2.1. The findings of the Panel and the Appellate Body on the FSC scheme
30. The Panel will recall that the FSC scheme was held to involve a financial contribution by
government that confers a benefit and therefore to give rise to a subsidy because it involved the
forgoing of revenue that would otherwise be due. As the Appellate Body stated in upholding the
finding of the Panel:
14
In our view, the "foregoing" of revenue "otherwise due" implies that less revenue has
been raised by the government than would have been raised in a different situation,
or, that is, "otherwise". Moreover, the word "foregone" suggests that the government
has given up an entitlement to raise revenue that it could "otherwise" have raised.
This cannot, however, be an entitlement in the abstract, because governments, in
theory, could tax all revenues. There must, therefore, be some defined, normative
benchmark against which a comparison can be made between the revenue actually
raised and the revenue that would have been raised "otherwise". We, therefore, agree
with the Panel that the term "otherwise due" implies some kind of comparison

14 Appellate Body Report, para. 90.

between the revenues due under the contested measure and revenues that would be
due in some other situation. We also agree with the Panel that the basis of
comparison must be the tax rules applied by the Member in question.
31. The only point on which the Appellate Body’s reasoning on Article 1 of the SCM Agreement
differed from that of the Panel related to the question of whether:15
… the term "otherwise due" establishes a "but for" test, in terms of which the
appropriate basis of comparison for determining whether revenues are "otherwise
due" is "the situation that would prevail but for the measures in question…"
32. The Appellate Body’s difficulty with this test was that it was not treaty language and would
imply that changing an exception from taxation into an exclusion from taxation would imply that
there was no subsidy. In the Appellate Body’s words:
16
It would, we believe, not be difficult to circumvent such a test by designing a tax
regime under which there would be no general rule that applied formally to the
revenues in question, absent the contested measures.
33. The Panel and the Appellate Body also stressed that there the WTO Agreement did not restrict
the right (indeed “the sovereign authority”) of WTO Members to tax, or not to tax, particular
categories of revenue,
17 so long as it respects its WTO obligations. It appears that the US will attempt
to argue that the FSC Replacement Act does not give rise to a subsidy because the US has simply
exercised this right and has chosen not to tax a category of income that it terms “extraterritorial” (or
“qualifying foreign trade income”).
3.2.2. The changes introduced by the FSC Replacement Act
34. The FSC Replacement Act abolishes, subject to various transitional arrangements, the FSC
exemptions and replaces them with a scheme whereby certain “qualifying foreign trade income” is
said to be “excluded” from taxation.
35. This “excluded” qualifying foreign trade income corresponds arithmetically to the exempt
foreign trade income of FSC scheme. The text of the new Section 941(a) of the IRC, which defines
this concept, merits quoting in full:
(1) I
N GENERAL . The term `qualifying foreign trade income' means, with
respect to any transaction, the amount of gross income which, if excluded, will result
in a reduction of the taxable income of the taxpayer from such transaction equal to the
greatest of
(A) 30 per cent of the foreign sale and leasing income derived by the taxpayer
from such transaction,
(B) 1.2 per cent of the foreign trading gross receipts derived by the taxpayer from
the transaction, or
(C) 15 per cent of the foreign trade income derived by the taxpayer from the
transaction.

15 Appellate Body Report, para. 91 referring to Panel Report, paragraph 7.45.
16 Appellate Body Report, para. 91.

36. Thus, the new Section 941(a)(1)(A) provides an exclusion equal to 30 per cent of foreign sale
and leasing income which corresponds to the 30 per cent exclusion available under in the FSC scheme
applicable when the administrative pricing rules are not applied (Section 923(a)(2)). The new
Section 941(a)(1)(B) provides an exclusion equal to 1.2 per cent of foreign trading gross receipts is
equal to that available under the FSC scheme 18 (multiplying 15/23 by 1.83 per cent yields 1.2 per
cent.). The new Section 941(a)(1)(C) provides an exclusion equal to 15 per cent of foreign trade
income, which is equal to that available under FSC scheme19 (multiplying 15/23 by 23 per cent yields
15 per cent).
37. The FSC Replacement Act also simplifies the availability of the benefit by removing the need
for a foreign subsidiary (the FSC), removing other formalities and placing on the US Internal Revenue
Service the task of identifying the formula that maximises the benefit to the taxpayer for each
transaction.
38. The first basic question is therefore whether the fact that the FSC Replacement Act is
expressed in terms of excluding certain income from taxation, whereas the FSC scheme used the term
“exempt” (as well as the term “excluded”), means that there is no longer any subsidy (because WTO
Members are allowed to choose what categories of income they will tax).
39. The EC will show below that the FSC Replacement scheme is just as much a subsidy as was
(and is) the FSC scheme. The EC will first explain why the US is playing with words when it claims
that the scheme is different from the FSC scheme by excluding income from tax rather than exempting
it. The EC will then return to the terms of Article 1.1 SCM Agreement as interpreted by the Panel and
the Appellate Body to demonstrate that the cosmetic changes which the US has made have not
changed the fact that revenue that is otherwise due is forgone.
3.2.3. It is irrelevant and misleading to refer to the FSC Replacement scheme as an “exclusion from
tax” rather than an exemption
40. The EC has already noted above 20 the Appellate Body’s observation that a formalistic
approach based on a distinction between an “exclusion” from tax and an exemption could provide an
easy but inappropriate means of circumventing the SCM Agreement prohibition on export contingent
subsidies. Already for this reason the US device is doomed to fail. The EC will explain why the
change in terminology is irrelevant and misleading.
41. Indeed, the words “exemption” and “exclusion” can and are used fairly interchangeably in tax
legislation. Already the basic FSC provision, Section 921 of the IRC has as its first heading “Exempt
Foreign Trade Income” and as its second “Exclusion.” It operated formally as an exclusion, since
income was deemed to be “foreign source income which is not effectively connected with the conduct
of a trade or business within the United States” and thus not taxable. In reality everyone recognised,
and the Panel and the Appellate Body held, that the FSC scheme exempted income from tax. The
confusion of terminology is nothing new, and the EC will now explain why the true nature of the FSC
Replacement scheme is that of an exemption from tax.
42. The new Section 114(a) of the IRC inserted by the FSC Replacement Act provides that:
(a) E
XCLUSION. Gross income does not include extraterritorial income.

18 Sections 923(a)(3) (as modified by Section 291(a)(4) IRC ) and 925(a)(1) of the IRC.
19 Sections 923(a)(3) (as modified by Section 291(a)(4) IRC ) and 925(a)(2) of the IRC.
20 Paragraph 31.

43. But Section 114(b) then immediately states that:
(b) EXCEPTION. Subsection (a) shall not apply to extraterritorial income which
is not qualifying foreign trade income as determined under subpart E of part III of
subchapter N.
44. Thus, it is immediately apparent that it is only “qualifying foreign trade income” that is
“excluded.” The invention of an additional category of “extraterritorial income” is largely
unnecessary, misleading and irrelevant. Read together, paragraphs (a) and (b) do nothing other than
provide for a limited exemption from tax of an amount of income that is later defined as qualifying
foreign trade income. Reference to the defi nition of “qualifying foreign trade income” in
Section 941(a) further shows that this amount of in come is defined in terms of “the amount of gross
income which, if excluded, will result in a reduction of the taxable income of the taxpayer from such
transaction equal to …” This is exactly equivalent to an exemption of the amounts that are then listed.
45. As explained in Section 3.2.2 above, the amounts exempted are arithmetically equivalent to
the amounts exempted under the FSC scheme.
46. Thus, the first reason why the FSC Replacement scheme is not really an exclusion of income
from the tax base but rather a new exemption of income from taxation is that the “excluded income”
is expressly defined in terms of “the amount of gross income which, if excluded, will result in a
reduction of the taxable income of the taxpayer from such transaction equal to” a defined amount.
47. Clearly, any exemption can be presented as an exclusion in this way. If a WTO Member
wanted to give a 1 per cent bounty for the value of goods exported it could simply exclude from
taxation “the amount of gross income which, if excluded, will result in a reduction of the taxable
income of the taxpayer from such transaction equal to 1 per cent of the value of goods exported.”
48. A second reason why the new scheme creates an exception and not an exclusion from tax
liability is that it is subject to a large number of special conditions. These will be discussed in more
detail below, and it is sufficient to note here that they are not only conditions related to export (i.e.
sale for consumption outside the US) but also require, for example, that qualifying property must have
less than 50 per cent foreign content. There are also numerous exceptions (for example, the scheme
does not apply to the income from the export of lumber or of goods deemed to be in short supply).
49. A third reason why there is an exception and not an exclusion is that only part of the income
from a given taxable event (that part which is qualifying foreign trade income) is “excluded” from tax.
Indeed the US does subject the major part of what it calls “extraterritorial income” to tax. It is only
that variable part of it that is designated qualifying foreign trade income and that the taxpayer chooses
to bring within the exclusion that escapes tax. It is not therefore in any event possible to speak of a
“category of income” being excluded from tax.
50. The US seeks to turn this argument around
21 by saying that the taxation of the part of
extraterritorial income which is not qualifying fo reign trade income is the exception to the general
rule of not taxing extraterritorial income and that , if it is allowed to exclude all the income, then
surely it can exclude some of it.
51. The EC submits that this is merely playing with words. The “exception”, by its very nature, is
the decision not to tax a part of such income. The fact that the majority of “extraterritorial income”
(the part that is not qualifying foreign trade income ) is subject to the normal rate of tax is simply

21 [In the House Ways and Means Report of 12.9.2000 (P.10)]

evidence that there is no general rule excluding such income from taxation – this reinforces the
argument that the non-taxation of qualifying foreign trade income is the exception.
52. Fourthly, the FSC Replacement scheme is elective. Firms can choose to avail of the FSC
Replacement scheme or use the normal US tax rules until 1 January 2002,22 or, in some circumstances
during the indefinite transitional period, the FSC scheme.23
3.2.4. The FSC Replacement scheme gives rise to revenue forgone that is otherwise due
53. The EC submits that the factor that determines whether the FSC Replacement scheme gives
rise to a financial contribution and therefore a subsidy is not whether the legislative provisions on
which it is based use the word “exclude” or the word “exempt” or neither, but whether there is
revenue forgone that is otherwise due within the meaning of Article 1.1(a)(1)(ii) of the SCM
Agreement.
54. Both the Panel
24 and the Appellate Body 25 made clear that this requires comparison of the
revenue actually raised following application of the measure in question and that raised under a
“benchmark” situation which would otherwise prevail under the law of the Member in question.
55. The FSC Replacement Act provides that income is partially “excluded” from taxation if all
the conditions laid down by the FSC Replacement scheme are satisfied, that is, in particular:
• The income must derive from the sale of “qualifying foreign trade property” and must
therefore:
/g216be held for ultimate use outside the US;
26and
/g216have foreign content of not more than 50 per cent of the fair market value;27
• The income must be “qualifying foreign trade income” (in particular, the property must not be
sold for final consumption in the US);28
• Elections must have been made or not made as required;29
• None of the various exclusions from the benefit of the FSC Replacement scheme must apply,
such as those:
/g216for agricultural and horticultural cooperatives;30
/g216for members of groups of companies including DISCs;31
/g216for FSCs;32

22 See Section 942(a)(3) of the IRC.
23 See Section 5 of the FSC Replacement Act and the explanation in Section 3.9 below.
24 Panel Report, paras. 7.42-7.43.
25 Appellate Body Report, para. 90.
26 Section 943(a)(1)(B) of the IRC.
27 Section 943(a)(1)(C) of the IRC.
28 Section 941(a) of the IRC.
29 E.g. under Sections 942(a)(3),943(e).
30 Section 943(g) of the IRC.
31 Section 943(h) of the IRC.

/g216for categories of foreign corporations designated by the Secretary;33
/g216exclusion of income by the Secretary as a consequence of participation by taxpayers
in an “international boycott” and corrupt practices.34
56. If these conditions are met, the income is “excluded” from taxation. If they are not met, it is
not excluded (i.e. is included) and tax is due on it. Consequently, if the conditions are met, the tax
revenue that would otherwise be due from this income is not raised – that is, it is forgone.
57. Thus, the “exclusion” from taxation that is effected through the operation of the FSC
Replacement scheme cannot at all be assimilated to the non taxation of categories or classes of
income that are not subject to taxation. The FSC Replacement Act does not qualitatively define a
class or category of income that is excluded from the tax base – it lays down conditions for the partial
non-taxation of income that otherwise would be fully taxed. The income is of the same nature
whether or not the conditions are met. Part of the income from a single taxable event is taxed and part
is not.
58. It is true that WTO Members are free not to tax a general category of income and that foreign
source income may be one such general category.
59. “Extraterritorial income” is not however foreign source income. As noted in Section 2 above
it may be earned entirely in the US and the only “extraterritorial” characteristic is that it is revenue
from sales for final consumption outside the US. Although new Section 942(b) IRC establishes a
number of foreign economic process requirements, there is no relationship between the value of these
processes and the extent to which they are performed outside the US and the amount of income
exempted.
60. “Extraterritorial income” (and even less so, qualifying foreign trade income) is not a general
category of income that a WTO Member may choose not to tax in conformity with the SCM
Agreement. It is no more than an artificial device designed to replicate FSC benefits in the guise of a
general exclusion.
61. As explained above, what is excluded from tax is a quantity of income - “the amount of gross
income which, if excluded, will result in a reduction of the taxable income of the taxpayer from such
transaction equal to” a predetermined amount.
35
3.2.5. There are two distinguishable subsidies
62. The novel feature of the FSC Replacement scheme is that it also applies to transactions
involving certain foreign produced goods (provide d they contain no more than 50 per cent foreign
content).
63. The conditions applying to each are not the same and nor, as will be shown, is the analysis
under the SCM Agreement. The main formal difference is that the subsidy relating to transactions
involving certain foreign produced goods only applies if the producing company has volunteered to be
subject to US taxation as a domestic company. In addition, there are many other differences of
treatment arising from the fact that formally identical treatment is applied to differing situations,

32 Section 5(c) of the FSC Replacement Act.
33 Section 943(e)(4)(C) of the IRC.
34 Sections 941(a)(5) of the IRC.
35 See the definition of qualifying foreign trade income in Section 941(a) of the IRC.

notably production outside the US rather than inside and by a foreign person rather than by a US
person.
64. The EC will refer to the subsidy granted in respect of the export of US produced goods as the
“basic FSC Replacement subsidy” and that accorded to transactions involving foreign produced goods
as the “extended FSC Replacement subsidy” in order to distinguish them. When there is no need to
distinguish the two cases, the EC will refer to them generally as the “FSC Replacement subsidy” or
the “FSC Replacement subsidies”.
65. The fact that subsidies paid to foreigners may also fall under the SCM Agreement has already
been recognised in Brazil – Export Financing Programme for Aircraft, 36 where the subsidies were
paid to non-Brazilian airlines purchasing Brazilian aircraft.
66. The availability of the FSC Replacement scheme to transactions involving foreign produced
goods gives rise to revenue forgone and confers a benefit in the same way as the application of the
scheme to the export of US produced goods. Indeed, it is arguably even clearer, since foreign
produced goods will only be qualifying foreign trade property where the foreign producer
affirmatively elects to be treated as a US domestic corporation and benefit from the scheme, whereas
the scheme is supposed to apply automatically in the case of exports of US produced goods (unless
the taxpayer elects to exclude receipts under Section 943(a)(3)). It is clear that the FSC Replacement
scheme will not be invoked in the case of foreign produced goods unless this gives rise to a tax saving
under US law.
3.2.6. The FSC Replacement scheme also provides subsidies within the meaning of the Agreement
on Agriculture
67. In the earlier proceedings, the Panel found that a measure falling within the definition of
subsidy under the SCM Agreement would also be a subsidy for the purposes of the Agreement on
Agriculture when applied to agricultural products unless there were provisions of the Agreement on
Agriculture which suggested a different conclusion.
37 The Appellate Body found no reason to
disagree with this finding. Nothing in the FSC Replacement Act suggests that a different conclusion
is called for in respect of the FSC Replacement scheme.
3.2.7. Conclusion
68. The EC therefore concludes that the FSC Replacement scheme created by the FSC
Replacement Act gives rise to subsidies within the meaning of the SCM Agreement and the Agreement
on Agriculture.
3.3. The FSC Replacement subsidy is contingent upon export performance
3.3.1. Introduction – the FSC Replacement scheme as an export subsidy
69. The US has signalled that its defence of the FSC Replacement scheme will concentrate on its
contention that it has eliminated export contingency by making the FSC Replacement scheme
available also for transactions involving goods produced outside the US (so long as the foreign
content does not exceed 50 per cent).

36 Brazil – Export Financing Programme for Aircraft , Panel Report, WT/DS46/R, 14 April 1999, and
Brazil – Export Financing Programme for Aircraft , Appellate Body Report, AB-1999-1, WT/DS46/AB/R,
2 August 1999.
37 Panel Report, paras. 7.149 – 7.151.

70. This is in fact a rather extraordinary claim. It defies common sense to suggest that a measure
will cease to be an export subsidy if an additional export promoting feature is added to it!
71. The US has replaced the requirement of export with a requirement that goods not be sold “for
ultimate use in the United States”. 38 As regards US goods, this is of course simply another way of
saying that they must be exported (and indeed si milar language has already been considered by the
Panel because it is used in the FSC scheme 39). The saving grace of the FSC Replacement scheme,
according to the US, is that its scope is wider and also regulates the (probably very rare) case of
foreign producers who are subject to US taxation as domestic companies but who produce abroad and
whose goods are sold abroad. If the prohibition on export subsidies in the SCM Agreement ceases to
apply for such a reason, it is a very poorly designed provision indeed.
72. The EC will set out in Sections 3.3.2 to 3.3.5 below a number of detailed legal reasons why
the US is wrong. First and most fundamentally, the point of comparison for considering whether a
subsidy is contingent upon export performance is the treatment accorded to domestic sales, not the
treatment accorded to sales of foreign produced goods. Second, the alleged alternative means of
obtaining the subsidy is also export contingent, that is the extended FSC Replacement subsidy is also
prohibited. Third, Article 3.1(a) expressly states that a subsidy is prohibited whether export
performance is the sole or one of several conditions. Fourth, the consequences of an election by a
foreign producer to be subject to US tax are such that it cannot be expected that the election will be
used in practice.
73. The EC will also argue in Section 3.4 below that the FSC Replacement scheme is also a
prohibited export subsidy because it is specifically related to exports.
3.3.2. The tax treatment of domestic sales of domestic goods, not that of foreign sales of foreign
goods, is the proper basis for comparison
3.3.2.1. Introduction – the US argument
74. Article 3.1(a) of the SCM Agreement prohibits:
subsidies contingent, in law or in fact, whether solely or as one of several other
conditions, upon export performance, including those illustrated in Annex I
(footnotes omitted)
75. As noted above, the US appears to be arguing that since it is possible to obtain the FSC
Replacement subsidy without exporting, it is not export contingent.
76. Since the subsidy is in fact the exemption (or exclusion) of certain income from tax, the US
could in fact be arguing that since it is possible to earn tax free income without exporting, exempting
(or excluding) income from tax is not an export subsidy.
77. There are a number of categories of income that are not subject to tax in the US. The FSC
Replacement Act operates by inserting a new Section 114 into the IRC that deems certain income to
be excluded from “gross income” for US tax purposes. There are many other provisions that do
exactly the same. Like the exclusion from gross income that is the starting point of the FSC
Replacement scheme, they are contained in Subtitle A, Chapter 1, Subchapter B, Part III of the IRC
and include certain rental income, certain interest on State bonds and compensation for sickness.
40

38 Section 942(a)(2)(A)(i) of the IRC.
39 Section 927(a)(1)(B) of the IRC.
40 A list of some of the provisions is contained in Exhibit EC-9.

78. It is immediately apparent that the simple fact that tax free income – or even income that is
given the name “extraterritorial” – can be earned without exporting cannot suffice to prevent an
export subsidy from being present if such income can be earned contingent upon export performance.
Otherwise, it would have been sufficient to incl ude in the exemption any other category of income
which is already exempted, or which it is thought desirable to exempt from tax.
79. In order to assess whether an exemption is contingent upon export or specifically related to
export, there must be a comparison with some relevant benchmark.
80. The US seems to be arguing that the relevant benchmark for the tax treatment of sales of US
produced goods sold outside the US can be taken to be the tax treatment of foreign produced goods
sold outside the US and then argues that the ta x exemption for income from such sales of the US
produced goods is not export contingent because the same treatment is given to foreign produced
goods.
81. The argument is mistaken because the wrong benchmark is being used. For the reasons that
will be examined in the next Section, the correct benchmark in the case of the US produced goods is
the treatment accorded to domestic sales.
3.3.2.2. The correct benchmark for US produced goods
82. The EC submits that the correct benchmark must be determined by examining the terms of
Article 3.1(a) in context.
Contingent
83. It is the term “contingent” that has been subject of most attention in export subsidy cases so
far. The Appellate Body has explained, for the first time in Canada – Measures Affecting the Export
of Civilian Aircraft ("Canada - Aircraft"), that “contingent” is the key word in Article 3.1(a). It stated
that
41:
…the ordinary connotation of "contingent" is "conditional" or "dependent for its
existence on something else". This common understanding of the word "contingent"
is borne out by the text of Article 3.1(a), which makes an explicit link between
"contingency" and "conditionality" in statin g that export contingency can be the sole
or "one of several other conditions".
84. The Appellate Body has also made clear that “the legal standard expressed by the word
‘contingent’ is the same for both de jure or de facto contingency”
42 and that it is only the evidence
that differs. 43 I n Canada – Certain Measures Affecting the Automotive Industry (“Canada –
Automobiles”),44 it went on to say that:
A subsidy is contingent "in law" upon export performance when the existence of that
condition can be demonstrated on the basis of the very words of the relevant
legislation, regulation or other legal instrument constituting the measure. The

41 Canada – Measures Affecting th e Export of Civilian Aircraft , Appellate Body Report, AB-1999-2,
42 Ibid., para. 167.
43 Ibid.
44 Canada – Certain Measures Affecting the Automotive Industry , Appellate Body Report, AB-2000-2,
WT/DS139/AB/R, WT/DS142/AB/R, 31 May 2000, para. 100.

simplest, and hence, perhaps, the uncommon, case is one in which the condition of
exportation is set out expressly, in so many words, on the face of the law, regulation
or other legal instrument. We believe, however, that a subsidy is also properly held
to be de jure export contingent where the condition to export is clearly, though
implicitly, in the instrument comprising th e measure. Thus, for a subsidy to be de
jure export contingent, the underlying le gal instrument does not always have to
provide expressis verbis that the subsidy is available only upon fulfilment of the
condition of export performance. Such conditionality can also be derived by
necessary implication from the words actually used in the measure.
Export
85. The term “export” is not defined in the SCM Agreement despite its fundamental importance.
The dictionary definition of the noun “export” is
An article that is exported45
and the verb “export” means:
Send (esp. goods) to another country46
86. As usual, this dictionary definition is not of much help. Guidance is available however from
the context in which this word is used, that is the rest of the SCM Agreement and indeed the rest of the
WTO Agreement.
87. The importance of the context is also evident when one considers that if the term “export”
were taken literally to refer to any export in the abstract independently of its context then any
autonomous reduction of import duties on a product by a country would be a prohibited export
subsidy since there would be revenue forgone and a benefit conferred and the amount would depend,
literally, on export performance (of the third country exporters). It may be assumed that this was not
the intention of the WTO Members when they concluded the SCM Agreement . It is necessary
therefore to examine the meaning of the term in its context.
88. The immediate context is of course the Illustrative List, which is expressly stated to illustrate,
that is to shed light on, the meaning of Article 3.1(a). In many places in the Illustrative List it is made
clear that the term “export” refers to products destined for the market of another country, or for
consumption in that other country. Thus, items (d), (f), (g) and (h) all require a comparison of the
conditions applicable to exports with those applying in the case of goods for domestic consumption.
Item (l) includes in the Illustrative List e xport subsidies identified in Article XVI of GATT 1994,
paragraph 4 of which refers to export subsidies as giving rise to bi-level pricing between markets.
47

45 New Shorter Oxford English Dictionary CD-ROM version (1997).
46 New Shorter Oxford English Dictionary CD-ROM version (1997).
47 Article XVI:4 of the GATT 1994 provides as follows:
Further, as from 1 January 1958 or the earliest practicable date thereafter, contracting parties shall cease
to grant either directly or indirectly any form of subsidy on the export of any product other than a primary product
which subsidy results in the sale of such product for export at a price lower than the comparable price charged for
the like product to buyers in the domestic market. Until 31 December 1957 no contracting party shall extend the
scope of any such subsidization beyond that existing on 1 January 1955 by the introduction of new, or the
extension of existing, subsidies.*

89. Looking to the rest of the SCM Agreement, it may be noted that the first mention of the word
“export” occurs in its footnote 1, which contrasts “exports” with “the like product when destined for
domestic consumption.” 48
90. The fact that the term “exports” describes goods destined for the markets of (that is,
consumption in) other countries is also clearly expressed in GATT 1994. Thus, Article I of GATT
1994 associates the concepts of importation/exportation and imports/exports with the phrase “products
originating in or destined for any other country” 49 and similar language is found elsewhere in GATT
1994. That the use of the term “destined for” in relation to exports is not accidental is shown by
Article V of GATT 1994 which does not refer to exports but defines the contrasting concept of
“transit”.50
91. Thus, the EC submits that the term “export” in Article 3.1(a) of the SCM Agreement refers to
the sale of:
• Goods;
• Originating in the country providing the subsidy;
• Destined for the market of, that is for final consumption in, another country.
92. The EC considers that this examination of the term “export” as used in Article 3.1(a)
demonstrates that the provisions are written from the perspective of goods located in the country
providing the subsidy and that accordingly the ba sis for comparison for the treatment accorded to
export transactions is that accorded to domestic transactions.
Performance
93. The fact that the perspective of the Article 3.1(a) is that of producers in the territory of the
country granting the subsidy is also clear from the use of the word “performance”.

48 The full text of footnote 1 is:
In accordance with the provisions of Article XVI of GATT 1994 (Note to Article XVI) and the
provisions of Annexes I through III of this Agreement, the exemption of an exported product from duties or
taxes borne by the like product when destined for domestic consumption, or the remission of such duties or
taxes in amounts not in excess of those which have accrued, shall not be deemed to be a subsidy.
49 The full text of Article I:1 of the GATT 1994 reads:
With respect to customs duties and charges of any kind imposed on or in connection with importation or
exportation or imposed on the international transfer of payments for imports or exports, and with respect to the
method of levying such duties and charges, and with respect to all rules and formalities in connection with
importation and exportation, and with respect to all matters referred to in paragraphs 2 and 4 of Article III,* any
advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined
for any other country shall be accorded immediately and unconditionally to the like product originating in or
destined for the territories of all other contracting parties.
50 Article V:1 provides that:
Goods (including baggage), and also vessels and other means of transport, shall be deemed to be in transit
across the territory of a contracting party when the passag e across such territory, with or without trans-shipment,
warehousing, breaking bulk, or change in the mode of transport, is only a portion of a complete journey beginning
and terminating beyond the frontier of the contracting party across whose territory the traffic passes. Traffic of this
nature is termed in this article "traffic in transit".

94. The primary dictionary definition of “performance” in this context is
The execution or accomplishment of an action, operation, or process undertaken or
ordered; the doing of any action or work; the quality of this, esp. as observable under
particular conditions;51
95. Used with the word “export”, this word implie s that the link or dependency need not exist for
every single transaction but that exports in general (that is the process of export) should be
determined by the availability of the subsidy. T hus a commitment to export 50 per cent of the output
resulting from a subsidised production facility w ould be contingent upon export performance, even
though there is no requirement to export every product produced by the facility.
Conclusion
96. Accordingly, the EC considers that it does not need to show that all subsidies granted under
the FSC Replacement scheme are export dependent. It is sufficient if some of the beneficiaries
receive the benefit conditional upon exporting from the US rather than selling domestically. If there
are circumstances in which exportation is obligatory in order to obtain the subsidy, then the subsidy is
dependent or contingent upon export in these circumstances, and must therefore be an export subsidy.
97. Thus, the notion of contingency does not exist in the abstract but must be understood in the
light of the actual circumstances of a recipient and compared with the relevant alternative (in the case
of export contingency sale for consumption abroad rather than sale for domestic consumption). In
particular, producers (or more exactly owners) of US goods have no choice but to export in order to
obtain the subsidy in respect of those goods.
98. It is true that where a subsidy is made available, for example, to all producers of shoes, some
producers may in fact qualify by producing shoes which they export, but this does not make the
subsidy export contingent. Each producer is free to sell on the domestic market or to export and this
does not affect entitlement to the subsidy. However, in the case of the FSC Replacement scheme, the
situation is different. Owners of US goods for sale in the US do not have a choice in how to obtain the
subsidy. They cannot, unlike the shoe manufacturers in the above example, satisfy the conditions by
selling domestically. They have to export. Thus they obtain the subsidy by performing one function,
export, in preference to another, selling on the domestic market.
3.3.2.3. Application to the FSC Replacement scheme
99. The FSC Replacement Act avoids any mention of the word “export”. It uses other words to
achieve the same result. (It is not uncommon for ex port subsidies to avoid the word “export” as the
Appellate Body remarked in Canada – Automobiles .
52) The FSC Replacement scheme is only
available in respect of sales of “qualifying foreign trade property.” Part of the definition of this
concept limits it to goods for use or consumption outside the US. Section 943(a)(1)(B) of the IRC
provides that it must be:
held primarily for sale, lease, or rental, in the ordinary course of trade or business for
direct use, consumption, or disposition outside the United States,
100. Further, the sale of qualifying foreign trade pr operty for ultimate use in the US will prevent
foreign trading gross receipts from arising. Section 942(a)(2)(A)(i) of the IRC provides that

51 New Shorter Oxford English Dictionary CD-ROM version (1997).
52 See the quotation from the Appellate Body in the discussion of the word “contingent” in
Section 3.3.2.2 above.

The term `foreign trading gross receipts' shall not include receipts of a taxpayer from
a transaction if the qualifying foreign trade property or services are for ultimate use in
the United States
101. The phrase “for ultimate use within the US” is for US goods obviously simply another way of
saying “not exported”. Thus, the key distinction for the availability of the FSC Replacement subsidy
is whether such property is exported. A sale of goods for ultimate use outside the US (i.e. an export)
has as its consequence the availability of the FSC Replacement subsidy; a sale of goods for ultimate
use in the US is deprived of the same advantage. The EC submits that that makes the availability of
the subsidy contingent upon export performance.
102. It is true that the same consequence (the availability of the FSC Replacement subsidy) can
arise in other ways. One example is the provision of services outside the US. That does not diminish
the fact that it is only available to US goods if they are exported, not if they are sold on the US
market. It does not undermine the conclusion that this availability for export is a reward for export
performance.
103. It is also true that the same consequence can arise through production and sales of certain
goods outside of the US (although, as will be discussed below, this is not likely). Again, that is not
the relevant point of comparison. Article 3.1(a) addresses export contingency relating to the goods of
the country providing the subsidy (in this case the US) and prohibits making the availability of the
subsidy contingent on export performance and therefore on whether the goods are exported.
3.3.3. The alleged alternative means of obtaining the subsidy is also export contingent, that is, the
extended FSC Replacement subsidy is also prohibited
104. Another reason why the US attempt to remove the export contingency from the FSC
Replacement scheme fails is that the alleged alternative means of obtaining the subsidy (the EC will
explain in Section [3.3.5] below that it is unlikely to be used) also involves export contingency. In
other words, the extended FSC Replacement subsidy is also prohibited.
105. If both elements of the FSC Replacement su bsidy are contingent upon export performance,
so, whatever interpretation of Article 3.1(a) is adopted, is the whole.
106. The export contingency of the extended FSC Replacement subsidy arises out of the
requirement that the foreign produced goods be sold outside the US in conjunction with the fact that
they cannot be qualifying foreign trade property and therefore cannot benefit from the FSC
Replacement scheme if they have a foreign content exceeding 50 per cent.
107. As already mentioned above, the FSC Replacement subsidy is only available for the sale of
“qualifying foreign trade property”. According to Section 943(a)(1) of the IRC:
The term ‘qualifying foreign trade property’ means property –
(A) manufactured, produced, grown or extracted within or outside the
United States
(B) held primarily for sale, lease or rental, in the ordinary course of trade or
business for direct use, consumption, or disposition outside the Unites States,
and
(C) no more than 50 per cent of the fair market value of which is attributable to -

(i) articles manufactured, produced, grown, or extracted outside the
United States, and
(ii) direct costs for labour (determined under the principles of
Section 263A)
performed outside the United States.53
108. In many cases, the requirement that no more than 50 per cent of the fair market value be
attributable to articles manufactured, produced, grown, or extracted outside the United States, and
direct labour costs will mean that inputs will have to be exported from the US, as the EC will now
proceed to demonstrate.
109. The terms “articles” and “attributable” are not defined in the legislation. It may be that the
US will clarify them during these panel proceedings and the EC may then be able to refine its
argument on this point.
110. However, for present purposes, it is sufficient to note that fair market value of a product
(FMV) can be considered to be made up of the sum of the following:
• The cost of “articles attributable” (hereinafter “articles”) (A), which may again be split into:
/g216US articles; (A1) and
/g216Foreign articles (A2);
• The direct cost of labour (B);
• The cost of other inputs (which may include energy, royalties for intellectual property used,
overheads etc) (C);
• Profit (D).
111. If these categories are considered to cover all costs (with any residual costs being included in
(C), A1+A2+B+C+D must equal the sales price (SP). In normal cases SP will be equal to FMV.
112. Since A2 + B may not exceed 50 per cent of P, (i.e. A2 + B must be = or < SP/2), then
mathematically,
A1+C+D must constitute at least 50 per cent of SP (i.e. A1+C+D must be = or > SP/2
which can be expressed as A1 = or > SP/2-C-D). This means that A1 will be positive
whenever SP/2 > C+D
In other words, US articles must be used whenev er the cost of other inputs (not articles or direct
labour) (C) and profit (D) are less than 50 per cent of the selling price (or more exactly the US-
assessed fair market value) of the goods.
113. This condition (and therefore the need for there to be exports of US articles) will not always
be met but it will in many cases. Whether it is met or not will depend on the nature of the production
process. There are a series of factors that render the condition more difficult to meet and others that
render it easier to meet. Factors that will make the condition more difficult to meet include:

53 Emphasis added.

• A high cost of articles used in production;
• A high amount and therefore cost of foreign direct labour in production;
• A low intellectual property component;
• A low profit.
114. Correspondingly, factors that will make the condition easier to meet include:
• A low cost of articles used in production;
• A low amount and therefore cost of foreign direct labour in production;
• A high intellectual property component;
• A high profit margin.
115. The EC’s point is that the importance of thes e factors varies between sectors and companies
and there will inevitably be companies who will ha ve to use US products. That in the EC view is
sufficient to establish contingency.
116. In order to illustrate this argument, the Annex to this submission gives a series of examples of
where the requirement to use US articles must arise in practice. The Annex identifies cases where the
cost of “articles” used to produce finished goods exceed 50 per cent of the value of the finished
product. In all these cases, some US articles will have to be used in order to produce “qualifying
foreign trade property”. In fact, the approach followed in the Annex is conservative since foreign
direct labour costs are not taken into account in the Annex but are included in the foreign content
limitation, thus further reducing the ability of producers to fulfil the condition without using US
articles. In other words, for every percentage increase in the value of foreign direct labour, there is a
corresponding increase in the percentage in value of US articles that must be used.
117. Even in cases where the above foreign conten t limitation could be met without the need for
US inputs, a foreign producer who wishes his goods to benefit from the FSC Replacement scheme
will still have an incentive to purchase US goods in order to make it easier to comply with the
requirement and to ensure that the benefit will be available.
118. The foreign content is expressed as a fraction of the price a company can obtain from the sale
of the finished product. However, the price a company expects from the sale of such finished product
may not materialise due to a number of unforeseen (or not entirely foreseen) circumstances: for
example price trends may dramatically change downwards so that the fair market value also decreases
(and a company can no longer obtain the prices based on which it had made its production
calculations). In order to minimise such risk of not being able to qualify, companies will need to
reduce the value of foreign articles and direct labour to a level that will always ensure that they
account for no more than 50 per cent of the price, even in case of price decreases.
119. Accordingly, the fact that the extension of the FSC Replacement scheme to foreign produced
goods is subject to a foreign content requirement creates in many cases a requirement for exports to be
made from the US. This renders the extended FSC Replacement subsidy also export contingent and
thus prohibited.
120. Since both elements of the FSC Replacement subsidy are contingent upon export
performance, so is the whole. The FSC Replacement scheme is therefore a prohibited export subsidy
contrary to Article 3.1(a) of the SCM Agreement.

3.3.4. Article 3.1(a) expressly states that a subsidy is prohibited whether export performance is the
sole or one of several conditions.
121. The US approach to implementation of the Panel Report has been to endeavour to hide, what
is essentially the same subsidy as that before the Panel in the original proceeding, within a slightly
wider subsidy. It does this by adding to the basic FSC Replacement subsidy the extended FSC
Replacement subsidy.
122. The drafters of the SCM Agreement , were aware of the potential for such devices and
expressly provided that a subsidy shall be prohibited if it is contingent “contingent, … whether solely
or as one of several other conditions, upon export performance.”
123. In other words, a subsidy that is export continge nt in some situations does not cease to be so if
it can also be obtained in other situations which do not require export. A subsidy that is available to
exporters and to producers of certain categories of goods is still prohibited in those situations where
export is required to obtain it.
124. To take an example: suppose a subsidy programme is available to all goods produced in a
certain region of a WTO Member’s territory, but only available to goods produced outside that region
if exported from that WTO Member’s territory. It is true that it is not in all circumstances necessary
to export to obtain the subsidy, since goods from the eligible region can benefit if sold domestically.
But goods from outside the eligible region can only qualify for the subsidy when exported. There are
no “alternative” conditions in this case - the subsidy is export contingent. The same situation arises
with the FSC Replacement scheme. Although ther e may be cases of production outside the US that
may benefit in the absence of export, goods produced in the US can only obtain the benefit in one way
– if exported. In these circumstances, the subsidy is export contingent.
125. It is true that a where a subsidy is made available, for example, to all producers of shoes,
some producers may in fact qualify by producing shoes which they export, but this does not make the
subsidy export contingent. Each producer is free to sell on the domestic market or to export and this
does not affect entitlement to the subsidy. However, in the case of the FSC Replacement scheme, the
situation is different. Owners of US goods produced in the US do not have a choice in how to obtain
the subsidy. They cannot, unlike the shoe manufacturers in the above example, satisfy the conditions
by selling domestically. They have to export. Thus they obtain the subsidy by performing one
function, export, in preference to another, selling on the domestic market.
126. That this is the correct interpretation of Article 3.1(a) is confirmed by the panel and Appellate
Body reports Canada – Aircraft . One of the subsidies involved in that case, the Technology
Partnerships Canada programme, was available to non-export sectors such as environmental
technologies and “enabling technologies.”
54 The fact that the subsidy was available in some situations
without any export contingency did not stop the payments under the programme to the regional
aircraft industry being found export contingent.
127. Thus, even if the Panel were not to agree with the position set out in Section 3.3.2 above - that
the extended FSC Replacement subsidy is also expor t contingent, this will not prevent a finding that
the basic FSC Replacement subsidy is export contingent.
128. Indeed, the above view of alternative conditions is also that adopted by the US when it applies
its own countervailing duty rules on export subsides to foreign producers. This rule (§351.514 of the
US countervailing duty rules) is very similar to Article 3.1(a) of the SCM Agreement, read with its
footnote, since it provides that:

54 See e.g. Canada – Aircraft, Panel Report, para. 6.174.

….(a) In general. The Secretary will consider a subsidy to be an export subsidy if the
Secretary determines that eligibility for, approval of, or the amount of, a subsidy is
contingent upon export performance. In applying this section, the Secretary will
consider a subsidy to be contingent upon export performance if the provision of the
subsidy is, in law or in fact, tied to actual or anticipated exportation or export
earnings, alone or as one of two or more conditions.”
In the discussion section of its own countervailing duty rules, the US states that:
55
In situations where the government evaluates multiple criteria under a program,
§351.514 would require an analysis different from that described in Extruded Rubber
Thread from Malaysia, 57 FR 38472 (August 25, 1992). In that case, the Malaysian
Government considered 12 criteria in evaluating whether a particular company should
receive "pioneer" status. Two of these criteria addressed the export potential of a
product or activity. In addition, in certain situations, companies were required to
agree to export commitments. In analyzing the Pioneer program, the Department
examined the criteria being applied with respect to a particular company. If one or
more of the criteria applied by the Government included favorable prospects for
export, but the export criteria did not carry preponderant weight, we did not consider
the award of Pioneer status to constitute an export subsidy. However, under the new
standard contained in §351.514, if exportation or anticipated exportation was either
the sole condition or one of several conditions for granting Pioneer status to a firm,
we would consider any benefits provided under the program to the firm to be export
subsidies unless the firm in question can clearly demonstrate that it had been
approved to receive the benefits solely under non-export-related criteria. I n s u c h
situations, we would not treat the subsidy to that firm as an export subsidy. (Emphasis
added in italics).
129. Thus it is clear that in its countervailing duty law, the US considers that export subsidies exist
for some firms even in cases where certain other firms can demonstrate that they do not need to obtain
the benefits. This situation is analogous to that of the FSC Replacement scheme.
130. Indeed, the contention of the US that the SCM Agreement should be interpreted so as to allow
the FSC Replacement scheme to escape the disciplines of the SCM Agreement bring to mind the
words used by the US in connection with an export subsidy of another Member, when it said of an
argument made by that Member:
56
If adopted, this standard would enable governments to engage in the very sorts of
manipulation and modifications of subsidy programmes that the drafters of the SCM
Agreement sought to curtail.
3.3.5. The consequences of an election by a foreign producer to be subject to US tax are such that it
cannot be expected that the election will be used in practice.
131. The EC further considers that the addition of the extended FSC Replacement subsidy to the
FSC Replacement scheme is merely cosmetic (and an attempt to hide a prohibited export subsidy)
because there are a number of reasons to believe that it will rarely be used.

55 US Department of Commerce (International Trade Administration) Countervailing duties : Final
Rule 19 CFR Part 351 (WTO Document G/ADP/N/1/USA/1/Suppl.4, G/SCM /N/1/USA Suppl.4 29.3.99 p.62)
56 Panel Report, Canada – Aircraft, paragraph 7.143.

132. The most important of these reasons is that the extended subsidy is only available where the
foreign producer makes an election to be taxed as a domestic US corporation. Section 943(a)(2) of the
IRC provides that:
Property which (without regard to this paragraph) is qualifying foreign trade property
and which is manufactured, produced, grown, or extracted outside the United States
shall be treated as qualifying foreign trade property only if it is manufactured,
produced, grown, or extracted by
(A) a domestic corporation,
(B) an individual who is a citizen or resident of the United States,
(C) a foreign corporation with respect to which an election under subsection (e)
(relating to foreign corporations electing to be subject to United States
taxation) is in effect, or
(D) a partnership or other pass-thru entity all of the partners or owners of which
are described in subparagraph (A), (B) or (C);
133. The election required by Section 943(a)(2) would create additional tax liability, reporting
requirements and administrative burdens on the corporation without reducing its liability,
requirements and burdens in its own jurisdiction. Fo reign corporations are only likely to elect to be
treated as domestic companies in the US in such situations where such an election would entail an
overall tax saving (or a benefit) and thus it is only likely to be contemplated in special circumstances.
134. In addition, Section 943 (e)(1) provides that:
(e) ELECTION TO BE TREATED AS DOMESTIC CORPORATION. -
(1) IN GENERAL. - An applicable foreign corporation may elect to be treated as a
domestic corporation for all purposes of this title if such corporation waives all
benefits to such corporation granted by the United States under any treaty. No
election under section 1362(a) may be made with respect to such corporation.
135. Any benefit that might possibly arise from being treated as a US domestic corporation and
benefiting from the FSC Replacement scheme would have to weighed against the consequences of
waiving all benefits granted by the US under any treaty!
136. It is true that elections under the FSC Replacement scheme can be revoked for subsequent tax
years but this also brings with it serious disadvantages.
137. The additional tax consequences of elections and their revocations require some explanation.
By virtue of Section 943 (e)(4)(B):
(B) EFFECT OF ELECTION, REVOCATION, AND TERMINATION. -
(i) ELECTION. - For purposes of section 367, a foreign corporation making an
election under this subsection shall be treated as transferring (as of the first day of the
first taxable year to which the election applies) all of its assets to a domestic
corporation in connection with an exchange to which section 354 applies.
(ii) REVOCATION AND TERMINATION. - For purposes of section 367, if -

(I) an election is made by a corporation under paragraph (1) for any taxable year,
and
(II) such election ceases to apply for any subsequent taxable year,
such corporation shall be treated as a domestic corporation transferring (as of the 1st
day of the first such subsequent taxable year to which such election ceases to apply)
all of its property to a foreign corporation in connection with an exchange to which
section 354 applies.
138. This provision confirms that an election of a foreign corporation to be treated as a US
domestic corporation gives rise to a deemed transfer of assets between corporation. One consequence
of this is that non-distributed profits of a foreign corporation are immediately subject to US taxation
when a foreign corporation elects to be treated as a US domestic corporation, which may not have
been the case otherwise.
57 Another, and arguably more serious consequence, is that an election to
cease being treated as a US domestic corporation gives rise to a deemed transfer of assets out of the
US. This will give rise to US tax charge not only on all its non-distributed profits but also on
unrealised capital gain in the value of its assets. This latter future and uncertain tax liability on the
revocation of an election is likely to be the greater barrier to the making of an election to be treated as
a US domestic corporation in the first place since its importance will not be known when that election
is made.
139. Electing to be treated as US domestic corporations for US tax purposes may subject foreign
corporations them to reporting and other requirements inconsistent with their domestic law and
possibly impact in other ways on their business. The principle behind bilateral tax treaties is that a
corporation will be resident in one jurisdiction or another (even though it may be subject to tax as a
non-resident in the jurisdiction where it is not resident). Traditionally, the primary purpose of such
treaties is to eliminate or reduce double taxation, with the ancillary goal of determining the taxing
rights of the Contracting States. As regards business income, the OECD Model Tax Convention (on
which most tax treaties concluded between industrialised countries are based) provides that it is only
taxable in the Contracting State in which the taxable person is resident. A Contracting State may only
impose tax on the business income of a resident of the other Contracting State in so far as this has a
permanent establishment in the first mentioned Contracting State. An election under the FSC
Replacement scheme will disrupt this assumption and mean that corporations will start to be resident
for tax purposes in two jurisdictions, which can give rise to potential conflicts. To date the
consequences of such conflicts remain unknown, which is why it is also reasonable to presume that
any prudent economic operator (in this case a foreign corporation) might be reluctant to elect to be
treated in the US as a domestic corporation. By doing so it would assume a risk of rather adverse
effects of which the significance is unknown to it at the time of the election.
140. Indeed one example of a conflict is given in apparent from the FSC Replacement Act itself.
New Section 941(a)(5) IRC, for example, denies the benefit of the scheme to firms that participate in
“international boycotts etc.”. Clearly, many other States may make participation in such boycotts
obligatory.

57 More precisely, the regulations under Section 367(b) will require US shareholders of the foreign
corporation to take into income a deemed dividend based on the undistributed earnings of the corporation
accumulated prior to its election. The FSC Replacement Act has a transition provision (Section 5(c)(3))
pursuant to which earnings and profits accumulated by the domesticating corporation in taxable years ended
prior to 1 October 2000 will not be included in the income of the shareholders of the corporation. This
transition provision is applicable only in those circumstances specified in the provision.

141. More generally in the case of tax law, US law may require certain expenses to be written off
over a period that conflicts with the period required by other jurisdictions.
142. It may also be expected that foreign governme nts will oppose (or refuse to acknowledge) their
corporations becoming subject to all the obligations of the US tax code. The elections provided for in
the FSC Replacement scheme disrupt the balance of rights and obligations, benefits and costs, on
which bilateral tax treaties are concluded. Accordingly, as the treaty rights of a foreign government
would be breached it might in its turn decline to respect its treaty obligations (for example, granting of
double tax relief). Any prudent foreign corporation contemplating election to be treated in the US as a
domestic corporation would certainly be mindful of this risk and assess its importance against any
potential benefits from it could receive as a result of the election. Foreign governments may also
object to corporations under their jurisdiction being required “to waive all benefits … granted by the
US under any treaty” and to way this provision may be interpreted by the US. Such objections by
foreign governments could be based on the rights they have under bilateral tax treaties (which will
limit the way in which the US can tax the foreign country’s corporations) and on the basis of
international law principles of jurisdiction which limit the extent to which States may assert
jurisdiction over foreign corporations. There is no exception to these principles that would allow
corporations to “elect” to be subject to a State’s jurisdiction in return for some benefit.
143. It is clear that if a foreign government objected to corporations under its jurisdiction waiving
their rights and electing to be subject to the US tax code, that election could not be made.
144. Additionally, as explained above, foreign corporations can in many cases only benefit from
the FSC Replacement scheme if they use US articles. This is a further disincentive to using the
scheme.
145. In view of these obstacles, the EC considers that even if the extension of the FSC
Replacement scheme to foreign production had its intended effect of removing the de jure export
contingency of the scheme ( quod non ), that scheme would in any event remain de facto export
contingent and still be contrary to Article 3.1(a) of the SCM Agreement.
3.3.6. Conclusion
146. For all these reasons the EC considers that the FSC Replacement scheme is a prohibited
export subsidy contrary to Article 3.1(a) of the SCM Agreement.
3.4. The FSC Replacement subsidies are specifical ly related to exports within the meaning of
item (e) of the Illustrative List
3.4.1. Introduction
147. In this Section the EC will explain that item (e) of the Illustrative List in Annex I to the SCM
Agreement also renders the FSC Replacement subsides prohibited.
148. Item (e) defines as an export subsidy:
The full or partial exemption remission, or deferral specifically related to exports, of
direct taxes or social welfare charges pa id or payable by industrial or commercial
enterprises (footnotes omitted)
149. This provision is specifically designed to deal with export subsidies granted through the tax
system.

150. The Panel considered Item (e) in its report in the original proceeding 58 and considered it to be
applicable to the FSC scheme – in particular that the provision applied to exemptions from
corporation taxes and that the beneficiary taxpayers were “industrial or commercial enterprises”.
151. Although the FSC Replacement scheme differs sl ightly from the FSC scheme in that part of
the income is expressed as being “excluded” from tax rather than expressed as an “exemption,” it has
been demonstrated in Section 3.2 above that it is in substance an exemption. The term “exports” has
already been discussed in detail above. It remains to examine the meaning of “specifically related to”
exports.
152. The dictionary definition of “specifically” is:
(a) in respect of specific or distinctive qualities;
(b) peculiarly;
(c) in a clearly defined manner, definitely, precisely 59
and the dictionary definition of “related” is:
Having relation; having mutual relation; connected60
153. Accordingly, “specifically related to exports” means “having a special, precise or clearly
defined relationship or connection to exports”.
3.4.2. The FSC Replacement subsidies are caught by item (e)
154. The EC has shown above that the FSC Replacement subsidies are contingent upon export
performance because they are dependent upon exportation.
155. The “exports” referred to in item (e) must be understood in the same as “export” in
Article 3.1(a), that is as referring to exports from the country granting the subsidy.
156. Contingency is a particular form of special relationship. Therefore any subsidy that is
contingent upon export performance must, necessarily, also be “specifically related to exports” within
the meaning of item (e)
157. However, the term “specific relation” is broader than the term “contingency.” The former
term covers any specific link and thus would include a simple incentive. Thus, since the Illustrative
List illustrates the meaning of Article 3.1(a), the prohibition on export subsidies must, at least, as it
applies to subsidies granted through the tax measures described in item (e), also cover measures that
specifically encourage exports.
158. Accordingly item (e) supports and confirms the conclusion that the FSC Replacement
subsidies are prohibited under Article 3.1(a) SCM Agreement.

58 Panel Report, para. 7.110.
59 New Shorter Oxford English Dictionary CD-ROM version (1997).
60 New Shorter Oxford English Dictionary CD-ROM version (1997).

3.5. The FSC Replacement scheme provides subsidies which are contingent upon the use of
domestic over imported goods contrary to Article 3.1(b) of the SCM Agreement
3.5.1. Introduction – the US rules
159. In the same way as the FSC scheme, the FSC Replacement scheme continues to require, as a
condition for enjoying the tax benefit it provides, that the qualifying transactions concern goods
produced with a foreign content not exceeding 50 per cent (which now includes direct labour costs).
The EC submits that this requirement makes the FSC Replacement scheme contingent in law “upon
the use of domestic over imported goods” within the meaning of Article 3.1(b) of the SCM
Agreement. The EC submits, in the alternative, that even if the Panel considered that this requirement
does not amount to contingency in law, it would stil l need to conclude that, for certain sectors, it de
facto makes resort to US inputs necessary and the subsidy is therefore de facto contingent upon the
use of domestic over imported goods.
160. The virtual identity of this requirement which with the one applicable to FSCs is immediately
apparent:
IRC RULES APPLICABLE TO FSC
SCHEME
Sec. 927. OTHER DEFINITIONS AND
SPECIAL RULES
FSC REPLACEMENT ACT SCHEME – NEW
IRC RULES
Sec. 943. OTHER DEFINITIONS AND SPECIAL
RULES
(a) EXPORT PROPERTY
- For purposes of this subpart –
(1) IN GENERAL. –
(a) QUALIFYING FOREIGN TRADE
PROPERTY
- For purposes of this subpart –
(1) IN GENERAL. –
The term ''export property'' means property - The term ‘qualifying foreign trade property’ means
property –
(A) manufactured, produced, grown, or
extracted in the United States by a person
other than a FSC,
(B) held primarily for sale, lease, or rental, in
the ordinary course of trade or business, by,
or to, a FSC, for direct use, consumption, or
disposition outside the United States, and
(C) not more than 50 per cent of the fair
market value of which is attributable to
articles imported into the United States.
(A) manufactured, produced, grown or extracted
within or outside the United States,
(B) held primarily for sale, lease or rental, in the
ordinary course of trade or business for direct
use, consumption, or disposition outside the
Unites States, and
(C) no more than 50 per cent of the fair market
value of which is attributable to–
(i) articles manufactured, produced, grown, or
extracted outside the United States, and
(ii) direct costs for labour (determined under the
principles of Section 263A) performed outside the
United States.(emphasis added)
For purposes of subparagraph (C), the fair
market value of any article imported into the
United States shall be its appraised value, as
determined by the Secretary under section 402
of the Tariff Act of 1930 (19 U.S.C. 1401a) in
connection with its importation.
For purposes of subparagraph (C), the fair market
value of any article imported into the United States
shall be its appraised value, as determined by the
Secretary under section 402 of the Tariff Act of
1930 (19 U.S.C. 1401a) in connection with its
importation, and the direct costs for labour under
clause (ii) do not include costs that would be
treated under the principles of section 263A as
direct labour costs attributable to articles described
in clause (i).

161. In addition, the rules relating to “excluded property” and other limitations to “export
property” are carried over in the FSC Replacement scheme in relation to “qualifying foreign trade
property”.
162. Thus, apart from some adjustments to take account of the fact that a separate legal entity in
the form of a FSC is no longer required, the only innovation appears to be the addition of foreign
direct labour costs to the foreign content to which the 50 per cent limitation applies. 61 The EC will
explain below that this difference does not appreciably change the situation which already gave rise to
its claim under Article 3.1(b) of the SCM Agreement in respect of the FSC regime, and that its
arguments developed in the original Panel and Appellate Body proceedings apply mutatis mutandis.
3.5.2. Article 3.1(b) of the SCM Agreement
163. The EC submits that, by providing for the re quirement just described, the FSC Replacement
scheme makes the granting of a subsidy contingent upon the use of US goods thereby violating
Article 3.1(b) of the SCM Agreement.
164. Article 3.1(b) prohibits:
subsidies contingent, whether solely or as one of several other conditions, upon the
use of domestic over imported goods
165. The only appropriate meaning for the word “over” in this context given by the New Shorter
Oxford English Dictionary is “in preference to”.
62 Accordingly, the words “use of domestic over
imported” mean “use of domestic in preference to imported” and render this provision very broad, so
that it may include any form of “preference” or “incentive” or “boost” to domestic production by the
Member conferring a subsidy at the expense of imported goods.
166. The Appellate Body has had one recent occasion to interpret this provision. In doing so, it
has notably:
• extended its interpretation of “contingent” developed with respect to Article 3.1(a) to
Article 3.1(b);63
• extended its interpretation of de iure contingency developed under Article 3.1(a) of the SCM
Agreement to Article 3.1(b);64
• clarified that Article 3.1(b) covers subsidy schemes which are de iure contingent upon use of
domestic over imported goods, but also de facto ones;65
• clarified that the wording “use of domestic over imported goods” also covers value added
requirements.66

61 The EC of course assumes that identical words used in different parts of the IRC will have the same
meaning unless otherwise specified.
62 New Shorter Oxford English Dictionary CD-ROM version (1997).
63 Canada – Aircraft , Appellate Body Report, para. 166; Canada - Automobiles , Appellate Body
Report, para. 123.
64 Canada – Aircraft , Appellate Body Report, para. 100; Canada - Automobiles , Appellate Body
Report, para. 123.
65 Canada – Automobiles, Appellate Body Report, WT/DS139/AB/R, WT/DS142/AB/R, para. 143.
66 Id., para. 130.

3.5.3. The basic FSC Replacement subsidy is contingent upon use of domestic over imported goods
167. The FSC Replacement scheme does not impose explicitly an obligation to “use domestic over
imported goods”, but rather an obligation not to exceed a certain proportion of foreign articles or
labour. Nevertheless, the cost of articles and labour are amongst production costs - indeed still the
main ones in the production of many goods – that are reflected in the “fair market value” of the
finished product.
168. Just as in the case of the FSC scheme, the foreign content limitation under the FSC
Replacement scheme must in principle be satisfied for each transaction for which the benefit is
sought. The difference with the FSC scheme lies in the fact that the foreign content limitation is also
imposed on companies producing goods outside the US that make an election to be treated as a
domestic US corporation pursuant to Section 943(e) of the IRC. In this respect, the FSC Replacement
Act makes clear that the foreign content limitation applies not only to foreign articles but also to direct
costs for labour performed outside the US. The inclusion of foreign direct costs for labour in the
foreign content limitation appears to be of no practical significance to goods produced in the US since
these will, by definition, not contain any “foreign direct costs for labour performed outside the US.”
In any event, if foreign direct labour costs were ever relevant in assessing the foreign content of US
produced goods, this would further reduce the scope for using foreign articles and thus make it more
difficult to respect the 50 per cent foreign content limitation. The foreign content limitation would
therefore be more restrictive than is the case under the FSC scheme.
169. In Section 3.3.2 above, it was explained how the foreign content limitation applied to foreign
produced goods would often require the use of US “articles” and in other cases would require that US
articles be used in order to ensure that the foreign content limitation was not exceeded. For analogous
reasons, the foreign content limitation applied to US produced goods will also often require the use of
US articles and in other cases would require that US articles be used in order to ensure that the foreign
content limitation was not exceeded.
170. The use of US articles will be required whenever the cost of inputs other than articles, any
foreign direct labour and profit amount to 50 per cent or less of the selling price (or more exactly the
fair market value) of the finished goods. In such cases the cost as articles will exceed 50 per cent of
the total value of the product and the FSC Replacement subsidy will not be available if the articles are
all foreign.
171. This condition (and therefore the need for US articles to be used) will not always be met but it
will in many cases. The EC listed in Section 3.2.2 some factors that affected whether this condition
would be met.
172. Further, the foreign content is expressed as a fraction of the price a company can obtain from
the sale of the finished product. However, the price a company expects from the sale of such good
may not materialise due to a number of unforeseen (or not entirely foreseen) circumstances: for
example price trends may dramatically change downwards so that the fair market value also decreases
(and a company can no longer obtain the prices based on which it had made its production
calculations). In order to minimise such risk of not being able to qualify, companies will be induced
to reduce the cost of foreign articles and labour to a level that will always ensure that they account for
no more than 50 per cent of the price, even in case of price decreases.
173. For reasons analogous to those set out in Section 3.3.2, the fact that some companies will
have to use US articles is sufficient to establish contingency. The examples in the Annex (cases where
materials exceed 50 per cent of the final value of the product) illustrate on a conservative basis the
fact that such products exist.

174. Accordingly, the basic FSC Replacement subsidy is “contingent upon the use of domestic
over imported goods” within the meaning of Article 3.1(b) of the SCM Agreement because using
domestic US articles will often be necessary to ensure that the foreign content limitation is not
exceeded, whereas using foreign articles (and foreign direct labour if possible) will often prevent this
limitation from being respected and make the FSC Replacement scheme unavailable. In other cases
the use of foreign articles will impair a company’s chances of respecting this limitation and the
company will still be required to use US articles in order to ensure that the subsidy will be available.
175. The US has suggested that FSC Replacement scheme is not contingent upon the use of
domestic over imported goods because it does not “affirmatively require” the use of US articles. In
the US view, companies can respect the foreign content limitation (and thus obtain the tax benefit if
the other conditions are met) without using any domestic parts and materials at all.
176. In order to establish a violation of Article 3.1( b), however, it is not necessary to show that the
subsidy requires the actual use of domestic over imported goods in every case. The mere fact that in
some cases a beneficiary will be required to use domestic goods instead of imported goods in order to
qualify for the subsidy, if it can be demonstrated “on the basis of the words of the relevant legislation,
regulation or other legal instrument”,
67 is sufficient to trigger the application of Article 3.1(b).
177. At any rate, assuming arguendo that the actual use of domestic goods had to be a necessary
condition for granting the subsidy, as explained a bove and in Annex to this submission, the foreign
content ceiling requirements have been set at such a level in the FSC Replacement Act that at least in
certain sectors the beneficiaries cannot possibly meet them without using some US articles.
178. Further, the fact that a US producer may have alternative means of avoiding a breach of the
foreign content limitation (e.g. by using US labour) does not per se rule out a violation of
Article 3.1(b) of the SCM Agreement. Just as Article 3.1(a), and for the same anti-circumvention
concerns, Article 3.1(b) foresees that the “use of domestic over imported goods” may be an alternative
condition and prohibits such use “whether solely or one of several other conditions”.
3.5.4. The extended FSC Replacement subsidy
179. As explained above in Section 3.3.5 the EC has doubts as to whether the extended scheme
can be used by companies located outside the US. The way in which the foreign content limitation is
formulated in Section 943 of the IRC is one reason for this. As recalled above, that Section imposes
the 50 per cent foreign content limitation, which is described in the following terms:
(C) no more than 50 per cent of the fair market value of which is attributable to–
(i) articles manufactured, produced, grown, or extracted outside the
United States, and
(ii) direct costs for labour (determined under the principles of Section 263A)
performed outside the United States.
180. The EC has also argued above in Section 3.3.3 that, even if the extended FSC Replacement
subsidy will ever be available, it will constitute a prohibited export subsidy within the meaning of
Article 3.1(a) of the SCM Agreement.

67 Id., para. 123.

181. Since in its view the foreign content limita tion applied to foreign products leads to the
extended subsidy being a prohibited export subsidy, the EC does not consider that it can also be a
local-content contingent subsidy.
182. If, however, the Panel should not agree that the foreign content limitation applied to foreign
producers has this effect, the EC argues in the alte rnative that Article 3.1(b) should be interpreted as
also prohibiting the imposition of a foreign content limitation on foreign producers.
3.5.5. Conclusion
183. For the above reasons the EC submits that the foreign content limitation in the FSC
Replacement scheme renders the basic FSC Replacement subsidy de iure o r a t l e a s t de facto
contingent upon the use of US over imported goods contrary to Article 3.1(b) of the SCM Agreement.
184. The EC asks the Panel to consider the applicat ion of the foreign content limitation in the case
of non-US producers only if it is of the view that this limitation does not make the extended FSC
Replacement subsidy contingent upon export performance contrary to Article 3.1(a).
3.6. The FSC Replacement scheme grants and maintains subsidies contrary to Article 3.2 of
the SCM Agreement
185. Article 3.2 SCM Agreement confirms that:
A Member shall neither grant nor maintain subsidies referred to in paragraph 1
186. It has been demonstrated above the FSC Replacement subsidies fall under paragraph 1 of
Article 3. The US is therefore failing to comply with its obligations under Article 3.2 by granting and
maintaining them.
3.7. The FSC Replacement scheme provides treatment less favourable to products imported
into the US that is accorded to like US products, contrary to Article III:4 of GATT 1994
187. Article III:4 of GATT 1994 provides in relevant part that
The products of the territory of any contracting party imported into the territory of
any other contracting party shall be accorded treatment no less favourable than that
accorded to like products of national origin in respect of laws, regulations and
requirements affecting their internal sale, offering for sale, purchase, transportation,
distribution or use […].
188. The EC considers that the foreign content limitation contained in the FSC Replacement
scheme is inconsistent with Article III:4 of GATT 1994 in that it provides less favourable treatment to
imported parts and materials than to like domestic goods with respect to their internal use in the
production of goods.
189. On the other hand, the EC is making no claim about more favourable treatment in respect of
the export from the US of US finished goods than of like foreign goods present on the US market, nor
about more favourable treatment of exported US finished goods than like foreign goods present on the
same foreign market (situations which are not covered by Article III:4).
190. In view of the terms of Article III:4, in order to rule on this claim the Panel is required to
address the following issues:

• first, whether the measures at issue are “laws, regulations or requirements”;
• second, whether domestic products are “like” imported products;
• third, whether the measures “affect” the “internal use” of the products concerned; and
• fourth, whether the measures afford “less favourable treatment” to imported products than to
domestic products.
3.7.1. The foreign content limitation is a “requirement”
191. By now it is firmly established that a measure need not be compulsory in order to qualify as a
“requirement” for the purposes of GATT Article III:4, and that Article III:4 also applies to
“measures” in the form of conditions to obtain an advantage.
68
192. In EEC – Parts and Components the Panel concluded that the conditions accepted by a firm
in order to obtain an “advantage” granted by the EC authorities also constituted “requirements”.69
193. More recently, in Canada – Automobiles the Panel went even further by holding that the
“letters of undertaking” submitted by certain firm s at the request of the Canadian Government were
“requirements”, even though they were neither legally enforceable nor a condition to obtain an
advantage.70

68 For example, in Canada – Administration of the Foreign Investment Review Act , adopted on
7 February 1984, BISD 39S/140 (“ Canada – FIRA ”), para. 4.5 the Panel held that the legally enforceable
undertakings given by some foreign investors to the Canadian Government constituted “requirements”, even
though the submission of such undertakings was voluntary.
69 EEC – Regulation on Imports of Parts and Components , Panel Report, BISD 37S/132, adopted on
16 May 1990 (“EEC- Parts and components”), para. 5.21:
"…. Article III:4 refers to 'all laws, regulations or requirements affecting the internal sale,
offering for sale, purchase, transportation, distribution or use'. The Panel considered that the
comprehensive coverage of 'all laws, regulations or requirements affecting (emphasis added)
the internal sale, etc.’ of imported products suggests that not only requirements which an
enterprise is legally bound to carry out, such as those examined by the FIRA Panel (BISD
30S/140, 158), but also those which an enterprise voluntarily accepts in order to obtain an
advantage from the government constitute 'requirements' within the meaning of that
provision."
The same interpretation underlies the Report on Italian Discrimination against Imported Agricultural
Machinery, adopted on 23 October 1958, BISD 7S/60 (“ Italian Agricultural Machinery ”), where the Panel
concluded that an Italian law providing special cred it terms to farmers for the purchase of agricultural
machinery conditional upon the purchase by the farmers of Italian machinery was contrary to Article III:4 of
GATT.
70 Canada – Automobiles , Panel Report, para. 10.122. The Panel cited the following circumstances in
order to conclude that the “letters of undertaking” were “requirements”:
“(i) in making the undertakings contained in the Letters, the companies acted at the request of the
Government of Canada; (ii) the anticipated conclusion of the Auto Pact was a key factor in the decision of the
companies to submit these undertakings; (iii) the companies accepted responsibility vis-à-vis the Government of
Canada with respect to the implementation of the undertakings contained in the Letters, which they described as
‘obligations’ and in respect of which they undertook to provide information to the Government of Canada and
indicated their understanding that the Government of Cana da would conduct yearly audits; and (iv) at least until
model year 1996, the Government of Canada gathered information on an annual basis concerning the
implementation of the conditions provided for in the Letters.”

194. As discussed in Section 3.5 above, while the FSC Replacement scheme does not oblige US
producers to use of US inputs, this is in many cases one of the necessary conditions for obtaining an
advantage, the tax benefit, and in many other cases the scheme encourages the use of US goods over
imported goods.
195. The EC submits that, in light of the precedents cited above, the fact that the limit on those
foreign inputs is one of the conditions to obtain the tax benefit is sufficient to conclude that the
foreign content limitation constitutes a “require ment” within the meaning of Article III:4 of GATT
1994.
3.7.2. Domestic parts and materials are “like” the imported goods
196. The distinction operated by the foreign content limitation relates to the origin of the products:
whereas goods of US origin contribute to satisfy the foreign content limitation, imported goods do
not.
197. Clearly, however, the mere fact of having US origin is not, as such, apt to confer upon goods
any characteristic, property or quality which makes them, by definition, “unlike” any imported good.71
3.7.3. The foreign content limitation “affects” the internal “use” of the products concerned
198. The term “affect” has been interpreted broadly since the early days of the GATT. According
to the Panel Report in Italian Agricultural Machinery,
The selection of the word ‘affecting’ would imply […] that the drafters of the Article
intended to cover in [Article III:4] not only the laws and regulations which directly
governed the conditions of sale and purchase but also any laws or regulations which
might adversely modify the conditions of competition between the domestic and
imported products on the internal market
72
199. In the present case, the foreign content limitation “affects” directly the “internal use” of goods
because it will in many cases determine which goods a producer will use. In order not to exceed it,
US producers must, in many cases, incorporate into their products a certain amount of domestic
goods.
200. In addition, as recalled above in Section [ ] there will e.g. be cases in which a firm will be
induced to increase the value of US goods it uses to anticipate price decreases (and therefore the
increase of foreign inputs value relative to price of the finished good). In other words, the content
limitation will play a role on the sourcing decisions in those cases as well. In each and every case, it
will be easier for a US producer to qualify for the tax benefit if it prefers domestic to foreign goods.
Accordingly, the requirement “affects” the “s ale … or use” of goods within the meaning of
Article III:4 of GATT 1994.
201. The word “affecting” must also be interpreted in the light of the object and purpose of
Article III:4. As most recently recalled by the Panel in Canada – Automobiles,

71 In Indonesia – Measures affecting the Automotive Industry , WT/DS54/R, WT/DS55/R, WT/DS59/R,
WT/DS64/R, adopted 23 July 1998 (Indonesia – Autos), the Panel noted, at para 14.113, that an
“… origin-based distinction in respect of internal ta xes suffices in itself to violate Article III:2, without
the need to demonstrate the existence of actually traded like products”.
See also the Panel Report on Canada – Automobiles, para. 10.174.
72 Panel Report on Italian Agricultural Machinery , para. 12. The Appellate Body confirmed that
interpretation of the term “affect” in EC – Bananas, WT/DS27/AB/R, para. 220.

The "no less favourable treatment obligation" in Article III:4 has been consistently
interpreted as a requirement to ensure effective equality of opportunities between
imported products and domestic products. In this respect, it has been held that, since
a fundamental objective of Article III is the protection of expectations on the
competitive relationship between imported and domestic products, a measure can be
found to be inconsistent with Article III:4 because of its potential discriminatory
impact on imported products. The requirement of Article III:4 is addressed to
""relative competitive opportunities created by the government in the market, not to
the actual choices made by enterprises in that market." Both in relation to Article III:2
and Article III:4 it has been established that the actual trade effects of a disputed
measure are not a decisive criterion in determining whether the requirements of these
provisions are met in a given case. Finally, as stated by the Appellate Body, a
determination of whether there has been a violation of Article III:4 does not require a
separate consideration of whether a measure affords protection to domestic
production.
73
The Panel so ruled in respect of a requirement which it described as
a measure which provides that an advantage can be obtained by using domestic
products but not by using imported products 74
202. This characterization clearly also applies to the foreign content limitation contained in the
FSC Replacement scheme: whereas the use of US goods will always guarantee that the content
requirement can be met, and thus will not impair the prospects of obtaining the benefit, the use of
non-US inputs will in many cases impair the possibility of meeting the foreign content limitation.
203. The foreign content limitation is a legal requirement that the foreign inputs and labour not be
used above a certain ceiling, if a taxpayer wants to obtain the tax benefit.
204. In view of the above, the Panel in Canada – Automobiles considered that the measure which it
had just described
has an impact on the conditions of competition between domestic and imported
products and thus affects the "internal sale,… or use" of imported products, even if
the measure allows for other means to obtain the advantage, such as the use of
domestic services rather than products. 75
Accordingly, it concluded that
We also see no merit in Canada's argument that the CVA requirements do not in
practice "affect" the internal sale or use of imported parts and materials because the
CVA levels are so low that they can be easily met on the basis of labour costs alone.
As discussed above, based on the ordinary meaning of the term "affecting", the CVA
requirements must be considered to affect the internal sale or use of imported

73 Canada - Automobiles, Panel Report, para. 10.78 (footnotes omitted). In support of its statement the
Panel refers, in footnotes 842-845, to Panel Report on US – Section 337 of the Tariff Act of 1930 (“United States
- Section 337 ”), BISD 36S/395 , paras. 5.11 and 5.13; Panel Report on US – Malt Beverages , para. 5.31;
Appellate Body Report on Japan – Alcoholic Beverages, p. 16; Appellate Body Report on EC – Bananas, paras.
179 and 216. The Panel’s findings on Article III:4 were not appealed.
75 Ibid. (emphasis added).

products because they have an effect on the competitive relationship between
imported and domestic products by conferring an advantage upon the use of domestic
products while denying that advantage if imported products are used. Thus, we
consider that the fact that it is easier to meet the CVA requirements and thus to obtain
the benefit of the import duty exemption if domestic products are used than if
imported products are used is sufficient to find that these requirements affect the
internal sale or use of products, and we do not believe that we need to examine how
important the CVA requirements are under present circumstances as a factor
influencing the decisions of motor vehicle manufacturers in Canada regarding the
choice between domestic parts, materials and non-permanent equipment, on the one
hand, and imported parts, materials and non-permanent equipment, on the other.
76
205. In the same way, since it will in many cases be easier to respect the foreign content limitation
and thus obtain the benefit of the FSC Replacement subsidy if US products are used than if imported
products are used, the competitive position of thes e products on the US market is “affected” and the
limitation is contrary to Article III:4 of the GATT.
3.7.4. Imported goods are afforded “less favourable treatment”
206. Finally, by requiring in some cases the use of a minimum amount of domestic parts and
materials, the foreign content limitation preclu des producers wishing to benefit from the FSC
Replacement scheme from using an equivalent amount of imported parts and materials and, therefore,
affords “less favourable treatment” to imported products.
207. Furthermore, using domestic parts and materials makes it easier for the beneficiaries not to
exceed the foreign content limitation and hence to qualify for the tax benefit which it is conditional
upon it, than using “like” non-US products.
208. As a consequence, prospective beneficiaries will always give preference, all other conditions
being equal, to US “articles” over like imported goods. Thus, in all cases the foreign content
limitation affords “less favourable treatment” to imported goods than like domestic goods in respect
of their use.
209. The US may try to restate also in respect of this claim its argument that it is also possible to
meet the foreign content limitation other than by using US articles and therefore that requirement is
not WTO-incompatible.
210. However, Article III:4 of GATT must be respected in each and every case, for each and every
transaction. The fact that an analysis transaction by transaction is necessary under Article III:4 is
confirmed by the panel report in United States - Standards for reformulated and conventional
gasoline.
77 In that report the panel rejected the argume nt that the US measures involved in that case
could be justified because imported gasoline was treated “on the whole” no less favourably than
domestic gasoline. The US did not appeal this element of the panel report. The panel in the US –
Gasoline case rejected the “on the whole” reasoning because it would mean that less favourable
treatment in one instance could be offset by more favourable treatment in another instance and noted
that such an approach had also been rejected under GATT 1947.
78

76 Id. at 10.83.
77 United States - Standards for Reformulated and Conventional Gasoline (“US – Gasoline ”), Panel
Report, WT/DS2/R, 29 January 1996.
78 The Panel referred to the Panel Report on United States - Section 337.

211. It is therefore clear that under Article III:4 an analysis has to be carried out at the level of an
individual product, not at the level of the applic ation of the law to all possible products. Any
individual product must be treated no less favourably than a like domestic product – and this in all
cases, for all transactions.
3.7.5. Precedent and the TRIMs Agreement confirm that the foreign content limitation is
inconsistent with Article III:4
212. Local content requirements constitute a clear-cut violation of the national treatment
requirements imposed by GATT Article III:4, which has already been condemned by GATT/WTO
panels on several occasions.
213. In Canada – FIRA, the Panel found that the undertakings given to the Canadian Government
by some foreign investors to, inter alia, purchase goods of Canadian origin in specified amounts or
proportions was contrary to Article III:4.79
214. Similarly, in EEC- Parts and Components , the Panel concluded that, by making the
suspension of anti-circumvention proceedings conditional upon an undertaking to limit the use of
Japanese parts and materials, the EC acted inconsistently with Article III:4.80
215. In Indonesia – Autos, the Panel found that the grant of certain tax and import duty benefits to
a so-called “National Car” manufacturer conditional upon meeting a certain local content percentage
was in violation of Article III:4.81
216. Finally, in Canada – Automobiles, the Panel held that the grant of a customs duty exemption
to certain manufacturers of motor vehicles subject to compliance with certain “Canadian Value
Added” requirements was inconsistent with Article III:4.82
217. The Agreement on Trade-Related Investment Measures (the “TRIMs Agreement”) has
confirmed beyond doubt that local content requirements are inconsistent with Article III:4 of GATT.
Item 1.a) of the Illustrative List of TRIMs includes, among the TRIMs that are inconsistent with
Article III:4, those which require
“a) the […] use by an enterprise of products of domestic origin […], whether
specified in terms of […] value of products, or in terms of a proportion of […] value
of its local production”
218. As the EC has explained above in Section [3.3.2], the foreign content limitation contained in
the FSC Replacement scheme amounts in many cases to a requirement to use US goods rather than
imported articles. Accordingly, it is equivalent to requirements described in item 1(a) of the
Illustrative List. This further confirms that it is inconsistent with Article III:4 of GATT 1994.
3.7.6. Conclusion
219. For the above reasons the EC submits that the Panel should find that the FSC Replacement
scheme accords more favourable treatment to US than to like imported products in relation to the use
of such products for the production of goods for export under the scheme, contrary to Article III:4 of
GATT 1994.

79 Canada – FIRA, Panel Report, paras. 5.4-5.12.
80 EEC –Parts and Components, Panel Report, paras. 1.19-5.21.
81 Indonesia – Autos, Panel Report, para. 14.83 et seq.
82 Canada – Automobiles, Panel Report, para. 10.58 et seq.

3.8. The FSC Replacement subsidies are also inconsistent with the Agreement on
Agriculture
3.8.1. Introduction
220. The US appears to have ignored the Agreement on Agriculture in implementing the DSB
recommendations in this case. Its main argument, that there is a possibility of benefiting from the
FSC Replacement scheme by producing outside the US, has no relevance to agricultural products. As
the US argued itself in the original Panel proceedings:83
It has to be recognised that for important exporting industries, the 50 per cent
requirement has little or no practical effect. For example, in the agricultural sector
that the European Communities targets in this case, the notion of incorporating
imported goods into export products is impractical and artificial. Thus, for the
agricultural sector, the 50 per cent requirement is largely inapplicable.
221. The US therefore agrees that by their very nature agricultural products, in particular
commodities, will not satisfy the test unless produced in the US. They are indeed “grown” outside of
the United States for the purposes of the condition under C) i).
222. The Panel will recall that it found
84 that the US had
acted inconsistently with its obligations under Article 3.3 of the Agreement on
Agriculture (and consequently with its obligations under Article 8 of that
Agreement):
- by providing export subsidies listed in Article 9.1(d) of the Agreement on
Agriculture in excess of the quantity commitment levels specified in the
United States' Schedule in respect of wheat;
- by providing export subsidies listed in Article 9.1(d) of the Agreement on
Agriculture in respect of all unscheduled products.
223. The Appellate Body however disagreed that the FSC scheme involved a reduction in the costs
of marketing exports within the meaning of Article 9.1(d) of the Agreement on Agriculture. This was
because it adopted a slightly different interpretation of the word “marketing” than had the Panel.85
224. The Appellate Body therefore addresse d the EC’s alternative claim under the Agreement on
Agriculture and held that:86
the United States acts inconsistently with its obligations under Articles 10.1 and 8 of
the Agreement on Agriculture by applying export subsidies, through the FSC
measure, in a manner which results in, or which threatens to lead to, circumvention of
its export subsidy commitments with respect to both scheduled and unscheduled
agricultural products;

83 Panel Report, para. 4.1211.
84 Panel Report, para. 8.1(b).
85 Appellate Body Report, paras. 131 and 132.

225. One consequence of the Appellate Body adoption of the alternative claim is that the
distinction between scheduled and unscheduled ag ricultural products becomes unimportant, since
Article 10.1 of the Agreement on Agriculture applies to both equally.
226. The EC will show in [Section 3.7.2] below that nothing has changed with the introduction of
the FSC Replacement scheme and that the US still acts inconsistently with its obligations under
Articles 10.1 and 8 of the Agreement on Agriculture by applying export subsidies, through the FSC
Replacement scheme, in a manner which results in, or which threatens to lead to, circumvention of its
export subsidy commitments with respect to both scheduled and unscheduled agricultural products.
227. For the case that the US should argue or the Panel consider that the FSC Replacement scheme
escapes being prohibited under Article 10.1 of the Agreement on Agriculture by virtue of being a
subsidy within the meaning of Article 9.1 of the Agreement on Agriculture, the EC will also argue in
the alternative in [Section 3.7.3] below that the FSC Replacement scheme will in any event be
inconsistent with the obligations of the US under the Agreement on Agriculture for similar reasons to
those given by the Panel in respect of the FSC scheme.
3.8.2. The FSC Replacement scheme is inconsistent with Articles 10.1 and 8 of the Agreement on
Agriculture
228. The Appellate Body’s reasoning under the Agreement on Agriculture can be summarised as
follows:
• The Appellate Body concluded that the FSC sc heme involved a “subsidy contingent upon
export performance” under the Agreement on Agriculture, for essentially the same reasons as
underlay its and the Panel’s corresponding conclusion with respect to the SCM Agreement;87
• The Appellate Body then reasoned that the term “export subsidy commitments”, in
Article 10.1 must, when read in the light of Articles 3, 8 and 9 of the Agreement on
Agriculture, be considered to relate to both scheduled and unscheduled agricultural
products;88
• Article 10.1 of the Agreement on Agriculture prohibits export subsides being “applied in a
manner which results in , or which threatens to lead to , circumvention of export subsidy
commitments.” Since the FSC scheme creates legal entitlements to receive unlimited amounts
of export subsidies not listed in Article 9.1, both for scheduled and unscheduled products, the
Appellate Body concluded that they “at the very least” threaten to lead to circumvention of
the export subsidy commitments in the first and second clauses of Article 3.3 of the
Agreement on Agriculture;
89
• Consequently, the FSC subsidies are also inconsistent with Article 8 of the Agreement on
Agriculture, in which Members undertook not to provide e xport subsidies otherwise than in
conformity with the Agreement on Agriculture.90
229. Exactly the same reasoning applies in respect of the FSC Replacement scheme. Indeed, a
circumvention of a circumvention is surely still a circumvention!
230. The EC has demonstrated above that the FSC Replacement scheme involves export subsidies.
The FSC Replacement scheme also creates a legal entitlement for companies to receive these

87 Appellate Body Report, paras. 136 to 142.
88 Appellate Body Report, paras. 145 to 147.
89 Appellate Body Report, paras. 150 and 153.
90 Id., at para. 154.

subsidies. They must therefore “at the very least” threaten to lead to circumvention of export subsidy
commitments, that is the commitment in the first clause of Article 3.3 of the Agreement on Agriculture
not to provide export subsides listed in Article 9.1 on scheduled products in excess of its the
budgetary outlay and quantity commitments specified in the relevant part of its Schedule and the
commitment in the second clause of Article 3.3 of the Agreement on Agriculture not to provide export
subsides listed in Article 9.1 at all on unscheduled products. The FSC Replacement scheme is
therefore also inconsistent with Articles 10.1 and 8 of the Agreement on Agriculture.
3.8.3. In the alternative, the FSC Replacement subsidies are inconsistent with Article 3.3 and 8 of
the Agreement on Agriculture read in conjunction with Article 9.1 of the Agreement on
Agriculture
231. Apart from maintaining that the FSC Replacement scheme does not give rise to subsidies or
that they are not export contingent, it would seem that the only way in which the US could argue that
the FSC Replacement subsidies escape prohibition under Article 10.1 of the Agreement on Agriculture
would be to claim that they are export subsidies but fall under one of the categories in Article 9.1 of
the Agreement on Agriculture.
232. Apart from Article 9.1(d) of the Agreement on Agriculture, which the Appellate Body has held
is not applicable to the forgoing of tax receipts indirectly linked to the marketing of agricultural
products, the only other provision of Article 9.1 of the Agreement on Agriculture that has ever been
mentioned as being possibly relevant to this kind of subsidy91 is paragraph (a).
233. For the case that the US makes such an argu ment, the EC maintains an alternative claim that
the FSC Replacement subsidies are inconsistent with Articles 3.3 and 8 of the Agreement on
Agriculture in conjunction with whichever paragraph of Article 9.1 is considered applicable, for the
same reasons, mutatis mutandis, given by the Panel in paragraphs 7.144 to 7.151 and 7.160 to 7.177
of the original Panel Report. There is no need for the EC to examine here the applicability of
whatever paragraph of Article 9.1 is considered applicable because this is what will be established or
admitted before the alternative claim can be considered at all.
3.9. The transitional provisions of the FSC Replacement Act allow companies to continue to
benefit from the WTO incompatible FSC scheme beyond 30 September 2000
234. Section 2 of the FSC Replacement Act formally provides for the repeal of the FSC scheme. It
states that:
Subpart C of part III of subchapter N of chapter 1 (relating to taxation of foreign sales
corporations) is hereby repealed.
235. However, this repeal is something of an il lusion, because FSC transactions can continue for
an indefinite period.
236. While Section 5(c)(1) of the FSC Replacement Act provides in general terms that the Act
applies to transactions entered into after 30 September 2000 and that no new FSC may be created after
the same date, for FSC “in existence on September 30, 2000 and at all times thereafter” the
amendments laid down in the FSC Replacement Act shall not apply to any transaction occurring
• before 1 January 2002, or

91 The Panel mentioned that Article 9.1(a) might be relevant in footnote 700 to paragraph 7.159 of the
Panel Report. The US also frequently referred to it in argument to support its view that paragraph (d) was not
applicable to the FSC scheme.

• after 31 December 2001, pursuant to a binding contract
/g216with unrelated parties and
/g216in effect on 30 September 2000.
237. Binding contracts include contract renewal options, purchase options and replacement options
included in a contract. This only applies if such options are binding against the seller or lessor or
equivalent.
238. There is no legal limit whatsoever to the duration of the FSC scheme through these contracts
and options.
239. The EC submits that the above provision allow companies to continue to benefit from the
WTO incompatible FSC scheme for an indefinite period, and thus perpetuates the violations found to
result from the FSC scheme beyond the period provided for in the Panel Report and confirmed by the
Appellate Body. Accordingly, the US has failed to implement the relevant DSB recommendations
and rulings.
240. Furthermore, pursuant to Section 5(c)(2) of the FSC Replacement Act, FSCs can refuse this
benefit by requesting immediate subjection to the new rules, if applicable, by making an “election” to
this effect. This election can be made in respect of a single transaction, so that for the rest the new
rules will apply. This of course offers old FSCs still an additional option to maximise their tax
benefits according to the most suitable formula.
241. Accordingly, by maintaining the availabili ty of FSC subsidies after 30 September 2000, for
transactions effected by existing FSCs until 31 December 2001 (and, under certain conditions, for an
indefinite period) the US has failed to withdr aw the FSC subsidies as required by Article 4.7 SCM
Agreement and the recommendations and rulings of the DSB and has also failed to comply with its
obligations under Article 21 DSU.
3.10. The US failed to comply with the DSB recommendations and rulings within the time
period specified by the DSB
242. When adopting the Panel and the Appellate Body Reports on 20 March 2000, the DSB
formulated recommendations and rulings also in respect of the compliance “with effect from
1 October 2000”, that is the deadline laid down in the Panel Report and confirmed by the Appellate
Body.
92
243. Failure of the United States to comply with the DSB recommendations and ruling within such
mandatory deadline would have of course placed the US in a position of non-compliance as from
1 October 2000. It would thus have exposed the US to the risk of countermeasures and suspension of
concessions or other obligations by the EC.
244. Given that it had become clear that the United States would not be able to comply within this
mandatory deadline, the US requested the DSB a modification of the time period for compliance, to
which the DSB acceded on 12 October 2000. 93
245. The EC points out that the FSC Replacement Act became law when signed by the President
of the United States on 15 November 2000, that is 15 days after the deadline as extended by the DSB.

92 Panel Report, para. 8.8.
93 WT/DS108/11, 2 October 2000; WT/DSB/M/90, 31 October 2000, para. 6.

246. Accordingly, the EC submits that the US failed to comply with the DSB recommendations
and rulings within the period of time specified by the DSB and has therefore also failed to comply
with Article 21 DSU.
4. PRELIMINARY OBJECTION: THIRD PARTIES’ RIGHTS UNDER THE PANEL
WORKING PROCEDURES
247. Before concluding the EC would like to bring to the attention of the Panel a difficulty
concerning third parties that arises, no doubt inadvertently, out of its Working Procedures.
248. Amongst the additional Working Procedures adopted by the Panel pursuant to Article 12.1 of
the DSU (and item 11 of Appendix 3 to the DSU), rule 9 regulates third parties’ access to the main
parties’ submissions. It provides in relevant part that
Third parties shall receive copies of the parties’ first written submissions. Any party
may decide to provide the third parties with a copy of its rebuttal or other
submissions.
249. A clear distinction is therefore between access to the first submissions and to other
submissions. Whereas third parties have a fully-fledged right to obtain a copy of the main parties’
first written submissions, their access to the other submissions is left to the discretion of such main
parties.
250. The EC considers that the interests of third parties recognized in the DSU are not adequately
protected in this case as these parties are denied a legal right to receive a copy of the parties’
submissions to the first meeting of the Panel other than the first submissions.
251. In the EC’s view this part of the Working Procedures conflicts with Article 10.3 of the DSU,
which reads as follows
Third parties shall receive the submissions of the parties to the dispute to the first
meeting of the panel (emphasis added).
252. This provision is binding on the parties and the Panel; it is unambiguous and does not provide
for exceptions or derogations. Panels are not free to derogate in their Working Procedures from
binding provisions of the DSU that grant procedural rights to the parties or to third parties. Nor is it in
the interest of a fair and objective procedure to prevent third parties from having access to some of the
written submissions that are made in preparation of the first (and only) substantive meeting of the
Panel with the parties and the third parties.
253. The EC would like to stress that the panel pr ocess might seriously suffer from this way of
proceeding. Preventing third parties from usefully participating in the procedure will obviously not
further the Panel’s task of making an objective assessment of the facts and the legal issues before it.
Third parties should not be forced to base their contribution to a dispute settlement procedure on
guesswork or hearsay information about the arguments submitted by the parties. The Working
Procedures prevent third parties from being fully informed about the arguments exchanged before this
Panel by the time of the substantive meeting with the parties and the third parties. As a consequence,
the limitation of the access to documents that are befo re the Panel at the time of the meeting with the
parties and the third parties is also likely to prevent the Panel from the benefit of useful contributions
by third parties which could help the Panel to make the objective assessment that it is required to
make under Article 11 of the DSU.

254. The EC is aware that some other panels have adopted similar working procedures, and this is
no doubt the origin of the adoption of the above provision in this proceeding. But a practice which is
in conflict with the express provisions and the objectives of the DSU cannot be considered as being
justified because it has also been followed in some other procedures. A procedural error cannot be
healed by repeating it. As in all the other cases of a similar nature in which it was involved, the EC
therefore maintains that this way of proceeding is incompatible with fundamental guarantees of
procedural fairness which are implicit in the DSU and must be respected by this Panel, whatever the
practice of other panels may have been.
94
255. A previous panel report under Article 21.5 of the DSU ( Australia – Salmon)95 has addressed
this issue but has taken a different view from that set out by the EC above. The EC would make the
following comments on the reasoning in the Australia – Salmon report.
256. The panel in that case expressly recognized that the fact of sending third parties only copies
of what is - normally - the first round of submissions is a mere “practice” under Article 10.3. 96 This
rather confirms that there is no legal requirement to this effect in the DSU.
257. The panel further recalled the expedited nature of proceedings under Article 21.5. The EC
would however insist again that supplying third parties with all the submissions available to the panel
ahead of the third party session would in no way ma ke this process more burdensome or slower. It
would be incumbent upon third parties to avail th emselves of the opportunity to make a fully
informed intervention before the panel within the deadline that the panel has already established.
258. In view of the foregoing, the EC requests that the Panel rule that third parties be allowed to
receive all the main parties’ submissions preceding the single Panel meeting. In order for this ruling
to be effective, the EC requests that the Panel make its ruling, and communicate it to the parties and
the third parties as soon as possible after the US has had an opportunity to comment, that is after
receipt of the US first written submission and before the date for the presentation of the second
written submissions.
5. CONCLUSION
259. For the above reasons the EC requests the Panel to find that:
• The FSC Replacement scheme created by the FSC Replacement Act gives rise to subsidies
within the meaning of the SCM Agreement and the Agreement on Agriculture.
• The FSC Replacement scheme provides subsidies contingent upon export performance
contrary to Article 3.1(a) of the SCM Agreement. This prohibition is supported and confirmed
by the fact that these subsidies are specifically related to exports within the meaning of
item (e) to the Illustrative List in Annex I to the SCM Agreement.
• The foreign content limitation in the FSC Replacement scheme renders the basic FSC
Replacement subsidy (and the extended FSC Replacement subsidy, if this is not contrary to
Article 3.1(a)) contingent upon the use of US over imported goods contrary to Article 3.1(b)
of the SCM Agreement.

94 Cf. para. 3.7 to 3.10 of the Panel report on “ Australia – Subsidies Provided to Producers and
Exporters of Automotive Leather – Recourse to Article 21.5 of the DSU by the United States ”, doc.
WT/DS126/RW, 21 January 2000.
95 Australia – Measures Affecting Importation of Salmon – Recourse to Article 21.5 by Canada , Panel
Report WT/DS18/RW, 18 February 2000.
96 Ibid., para. 7.

• The FSC Replacement scheme accords more favourable treatment to US than to like imported
products in relation to the use of such products for the production of goods for export under
the scheme, contrary to Article III:4 of GATT 1994.
• The FSC Replacement scheme is inconsistent with Articles 10.1 and 8 of the Agreement on
Agriculture or, in the alternative, with Articles 3.3 and 8 of the Agreement on Agriculture in
conjunction with Article 9.1 of the Agreement on Agriculture.
• By maintaining the availability of FSC subsidies after 30 September 2000, for transactions
effected by existing FSCs until 31 December 2001 (and, under certain conditions, for an
indefinite period) the US has failed to withdraw the FSC subsidies as required by Article 4.7
SCM Agreement and the recommendations and rulings of the DSB and has also failed to
comply with its obligations under Article 21 DSU.
• By failing to withdraw the FSC subsidies and to comply with the rulings and
recommendations of the DSB by the end of the period of time allowed by the DSB, the US
has also failed to comply with its obligations under Article 21 DSU
260. In addition, the EC requests the Panel to make a preliminary ruling to the effect that third
parties are entitled to receive all written submissions of the parties submitted prior to the meeting of
the Panel and to make this preliminary ruling and communicate it to the parties and the third parties as
soon as possible after receipt of the US first written submission and before the date for the
presentation of the second written submissions.

ANNEX
The cost of materials a percentage of the fair market value of products
Section 943(1)(C) of the IRC, introduced by the FSC Repeal and Extraterritorial Income
Exclusion Act, defines qualifying foreign trade property to be, inter alia,
property—
(C) not more than 50 per cent of the fair market value of which is attributable to—
(i) articles manufactured, produced, grown, or extracted outside the United States, and
(ii) direct costs for labour (determined under the principles of section 263A) performed
outside the United States.
The cost of materials as a percentage of the final price of any product varies according to a
number of factors, e.g. the market price of the materials, the relative cost of other factors of
production (e.g. labour, overheads, depreciation), the level of integration of the producer concerned,
and the expected level of profit.
Nevertheless, there are some products, produced or assembled in certain ways, for which the
materials are so important an input that it is difficult to believe that their contribution to fair market
value could ever be below 50 per cent.
The EC’s main legal argumentation in respect of this requirement is developed in the text of
its submission to the Panel. In addition, and for purely illustrative purposes of that general
argumentation, the EC gathered some data relating to the production in certain sectors (and has cross-
checked them with information obtained from certain European industries and in the course of various
trade investigations).
The most obvious examples will be fairly basic products, with little or no brand value, having
a low level of processing and attracting a low profit margin. Some examples are as follows.
1. The Steel industry
(a) Hot-rolled coils
Hot-rolled coils are manufacturing in steel mills and are the pre-material for many types of
steel products e.g. wide and narrow strips, cold-rolled products, tubes. The normal cost of production
(including SGA expenses) of hot-rolled coils is around 207 Euro per tonne; on this basis fair market
value is around 220 Euro per tonne.
The cost of materials involved in production is:
Iron 109 Euro per tonne
Steel scrap 15 Euro per tonne
Others 8 Euro per tonne
Total 132 Euro per tonne
The contribution of materials to the fair market value of hot rolled coils is 60 per cent.

(b) Heavy Steel Plate
The normal cost of production (including S GA expenses) of heavy plate is 290 Euro per
tonne ; on this basis the fair market value is around 310 Euro per tonne.
The cost of materials involved in production:
Steel slab 200 Euro per tonne
Steel scrap -10 Euro per tonne (recovered)
Total 190 Euro per tonne
The contribution of materials to the fair market value of steel plate is 61 per cent.
(c) Stainless Steel Fasteners
The raw material for making stainless steel fasteners is stainless steel wire rod. The cost of
the raw material accounts for between 55 and 61 per cent of the fair market value (normal selling
price) of the final product.
2. Other metal products
(a) Aluminium household foil
The main raw material for aluminium household foil is aluminium slabs. The cost of the raw
material accounts for between 58 and 63 per cent of the fair market value (normal selling price) of the
final product.
3. Woven glass fibre fabrics
The raw material for producing woven glass fibre fabrics is glass fibre yarn. The cost of the
raw material accounts for between 55 and 60 per cent of the fair market value (normal selling price)
of the final product.
4. Chemicals and synthetic fibres
(a) Polyethylene Terephthalate Bottle Resin
The raw materials for producing this product, which is used for the production of plastic
bottles, are purified terephthalic acid, mono ethylene glycol, di-ethylene glycol and isophthalic acid.
Together these account for up to 70 per cent of the fair market value (normal selling price) of the final
product.
5. Aircraft
The engines of an aircraft can account for 30 per cent of the final price of the finished
product. Similarly, the avionics on a modern aircraft can also cost 30 per cent of the final value.
Engines and avionics are typically purchased from outside suppliers. Together they can
account for 60 per cent of the final price.

NOTE
Assembly always involves direct labour costs which can be quite high. This means that, to
take the example of aircraft where bought-in engines and avionics account for 60 per cent of the final
value, the 10 per cent that must be sourced in or from the US in order not to exceed the 50 per cent
limitation is increased by the amount of the foreign direct labour costs also incurred by the producer.

List of Exhibits
EC-1 Extract from Inside US Trade, 24 March 2000 (page 9).
EC-2 The initial US proposal to replace the FSC scheme.
EC-3 Letter of Commissioner Lamy to US De puty Secretary of State Eizenstat of 26 May 2000.
EC-4 Letter of Commissioner Lamy to US Deputy Secretary of State Eizenstat of
31 August 2000.
EC-5 FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (the “FSC Replacement
Act”).
EC-5A Technical Explanation of the Senate Amen dment to H.R. 4986, the “FSC Repeal and
Extraterritorial Income Exclusion Act of 2000 (JCX-111-00) of 1 November 2000.
EC-6 Congressional Research Service Report on Foreign Sales Corporation Tax Benefit
for Exporting and World Trade Organization The Foreign Sales Corporation FSC
Tax Benefit for Exporting and the WTO David L. Brumbaugh Specialist in Public
Finance. Government and Finance Division.
EC-7 Report of US Deputy Secretary of State Eizenstat speaking during the Senate Finance
Committee passing of the FSC Replacement Bill on 19 September 2000, Inside US Trade,
3 November 2000 (Article starts on page 26 and continues on pages 24 and 25. The quoted
text is on page 25).
EC-8 The Congressional Budget Office Cost Estimate of 13 September 2000.
EC-9 List of provisions in Subtitle A, Chapter 1, Subchapter B, Part III of the IRC excluding
certain income from US tax.

(a) The Appellate Body’s Decision ............................................................................................... 96
(b) The Application of Canada-Autos to the Act ..........................................................................97
F. T HE ACT’S 50 PER CENT RULE IS NOT INCONSISTENT WITH ARTICLE III:4 OF GATT
1994 .........................................................................................................................................98
1. The Meaning of Article III:4................................................................................................. 98
2. The EC Inaccurately Describes the 50 Per cent Rule .........................................................98
3. The EC Proffers No Evidence To Support Its Claim Under Article III:4........................99
G. T HE ACT’S EXCLUSION OF EXTRATERRITORIAL INCOME DOES NOT VIOLATE US
OBLIGATIONS UNDER THE AGREEMENT ON AGRICULTURE ..................................................100
H. T HE UNITED STATES COMPLIED WITH THE DSB’S RECOMMENDATIONS AND RULINGS .......101
1. Based on All of the Circumstances Surrounding this Dispute, the Panel Should
Find that the Act’s Transition Rules Constitute a Reasonable Method of
Complying with the DSB’s Recommendations and Rulings ............................................101
2. The United States Complied with the Time Period Specified by the DSB......................102
I. T
HE PANEL SHOULD REJECT THE EC’S PRELIMINARY OBJECTION REGARDING THIRD
PARTY RIGHTS .......................................................................................................................103
VI. CONCLUSION .................................................................................................................. ...104
I. INTRODUCTION
1. The European Communities (“EC”) has initiated these proceedings to challenge the FSC
Repeal and Extraterritorial Income Exclusion Act of 2000 (“the Act”). 1 In doing so, the EC claims
that the new law is essentially the same as the former US Foreign Sales Corporation (or “FSC”) tax
provisions it replaced, and the EC proposes novel interpretations of WTO rules. The United States
presents the Panel with this submission to explain how the new law works and why it is consistent
with WTO rules.
2. The EC’s efforts to paint the Act with the same brush it used on the FSC is inappropriate
given that the Act was specifically designed to remedy defects found by the FSC Panel and the
Appellate Body. The Act differs from the FSC in many ways, but two are particularly significant.
First, unlike the FSC, the Act changes the United States’ general rule – or normative benchmark – for
taxation of foreign income and does not create a tax-saving exception to an otherwise applicable
revenue-raising general rule. Thus, the Act does not confer a subsidy. Second, because the Act
applies to a broad category of income, it is not export-contingent. Thus, the Act does not – as the
Panel and Appellate Body found in the case of the FSC – create a situation in which a WTO Member,
“having decided to tax a particular category of income . . . carve[s] out an export contingent
exemption from . . . its other rules of taxation.”
2 In fact, the Act has no such export contingency, and
it does not “carve out” any income that would be “taxed . . . under other rules” at all.
3. Instead, the Act represents a major change in the way the United States approaches the
taxation of income derived from the sale, lease and rental of goods outside its borders and the method

1 Public Law 106-519, 114 Stat. 2423 (2000), copy attached as Exhibit US-1.
2 United States - Tax Treatment for “Foreign Sales Corporations” (“FSC (AB) ”), WT/DS108/AB/R,
Report of the Appellate Body adopted 20 March 2000, para. 99; and United States - Tax Treatment for “Foreign
Sales Corporations” (“FSC (Panel )”), WT/DS108/R, Report of the Panel, as modified by the Appellate Body,
adopted 20 March 2000, para. 7.108.

by which the United States avoids double taxation of such income. Previously, the United States
relied on a worldwide approach, taxing all income of US individuals and corporations wherever
earned. In the context of this worldwide approach to taxation, the United States relied principally on
tax credits to offset foreign taxes paid in order to avoid taxation of the same income by two taxing
authorities. With the Act, the United States has moved away from a system that relies principally on
tax credits to relieve double taxation. The Act avoids double taxation by virtue of the fact that income
is not subject to US tax in the first place. By excluding income from US taxation rather than
employing tax credits to relieve double taxation, the Act in many respects adopts an approach to
relieving double taxation that is similar to territori al exemptions for foreign-income provided by a
number of countries around the world.
4. As troubling as the EC’s mischaracterization of the Act may be, its recasting of WTO rules is
even worse. With regard to the definition of “subsidy”, the EC ignores what the Appellate Body said
about the meaning of a “defined, normative benchm ark” against which to compare “the contested
measure and revenues that would be due in some other situation.”
3 Rather than adhering to these
words, the EC asks the Panel to reverse the Appellate Body’s analysis by treating the revenue-raising
exception in the Act as the “defined, normative benchmark” and to compare it against the new US
general rule of xcluding extraterritorial income from US taxation.
5. In addition, the EC proposes a new standard for defining an export subsidy. The EC claims
that the test is not whether a subsidy is conditioned or dependent for its existence on export
performance, as the Appellate Body has said, but rather whether exports are treated differently than
like domestic transactions. Such a test is not grounded in the language of the Agreement on Subsidies
and Countervailing Measures (“SCM Agreement”) or in panel or Appellate Body reports interpreting
that agreement. The EC even goes so far as to ar gue that the Illustrative List of Export Subsidies –
which merely provides examples of prohibited export subsidies – broadens the prohibition beyond
subsidies that are “contingent . . . upon export performance”.
6. The EC’s attempts to ignore the significant ways in which the Act differs from the FSC, to
transform the Act into something it is not, and to reshape WTO provisions in ways they do not bend,
suggests that the EC cannot quite fit the Act neatly into any pre-existing paradigm for establishing a
WTO inconsistency, and that it cannot explain why the Act is an export subsidy but comparable
measures of its own member states are not. In effect, the EC is saying that while it might not be able
to define what a subsidy or export subsidy is, it knows one when it sees one.
7. For this reason, the EC not only attacks the 50 per cent limitation on certain foreign value in
the Act (the “50 per cent rule”), but also attempts to rely on its own erroneous interpretation of that
limitation to infect all other provisions of the Act. Specifically, the EC argues that, even if the other
provisions of the Act do not constitute subsidies or export subsidies in and of themselves, the 50 per
cent rule taints the whole Act and causes it to be an export subsidy. The 50 per cent rule, however,
limits only certain kinds of foreign value, and does not disadvantage imported products as the EC
contends. It certainly does not taint the rest of the Act in the way the EC claims.
8. The EC’s pliable approach to adjudication is inappropriate. Interpretation and application of
treaties under public international law require a strict adherence to the language of an agreement, as
well as a clear explanation of the reasons why a contested measure does or does not conform to that
language. The United States respectfully requests the Panel to resist the EC’s outcome-determinative
approach and instead to apply a principled mode of analysis that is faithful to the language of the
relevant WTO provisions. The United States submits that such an analysis will lead to the conclusion
that the Act is consistent with these provisions.

3 FSC (AB), para. 90.

II. PROCEDURAL BACKGROUND
9. This proceeding concerns measures taken by the United States to comply with the
recommendations and rulings of the DSB in WT/DS108.
10. The procedural history of this dispute up through the initial panel phase is set forth in
paragraphs 1.1-1.7 of FSC (Panel). On 8 October 1999, the Panel circulated its final report. The
Panel found that the FSC tax exemption constituted a prohibited export subsidy that was inconsistent
with US obligations under Article 3.1(a) of the SCM Agreement. 4 The Panel also found that the FSC
tax exemption constituted an export subsidy within the meaning of Article 9.1(d) of the Agreement on
Agriculture and that the United States had acted inconsistently with its obligations under Articles 3.3
and 8 of that Agreement. 5 Pursuant to Article 4.7 of the SCM Agreement, the Panel specified that
“FSC subsidies must be withdrawn at the latest with effect from 1 October 2000.”6
11. Both the United States and the EC appealed certain of the Panel’s findings. The Appellate
Body circulated its report on 24 February 2000. The Appellate Body affirmed the Panel’s findings
under the SCM Agreement, but modified the Panel’s reasoning somewhat. The Appellate Body
reversed the Panel’s findings under the Agreement on Agriculture, finding instead that the United
States had acted inconsistently with its obligations under Articles 10.1 and 8 of that Agreement.7
12. On 20 March 2000, the DSB adopted the reports of the Panel and the Appellate Body. On
7 April 2000, the United States informed the DSB of its intention to implement the recommendations
and rulings of the DSB in a manner consistent with its WTO obligations.
13. Notwithstanding its best efforts, for a variety of reasons the enactment of corrective
legislation took longer than anticipated. 8 Accordingly, on 29 September 2000, the United States
requested that the DSB extend the time period for withdrawing the FSC to 1 November 2000.9 On 12
October 2000, the DSB granted this request. Also on 29 September, the United States and the EC
entered into a procedural agreement applicable to the follow-up to the FSC dispute.10 Essentially, this
agreement provides for panel and Appellate Body review of the WTO-consistency of the Act before
any consideration of the appropriate amount, if any, of countermeasures or suspension of concessions
under Article 22.6 of the DSU.
14. On 15 November 2000, the Act was signed into law. The provisions of the Act were made
effective with respect to transactions after 30 September 2000.
15. On 17 November 2000, the EC initiated proceedings under Article 21.5 of the DSU by
requesting consultations with the United States regarding the Act. 11 O n t h e s a m e d a y , t h e E C
requested authorization from the DSB to take appropriate countermeasures and suspend concessions

4 FSC (Panel), para. 8.1(a).
5 Id., para. 8.1(b).
6 Id., para. 8.8.
8 The United States notes that the EC has referred to discussions between U.S. and EC officials
regarding initial legislative proposals to comply with the DSB’s recommendations and rulings. EC First 21.5
Submission, paras. 4-14. The legislation ultimately passed by the United States, the Act, differs substantially
from these initial proposals and, in fact, addresses certa in concerns raised by the EC. Considering these
differences, these initial legislative proposals, while reflecting the United States’ extensive efforts and good
faith in attempting to address the EC’s concerns and honor U.S. WTO obligations, are irrelevant to the issues
before the Panel.
9 WT/DS108/11 (2 October 2000).
10 WT/DS108/12 (5 October 2000).
11 WT/DS108/14 (21 November 2000).

pursuant to Article 4.10 of the SCM Agreement and Article 22.2 of the DSU. 12 On 27 November
2000, pursuant to Article 4.11 of the SCM Agreement and Article 22.6 of the DSU, the United States
objected to the appropriateness of the countermeasures and the level of suspension of concessions
proposed by the EC, thereby resulting in a referral of the matter to arbitration.13
16. The United States and the EC consulted on 4 December 2000, but were unable to resolve the
matter. On 7 December 2000, the EC requested the establishment of a panel under Article 21.5.14 On
20 December 2000, the DSB established a panel.15
17. In accordance with the 29 September procedural agreement, on 21 December 2000, the
United States and the EC submitted a joint request that the arbitration proceeding under Article 4.11
and Article 22.6 be suspended until the adoption of the Article 21.5 panel report or, in the event of an
appeal, the adoption of the Appellate Body report.16 As a result, the arbitration was suspended.17
18. Following the establishment and composition of the Panel, on 21 December 2000, the Panel
held an organizational meeting with the parties and presented the parties with a draft schedule and
Working Procedures. The draft schedule called for the simultaneous filing of written rebuttal
submissions by both parties. At the organizational meeting, the United States observed that if written
rebuttals were simultaneous, the United States essentially would have nothing to say, given that in its
first submission it already would have responded to the EC’s first submission. The EC, on other
hand, would be able to respond in its rebuttal to th e first US submission. Effectively, the EC would
be given the opportunity to file two written submissions, while the United States would be limited to
one. Accordingly, the United States requested that rebuttal submissions be staggered, so that the EC
would file its rebuttal submission first, followed by the US rebuttal submission.
III. FACTUAL BACKGROUND
19. In this section, the United States describes the Act and the territorial limitation on US taxing
authority that it creates. This section then co mpares the Act to European systems that provide a
territorial exemption for income earned in export transactions. Finally, this section distinguishes the
Act from the former FSC regime.
A. D
ESCRIPTION OF THE ACT
20. The Act accomplishes two primary objectives. First, to comply with the DSB’s
recommendations, section 2 of the Act repeals the FSC provisions in sections 921 through 927 of the
US Internal Revenue Code (“IRC”).18 Second, section 3 of the Act establishes a new regime for the
treatment of extraterritorial income.19 Under the new regime, extraterritorial income is excluded from
gross income for US tax purposes, and, as explained below, is thereby placed outside the taxing
jurisdiction of the United States. The rationale for, and details of, this exclusion are explained below.

12 WT/DS108/13 (17 November 2000).
13 WT/DS108/15 (27 November 2000).
14 WT/DS108/16 (8 December 2000).
15 See WT/DS108/19 (5 January 2001).
16 WT/DS108/19 (5 January 2001).
17 WT/DS108/18 (21 December 2000).
18 The Act § 2.
19 The Act § 3.

1. Objectives of the Act and Its Effect on the US Tax System
21. Reports of the relevant committees of the US Congress form essential parts of the legislative
history of the Act, and explain the underlying intent of Congress.20
(a) Compliance with the Panel and Appellate Body Reports
22. The legislative history makes clear that one of the objectives of the Act was to comply with
the findings contained in the FSC Panel and Appellate Body reports. 21 The Act accomplishes this
objective in two ways. First, the Act repeals th e FSC provisions with effect from 1 October 2000.
From that date, no corporation may elect to be treated as a FSC. 22 In addition, subject to reasonable
and customary transition rules, the FSC provisions cease to have any application with respect to post-
effective date transactions through existing FSCs.
23. Second, the Act also remedies the defect in the FSC found by both the Panel and the
Appellate Body – namely, that th e FSC tax exemption was an exception to otherwise applicable tax
rules that applied only to exports. Rather than providing unique or special treatment for export-
related income, the Act treats all foreign sales and all taxpayers alike. Under the Act, as under many
EC and other tax systems, the income that is outside the US tax jurisdiction is in no way limited to
income earned through exporting. Thus, taxpayers receive the same US tax treatment with respect to
income derived from foreign transactions regardless of whether exports are involved. Moreover, the
Act’s exclusion of income applies without regard to whether the income is earned by a US or foreign
individual, a US or foreign corporation, or a partnership or other pass-through entity.
(b) A New US Approach to Taxation of Foreign Income
24. In addition to implementing the DSB’s reco mmendations, the Act also was intended to
rationalize the treatment of foreign income under the US system of taxation. Wholly apart from the
FSC dispute, the United States Senate had begun a process of reviewing the international provisions
of the IRC with hearings early in 1999. Among the issues identified was the need to re-examine the
US tax treatment of foreign income.
23
25. Although the timing of the Act certainly was affected by the FSC dispute, the substance of the
Act was influenced by ongoing congressional review . By excluding extraterritorial income from the
definition of “gross income”, the Act fundamentally changes the way the United States taxes foreign
income.24 As the legislative history of the Act makes clear, the definition of “gross income,” as
modified by the Act, defines the outer limits of US tax jurisdiction. 25 Whereas the United States
previously operated under the principle that all income of US persons is within the US taxing
jurisdiction, the Act creates a new general rule under which excluded extraterritorial income earned
by US taxpayers is outside US taxing jurisdiction. In recognition of this, a congressional report states
that the territorial limitations created by the Act “parallels the exclusions under most territorial tax
systems, particularly those employed by European Union member states.”
26

20 S. Rep. No. 106-416 (2000) (“ Senate Report”) (Exhibit US-2); and H.R. Rep. No. 106-845 (2000)
(“House Report”) (Exhibit US-3).
21 Senate Report, page 5; House Report, page 3.
22 The Act § 5(b)(1).
23 Senate Report, page 5; House Report, page 18.
24 Senate Report, page 17.
25 Id., page 16.
26 Id., page 5.

(c) A Measure to Avoid Double Taxation
26. Finally, the Act provides a method for avoiding double taxation. 27 The legislative history
makes clear that Congress intended that the Act’s exclusion serve as a means of avoiding double
taxation of excluded income. 28 Because the exclusion avoids double taxation, the Act disallows
foreign tax credits and deductions that otherwise might be allocable to excluded extraterritorial
income.
29 By excluding certain foreign income, the Act adopts an internationally-accepted method for
avoiding double taxation, a method employed by a number of EC member states and other countries.
2. Description of Excluded Extraterritorial Income
27. Turning to the details of the Act, under section 114(a) of the IRC, as added by the Act,
extraterritorial income is excluded from “gross in come.” Thus, extraterritorial income is placed
outside the limits of US taxing jurisdiction.
28. The Act provides a detailed definition of the term “extraterritorial income.” The definition is
contained primarily in new sections 114, 941, 942, and 943 of the IRC. These sections are included in
Exhibit US-1 and are summarized here.
29. There are three main aspects to the definition of extraterritorial income. Extraterritorial
income generally is defined as (1) qualifying foreig n trade income (2) attributable to foreign trading
gross receipts (3) with respect to which the taxpayer has performed certain foreign economic
processes.
30 This definition contains both a qualitative and a quantitative component. The qualitative
component relates to the type of transactions subject to an exclusion, while the quantitative
component relates to the amount of the exclusion. Each of these components is described below.
(a) The Qualitative Component of Excluded Income: Its Extraterritorial Nature
30. The first and perhaps most basic element of extraterritorial income is that it arises from
extraterritorial transactions – i.e., foreign – sales, leases and rentals. The Act provides that
extraterritorial income must derive from one of five categories of foreign transactions. 31 These five
categories include:
(1) the sale of qualifying property for its use or disposition outside the United States,
(2) the lease of qualifying property for use by the lessee outside the United States,
(3) the provision of services related and subsidiary to the first two categories,
(4) the provision of managerial services performed for unrelated persons in connection
with the first three categories, and
(5) the provision of engineering or architectural services for projects located outside the
United States.
32

27 Id., pages 2, 6.
28 House Report, page 18 (“the extraterritorial income excluded by this legislation from the scope of
US income taxation is parallel to the foreign-source income excluded from tax under most territorial tax
systems”).
29 The Act § 3, amending IRC § 114(c)-(d).
30 The Act § 3, amending IRC §§ 114(b)- (e) and 942(b)(1).
31 To be precise, under section 114(e), extraterritorial income is defined as gross income attributable to
“foreign trading gross receipts.” “Foreign trading gross receipts”, in turn, is defined by section 942(a) as gross
receipts derived from one of five categories of foreign transactions listed here. See id.
32 The Act § 3, amending IRC § 941(a)(1).

The Act makes the extraterritorial nature of excluded income clear by providing that the goods or
services sold or leased are ultimately not to be used or performed in the United States, and may not be
for the use of the United States itself or any instrumentality thereof.33
31. In addition, the Act requires that the gross receipts from which excluded extraterritorial
income arises must have a nexus with activity occurring in a foreign jurisdiction. Excluded
extraterritorial income can be derived only from tran sactions with respect to which the taxpayer (or a
related person) engages in solicitation, negotiation, or contracting activities in a foreign jurisdiction,
and incurs a certain threshold amount of costs associated with economic activities in a foreign
jurisdiction.34 These foreign economic activities (or “processes”) may consist of one or more of the
following five categories:
(1) advertising and sales promotion,
(2) processing of customer orders and arranging for delivery,
(3) transportation outside the United States in connection with delivery to the customer,
(4) billing activities, and
(5) the assumption of credit risk. 35
The threshold amount of costs is 50 per cent of the aggregate total costs incurred in all five categories
or 85 per cent of the total costs incurred in any two of the five categories.
36 These foreign economic
processes must be performed, and the threshold re quirements met, with respect to every foreign
transaction giving rise to excluded extraterritorial income.
32. The Act also provides that no more than 50 per cent of the fair market value of any goods
involved may be attributable to articles produced outside the United States and direct labour costs
incurred outside the United States.37 Goods can meet this requirement even if 100 per cent of the fair
market value of their inputs or content is foreign.
(b) The Quantitative Component of Excluded Foreign Trade Income
33. In addition to the qualitative component of excluded income described above, the Act
provides three different methods for identifying “excluded income”. Specifically, “qualifying foreign
trade income” is the amount of income from covered transactions, which, if excluded, would reduce
the taxpayer’s taxable income by the greatest of: 15 per cent of foreign trade income, 1.2 per cent of
total gross receipts, or 30 per cent of foreign sale and leasing income.38 Different methods are needed
because different taxpayers use different business models, and the use of only one method could lead
to disparate results among businesses engaged in similar foreign business activities. Accordingly,
taxpayers may choose the method for quantifying excluded income that is most appropriate to their
business circumstances.
39

33 The Act § 3, amending IRC § 942(a)(2).
34 The Act § 3, amending IRC §§ 942(b)(1), 942(b)(2)(A).
35 The Act § 3, amending IRC § 942(b)(3).
36 The Act § 3, amending IRC § 942(b)(2)(A)(ii) and (B).
37 The Act § 3, amending IRC § 943(a)(1)(C).
38 The Act § 3, amending IRC § 941(a)(1).
39 The Act § 3, amending IRC § 941(a)(2). Of the three calculations used to determine “qualifying
foreign trade income”, one is a percentage of overall “foreign trade income”, one is a percentage of total
receipts, and the third – involving “foreign sales and leasing income” – is a percentage of a subset of “foreign
trade income”. In other words, “foreign sales and leasing income” is a type of foreign trade income. “Foreign
sales and leasing income” is “foreign trade income” that is attributable to the lease or sale of certain types of
property, and that is directly tied to the performance of the prescribed foreign economic processes described
above. The Act § 3, amending IRC § 941(c).

3. Evenhanded Treatment of Taxpayers
34. The Act applies equally to individuals, partnerships, and corporations that earn excluded
extraterritorial income. The Act applies to these taxpayers irrespective of whether they are located in
the United States or abroad, the only requirement being that these persons be subject to US taxation. 40
As explained by the legislative history,
the bill requires that property manufactured outside of the United States be
manufactured by (1) a domestic corporation, (2) an individual who is a citizen or
resident of the United States, (3) a foreign corporation that elects to be subject to US
taxation in the same manner as a US corporation, or (4) a partnership or other pass-
through entity all of the partners or owners of which are described in (1), (2), or (3)
above.41
This requirement is intended to equalize treatment of US taxpayers operating abroad in branch form
with the treatment of US taxpayers operating abroad in corporate subsidiary form.42 To reinforce this
evenhanded treatment, the Act provides that property may be the subject of a qualifying transaction
even if it is produced outside of the United States.43
35. In addition, the Act permits a foreign corporation to elect to be treated as a domestic
corporation to ensure that property produced outside the United States need not be produced by a US
person (e.g., a US corporation). 44 This election is similar to other elections given to taxpayers that
would not otherwise be subject to US tax jurisdiction.45
4. The Act’s Effective Date
36. The Act is effective for transactions after 30 September 2000. 46 All provisions of the Act
have effect from this date. Thus, no FSCs may be created after 30 September 2000. 47 A foreign
corporation created after 30 September 2000, will be treated under general rules applicable to all
foreign corporations. None of the rules under the former FSC provisions, including the special
“dividends-received deduction”, will be available to such a corporation or its US parent. In addition,
subject to reasonable and customary transition rules, described below, the FSC provisions cease to
have any application with respect to post-effective date transactions.
5. The Act’s Transition Rules
37. Transition relief is common under US tax law in order to avoid undue hardship or confusion
with respect to pre-existing business arrangements entered into under pre-existing law. Section 5(c)
of the Act provides that the Act’s amendments do not apply to a transaction in the ordinary course of a
trade or business of a FSC already in existence as of 30 September 2000, which occurs: (1) before
1 January 2002,
48 or (2) after 31 December 2001, pursuant to certain binding contracts. 49 The only

40 The Act § 3, amending IRC § 942(a)(2).
41 Senate Report, page 10.
42 Id.
43 The Act § 3, amending IRC § 943(a)(1)(A).
44 The Act § 3, amending IRC § 943(e)(1).
45 For example, a foreign corporation may elect to be treated as a US corporation under IRC § 953(d)
(relating to foreign insurance companies), IRC § 897(i) (relating to foreign corporations with US real property
interests), and IRC § 1504 (relating to foreign corporations formed solely for foreign law purposes). See
Exhibit US-4.
46 The Act § 5(a).
47 The Act § 5(b)(1).
48 The Act § 5(c)(1)(A).

binding contracts to which the transition rules may apply are transactions between a FSC (or a related
person) and an unrelated person that are already in effect on 30 September 2000.50
38. At any time during the transition period, a taxpayer may elect to apply the Act to a transaction
that would otherwise be eligible for transition relief. 51 Such an election would be effective for the
taxable year for which it was made and for all subsequent taxable years. 52 Under no circumstances is
a taxpayer permitted to apply the FSC provisions and the Act to the same transaction or transactions.53
The Act automatically applies (without any election or other notification) to transactions not covered
by the transition rules.54
B. THE ACT MOVES THE US A PPROACH TO TAXATION OF FOREIGN INCOME CLOSE TO THE
EUROPEAN MODEL
39. The US Congress recognized that by excluding extraterritorial income from gross income, the
Act “parallels the foreign-source income excluded under most territorial tax systems, particularly
those employed by Europ ean Union member states.”
55 In this regard, many European countries
impose income taxes on a territorial basis, at least in part. Subject to numerous exceptions, European
governments applying a territorial approach do not tax income earned outside their borders. European
territorial exemptions extend not only to income earned by resident corporations and offshore
branches, but also to income earned by foreign subsidiaries and dividends paid to domestic parents by
foreign subsidiaries.
40. European tax exemptions for offshore income apply to three types of transactions: imports,
wholly foreign transactions, and exports. In most cases, European countries do not require the foreign
tax rate to be equal to or greater than the home country rate and, in some instances, no minimum
foreign rate is required at all. Thus, European companies with overseas operations in low tax
jurisdictions can receive a tax benefit from a territorial exemption. Insofar as the sale of goods is
concerned, European manufacturers operating in these types of tax regimes may obtain the benefits of
a territorial exemption only by exporting.
41. As indicated above, no EC member state now provides a blanket exemption for foreign-
source income. In fact, as the EC explained to the Panel in the initial proceeding, EC member states
providing an exemption for foreign-source income do so only partially, and most generally treat
foreign-source income as an exception to the general rule that the worldwide income of a domestic
corporation is subject to taxation in its country of residence.
56 Thus, just as the Act has introduced an
element of territoriality into the US system of taxation, European systems themselves are a mix of
worldwide and territorial principles.
42. This confluence of worldwide and territorial approaches is perhaps most striking in the Dutch
tax system. As the Panel may recall from the initial proceeding, as a general matter, Dutch resident
companies are liable for corporate income tax on a worldwide basis. However, the income of foreign
branches of Dutch resident companies generally is not taxed. Even in the absence of a treaty, income

49 The Act § 5(c)(1)(B).
50 The Act § 5(c)(1)(B)(i)-(ii). A binding contract for this purpose includes “a purchase option,
renewal option, or replacement option wh ich is included in such contract and which is enforceable against the
seller or lessor.” The Act § 5(c)(1).
51 The Act § 5(c)(2).
52 Id.
53 Senate Report, page 21.
54 The Act § 5(a).
55 Senate Report, page 5.
56 EC Second Written Submission to the FSC Panel, Annex EC-2, para. 2, attached as Exhibit US-5.

earned by a foreign branch of a Dutch company that is subject to any income tax in a foreign country
is also exempt from Dutch tax.57
43. In addition, the income of a foreign subsidiary of a Dutch company is not subject to Dutch
income tax, even in the case of income from export activities, so long as the subsidiary does not have
substantial activities in the Netherlands. Moreover, any Dutch shareholder that owns 5 per cent or
more of a foreign corporation may generally exempt from tax 100 per cent of the dividends paid by
the foreign corporation to that shareholder.
44. As with a foreign branch, income from a fore ign subsidiary will qualify for the exemption so
long as the subsidiary is subject to any national-level income tax in its country of residence. Thus, a
subsidiary that is resident in a low-tax jurisdiction such as the Netherlands Antilles is generally
exempt from Dutch tax on income earned outside the Netherlands. Moreover, a Dutch parent
corporation will, subject to certain requirements, receive a 100 per cent participation exemption
(dividends-received deduction) on dividends from that subsidiary, even though the income may be
subject to tax in the Netherlands Antilles at a very low rate of tax (two or three per cent).
45. To appreciate how the Dutch system operates, assume that a Dutch manufacturing company
and its Netherlands Antilles sales subsidiary engage in an export transaction in which the subsidiary
acts on the parent company’s behalf to sell items exported from the Netherlands, and the companies
together earn a total of $100,000.
58 Further assume that each company earns the equivalent of
$50,000 under arm’s-length transfer pricing principles. The Netherlands Antilles subsidiary’s income
from the transaction – that is, $50,000 – would be fully exempt from taxation by the Netherlands and,
at a 3 per cent rate, would owe tax of only $1,500 to the Netherlands Antilles.
46. Due to the 100 per cent participation exemption, the Dutch parent corporation would not pay
taxes upon the repatriation of the exempt income earned by the foreign subsidiary. On the other hand,
the Dutch parent company would be liable for taxes in the Netherlands, at a rate of 35 per cent, on the
income it earned from the transaction; i.e., the other $50,000. The taxes on this income would amount
to $17,500. The overall taxes on the total export income of $100,000 would be $19,000 – or an
effective tax rate of 19 per cent – resulting in a tax savings of $16,000 ($35,000-$19,000) as
compared to the tax that would have been incurred if the same transaction had involved a domestic
sale.
C. T
HE ACT IS FUNDAMENTALLY DIFFERENT FROM THE FSC
47. Throughout its First Submission, the EC portrays the Act as “essentially the same subsidy” as
the FSC.59 This portrayal is erroneous, because it ignores the fundamental ways in which the Act
differs from the FSC, as described below.
1. The FSC Was a Relatively Narrow Exception to US General Rules of Worldwide
Taxation for Export-Related Income
48. Prior to adoption of the Act, the US tax system operated principally on a worldwide basis.
The United States asserted the right to tax all income earned by US citizens and residents (including
US corporations), as well as income earned by nonresidents conducting activity within US borders.
The US system treated all income earned by US persons as taxable, even if earned outside the United
States. The United States generally exempted from direct taxation, however, all income earned
outside the United States by foreign corporations.

57 FSC (Panel), para. 4.809.
58 For a more detailed discussion of this example, see FSC (Panel), paras. 4.809 and 4.1042.
59 See, e.g., First EC 21.5 Submission, para. 121.

49. This exemption applied even if the foreign corporation was owned by a US person. Subject
to certain antideferral rules, the United States generally taxed the US shareholders of foreign
corporations at the time income was distributed to the US shareholder. Thus, as a general matter, US
shareholders of foreign corporations benefitted from the deferral of US tax on income earned through
a foreign corporation.
50. Notwithstanding this general rule, the United States has adopted a series of “anti-deferral”
regimes that constitute limited exceptions to the general norm of deferral and that, in general, respond
to specific concerns about potential tax avoidance by US corporations through foreign affiliates. One
of these regimes is found in subpart F of the IRC. Subpart F limits the availability of deferral for
certain types of income earned by certain controlled foreign subsidiaries of US companies.60 Pursuant
to subpart F, a US shareholder that controls a foreign corporation must pay US tax on certain types of
income earned by the foreign corporation at the time the income is earned by such foreign
corporation, and without regard to whether the income is distributed to the shareholder.
51. As the Panel and Appellate Body found in FSC, the FSC operated as an exception to these
general rules of US corporate taxation. It subjected the income of a foreign corporation directly to US
taxation. It provided a dividends received deduction for income repatriated by a foreign subsidiary to
a domestic parent. It created an exception to subpart F for income of a controlled foreign corporation
that otherwise might have been deemed to be immediately taxable to the foreign corporation’s parent.
And, of course, the FSC applied only to income from “export property”; i.e., property manufactured
in the United States and sold abroad.
2. The Act Makes a Fundamental Shift in US Tax Treatment of Extraterritorial Income
52. The Act modified the general rule of US taxation by fundamentally amending the definition
of “gross income”, the term which, under US tax law, defines the boundaries of US taxing
jurisdiction. In contrast to the former US worldwide approach, the Act excludes income earned in
qualifying foreign transactions from the definition of gross income and, thus, modifies the extent to
which the United States seeks to tax such income.
53. This new general rule applies to a substantially broader category of income than that which
was exempted from tax under the FSC provisions. It applies to foreign transaction income
irrespective of whether the goods in question were produced in the United States. It requires no
related foreign company to be involved in the transactions in question, and it is applicable to a broader
group of taxpayers, including foreign corporations.
54. Thus, unlike the FSC, the Act’s exclusion of income from US taxation is automatic. It does
not result from the creation of an exception to US general rules for taxing foreign corporations, an
exception to the subpart F rules, or an exception to the rules governing the dividends received
deduction. Instead, the Act’s exclusion is part of the US general rules of taxation.
3. The Act Does Not Require Exportation
55. Not only is the Act broader than the FSC in terms of the rules it establishes for the US tax
system and with respect to the taxpayers that may use it, it also is broader with respect to the
transactions it covers. Unlike the FSC, the Act is not limited to ‘‘export property”. Instead, the Act
applies to income involving property produced within or without the United States. Indeed, unlike the
FSC, excluded income under the Act can arise from transactions involving property that is
manufactured and sold outside the United States, and all of the value of which is comprised of 100 per

60 IRC § 951 (US-4).

cent foreign content. As in the case of European tax regimes, exporters are eligible for the exclusion,
but the Act nowhere requires a taxpayer to export in order to earn excluded extraterritorial income.
IV. ISSUES RAISED IN THIS PROCEEDING
56. The following issues are raised in this proceeding for resolution by the Panel:
(a) Whether the Act’s exclusion of extraterritorial income from US taxation confers a subsidy
within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.
(b) Whether the Act’s exclusion of extraterritorial income from US taxation is contingent upon
export performance within the meaning of Article 3.1(a) of the SCM Agreement.
(c) Whether the Act’s exclusion of extraterritorial income from US taxation constitutes a measure
to avoid double taxation within the meaning of the fifth sentence of footnote 59 of the SCM
Agreement and whether, for that reason, the exclusion does not constitute a prohibited export
subsidy under Article 3.1(a) of the SCM Agreement.
(d) Whether, if the Act’s exclusion of extraterritorial income from US taxation does not
constitute a prohibited export subsidy by virtue of the fifth sentence of footnote 59, the
exclusion is not prohibited by any other provision of the SCM Agreement by virtue of
footnote 5 of that Agreement.
(e) Whether the Act’s 50 per cent rule on certain foreign value renders the Act’s exclusion of
extraterritorial income from US taxation contingent upon the use of domestic goods over
imported goods within the meaning of Article 3.1(b) of the SCM Agreement.
(f) Whether the Act’s 50 per cent limitation on certain foreign value provides less favourable
treatment to imported goods in comparison to the treatment afforded to like domestic goods
so as to be inconsistent with Article III:4 of GATT 1994.
(g) Whether the Act’s exclusion of extraterritorial income from US taxation is inconsistent with
US obligations under Articles 10.1 and 8, or Article 3.3 and 8, of the Agreement on
Agriculture.
(h) Whether the DSB’s recommendation that the FSC subsidy be withdrawn with effect from
1 November 2000 precludes a reasonable transition period.
(i) Whether third parties to this proceeding have a right to the parties’ rebuttal submissions.
V. ARGUMENT
A. G
ENERAL CONSIDERATIONS
57. Although this principle is now well-established in WTO jurisprudence, it is nonetheless worth
recalling that the EC, as the complainant, bears the burden of proof both in terms of presenting a
prima facie case and in the sense of the ultimate burden of persuasion. Thus, if the balance of
evidence is inconclusive, the EC will have failed to have established its claims.61

61 See, e.g., India - Quantitative Restrictions on Imports of Agricultural, Textile and Industrial
Products, WT/DS90/R, Report of the Panel, as affirmed by the Appellate Body, adopted 22 September 1999,
para. 5.120.

58. It also is worthwhile to recall the principles of treaty interpretation that govern this
proceeding. Article 3.2 of the DSU states that provisions of WTO agreements are to be read in
accordance with “the customary rules of interpretation of public international law.” The Appellate
Body has frequently explained that the “general rule of interpretation” under public international law
is set forth in Article 31(1) of the Vienna Convention on the Law of Treaties (“ VCLT”), which
provides that “[a] treaty shall be interpreted in good faith in accordance with the ordinary meaning to
be given to the terms of the treaty in their context and in light of its object and purpose.” As the
United States demonstrates in the sections that follow, when the relevant provisions of the WTO
agreements are considered in light of their ordinary meaning, context and object and purpose, it
becomes clear that the Act is consistent with US WTO obligations.
B. THE EXCLUSION OF EXTRATERRITORIAL INCOME UNDER THE ACT DOES NOT CONSTITUTE A
SUBSIDY UNDER ARTICLE 1 OF THE SCM AGREEMENT
59. The first issue before the Panel is whether the exclusion of extraterritorial income under the
Act constitutes a “subsidy” within the meaning of Article 1 of the SCM Agreement. If it does not, it
cannot be a prohibited subsidy under either Article 3.1(a) or Article 3.1(b), and the Panel need not
reach any of the issues raised by Article 3 at all. 62 In this section, the United States explains why the
exclusion of extraterritorial income under the Act does not constitute a “subsidy” as that term is
defined in Article 1, as construed by the FSC Panel and the Appellate Body.
1. Under Article 1, the Normative Benchmark Is the Member’s “Prevailing Domestic
Standard”
60. Article 1 of the SCM Agreement provides that “a subsidy shall be deemed to exist if . . . there
is a financial contribution by a government . . . and a benefit is thereby conferred.” With respect to
tax measures, Article 1.1(a)(1)(ii) provides that a “financial contribution” exists where “government
revenue that is otherwise due is foregone or not collected”. The determinative Article 1 issue in this
case is thus whether, by excluding extraterritorial income from gross income – and, thus, excluding
extraterritorial income from US taxing jurisdiction – the United States has “foregone or not
collected” revenue that is “otherwise due”.
61. With respect to the ordinary meaning of the critical terms used in subparagraph (ii), the
meaning of “revenue” most applicable to this case is “the annual income of a government or State,
from all sources, out of which the public expenses are met”.
63 The definition of “forego” is “to
abstain or refrain from” or “go without; deny to oneself”. 64 “Otherwise” is defined as “by other
means; differently; in another case; in other circumstances”, 65 and “due” is defined as “an obligatory
payment; a fee, a tribute, a toll; a legal charge”. 66 Taking the ordinary meaning of these terms
together, the foregoing of revenue otherwise due means that a government has refrained from
collecting income that in another circumstance would be legally owed to the government.
62. The classic case to which this language applies is a situation in which a company or group of
companies has a legal tax obligation that the government forgives or fails to enforce. Selectively
rebating a company’s taxes or failing to enforce its existing tax obligations or giving the company

62 FSC (AB) , 93 (“This definition [of subsidy] . . . applies wherever the word “subsidy” occurs
throughout the SCM Agre ement and conditions the application of the provisions of that Agreement regarding
prohibited subsidies in Part II ... .”) (emphasis in original); see also FSC (Panel) , para. 7.39 (“in order for a
measure to be an export subsidy within the meaning of Article 3.1(a) of the SCM Agreement, it must be a
subsidy within the meaning of Article 1 of that Agreement”).
63 The New Shorter Oxford English Dictionary (1993).
64 Id.
65 Id.
66 Id.

preferential treatment under a generally applicable law are all situations that readily fit the ordinary
meaning of subparagraph (ii). Each would be an example of a government’s foregoing or not
collecting taxes that are otherwise due.
63. Where the tax laws of a country themselves create a special exception from general tax
obligations, that, too, may come within the language of subparagraph (ii). In the case of a statutory
exception, the inquiry is again whether the income expressly excepted from tax would be “otherwise
due” under other provisions of the country’s tax law. Both the FSC Panel and the Appellate Body
found that to determine whether taxes on statutorily excepted income would be “otherwise due,” it is
necessary to compare the challenged statutory measure with a “normative benchmark”. As the
Appellate Body stated, under subparagraph (ii), determining whether taxes are “otherwise due”
requires a “defined, normative benchmark against which a comparison can be made between the
revenue actually raised and the revenue that would have been raised otherwise”.
67
64. Moreover, both the FSC Panel and the Appellate Body made clear that the normative
benchmark must be found in the tax regime of the Member whose measure is being challenged. As
the FSC Panel explained, “there is in the WTO Agreement no theoretical ‘correct’ benchmark for
taxes that would represent the norm for taxes and duties ‘otherwise due.’” 68 Rather, “the
determination whether revenue foregone is ‘otherwise due’ must involve a comparison between the
fiscal treatment being provided by a Member in a particular situation and the tax regime otherwise
applied by that Member ... .”
69 As explained by the Appellate Body, “the word ‘foregone’ suggests
that the government has given up an entitlement to raise revenue that it could ‘otherwise’ have raised.
This cannot, however, be an entitlement in the abstract, because governments, in theory, could tax all
revenues.”70 Instead, it must be an entitlement established in a government’s own tax laws.
65. The FSC Panel applied this concept by asking whether taxes would have been collected “but
for” the measure in question.71 Applying this “but for” test, the Panel considered “whether, if the FSC
scheme did not exist, revenue would be due which is foregone by reason of that scheme.” 72 While
noting that it might not be appropriate in all cases, the Appellate Body agreed that the panel’s “but
for” test was appropriate for the FSC case. Stressing that WTO obligations do not compel any
particular kind of tax system, and that Members have the sovereign authority to tax or not to tax
particular categories of revenue, the Appellate Body concluded that the comparison must be with the
“prevailing domestic standard” of the Member in question.73
66. Thus, the standard of subparagraph (ii), by its own terms and as construed by the FSC Panel
and the Appellate Body, looks to whether, by virtue of a challenged measure, a government foregoes
tax revenues that would otherwise be due under the normative benchmark that is the Member’s
“prevailing domestic standard.” It was with reference to this WTO legal standard that the United
States developed the Act.
2. By Excluding Extraterritorial Income from “Gross Income”, the Act Does Not Forego
Revenue that Is Otherwise Due
67. In determining how to revise the US tax system, Congress relied on and sought to incorporate
the principles articulated by the FSC Panel and the Appellate Body. In particular, it designed the Act

67 FSC (AB) , para. 90 (“the basis of comparison must be the tax rules applied by the Member in
question”).
68 FSC (Panel), para. 7.42.
69 Id., para. 7.43.
70 FSC (AB), para. 90 (emphasis in original).
71 FSC (Panel), para. 7.45.
72 Id.
73 FSC (AB), para. 90.

to meet the articulated standard of Article 1 of the SCM Agreement. Congress achieved this result by
altering the general jurisdictional rule of US taxing authority; i.e., the “outer boundary” of US taxing
authority.
68. Incorporating limitations similar to those found in many European countries that place
territorial limits on their own taxing authority, the United States restricted the statutory scope of its
own taxing authority. Not unlike European countries that decline to tax certain categories of foreign
income, the United States placed new limits on its own taxing authority with respect to
“extraterritorial income”. To accomplish this as a technical matter under the US tax system, the
United States modified the domestic standard of “gross income”, the concept that defines income that
is subject to taxation for purposes of US tax law. In the words of the FSC Panel and the Appellate
Body, the United States modified the “normative benchmark” for taxation under US law.
(a) Under US Tax Law, “Gross Income” Defines US Taxing Jurisdiction
69. Under US law, the taxing authority of the United States government is defined by the
statutory definition of “gross income.”
74 “Gross income” is defined in Parts I - III of Chapter 1B,
Subtitle A of the IRC, in particular section 61, se ctions 71 through 90, and sections 101 through 139.
These provisions define items that are specifically included in and specifically excluded from the
definition of “gross income”.
70. In addition to setting the outer limits of US taxing authority, “gross income” serves as the
central reference point for determining the tax liabi lity of US taxpayers. For example, it is the
threshold reference point in determining whether a person or entity must file a tax return. It is the
starting point for determining “taxable income,” and thus one’s tax obligations. 75 “Gross income” is
the reference point for computing state and local taxes, for taking tax deductions, and for determining
eligibility for certain tax benefits. In the context of prosecuting underpayment of taxes, whether the
statute of limitations can be extended is based on whether the amount of omitted gross income
exceeds 25 per cent of the amount of gross income reported.76
71. The definition of “gross income” is thus the “prevailing domestic standard” for US taxation.
It defines the general rule, or the jurisdictional boundary, of US taxing authority. In the words of the
Appellate Body, it is the “normative benchmark” under US law against which any particular measures
must be evaluated. It is the benchmark against which exemptions or deductions or allowances are
figured and, therefore, is the rule that would otherwise apply “but for” any exemption, deduction, or
allowance. Income that does not come within the definition of “gross income” is beyond the statutory
taxing authority of the US Government.
72. By modifying the definition of “gross income” through the Act, the United States made a
fundamental change in its tax structure, establishing a new “prevailing domestic standard” for US
taxation. Thus, new section 114(a) of the IRC, which provides that “[g]ross income does not include
extraterritorial income,” represents a significant shift in US taxing jurisdiction and the normative
benchmark for US taxation of foreign income.
73. The legislative history of the Act makes clear that Congress understood that it was making
just such a fundamental, jurisdictional change. The House Report, at pages 16-17, specifically states
as follows:

74 See 501-2d Tax Mgmt. (BNA), page A-1(Exhibit US-6) (“Gross income is a fundamental ingredient
in the determination of federal income tax liability”).
75 See IRC § 63 (US-4).
76 IRC § 6501(e) (US-4).

[The Act] modifies the general rule of US taxation by fundamentally amending the
definition of gross income. Under the Code, the definition of “gross income” defines
the outer boundaries of US income taxation. The bill excludes income derived from
certain activities performed outside the United States, referred to as “extraterritorial
income,” from the definition of gross income and, thus, modifies the extent to which
the United States seeks to tax such income. This new general rule thus becomes the
normative benchmark for taxing income derived in connection with certain activities
performed outside the United States.
(b) A WTO Member Is Free to Change the Standard that Governs Its Own Taxing Jurisdiction
74. WTO Members are, of course, free to modify their own tax systems. As the Appellate Body
took pains to point out, WTO obligations do not dictate what type of tax system a Member must have.
Indeed, as discussed further below, there is great variety in the tax principles that Members apply and
in how they apply them. So long as they do not contravene specific WTO obligations, Members have
“the sovereign authority to tax any particular categories of revenue” and are “also free not to tax any
particular categories of revenues.”
77
75. The Appellate Body thus confirmed a principle that is fundamental to the application of WTO
rules to national tax measures. It must necessarily be the case that Members are free to change their
policies as to what categories of revenue they choose to tax or not to tax. It could not be the case that
Members are free to expand their taxing authority to new categories of income, but not free to
contract their taxing authority by deciding not to tax certain previously taxed categories of income.
To argue that a country’s decision not to tax a category of income constitutes a subsidy (because “but
for” the change the income would be taxed) would mean that a country could change its general
taxing authority only by expanding it. Applying the “but for” test in such an over broad manner
would produce a perverse situation in which any decision to reduce taxes or reduce taxing authority
would constitute a “subsidy” under Article 1 of the SCM Agreement. Such a position would be
untenable and illogical.
78
76. Moreover, a Member must be free to modify its general rule of taxation in order to comply
with a decision by a WTO panel or the Appellate Body. Where a Member has a measure that is
inconsistent with the Article 1 subsidy standard, the Member is free to cure that failing by modifying
the offending measure or by changing its general rule of taxation, or by doing both.
(c) Under the Modified US Normative Benchmark, the Income Excluded by the Act Is Not
“Otherwise Due”
77. Applying the standard of Article 1, as articulated by the FSC Panel and the Appellate Body,
the Act does not constitute a subsidy because tax on the excluded income is not “otherwise due”.
Because the United States lacks statutory authority to tax anything that falls outside the definition of
“gross income”, there is no general rule of taxation that would apply “but for” the definition of “gross
income”.
78. This new limitation on US taxing authority is analogous to territorial limits that other
governments impose on themselves in limiting their own taxing jurisdiction. Although any limitation

77 FSC (AB), para. 90.
78 For example, assume that the United States chose to overhaul its tax system and adopt the tax regime
of France (which the EC presumably maintains does not confer a subsidy, even though export transactions are
treated more favourably than comparable domestic transactions). Under the EC’s reasoning, the United States
has foregone revenue that is otherwise due, because “but for” the legislation establishing the new tax regime, the
United States would have taxed some categories of revenue that are excluded from tax under the new regime.

or restraint that causes a country to exercise less than its theoretical maximum taxing authority is, in
one sense, a decision to forego potential revenue, it is clear, as the Appellate Body stated, that neither
the WTO Agreement in general, nor the SCM Agreement in particular, requires Members to tax all
categories of potentially taxable income.
79. The Act excludes extraterritorial income from gross income. This exclusion constitutes a
defined, normative benchmark for taxing income earned on foreign transactions. Because this
exclusion constitutes a jurisdictional limitation on taxing income from foreign transactions, taxes on
extraterritorial income are not “foregone” and are not “otherwise due”.
80. Under a “but for” analysis of the type the Panel undertook in FSC, the Act does not satisfy the
Article 1 definition of a “subsidy”. Applying that analysis, it is clear that, unlike the FSC, the Act’s
exclusion of extraterritorial income is not a narrow tax-reducing exception to a general tax-raising
rule. Rather, the limitation that it places on US taxing authority is a part of the general rule of
taxation itself. The exclusion does not provide an exception against a broader definition of “gross
income” that would otherwise apply.
81. Indeed, under the “but for” test, the absence of the tax-raising exception would leave only the
general exclusion. Section 114(a) of the IRC provides that gross income does not include
extraterritorial income. Section 114(b) states that extraterritorial income does not include income that
is not qualified foreign trade income. Thus, the exception found in section 114(b) raises revenue. But
for section 114(b), all extraterritorial income would be excluded from gross income under section
114(a), and the exclusion would be broader.
82. Similarly, the Act meets other elements of the standard articulated by the Appellate Body. To
constitute an Article 1 “subsidy”, the government must have “given up an entitlement to raise
revenue” and that entitlement must be based on “some defined, normative benchmark against which a
comparison can be made between the revenue actual ly raised and the revenue that would have been
raised ‘otherwise.’”
79 Turning, as the Appellate Body directs, to the United States’ “prevailing
domestic standard”, one finds that there is now no general principle that would impose tax on income
now excluded by the Act. To the contrary, the general authority to tax extraterritorial income has now
been eliminated from the prevailing US standard.
83. Accordingly, applying the ordinary meaning of subparagraph (ii) and the test articulated by
the FSC Panel and the Appellate Body, the Act does not constitute a subsidy within the meaning of
Article 1. No longer does the IRC contain a specific exception from a general rule that would broadly
tax extraterritorial income; instead, it now contains a jurisdictional limit that places such income
beyond the taxing authority of the United States. By making this change, the United States has
imposed a type of territorial limit on its taxing authority that is in many respects similar to that
imposed by numerous European countries. European taxing limits, many of which are defined or
qualified narrowly by very specific provisions, cause certain foreign-source income to be taxed and
some not to be taxed. In seeking to comply with the rulings in FSC by deciding not to tax a certain
category of income – excluded extraterritorial income – the United States has exercised the same
sovereign authority that has been exercised by numerous Members in Europe and elsewhere.
3. The EC’s Article 1 Arguments Are Inconsistent With the Text of Subparagraph (ii), as
Interpreted by the FSC Panel and the Appellate Body
84. The EC argues that the Act’s exclusion of extraterritorial income comes within the definition
of the term “subsidy” in Article 1 for reasons that are unrelated to the standard of subparagraph (ii),

79 FSC (AB), para. 90.

and for reasons that ignore the realities of tax systems around the world and in Europe, in particular.
The reasons why the EC’s arguments are not legally tenable are set forth below.
(a) The EC’s Argument that the Act’s Exclusion of Extraterritorial Income Should Be Viewed as
an Exemption
85. The EC argues that it is “misleading” for the Act to be denominated as an “exclusion” rather
than an “exemption”. The EC then argues that the tax-raising exception in section 114(b) is the
general rule and the exclusion of extraterritorial income is the exception.
86. This line of argument is defective for several reasons. First, it fails to address the law that the
United States did adopt. Instead, it seeks to redesign that law and then critique the redesigned version
as legally insufficient. Obviously, the law before this Panel is the law that the US Congress enacted,
not a different version that, had it been adopted and structured as the EC suggested, would, in the
EC’s eyes, be legally defective.
87. Second, whether, as a matter of US tax law, the new modifications to the term “gross income”
are more appropriately designated as an “exclusion” than as an “exemption” is really a judgment that
the United States Congress is in a better position to make than EC officials. Although the EC may
believe that an “exemption” could be more readily challenged under Article 1 than an “exclusion,” the
EC cannot bootstrap itself into such an argument by claiming that the Act really should have been
called an “exemption”.
88. Third, and most important, the semantic distinction between an exclusion and an exemption
would not, in any event, be determinative. Rather, the test under subparagraph (ii) is whether tax on
the income now excluded would be otherwise legally owed to the go vernment. Under that standard,
as further explicated by the FSC Panel and the Appellate Body, tax on the now-excluded income is
not “otherwise due” under the current prevailing standard of US taxation.
(b) The EC Argument that the Excluded Income Is a Subsidy Because the Exclusion Should Be
Larger
89. The EC makes a variety of arguments to the effect that the Act confers a subsidy because the
exclusion ought to be larger. For example, the EC objects to the Act on the grounds that non-
qualified foreign trade income is taxed. It characterizes the definitional limits of “extraterritorial
income” as “conditions” that narrow the scope of the exclusion, and it faults the new Act because
excluded “extraterritorial income” does not include all “foreign source income”. Thus, the EC
contends, because the exclusion is not larger or unqualified, it must be deemed to be a “subsidy”
within the meaning of Article 1.
90. Subparagraph (ii), however, does not specify that revenue that governments elect to forego
can be foregone only in particularly designed categories. Members are not obliged, for example, to
take an “all-or-nothing” approach with respect to the taxation of “foreign source income”. If that
were the standard, then most likely all Member s, including EC member states, would fail that
standard.
80
91. Nor are Member governments required to ignore the revenue implications of their tax policy
decisions. It is both appropriate and permissible for governments to adjust their taxing policies to
meet certain revenue objectives or constraints. Thus, the fact that a category of income is given a

80 For example, Belgium grants a 95 per cent participation exemption on distribution of earnings from a
foreign subsidiary of a Belgian corporation. FSC (Panel), para. 4.811, note 408. Under the EC’s argument,
Belgium is foregoing revenue that is otherwise due because it taxes the other 5 per cent.

partial rather than an absolute exclusion from tax is an appropriate fiscal determination for a Member
to make. It was entirely appropriate for the US Congress to determine that the revenue implications
of the Act should not be drastically different from the revenue implications of the discarded FSC.
That an exclusion is qualified or moderated, however, does not convert it into a subsidy under
Article 1.
(c) The EC Argument that “Extraterritorial Income” Is Not a “General Category”
92. A variation on the EC’s argument that the Act’ s exclusion should be larger is its argument
that “extraterritorial income” is “not a general category of income that a WTO Member may choose
not to tax”. 81 This is a conclusory, circular argument that can be advanced only by studiously
avoiding the scope of the Act and the tax practices in use throughout Europe and the rest of the world.
93. To support the conclusory argument that “extraterritorial income” is not a suitable category of
income to exclude from tax, the EC is simply asse rting that this category is not, in its view,
sufficiently unqualified, or that it cannot be structured so as to calibrate the fiscal consequences of the
exclusion. Again, this is an argument that finds no textual support in subparagraph (ii) or in panel or
Appellate Body decisions. Even if the EC’s argume nt did have some basis in law, the fact remains
that the Act applies generally to foreign transactions. It does so irrespective of whether goods are
manufactured in the United States or abroad, and it applies to all US taxpayers who earn
extraterritorial income.
94. Notwithstanding the general applicability of the Act’s exclusion, the EC’s argument that only
the non-taxation of a “general” category falls outside of subparagraph (ii) would mean that most of
the tax systems in Europe are subsidy schemes. In construing subparagraph (ii), it is reasonable for
the Panel to consider whether the intent of the Uruguay Round negotiators was to adopt a principle
under which the tax systems of most industrialized countries would be subsidies.
95. Specifically, European tax systems exclude from taxation a wide variety of categories of
foreign source or extraterritorial income. However, the scope of those exclusions is by no means
uniform. To the contrary, most European countries have detailed rules or conventions that allow
certain income, either earned abroad or associated with foreign transactions, to escape domestic tax or
to be taxed. Like the Act, these systems reflect some legislative discretion as to the size and extent of
the categories that are not subject to domestic tax, and the line-drawing that occurs varies from
country to country. However, it cannot be seriously contended that those systems constitute subsidies
merely because they are not identical to one another. Likewise, it cannot be seriously contended that
the Act constitutes a subsidy simply because the US Congress chose to draw a jurisdictional line in a
place different from that chosen by European legislators.
96. To give just a few brief examples:
• In Belgium, resident companies are subject to Belgian corporate income taxes on profits from
their activities, wherever conducted, unless specifically excluded by domestic law or as a
result of a tax treaty. One such exclusion is that 75 per cent of foreign branch income
generated in a country with which Belgium has not concluded an income tax treaty – whether
export-related or otherwise – is exempt from Belgian tax. Another source of profit that is
excluded from taxation is foreign-source dividend income. Nineyfive per cent of dividend
income from a foreign subsidiary to a shareholde r owning at least 5 per cent of the shares of
the subsidiary (or holding an interest in the s ubsidiary with an acquisition value of at least
BFr 50 million) is not taxed, but the remaining five per cent is taxed. Therefore, the tax
exclusion is not unqualified.

81 EC First 21.5 Submission, para. 60.

• In France, foreign income directly attributable to operations conducted abroad – either by a
company directly or though a branch – is exempt from tax. As a result, 95 per cent of the
gross amount of dividends receivable from a foreign company by either a 10 per cent
shareholder or a shareholder holding an interest in the foreign company of at least
FF 150 million is exempt from French tax. However, this qualified exemption is further
limited. A French corporate taxpayer is required to include in its taxable income its pro rata
share of the income of a foreign company in which it either has a direct or indirect interest of
10 per cent or more or at least FF 150 million, if the foreign company is subject to a
“privileged tax regime”. A foreign tax regime is considered “privileged” if the foreign tax
rate is two-thirds or less than the tax rate that would have been payable in France on the same
income. This “low tax exception” does not apply if the foreign company at issue has an
effective commercial or industrial activity predominantly performed in the local market. The
“low tax exception” also may not apply under certain tax holidays or if a tax treaty provides
for different tax treatment.
• In Germany, companies are subject to German corporate tax on their income regardless of its
source if they have their statutory seat of business or effective place of management in
Germany. However, German tax authorities exclude from income dividends received from
foreign branches and foreign subsidiaries of corporate shareholders in about 70 treaty
countries. Nevertheless, despite this exclusion, foreign-source income is treated differently
depending upon the country in which the foreign branch or subsidiary resides because the
specific requirements for receiving the tax benefit vary from treaty to treaty.
• In Italy, resident companies are subject to corporate income tax on all sources of income.
However, dividends paid to Italian shareholders are 95 per cent exempt from Italian tax, as
long as (1) the company paying dividends is resident in a country included in a “parent-
subsidiary directive list” (currently EC countries) and (2) the Italian shareholder (parent
company) has held more than 25 per cent of the subsidiary’s capital for over one year. This
exemption will also apply only if the subsidiaries are located in countries that do not have a
privileged tax system.
97. These are but a few examples illustrating the point that tax systems around the world refrain
from taxing foreign income in a qualified or conditional manner. Treating the Act’s exclusion as a
subsidy could result in parallel measures among many, if not most, WTO Members to be deemed
subsidies. This would indeed be a disturbing result, one that would come as a surprise to these
Members and one that could not have been intended by the drafters of the SCM Agreement.
98. In conclusion, the EC’s arguments that the Act’s exclusion constitutes a subsidy are not based
on the text of subparagraph (ii) or the standards articulated by the FSC Panel and the Appellate Body.
Instead, the EC’s objections essentially are nothing more than that the Act did not make the US tax
system sufficiently “European”.
99. The EC asserts that by adopting the Act, the US Congress was “playing with words.”
82 What,
in fact, the US Congress was doing was being exceed ingly attentive to the words of subparagraph (ii)
and the words of the FSC Panel and the Appellate Body, as US WTO obligations required it to do.
Ironically, the EC’s arguments in this proceeding are not textual, but rather are based on standards
that are not reflected in the SCM Agreement. However, when one applies the actual terms of
subparagraph (ii) and the standards articulated by the FSC Panel and Appellate Body, it becomes clear
that the Act’s exclusion of extraterritorial income is not a “subsidy” within the meaning of Article 1 of
the SCM Agreement.

82 EC First 21.5 Submission, para. 39.

4. The EC Has Failed to Demonstrate that, as a Factual Matter, the Act’s Exclusion of
Extraterritorial Income Results in the Foregoing of Revenue that Is Otherwise Due
100. As discussed above, the EC essentially argues that the determination of whether revenue is
foregone depends upon a comparison of the US tax system before adoption of the Act with the US tax
system after adoption of the Act. This comparison is not, and cannot be, the appropriate comparison
for determining whether a measure foregoes revenue that is otherwise due, because, by that standard,
any amendment to a Member’s tax laws with a net revenue cost automatically would qualify as a
subsidy.
101. Even assuming arguendo that the legal standard articulated by the EC is correct, the EC has
not established, as a factual matter, that extraterritorial income would be taxed or taxed to a greater
extent absent the Act. In fact, absent the Act, income currently defined as extraterritorial income may
not be subject to tax at all or taxed to a lesser extent. Indeed, without additional facts, it is unclear
how excluded income would be treated under US tax rules if the Act’s exclusion did not exist. The
EC simply has not presented any evidence demonstrating that the Act will cause the United States to
forego revenue that would be otherwise due.
102. There are a number of factors suggesting that revenue is not foregone as a result of the Act’s
exclusion of extraterritorial income. For example, foreign corporations are among the taxpayers that
may earn excluded extraterritorial income. The existence of the Act as part of the US tax system
might motivate foreign corporations to structure a portion of their operations in the United States to
achieve a tax-efficient global operating structure. Without the Act, these foreign corporations might
structure their operations in such a manner so as to avoid being subject to US taxation altogether. In
that case, such foreign corporations might not pay any US taxes on income currently defined as
extraterritorial income, and, thus, it cannot be said the Act has caused the United States to forego
revenue.
103. Similarly, in the absence of the Act, US companies that otherwise would earn extraterritorial
income could choose to structure their foreign sales operations through a jurisdiction that provides an
exclusion for income from foreign sales similar to the exclusion currently provided by the Act (for
example, by establishing the operation in a country that has adopted a territorial system). In that case,
income that otherwise would have been excluded income under the Act would not be subject to US
tax. Accordingly, it cannot be said that the United States has foregone any revenue.
104. Finally, because the Act does not allow for deferral, deductions, or foreign tax credits in
relation to excluded income, it is possible, depending on the facts, that taxpayers would rely on such
tax-reducing mechanisms in the absence of the Act.
105. All of these circumstances and variables undermine the EC’s unsupported assertion that
extraterritorial income excluded by the Act necessarily would be taxed absent the Act.
106. Similarly unavailing is the EC’s attempt to “p rove” that the United States is foregoing
government revenue “otherwise due” by referring to a Congressional study on the “cost” of the Act.
83
The EC’s reliance on this study is misplaced, because the EC misinterprets its meaning. The “cost”
cited by the EC is actually a comparison of the revenue consequences under the Act versus the FSC
and the former US worldwide tax system. By shifting to a territorial-like regime, the US is no longer
collecting the same kinds and amounts of tax revenue that were collected under its worldwide system.
This “cost” in relation to the prior US tax system is simply not relevant to an analysis under Article 1
and how the United States would capture tax “but for” the new law.

83 Id., para. 21.

C. THE ACT’S EXCLUSION OF EXTRATERRITORIAL INCOME DOES NOT CONSTITUTE A
PROHIBITED EXPORT SUBSIDY UNDER ARTICLE 3.1(A) OF THE SCM AGREEMENT
107. Even assuming arguendo that the Act’s exclusion of extraterritorial income constitutes a
subsidy, the EC’s claim that this “subsidy” is a prohibited export subsidy is based on an erroneous
interpretation of Article 3.1(a) and a misunderstanding of the Act. As demonstrated below, the Act’s
exclusion of extraterritorial income is not contingent on export performance within the meaning of
Article 3.1(a), and the EC has failed to demonstrate that it is.
1. The Meaning of Article 3.1(a)
108. Article 3.1(a) of the SCM Agreement provides in relevant part that “the following subsidies,
within the meaning of Article 1, shall be prohibited: (a) subsidies contingent in law or in fact,
whether solely or as one of several other conditions, upon export performance, including those
illustrated in Annex I.” Thus, assuming arguendo that a subsidy exists, for the EC to succeed in
establishing a prima facie case of a prohibited export subsidy, it must establish that the subsidy
conferred is contingent, as a matter of law or fact, on export performance.
109. According to the Appellate Body, the “key word” in Article 3.1(a) is “contingent”. 84 T h e
Appellate Body has explained that the term “contingent” has an ordinary meaning of “conditional” or
“dependent for its existence on something else.” 85 Thus, an export subsidy within the meaning of
Article 3.1(a) is a subsidy that requires recipients to export in order to obtain it. Or, in the words of
the Appellate Body, “the subsidy is available only upon fulfillment of the condition of export
performance.”86
110. It is not enough for a subsidy to be granted upon the mere expectation that the subsidy will
lead to new or additional exports; the grant of the subsidy in and of itself must be conditioned on
export performance. As the Appellate Body has said, “It does not suffice to demonstrate solely that a
government granting a subsidy anticipated that exports would result. The prohibition in Article 3.1(a)
applies to subsidies that are contingent upon export performance ... . A subsidy may well be granted
in the knowledge, or with the anticipation that exports will result. Yet, that alone is not sufficient,
because that alone is not proof that the granting of the subsidy is tied to the anticipation of
exportation.”
87
2. The Act’s Exclusion of Extraterritorial Income Is Not Contingent on Export
Performance
111. The Appellate Body has stated that de jure export contingency can be “demonstrated on the
basis of the words of the relevant legislation” 88 or “derived by necessary implication from the words

84 Canada – Measures Affecting the Export of Civilian Aircraft (“ Canada Aircraft (AB) ”),
WT/DS70/AB/R, Report of the Appellate Body adopted 20 August 1999, para. 167. In this case, the Appellate
Body held that “the legal standard expressed by the word ‘contingent’ is the same for both de jure and de facto
contingency.” Id. The principal difference between the two is “what evidence may be employed to prove that a
subsidy is export contingent.” Id. While it appears that the EC has confined its challenge to the Act to a de jure
claim, the analysis of Article 3.1(a) in de facto cases such as Canada Aircraft are relevant here.
85 Id.
86 Canada – Certain Measures Affecting the Automotive Industry (“ Canada Autos (AB) ”),
WT/DS139/AB/R, WT/DS142/AB/R, Report of the Appellate Body adopted 19 June 2000, para. 100.
87 Canada Aircraft (AB), paras. 171-172 (emphasis in original).
88 Id., para. 167.

actually used in the measure.” 89 As demonstrated below, the Act’s exclusion of extraterritorial
income is not export-contingent expressly or by implication.
(a) The Act Does Not Expressly Condition The Exclusion of Extraterritorial Income on Export
Performance
112. The starting point in determining whether a measure grants prohibited de jure export
subsidies is the text of the legislation, regulation, or other legal instrument in dispute. 90 I n s h a r p
contrast to the FSC, which the Panel found explicitly required exportation in order for its tax
exemption to apply, 91 the Act does not require or even refer to exportation in relation to the
availability of its exclusion. Indeed, the EC concedes this point.92
113. In order to comply with Article 3.1(a), the Act was purposefully drafted to broaden the
universe of transactions eligible for the exclusion beyond those eligible for the FSC tax exemption.
The legislative history makes this point expressly:
In addition to ensuring that the FSC replacement regime is not a “subsidy,” the
Committee believes that, in order to ensure WTO compatibility, it is important that
the new regime not confer export-contingent benefits. To achieve this goal, the
Committee has relied on the WTO Appellate Body’s interpretation of the meaning of
‘‘contingent’’ for purposes of the Agreement on Subsidies and Countervailing
Measures in crafting this legislation. It is the Committee’s intent and belief that the
exclusion of extraterritorial income from US gross income is not dependent on such
income arising from export activities. Accordingly, the Committee has determined
that it is appropriate to treat all foreign sales alike, whether the goods were
manufactured in the United States or abroad. A taxpayer would receive the same US
tax treatment with respect to its foreign sales regardless of whether it exports. As a
result, the exclusion for certain extraterritorial income is not ‘‘conditional’’ or
‘‘dependent’’ on whether an entity exports; therefore, it clearly is not export
contingent.
93
114. Thus, unlike the FSC, the Act provides an exclusion from taxation for income derived from
all qualifying foreign transactions, not simply exports. 94 The Act does not require that goods that are
the subject of transactions eligible for the exclusion need be manufactured or produced in the United
States.95 Instead, they may be produced outside the United States. 96 Thus, the Act does not expressly
require exportation in order for its exclusion to apply.
(b) In Operation, the Act Does Not Condition the Availability of the Exclusion of Extraterritorial
Income On Export Performance
115. Just as the Act does not require exportation on its face, it does not do so through its operation
or application. As demonstrated below, the Act’s exclusion of extraterritorial income is available to a

89 Canada Autos (AB), para. 100.
90 Id. By contrast, proving de facto export contingency requires that “the relationship of contingency,
between the subsidy and export performance, must be inferred from the total configuration of the facts
constituting and surrounding the granting of the subsidy, none of which on its own is likely to be decisive in any
given case.” Id. (emphasis in original).
91 FSC (Panel), para. 7.108.
92 EC First 21.5 Submission, para. 99.
93 House Report, page 17.
94 The Act § 3, amending IRC § 942(a)(1).
95 The Act § 3, amending IRC § 943(a)(1)(A).
96 Id.

range of foreign transactions that do not necessarily involve exportation. In this way, the exclusion is
not contingent, conditioned, or dependent for its existence on export performance.
(i) The Act Implements an Export-Neutral Principle
116. As previously noted, the rationale for the Act’s exclusion of extraterritorial income was to
treat all foreign transactions alike, regardless of where goods are manufactured. 97 To the extent that
exporting is involved in relation to the Act at all, it is merely incidental:
The Committee emphasizes that the extraterritorial income excluded by this
legislation from the scope of US income taxation is parallel to the foreign-source
income excluded from tax under most territorial tax systems. Under neither the US
tax system as modified by this legislation nor many European tax systems is the
income excluded from taxation limited to income earned through exporting. At the
same time, under both systems, exporting is one way to earn foreign source income
that is excluded from taxation, and exporters under both systems are among those
who can avail themselves of the limitations on the taxing authority of both systems.
While exporters may be among those who are eligible for the exclusion, this fact does
not make that exclusion ‘‘export contingent’’. If it did, every general exclusion from
tax applicable to, among others, exporters would become a prohibited export
subsidy.
98
117. Just as a production or sales subsidy could include exports, the Act’s exclusion is based on an
export-neutral principle – foreign-transaction income – which can, but does not necessarily, include
income derived from export transactions. That a private party might choose to export in order to rely
on the exclusion does not mean that the exclusion is conditioned or dependent on exporting.
(ii) Because Extraterritorial Income Arises From A Broad Range of Foreign Transactions,
Taxpayers May Qualify Under the New Regime Without Exporting
118. The Act’s exclusion of extraterritorial income can be triggered by a broad range of
transactions. Irrespective of whether the goods or services involved originate in the United States,
such transactions may include:
• the sale, exchange, or other disposition of qualifying foreign trade property;
• the lease or rental of qualifying foreign trade property for use by the lessee outside the
United States;
• the provision of services which are related and subsidiary to any sale, exchange, or other
disposition of qualifying foreign trade property;
• the provision of services which are related and subsidiary to any lease or rental of qualifying
foreign trade property;
• the provision of engineering or architectural services for construction projects located (or
proposed for location) outside the United States; or

97 House Report, page 18.
98 Id.

• the performance of managerial services for a person other than a related person in furtherance
of the production of foreign trading gross receipts.99
119. This expansive definition permits a broad range of taxpayers to earn extraterritorial income,
including US and foreign corporations, as well as individuals. In addition, US corporations may earn
extraterritorial income through either domestic or offshore manufacturing operations.
100 For example,
a US multinational manufacturer can produce qualifying merchandise in foreign plants, and US
companies selling products abroad can source their goods through suppliers located outside the United
States. Despite EC claims to the contrary, the goods that may be the subject of qualifying transactions
can be manufactured, produced, grown, or extracted within or outside the United States, 101 and
nothing in the Act precludes a US or foreign ma nufacturer from producing or selling such property
exclusively from foreign-produced inputs.102
120. Thus, not only does the Act make no reference to exporting, but its exclusion of
extraterritorial income is available in a broad array of circumstances. While export transactions, as
one type of foreign sale, can generate extraterritorial income, no provision in the Act requires
exporting, and the Act’s exclusion clearly applies to income that is wholly unrelated to exporting.103
(iii) Under the Act, Taxpayers Can Maximize Their Excludable Extraterritorial Income Without
Exporting
121. Another factor indicating that the Act is not export-contingent is that taxpayers do not have to
export in order to maximize their benefits. Taxpayers may engage in an unlimited number of non-
export transactions and continue to exclude a portion of income from qualifying transactions.
122. In this sense, the Act is quite distinct from the situation addressed by the Appellate Body in
Canada Autos, which involved the question of whether certain import-duty exemptions provided to
automobile manufacturers were export contingent. One class of exemptions under consideration did
not require automobile manufacturers to export in order to participate in the duty-exemption
programme, but the benefits available under this class of duty exemption were limited. The Appellate
Body observed that participating manufacturers could import duty-free only up to a fixed amount, and
were required to export if they wanted additional duty-free import opportunities.
104 Because
automobile manufacturers relying on this second class of duty exemption could not maximize their
benefits without exporting, the Appellate Body found “a clear relationship of dependency or

99 The Act § 3, amending IRC § 942(a)(1).
100 The ability of US companies to generate excludable income from transactions taking place entirely
outside of the United States refutes the EC’s conten tion that US corporate taxpayers “have no choice but to
export in order to obtain the subsidy in respect of those goods.” See EC First 21.5 Submission, para. 97.
101 The Act § 3, amending IRC § 943(a)(1)(C).
102 The EC argues that the 50 per cent rule embodied in the definition of “qualifying foreign trade
property under the Act “involves” an export contingency. EC First 21.5 Submission , paras. 104-120. As
demonstrated below in Section V.E, the 50 per cent rule does not require the use of any goods exported from the
United States.
103 The Act thus stands in sharp contrast to the measure at issue in Australia - Subsidies Provided to
Producers and Exporters of Automotive Leather , WT/DS126/R, Report of the Panel adopted 16 June 1999
(“Australia Leather ”), in which the Panel examined a series of grants provided by the Australian Government
to Howe Leather, an Australian automotive leather compan y. At the time the grant contract was concluded, the
overwhelming majority of Howe’s sales were for export. The Panel concluded that, “in order to expand its sales
in a manner that would enable it to reach the sales performance targets . . . set out in the grant contract, Howe
would, of necessity, have to continue and probably increase exports.” Id., para. 9.67 (emphasis added). Because
these facts effectively transformed the sales performance targets into export performance targets, the Panel
concluded that “Howe’s anticipated export performance was one of the conditions for the grant of the
subsidies.” Id. (emphasis added).
104 Canada Autos (AB), para. 105.

conditionality exists between the granting of the import duty exemption and the exportation of motor
vehicles by manufacturer beneficiaries.”105
123. The Act does not create a “clear relationship of dependency or conditionality” between the
exclusion of extraterritorial income and export performance. US and foreign businesses subject to US
taxation can rely on the Act’s exclusion without limitation and without engaging in a single export
transaction.
(iv) The Foreign Use Requirement Defines, in Part, a “Foreign Transaction"
124. The EC contends that the Act’s foreign-use requirement – mandating that goods that are the
subject of qualifying transactions must be “held for use, consumption, or disposition outside the
United States”
106 – renders the Act and its exclusion of extraterritorial income export-contingent. 107
The EC believes that not extending the exclusion of extraterritorial income to transactions involving
property consumed in the United States “makes the availability of the subsidy contingent upon export
performance.”
108 The EC’s argument is illogical, and appears to be based on a misunderstanding of
the nature of the Act.109
125. The Act provides for the exclusion of income ar ising in foreign sales transactions. The “use,
consumption, or disposition” of property outside the United States is but one characteristic of a
“foreign” transaction. Another is that the Act explicitly provides that the products in question need
not be manufactured or produced in the United States. Thus, the foreign transactions that come within
the scope of the Act’s exclusion could involve shipments from the United States, but they also could
involve transactions entirely within one other nation or within multiple nations other than the United
States.
126. Transactions involving property used or consumed in the United States are not covered by the
Act because they are not foreign transactions. For example, products manufactured and sold in the
United States cannot be said to be foreign. If the United States is obligated to include such
transactions in the Act, as the EC contends, that would mean that WTO Members are not permitted to
provide a tax exemption or exclusion for foreig n transaction income. Yet, that is not what
Article 3.1(a) is about. It is about export-contingent subsidies.
127. Contrary to what the EC asks this Panel to be lieve, the Act’s foreign-use requirement is not a
“code word” for exports. As reflected in the discussion above, a broad range of foreign transactions
are covered by the Act, many of which do not involve manufacturing in, or shipment from, the United
States, and, thus, do not involve exportation from the United States. Accordingly, the foreign-use
requirement does not render the exclusion of extraterritorial income contingent on export
performance.
3. The EC’s Claim Under Article 3.1(a) Rests Upon an Erroneous Legal Standard
128. The EC’s claim under Article 3.1(a) is based on a legal standard that is unfounded in the
language of the SCM Agreement.

105 Id., para. 108.
106 The Act § 3, amending IRC § 943(a)(1).
107 EC First 21.5 Submission, paras. 99-103.
108 Id., para. 101.
109 Simply as a matter of logic, if there are three possible options (A, B and C), precluding A does not
compel B, because C remains an option.

(a) The EC Creates a New Test for Applying Article 3.1(a)
129. The EC asserts that to assess export contingency, “there must be a comparison with some
relevant benchmark.”110 The EC goes on to say that the “correct benchmark . . . is the treatment
accorded to domestic sales.”111
130. This analytical framework is not found in Article 3.1(a) or anywhere else in the SCM
Agreement, and has never been discussed or adopted by the Appellate Body in connection with
Article 3.1(a). Indeed, such a comparison test is incompatible with the reasoning of the Appellate
Body in prior cases involving export subsidies. As discussed above, the Appellate Body has said that
a measure falls under Article 3.1(a) if, by its terms or operation, it conditions the granting of a subsidy
on export performance. A comparison between treatment under one set of conditions and another – in
particular between domestic and foreign sales – is irrelevant.
131. The EC’s non-textual-based theory of Article 3.1(a) turns in large part on its
mischaracterization of elements of the Illustrative List of Export Subsidies in Annex I of the SCM
Agreement. The EC cites paragraphs (d), (f), (g), (h), and (l) of Annex I as instances in which
treatment of exported products is to be comp ared to that afforded to domestic products. 112 However,
the comparison between exported and domestic products suggested by the cited paragraphs is not to
be made for purposes of determining whether or no t a measure is tied to exportation or is otherwise
export contingent (since the practices in these paragraphs are directly tied to exportation). Instead,
this comparison is to be done for purposes of determining whether a measure that applies to exports
involves a financial contribution by a government or confers a benefit.
132. Even if a comparison between treatment provided to exported and domestic products were
indicated by the paragraphs of Annex I cited by the EC – which are, after all, just examples of
particular kinds of export subsidies – there is no indication that this type of comparison should be
made in the present dispute. The language at issue here does not reference such a comparison, and
neither the FSC Panel nor the Appellate Body proposed such a comparison.
(b) The Act Does Not Make Export Performance “One of Several Other Conditions”
133. Unable to meet the burden imposed by the “contingent” standard, the EC attempts to rewrite
it by giving an expanded meaning to the language “one of several other conditions.”
113 The EC
contends that this language in Article 3.1(a) prohibits measures even where exporting is one way of
satisfying export-neutral eligibility criteria. 114 The EC’s interpretation of Article 3.1(a) goes well
beyond export-contingency. It extends the provision’s application to essentially any measure that has
any relationship to exportation or that might result in exportation. However, the phrase “one of
several other conditions” does not have such a meaning.

110 EC First 21.5 Submission, para. 79.
111 Id., para. 81.
112 Id., para. 88.
113 Id., paras. 121-130.
114 See id. para. 123; see also id., para. 96. At the outset, the EC’s reliance on Canada Aircraft (AB) as
support for its interpretation is misplaced. See id., para. 126. Nowhere in that case did the panel or the
Appellate Body construe the phrase “one of several other conditions.” Instead, the Panel and Appellate Body
concluded that the export contingency relating to subsidies given to industries other than aircraft was not
relevant to its de facto analysis of payments given to the aircraft industry. See Canada – Aircraft (AB) , para.
179; and Canada - Measures Affecting the Export of Civilian Aircraft , WT/DS70/R, Report of the Panel, as
modified by the Appellate Body, adopted 20 August 1999, paras. 9.305-9.348.

134. The key word in the phrase “one of several other conditions” is “other.” The EC wrongly
suggests that the meaning of “other” is “alternative.”115 The ordinary meaning of the word “other” is
“one – of two” or “[t]hat [which] follows the first, second; further, additional”. 116 In this light, the
term “other” is synonymous with the concept of being additional.
135. Given the ordinary meaning of the term “other,” the phrase “one of several other conditions”
suggests that export performance may be an additional condition to others that apply, but export
performance remains a condition that must be satisfied. The phrase “several other conditions” thus
means a series of conditions precedent – all of which must be satisfied for something to occur.
Therefore, in the context of Article 3.1(a), only where a government provides a subsidy contingent on
the fulfillment of a series of conditions, one of which is export performance, is such a subsidy
“contingent, . . . as one of several other conditions, upon export performance”.
136. One consequence of the EC’s reasoning would be that territorial tax exemptions used by
many WTO Members, including EC member states, would be export-contingent within the meaning
of Article 3.1(a). In the same way that the EC argues that the Act’s exclusion applies to exports and
wholly foreign transactions – an oversimplification the United States rejects, as discussed above – tax
exclusions applied by other countries with respect to offshore income can be said to apply to three
types of transactions: imports, wholly foreign transactions, and exports. In the same way that the EC
erroneously contends that US manufacturers must export in order to earn excluded income under the
Act, it could equally be said that domestic manufacturers in these countries may obtain the benefits of
a territorial exemption only by exporting. Income from the sale of those same manufacturers’
products through a domestic distributor or directly on the domestic market is not eligible for a
comparable exemption. It is difficult to imagin e that this was the intent of the drafters of
Article 3.1(a). Only by interpreting “several other conditions” as a series of conditions precedent can
the proper effect be given to the term “contingent” in this context.
117
4. The EC’s Contention that the Exclusion Will Not Apply to Foreign Manufacturing Is
Erroneous and Without Any Factual Support
137. The EC contends that the application of the Act’s exclusion to foreign manufacturing is
“merely cosmetic (and an attempt to hide a prohibited export subsidy).” 118 The EC contends that the
application of the exclusion to foreign manufacturing “is only available where the foreign producer
makes an election to be taxed as a domestic US corporation.” 119 According to the EC, a foreign
corporation would never make this “domesticati on election” because it allegedly would impose an
additional tax liability without reducing the tax liability of the corporation in its original
jurisdiction.120 The EC’s assertions are erroneous and are without any factual support.
(a) Application of the Exclusion to Transactions Involving Foreign Manufactured Goods Is Not
Limited to Circumstances Where a Foreign Manufacturer Makes a Domestication Election
138. The EC asserts that the Act’s application to foreign-manufactured goods is merely cosmetic
because allegedly no foreign manufacturer will make an election under section 943(e)(1) of the IRC to

115 EC First 21.5 Submission, para. 128.
116 The New Shorter Oxford English Dictionary (1993).
117 The EC discusses the US Department of Commerce’s countervailing duty regulations as support for
its interpretation of “one of several other conditions.” EC First 21.5 Submission , para. 128. US countervailing
duty regulations, however, cannot modify the ordinary meaning of provisions of the SCM Agreement.
118 EC First 21.5 Submission, para. 131.
119 Id., para. 132.
120 Id.

be treated as a domestic corporation. 121 However, the EC’s assumes that the Act applies to foreign-
manufactured goods only where there has been such an election. This assumption is incorrect.
139. In general, the Act applies to foreign branches of US businesses manufacturing outside the
United States without the need for an election. This is because, under US law, a foreign branch of a
US business is not treated as a separate entity for tax purposes. Thus, goods manufactured by a
foreign branch of a US business are treated as goods manufactured by the related US business, which
is responsible for paying US taxes on manufacturing income arising from those goods.
122
140. To demonstrate the point, an example may prove helpful. Assume a US corporation owns a
factory in Mexico and regularly sells goods manufactured in that factory to purchasers outside the
United States. Under prior US law, the US corporation generally would have been required to pay US
taxes on the manufacturing income attributable to the Mexican factory. However, under the Act,
income derived from these foreign transactions involving goods manufactured in Mexico by the
branch would be treated as extraterritorial income of the US corporation.
141. In such a case, which is not uncommon, the Act’s exclusion would apply to transactions
involving foreign-manufactured goods without the need for a foreign manufacturer to elect to pay US
tax. Accordingly, the EC’s assertion that the Act’s exclusion would never apply to foreign-
manufactured goods is incorrect.
(b) Foreign Manufacturing Corporations May Make Domestication Elections Without Incurring
Additional Tax Liability
142. In addition to this basic misunderstanding of the language of the Act, the EC also
misunderstands the operation of the domestication election itself. With respect to the category of
transactions for which a domestication election is required, the EC alleges that no foreign taxpayer
would make such an election because it would increase its overall tax liability. This is a factual
assertion for which the EC has not provided any support.
143. Moreover, the assumption underlying the EC’s assertion – that a domestication election
would necessarily increase a foreign corporation’s tax liability – is false. In fact, there are a number
of circumstances in which an election to be treated as a domestic corporation would not result in an
increase in a corporation’s overall tax liability.
144. For example, assume that a foreign manufacturing corporation is incorporated in country X
and is the supplier to a distribution company located in the United States. Assume further that the
country X tax rate is greater than or equal to the US tax rate. It is true that the corporation, upon
making the election, would be subject to tax on its manufacturing income both in the United States
and in country X.
145. However, under the Act, the election will cause the foreign corporation to be treated as a US
corporation for all purposes of the IRC. As such, the corporation will be eligible to claim a foreign
tax credit against its US tax liability with respect to any taxes paid to country X. US law would allow
the foreign corporation to completely offset its US tax liability through the use of foreign tax credits.
In this case, the foreign corporation will be in the same tax position as before the election, and, thus,

121 The Act § 3, amending IRC § 943(e)(1).
122 As noted above, qualifying foreign trade property includes property manufactured outside the
United States. See The Act § 3, amending IRC § 943(a)(1)(A).

should be indifferent to making the election. By virtue of the election, the Act’s exclusion would
apply to sales of goods manufactured by the foreign manufacturing company and sold abroad.123
146. Thus, the EC’s assertion that the domestication election typically would entail a higher tax
burden for an electing corporation is false.
(c) The Domestication Election Was Intended to Equalize the Tax Treatment of US Taxpayers
Operating Abroad
147. As demonstrated by the Act’s legislative history, the domestication election was intended to
equalize the treatment of US taxpayers abroad, regardless of whether they operate in branch or
corporate form. The purpose of the domestication election was not to discourage the application of
the Act to foreign-manufactured goods. As described above, the application of the Act’s exclusion to
foreign-manufactured goods is real and establishes that the exclusion is not export-contingent.
148. Before the Act, US taxpayers manufacturing abro ad in branch form generally were subject to
current tax on all of their branch manufacturing income. US taxpayers, however, generally could
defer taxation of manufacturing income of their foreign corporate subsidiaries. In drafting the Act,
the US Congress sought to prevent taxpayers from inappropriately invoking the Act’s exclusion with
respect to tax-deferred income. Accordingly, the Act provides that property manufactured outside the
United States is not qualifying foreign trade property unless it is manufactured by a person that pays
US tax on its manufacturing income.
149. To ensure that this limitation did not cause the Act’s exclusion to apply only to foreign sales
by branches of US businesses, the Act permits foreign corporations – i.e., subsidiaries – to elect to be
treated as domestic corporations.
150. In sum, sections 942(a)(2) and 943(e)(1) of the IRC, as amended by the Act, were intended to
equalize branch and corporate treatment of US taxpayers with production facilities abroad. These
sections were not, as alleged by the EC, designed to discourage the application of the Act to foreign
manufacturing companies or property manufactured outside the United States.
5. The EC Has Failed to Provide Evidence that the Act’s Exclusion is Export-Contingent
151. The EC’s new legal standards are born of necessity considering its lack of evidence
demonstrating export-contingency. Even though the EC appears to be making a legal challenge, in
reality, it is making factual assertions about the Act’s effects on exportation that have not been
substantiated. All that the EC has presented to the Panel regarding export-contingency is that, under
the Act, some taxpayers may earn excluded extraterritorial income by exporting. However, as shown
above, the fact that exporting is one way of satisfying a neutral standard does not render the Act
export-contingent within the meaning of Article 3.1 (a). The EC has not shown that there is any
requirement to export in order to earn excluded income.
152. The EC has tried to point to the fact that some taxpayers who used the FSC may be eligible to
earn excluded income under the Act, claiming that the export-contingency of the former proves the
export-contingency of the latter. However, footnote 4 of the SCM Agreement, which is attached to

123 If the foreign-manufactured goods are sold abroad by the US distribution company, the exclusion
would apply to the income of the distribution company, not to the income of the manufacturing company. If the
manufacturing company sells the goods abroad directly, then the exclusion would apply to the manufacturing
company’s foreign sales income. In that case, the manufacturing company would receive US foreign tax credits
only with respect to its income that is not excluded under the Act. It would not receive credits with respect to
excluded income.

Article 3.1(a), confirms that the granting of a subsidy to exporters, in and of itself, does not render a
subsidy export-contingent. Footnote 4 states:
The mere fact that a subsidy is granted to enterprises which export shall not for that
reason alone be considered to be an export subsidy within the meaning of [Article
3.1(a)].
Thus, the fact that exporters may earn excluded income under the Act is not sufficient proof that the
granting of subsidies is tied to or contingent upon exportation.124
153. In summary, assuming arguendo that the Act’s exclusion of extraterritorial income constitutes
a subsidy, the EC has failed to establish that this “subsidy” is contingent on export performance.
Absent such a demonstration, the exclusion of extraterritorial income does not constitute an export
subsidy within the meaning of Article 3.1(a) of the SCM Agreement.
D. BECAUSE THE ACT’S EXCLUSION OF EXTRATERRITORIAL INCOME IS A MEASURE TO AVOID
THE DOUBLE TAXATION OF FOREIGN-SOURCE INCOME, THE EXCLUSION IS NOT A
PROHIBITED EXPORT SUBSIDY BY VIRTUE OF THE FIFTH SENTENCE OF FOOTNOTE 59 OF THE
SCM AGREEMENT
154. Even if the Act’s exclusion of extraterritorial income could be said to be a subsidy within the
meaning of Article 1, and even if that “subsidy” could be regarded as export-contingent within the
meaning of the otherwise unqualified language of Article 3.1(a), it nonetheless would not constitute a
prohibited export subsidy under the SCM Agreement. This is because footnote 59 of the SCM
Agreement qualifies the application of the SCM Agreement’s prohibition against export subsidies.
More specifically, the fifth sentence of footnote 59, when read in conjunction with footnote 5 of the
SCM Agreement, provides that “measures to avoid the double taxation of foreign-source income” are
not prohibited by the SCM Agreement. Because the Act’s exclusion of extraterritorial income is
precisely such a measure to avoid double taxation of foreign-source income, it is not prohibited by the
SCM Agreement.
1. The Relationship Between Article 3.1(a) and Footnote 59
155. Before discussing the meaning of the fifth sentence of footnote 59, the United States first
explains how the footnote fits into the SCM Agr eement in general and how it relates to Article 3.1(a)
in particular.
(a) Practices Identified in Annex I as Not Being an Export Subsidy Are Not Prohibited Under the
SCM Agreement
156. To clarify the meaning of Article 3.1(a), the drafters of the SCM Agreement attached at
Annex I an “Illustrative List of Export Subsidies.” The drafters specified in Article 3.1(a) that this

124 Canada Autos (AB) , para. 172. In the Article 21.5 proceeding in Canada Aircraft , the Appellate
Body said that a subsidy granted to enterprises that export does not “compel the conclusion that there is a
relationship of conditionality or dependence such that the granting of a subsidy is ‘tied to’ export performance.”
Canada – Measures Affecting the Export of Civilian Aircraft - Recourse by Brazil to Article 21.5 of the DSU ,
WT/DS70/AB/RW, Report of the Appellate Body adopted 4 August 2000, para. 48. Considering evidence that
subsidies were specifically targeted to the aircraft indus try because of its high export orientation, the Appellate
Body said that “the targeting factors may very well be relevant to an inquiry under Article 3.1(a) of the SCM
Agreement, but they do not necessarily provide conclusive evidence that the granting of a subsidy is
‘contingent,’ ‘conditional,’ or ‘dependent’ upon export performance. In these proceedings, we do not see the
two ‘targeting’ factors, by themselves, as adequate proof of prohibited export contingency.” Id., para. 49.

Illustrative List identifies practices that come within the provision’s prohibition.125 At the same time,
the drafters also made clear that practices identified by the Illustrative List as not constituting an
export subsidy are not prohibited by Article 3.1(a) or any other provision of the Agreement. They did
so by means of footnote 5 of the Agreement, which is attached to Article 3.1(a). Footnote 5 states that
“[m]easures referred to in Annex I as not constitu ting export subsidies shall not be prohibited under
this or any other provision of this Agreement”. Under this structure, if a type of measure is deemed to
be an export subsidy by the Illustrative List, it is prohibited by Article 3.1(a); if a measure is deemed
not to be an export subsidy by the List, it is not prohibited by any provision of the SCM Agreement.
(b) Paragraph (e)’s Relationship to Article 3.1(a)
157. Paragraph (e) of Annex I sets forth a general prohibition against foregoing or reducing taxes
to be collected on export income. It states that “the full or partial exemption, remission, or deferral
specifically related to exports, of direct taxes” is an export subsidy. The EC correctly defined the
terms of paragraph (e) as “having a special, precise or clearly defined relationship or connection to
exports.”
126 This means that paragraph (e) applies to income tax exemptions, remissions, or deferrals
that are directly connected to, narrowly or singularly tailored to, or overtly tied to income derived
from export transactions.
158. Despite this definition, and in particular paragraph (e)’s use of the word “specifically,” the EC
argues that paragraph (e) expands the scope of Article 3.1(a). The EC asserts that:
Contingency is a particular form of special relationship. Therefore any subsidy that is
contingent upon export performance must, necessarily, also be ‘specifically related to
exports’ within the meaning of item (e). However, the term ‘specific relation’ is
broader than the term ‘contingency.’ The former covers any specific link and thus
would include a simple incentive.
127
159. The EC’s theory of paragraph (e) is untenable, because the EC ignores the relationship
between Article 3.1(a) and Annex I. Article 3.1(a) expressly states that the subsidies listed in Annex I
are “illustrative” in that they provide a non-exhaustive list of export subsidies that are “contingent . . .
on export performance.” For this reason, the drafters of the Agreement explained the relationship
between Annex I and the prohibition against export subsidies by saying: “ including those illustrated
in Annex I”. (emphasis added).
160. The ordinary meaning of the term “including” confirms that the Illustrative List does not
expand Article 3.1(a). “Including” means “inclusi ve of”, and “inclusive” means “that includes”.
128
The term “include” is defined as “contain as a part of a whole” or “place in a class or category”. 129
Thus, the export subsidies identified in Annex I are but examples of a class or category of “export
subsidies” that come within the scope of Article 3.1(a). While they to some extent clarify the
meaning of Article 3.1(a), these examples do not expand Article 3.1(a)’s application as the EC
suggests. In contrast to the EC’s position, pa ragraph (e) does not and cannot prohibit direct tax
exemptions, remissions, or deferrals that are not “contingent . . . upon export performance.” Indeed,
to the extent that the contingency requirement of Article 3.1(a) does not encompass subsidies granted
based on the mere expectation of export performance – as discussed in section C above – paragraph

125 Article 3.1(a) states in relevant part that “the following subsidies, within the meaning of Article 1,
shall be prohibited: (a) subsidies contingent in law or in fact, whether solely or as one of several other
conditions, upon export performance, including those illustrated in Annex I” (emphasis added).
126 EC First 21.5 Submission, paras. 149-153.
127 Id., paras. 156-157.
128 The New Shorter Oxford English Dictionary (1993).
129 Id.

(e) cannot provide a backdoor way of reaching what the EC refers to as “incentives” that are not
export contingent.130
161. The essence of paragraph (e) is a ban against export-specific income tax benefits or relief. It
applies to measures that forego taxes directly or only on income derived from export transactions. In
order for paragraph (e) to apply, the tax benefits at issue must be export-contingent within the
meaning of Article 3.1(a).
(c) Footnote 59’s Relationship to Paragraph (e)
162. Footnote 59 explains and qualifies the application of paragraph (e). Footnote 59, which is
attached to paragraph (e),
131 identifies certain practices that, though they involve the failure to collect
direct taxes on income earned in export transactions, nonetheless fall outside the scope of paragraph
(e). As noted above, by virtue of footnote 5, if footnote 59 identifies measures that are not export
subsidies, such measures are not prohibited by the SCM Agreement.
(i) The First Sentence of Footnote 59: Deferral
163. The first sentence of footnote 59 states that “[t]he Members recognize that deferral need not
amount to an export subsidy where, for example, appropriate interest charges are collected.” This
sentence makes clear that, despite paragraph (e)’s otherwise unequivocal pronouncement that “[t]he
full or partial . . . deferral specifically related to exports, of direct taxes” is a prohibited export
subsidy, paragraph (e) does not apply to a deferral scheme if “appropriate interest” is charged.
132
164. Neither paragraph (e) nor footnote 59 defines what is meant by the term “deferral”, but it
appears to refer to instances where taxation is delayed, perhaps indefinitely, pending the occurrence of
some event.133 Deferral could be applied to export income in a number of ways, but it is particularly
relevant in connection with exports in situations where taxes on export income earned by an offshore
related entity ( e.g., a foreign subsidiary) are not assessed unless and until they are repatriated to a
domestic parent.134 This means that, under the first sentence of footnote 59, a measure deferring taxes
on foreign-source export income earned by an offshore subsidiary may escape the reach of paragraph
(e) provided that “appropriate interest” is charged.135
165. Thus, the first sentence of footnote 59 qualifies paragraph (e). It makes clear that at least in
one circumstance, despite the otherwise unqualified language of paragraph (e), the non-taxation of

130 The EC’s attempt to expand the meaning of Article 3.1(a) through paragraph (e) differs from its
approach in challenging the FSC. As the Panel may reca ll, in the initial proceeding, the EC invoked paragraph
(e) because the FSC applied explicitly and only to exports , alleging in its first submission to the FSC panel,
para. 159, the FSC benefits were “‘specifically related to exports’ since they are conditional upon exportation of
US goods and limited in scope to the extent of such exportation”. FSC (Panel), para. 4.304 (emphasis added).
The EC recognized then that paragraph (e) applies to a relatively narrow subset of subsidies that are contingent
or “conditional” on – as well as focused on or “limited” to – exportation.
131 Unlike footnote 58, which applies to more than one paragraph of Annex I, footnote 59 is connected
only to paragraph (e).
132 The reason this is so appears to be that chargi ng “appropriate interest” sufficiently negates benefits
that may be conferred on exports.
133 According to The New Shorter Oxford English Dictionary (1993), “defer” means “to put off (an
action or procedure, an event, matter, or question) to some later time; to delay, postpone.”
134 Deferral could also apply to the non-taxation of export income earned by offshore companies
pending repatriation not only to domestic parents but also to shareholders in general.
135 Deferral with interest is only one form of deferral of taxes on export income that is not an export
subsidy. This is because the first sentence of footnote 59 identifies charging “appropriate interest” as but an
“example” of an instance in which “deferral specifically related to exports” does not constitute a prohibited
export subsidy.

export income is not prohibited by the SCM Agreement. While the Appellate Body in its FSC
decision declined to comment on the meaning of the first sentence of footnote 59 because the FSC did
not involve deferral, the Appellate Body did acknowledge that the first sentence is “specifically
related to” and “qualifies” paragraph (e).136
(ii) The Fifth Sentence of Footnote 59: Avoiding Double Taxation
166. A second area in which footnote 59 carves out an exception to paragraph (e) is with respect to
measures to avoid the double taxation of foreign-source income. 137 The last sentence of the footnote
states that “[p]aragraph (e) is not intended to limit a Member from taking measures to avoid the
double taxation of foreign-source income earned by its enterprises or the enterprises of another
Member.” Footnote 59 does not define what “doub le taxation” means, or what types of measures
appropriately serve to “avoid” it, but the ordinary meaning of this language indicates that it
encompasses measures to prevent the same inco me from being subjected to tax twice. This
understanding of the last sentence of footnote 59 derives from the fact that “avoid” means “keep off;
prevent; obviate”, 138 “double” means “twice as much or as many” or “occurring twice”, 139 and
“taxation” means “the imposition or levying of taxes”.140
167. Significantly, the fifth sentence of footnote 59 does not apply to any type of income, but only
to “foreign-source income”. The footnote does not define this term, but its ordinary meaning is as
follows: (1) “income” means “the (amount) of money or other assets received or due to be received
from employment, business, investments, etc.”;
141 (2) “foreign” means “carried on or taking place
abroad” or “situated outside the country; not in one’s own land”;142 and (3) “source” means “a place or
thing from which something material is obtained or originates.”143 Thus, for purposes of footnote 59,
foreign-source income would appear to include money (or other assets) originating outside the borders
or territory of the WTO Member instituting a measure to avoid double taxation.
168. Foreign-source income raises the possibility of double taxation because it can be subjected to
taxation by the country that is the source of income (sometimes referred to as the country of source)
as well as by the country in which the taxpayer resides (sometimes referred to as the country of
residence). It also can arise because two countries claim that the same taxpayer is a resident subject to
their jurisdiction or the same income originates with in their borders. Whatever the legal basis, the
issue of double taxation of foreign-source income is significant in the context of exports because, by
definition, goods or services sold in an export transaction are sold from one country to another. As a
result, some or all of the income generated by an export transaction can be said to be “foreign”
because the destination of the exported goods, the location of the purchaser, the transfer of title, the
making of payment, or the economic activities giving rise to the sale may occur outside the seller’s
country of residence. A foreign country that can lay claim to being the “source” of some or all of
income earned outside of the seller’s country of residence – e.g., for one of the foregoing enumerated
reasons – might seek to tax such income. At the same time, the country of residence of a taxpayer
might make the same claim with respect to that same income.

136 FSC (AB) , para. 97. The United States does not contend that the Act involves deferral, but
discusses the first sentence of footnote 59 to illustrate the overall meaning and significance of the footnote.
137 In the FSC case, the Appellate Body declined to examine the meaning of the fifth sentence of
footnote 59, finding that the United States had not raised the issue before the panel. FSC (AB), paras. 101-03.
138 The New Shorter Oxford English Dictionary (1993).
139 Id.
140 Id.
141 Id.
142 Id.
143 Id.

169. To alleviate this and related concerns, the fifth sentence of footnote 59 permits WTO
Members to refrain from taxing foreign-source income earned in export transactions. There can be no
doubt that this is so, because the fifth sentence of footnote 59 narrows the scope of paragraph (e),
which prohibits direct tax exemptions, remissions, or deferrals that are made available “specifically in
relation to exports.” As the fifth sentence of footnote 59 states, “ Paragraph (e) is not intended to
limit a Member from taking measures to avoid double taxation of foreign-source income ... .”
(emphasis added).
(d) Footnote 59 Identifies Certain Measures As Not Being Export Subsidies Within the Meaning
of Footnote 5
170. As demonstrated above, the first and fifth sentences of footnote 59 qualify paragraph (e).
These two sentences of footnote 59 identify certain tax practices that are permissible despite the fact
that they may be directly tied to exports.
171. The first sentence of footnote 59 makes clear that deferral of taxation “specifically in relation
to exports” is permissible where “appropriate interest in charged”. A deferral that is not made
“specifically in relation to exports” would be outside the scope of paragraph (e) and would need no
qualification under footnote 59 in order to be exempt from the SCM Agreement’s export subsidy
prohibition. The first sentence of footnote 59 was included by the drafters to make clear that a
deferral-with-interest regime, even one that applies specifically to exports, is not a prohibited export
subsidy.
172. Likewise, the fifth sentence of footnote 59 permits measures to avoid double taxation even
though they might otherwise constitute export-specific tax exemptions, remissions, or deferrals of
direct taxes pursuant to paragraph (e). This can be seen from the fifth sentence’s opening terms:
“Paragraph e is not intended to limit a Member from taking measures to avoid . . . double taxation ...
.” Indeed, if a measure to avoid double taxation were permitted only if it were not specifically related
to exports, then the fifth sentence would have no meaning. It would merely state what is obvious, that
non-export-specific measures are not subject to paragraph (e) or Article 3.1(a) at all.
173. Measures to avoid double taxation, therefore, come within the meaning of footnote 5. That
footnote provides that “[m]easures referred to in Annex I as not constituting export subsidies shall not
be prohibited ... .” The ordinary meaning of “referred” is “to assign to a thing, or class of things, as
being properly included or comprehended in this; to regard as naturally belonging, pertaining, or
having relation to; to attach or attribute to.”
144 It also can mean something as simple as “a reference in
a book”.145 Footnote 5 thus indicates that a measure need only be included or mentioned in Annex I in
such a way as to be properly assigned or classified as not being an export subsidy. Footnote 5 does
not require that the words “is not an export subsidy” appear in the Illustrative List’s description of the
measure in question.
174. In so arguing, the United States is not relying on the principle of a contrario sensu , the
doctrine of assuming that the opposite conclusion may be drawn from an affirmative rule or
statement. Rather, the fact that the fifth sentence of footnote 59 explicitly provides a narrowing of
paragraph (e) signals that the drafters of the SCM Agreement intended that measures to avoid double
taxation should not be treated as prohibited export subsidies.

144 Id.
145 Id.

175. This is a distinction made by the panel in the Brazil Aircraft case.146 The panel first found
that “in its ordinary meaning, footnote 5 relates to situations where a measure is referred to as not
constituting an export subsidy.” 147 In addition, the panel observed that the ordinary meaning of
footnote 5 “could extend more broadly to cover cases where the Illustrative List contained some other
form of affirmative statement that a measure is not subject to the Article 3.1(a) prohibition.” 148 The
panel then indicated that this reasoning applied to the first and fifth sentences of footnote 59.149 Thus,
following this reasoning, measures to avoid double taxation are “referred” to in Annex I as not being
export subsidies and, therefore, are not prohibited under Article 3.1(a) or any other provision of the
SCM Agreement.
2. Measures to Avoid Double Taxation Under Footnote 59
176. In the preceding section, the United States demonstrated that under the fifth sentence of
footnote 59, measures taken to avoid double taxation of foreign-source income are not prohibited by
the SCM Agreement. In this section, the United States demonstrates that the non-taxation of foreign-
source income is a measure to avoid double taxation for purposes of footnote 59.
(a) Non-Taxation of Foreign-Source Income Is a Widely Accepted Method of Avoiding Double
Taxation
177. There does not appear to be any dispute between the EC and the United States as to whether a
system of non-taxation of foreign-source income is an acceptable means of avoiding double taxation.
This mutual position derives from the fact that well-established international tax disciplines have long
recognized that two countries may claim the righ t and ability to tax the same income, leaving
taxpayers with an undue burden and requiring that the respective countries take action to rectify a
potential injustice. As the EC stated to the FSC Panel,
When a resident of a country earns income from outside the country (foreign-source
income), the claim of that country to tax the income based on its worldwide residence
jurisdiction may overlap the claim of a foreign country to tax revenue based on
source jurisdiction. Consequently, foreign-source income earned by a resident of a
country may be taxed by both the country of source and the country of residence,
absent relief provisions to prevent double taxation. The necessity for relief is clear on
grounds of equity and economic policy.
150
178. While the WTO has not defined the types of measures that may be used to avoid double
taxation of foreign-source income, two general categories of measures are well accepted and used
around the world for this purpose. They are the exemption (or non-taxation) method and the credit
method. Both have been endorsed by the two leading model tax treaties, prepared under the auspices
of the Organization for Economic Cooperation an d Development (“OECD”) and the United Nations

146 Brazil - Export Financing Programme for Aircraft - Recourse by Canada to Article 21.5 of the
DSU, WT\DS46\RW, Report of the Panel, as modified by the Appellate Body, adopted 4 August 2000.
147 Id., para. 6.36.
148 Id.
149 Id. In contrast, the Panel found that there is no basis to assume that measures that merely fall
outside the scope of illustrative export subsidies in Annex I are not export subsidies for purposes of footnote 5.
Id.
150 Annex EC-2, page 1 (US-5).

(“UN”).151 Indeed, the EC cited both to the Panel as establishing proper ways of avoiding double
taxation.152
(b) An Explanation of the Exemption (Non-Taxa tion) Method for Avoiding Double Taxation:
the OECD Model Rules
179. Both the OECD and the UN model treaties expressly allow countries to use either exemption
(non-taxation) or credits to avoid double taxation of foreign-source income. Though their relevant
provisions differ on the details, the two model treaties achieve the same ends for present purposes. To
explain what the exemption method is and how it operates to avoid double taxation, the United States
will refer to the OECD Model Convention’s provision on exemption.153 The OECD Convention is the
model treaty that most EC member states rely on, and it makes clear how exemption (non-taxation)
may be employed to avoid double taxation.
180. The OECD Model Convention provides in pertinent part:
METHODS FOR ELIMINATION OF DOUBLE TAXATION
Article 23A
EXEMPTION METHOD
1. Where a resident of a Contracting State derives income or owns capital which, in accordance
with the provisions of this Convention, may be taxed in the other Contracting State, the first-
mentioned State shall, subject to the provisions of paragraphs 2 and 3, exempt such income or capital
from tax.154

Article 23B
CREDIT METHOD

151 Model Tax Convention on Income and Capital (OECD 1992) (“OECD Model Tax Convention”)
(Exhibit US-7); see also United Nations Model Double Ta xation Convention Between Developed and
Developing Countries, Pub. No. ST/ESA/102 (1980).
152 Annex EC-2, page 2 (US-5).
153 In doing so, the United States does not rely on the OECD Model Convention as an authoritative
source for interpreting WTO rules. The United States cites the Convention solely as an example.
154 The rest of Article 23A states:
2. Where a resident of a Contracting State derive s items of income which, in accordance with the
provisions of Articles 10 and 11 [involving cross-border dividend and interest income, respectively], may be
taxed in the other Contracting State, the first mentioned state shall allow as a deduction from the tax on the
income of that resident an amount equal to the tax paid in that other State. Such deduction shall not, however,
exceed that part of the tax, as computed before the dedu ction is given, which is a ttributable to such items of
income derived from the other state.
3. Where in accordance with any provision of the Convention income derived or capital owned
by a resident of a Contracting State is exempt from tax in that State, such State may nevertheless, in calculating
the amount of tax on the remaining income or capital of such resident, take into account the exempted income or
capital.

1. Where a resident of a Contracting State derives income or owns capital which, in accordance
with the provisions of this Convention, may be taxed in the other Contracting State, the first-
mentioned State shall allow:
(a) as a deduction from the tax on the income of that resident, an amount equal to the
income tax paid in that other State;
(b) as a deduction from the tax on the capital of that resident, an amount equal to the
capital tax paid in that other State.
Such deduction in either case shall not, however, exceed that part of the income tax or capital
tax, as computed before the deduction is given, which is attributable, as the case may be, to
the income or the capital which may be taxed in that other State.155
181. The Commentary to the OECD Model Conventi on explains that both the exemption method
and the credit method serve to avoid double taxation in the context of foreign-source income. 156 The
Commentary makes clear that exemption applies not only to foreign-source income earned directly by
a resident of the taxing country, but also to dividend and interest income that is repatriated to the
taxing country.
157 The Commentary further makes clear that countries are free to adopt one or both
methods and the means by which they are implemented may vary from country to country.158
182. In addition, the Commentary provides that, “[u]nder the principle of exemption, the state of
residence R does not tax the income which . . . may be taxed in [another country].” Thus, the term
“exemption” for purposes of double tax avoidance does not mean only the establishment of a legal
exception to an otherwise applicable revenue-raising general rule. “Exemption” in this context means
the non-taxation of income subject to double tax.
159 As long as income “may be taxed” in another
country, the Commentary states that a country of residence must not tax that same income.160
(c) The Exemption Method May Allow for An Overall Tax Reduction for Some Taxpayers
183. An important distinction between the exemption (non-taxation) method and the credit method
is that the former operates on an ex ante basis while the latter operates on an ex post basis. The
exemption method does not tax income that potentially may be subjected to the tax systems of two
sovereign nations. It does so in general and “before the fact” – that is, without regard to the particular
income or foreign tax that is involved. This stands in contrast to the tax credit method, which only

155 Article 23B has a second paragraph, which provides that “[w]here in accordance with any provision
of the Convention income derived or capital owned by a resident of a Contracting State is exempt from tax in
that State, such State may nevertheless, in calculating the amount of excess tax on the remaining income or
capital of such resident, take into account the exempted income or capital.”
156 OECD Model Tax Convention, p. C(23)-3 (US-7) (“Articles 23A and 23B apply to the situation in
which a resident of State R [residence] derives income from, or owns capital in, the other Contracting State S
[source] . . . and that such income or capital, in acco rdance with the Convention, may be taxed in such other
State S.”).
157 Commentary to the OECD Model Tax Convention , p. C(23)-14 (US-7) (“In Articles 10 and 11 the
right to tax dividends and interest is divided between the States of residence and the State of source. In these
cases, the State of residence is left free not to tax if it wants to do so . . . and to apply the exemption method also
to the above-mentioned items of income.”). The second paragraph of Article 23A, however, imposes limitations
on the exemption method with regard to these types of income that do not apply to other types of income.
158 Id., page C(23)-14 (“In view of the wide variety of fiscal policies and techniques in the different
States regarding the determination of tax, especially deductions, allowances and similar benefits, it is preferable
not to propose an express and uniform solution in the C onvention, but to leave each State free to apply its own
legislation and technique.”).
159 Id., page C(23)-4.
160 Id., page C(23)-11.

offsets foreign taxes actually paid on specific inco me “after the fact”. International principles of
taxation recognize these differences, but embrace both.
184. While tax credits are capped by the amount of foreign taxes paid – and can provide only
partial relief where exceptions apply – the overall tax liability of a given taxpayer under the
exemption method is determined by the tax rate applie d by the source country. To the extent that the
tax rate applied by the source country is higher than that of the country of residence, a taxpayer will
pay more in taxes on the income in question than if that income were earned in the country of
residence. Conversely, if the source country applies a lower rate, then a taxpayer will pay less than if
the income were earned exclusively within the country of residence.
185. That the exemption method may result in an overall tax reduction in no way undermines the
validity of the method under accepted international tax norms. Neither the OECD nor the UN model
treaty requires treaty parties to impose any minimum level of tax under an exemption system. The
model treaties leave to individual countries the determination of whether a minimum level of taxation
by a treaty party is necessary for exemption to apply under their national laws. In fact, the OECD
Commentary specifically provides that the state of residence must “give exemption whether or not the
right to tax is in effect exercised by the other States.”
161 The Commentary explains that this method is
the most practical, “since it relieves the State of residence from undertaking investigation of the actual
taxation position of the other States.”
162
186. The EC has acknowledged this feature of the exemption system. Because the exemption
method of avoiding double taxation is not calibrated to the tax paid to a foreign country, the EC has
explained, “[t]o the extent that foreign taxes are lower than domestic taxes, resident taxpayers with
exempt foreign-source income are treated more favourably than other residents.”163
3. The Act’s Exclusion of Extraterritorial Income Is a Measure to Avoid Double Taxation
Within the Meaning of Footnote 59
187. By operation and design, the Act is a measure to avoid double taxation of foreign-source
income for purposes of footnote 59.
(a) The Act Relies on Non-Taxation Rather than Tax Credits as a Double Tax Avoidance
Mechanism
188. The Act expressly relies on the non-taxation method to avoid double taxation of foreign-
source income. The legislative history accompanying the Act makes the point explicitly: “Because
the exclusion of such extraterritorial income is a means of avoiding double taxation, no foreign tax
credit is allowed for income taxes paid with respect to such excluded income.” 164 The legislative
history further explains that, in shifting from a worldwide tax system to a more territorial approach,
the United States was, through the Act, embracing an exemption (or non-taxation) method of avoiding
double taxation typically employed under territorial systems. The Act’s exclusion would take the
place of foreign tax credits, which ordinarily serve under the IRC as the mechanism for avoiding
double taxation. The legislative history states:
It is important to note that each type of system [worldwide versus territorial]
generally uses a different method to avoid double taxation of foreign-source in-come.
Although this is an oversimplification, in a worldwide system, the ‘‘credit method’’

161 Id.
162 Id.
163 Annex EC-2, page 6 (US-5).
164 House Report, page 10; see also Senate Report, page 2.

typically is used; that is, a tax credit is provided for taxes paid to foreign governments
on income earned abroad. In a territorial system, the ‘‘exemption method’’ is used;
that is, income earned abroad is simply not subject to tax. While tax policy
arguments can be used to justify the superiority of one method over the other, both
methods are accepted internationally, and it also is accepted internationally that a
country is free to use either method or both.
165
189. The Act achieves double taxation avoidance through the exclusion of extraterritorial income.
In addition, section 114(d) of the IRC, as added by the Act, provides that “no credit shall be allowed
under this chapter for any income, war profits and excess profits taxes paid or accrued to any foreign
country or possession of the United States with respect to extraterritorial income which is excluded
from gross income under subsection (a).” The Act also provides that deductions are not allowed with
respect to excluded income.166
(b) The Act Provides a Partial Exclusion for Foreign-Source Income
190. By creating a general exclusion from US taxation for extraterritorial income in section 114(a),
and then establishing limited exceptions that allow for tax on a portion of such income in section
114(b), the Act provides a partial exclusion for fore ign-source income within the meaning of the fifth
sentence of footnote 59. As noted above, the ordinary meaning of the term “foreign-source income”
is profits or proceeds originating outside the borders or territory of the WTO Member instituting a
measure to avoid double taxation. The essential characteristics that would indicate whether profits or
proceeds originate outside the borders or territory of a country might include one or more of the
following: the goods or services in question are sold outside the territory of the taxing authority, the
purchaser is located outside the territory of the taxing authority, title to the merchandise is transferred
outside the territory of the taxing authority, payment is made or issued outside the territory of the
taxing authority, or economic activities giving rise to the sale occur (at least in part) outside the
territory of the taxing authority.
191. “Extraterritorial income” under the Act involves these foreign attributes. The central premise
of the Act is to provide a tax exclusion for income from foreign sales.
167 With regard to the types of
transactions that may generate excludable income, the Act provides that the goods involved must be
used, consumed, or disposed of outside the United States. 168 As such, the purchasers of these goods
typically will be located outside the United States, they generally will authorize or make payment for
the goods in another country, and in many instances title will pass in that country as well. The goods
may be produced outside the United States, 169 and certain required levels of foreign economic
activities must be performed with respect to the sales and distribution functions associated with
qualifying transactions.170
192. It is because of these considerations that income excluded under the Act may properly be
characterized as extraterritorial and, thus, “foreign-source.” Although the EC complains that the Act
“does not concern ‘extraterritorial’ income in any real [sense] of that word”,171 the EC acknowledges
that the Act applies to income “derived from foreign sales.” 172 As discussed above, “extraterritorial

165 House Report, page 13.
166 The Act § 3, amending IRC § 114(c).
167 The Act § 3, amending IRC § 114(e), defines “extraterritorial income” as the proceeds generated
from qualifying foreign sales.
168 The Act § 3, amending IRC § 943(a)(1)(B).
169 The Act § 3, amending IRC § 943(a)(1)(A).
170 The Act § 3, amending IRC § 942(b).
171 EC First 21.5 Submission, para. 17.
172 Id.

income” under the Act is income derived from non-domestic sources. As such, it comes within the
ordinary meaning of “foreign-source.”
(c) The Act’s Exclusion Is Akin to Territorial Exemptions Under EC Member State Systems
193. The exclusion established by the Act was designed to parallel aspects of the territorial
exclusions or exemptions used by EC member states. The Act’s legislative history makes this plain:
The Committee emphasizes that the extraterritorial income excluded by this
legislation from the scope of US income taxation is parallel to the foreign-source
income excluded from tax under most territorial tax systems. Under neither the US
tax system as modified by this legislation nor many European tax systems is the
income excluded from taxation limited to income earned through exporting. At the
same time, under both systems, exporting is one way to earn foreign source income
that is excluded from taxation, and exporters under both systems are among those
who can avail themselves of the limitations on the taxing authority of both systems.
While exporters may be among those who are eligible for the exclusion, this fact does
not make that exclusion ‘‘export contingent.’’ If it did, every general exclusion from
tax applicable to, among others, exporters would become a prohibited export
subsidy.
173
194. The exclusion provided under the Act is similar to the practice of a number of EC member-
state tax systems in exempting foreign-source income from taxation. 174 Like the Act, these EC
systems do not tax at least a portion of the income generated by foreign sales. Among EC tax systems
that apply the territorial principle of taxation, the form and extent of each country’s application of that
principle vary. Some countries, such as France, have historically exempted all income earned outside
their borders. However, no EC country now provides a blanket exemption for foreign-source income.
In fact, as the EC explained to the FSC Panel, EC member states providing an exemption for foreign-
source income do so only partially, and most generally treat foreign-source income as an exception to
the general rule that the worldwide income of a domestic corporation is subject to taxation in its
country of residence.
175 Just as the Act moves the United States toward a more territorial approach to
its system of taxation, EC systems are a mix of worldwide and territorial principles.
4. Conclusion
195. For the foregoing reasons, the exclusion of extraterritorial income under the Act is a measure
to avoid double taxation within the meaning of footnote 59. Therefore, pursuant to footnote 5 of the
SCM Agreement, the exclusion does not constitute a prohibited export subsidy for purposes of Article
3.1(a).
E. THE 50 P ER CENT RULE ON CERTAIN FOREIGN VALUE DOES NOT RENDER THE ACT’S
EXCLUSION OF EXTRATERRITORIAL INCOME INCONSISTENT WITH ARTICLE 3.1(B) OF THE
SCM AGREEMENT
196. The EC argues that the 50 per cent rule on certain foreign value in the Act violates Article
3.1(b) of the SCM Agreement. 176 The Panel need not reach this issue for two reasons. First, as

173 House Report, page 18.
174 These are discussed in more detail in the “Factual Background” section above.
175 EC Annex-2, page 2 (US-5).
176 EC First 21.5 Submission, paras. 159-184.

demonstrated above, the Act’s exclusion does not constitute a subsidy within the meaning of Article
1.1(a)(1)(ii). Second, footnote 5 provides that measures not constituting export subsidies under
Annex I are not prohibited under any provision of the SCM Agreement, including Article 3.1(b).
Should the Panel find that Article 3.1(b) is appli cable to this dispute, however, the EC’s claim
nonetheless fails because it rests on a misunderstanding of the 50-per cent rule and a failure to
demonstrate that the Act’s exclusion is “contingent” on the use of domestic over imported goods.
1. The EC’s Claim Under Article 3.1(b) Is Re ndered Moot By Footnote 5 of the SCM
Agreement
197. As demonstrated above in connection with Article 3.1(a), footnote 5 to the SCM Agreement
states that “[m]easures referred to in Annex I as not constituting export subsidies shall not be
prohibited under this or any other provision of this Agreement.” Footnote 5 thus provides an
immunity from all prohibitions in the SCM Agreement - including the one established under Article
3.1(b) - provided that the terms of the footnote are met. As also demonstrated above, the Act’s
exclusion of extraterritorial income is a meas ure to avoid double taxation within the meaning of
footnote 59 of Annex I. Therefore, because the exclusion is a “[m]easure referred to in Annex I as not
constituting [an] export subsid[y]”, it is not prohibited under any provision of the SCM Agreement,
including Article 3.1(b). Accordingly, the Panel need not address the EC’s claim under Article 3.1(b).
2. The Meaning of Article 3.1(b)
198. If the Panel determines that the exclusion of extraterritorial income falls outside the scope of
footnote 5, then analysis of the EC’s claim under Article 3.1(b) must begin with the text of that
provision. In this regard, Article 3.1(b) prohibits “[s]ubsidies contingent, whether solely or as one of
several other conditions, upon the use of domestic over imported goods.” The Appellate Body has
stated that the legal standard embodied by the term “contingent” applies equally under Articles 3.1(a)
and 3.1(b) of the SCM Agreement.
177 Thus, for purposes of Article 3.1(b), the Appellate Body has
confirmed that “contingent” means “conditional” or “dependent for its existence on” something
else.178 For a subsidy to be “contingent . . . on the use of domestic over imported goods,” it must be
conditioned on or dependent for its existence on the use of domestic goods instead of imported goods.
3. The EC Misunderstands the 50 Per cent Rule
199. The EC’s claim reflects a basic misunderstanding of the 50 per cent rule. The EC suggests
throughout its First Submission that the Act contains a domestic content requirement that precludes
manufacturers from using more than a fixed amount of imported inputs in their production
operations.179
200. However, the Act neither precludes manufacturers from using more than a fixed amount of
imported articles nor requires the use of any US manufactured articles for a transaction to earn
excludable extraterritorial income. Instead, the Act provides that up to 50 per cent of the fair market
value of goods involved in a transaction may be a ttributable to articles produced outside the United
States and direct labour costs incurred outside the United States.
180 Under this rule, a good can meet
this requirement even if 100 per cent of its content is foreign.
201. The 50 per cent rule takes into account only the value of foreign articles and foreign direct
labour costs used in producing a finished product. It does not limit other foreign value. Thus, the

177 Canada Autos (AB), para. 123.
178 Canada Aircraft (AB), para. 167.
179 E.g., EC First 21.5 Submission, paras. 55, 69, 106, 159 and 179.
180 The Act § 3, amending IRC § 943(a)(1)(C).

remaining 50 per cent of fair market value of the finished product can be attributed to non-tangible
elements, including intellectual property rights, goodw ill, capital, marketing, distribution, and other
services, which may be of either US or foreign origin. The articles used in manufacturing, whatever
their origin, account for only part of the total value.
202. The operation of the 50 per cent rule can be illustrated through an example. Assume a
product consists of 100 per cent foreign articles and is manufactured using only foreign direct labour.
Assume further that the sum of va lue of the foreign articles and foreign direct labour costs is $200.
Assume also that, because of significant foreign brand name value and foreign capital costs, the fair
market value of the product (i.e., the price at which it can be sold to consumers) is $450. The sale of
such a product qualifies for the exclusion under the Act, notwithstanding the fact that no US goods are
involved, because $200 is less than 50 per cent of $450.
203. The practical effect of the 50 per cent rule is further diminished by the principle of origin
applicable to components incorporated into manuf actured products. An input sourced from a US
supplier may be deemed US-origin for purposes of the 50 per cent rule, despite the fact that the goods
from which that component was manufactured may have been primarily, or even entirely, imported
goods. In such circumstances, there is no preference for domestic over imported goods because the
finished component typically is deemed to be a US-origin good.181
4. Canada Autos Confirms that the Exclusion of Extraterritorial Income Is Not Contingent
Upon the Use of Domestic Over Imported Goods
204. The foregoing discussion of why the Act’s 50 per cent rule does not violate Article 3.1(b) is
confirmed by the Appellate Body report in Canada Autos. In that case, the Appellate Body found that
even a 60-per cent value-added requirement does not necessarily raise a presumption of inconsistency
with Article 3.1(b) of the SCM Agreement. The Appellate Body concluded that only where there is
evidence that a manufacturer actually will be required to use domestic over imported goods will the
prohibition in Article 3.1(b) be implicated.
(a) The Appellate Body’s Decision
205. In Canada-Autos, the panel and the Appellate Body considered whether a Canadian value-
added requirement rendered the subsidy at issue contingent on the use of domestic over imported
goods.
182 Under the applicable measure, a Canadian motor vehicle manufacturer was entitled to
benefit from an import duty exemption if, inter alia, that manufacturer’s total Canadian value- added
with respect to a class of vehicles reached a certain proportion of the final product’s total value.
Canadian value added (CVA) could be established through various elements. These elements, while
including the costs of parts produced in Canada, also consisted of transportation costs; wages paid for
non-production labour in Canada; cost of materials used in the production operation but not
incorporated in the final product; overhead costs; worker’s compensation and insurance; real estate
taxes; and a capital cost allowance. One manufacturer was eligible for the import duty exemption if
60 per cent of the total value added by the manufacturer was Canadian. The record did not show the
particular CVA requirements for other manufacturers.

181 The EC provides a comparison between the 50 per cent rule and the limitation on articles imported
into the United States contained in the repealed FSC statute. EC First 21.5 Submission , paras. 159-162. This
comparison, and any reference to the FSC rules, is irrelevant to the issues before this Panel. It should be noted,
however, that in the initial proceeding, the United States provided a detailed explanation as to why the FSC
provision was consistent with Article 3.1(b) of the SCM Agreement, but neither the FSC Panel nor the Appellate
Body reached this issue.
182 A description of the measure in question can be found in Canada Autos (AB), paras. 124-129.

206. In analyzing the Canadian CVA requirements, the Appellate Body stated that “[t]he precise
issue under Article 3.1(b) is whether the use of domestic over imported goods is a ‘condition’ for
satisfying CVA requirements, and, therefore, for receiving the import duty exemption.” 183 T h e
Appellate Body considered that the required CVA level, or percentage, was relevant to whether a
particular manufacturer might be able to satisfy its specific CVA requirements without using any
Canadian parts and materials in its production.
184 The Appellate Body found that, even where the
CVA requirement was 60 per cent, a manufacturer could satisfy the requirement without having to use
domestic goods.185 According to the Appellate Body, where there is a “multiplicity of possibilities for
compliance” with a value-added requirement, it is not enough to show that “use of domestic goods [is]
only one possible means (means which might not, in fact, be utilized) of satisfying [such]
requirements.”186
207. The Appellate Body emphasized the importance of establishing “how they [the required CVA
levels] operate for individual manufacturers.” 187 Without this “vital information,” a panel cannot
know “enough about the measure to determine whether the CVA requirements were contingent ‘in
law’ upon the use of domestic over imported goods.” 188 For this reason, the Appellate Body
concluded that the 60 per cent CVA requirement did not raise a presumption of inconsistency with
Article 3.1(b). Thus, in order to prevail, a complaining party must demonstrate “how [value-added]
requirements would actually operate” to substitute domestic goods for imported goods.
189
(b) The Application of Canada-Autos to the Act
208. Based on the Appellate Body’s analysis in Canada Autos, the EC has not met its burden of
showing that the exclusion of extraterritorial income under the Act is contingent on the use of
domestic over imported goods. As with the CVA requirements at issue in Canada Autos, the 50 per
cent rule can be satisfied without the use of any domestic goods. In fact, the 50 per cent rule does not
require any US value in general, or US goods in particular. Because more than 50 per cent of the fair
market value of any property sold in a trans action generating extraterritorial income may be
attributable to elements other than goods – including intellectual property content, overhead, and other
costs unrelated to goods – a manufacturer can earn extraterritorial income by selling products that
consist entirely of imported goods.
209. In the words of the Appellate Body, the “multiplicity of possibilities for compliance” with the
Act’s 50 per cent rule suggests that the “use of domestic goods [is] only one possible means (means
which might not, in fact, be utilized) of satisfying the . . . requirements.” As the Appellate Body made
clear in Canada Autos, such a showing, without more, is simply insufficient to warrant a finding that a
measure is “contingent” upon the use of domestic over imported goods.
210. In this case, the EC has offered no evidence that the Act’s 50 per cent rule conditions the
exclusion of extraterritorial income on the use of domestic over imported goods. The only “evidence”
proffered by the EC in this case is an annex that purportedly describes products of which more than
50 per cent of their value derives from inputs or tangible articles.
190 The basis for these descriptions
are “some data relating to the production in certain sectors . . . cross-checked . . . with information

183 Canada Autos (AB), para. 126 (emphasis in original).
184 Id., para. 130.
185 Id.
186 Id. (emphasis in original). By contrast, where the CVA requirements are set “very high,” the
Appellate Body stated that “the use of domestic goods may well be a necessity and thus be, in practice, required
as a condition for eligibility for the import duty exemption.” Id. (emphasis in original).
187 Id., para. 131.
188 Id.
189 Id. (emphasis added).
190 EC First 21.5 Submission, Annex.

from certain European industries and in the course of various trade investigations.” 191 T h i s
“evidence”, though, does not describe how the Act’s 50 per cent rule actually operates with respect to
US taxpayers that are eligible to exclude extraterritorial income. Based on the teaching of the
Appellate Body in Canada Autos, only through evidence showing that the 50 per cent rule actually
requires the use of domestic goods can the EC make a viable claim under Article 3.1(b).
F. THE ACT’S 50 PER CENT RULE IS NOT INCONSISTENT WITH ARTICLE III:4 OF GATT 1994
211. The EC claims that the 50 per cent rule of the Act provides less favourable treatment to
imported products than to like domestic products in violation of Article III:4 of GATT 1994. 192
Similar to the claim it makes in relation to Articl e 3.1(b) of the SCM Agreement, the EC’s argument
under Article III:4 rests on an inaccurate description of the 50 per cent rule and suffers from
insufficient proof to establish a prima facie violation.
1. The Meaning of Article III:4
212. Article III:4 provides in relevant part that:
The products of the territory of any contracting party imported into the territory of
any other contracting party shall be accorded treatment no less favourable than that
accorded to like products of national origin in respect of all laws, regulations and
requirements affecting their internal sale, offering for sale, purchase, transportation,
distribution or use ... .
To establish a violation of Article III:4, the EC must demonstrate the existence of: (a) a law,
regulation or requirement affecting the internal sale, offering for sale, or distribution of an imported
product; and (b) treatment accorded in respect of the law, regulation or requirement that is less
favourable to the imported product than to like products of national origin.
193 The requirement of
Article III:4 that imported products be accorded treatment “no less favourable” than that accorded to
like products of national origin has been interpre ted to ensure “effective equality of opportunities
between imported products and domestic products.”194
2. The EC Inaccurately Describes the 50 Per cent Rule
213. The EC’s argument regarding Article III:4 is littered with erroneous descriptions of the 50 per
cent rule contained in the Act. To start with, the EC states that “the limit on . . . foreign inputs is one
of the conditions to obtain the tax benefit.” 195 The EC also claims that the Act contains a “legal
requirement that the foreign inputs and labour not be used above a certain ceiling, if a taxpayer wants
to obtain the tax benefit.” 196 The EC maintains that the Act “requires in some cases the use of a
minimum amount of domestic parts and materials . . . [and] precludes producers wishing to benefit . . .
from using an equivalent amount of imported parts and materials.” 197 Finally, the EC asserts that the

191 Id.
192 EC First 21.5 Submission, paras. 187-219.
193 Japan - Measures Affecting Consumer Photographic Film and Paper (“Japan Film”), WT/DS44/R,
Report of the Panel adopted 22 April 1998, para. 10.369.
194 Canada - Certain Measures Affecting the Automotive Industry (“Canada Autos (Panel) ”),
WT/DS139/R, WT/DS142/R, Report of the Panel, as modified by the Appellate Body, adopted 19 June 2000,
para 10.78.
195 EC First 21.5 Submission, para. 195.
196 Id., para. 203.
197 Id., para. 206.

Act requires “the . . . use by an enterprise of products of domestic origin . . ., whether specified in
terms of . . . value of products, or in terms of a proportion of . . . value of its local production.”198
214. These statements simply do not accurately describe the Act. As discussed throughout this
submission, including the immediately preceding section, the Act does not require the use of any US-
origin goods for a transaction to earn excluded extraterritorial income. Instead, the Act provides that
up to 50 per cent of the fair market value of goods involved in a transaction may be attributable to
articles produced outside the United States and direct labour costs incurred outside the United
States.
199 Goods can meet this requirement even if 100 per cent of the fair market value of their inputs
is foreign. Thus, contrary to the EC’s arguments,
• the Act does not place a “limit on foreign inputs”;
• there is no “legal requirement that the foreign inputs and labour not be used above a certain
ceiling”;
• the Act does not “require[] in some cases the use of a minimum amount of domestic parts and
materials”; and
• the Act does not require “the . . . use by an enterprise of products of domestic origin”.
215. Certainly, a claim of inconsistency under Arti cle III:4 cannot rest upon such an erroneous
description of the contested measure. For this reason alone, the EC has not made a prima facie case
of inconsistency with Article III:4.
3. The EC Proffers No Evidence To Support Its Claim Under Article III:4
216. In addition to inaccurately describing the measure it seeks to invalidate, the EC has presented
no evidence supporting its claim under Article III:4. The EC states that, “ in many cases ,” the Act
requires the use of US-produced inputs.200 The EC also states “there will be cases in which a firm will
be induced to increase the value of US goods it uses ... .” 201 Moreover, the EC claims that the Act
will “in many cases determine which goods a producer will use”, 202 and “it will in many cases be
easier” to meet the 50 per cent rule if US products are used. 203 F i n a l l y , t h e E C c l a i m s t h a t
“prospective beneficiaries will always give preference, all other conditions being equal, to US
‘articles.’”204
217. Despite the rhetoric, nowhere does the EC cite to a single case where a class of imported
goods will be accorded less favourable treatment than a class of domestic “like products.” In fact, the
EC has not described one product that would be “affected” by the 50 per cent rule contained in the
Act, thereby undermining the EC’s own interpretation of Article III:4 as requiring an examination of
“individual products” rather than “all possible products.” Simply asserting that “many cases” of less
favourable treatment exist does not make the assertion true and does not suffice to support a claim
under Article III:4. In fact, the EC itself has acknowledged that, “an analysis [under Article III:4] has

198 Id., para. 217, quoting the Agreement on Trade-Related Investment Measures, Illustrative List, Item
1.a.
199 The Act § 3, amending IRC § 943(a)(1)(C).
200 EC First 21.5 Submission, para. 194 (emphasis added).
201 Id., para. 200 (emphasis added).
202 Id., para. 199 (emphasis added).
203 Id., para. 205 (emphasis added).
204 Id., para. 208 (emphasis added).

to be carried out at the level of an individual product, not at the level of the application of the law to
all possible products.”205
218. Many of the GATT and WTO panel cases cited by the EC involve laws, regulations, and
requirements explicitly applicable to a particular class or category of imports. 206 In such cases, it is
not difficult to consider how such imports would be “affected” by those measures. However, in cases
involving a generally applicable measure, there must be a heightened evidentiary burden for the
complaining party. Measures of general application, like the Act, do not necessarily affect imported
goods. Evidence must be introduced to establish a “meaningful nexus” between such a measure and
adverse effects on competitive conditions for a like class of imported goods before determining that
the measure accords less favourable treatment to imports.
207
219. The foregoing discussion demonstrates that the EC has failed to make a prima facie case of
inconsistency with Article III:4. By inaccurately portraying the measure it seeks to invalidate and by
failing to provide adequate evidence to substantiate its conclusions, the EC has not proven its claim
that the Act is inconsistent with Article III:4.
G. T
HE ACT’S EXCLUSION OF EXTRATERRITORIAL INCOME DOES NOT VIOLATE US
OBLIGATIONS UNDER THE AGREEMENT ON AGRICULTURE
220. The EC contends that the Act’s exclusion of extraterritorial income violates Article 10.1 of
the Agreement on Agriculture, as read together with Article 8 of that Agreement, or, in the alternative,
Articles 3.3 and 8, in conjunction with Article 9.1, of the Agreement.208 For the following reasons, the
EC’s claim lacks merit.
221. Article 10.1 of the Agriculture Agreement provid es that “[e]xport subsidies not listed in
paragraph 1 of Article 9 shall not be applied in a manner which results in, or which threatens to lead
to, circumvention of export subsidy commitments ... .” In the FSC case, the Appellate Body relied
upon the definitions of subsidy in Article 1 of the SCM Agreement and export contingency in Article
3.1(a) of the SCM Agreement as context in considering what is an “export subsidy” under the
Agriculture Agreement.
209 For the same reasons already discussed by the United States that the Act’s
exclusion does not constitute an export subsidy within the meaning of Articles 1 and 3.1(a) of the
SCM Agreement, the exclusion does not constitute an export subsidy within the meaning of Article
1(e) of the Agriculture Agreement. Thus, the exclusion of extraterritorial income under the Act does
not violate US obligations under the Agriculture Agreement.
210

205 Id., para. 211.
206 See, e.g., Canada Autos (Panel); and United States - Standards for Reformulated and Conventional
Gasoline, WT/DS2/R, Report of the Panel, as modified by the Appellate Body, adopted 20 May 1996.
207 See, e.g., Japan Film, para. 10.381.
208 EC First 21.5 Submission , paras. 222-233; see also id., paras. 67-68. The EC provides an
extraneous and seemingly irrelevant description of the 50 per cent rule in its discussion of the Agriculture
Agreement. Id., paras. 220-21. Because the EC has failed to make any legal claim under the Agriculture
Agreement with respect to this aspect of the Act, th e United States does not address the factual inaccuracies
contained in the EC’s description in this section. The United States respectfully refers the Panel to the
discussion in Section V.E, above, that explains the operation of the 50 per cent rule.
209 FSC (AB) , paras. 136-142, citing Canada - Measures Affecting the Importation of Milk and the
Exportation of Dairy Products , WT/DS103/AB/R, WT/DS113/AB/R, Report of the Appellate Body adopted
27 October 1999.
210 The EC posits an alternative argument under the Agriculture Agreement that is conditioned on the
United States making an argument that the Act confers export subsidies that are covered by Article 9.1 of the
Agriculture Agreement. Because the United States does not make this argument, the EC’s alternative argument
need not be addressed.

H. THE UNITED STATES COMPLIED WITH THE DSB’S RECOMMENDATIONS AND RULINGS
222. The EC contends that the United States has not complied with the DSB’s recommendations
and rulings because: (1) the Act contains transition rules that extend the FSC regime beyond
30 October 2000; and (2) because the Act was not signed into law until after 1 November 2000.211 As
discussed below, the United States believes that it satisfactorily complied with the DSB’s
recommendations and rulings.
1. Based on All of the Circumstances Surrounding this Dispute, the Panel Should Find that
the Act’s Transition Rules Constitute a Re asonable Method of Complying with the
DSB’s Recommendations and Rulings
223. The Act repealed sections 921-927 of the IRC, the FSC tax provisions.
212 The Act also
provides that no FSCs may be created after 30 September 2000.213 As a result, the measures contested
by the EC in the FSC case and found by the DSB to give rise to prohibited export subsidies under the
SCM Agreement no longer exist.
224. The Act, though, does provide limited transition relief to lessen the administrative burden and
impact on taxpayers’ business operations that might result due to the repeal of the FSC. The Act
provides one tax year (i.e., through December 2001) for FSCs in existence as of 30 September 2000 to
continue in operation. 214 In addition, with respect to FSCs that entered into long-term, binding
contracts with unrelated parties before 30 September 2000, the Act does not alter the tax treatment of
those contracts.215 As such, these rules are relatively narrow and apply only in highly particularized
circumstances.
225. It is customary practice in the United States and other countries to promulgate transition rules
when repealing significant tax legislation. This is done to avoid impairing pre-existing binding
contracts and to otherwise minimize uncertainties that may ensue. Complex and harmful tax
consequences could result where, for example, a profit or a loss is accounted for in one tax year while
the transaction creating that profit or loss was entered into in a previous year.
216 If tax laws affecting
that transaction are amended, questions would arise as to which law governs and whether the
transactions need to be unwound or substantially revamped.
226. Transition rules, therefore, provide domestic and foreign businesses with an opportunity to
adjust, and they “protect people who might have altered their conduct in reliance upon” the tax
treatment provided under the earlier law. 217 As one scholar has explained, “those who reasonably
relied upon an existing law should not be subjected to the costs associated with unexpected changes in
that law.”218
227. The Appellate Body has recognized that WTO ru les must be construed flexibly. Thus, the
Appellate Body has stated that “WTO rules are not so rigid or so inflexible as not to leave room for
reasoned judgments in confronting the endless and ever-changing ebb and flow of real facts in real
cases in the real world. They will serve the multi lateral trading system best if they are interpreted

211 EC First 21.5 Submission, paras. 234-241.
212 The Act § 2.
213 The Act § 5(b)(1).
214 The Act § 5(c)(1)(A).
215 The Act § 5(c)(1)(B).
216 Kirk J. Stark, The Elusive Transition to a Tax Transition Policy , 13 Amer. J. Tax Pol’y 145, 149
(1996) (Exhibit US-8).
217 Id., page 150.
218 Id., pages 149-150.

with that in mind.”219 In several recent cases, WTO panels have excused procedural violations in the
absence of prejudice to the complaining party, essentially taking into account equitable considerations
in issuing their decisions.220
228. A limited transition period allowing taxpayers to adjust to a new tax regime appears all the
more reasonable in light of the circumstances surrounding this case. Specifically, notwithstanding the
EC’s assertions that it never agreed that the FSC was GATT- or WTO-consistent, it waited until
thirteen years after the FSC was enacted before challenging it. During that time, US taxpayers came
to rely on the FSC provisions in structuring their foreign transactions. Furthermore, the United States
promulgated and maintained the FSC tax provisions in reliance on the 1981 Understanding adopted
by the GATT Council. Notwithstanding the status ultimately accorded to the 1981 Understanding in
this case, such reliance was not unjustified.
229. Despite the many obstacles posed by the fact that 2000 was a presidential election year in the
United States, and acting under the strict time restraints set by the DSB, the United States did repeal
the FSC provisions. The United States attempted to work in good faith with the EC to find a
legislative solution that would be mutually acceptable. When that did not occur, the United States
repealed the FSC provisions with effect from 1 October 2000, with the exception of the transition
rules described above. Considering these factors, under the particular circumstances of this dispute,
the United States believes that the Panel should find that the limited transition rules provided for in
the Act constitute a reasonable implementation of the DSB’s recommendations.
2. The United States Complied with the Time Period Specified by the DSB
230. The EC also argues that the United States failed to comply with the DSB’s recommendations
in the FSC case because the Act was not signed until 15 November 2000.
221 The EC’s argument fails
for several reasons.
231. First, the Act’s provisions apply retroactively and repeal the FSC provisions before
1 November 2000. The DSB recommended that the United States withdraw the FSC subsidies with
effect from 1 October 2000, which the DSB then extended to 1 November 2000. The DSB did not
indicate when the legislation had to be enacted, although the United States obviously sought to
eliminate any controversy on this point by attempting to enact the legislation by 1 October (and,
thereafter, by 1 November). The Act provides that the “amendments made by this Act shall apply to
transactions after 30 September 2000.”
222 Thus, the United States repealed the FSC with effect from 1
October 2000, thereby complying with the DSB’s recommendation.
232. Second, the WTO generally does not examine claims regarding measures that are no longer in
effect and that were not in effect at the time a panel’s terms of reference were established. This
comports with the fact that the WTO does not provide relief retroactively for alleged past wrongs.223
233. The same principle applies here. The “measure” in question constitutes an omission in the
form of an alleged failure to act by 1 November 2000. However, the measure ( i.e., the omission)

219 Japan - Taxes on Alcoholic Beverages , WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R, Report
of the Appellate Body adopted 1 November 1996, page 34.
220 See, e.g. , United States - Safeguard Measures on Imports of Fresh, Chilled or Frozen Lamb Meat
from New Zealand and Australia , WT/DS177/R, WT/DS178/R, Report of the Panel circulated 21 December
2000 (on appeal), paras. 5.48-5.53, or on the basis of estoppel (see, e.g., FSC (Panel), para. 7.10.
221 EC First 21.5 Submission, paras. 244-246.
222 The Act § 5(a).
223 This principle is reflected in Article 19.1 of the DSU, which provides that when a panel concludes
that a measure is inconsistent with a covered agreement, the panel “shall recommend that the Member
concerned bring the measure into conformity with that agreement.” (footnote omitted).

ceased to exist as of 15 November 2000 when the Act was signed into law. In other words, by the
time the EC made its panel request to commence this Article 21.5 proceeding, the measure it
ostensibly was challenging no longer existed. Panels typically refrain from examining measures that
cease to be in existence or in effect before a panel’s terms of reference are set.224
I. THE PANEL SHOULD REJECT THE EC’S PRELIMINARY OBJECTION REGARDING THIRD PARTY
RIGHTS
234. The EC has made a preliminary objection to paragraph 9 of the Panel’s Working Procedures,
which require the parties to serve their first written submissions on third parties. The EC essentially
asks the Panel to require the parties to also serve their written rebuttals on third parties. 225 According
to the EC, paragraph 9 is inconsistent with Article 10.3 of the DSU.
235. The EC has made similar arguments in other Article 21.5 proceedings in which a panel has
held only a single meeting with the parties and third parties, and in each such proceeding, the panel
has rejected the EC argument. The first in this line of cases is Australia Leather, in which the panel
made the following ruling:
In its 11 November 1999 response to the EC, the Panel indicated that it had decided
not to change the existing working procedures which provide for third parties to
receive the first written submissions of the parties, but not the rebuttals. The Panel
stated that if it had decided to hold two meetings with the parties, as is the normal
situation envisioned in Appendix 3 of the DSU, third parties would have received
only the written submissions made prior to the first meeting, but not rebuttals or other
submissions made subsequently. Thus, in the more usual case, third parties would be
in the same position as they were in this ca se with respect to their ability to present
views to the panel. In the view of the Panel, the procedure it had established
conformed more closely with the usual practice than would be the case if third parties
received the rebuttals, and was in keeping with Article 10.3 of the DSU in a case
where the Panel holds only one meeting.
226
236. More recently, the panel in Korea DRAMS also rejected the EC’s position. Because the
parties were able to reach a mutually acceptable solution in that case, the panel never issued a report.
However, prior to the termination of the proceeding, the panel issued a decision in which it rejected
the EC request. The pertinent portions of the decision read as follows:
The Panel took note of the possible merit of the EC’s argument when looking only at
the words of Article 10.3. However, pursuant to the Vienna Convention rules on
treaty interpretation one cannot isolate the words of a treaty from their context. The
reference in Article 10.3 to “submissions . . . to the first meeting of the panel” is made
in the context of standard panel procedures. There, a panel holds two meetings and
documentation is submitted before each of these meetings. Third parties normally do
not have a right to hear the oral statements of the main parties at panel meetings
(including the first meeting). A special third party oral session is reserved for them
only once, subsequent to the first meeting with the main parties. In that context, the
effect of Article 10.3 is to limit third party rights to receive only the parties’ first

224 See, e.g., Argentina - Measures Affecting Imports of Footwear, Textiles, Apparel and Other Items ,
WT/DS56/R, Report of the Panel, as modified by the Appellate Body, adopted 22 April 1998, paras. 6.13-15.
225 EC First 215. Submission, paras. 247-258.
226 Australia - Subsidies Provided to Producers and Exporters of Automotive Leather - Recourse to
Article 21.5 of the DSU by the United States , WT/DS126/RW, Report of the Panel adopted 11 February 2000,
para. 3.9. This decision was followed in Australia - Measures Affecting Importation of Salmon - Recourse to
Article 21.5 by Canada, WT/DS18/RW, Report of the Panel adopted 20 March 2000, paras. 7.5-7.6.

written submissions (submitted to the first meeting); not the parties’ written rebuttals
(presented to the second meeting).
A panel under Article 21.5 has to follow DSU panel procedures. But it is obliged to
do so in a different context, namely in the context of a much stricter timeframe. As a
result, this Panel decided to hold only one meeting; not two as is usually the case.
The practice of obtaining from the parties two sets of documentation in the form of
first written submissions and written rebuttals (both, however, before the single
meeting of the Panel) was maintained. In this context, the Panel is of the view that, in
order to give effect to Article 10.3, Article 10.3 has to be interpreted as limiting third
party rights to the first written submissions only; not including the written rebuttals.
The drafters of the DSU restricted third party rights. It is not the task of this Panel to
extend them in Article 21.5 procedures.
227
237. In the view of the United States, the reasoning of these prior panels is sound, and should be
followed by this Panel. Thus, the Panel should find that third parties do not have a right to the
rebuttal submissions of the parties in this proceeding.228
238. Having said that, the United States notes that, with the exception of business confidential
information, it routinely makes its submissions to WTO panels available to the public by placing its
submissions on the Internet Web page of the Office of the US Trade Representative. Thus, as a
practical matter, third parties (along with the rest of the world) will have access to the US rebuttal
submission. Nothing prevents the EC from providing its rebuttal submission to the third parties in this
proceeding (or for that matter, to the citizens of EC member states).
VI. CONCLUSION
239. For the forgoing reasons, the United States requests that the Panel find as follows:
(a) The Act’s exclusion of extraterritorial income from US taxation does not constitute a
prohibited subsidy contingent upon export performance within the meaning of
Article 3.1(a) of the SCM Agreement.
(b) The Act’s exclusion of extraterritorial income from US taxation does not constitute a
prohibited subsidy contingent upon the use of domestic over imported goods within
the meaning of Article 3.1(b) of the SCM Agreement.
(c) The Act does not result in less favourable treatment being provided to imported goods
in comparison to the treatment afforded to like domestic goods within the meaning of
Article III:4 of GATT 1994.
(d) The Act’s exclusion of extraterritorial income from US taxation is not inconsistent
with US obligations under Articles 10.1 and 8, or Article 3.3 and 8, of the Agreement
on Agriculture.

227 United States - Anti-Dumping Duty on Dynamic Random Access Memory Semiconductors (DRAMs)
of One Megabit or Above from Korea - Recourse by Korea to Article 21.5 of the DSU , WT/DS99, Decision of
the Panel Concerning the EC Request for Access to th e Parties’ Rebuttal Submissions, 27 June 2000 (footnotes
omitted).
228 The United States notes further that none of the third parties that have expressed an interest in this
proceeding have requested expanded third party rights.

(e) The United States complied with the DSB’s recommendations and rulings in the FSC
dispute.
(f) The third parties in this proceeding do not have a right to the parties’ rebuttal
submissions.
WT/DS/108/RW

ANNEX B
Third Party Submissions
Contents Page
Annex B-1 Third Party Submission by Australia B-2
Annex B-2 Third Party Submission by Canada B-6

ANNEX B-1
THIRD PARTY SUBMISSION BY AUSTRALIA
(14 February 2001)
Overview
1. Australia welcomes the opportunity to submit a third party submission for the Article 21.5
panel’s examination on “United States – Tax Treatment for Foreign Sales Corporations (FSC)”. As a
medium size exporting country, Australia derives significant benefits from the rules-based framework
of the WTO Agreements. The provision by the United States of prohibited export subsidies has a
direct impact on the competitive trading opportunities of Australian exporters in all markets.
2. It is Australia’s view that the “FSC Repeal and Extraterritorial Income Exclusion Act of
2000”, as enacted by the United States on 15 November 2000, remains WTO-inconsistent.
3. The FSC replacement measure provides a subsidy contingent upon export performance or the
use of domestic over imported goods within the meaning of Article 3.1 of the Agreement on Subsidies
and Countervailing Measures (the SCM Agreement). Moreover, the original FSC subsidies will
continue to be provided until 1 January 2002. Australia will confine its comments to specific legal
issues under the SCM Agreement.
The FSC Replacement Measure
4. As a general rule, the United States asserts the right to tax all income earned worldwide by its
citizens and residents. The FSC measure provided certain tax exemptions to “foreign sales
corporations” connected with the sale or lease of goods produced in the United States for export. This
was found to be a prohibited export subsidy under Section 3.1(a) of the SCM Agreement, and under
Articles 10.1 and 8 of the Agreement on Agriculture.
5. The “FSC Repeal and Extra-territorial In come Exclusion Act” (HR 4986) amended the
Internal Revenue Code by repealing the FSC provisions and by exempting “extraterritorial income”
from gross income on which tax liability is calculated. Extraterritorial income is defined as gross
income attributable to “foreign trading gross receipts”.
1
6. “Foreign trading gross receipts” includes gross receipts from sale, exchange, lease or rental of
“qualifying foreign trade property”, and related and subsidiary services.
2 It does not include receipts
from transactions where the qualifying foreign trade property or services are for ultimate use in the
United States.3
7. “Qualifying foreign trade property” is defined as property:
(A) manufactured, produced, grown, or extracted within or outside the United States,
(B) held primarily for sale, lease, or rental, in the ordinary course of trade or business for
direct use, consumption, or disposition outside the United States, and

1 Section 114(a), (b) and (e) of the IRC, as amended by HR 4986.
2 Section 942(a)(1)(A) and (B) of the IRC, as amended by HR 4986.
3 Section 942(a)(2) of the IRC, as amended by HR 4986.

(C) not more than 50 per cent of the fair market value of which is attributable to:
(i) articles manufactured, produced, grown or extracted outside the United States,
and
(ii) direct costs for labor performed outside the United States. 4
8. Property shall be treated as qualifying foreign trade property only if it is manufactured,
produced, grown or extracted outside the United States by: a domestic corporation; a citizen or
resident of the United States; a foreign corporation which has elected to be subject to United States
taxation; or a partnership in which all the partners or owners fall within one of the first three
categories.
5
The United States Has Not Withdrawn the Original FSC Subsidies “Without Delay”
9. Section 59(c)(1)(A) provides a transition period for FSCs in existence on 30 September 2000
from the FSC legislation amendments. The amendments do not apply to transactions of such FSCs
before 1 January 2002 and FSCs can continue to benefit from FSC taxation refunds until that date.
10. Australia recalls that the panel report, as modified by the Appellate Body, required the
United States to withdraw the FSC subsidies by 1 October 2000. This period was extended by
agreement between the United States and the EC until 1 November 2000.
11. Given that existing FSCs can continue – until 1 January 2002 - to benefit from the original
FSC subsidies, the United States has not withdrawn the subsidies “without delay” and has not
implemented the recommendations and rulings of the DSB.
The Replacement FSC Measure Constitutes a Prohibited Subsidy Under the SCM Agreement
12. The replacement FSC measure constitutes a prohibited subsidy “contingent ... upon export
performance” under Article 3.1(a) of the SCM Agreement and “contingent ... upon the use of
domestic over imported goods” under Article 3.1(b) of the SCM Agreement.
13. Article 1.1(a)(1)(ii) of the SCM Agreement deems a subsidy to exist where government
revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits).
The term “otherwise due” implies a comparison between the revenues due under the contested
measure and revenues that would be due in some other situation. As stated by the panel and Appellate
Body in the examination of the original FSC measure, the basis of comparison is the tax rules applied
by the United States.
6
14. Under the new regime, “foreign trading gross receipts” is excluded from gross income on
which tax liability is calculated. The effect of the exclusion is to reduce the tax liability of the
beneficiary corporation. This represents a departure from the rules of taxation that would “otherwise”
apply to such gross income. Accordingly, gove rnment revenue otherwise due is foregone or not
collected within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement. A benefit is also
conferred under Article 1.1(b) in the form of a reduction in tax liability.
15. The subsidy is a prohibited subsidy within th e meaning of Article 3.1 of the SCM Agreement.
The tax exemption applies in relation to “qualifying foreign trade property”. This is property

4 Section 943(a)(1) of the IRC, as amended by HR 4986.
5 Section 943(a)(2) of the IRC, as amended by HR 4986.

manufactured, produced, grown or extracted within or outside the United States and which satisfies
two requirements:
(1) it must be held primarily for sale, lease or rental for – in the ordinary course of business
- direct use, consumption, or disposition outside the United States; and
(2) at least 50 per cent of its fair market value is attributable to articles manufactured,
produced, grown or extracted in the United States, and the direct costs for labour
performed in the United States.
16. Two conclusions can be drawn from this. Firstly, for property manufactured, produced,
grown or extracted within the United States to qualify for the tax exemption, it must be transacted for
direct use, consumption or disposition outside the United States. The subsidy is therefore “contingent,
in law or in fact ... upon export performance” within the meaning of Article 3.1(a) of the SCM
Agreement. This is further reinforced by Section 942(a)(2) of the IRC which excludes from “foreign
trading gross receipts” qualifying foreign trade property or services for ultimate use in the
United States.
17. Australia emphasises it is not arguing the measure to be an export subsidy simply because it is
provided to corporations that produce within the United States for sale, lease or rental outside the
United States. Footnote 4 provides that the mere fact that a subsidy is granted to enterprises which
export shall not, for that reason alone, be considered to be an export subsidy. However in the present
case, the tax exemption to corporations that produce within the United States is conditioned on the
sale, lease or rental of products for direct use, consumption or disposition outside the United States.
18. The measure is also “contingent, in law or in fact ... upon export performance” in relation to
property manufactured, produced, grown or extracted outside the United States. For such property to
qualify for the tax exemption, at least 50 per cent of its fair market value must be attributable to
United States content and United States direct labour costs. This necessarily requires the export of
United States product for the foreign producer to meet the 50 per cent United States content
requirement.
19. Secondly, the subsidy is “contingent ... upon the use of domestic over imported goods” within
the meaning of Article 3.1(b) of the SCM Agreement. For property to constitute “qualifying trade
property” for which the tax exemption applies, at least 50 per cent of its fair market value must be
attributable to articles manufactured, produced, grown or extracted within the United States , and
direct costs for labour performed within the United States. Given the tax exemption only arises on the
meeting of a 50 per cent local content requirement, it is contingent upon the use of domestic over
imported goods.
It is Not a Measure To Avoid Double Taxation of Foreign-Source Income
20. Footnote 59 of the SCM Agreement provides that paragraph (e) of the Illustrative List of
Export Subsidies is not intended to limit a Member from taking measures to avoid the double taxation
of foreign-source income earned by its enterprises or the enterprises of another Member.
21. The FSC replacement measure cannot be justified as a measure “to avoid double taxation of
foreign-source income”. Firstly, the general United States tax rules already provide income tax
credits to minimise double taxation. Sections 27(a) and 901 of the IRC provides tax credits to
United States citizens and domestic corporations for taxes imposed by foreign countries and
possessions of the United States. The United States has also entered into agreements with other
countries to avoid double taxation of income. For example, Article 22(1)(a) of the 1983 Australia-
United States double tax agreement obliges the United States to provide tax credits to United States
residents or citizens for income tax paid to Australia.

22. Secondly, the tax exemptions provided by the proposed measure are not calculated on, or
limited to, the amount of foreign tax paid on “extraterritorial income”. It is calculated on receipts
from the sale, exchange, lease or rental of “qualifying foreign trade property”.
Conclusion
23. The FSC replacement measure provides prohibited subsidies within the meaning of
Article 3.1 of the SCM Agreement. The measure constitutes a subsidy by providing tax exemptions
which forego government revenue otherwise due. The subsidy is “contingent ... upon export
performance” by being conditioned on the sale, lease or rental of products for direct use, consumption
or disposition outside the United States. It is also “contingent ... upon the use of domestic over
imported goods” by being conditioned on a 50 per cent United States content requirement.
Accordingly, the United States has also breached Article 3.2 of the SCM Agreement.
24. In making this submission, Australia is not disputing the United States’ right to maintain a
worldwide taxation system as opposed to a territorial taxation system. However, Australia recalls the
Appellate Body’s statement in the original dispute that: “A Member of the WTO may choose any kind
of tax system it wishes – so long as, in so choosing, that Member applies that system in a way that is
consistent with its WTO obligations”.

a benefit to US-based enterprises by excluding from taxation income that they earn on exports from
the United States. Accordingly, there still exists a “subsidy” under Article 1.1 of the SCM Agreement.
4. Canada argues that the “subsidy” is contingent upon export performance and, therefore,
prohibited under Article 3.1(a) of the SCM Agreement as in order to benefit from the “subsidy”, US-
based enterprises must not sell their goods “for ultimate use in the United States.” Canada agrees
with the European Communities that these words are simply “another way of saying that they must be
exported”.
5. Finally, Canada argues that the fact that the FSC Replacement scheme is available to foreign
manufacturers on the sale of foreign goods is irrelevant to the determination of whether the “subsidy”
provided to US-based enterprises on the income earned from export transactions is contingent upon
export performance.
II. INTRODUCTION
6. Canada is appreciative of the opportunity to participate in this proceeding under Article 21.5
of the Understanding on Rules and Procedures for the Settlement of Disputes.1
7. Canada participated in previous proceedings before the Panel and the Appellate Body. 2
III. BACKGROUND
A. F INDINGS OF THE PANEL AND APPELLATE BODY
8. On 24 February 2000, the Appellate Body upheld the Panel’s finding that various exemptions
for certain types of income under the US Internal Revenue Code earned by foreign sales corporations
(the FSC measure or FSC scheme), taken together, constituted a prohibited export subsidy under
Article 3.1(a) of the Agreement on Subsidies and Countervailing Measures (SCM Agreement).
9. More particularly, the Appellate Body agreed with the Panel that having decided to tax
foreign-source income, the United States could not exclude certain types of this income from taxation
without foregoing government revenue that would otherwise be due, and, therefore, without providing
a financial contribution under Article 1.1(a)(ii) of the SCM Agreement. Having also agreed with the
Panel that the FSC measure provided a “benefit” to the recipients of the exemption, the Appellate
Body agreed that the FSC measure represented a “subsidy” within the meaning of Article 1.1 of the
SCM Agreement . Finally, the Appellate Body upheld the Panel’s finding that the “subsidy” was
contingent upon export performance and, therefore, prohibited under Article 3.1(a) of the SCM
Agreement.3

1 Although the European Communities raises several arguments in this 21.5 proceeding, Canada only
makes submissions with respect to one of these arguments, i.e. the argument that the United States, through the
FSC Repeal and Extraterritorial Income Exclusion Act of 2000 , continues to provide prohibited export
subsidies inconsistent with Article 3.1(a) of the Agreement on Subsidies and Countervailing Duty Measures.
2 United States – Tax Treatment for “Foreign Sales Corporations” , Reports of the Panel (WT/DS
108/R, 8 October 1999 (Compl aint by the European Communities) and of the Appellate Body (AB-1999-9,
WT/DS 108/AB/R, 24 February 2000) (Appeal by the Un ited States) adopted by the Dispute Settlement Body
on 20 March 2000.
3 Report of the Appellate Body, Ibid. paras. 90 to 121.The Appellate Body also upheld the Panel’s
finding that the United States acted inconsistently with its obligations under Articles 10.1 and 8 of the
Agreement on Agriculture by applying export subsidies, through the FSC measure, in a manner which resulted
in, or which threatened to lead to, circumvention of its export subsidy commitments with respect to both
scheduled and unscheduled agricultural products. Furthermore, having upheld the Panel’s findings under Article
3.1(a) of the SCM Agreement, the Appellate Body did not rule on the European Communities conditional appeal
under Article 3.1(b) of the SCM Agreement.

10. The Appellate Body recommended that the Di spute Settlement Body (DSB) request the
United States to bring the FSC measure into conformity with its WTO obligations4 .
11. The Appellate Body emphasized that its ruling was in no way a judgment on the consistency
or the inconsistency of the relative merits of the tax system chosen by the United States. The
Appellate Body held that:
[a] Member of the WTO may chose any kind of tax system it wishes, so long as, in so
choosing, that Member applies that system in a way that is consistent with its WTO
obligations. Whatever kind of tax system a Member chooses, that Member will not be
in compliance with its WTO obligations if it provides, through its tax system,
subsidies contingent upon export performance that are not permitted under the
covered agreements.5
12. The findings and conclusions of the Appellate Body were adopted by the DSB on
20 March 2000.6
B. M EASURES TAKEN BY THE UNITED STATES
13. In order to comply with the recommendations and rulings of the DSB, the United States
adopted the FSC Repeal and Extraterritorial Income Exclusion Act of 20007 on 15 November 2000.
14. According to the United States, the new taxing rules contained in the FSC Replacement
scheme are consistent with US obligations under the WTO. The United States argues that the new
legislation does not confer a “subsidy”, rendering moot the issue of “export contingency”.
Nonetheless, the United States argues that in the ev ent the Panel finds that there still exists a subsidy,
it is not prohibited under Article 3.1(a) of the SCM Agreement, as it does not limit the income that is
excluded from US taxing authority to export income. The United States also argues that the FSC
Replacement scheme is meant to achieve some leve l of tax parity with European territorial tax
systems in a WTO-consistent manner.
15. More specifically, the United States argues that by adopting the FSC Replacement scheme, it
has withdrawn the export subsidy at issue, as the provisions relating to taxation of foreign sales
corporations have been repealed.
16. Relying on the finding of the Appellate Body that a WTO Member has the sovereign right not
to tax certain categories of income, the United States argues that the FSC Replacement scheme is
WTO consistent as it creates a general rule exempting “extraterritorial income” from the definition of
“gross income” in the Internal Revenue Code. Acco rding to the United States, the fact that this
exclusion does not apply to all categories of “extraterritorial income” does not render the measure
WTO inconsistent, as the exclusion is from a general rule of non-taxation rather than taxation. The
United States argues that, as a sovereign nation, it is free not to tax certain categories of
“extraterritorial income” and that the WTO does not compel Members to adopt pure territorial tax
regimes.
17. The Unites States argues that the measure is not contingent upon export performance as the
exclusion applies to qualifying income, whether it is earned in the United States or abroad, a

4 Report of the Appellate Body, Ibid. para. 178.
5 Report of the Appellate Body, Ibid. para. 179.
6 Doc. WT/DS 108/10, 24 March 2000.
7 US Public Law No. 106-519; Similar to the EC, Canada refers to the FSC Repeal and Extraterritorial
Income Exclusion Act as the FSC Replacement scheme when we refer to the measure as a whole and as the FSC
Replacement Act when we refer to particular sections.

substantially broader category of income than that which was exempted from tax under the FSC
measure.
IV. ISSUE AND CANADA’S POSITION BEFORE THIS PANEL
18. The issue before this Panel is whether the FSC Replacement scheme is consistent with the
recommendations of the DSB to withdraw the FSC m easure found to be a prohibited export subsidy
inconsistent with Article 3.1(a) of the SCM Agreement.8 In order to be found to have complied, the
United States must have ceased providing prohibited export subsidies.9
19. As noted by the Appellate Body, the Panel’s task is not to examine the merits of the tax
system chosen by the United States. Rather, the Panel’s task is limited to determining whether the
measure put in place by the United States is consistent with its obligations under the WTO.
20. Canada agrees with the EC that the FSC Replacement scheme fails to bring the United States
into compliance with the DSB recommendations and rulings and that the United States, through the
FSC Replacement scheme, continues to provide subsidies which are contingent upon export
performance within the meaning of Article 3.1(a) of the SCM Agreement.
V. LEGAL ANALYSIS
A. T
HE FSC R EPLACEMENT SCHEME PROVIDES A “SUBSIDY” TO US-BASED ENTERPRISES
EARNING “DOMESTIC INCOME FROM EXPORT TRANSACTIONS” W ITHIN THE MEANING OF
ARTICLE 1.1 OF THE SCM AGREEMENT
21. The definition of “subsidy” under Article 1.1 of the SCM Agreement consists of two discrete
elements: (1) a financial contribution by a government or any public body; and (2) a benefit is thereby
conferred.10 Both of these elements must be present in order for there to be a “subsidy” under
Article 1.1 of the SCM Agreement, and, correspondingly, under Article 3.1 of that Agreement.
1. There is a “Financial Contribution” to US -based Enterprises Within the Meaning of
Article 1.1(a)(ii) of the SCM Agreement
22. In Canada’s view, the United States continues, through the FSC Replacement scheme, to
provide a financial contribution to US-based enterprises by excluding from taxation domestic income
that they earn from export transactions.
23. The Appellate Body stated the following regard ing the meaning to be attributed to the words
“foregoing” of government revenue “otherwise due”:
[i]n our view, the “ foregoing” of revenue “otherwise due” implies that less revenue
has been raised by the government than would have been raised in a different
situation, or, that is, “otherwise”. More over, the word “foregone” suggests that the
government has given up an entitlement to raise revenue that it would “otherwise”
have raised.11

8 Canada does not address arguments raised by the EC under Article 3.1(b) of the SCM Agreement ,
Articles 10.1 and 8 of the Agreement on Agriculture, and Article III:4 of the General Agreement on Tariffs and
Trade 1994.
9 Canada – Measures Affecting the Export of Civilian Aircraft, Recourse by Brazil to Article 21.5 of the
DSU, Report of the Panel (WT/DS70/RW, 9 May 2000), para. 5.63.
10Canada – Measures Affecting th e Export of Civilian Aircraft , Report of the Appellate Body (AB-
11 Report of the Appellate Body, supra, note 1, para. 90.

24. The Appellate Body held that the decision as to whether the government has given up an
entitlement to raise revenue that it would “otherwise” have raised implies some kind of comparison
between the revenues due under the contested measure and revenues that would be due in some other
situation. The Appellate Body agreed with the Pane l that the basis for comparison must be the tax
rules applied by the Member in question.12
25. As noted above, the Appellate Body ruled that a WTO Member has the sovereign authority to
tax any particular categories of revenue it wishes, and that it is also free not to tax any particular
categories of revenue. However, the Appellate Body ruled that, in both instances, the WTO Member
must respect its WTO obligations. The Appellate Body held that what is “otherwise due” depends on
the rules of taxation that each Member, by its own choice, establishes for itself.
13
26. The Appellate Body held that the “but for” test established by the Panel, that is, “the situation
that would prevail but for the measure in question”, provided “a sound basis for comparison” in the
case of the FSC scheme, because it was “not difficult to establish in what way the foreign-source
income would be taxed “but for” the contested measure”. The Appellate Body stated that it had
“certain abiding reservations about applying any legal standard, such as this “but for” test, in the place
of the actual treaty language”, and “particular misgivings about using a “but for” test if its application
were limited to situations where there actually existed an alternative measure, under which the
revenues in question would be taxed, absent the contested measure.” The Appellate Body believed
that it would “not be difficult to circumvent such a test by designing a tax regime under which there
would be no general rule that applied formally to the revenues in question, absent the contested
measure.” The Appellate Body, therefore, observed that, although the Panel’s “but for” test worked in
the case of the FSC scheme, that it might not work in other cases.
14
27. It appears that the United States has relied on this “but for” test in implementing the
recommendations and rulings of the DSB. Essentiall y, the United States’ position is that it has
brought its measures into conformity with its WTO obligations by reversing the situation under its tax
rules from one of having decided to tax a particular category of income and then excluding part of that
income from taxation to one of having decided to exclude from taxation a category of income which
includes the previously excluded income. In the view of the United States, since there is no general
rule that formally applies to tax the revenues in question, there can be no foregoing of government
revenue, as absent the contested measure, there would be no tax due.
28. The United States appears to have designed the precise type of tax regime the Appellate Body
believed a Member could design in order to circumvent the “but for” test. Canada, therefore, submits
that the analysis conducted by the Panel does no t work in this case to determine whether the
government has given up an entitlement to raise revenue that it would “otherwise” have raised. The
exclusion of “extraterritorial income” from the definition of “gross income” in section 114(a) of the
FSC Replacement Act
15 is, therefore, not determinative of the issue of whether the government has
foregone revenue otherwise due.
29. In Canada’s view, the finding of the Appellat e Body clearly stands for the proposition that,
absent a rule formally taxing the revenues in question, a more complete analysis of domestic tax rules
must be conducted in order to determine what situation would apply to the revenues in question
absent the contested measure. Canada submits that such an analysis of US tax rules in this case
reveals that income earned by US-based enterprises on export transactions, which is part of the

12 Ibid.
13 Ibid.
14 Report of the Appellate Body, supra note 1, para. 91.
15 Section 114(a) of the FSC Replacement Act provides as follows:
EXCLUSION.⎯ Gross income does not include extraterritorial income

income excluded from taxation under the definition of “extraterritorial income”, would otherwise be
subject to tax, absent the FSC Replacement scheme.
30. It is clear that although the FSC Replacement scheme excludes “extraterritorial income” from
the definition of “gross income”, that the “true exclusion” from taxation under this scheme is only for
“qualifying foreign trade income”.
16 Accordingly, only certain categories of “extraterritorial income”
are excluded from tax.17
31. The definition of “qualifying foreign trade income” in the FSC Replacement Act encompasses
two very different types of income that must be clearly distinguished for purposes of the analysis. On
the one hand, it includes income earned from export transactions by US-based enterprises, that is,
transactions entered into by an enterprise located in the United States entailing the shipments of goods
from the territory of the United States to the territory of another country. The definition of
“qualifying foreign trade income” also includes foreign-source income earned by enterprises (through
a branch of a US corporation, a subsidiary of a US corporation or other entities otherwise eligible
under the scheme) located outside the United States, that is, entailing the sales of goods from a
territory other than that of the United States.
32. Canada agrees with the EC that income earned from export transactions under the FSC
Replacement scheme “corresponds arithmetically to the exempt foreign source income of the FSC
scheme”.
 18 Canada submits that the United States continues to provide subsidies to US-based
enterprises earning this type of income.
33. The United States has argued that the exclusion of “extraterritorial income” from the
definition of “gross income “ is a measure to avoid double taxation of foreign source income, and,
therefore, the income covered under this exclusion would normally not be subject to domestic tax.
Canada agrees that the “foreign income” component of “extraterritorial income” is the type of income
typically subject to a measure designed to avoid double taxation. However, in Canada’s view, the
United States has added this new category of income to the measure in question in an attempt to
confuse the domestic tax situation that would otherwise apply to the “domestic export income”
component of “extraterritorial income”.
19
34. In Canada’s view, income earned from export transactions is income that would generally be
taxable only in the United States, since it is sourced in the United States, that is, it arises from
economic activities taking place in the United States. The fact that the proceeds of sales are from

16 Section 114(b) of the FSC Replacement Act , which, in Canada’s view, is the critical section in the
Act provides as follows:
EXCEPTION.⎯ Subsection (a) shall not apply to extraterritorial income which is not
qualifying foreign trade income as determined under subpart E of part III of subchapter N.
17 The highly selective application of the income exclusion under the scheme is achieved by imposing
conditions and providing elections to taxpayers in order for them to maximise the amount of the exclusion to fit
their specific circumstances. Canada therefore agrees with the EC that “the FSC Replacement Act does not
qualitatively define a class or category of income that is excluded from the tax base – it lays down conditions for
the partial non-taxation of income that would otherwise be taxed” (First Submission of the European
Communities, para. 57.
18 First Written Submission of the European Communities, para. 35.
19 It must be noted that the FSC Replacement scheme does not purport to replace the foreign tax credit
as the means by which double taxation of foreign income earned by US taxpayers is relieved. The foreign tax
credit provisions of the US Internal Reve nue Code have not been repealed by the FSC Replacement Act and still
provide the basic approach used by the United States to relieve double taxation with respect to income subject to
tax in other countries. If, as the United States allege , the exclusion of “extraterritorial” income is a measure to
avoid double taxation, then it cannot, at the same time, be argued that the exclusion constitutes “a defined
normative benchmark for taxing income earned on foreign transactions”, since there cannot be two benchmarks.
Canada submits that the US taxation of foreign income subject to a foreign tax credit remains the true
benchmark despite the enactment of the FSC Replacement Act, and that the latter cannot be regarded as a “new”
benchmark for the taxation of foreign income in the United States.

foreign sources does not transform the export income into “foreign income” for tax purposes.
Exporting goods in a foreign country does not create a sufficient nexus to trigger taxation in the
importing country, even when one takes into account the “foreign economic processes” required
under the FSC Replacement scheme. 20 Canada submits that such processes do not create a taxable
presence abroad, and, therefore, would not be considered foreign business income subject to double
taxation. Therefore, no double taxation needs to be relieved with respect to this component of
“extraterritorial” income.
21
35. In Canada’s view, since income earned from export transactions cannot by definition face
double taxation, the exclusion from taxation provided for this income under the FSC Replacement
scheme can only reduce US tax otherwise payable.
36. Canada therefore submits that the revenue or tax that would otherwise be due on “income
earned from export transactions”, which is part of the income excluded from taxation under the FSC
Replacement scheme, would be the tax applicable to such income under US taxation rules. Thus, the
US Government is providing a financial contribution to US-based enterprises earning this type of
income by foregoing revenue that would otherwise be due in the sense of Article 1.1(a)(ii) of the SCM
Agreement.
2. The “Financial Contribution” Confers a “B enefit” to US-based Enterprises Earning
“Domestic Income from Export Transactions”
37. The Panel held as follows regarding the issue of “benefit”:
Having found that the various tax exemptions under the FSC scheme give rise to a
financial contribution, our next task is to consider whether a benefit is thereby
conferred. In our view, the financial contribution clearly confers a benefit, in as much
as both the FSCs and their parents need not pay certain taxes that would otherwise be
due. Further, that benefit can be quite substantial; according to the US Department of
Commerce, “the tax exemption can be as great as 15 to 30 per cent on gross income
from exporting.
22
38. The Appellate Body upheld the Panel’s finding on this issue. Canada submits that this
reasoning is equally applicable to the FSC Replacement scheme, as it applies to US-based enterprises
by exempting from taxation the domestic income they earn on export transactions.
39. Accordingly, Canada submits that there still exists a “subsidy” within the meaning of
Article 1.1 of the SCM Agreement, as the two elements of a “subsidy” continue to be present, i.e. a
“financial contribution” and a “benefit”.

20 These “foreign economic processes” may consist of one or more of the following five categories: (1)
advertising and sales promotion; (2) processing of customer orders and arranging for delivery; (3) transportation
outside the United States in connection with delivery to the customer; (4) billing activities; and (5) the
assumption of credit risks.
21 This is certainly the case under US tax treaties that adopt the approach of the Model Tax Convention
on Income and on Capital (OECD Committee on Fiscal Affairs, Paris), under which the need for double tax
relief with respect to income derived from sales made in a foreign country does not arise unless the sales
activities occur through a fixed based that the taxpayer maintains in that foreign country, thereby ruling out the
possibility that such relief may be granted to “domestic export income”. Under Article 7 of the OECD Model
Tax Convention “a Contracting State cannot tax the profits of an enterprise of the other Contracting State unless
it carries on its business through a permanent establishment situated therein.” Article 5 defines a permanent
establishment as being “a fixed place of business, through which the business of an enterprise is wholly or partly
carried on.” In this definition, “place of business” means facility such as premises or, in certain instances,
machinery or equipment.
22 Report of the Panel, supra, note 1, para. 7.10.

B. THE SUBSIDY PROVIDED UNDER THE FSC R EPLACEMENT SCHEME TO US-BASED
ENTERPRISES IS PROHIBITED UNDER ARTICLE 3.1(A) OF THE SCM A GREEMENT, AS IT IS
“CONTINGENT UPON EXPORT PERFORMANCE”
40. Canada submits that the “subsidy” provided to US-based enterprises is clearly “contingent
upon export performance”, as in order to benefit from the “subsidy”, goods must not be sold “for
ultimate use in the United States.” 23 Canada agrees with the EC that this is simply “another way of
saying that they must be exported” 24, and that these words are sufficient to make the subsidy de jure
export contingent. As stated by the Appellate Body in Canada – Certain Measures Affecting the
Automotive Industry25:
a subsidy is … properly held to be de jure export contingent where the condition to
export is clearly, though implicitly, in the instrument comprising the measure. Thus,
for a subsidy to be de jure export contingent, the underlying legal instrument does not
always have to provide expressis verbis that the subsidy is available only upon
fulfilment of the condition of export performance. Such conditionality can also be
derived by necessary implication from the words actually used in the measure.26
41. In Canada’s view, the fact that the FSC Replacement scheme is available to foreign
manufacturers is irrelevant to the determination of whether the “subsidy” provided to US-based
enterprises on the income earned from export transactions is contingent on export performance.
42. It is clear that, under the FSC Replacement scheme, a US-based enterprise must export in
order to qualify for the exclusion from tax. Whethe r, in addition to US-based enterprises, a foreign
entity may qualify or not for the scheme does not modify the requirement imposed on US-based
enterprises and the fact that it explicitly discriminates amongst US-based enterprises on the basis of
export performance.
43. As indicated earlier, the FSC Replacement scheme, when applied to income earned from
exports of domestic goods of US-based enterprises, results in the permanent reduction of US taxes
otherwise payable, in particular as compared to taxes payable on equivalent domestic sales of US-
based enterprises. The export-contingent nature of the scheme leaves no doubt that the only way that
income derived from the sale of a domestic good can qualify under the scheme is if the good is
exported.
44. Canada submits that this export-contingent nature of the scheme cannot be eliminated or
otherwise mitigated by the fact that the scheme applies to goods sold by a foreign branch or a foreign
corporation subject to US taxation. Discrimination among sales of US domestic goods on the basis of
export performance is not ameliorated by the imposition of a similar discrimination with respect to
sales of goods by foreign entities. In Canada’s view, the only way that the scheme could be non-
export-contingent is if it conferred benefits to the sales of US domestic goods that are not exported.
Such is not the case under the FSC Replacement scheme. Canada agrees with the EC that the proper
basis of comparison must necessarily be with the tax treatment of domestic sales of domestic goods.
27
In Canada’s view, the Reports of the Panel and of the Appellate Body in Canada – Measures
Affecting the Export of Civilian Aircraft 28 provide clear support for Canada and the EC’s position in
this case.

23 FSC Replacement Act, section 942(a)(2)(A)(i).
24 First Submission of the European Communities, supra note 1, para. 71.
25 WT/DS 139/AB/R, WT/DS 142/AB/R, Report of the Appellate Body adopted 19 June 2000.
26 Ibid. para. 100.
27 First Submission of the European Communities, supra note 1, para. 71.
28 Report of the Panel, WT/DS70/R, 14 April 1999; Report of the Appellate Body, supra note 9.

46. In Canada – Aircraft , Canada argued that a “subsidy” provided through Technology
Partnerships Canada (TPC) was not contingent upon export performance as TPC provided support to
a broad base of sectors and technologies that touc hed on virtually all industrial sectors of Canada.
According to Canada, the fact that some of the contributions provided under the programme were
made to companies that were involved in exports did not make the program export contingent. The
Panel rejected Canada’s arguments and found that the “subsidy” was contingent upon export
performance.
47. Canada appealed the finding of the Panel. One of the issues raised by Canada on appeal was
the fact that the Panel had given “no indication that … the operation of the TPC programme as a
whole” had been considered. The Appellate Body rejected this argument and ruled as follows:
the fact that some of the TPC’s contributions, in some industry sectors, are not
contingent upon export performance, does not necessarily mean that the same is true
for all of TPC’s contributions. It is enough to show that one or some of TPC’s
contributions do constitute subsidies “contingent … in fact… upon export
performance.”29
48. Canada submits that this reasoning equally applies to the financial contribution or “subsidy”
being provided to US-based enterprises on domestic income earned on export transactions. The fact
that the exclusion provided to foreign source income may not be contingent on export performance
does not mean that the same is true for income earned on export transactions. It is enough to show that
part of the contribution under the FSC Replacement scheme is export contingent.
49. Canada therefore submits that the United States continues to provide prohibited export
subsidies inconsistent with Article 3.1(a) of the SCM Agreement.
VI. CONCLUSION
50. Accordingly, Canada respectfully requests that the Panel find that the United States has not
complied with the recommendations and rulings of the DSB and that the United States continues to
provide prohibited export subsidies under the FSC Replacement scheme inconsistent with
Articles 3.1(a) of the SCM Agreement.

29 Report of the Appellate Body, Ibid. para. 179.

ANNEX C
Second Submissions by the Parties
Contents Page
Annex C-1 Second Written Submission of the European Communities C-2
Annex C-2 Second Written Submission of the United States C-54

1. Introduction
1. The EC respectfully submits to the Panel its second written submission in this case in rebuttal
to the first written submission of the US.
2. The EC finds that the US submission does not respond to a number of the arguments
contained in the first written submission of the EC. The EC will therefore commence this submission
(Section 2 below) by recalling the arguments to which the US has not responded, as this may assist
the Panel in identifying what is not contested.
3. Another feature of the first written submission of the US is that it provides little in the way of
concrete information in response to that furnished by the EC but instead contains a number of
misleading statements. The EC will comment on the US presentation of the facts in Section 3 below
in order to clarify these issues for the Panel.
4. The legal arguments of the US are rebutted in Section 4 below. This section commences with
a discussion of the questions of the burden and standard of proof to be applied in Article 21.5 DSU
proceedings and its consequences for the present proceedings. It will continue with a discussion of
the legal issues in the following order:
/g216Arguments relating to the existence of a subsidy;
/g216Arguments relating to export contingency;
/g216Arguments relating to the requirement to use US over foreign articles;
/g216The double taxation defence;
/g216Arguments relating to Article III:4 GATT 1994;
/g216Arguments concerning the transitional period;
/g216Arguments concerning the failure of the US to implement the rulings and
recommendations of the DSB by 1 November 2000.
5. Finally, the EC will summarise its conclusions (Section 5).
6. The EC notes that the third parties who have submitted comments agree with the EC position.
The EC will comment on these submissions as required during the discussion of the arguments.
2. The EC Arguments that remain unaddressed
7. The US has failed to address a number of claims and arguments made by the EC in its first
written submission. The EC wishes to draw the a ttention of the Panel to the following unanswered
claims and arguments.
2.1. The EC’s basic argument concerning export contingency and illustrations
8. In paragraphs 77 to 79 of the EC’s first written submission, the EC explained that one basic
error of the US was to consider that extending a tax exemption (or exclusion) to other categories of
income than that earned by selling US goods could prevent it being contingent upon export in those
situation where export is a necessary condition for obtaining the tax exemption. More generally, a

subsidy that is export contingent in some situations does not cease to be so if it can also be obtained in
other situations which may not require export.
9. In other words, it should not be possible for the US to hide, what is essentially the same
subsidy as that before the Panel in the original proceeding, within a slightly wider subsidy by adding
to the basic FSC Replacement subsidy what the EC has called the extended FSC Replacement
subsidy.
1
10. The simple fact that tax-free income – or even income that is given the name “extraterritorial”
or “excluded” – can be earned without exporting in some situations cannot suffice to prevent an
export subsidy from being present if such income can be earned in other situations only by exporting.
Otherwise, it would have been sufficient for the US to include in the FSC scheme any other category
of income which is already exempted, or which it is thought desirable to exempt from tax to bring
itself into ‘compliance’.
11. The EC does not consider that the US has replied to these arguments. 2
12. The EC developed its position by arguing that in order to assess whether a subsidy is
contingent upon export or specifically related to export it is necessary to compare like with like – or,
as the EC put it, there must be a comparison with some relevant benchmark.
13. The EC illustrated its point as follows: 3 suppose a subsidy programme is available to all
goods produced in a certain region of a WTO Member’s territory, but only available to goods
produced outside that region if exported from that WTO Member’s territory. It is true that it is not in
all circumstances necessary to export to obtain the subsidy, since goods from the eligible region can
benefit if sold domestically. But goods from outside the eligible region can only qualify for the
subsidy when exported. There are no “alternative” conditions in this case - the subsidy is export
contingent. The same situation arises with the FSC Replacement scheme. Although there may be
cases of production outside the US that may benefit in the absence of export, goods produced in the
US can only obtain the benefit in one way – if exported. In these circumstances, the subsidy is export
contingent.
14. It is true that where a subsidy is made available, for example, to all producers of shoes, some
producers may in fact qualify by producing shoes which they export, but this does not make the
subsidy export contingent. Each producer is free to sell on the domestic market or to export and this
does not affect entitlement to the subsidy. However, in the case of the FSC Replacement scheme, the
situation is different. Owners of US goods produced in the US do not have a choice in how to obtain
the subsidy. They cannot, unlike the shoe manufacturers in the above example, satisfy the conditions
by selling domestically. They have to export. Thus they obtain the subsidy by performing one
function, export, in preference to another, selling on the domestic market.
15. The EC also pointed out that the situation of the FSC Replacement Act is in this respect
similar to the export subsidy found by the panel and Appellate Body in Canada – Aircraft.
4 One of the
subsidies involved in that case, the Technology Partnerships Canada programme, was available to
non-export sectors such as environmental technologies and “enabling technologies.”
5 The fact that
the subsidy was available in some situations without any export contingency did not stop the
payments under the programme to the regional aircraft industry being found export contingent.

1 For an identification and explanation of the two subsidies see first written submission of the EC,
paragraphs 62 to 66.
2 The EC replies to the arguments that the US has made in Section 4.3 below.
3 First written submission of the EC, paragraphs 123 to 127.
4 Panel Report, Canada – Measures Affecting the Export of Civilian Aircraft (“Canada – Aircraft”) ,
WT/DS70/R, adopted 20 August 1999, as upheld by the Appellate Body Report, WT/DS70/AB/R.
5 See, e.g., Panel Report, Canada – Aircraft, paragraph 6.174.

16. Again, the EC finds no answer to these argument s in the first written submission of the US.
2.2. The EC argument that the extended FSC Replacement Subsidy is also contingent
upon export performance and specifically related to exports
17. The US also fails to comment at all on the EC’s further argument that adding the extended
FSC Replacement subsidy to the basic FSC Replacem ent subsidy cannot, in any event, prevent the
basic FSC Replacement subsidy frombeing export contingent because the extended FSC Replacement
subsidy is itself also export contingent or specifically related to exports due to the existence of the
foreign content limitation, which is equivalent in many cases to a US content requirement.6
18. It may be that the US considers that it has responded to this argument with its arguments
relating to Article 3.1(b) of the SCM Agreement (that it does not consider that there is any requirement
to use goods exported from the US).
7 In no way however does it respond to the argument that the
extended FSC Replacement subsidy is specifically related to exports within the meaning of Item (e) of
the Illustrative List.
2.3. The EC claim that the FSC Replacement scheme also provides subsidies under
the Agreement on Agriculture and that these are contrary to Articles 10.1 and 8 of
the Agreement on Agriculture
19. The US defence of the FSC Replacement scheme under the Agreement on Agriculture is
limited to a reference back to its arguments under the SCM Agreement that the scheme does not give
rise to export contingent subsidies.8
20. The US does not contest that if the FSC Replacement subsidies are contingent upon export
performance for the purposes of the SCM Agreement for any reason, the FSC Replacement scheme
will be inconsistent with Articles 10.1 and 8 of the Agreement on Agriculture. In particular, the US
expressly confirms
9 that it does not argue that the FSC Replacement subsidies fall under any of the
categories listed in Article 9.1 of the Agreement on Agriculture. In the light of the Report of the
Appellate Body, the question of whether the FSC Replacement subsidies do fall under any of the
categories listed in Article 9.1 of the Agreement on Agriculture may therefore be considered academic.
3. Comments on the Factual Background
21. As mentioned above, there are a large number of incorrect and misleading statements in the
US first written submission. The EC will comment on and correct the statements that it considers
most relevant and important for a proper understanding of the case.
3.1. The relationship between the FSC and FSC Replacement schemes
22. The US challenges 10 the EC’s comment that the FSC Replacement scheme provides
“essentially the same subsidy” as the FSC scheme. The EC made this comment when considering the
subsidy from the point of view of US exporters and maintains that it is accurate. The attempt of the
US to present the schemes as different deserves a number of comments here.

6 First written submission of the EC, paragraphs 104 to 120, 220-221 (and paragraphs 147 to 158 in
connection with the term “specifically related to exports”).
7 First written submission of the US, footnote 102.
8 First written submission of the US, paragraph 221.
9 First written submission of the US, footnote 210.
10 First written submission of the US, paragraph 47 et seq.

23. First, as the EC explained, in particular in paragraphs 35 to 37 of its first written submission,
the FSC Replacement scheme provides arithmetically identical tax benefits to what was (and still is)
available under the FSC scheme, but the availability had been facilitated and somewhat widened.
24. The US does not contest these facts. The EC notes that Canada also agrees with its
arithmetic.11
25. Second, it is also clear from the transitional rules that the FSC Replacement scheme replaces
the FSC.12 The FSC Replacement Act does not apply to FSCs until 31 December 2001 and in some
case may not ever apply to them. In fact, one scheme is phased in while the other is phased out. Also
exporters can opt into the FSC Replacement scheme for individual transactions instead of using the
FSC scheme.13
26. Third, the US statement in footnote 181 to its first written submission is wrong (or at least
contradicts the stated intent of the US Congress) wh en it states, with reference to the foreign content
limitation, that:
This comparison, and any reference to the FSC rules, is irrelevant to the issues before
this Panel.
The US Congress Joint Committee on Taxation made a statement to the contrary (taken up in
the House and Senate Reports) in the following terms:
Gap period before administrative guidance is issued
The Committee recognizes that there may be a gap in time between the enactment of
the bill and the issuance of detailed administrative guidance. It is intended that during
this gap period before administrative guidance is issued, taxpayers and the Internal
Revenue Service may apply the principles of present-law regulations and other
administrative guidance under sections 921 through 927 to analogous concepts under
the bill. Some examples of the application of the principles of present-law regulations
to the bill are described below. These limited examples are intended to be merely
illustrative and are not intended to impl y any limitation regarding the application of
the principles of other analogous rules or concepts under present law.
3.2. The FSC Replacement Act as a “fundamental change” to the US tax system
27. Central to the US argument that the FSC Replacement scheme cannot give rise to any
subsidies at all are the contentions that the FSC Replacement Act is the result of congressional review
of the US tax system
14 and represents a fundamental shift in the jurisdiction to tax. 15 The legislative
history (even if considered relevant) does not, when examined, actually reflect any such intention and
the EC challenges these statements as misleading and incorrect.
28. The US attempt to contrast the FSC Replacement Act with the “former US worldwide
approach”16 only serves to highlight the artificiality of its arguments. The US approach to the taxation
of income is still fundamentally worldwide, even as regards so-called “extraterritorial income”. As
the EC has explained and the US has nowhere attempted to refute, the FSC Replacement Act excludes

11 Written Observations of Canada, paragraph 32.
12 The transitional rules are in section 5 of the FSC Replacement Act and are explained in
paragraphs 234 to 241 of the first written submission of the EC.
13 Section 5(c)(2) of the FSC Replacement Act.
14 First written submission of the US, paragraph 25.
15 First written submission of the US, paragraphs 52 to 54 (see also paragraphs 67 to 73).
16 First written submission of the US, paragraph 52.

only a variable part of “extraterritorial income” from gross income and therefore tax, and does so
subject to numerous conditions.17
29. The EC refers the Panel to an Article published in the US specialist publication Tax Notes
International entitled “US Treasury Official Denies FSC Repeal Signals Move to Territoriality.18 The
Article is attached as Exhibit EC-10. The official concerned was the US Treasury’s acting
international tax counsel and was closely involved in the preparation and defence of the FSC
Replacement Act, representing the US at the consultations held with the EC on 4 December 2000.
She is reported as saying that the FSC Replacement Act “is a narrow exception from the traditional
US tax model based on reaching the worldwide income of each tax payer, regardless of where such
income is derived.” The Article also makes clear that the US review of its subpart F legislation is yet
to be completed.19
3.3. The US argument that ‘extraterritorial income’ is ‘outside the taxing
jurisdiction of the United States’
30. A related argument to that about ‘fundamental change’ to the US tax system is the often
repeated US claim that ‘extraterritorial income’ is outside the taxing jurisdiction of the US. For
example, in paragraph 20 of the first written submission of the US:
Under the new regime, extraterritorial inco me is excluded from gross income for US
tax purposes, and, as explained below, is thereby placed outside the taxing
jurisdiction of the United States.
and in paragraph 25:
the Act creates a new general rule under which excluded extraterritorial income
earned by US taxpayers is outside US taxing jurisdiction.
31. These statements are misleading. First, as the EC has explained in its first written
submission, the US does tax ‘extraterritorial income’. It is only a variable part thereof – qualifying
foreign trade income that is excluded and then subject to numerous conditions, some of which were
listed by the EC in paragraph 55 of its first written submission.
32. The extent of the exclusion of ‘extraterritorial income’ from US taxation is very much under
US government control. There are many conditions in the FSC Replacement Act and further
extensive executive powers to regulate the taxation of this ‘extraterritorial income’. For example,
new section 943(a)(4) allows the President to designate any property as in short supply and exclude
income from its export from the FSC Replacement scheme. And new section 943(e)(4)(C) allows the
Secretary to the Treasury to generally exclude ‘one or more classes of corporations’ from the making
‘domestication elections’ and thus from participating in the FSC Replacement scheme.
3.4. The US inaccurate and misleading description of the FSC Replacement scheme
33. The EC considers that the first written submission of the US is replete with other misleading
and unjustified statements about the FSC Replacement scheme. For example, the US states that:
Rather than providing unique or special treatment for export-related income, the Act
treats all foreign sales and all taxpayers alike.
20

17 First written submission of the EC, paragraphs 48 to 51.
18 Tax Notes International, 18 December 2000, pp. 2749 to 2752.
19 Id. page 2752.
20 First written submission of the US, paragraph 23.

34. As the EC has pointed out the ‘special tax treatment’ under the FSC Replacement scheme is
only available for ‘foreign sales’ on condition that they are not ‘for ultimate use in the US’ 21 and is
also only available if certain conditions are met including a limitation on foreign content which
restricts availability of the ‘special tax treatment’ in some cases to foreign goods incorporating US
exports.22
35. Similarly, the US statement at another point of its first written submission:
Thus, taxpayers receive the same US tax treatment with respect to income derived
from foreign transactions regardless of whether exports are involved.23
is also, to say the least, misleading. It is clear that the vast majority of ‘foreign transactions’
are treated very differently by the US tax system.
36. A general feature of the first written submission of the US is the pervasive confusion that
exists between ‘foreign transactions’, ‘foreign sales’, ‘foreign goods’, ‘exports’ and ‘foreign-source
income.’ Different concepts are often assimilated when in truth they are distinct or only partially
overlap. To take a few examples:
• In paragraph 126 of the first written submission, the US attempts to deny the
comparability of goods sold domestically and those sold abroad by saying:
Products manufactured and sold in the US cannot be said to be foreign.
Obviously, products made in the US and then exported do not suddenly become foreign, even if the
transaction is made with a foreign company.
• In quoting the House Report, the US says24 that under the US and European systems
exporting is one way to earn foreign source income…
Of course, under the European systems, only the foreign activities relating to exporting earn such
income, while under the Act all the domestic activities relating to exports earn such income.
37. The US also attempts to blur the distinction between “extraterritorial” income and “excluded”
income. It erroneously states in paragraph 28 of its first written submission that the FSC Replacement
Act gives a detailed definition of extraterritorial income which is contained primarily in sections 114,
941, 942 and 943 of the IRC. It refrains from referring to the straightforward definition contained in
section 114(e) IRC but goes on in paragraph 29 to bring into the definition elements of qualifying
foreign trade income which, as the EC explained, merely limit the extent to which “extraterritorial
income” is subject to less tax than other income.
38. Thereafter, the US varies its terminology referring to “excluded income”
25 “excluded
extraterritorial income”26 and even “excludable extraterritorial income”27.

21 Section 942(a)(2)(A)(i) of the IRC as explained, for example, in the first written submission of the
EC, paragraphs 100-101.
22 Section 943(a)(1)(C) of the IRC as explained, for example, in the first written submission of the EC,
paragraph 107 et seq.
23 First written submission of the US, paragraph 23.
24 First written submission of the US, paragraph 193.
25 E.g., First written submission of the US, paragraph 33.
26 E.g., First written submission of the US, paragraph 31.
27 First written submission of the US, paragraph 200.

39. The EC considers that the US attempt to confuse the basic facts concerning its law to be
unhelpful. The EC considers that its own descript ion of the FSC Replacement Act is more reliable
and notes that the US has not demonstrated any instance in which the EC may have misunderstood
any aspect of the FSC Replacement Act.
3.5. US descriptions of European Tax systems
40. The US is also inaccurate in its description of “European” tax systems. 28 The EC has no
intention to defend the tax systems of its Member States, which it is convinced comply fully with their
international obligations. It will only make the following brief comments:
• First, it is misleading to talk of a “European Model” 29 tax systems. Most EU tax
systems are not territorial, as is shown in the description the EC produced in the
original proceedings and the US has attached to its first written submission as exhibit
US-5.
• Secondly and most importantly, the FSC Replacement Act is not comparable to any
EC system. The description of the “European tax exemptions” is misleading. The US
is simply wrong when its states, at the end of paragraph 40 of its first written
submission, that:
Insofar as the sale of goods is concerned, European manufacturers
operating in these types of tax regimes may obtain the benefits of a
territorial exemption only by exporting.
Contrary to the situation under the US FSC Replacement scheme, exemptions in the EC
Member States do not depend on whether the product on which the income arises is exported
or not. If a foreign distribution subsidiary of a Dutch producer, to take the example used by
the US, of goods sells those goods in the Netherlands, the resulting profit will have exactly
the same tax treatment as when the foreign subsidiary sells them outside the Netherlands.
Another important difference is that the exemp tion of foreign branch profits under the Dutch
tax system (as well as under any other EC Member State’s tax system which provide for the
exemption of foreign branch profits) is limited to the profits attributable to the foreign branch
in accordance with the arm’s length principle. The applicability of this principle to the
attribution profits between branch offices and head offices is well established in the
international tax disciplines 30 and it is strictly adhered to by the Dutch tax law. Under the
FSC Replacement scheme the amount of excluded income is simply calculated according to
three alternative formulas. In practice none of these formulas is likely to give a result that
would correspond to the amount of profits attributable to business activities carried out
outside the territorial limits of the US.

28 First written submission of the US, first in paragraph 25 and then in detail in paragraphs 39 to 46.
29 First written submission of the US, paragraph 39 et seq.
30 Among such internationally embraced disciplines, perhaps most relevant to the attribution of
business profits to a permanent establishment (e.g. a branch office) is that of Article 7 of the OECD Model Tax
Convention. This principle and its applicability to the attribution of business profits is clearly set out in
paragraph 2 of Article 7 of the Convention: “Subject to the provisions of paragraph 3, where an enterprise
carries on business in the other Contracting State through a permanent establishment situated therein, there shall
be in each Contracting State be attributed to that permanent establishment the profits which it might be
expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the
same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent
establishment.” (emphasis added).

3.6. The FSC Replacement Act as a measure for the avoidance of double taxation
41. The EC will be refuting the double taxation defence in detail in Section 4.6 below. However,
in the present context, it takes issue with the US statement that the avoidance of double taxation was a
purpose of the FSC Replacement Act. 31 The US refers to the House Report in footnote 28, but this,
on examination, does not bear out its contention. The passage referred to (page 18 of the House
Report) makes no reference to the avoidance of double taxation. The only references to double
taxation in the legislative history relate, in fact, to the need to limit the use of foreign tax credits in
respect of excluded income, a matter to which the EC will return in its discussion of the legal merits
of this defence below.
42. In truth, the avoidance of double taxation was not a motivation for the FSC Replacement Act,
since the US had no problem of double taxation to resolve but rather a need to replace a prohibited
export subsidy with a measure of equivalent effect.
4. Response to the Legal Arguments of the US
43. The EC will now proceed to refute in detail all the arguments that the US has made in its first
written submission.
4.1. Comments on the factual burden of proof in DSU Article 21.5 proceedings
44. The EC did not address the burden of proof in its first written submission but the US has.
More specifically, the US submits that the EC has the “burden of proof both in terms of presenting a
prima facie case and in the sense of the ultimate burden of persuasion. Thus, if the balance of
evidence is inconclusive, the EC will have failed to have established its claims.”32
45. This assertion suggesting that the EC generally bears the burden of proof in these Article 21.5
proceedings is too simplistic and calls for some clarification. At the outset, it might be noted that the
US has already accepted, e.g., the burden to establish its defence under footnote 59.33
46. The EC considers that the burden of proof should not give rise to any difficulty in the present
case because the FSC Replacement Act is de jure inconsistent with the covered agreements. The EC
believes that it has demonstrated this in its first written submission and will bring further arguments
below to refute those of the US. The EC has also provided some factual evidence – going beyond the
text and history of the FSC Replacement Act – in the Annex to its first written submission – which it
has developed and appends anew to this submission – but this is for the purposes of illustration
34
rather than in response for a need to provide such evidence.
47. The EC does however wish to make two brief cl arifications regarding the burden and standard
of proof in these Article 21.5 proceedings for reasons of principle.
4.1.1. The burden of proof in DSU Article 21.5 Proceedings
48. The case law governing the burden of proof in Article 21.5 proceedings is very limited. In the
Article 21.5 proceedings on Brazil – Aircraft and Canada – Aircraft , the Appellate Body has not
specifically addressed the issue. However, some guidance can be gleaned from scattered sentences in

31 First written submission of the US, paragraph 26.
32 First written submission of the US, paragraph 57 (footnote omitted).
33 Ibid. , paragraph 166, where the US qualified its defence as being an “exception”.
34 First written submission of the EC, paragraph 116.

these rulings suggesting that a compliance panel should, in principle, apply the basic rule governing
the burden of proof as established for original proceedings.35
49. Thus, following the decision of the Appellate Body in United States – Measure Affecting
Imports of Woven Wool Shirts and Blouses from India (“United States – Shirts and Blouses”),
the burden of proof rests upon the party, whether complaining or defending, who
asserts the affirmative of a particular claim or defence.36
50. In other words:
The initial burden lies on the complaining party, which must establish a prima facie
case of inconsistency with a particular provision … When that prima facie case is
made, the burden of proof moves to the defending party, which must in turn counter
or refute the claimed inconsistency.37
51. In short, the claimant in the Article 21.5 proceedings has the onus of establishing a prima
facie case of inconsistency of the implementing measure with the covered agreements. The EC
considers that it has met its burden, so that the onus is on the US to disprove the claims.
4.1.2. The standard of proof in DSU Article 21.5 proceedings
52. The EC takes issue with the statement of the US that in “cases involving a generally
applicable measure, there must be a heightened evidentiary burden for the complaining party”. 38 In
fact, the attempt, on the part of the US, to raise the standard of proof is tantamount to conceding that
the EC has successfully reached the initial level of proof which is to make a “presumption” or a
“prima facie case” of inconsistency with a particular provision. 39 The term prima facie denotes the
minimum quantum of evidence "which unexplained or uncontradicted is sufficient to maintain the
proposition affirmed."40 The Appellate Body elaborated on the standard of proof in United States –
Shirts and Blouses when holding:
In the context of the GATT 1994 and the WTO Agreement, precisely how much and
precisely what kind of evidence will be required to establish such a presumption will
necessarily vary from measure to measure, provision to provision, and case to case.41
Thus, the precise requirement of how much and which kind of evidence is necessary to substantiate a
claim needs to be tailored on a case-to-case basis.

35 Appellate Body Report, Brazil – Export Financing Programme for Aircraft Recourse by Canada to
Article 21.5 of the DSU , (“Brazil – Aircraft, 21.5 ”), WT/DS46/AB/RW, adopted 4 August 2000, paragraph 66,
which reads: “[T]he fact that the measure at issue was ‘taken to comply’ with the ‘recommendations and
rulings’ of the DSB does not alter the allocation of the burden of proving Brazil's ‘defence’ under item (k).” See
also, Appellate Body Report, Canada – Measures Affecting the Export of Civilian Aircraft Recourse by Brazil to
Article 21.5 of the DSU (“Canada – Aircraft, 21.5”), where the Appellate Body added, in paragraph 38, that “the
examination of ‘measures taken to comply’ is based on the relevant facts proved, by the complainant, to the
Article 21.5 panel, during the panel proceedings.”
36 Appellate Body Report, United States – Shirts and Blouses , WT/DS33/AB/R, adopted 23 May 1997,
p. 14.
37 Appellate Body Report, European Communities – Measures Concerning Meat and Meat Products
(Hormones) (“EC – Hormones”) , WT/DS26/AB/R, WT/DS48/AB/R, adopted 13 February 1998, paragraph 98.
38 First written submission of the US, paragraph 218.
39 Appellate Body Report, United States – Shirts and Blouses , p. 14. See also, Appellate Body Report,
EC– Hormones, paragraph 98.
40 Kazazi, Motjaba, "Burden of Proof and Related Issues, A Study of Evidence Before International
Tribunals" (Hague, Boston: Kluwer Law International, 1996), at 328 with further references.
41 Appellate Body Report, United States – Shirts and Blouses, p. 14

53. The case before the Panel involves a specific evidentiary situation. The measure at stake is
“legislation as such” as opposed to individual measures. Moreover, the Panel is now faced with a
measure purportedly implementing its recommendations in the original proceedings. The FSC
Replacement scheme is still in the process of being defined by regulation and considered by
taxpayers. Thus, no factual evidence exists, e.g., on the question whether the non-US producers will,
in practice, ever benefit from the FSC Replacement subsidy. When considering the standard of proof
to be applied in this case, the EC submits that the Panel should take account of the following
principles and considerations.
54. First, where the evidence regarding the effects of a piece of legislation is limited, panels may
be forced to adjudicate the dispute on the basis of the general make-up and design of the measure.
Thus, for example, in Argentina – Textiles and Apparel , the Appellate Body agreed with the Panel
that “the structure and design” of the measure resulted in a violation of Article II of the GATT.
42
More importantly, the Appellate Body did not find it necessary that the application of the measure
“result in a breach of Article II for each and every import transaction”.
43
55. A further illustration of how a prima facie case may be made on the basis of the law is the
recent ruling in Korea – Beef . In that case, the Appellate Body declined Korea’s argument that the
Panel’s finding on Article III:4 of the GATT 1994 was “seriously flawed, relying largely on
speculation rather than on factual analysis” and affirmed that the dual retail system infringed
Article III:4 of the GATT 1994 on the basis of an analysis of “the fundamental thrust and effect of the
measure itself”.44
56. Second, the Panel might also recall that, in the Canada – Aircraft case, Brazil did not possess
much evidence about one of the subsidy schemes alleged in that case. To offset this lack of
information on the part of the complainant, the Appellate Body clarified that each party has the duty
to produce the evidence in its possession as requested by the panel under Article 13.1 of the DSU.
45
A failure to furnish the information sought permits the panel to draw adverse inferences from it. 46
While the Panel, in that case, refused to draw adverse inferences from Canada’s failure to provide the
information requested under Article 13.1 of the DSU arguing that Brazil had failed to make a prima
facie case47, the Appellate Body emphasised that adverse inferences may be drawn independently of
whether a prima facie has been made. Thus:
A prima facie case, it is well to remember, is a case which, in the absence of
effective refutation by the defending party (that is, in the present appeal, the Member
requested to provide the information), requires a panel, as a matter of law, to rule in
favour of the complaining party presenting the prima facie case. […] [A] panel is
vested with ample and extensive discretionary authority to determine when it needs
information to resolve a dispute and what information it needs. A panel may need
such information before or after a complaining or a responding Member has
established its complaint or defence on a prima facie b a s i s . A p a n e l m a y , i n f a c t ,
need the information sought in order to ev aluate evidence already before it in the

42 Appellate Body Report, Argentina – Measures Affecting Imports of Footwear, Textiles, Apparel and
Other Items (“Argentina – Textiles and Apparel”), WT/DS56/AB/R, adopted 22 April 1998, paragraph 62.
43 Ibid.(emphasis added).
44 Appellate Body Report, Korea – Measures Affecting Imports of Fresh, Chilled and Frozen Beef
(“Korea – Beef”), WT/DS161/AB/R, WT/DS169/AB/R, adopted 10 January 2001, paragraph 142.
45 Appellate Body Report, Canada – Measures Affecting the Ex port of Civilian Aircraft (“Canada –
Aircraft”), WT/DS70/AB/R, adopted 20 August 1999, paragraphs 186-196.
46 Ibid., paragraphs 197-205.
47 Panel Report, Canada – Aircraft, as upheld by the Appellate Body Report, paragraph 9.181.

course of determining whether the claiming or the responding Member, as the case
may be, has established a prima facie case or defence.48
57. Finally, the specific situation of these Article 21.5 proceedings also bears upon the application
of the standard of proof. The main piece of evidence available to the Panel is the FSC Replacement
Act. In contrast to the original proceedings, there is only one Panel meeting at which the parties can
request and discuss factual evidence in addition to the implementation measure itself.
58. In applying the standard of proof, the Panel should consider the DSU objective of prompt
settlement of trade disputes and, in particular, the accelerated implementation provisions enshrined in
Article 4 of the SCM Agreement . Article 21.5 of the DSU and Article 4 of the SCM Agreement
envisage that an implementing measure be examined as soon as it is adopted. There is no time for its
application in practice to be assessed. Thus, the EC believes that the principles governing the
assessment and weighing of evidence in Article 21.5 cases involving prohibited export subsidies must
ensure that the obligation to “withdraw the subsidy” in Article 4.7 DSU does not simply mean, in
practice, maintaining the subsidy and disguising the export contingency in a manner that cannot be
established until long after the expiry of the period of time fixed for withdrawal.
4.2. The FSC Replacement scheme continues to provide subsidies
4.2.1. The meaning of “revenue foregone” and “otherwise due”
59. The US is correct in considering that the words “revenue foregone” and “otherwise due” in
Article 1.1(a)(1)(ii) of the SCM Agreement are the key to determining whether the FSC Replacement
scheme gives rise to a financial contribution and therefore a subsidy.
60. The EC is pleased to note that the US recognises in particular that
Where the tax laws of a country themselves create a special exception from general
tax obligations, that, too, may come within the language of subparagraph (ii).
49
61. However, the US proceeds to fundamentally misunderstand or misrepresent the interpretation
that the Appellate Body gave to these terms in the original proceedings. It quotes frequently from
paragraph 90 of the Appellate Body Report 50 but conspicuously fails to refer to the fact that the
Appellate Body considered “otherwise due” to refer to revenue that would be due ‘ in a different
situation’ or ‘in some other situation’ under the tax system of the member concerned. The US omits
these key words and instead contrives to conclude that the test is simply whether the taxes would have
been collected ‘but for’ the measure in question.51
62. The US is wrong to say that the Appellate Body agreed that the ‘but for’ test was appropriate
to the FSC case.
52 It stated that it worked in the FSC case but that
It would, we believe, not be difficult to circumvent such a test by designing a tax
regime under which there would be no general rule that applied formally to the

48 Appellate Body Report, Canada – Aircraft, paragraph 192.
49 First written submission of the US, paragraph 63.
50 First written submission of the US, paragraphs 63 and 64. The EC quoted paragraph 90 of the
Appellate Body Report correctly and in full in paragraph 30 of its first written submission.
51 First written submission of the US, paragraph 65.
52 First written submission of the US, paragraph 65.

revenues in question, absent the contested measures. We observe, therefore, that,
although the Panel's "but for" test works in this case, it may not work in other cases.53
63. The FSC Replacement scheme is a tax regime that endeavours to ‘circumvent’ in precisely
the way the Appellate Body had feared the ‘but fo r’ test would permit. The EC notes that Canada
shares its opinion.
54
64. The ‘normative benchmark’ referred to by the Appellate Body is therefore the tax that would
be due under the tax system of the Member in question in some other situation, not the legal rule that
would apply if the rule under consideration did not exist.
4.2.2. The US ‘prevailing legal standard’
65. The second step in the US false reasoning, after having attempted to dispense with the
requirement to consider the revenue that would be due in some other situation (i.e. domestic sale), is
to manipulate the phrase ‘prevailing legal standard’.
66. The US asserts that
Under US law, the taxing authority of the United States government is defined by the
statutory definition of “gross income.”
55
and
The definition of “gross income” is thus the “prevailing domestic standard” for US
taxation.56
67. The EC contests this approach. First, of course, the correct approach is, as explained above,
to compare the revenue due in one situation to that due in another under the tax system of the US. But
secondly, the US is confusing the income actually subject to taxation under US law with the taxing
authority of the US. It arrives at a ridiculous conclusion that would allow Members to provide any
subsidy they like through the tax system using the simple device of excluding the income concerned
from the definition of ‘gross income’. In this way, the exclusion from tax of ‘income derived from
the sale of textile products’ or ‘income earned from export’ from ‘gross income’ would also not be a
subsidy!
68. In reality, the US ‘prevailing domestic standard’ applying to the type of income under
consideration, that is corporate income from a commercial activity, is that income may be taxed if it is
earned by a US corporation or is ‘effectively connected’ with a US trade or business. The so-called
‘exclusion’ of ‘extraterritorial income’ from US taxation is a derogation from this prevailing domestic
standard. The fact that there are ‘exceptions’ to the exclusion does not change this.
69. In any event the US contention that
the general authority to tax extraterritorial income has now been eliminated from the
prevailing US standard
57

53 Appellate Body Report, paragraph 91.
54 Third Party statement of Canada, paragraph 28.
55 First written submission of the US, paragraph 69.
56 First written submission of the US, paragraph 71.
57 First written submission of the US, paragraph 82 in fine.

is simply wrong. The US does tax ‘extraterritorial income.’ It is only ‘qualifying foreign trade
income’ that is excluded and then under certain conditions, as the EC has explained in Section 3.2
above.
4.2.3. Inter-temporal comparisons
70. In paragraphs 74 to 76 of its first written submission, the US replies to an argument that the
EC has never made, reasoning that Members must have the right to change their tax systems and that
by doing so they are not forgoing revenue that would otherwise be due.
71. The misunderstanding by the US of the EC position is even clearer in paragraph 100 of its
first written submission, where it states that:
As discussed above, the EC essentially argues that the determination of whether
revenue is foregone depends upon a comparison of the US tax system before adoption
of the Act with the US tax system after adoption of the Act.
72. The EC trusts that it is clear to the Panel that it is not making such an argument. The
misunderstanding by the US of the EC position would not have arisen if the US had properly
described the standard established by the Appellate Body – that is that the comparison must be
between the revenue due under the special regime and the revenue that would be due “in some other
situation” under the prevailing domestic standard of the Member in question. For the EC it is clear
that the comparison must be conducted between si tuations prevailing at the same time, not between
the present and the past (or the present and the future).
73. Indeed, this further demonstrates that it is not appropriate to apply a simple ‘but for the
measure’ approach to establishing whether revenue that would otherwise be due is forgone.
4.2.4. The US response to the EC’s arguments
74. The EC will now reply in detail to the US response to the arguments on these issues contained
in the EC’s first written submission.
75. First, on the issue of whether the FSC Replacement scheme is an exclusion or an exemption,
the EC notes that the US is in substance agreeing with its position. To be clear, the EC agrees that
… whether, as a matter of US tax law, the new modifications to the term “gross
income” are more appropriately designated as an “exclusion” than as an “exemption”
is really a judgment that the United States Congress is in a better position to make
than EC officials.58
76. The important point is that made by the US in paragraph 88 of its first written submission
where it states that
… the semantic distinction between an exclusion and an exemption would not, in any
event, be determinative. Rather, the test under subparagraph (ii) is whether tax on the
income now excluded would be otherwise legally owed to the government.
77. The EC agrees and said as much in paragraph 53 of its first written submission, where it
stated that:

58 First written submission of the US, paragraph 87.

The EC submits that the factor that determines whether the FSC Replacement scheme
gives rise to a financial contribution and therefore a subsidy is not whether the
legislative provisions on which it is based use the word “exclude” or the word
“exempt” or neither, but whether there is revenue forgone that is otherwise due within
the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.
78. On this point at least the parties are in agreement.
79. The US next responds to what it calls “a variety of arguments to the effect that the Act
confers a subsidy because the exclusion should be larger” although it does also recognise that the
EC’s arguments related not to the size of the subsidy but the conditions under which it is granted. 59
The US argument is that if it can do more, it must be entitled to do less. In this way the US concludes
That an exclusion is qualified or moderated, however, does not convert it into a
subsidy under Article 1.60
80. Again, the US seems to be proclaiming a subsidiser’s charter. The very essence of a subsidy
is that a government gives to some but not to others. The principle “he who can do more can do less”
may apply to the amount of an exemption but it does not apply to the scope of exemptions (just as it
cannot justify discrimination).
81. In defence of its view that it is entitled to exclude from tax whatever arbitrarily defined
‘category’ of income it wishes on whatever condition it wishes without there being a subsidy the US
argues that
the EC’s argument that only the non-taxation of a “general” category falls outside of
subparagraph (ii) would mean that most of the tax systems in Europe are subsidy
schemes. In construing subparagraph (ii), it is reasonable for the Panel to consider
whether the intent of the Uruguay Round negotiators was to adopt a principle under
which the tax systems of most industrialized countries would be subsidies.
61
82. Here the US is of course departing from the words of the SCM Agreement and looking to the
intent of the Uruguay Round negotiators. The EC would make two comments.
83. First, the extent to which revenue is forgone that is otherwise due, depends principally on the
meaning given to the word ‘otherwise’. The Appellate Body has said that there must be a
comparison with a ‘normative benchmark’, that is with the revenue that would be due in some other
situation under the tax system of the Member concerned. The EC shares this view and considers in
addition that this ‘other situation’ must be a comparable situation. Thus, the EC believes, for
example, that lottery winnings cannot be compared with earned income. The fact that these classes of
income may be taxed differently does not mean that revenue is being forgone.
84. That is why the EC has argued
62 that different categories of income may be taxed differently
if the categories are defined generally, objectively and neutrally. It may be that the word ‘category’ is
insufficiently precise for this purpose because it can be defined arbitrarily (the US is arguing that
‘extraterritorial income’ or rather ‘qualifying foreig n trade income’ is a ‘category’). It is perhaps
more accurate to speak of ‘classes’ or ‘types’ of income. The important point is, as the EC has stated
above, that like be compared with like. Income from the sale of goods is a type or class of income.
Exporting and selling domestically are simply different situations in which it may arise or be earned.

59 First written submission of the US, paragraph 89.
60 Paragraph 91.
61 First written submission of the US, paragraph 94.
62 First written submission of the EC, paragraphs 57 to 61.

85. In the case with the FSC Replacement scheme, income from the sale of goods by commercial
enterprises is taxed in one way if the goods are for final consumption outside the US and in another if
they are for final consumption in the US. These are not in the EC’s views properly considered
different categories (in the sense of class or type) of income. In addition, as the EC pointed out in its
first written submission, the FSC Replacement scheme excludes from tax part of the income from a
single taxable event but only if this taxable event satisfies certain strict conditions.
63
86. Second, the definition of subsidy in Article 1.1 of the SCM Agreement is clearly very broad.
Apart from the provision on revenue forgone, which concerns us in this case, the definition is also
drafted in very wide terms in other respects, covering, for example any actual and potential transfer of
funds and even the purchase of goods by government where a benefit is conferred. The limitation on
the scope of the disciplines is laid down in Article 1.2, which provides that these disciplines only
apply to subsidies that are specific, within the meaning of Article 2. Of course Article 2.2 provides
that subsidies falling under Article 3 are deemed to be specific. Thus, the intent of the Uruguay
Round negotiators not to make all the exemptions and special conditions in tax laws (and indeed the
provisions of many other measures) subject to the disciplines of the SCM Agreement is expressed in
Article 1.2 rather than Article 1.1.
87. Accordingly, the EC maintains that for all the reasons that it set out in paragraphs 46 to 61 of
its first written submission, that the FSC Replacement scheme results in revenue being forgone that
would in other circumstance be collected.
4.2.5. The US’ factual allegations
88. There is one final argument of the US. In paragraphs 100 to 106 the US seems to be arguing
that the EC has not demonstrated any revenue loss and even suggests that
The existence of the Act as part of the US tax system might motivate foreign
corporations to structure a portion of their operations in the United States to achieve a
tax-efficient global operating structure.
64
89. The US dismisses the EC’s reliance on the Cong ressional Budget Office study in exhibit EC-
8 on the grounds that it compares the revenue consequences of the FSC Replacement scheme with
those of the FSC scheme under the “former US worldwide taxation system”.65
90. The EC will first note that the US is not cont esting the figures that the EC drew from the
Congressional Budget Office study. If it wanted to do so, or wanted to contest the conclusions that
the study appears to warrant, it should have produced the evidence that only it has of the budgetary
consequences of the FSC Replacement scheme. If the US does not, the Panel must assume that these
figures mean what they appear to mean.
91. The EC has already explained that the US stil l has a worldwide taxation system and that the
US argument that revenue is not forgone because the “jurisdictional boundary” of the US tax system
has changed is unfounded. 66 It therefore appears that the US argument that the EC has not
demonstrated a revenue loss shares the same fate as its argument that there is no revenue forgone.
92. In case the US is arguing that that the Congressional Budget Office Study is insufficient
because it compares the situation with that prevai ling under the FSC scheme, the EC also attaches as
exhibit EC-11 an extract from the US Treasury Budget estimates for Financial Year 2001 entitled

63 First written submission of the EC, paragraph 57.
64 First written submission of the US, paragraph 102.
65 First written submission of the US, paragraph 106.
66 Section 3.2 above.

Total Revenue Loss Estimates in the Income Tax and providing FSC revenue loss figures for financial
years 1999 to 2005. Since the Congressional Budget Office Study revenue loss figures which the EC
referred to in its first written submission are based on a comparison with the situation prevailing under
the FSC scheme, the total amount of revenue forgone by the FSC Replacement scheme is obtained by
adding to them the amounts shown in the table in exhibit EC 11.
93. In the absence of evidence from the US to the contrary, it must be presumed that the
Congressional Budget Office Study revenue figure s took account of any possible increase of revenue
due to corporations paying US tax that they would not otherwise have paid. In any event, any such
effect can only represent a small part of the revenue forgone.
94. One reason for this is that the controlled foreign corporation ("CFC") rules of the US IRC are
aimed exactly at preventing this type of jurisdiction-shopping. A sales subsidiary that was
incorporated in Country X, bought products from the US parent, and then had sales operations in
Country Y would have "foreign base company sales income" as defined in section 954(d) of the IRC.
In general, the CFC rules would require the US parent to include this amount in the US parent's
taxable income whether actually distributed to the US parent or not.
95. In any event, if the study did not take this into account, it would be for the US to produce the
contrary evidence, which only it has. To the extent that it has not done so, the Panel must presume
that the figures mean what they appear to mean. Also, for the purposes of these Article 21.5 DSU
proceedings, it is only relevant that there will be revenue forgone; the precise amount does not need to
be established.
4.3. The FSC Replacement subsidy is contingent upon export performance
96. The EC has already remarked on the incomplete manner in which the US has responded to the
arguments in the EC’s first written submission.
67 The EC has also already commented 68 on a number
of misleading and wrong statements of the US concerning the FSC Replacement scheme. Many more
are made when the US attempts to defend the FSC Replacement scheme as not contingent upon
export performance or not specifically related to export, for example that the FSC Replacement
scheme is “unrelated to exporting”69 or that exporting is “merely incidental”70 to it.
97. The EC does not comment further on such statements but in this section, will reply to the US
analysis of its legislation under Article 3.1(a) of the SCM Agreement and the comments that the US
does make on the EC’s analysis.
4.3.1. The fundamental difference between the EC and the US
98. The US is correct when it says that there is a difference in “analytical framework” 71 between
the EC and the US. However, it is the US anal ytical framework that does not correspond to the SCM
Agreement, not that of the EC.
99. The US argument is that there are various alternative ways (“a broad range of foreign
transactions”) in which a company may earn excluded income and therefore this is not export
contingent. According to the US, these include:72
• the sale, exchange, or other disposition of qualifying foreign trade property;

67 Sections 2.1 and 2.2 above.
68 Section 3 above.
69 First written submission of the US, paragraph 120.
70 First written submission of the US, paragraph 116.
71 First written submission of the US, paragraph 130.
72 First written submission of the US, paragraph 118.

• the lease or rental of qualifying foreign trade property for use by the lessee outside
the United States;
• the provision of services which are related and subsidiary to any sale, exchange, or
other disposition of qualifying foreign trade property;
• the provision of services which are related and subsidiary to any lease or rental of
qualifying foreign trade property;
• the provision of engineering or architectural services for construction projects located
(or proposed for location) outside the United States; or
• the performance of managerial services for a person other than a related person in
furtherance of the production of foreign trading gross receipts.
100. The US concludes that this allows a ‘broad range of taxpayers’ to earn ‘extraterritorial
income’.73
101. A first comment of the EC on this argument is that most of this impressive list relates to
services. As the EC argued in its first written submission (and as stated above, 74 the US has ignored),
an export-contingent subsidy for goods cannot cease to be so just because it is made available in
other, different, circumstances - for the supply of services abroad.
 75
102. The EC argument is that one has to compar e like with like. For owners of US produced
goods, export is a condition for obtaining the benefits under the scheme for those goods.
103. In the real world (and this is the perspective from which the SCM Agreement is drafted and
from which contingency must be assessed) companies do not start with a desire to earn excluded
income and then consider the various options available for this purpose. They then compare the
attractiveness of selling domestically and exporting goods they have produced or plan to produce. If
the goods and the place they are produced is taken as given, then the companies have no other option
than exporting if they want the benefit of the scheme.
104. Under the “analytical framework” of the US, on the other hand, companies are supposed to
compare the option of earning excluded income by exporting the goods they have produced in the US
with that of earning it by selling foreign-made goods abroad. Because the objective of companies is
to make a profit from selling the goods they produce rather than simply earning “excluded income”,
this is not the choice that is really before them. Th is is also clear from the fact that the US analytical
framework leaves open the question of what is to happen to the US produced goods if excluded
income is earned by selling foreign goods abroad. Assuming that the US produced goods are not to
be destroyed, the producer still has the choice of exporting them or selling them domestically. If it
does the former it will earn (more) excluded income, if it does the latter, it cannot. The US analytical
framework does not correspond to the true choice which is to be made.
105. To show that it is the EC approach that is required by the SCM Agreement, the EC set out in
its first written submission a number of contextual reasons why the comparison should be with the
sale of the same goods domestically (not different goods abroad). 76 The US has set out no reasons
why its analytical framework should be used. It merely criticises some (but by no means all) of the

73 First written submission of the US, paragraph 119.
74 Section 2.1.
75 First written submission of the EC, paragraph 102.
76 First written submission of the EC, paragraphs 85 to 98.

EC’s contextual arguments. The argument that the US chooses to respond to is the EC’s reference to
items (d), (f), (g), (h) and (l) of the Illustrative List as examples of where the benchmark is the
domestic sale of goods. The US claims 77 that the comparison made in these items of the Illustrative
List is made for the purpose of determining the financial contribution.
106. The US is wrong. For instance, under item (f) there is clear comparison between the domestic
and export tax base in order to determine whether there is export contingency. The financial
contribution already derives from the requirement that there be “special deductions”.
107. The US argument is in any event strange since financial contribution is defined in Article 1.1
of the SCM Agreement and the Illustrative List in Annex I merely illustrates export contingency. As
the Appellate Body observed in US - FSC , the Illustrative List is relevant for determining what are
prohibited export subsidies, not for determining what is a subsidy (and therefore what is a financial
contribution). Rather, the fact that the comparisons relate in many cases also to the question of
financial contribution, simply illustrates that the benchmark for establishing export contingency
should be the same as that for establishing the financial contribution.
108. Just as in the case of the examples in the Illustrative List, the relevant benchmark for
assessing the existence of a financial contribution in this case is the same as for establishing the export
contingency – it is the “some other situation” referred to by the Appellate Body.
109. In the case of the export of US goods the “other situation” for assessing whether there is a
financial contribution includes a situation where the goods are not exported, that is they are sold
domestically. The same comparison is to be made for assessing export contingency.
110. The error of the US is also reflected in the fact that it repeatedly considers exports to be a
subcategory of “foreign transactions” 78 and income from exports as a subcategory of “foreign
income”.79 They are not. In reality, exports are a subcategory of the total sales of a company and
income from exports a subcategory of total sales income.

77 First written submission of the US, paragraph 131.
78 E.g. first written submission of the US, paragraph 114, where it is stated that:
Thus, unlike the FSC, the Act provides an exclusion from taxation for income derived from all
qualifying foreign transactions, not simply exports
Another interesting example is in paragraph 126, where it is stated that
Transactions involving property used or consumed in the United States are not covered by the Act
because they are not foreign transactions.
Exports are covered by the FSC Replacement Act, whether or not they are foreign transactions.
79 E.g. first written submission of the US, paragraph 25, where it is stated that
By excluding extraterritorial income from the definition of “gross income”, the Act fundamentally
changes the way the United States taxes foreign income.

4.3.2. Whether there are ‘alternative’ conditions for obtaining the benefit of the FSC
Replacement scheme
111. The US has misunderstood the EC’s argument when it claims that the EC's position is that the
word “other” in the phrase “contingent, … whether solely or as one of several other conditions, upon
export performance” means “alternative” rather than “additional” in Article 3.1(a).80
112. The EC takes no position on the meaning of the world “other” in the above phrase. It would
only state that it is not necessary to the EC argume nt for the word “other” to mean “alternative”. The
EC argument is simply that a subsidy that is export contingent in some circumstances does not cease
to be so if it can also be obtained in other situations which do not require export.81 The EC proceeded
to give two illustrations of this principle 82 which the US has studiously ignored, as already observed
above.83
113. An owner of US goods does not have an alte rnative means of obtaining the FSC Replacement
Act subsidy on the sale of his goods. Export is a necessary condition for obtaining the benefit of the
FSC Replacement scheme in these circumstances and this is therefore export-contingent. This derives
directly from the ordinary meaning of ‘contingent’ and does not depend on the words “one of several
other conditions,” which were really only relevant to the EC’s observation that the US appeared to
consider export contingency to exist where export was truly an alternative condition in the US
Department of Commerce’s countervailing duty regulations.
84
4.3.3. The US comments on the EC’s de facto export contingency arguments
114. In Section V.C.4 (paragraphs 137 to 150) of its first written submission, the US responds to
the EC’s subsidiary arguments (Section 3.3.5, paragraphs 131 to 145 of the EC’s first written
submission) that, even if the EC’s other arguments are not successful, the FSC Replacement scheme
must be considered de facto export contingent because it cannot be expected that the extended FSC
Replacement scheme will be much used in practice.
115. The EC gave a whole series of reasons why this would be so. The US only replies partially to
this argument, as the EC will now explain.
116.The US has made three comments on this de facto export contingency argument, to which the EC
will now reply: that a ‘domestication election’ is not always necessary; that foreign corporations may
make ‘domestication elections’ without increasing their tax liability; and that the ‘domestication
election’ was intended to provide tax equity.
4.3.3.1. The US argument that a ‘domestication election’ is not always necessary
117. The EC agrees with the US
85 that a ‘domestication election’, that is for a foreign corporation
to opt to be treated as a domestic US corporation for US tax purposes, is not necessary if the foreign
manufacture is performed by a branch of a US corporation. In such cases the US corporation is
already subject to US tax as a domestic corporation. It is already ‘domesticated’. The EC never made
any assumption to the contrary.

80 First written submission of the US, paragraphs 134 and 135.
81 First written submission of the EC, paragraph 123.
82 First written submission of the EC, paragraphs 124 to 126.
83 Section 2.1 above.
84 The EC is pleased to note from footnote 117 of the US submission that the US does not consider that
its Department of Commerce’s countervailing duty regulations cannot change the interpretation of the SCM
Agreement but does still wonder if it considers them to be compatible with the SCM Agreement.
85 First written submission of the US, paragraphs 138 to 141.

118. It is, however, crucial to note that situations whereby the foreign manufacture is performed by
a branch of a US corporation are in relative terms bound to be far less common than those where the
US corporation decides to establish a subsidiary in the foreign jurisdiction to undertake such
activities. Undoubtedly, the choice of the legal form for the foreign manufacturing operations depends
on the particular circumstances present in each individual case but in general there are a number of
both tax and commercial reasons for the general preference for the legal form of a subsidiary.
119. First, and perhaps most importantly, from a US corporation’s point of view, it is essential to
take account of the fact that the mainstream profits of a foreign branch are subject to current taxation
in the hands of the corporation in the US. A foreign subsidiary is only liable to tax on such profits in
its country of residence and the taxation in the US is deferred until the repatriation of the profits (in
the form of dividends) to the US shareholder. The FSC Replacement scheme has not introduced any
fundamental change in this respect as the exclusion is merely partial and concerns only ‘qualified
foreign trading income’. The potential benefit of the deferral of taxation until the time when a foreign
subsidiary distributes dividends is, however, still available to US corporations who decide to structure
such foreign manufacturing operations in the legal form of a subsidiary.
120. Second, it is often a critical factor affecting the decision between a branch office and a
subsidiary that as a branch is not a separate legal entity and thus it has no separate limited liability
protection, i.e. distinct from that of the corporation of which it is an inherent part. Also, a local
subsidiary may have a marketing advantage as compared to a branch as it is more closely identified
within the local market.
121. Third, the legal form of a separate legal ent ity incorporated in the foreign jurisdiction may
often be an absolute precondition for being entitled to fully engage in all transactions necessary for
the carrying out of the manufacturing operations. For example, it is not uncommon that the legal
provisions of the host jurisdiction prevent a foreign entity from acquiring immovable property such as
land on which a manufacturing plant is to be built.
122. Fourth, it is also not uncommon that the legal provisions or the standard practice in the host
jurisdiction (where a branch is located) require disclosure of the annual financial statements for the
whole enterprise. This, in its turn may entail additional administrative burden and lead to tedious
disputes over the correct attribution of profits to the branch.
123. Fifth, when operating in the form of a branch there are many potential areas where disputes
concerning the proper attribution of profits to the branch may arise. A typical example is the
allocation and deductibility of the expenses incurred at the head office level but nevertheless partly for
the purposes of the branch (e.g. marketing, advertising, executive and general administrative
expenses). Moreover, there may be differences betw een the ways as to how the two tax jurisdictions
in question treat different classes of income, for example, currency conversion differences for tax
purposes. The resolution of such disputes between the tax jurisdictions may well be difficult to
achieve under (or it is fair to say, despite) the mutual agreement provisions. A non-incorporated entity
as a branch is under the double tax treaties not normally considered as a resident of the State in which
it constitutes a permanent establishment and therefore generally not entitled to the treaty benefits
unless there are specific rules to that effect.
86
124. Sixth, there may be local tax incentives which are only applicable to local incorporated
companies (i.e. only to subsidiaries and not to branches), that may equally affect the choice of the
legal form for the foreign manufacturing operations.

86 Such as the non-discrimination rule contained in paragraph 3 of Article 24 of the OECD Model Tax
Convention.

125. The EC therefore considers that the possibility for foreign branches of US corporations to
benefit from the extended FSC Replacement subsidy is of little practical significance.
4.3.3.2. The US argument that foreign corporations may make ‘domestication elections’
without increasing their tax liability
126. The EC can also agree that there may be circumstances in which foreign corporation can
make a ‘domestication election’ without increasing its tax liability. The US is wrong to say that the
EC has assumed the opposite.87
127. The EC’s point is, simply, that since
(a) The US does not normally tax foreign corporations more heavily than its domestic
corporations;
(b) Foreign countries cannot be expected to tax their companies less simply because they
make a ‘domestication election’ in the US;
Then making a ‘domestication election’ will only rarely reduce the tax burden and be advantageous.
128. The US is correct when it says that foreign corporations that make a ‘domestication election’
in the US will be entitled to foreign tax credits for foreign taxes in the same way as US corporations.
This will mean that when the foreign tax rate is higher or just as high as in the US, such corporations
may get full credit for foreign taxes paid in the US. (The reason the EC uses the word ‘may’ is that in
reality, matters are likely to be complicated by differing methods of calculating tax – e.g. rules on
deductions, tax deductible capital allowances, whether different classes of income are in fact subject
to tax and many other rules.)
129. Even when it is possible for a company to conclude that making a ‘domestication election’ in
the US is unlikely to give rise to an increase in overall taxation, this simply means that there will be
no immediate penalty for such a company. It will clearly not in itself persuade a company to make
such an election. A tax advantage from making a ‘domestication election’ is only likely to arise in
special circumstances, notably because the availability of the FSC Replacement scheme, will in the
first place involve a loss of the possibility of deferring US taxation of foreign income.
130. The EC’s main point is ignored by the US, however. It is that the minor benefit that a
company may sometimes have in making a ‘domestication election’ in the US cannot be expected to
overcome the following disadvantages:
• The additional reporting requirements and administrative burden involved in being
fully subject to an additional tax jurisdiction;
• The requirement to waive all benefits granted by the US under any treaty;
 88
• The fact that upon domestication election, the retained earnings of the foreign
corporation (the non-distributed profits of a foreign subsidiary of a US corporation)
will immediately become subject to US tax; 89

87 First written submission of the US, paragraph 137.
88 First written submission of the EC, paragraph 135.
89 First written submission of the EC, paragraph 138.

• The fact that reversing the ‘domestication election’ will give rise to additional and
unpredictable tax liability arising out of deemed transfers of assets under sections 367
and 354 of the IRC; 90
• The conflicts that complying with US ta xation requirements may create for foreign
corporation in their own jurisdictions and the application of double taxation treaties;91
• The fact that foreign states may object to their companies being made subject to US
jurisdiction in this way and prevent th eir companies from making ‘domestication
elections;92
• The need to ensure that the 50 per cent foreign content limitation is complied with.93
131. For all these reasons the EC maintains that the obligation of ‘domestication’ is bound to make
the use of the extended FSC Replacement subsidy rare and the FSC Replacement scheme is at least de
facto contingent upon export performance.
4.3.3.3. The US argument that the ‘domestication election’ was intended to provide tax equity
132. In paragraphs 147 to 150 of its first written submission, the US claims that the purpose of the
FSC Replacement Act was to “equalize the treatment of US taxpayers abroad, regardless of whether
they operate in branch or corporate form.” It also claims that the restrictions placed on the use of the
scheme by foreign corporations arise because:
In drafting the Act, the US Congress sought to prevent taxpayers from inappropriately
invoking the Act’s exclusion with respect to tax-deferred income.94
And that
These sections were not, as alleged by the EC, designed to discourage the application
of the Act to foreign manufacturing companies or property manufactured outside the
United States.95
133. The EC does not wish to speculate as to the in tent of the US Congress but would simply point
out some objective facts:
• The legal and factual situations of foreign branches and subsidiaries are complex and
diverse. The EC has pointed to a series of factors affecting the choice of using one or
other vehicle. Equalising the tax treatment of the two vehicles will only partially
affect the overall balance. In any event, the FSC Replacement Act does not do this.
To give just one example, only foreign corporations making a domestication election
are required to waive all benefits granted by the US under any treaty;
• Whether deliberate or not, the obstacles in the way of foreign manufacturers
benefiting from the extended FSC Replacement subsidy are, as explained above,
considerable;

90 First written submission of the EC, paragraph 136 to 138.
91 First written submission of the EC, paragraph 139 to 141.
92 First written submission of the EC, paragraphs 142 to 143.
93 First written submission of the EC, paragraph 144.
94 First written submission of the US, paragraph 148.
95 Paragraph 150.

• The FSC scheme is of much greater significance for US exporters who see the WTO-
inconsistent FSC scheme replaced by an arithmetically identical scheme.
134. The EC submits that objectively the overwhelming purpose of the FSC Replacement scheme
can only be considered to be the preservation of the FSC scheme benefits for US exporters.
4.3.3.4. Evidence
135. The title to Section V.C.5 of the US first written submission, 96 alleges that the EC has not
provided evidence that the FSC Replacement subsidies are export contingent. It is not entirely clear
what argument the US is making but the EC would make two points.
136. First, the EC believes that it has established with the arguments in its first written submission,
and developed above, that FSC Replacement subsidies are export contingent.
137. These arguments are based on the text and structure of the FSC Replacement Act and other
laws. The US has a responsibility to produce rebuttal arguments and, if necessary evidence. The EC
has set out its views on the standard and burden of proof in Section 4.1 above. The EC cannot be
expected to produce evidence that is within the control of the US.
138. Second, if the US is suggesting that factual proof is called for of specific companies actually
be required to export, the EC rejects this contention because it is attacking the FSC Replacement Act
as such.
4.4. The FSC Replacement subsidies are specifically related to exports within the
meaning of item (e) of the Illustrative List
139. In Section 3.4 (paragraphs 147 to 158) of its first written submission, the EC argued that its
conclusion that the FSC Replacement subsidies were prohibited export subsidies was confirmed by
Item (e) of the Illustrative List, which defines as an export subsidy:
The full or partial exemption remission, or deferral specifically related to exports, of
direct taxes or social welfare charges pa id or payable by industrial or commercial
enterprises (footnotes omitted)
140. The US responds to this argument indirectly in an introduction to its double taxation defence.
It expresses the view
97 that the Illustrative List does not expand the prohibition in Article 3.1(a) and
concludes that
In order for paragraph (e) to apply, the tax benefits at issue must be export-contingent
within the meaning of Article 3.1(a).98
141. The US position is therefore that the Illustrative List can only reduce the scope of the
prohibition in Article 3.1(a) through the operation of footnote 5 to the SCM Agreement,99 not expand
it.
142. The EC rejects this contention of the US. The word ‘including’ in Article 3.1(a) of the SCM
Agreement does not have to be taken to mean that the Illustrative List cannot expand the ordinary

96 Preceding paragraph 151.
97 First written submission of the US, paragraphs 158 to 161.
98 First written submission of the US, paragraph 161 in fine.
99 First written submission of the US, paragraph 156.

meaning of the first part of Article 3.1(a). It can al so mean that the export subsidies defined in Annex
I are deemed to be included in the prohibition of export subsidies.
143. The US is quoting the dictionary partially when it says that
The term “include” is defined as “contain as a part of a whole” or “place in a class or
category”.100
144. The word "include" can also mean, according to the same dictionary:
contain by implication, involve101
and, even more pertinently, the preposition "including" is defined as meaning
If one takes into account, inclusive.102
Therefore the word "including" can also mean that ‘taking into account’, ‘containing by implication’
and therefore ‘incorporating’. Indeed the same dictionary also gives ‘include’ as one of the meanings
of ‘incorporate’
145. This latter meaning of the word ‘including’ (that is ‘incorporating’ or ‘taking into account’) is
confirmed by, indeed, required by, the context. Footnote 5 expressly excludes from the scope of the
prohibition the measures referred to in Annex I as not constituting export subsidies. If the Illustrative
List could only reduce and not expand the prohibition, it would not have been necessary to include the
words ‘including those illustrated in Annex I’ in Article 3.1(a) which would then become redundant, a
result that the Appellate Body has many times made clear is not acceptable.
103
146. The meaning of the word ‘including’ is also required by the object and purpose of the SCM
Agreement.
147. One of objectives of the Uruguay Round negotiations, and one to which the US was
particularly attached, was to introduce more effective disciplines on certain subsidies which are
considered particularly pernicious – export subsidies and import substitution subsidies. This can be
seen from the fact that these subsidies are, unlike all other subsidies, prohibited and that action can be
taken against them without there being any need to prove adverse effects. 104 It is also evident from
the tighter deadlines105 and more expeditious procedures 106 and remedies 107 contained in Article 4 of
the SCM Agreement.
148. The intent of the parties in incorporating Annex I was not to ensure that everything that was
previously not prohibited would now be exempted (which would mean no progress). It was to ensure
that what was previously prohibited would remain prohibited (which means no backtracking). They
added footnote 5 to ensure that only what was referred to (that is identified) in the Illustrative List as
not being an export subsidy, would be exempted. If the Illustrative List exempted measures that are
simply not identified as export subsidies, the general words of Article 3.1(a) would fail in their basic
task of introducing stricter disciplines.

100 First written submission of the US, paragraph 160.
101 New Oxford Shorter English Dictionary (1997 - CD-ROM version)
102 Id.
103 See e.g. Appellate Body Report, United States - Import Prohibition of Certain Shrimp and Shrimp
Products WT/DS58/AB/R, adopted 6 November 1998, paragraph 131 and the other sources quoted there.
104 Cp. Article 5 of the SCM Agreement.
105 Deadlines are generally half those applicable in other disputes.
106 For example, a Panel may be established on the first request – Article 4.4 of the SCM Agreement.
107 Article 4.7 SCM Agreement requires an offending Member “withdraw the subsidy without delay”.

149. Therefore, the EC maintains that either
• Item (e) is relevant as a separate source of prohibition of export subsidies; or
• It requires the term ‘subsidies … contingent upon export performance’ in
Article 3.1(a) to be read as including, at least as regards direct taxation measures,
subsides that are specifically related to exports.
150. In either case the arguments presented by the EC in this connection in its first written
submission, remain valid and item (e) of the Illustrative List confirms that the FSC Replacement
scheme gives rise to prohibited export subsidies.
4.5. The FSC Replacement scheme provides subsidies which are contingent upon the
use of domestic over imported goods contrary to Article 3.1(b) of the SCM
Agreement
4.5.1. Footnote 5 of the SCM Agreement
151. The US first refers to footnote 5 of the SCM Agreement.
108 According to this footnote,
Measures referred to in Annex I as not constituting export subsidies shall not be
prohibited under this or any provision of this Agreement.
This reference is not entirely clear. The US does not specify which item of Annex I to the SCM
Agreement would provide that the FSC replacement subsidies are not “prohibited”.
152. To the extent that it hints to item (e) of Annex I, and in particular to the “double taxation”
reference in footnote 59, which is the EC’s assumption, it is addressed in Section 4.6 below.
4.5.2. The meaning of “contingent” and of the “local content” requirement
153. Next, the US also points out that the word “contingent” has the same meaning both in
Article 3.1(a) and in Article 3.1(b) of the SCM Agreement , and specifically that it means “
conditional” or “dependent for its existence on something else”.109
154. From this the US draws the consequence that the basic FSC Replacement subsidy is not
“contingent” within the meaning of Article 3.1(b) because, in the US view, they do not affirmatively
require the use of any US manufactured articles or preclude using more than a fixed amount of
imported articles.
155. It will already be clear to the Panel that the EC agrees that “contingent” means the same both
in Article 3.1(a) and 3.1(b), and notably means “dependent for its existence”.
110 In the Annex to its
first written submission, the EC has precisely shown cases in which the “foreign content limitation ”
in the FSC Replacement Act will render the use of US articles necessary. It has done so with respect
to certain production sectors in its first written su bmission. It further exemplifies those data with
company related information in this submission.

108 First written submission of the US, paragraph 196.
109 First written submission of the US, paragraph 198.
110 First written submission of the EC, paragraphs 166, 83.

156. The EC notes that in an attempt to rebut the EC’s claim, the US makes a very generic
allegation that under the foreign content limitation “a good can meet this requirement even if 100 per
cent of its content is foreign”.111
157. It is rather ironic that later in its submission the US contends that in order to establish its case
under Article 3.1(b) the EC has the burden of proving how the foreign content limitation works at
individual company level, while crafting for itself this very light standard of proof. At any rate, the
EC claim does not relate to a hypothetical and unspecified “good”. The EC has not argued that for
each and every product that can possibly be produced by the beneficiaries of the FSC replacement
scheme the foreign content limitation will require use of US over imported goods. Article 3.1(b)
however prohibits local-content contingency with respect to each and every product that can be
produced by a beneficiary of a subsidy scheme. Therefore, a WTO Member adopting a measure of
general application cannot excuse the WTO-inconsistencies of such measure in respect of some
products by referring to the possible WTO-conformity of the same measure in respect of other
products.
158. The US further tries to disguise the real scope of the foreign content limitation by suggesting
that its rules of origin anyway turn non-US input s into US origin components, thus diluting the real
impact of the foreign content limitation.
159. A number of WTO Members have rules of origin turning foreign inputs into a domestic
product upon a certain “transformation” or “processing”, but this has never affected the application of
WTO rules and notably those prohibiting local content requirements. The US rules of origin may
increase the scope for some companies to arrange thei r affairs so as to comply with the requirement
but do not remove the requirement.
160. The distinction between components entirely made of US inputs and components made up of
a mix of US and foreign inputs nowhere is drawn in the FSC Replacement Act. More importantly, it
is completely irrelevant under applicable WTO rules, and rightly so. If Article 3.1(b), in prohibiting
subsidies contingent upon “use of domestic over imported goods” made a distinction between “pure”
and “mixed” components, a WTO Member could simply dilute the local content contingency to the
necessary extent and then escape Article 3.1(b) prohibition.
112 Instead, Article 3.1(b) prohibits local-
content contingency to any degree, even a slight bias in favour of domestic goods. There is no de
minimis rule for prohibited subsidies in the SCM Agreement.
161. The foregoing considerations are confirmed by practice under Article III:4 of GATT 1994. If
the origin of the inputs of the domestic goods favoured by “local content” requirements were to be
relevant, probably hardly any case could have been successfully brought under Article III:4 of GATT.
Any country has rules of origin turning foreign inputs into a domestic product upon a certain
“transformation” or “processing” but assessing the underlying input composition of a domestic good
is not a type of enquiry which is required under WTO rules at issue in this dispute.
162. If moreover, it was true that the foreign content limitation is so limited in its impact, the US
has failed to explain why it has been so attached to it over the last fifteen years and continues to be so,
to the point of reproducing in identical terms the relevant wording of the FSC Act in the FSC
Replacement Act.
113

111 First written submission of the US, paragraph 200.
112 Suppose, for example that, in order to meet a foreign content limitation, a domestic good is used
which is in turn made up of foreign inputs for 85 per cent. According to the country’s rules of origin, these
foreign inputs are turned into a good of domestic origin by adding 10 per cent domestic inputs and 5 per cent
domestic value added. If this new good was not caught by Article 3.1(b), there would be a 10 per cent de
minimis rules.
113 See the comparison in the first written submission of the EC, Section 3.5.

4.5.3. Proof of the “contingency” in Article 3.1(b)
163. The US contends that the EC has failed to bring any evidence supporting its claims against
the foreign content limitation.114
164. The US response to the EC’s claims under Article 3.1(b) of the SCM Agreement and Article
III:4 of GATT 1994 mainly relates to the burden and the standard of proof, and is an adaptation of
that provided in connection with Article 3.1(a). The same considerations already developed by the
EC on these issues in Section 4.1 above are the first reason why the US arguments do not refute the
EC’s demonstration.
165. The only way to back up this proposition is to put forward, as the US does in paragraphs 204
and 207 of its first written submission, a standard of proof for the present case that nowhere has been
set out or applied to per se claims against legislative measures under Article 3.1(b). In essence, the
US argues that the EC would have to prove how the foreign content limitation would actually operate
at the level of individual beneficiaries of the FSC replacement scheme. As demonstrated below, this
contention rests on a misrepresentation of the Canada - Automobiles Appellate Body Report and
should be rejected.
4.5.3.1. The Canada – Automobiles case
166. The US seeks support for its contention in the Appellate Body’s interpretations of
Article 3.1(b) of the SCM Agreement in the Canada – Automobiles case.115
167. The EC is aware of such interpretations, but do es not consider that they affect its case and
draws the attention of the Panel to the following.
168. The measures before the Appellate Body in the Canada - Automobiles case were
fundamentally different in nature and content from that at issue in these proceedings. The measures
challenged in that case were a series of specific measures, each one contingent upon a different local
content requirement, each one addressed to one particular beneficiary. While the possibility of
becoming eligible for the duty free benefit (sub ject to the local content requirement set for each
beneficiary) had existed for any company for some time, as of 31 July 1989 this possibility
disappeared and the list of beneficiaries was frozen into a small closed class.116
169. The claim under Article 3.1(b) of the SCM Agreement concerned a “value added requirement”
(“Canadian value added”, or “CVA” requirement), imposed on car manufacturers as a condition for
obtaining a benefit (in the form of a right to import cars duty-free, which amounted to revenue
forgone by the Canadian tax authorities).117
170. The benefit was conferred upon a closed list of beneficiaries based on different individual
measures laying down a different levels of CVA. The measures were of two types:
(i) The “Auto Pact” of 1965, later replaced by the Motor Vehicles Tariff Order (MVTO)
of 1998
The MVTO was an administrative measure (Ord er-in-Council) addressed to a closed class of
beneficiaries (certain companies, four overall, which were manufacturing cars in Canada in a previous

114 First written submission of the US, paragraphs 207, 210, 216-217.
115 First written submission of the US, paragraphs 204 ff.
116 Panel Report, Canada – Certain Measures Affecting the Automotive Industry (“ Canada –
Automobiles”), WT/DS139/R, WT/DS142/R, adopted 11 February 2000, paragraph 2.10.
117 Id., paragraph 10.202.

“base-year”, that is 1963-64).118 For each of the beneficiaries, a different CVA was set in the “letters
of undertaking” that each of them had submitted to the Canadian authorities, as well as in the Order-
in-Council.
(ii) Special Remission Orders (SROs)
The SROs were also individual measures of administrative nature (Orders-in-Council). Some
car-making companies, which could not qualify under the Auto Pact of 1965 because not producing in
the “base year”, had later been granted the same benefit through these measures. These additional
beneficiaries also constituted a closed class
119 as a result of the 1989 “freezing”. The SROs which
were reviewed in the Canada – Automobiles case were thus individual measures, each one setting its
own CVA requirement.120
171. Thus, the measures that the Appellate Body had before it in Canada – Automobiles were
individual measures, each one applying a specific local content requirement to individual companies.
The requirement of bringing evidence as to how the individual and different local content
requirements were operating was set out by the Appellate Body in this context.
172. By requiring information at the level of indi vidual company, the Appellate Body was seeking
to assess how each different CVA requirement, and thus each of the challenged company-specific
measures, would operate.
173. On the contrary, the measure at issue in this dispute is a legislative measure applying to an
undetermined and unlimited series of instances and beneficiaries and setting out a single local content
requirement. It does not therefore correspond to the hypothesis reviewed by the Appellate Body in
the Canada – Automobiles case.
174. Moreover, the EC is contesting the consistency of the FSC Replacement Act with
Article 3.1(b) as such – it is not making any claim in respect of its application in a particular sector or
to a particular product.
175. Accordingly, the EC merely has to establish, based on the wording of the FSC Replacement
Act, that the Act in the abstract, or in some cases, will give rise to the use of US over imported goods.
176. It may be that in certain sectors the foreign content limitation will not require the use of US
products. This circumstance does not however make the foreign content limitation consistent with
Article 3.1(b) for all the cases where that requirement necessitates use of domestic goods over
imported goods in order to obtain the tax benefi t. Therefore the US cannot maintain a general,
horizontal measure with such a foreign content limitation. Article 3.1(b) must be respected in each
and every case, and the fact that the FSC Replacement Act may not in all cases give rise to use of
domestic over imported goods cannot compensate for the cases where it will give rise to such use.
177. At any rate, the EC provided information in the Annex to its first written submission in order
to illustrate its legal points. The EC notes that the US, while arguing that the EC should provide
information at company level, has not even tried to challenge the information supplied by the EC
relative to certain sectors.
178. Furthermore, although the EC does not believe that it is required to provide company specific
information, for the case the Panel considered it necessary that the EC respond to the US contention, it
has developed the Annex to its first written submission by providing additional explanation for the

118 Id., paragraphs 2.4, 2.21-22.
119 Id., paragraph 2. 31.
120 Id., paragraph 2.32.

figures indicated therein. This additional explanation is in the form of examples of companies
operating in the sectors considered in the Annex, for which the foreign content limitation gives rise to
an obligation to use US over foreign goods. For ease of understanding, this information is added to
the text of the Annex itself, which is hereby resubmitted. Should the Panel wish to review these data,
the EC will ensure that the confidential documents establishing the accuracy of the figures used in the
Annex are available at the meeting with the Panel.
179. For the foregoing reasons, the US has not re futed the EC’s claim that the foreign content
limitation makes the grant of the FSC Replacement subsidy contingent upon the use of domestic over
imported products, contrary to Article 3.1(b) of the SCM Agreement. Accordingly, the EC requests
the Panel to uphold its claim and find that the FSC Replacement Act is contrary to Article 3.1(b) and
that the US has not withdrawn its subsidy, thus contravening the DSB recommendations and rulings.
4.6. The Double Taxation Defence
4.6.1. Introduction – The status of footnote 59
180. The US develops in some detail the position that both the first and last sentences of footnote
59 refer to measures that are not export subsidies within the meaning of footnote 5 to the SCM
Agreement. The EC notes that the US is invoking the last sentence of footnote 59 as a defence.
181. The EC sees no reason to contest that the last sentence of footnote 59 may be an exception to
Article 3.1(a). However, for the reasons that it will explain below, the FSC Replacement scheme is
not a measure to avoid the double taxation of foreign source income.
182. The first sentence of footnote 59 on the other hand is more in the nature of a reminder that
there is only a subsidy if revenue is forgone, rather than a statement concerning export subsidies, and
in any event uses the words ‘need not’. However, since the first sentence of footnote 59 does not
appear relevant to the issues before the Panel, the EC will not comment further.
183. The EC notes that the terms “double taxation” and “foreign-source income” are terms of art
with special meanings. It therefore considers that an analysis of the particular meanings these terms
have acquired in the field of taxation is a more useful starting point than the dictionary definitions of
the individual words of which they are composed.
184. The EC will proceed to respond the double taxation defence by making the following points:
• Commenting on the meaning of ‘measures to avoid double taxation’;
• Explaining that the income excluded by the FSC Replacement scheme is not ‘foreign
source’;
• Explaining why the FSC Replacement Act is not necessary for the avoidance of
double taxation and may create double taxation or the ‘over-compensation’ of double
taxation;
• Arguing that even if it were a measure to avoid the double taxation of foreign-source
income, the FSC Replacement Act would in any event be contrary to Article 3.1(a)
because it gives exporters a choice that is not available to other operators.
185. Finally, the EC will comment on the view expressed by Canada that the income exempted
under the extended FSC Replacement subsidy may be foreign-source income.

4.6.2. The meaning of ‘measures to avoid double taxation’
186. The relief of double taxation forms one of the cornerstones of international tax policy.
Eliminating the burden which unrelieved double taxation places on international trade and investment
is one of the principal tasks of international tax rule s. In this context, the international tax disciplines
have been created in different levels, but the mo st widely recognised international standards for
relieving double taxation are those recorded in the OECD Model Tax Convention on Income and
Capital (hereinafter “the OECD Convention”).121 The US uses in its own treaty practice as a variation
of the OECD Convention. 122 The OECD Convention forms the basis of the vast majority of double
taxation treaties concluded between countries exercising their taxing rights and the two basic methods
developed in the Convention to deal with the issue of double taxation, the credit method and the
exemption method, are also commonly used as means of providing unilateral relief under the national
legislation of practically all industrialised countries.
187. The US refers to the OECD Convention for guidance on the meaning of ‘measures to avoid
the double taxation of income’. The EC would first of all point at a fundamental principle reflected in
the double taxation provisions of the OECD Convention.
188. The first paragraphs of Article 23A and Article 23 B of the OECD Convention state:
Article 23A
EXEMPTION METHOD
1. Where a resident of a Contracting State derives income or owns capital
which, in accordance with the provisions of this Convention, may be taxed in the
other Contracting State, the first-mentioned State shall, subject to the provisions of
paragraphs 2 and 3, exempt such income or capital from tax.
and
Article 23B
CREDIT METHOD
1. Where a resident of a Contracting State derives income or owns capital
which, in accordance with the provisions of this Convention, may be taxed in the
other Contracting State, the first-mentioned State shall allow:
a) as a deduction from the tax on the income of that resident, an amount
equal to the income tax paid in that other State;
b) as a deduction from the tax on the capital of that resident, an amount
equal to the capital tax paid in that other State.
Such deduction in either case shall not, however, exceed that part of the income tax or capital tax, as
computed before the deduction is given, which is attributable, as the case may be, to the income or the
capital which may be taxed in that other State.
189. A common feature of both of these paragraphs is the presence of the words:

121 The US provides extracts from the OECD Convention in its Exhibit US-7. The EC provides the full
text in Exhibit EC-12.
122 The US Model Tax Convention is Exhibit EC-13.

which, in accordance with the provisions of this Convention, may be taxed in the
other Contracting State
190. Measures for the avoidance of double taxation relate to measures that may legitimately (hence
“in accordance with the provisions of this Convention”) be taxed in another State. 123 If a country
provides a reduction of the tax burden for income that may not legitimately be taxed by another
country, that is single taxation relief, not double taxation relief. Such a relief is clearly not required
by any policy based on the relief from double taxation since double taxation by definition does not
exist.
191. This point demonstrates a fundamental flaw in the US defence. That the FSC Replacement
scheme income excludes from tax income that cannot be taxed by any other country. It is indeed an
internationally embraced principle, that no country can tax the business profits of an enterprise
resident in another country unless the enterprise resident in the other country carries on its business in
the first mentioned country through a permanent establishment situated therein.
192. Indeed, Article 7 of the OECD Convention 124 reflects this principle when it states:
Article 7
BUSINESS PROFITS
1. The profits of an enterprise of a Contracting State shall be taxable only in that
State unless the enterprise carries on business in the other Contracting State through a
permanent establishment situated therein. If the enterprise carries on business as
aforesaid, the profits of the enterprise may be taxed in the other State but only so
much of them as is attributable to that permanent establishment.
193. The taxing right over the business profits of an enterprise resident in any other country is
thereby made dependent on the existence of a permanent establishment 125, which in the OECD
Convention is defined in its Article 5;126

123 The EC notes that in paragraph 182 of its first written submission, the US omits referring to the
critical principle when it quotes selectively from the OECD Convention stating:
… the Commentary provides that, “[u]nder the principle of exemption, the state of residence R does
not tax the income which . . . may be taxed in [another country].”
124 Full text in Exhibit EC-12.
125 In the Commentary to Article 7 of the OECD Convention it is further explained that “This Article is
in many respects a continuation of, and corollary to, Article 5 on the definition of the concept of permanent
establishment. The permanent establishment criterion is commonly used in international double taxation
conventions to determine whether a particular type of income shall or shall not be taxed in the country from
which it originates but the criterion does not of itself provide a complete solution to the problem of double
taxation of business profits; in order to prevent such double taxation it is necessary to supplement the definition
of permanent establishment by adding to it an agreed set of rules of reference to which the profits made by the
permanent establishment, or by an enterprise trading with a foreign member of the same group of enterprises,
are to be calculated. To put the matter in a slightly di fferent way, when an enterprise of a Contracting State
carries on business in the other Contracting State the authorities of that second State have to ask themselves two
questions before they levy tax on the profits of the enterprise: the first question is whether the enterprise has a
permanent establishment in their country; if the answer is in the affirmative the second question is what, if any,
are the profits on which that permanent establishment should pay tax. It is with the rules to be used in
determining the answer to this second question that Arti cle 7 is concerned. Rules for ascertaining the profits of
an enterprise of a Contracting State which is trading with an enterprise of the othe r Contracting State when both
enterprises are members of the same group of enterprise s or are under the same eff ective control are dealt with
in Article 9.” (paragraph 1).

Article 5
PERMANENT ESTABLISHMENT
1. For the purposes of this Convention, the term "permanent establishment"
means a fixed place of business through which the business of an enterprise is wholly
or partly carried on.
2. The term "permanent establishment" includes especially:
a) a place of management;
b) a branch;
c) an office;
d) a factory;
e) a workshop, and
a mine, an oil or gas well, a quarry, or any other place of extraction of natural
resources.
194. Under the FSC Replacement scheme the excluded income is derived from:
127
- the sale, exchange, or other disposition of qualifying foreign trade property;
- the lease or rental of qualifying foreign trade property for use by the lessee outside
the United States;
- the provision of services which are related and subsidiary to any sale, exchange, or
other disposition of qualifying foreign trade property;
- the provision of services which are related and subsidiary to any lease or rental of
qualifying foreign trade property;
- the provision of engineering or architectural services for construction projects located
(or proposed for location) outside the United States; or
- the performance of managerial services for a person other than a related person in
furtherance of the production of foreign trading gross receipts.
195. All these transactions can well be performed physically from within the territorial limits of
the US and in so far as such activities are not carried out through a permanent establishment situated
in another country, that other country will not have a legitimate right to tax the income that is
excluded under the rules of the FSC Replacement scheme. The FSC Replacement scheme is therefore
single taxation relief, not double taxation relief.

126 In the Commentary to Article 5 of the OECD Convention it is further explained that “the main use
of the concept of a permanent establishment is to determine the right of a Contracting State to tax the profits of
an enterprise of the other Contracting State. Under Ar ticle 7 a Contracting State cannot tax the profits of an
enterprise of the other Contracting State unless it carries on its business through a permanent establishment
situated therein.” (paragraph 1).
127 As enumerated in paragraph 118 of the first written submission by the US.

196. It is in principle possible, subject to a number of preconditions, for an US enterprise to benefit
from the exclusion provided for in the FSC Replacement scheme by carrying out manufacturing
outside the US through a branch situated in a foreig n country, but as explained before such situations
are in practice rare.128
197. Similarly, it is in principle possible that the above enumerated activities are carried out
through a permanent establishment situated in a country other than the US, but here again it should be
recalled that doing so would only entail an additional administrative burden and could indeed result in
adverse tax consequences for the US taxpayer in question, which is why it is much more likely that
such operations are carried out from within the territorial limits of the US.
198. In addition, it is important to note that the FSC Replacement scheme in no way requires as a
precondition of the exclusion such foreign economic processes that would under the internationally
accepted standards, constitute a permanent establishm ent for an US enterprise wishing to earn such
excluded income.
4.6.3. The income excluded by the FSC Replacement scheme is not ‘foreign source’
199. The last sentence of footnote 59 is expressly limited to the avoidance of double taxation of
foreign-source income.
200. As a taxation term, the EC submits that the m eaning to be attributed to the term ‘foreign-
source income’ is that which it has in the field of taxation.
201. In tax treaties the source of income is usually referred to in an indirect manner. The term is
not expressly defined in the OECD Convention, but its meaning can be deduced from the provisions
of that Convention.
202. For example, Article 10 (Dividends) of the OECD Convention applies to ‘dividends paid by a
company which is a resident of a Contracting State’. The implication is that the company's residence
determines the source of the dividend. Paragraph 5 of the same Article of the OECD Convention
forbids imposition of tax on dividend in a Contracting State on the sole ground that the company's
profits are derived from that state.
203. When it comes to business profits the source of income is commonly understood to mean the
place in which the activities giving rise to these profits have taken place. Article 7 (Business Profits)
quoted above makes this clear when read in conjunction with Article 5 also quoted above.
204. Thus, and as explained in more detail before, the taxing rights over business profits depend on
the fact of whether and to what extent the activities have been carried out (are attributable to the
activities) within the geographical limits of which Contracting States.
205. The US attempts to derive a definition of foreign-source income from its reading of the
dictionary as follows:
foreign-source income would appear to in clude money (or other assets) originating
outside the borders or territory of the WTO Member instituting a measure to avoid
double taxation.
129

128 See Section 4.3.3.2 above.
129 First written submission of the US, paragraph 167

206. By substituting the words ‘money’ and ‘assets’ for ‘income’, the US introduces a confusion
that, when revealed, well illustrates the unfoundedness of its defence. The tax that is concerned by
the FSC Replacement Act is tax on income in the sense of profit. While it is true that the money to
pay for exports comes from (has its source) outside the US, the same is not true of the profit. The
profit on an export sale derives from the economic activity , which is conducted in the exporting
country. Thus when the word ‘income’ in the term ‘foreign-source income’ is correctly understood as
referring to profit, rather than price, it is clear that although the FSC Replacement Act undoubtedly
only applies to foreign sales, the income it is excluding from tax is not foreign-source income.
207. There are many other instances of confusion between profit and price in the US first written
submission leading ultimately to the manifestly wrong statement in paragraph 192 that:
“extraterritorial income” under the Act is income derived from non-domestic sources.
As such, it comes within the ordinary meaning of “foreign-source.”
208. The EC would also point out that 'extraterr itorial income' and 'qualifying foreign trade
income' are also not foreign source income as this term is used in US legislation. This is made
perfectly clear by section 943(c) of the IRC concerning source rules. This provision sets a limit to the
amount of income from the sales of qualifying foreign trade property that may be considered as “from
sources without the United States”, that is, foreign source.
4.6.4. FSC Replacement scheme was not intended to and is not necessary for the avoidance
of double taxation in the US and may create double taxation and in some cases over-
compensates for ‘double taxation’
209. The EC has noted in its factual comments above
130 that the US Congress did not understand
the FSC Replacement Act as a measure to avoid the double taxation of foreign-source income but
only referred to this notion in connection with the exclusion of foreign tax credits.
210. In this section the EC would simply refer to a number of more objective reasons that further
confirms that the FSC Replacement Act is not a measure to avoid the double taxation of foreign-
source income.
211. First, the US has no need of the FSC Replacement Act to avoid double taxation. Its system of
foreign tax credits is a comprehensive means of avoiding double taxation. Indeed, the FSC
Replacement Act, by providing a partial exemption from tax for ‘extraterritorial income’ and then
only under certain conditions cannot solve problems of double taxation. The amount of "excluded
income" under the FSC Replacement scheme being limited companies may still need to claim foreign
tax credits to relieve double taxation in some cases.
212. The foreign tax credit provisions of the US Internal Revenue Code have not been repealed by
the FSC Replacement Act and still provide the basic approach used by the US to relieve double
taxation with respect to income subject to tax in othe r countries. If, as the United States allege, the
exclusion of “extraterritorial” income is a measure to avoid double taxation, then it cannot, at the
same time, be argued that the exclusion constitutes “a defined normative benchmark for taxing
income earned on foreign transactions”, since there cannot be two benchmarks. Canada submits that
the US taxation of foreign income subject to a foreign tax credit remains the true benchmark despite
the enactment of the FSC Replacement Act, and that the latter cannot be regarded as a “new”
benchmark for the taxation of foreign income in the US.

130 Section 3.6 above.

213. Indeed the FSC Replacement Act, fits uneasily with the US arrangements for avoiding double
taxation. Apart from failing to relieve double taxation completely, in some circumstances, it can lead
to over-compensation of ‘double taxation' in other circumstances. This arises as follows:
214. The provision of the FSC Replacement Act that is presented as preventing the cumulation of
the foreign tax credits and excluded income under the FSC Replacement Act two is the new
section 114(d) of the IRC which generally disallows credit for foreign tax paid with respect to
extraterritorial income that is excluded from gross income. However the new section 943(d) of the
IRC states that, for purposes of section 114(d), any "withholding tax" shall not be treated as paid or
accrued with respect to excluded income.
215. As a result, a US taxpayer will be able to claim credit against its US taxes for a foreign tax
imposed on its excluded income provided that the tax is a "withholding tax."
216. The new section 943(d) of the IRC defines a "withholding tax" as "any tax which is imposed
on a basis other than residence and for which credit is allowable under section 901 or 903."
217. If a US corporation is engaged in selling goods in a foreign country, one would generally
expect the foreign country to subject those sales to its net income tax, not to a gross-basis withholding
tax, and do so only in the case where that US corporation carried out its business through a permanent
establishment situated in that foreign country. At the same time, the US corporation, while engaged
in business in the foreign country, will not typically be considered a "resident" of that country and in
fact normally for the purposes of double taxation treaties would not be accorded such resident status.
In such a case, the foreign tax would appear to come within the definition of "withholding tax" now in
new section 943(d). Thus, the US corporation would be entitled to credit for such withholding tax
even though a portion of its sales income is excluded from gross income under new section 114(a).
218. ‘Double’ relief from ‘double taxation’ cannot in any circumstances be considered a means of
avoiding double taxation and further demonstrates that the purpose of the FSC Replacement Act is the
granting of tax benefits to US exporters.
219. Second, the FSC Replacement Act, rather than avoiding double taxation actually creates it
since it requires foreign corporations that are subject to the tax jurisdiction of other countries but wish
to benefit from the FSC Replacement Act to make a ‘domestication election’ to become subject to US
tax jurisdiction as if they were US corporations and to waive all rights under treaties and in particular
under bilateral tax treaties.
220. Another indication of the fact that ‘avoiding of double taxation’ of foreign-source income
cannot be the real objective of the FSC Replacement Act is that it applies formulaic rules to calculate
the excluded part of the income. In doing so the amounts excluded do not correspond to the arm’s
length apportionment of the profits that would be considered to relate to the part of profit which
another country would seek to tax in case that th ere was such possibility for the other country to do
so. The foreign economic processes preconditions for the applicability of the exclusion are variable
and require different levels of inputs to be made outside the US, but the rules for calculating the
amount of excluded income remain the same irrespective of the nature of the foreign economic
processes. Anyway, none of the required foreign economic processes would imply that the country of
destination of the exported goods would have the right to tax the income derived from the export
transactions. They would not establish effective connection with trade and business and thereby a
permanent establishment in that country.

4.6.5. Even if it were a measure to avoid the double taxation of foreign-source income, the
FSC Replacement Act would in any event be contrary to Article 3.1(a) because it
gives exporters a choice that is not available to other operators
221. Even if it were a measure to avoid the double taxation of foreign-source income, the FSC
Replacement Act would in any event be contrary to Article 3.1(a) of the SCM Agreement because it
gives exporters a choice that is not available to other operators. Allowing exporters the choice
between two alternative methods of double taxation relief gives such companies an export-contingent
advantage which is not available to other companies. This additional advantage would also be a
subsidy, but would not be an “exemption, remission or deferral of tax,” which is the only kind of
measure that item (e) covers.131
222. An additional complaint that can be made against the FSC Replacement Act is that it can give
rise to ‘double’ double taxation relief as explained in the previous section. This unwarranted
overcompensation is also a subsidy that is contingent upon export performance and specifically
related to exports.
4.6.6. Comment on the view expressed by Canada that the income exempted under the
extended FSC Replacement subsidy may be foreign-source income
223. As mentioned above, the EC has one final comment to make on the double taxation defence.
Canada expressed the view in its third party submission that
the “foreign income” component of “extraterritorial income” is the type of income
typically subject to a measure designed to avoid double taxation.
132
224. It immediately went on to say that
However, in Canada’s view, the United States has added this new category of income
to the measure in question in an attempt to confuse the domestic tax situation that
would otherwise apply to the “domestic export income” component of
“extraterritorial income”.
225. Canada is clearly of the view that the income covered by the extension of the scheme to the
foreign sales of foreign goods is of a different nature than that earned by the sale of US goods. The
EC agrees and that is in fact why is consider s that there are two subsidies arising under the FSC
Replacement Act.
226. But the EC does not agree with Canada’s appa rent view that the income covered by the
extended FSC Replacement subsidy will be foreig n source and potentially benefit from the last
sentence of footnote 59.
227. The reason for this is that, as the US points out in a different context, US companies can earn
‘extraterritorial income’ by selling goods made abroad by a foreign producer (provided they satisfy
the conditions of the FSC Replacement Act, notably by making a domestication election and
respecting the foreign content limitation). The income earned by a US company by distributing
foreign goods may in large part be earned within the US. Indeed as observed above
133, the
Section 943(e)(4)(C) of the IRC limits the extent to which this income may be foreign-source income
for US tax purposes.

131 As the US rightly observes, footnote 59 is attached to item (e), not to any other provision of the
SCM Agreement and would not therefore be able to save the FSC subsidies. See e.g. paragraphs 103 and 110 of
the US Appellant’s Submission.
132 Third party submission of Canada, paragraph 33.
133 At the end of Section 4.6.3.

228. Accordingly, not even the extended FSC Repl acement subsidy can in any event be considered
to come within the last sentence of footnote 59 to the SCM Agreement.
4.7. The FSC Replacement scheme provides treatment less favourable to products
imported into the US than that accorded to like US products, contrary to Article
III:4 of GATT 1994
229. The US response to the EC claim under Article III:4 of GATT 1994 is limited to two points.
The first is again the argument that the FSC Replacement Act does not contain an affirmative
requirement to use US goods. The second relates to the burden and standard of proof.
4.7.1. The “affirmative requirement” argument
230. As the Panel will know by now, the US has repeated throughout its submission that the FSC
Replacement Act does not require use of US-origin goods but provides that no more than 50 per cent
of the value of goods may be attributable to foreign content (articles and direct labour).
231. As explained in its first written submission 134, the EC submits that in all cases, the
requirement will act as an incentive to source inputs domestically because this will enhance the
chances of a US producer intending to export its goods to qualify for the tax benefit. This is sufficient
to violate Article III:4 of GATT 1994, which guarantees equality of competitive opportunities and
foreign markets undistorted by discriminatory internal regulations. In addition, in some cases (like
the ones in the Annex to the first written submissi on of the EC), depending on the cost structure of a
given product type, the foreign content limitation will necessitate use of domestic goods.
135 I t will
thus be even more than an incentive for the use of US goods, which is the standard under Article III:4.
232. In the Canada – Automobiles case the panel was confronted with a similar argument. Canada
argued that the Canadian value added ("CVA") requirements did not provide less favourable treatment
within the meaning of Article III:4 since “these re quirements [did] not affect the "internal sale,… or
use" of imported products because they [did] not in law or in fact require the use of domestic products
and therefore play[ed] no role in the parts sourcing decisions of manufacturers.” 136 However, the
panel noted the broad interpretation given by the Appellate Body to the term “affecting” 137 and
concluded that
a measure which provides that an advantage can be obtained by using domestic
products but not by using imported products has an impact on the conditions of
competition between domestic and imported products and thus affects the "internal
sale,… or use" of imported products, even if the measure allows for other means to
obtain the advantage, such as the use of domestic services rather than products.
Consequently, the CVA requirements, which confer an advantage upon the use of
domestic products and deny that advantage in case of the use of imported products,
must be regarded as measures which "affect" the "internal sale,… or use" of imported
products, notwithstanding the fact that the CVA requirements do not in law require
the use of domestic products. 138
The panel report was not appealed on this point.

134 First written submission of the EC, Section 3.7.
135 First written submission of the EC, Section 3.5; rebuttal submission of the EC, supra, Section 4.6.
136 Panel Report, Canada - Automobiles, paragraph 10.79.
137 Id., paragraph 10.80.
138 Id., paragraph 10.82 (emphasis added).

4.7.2. The EC has made a prima facie case which stands unchallenged
233. More fundamentally, the US response fails to undermine the EC case because it is premised
on an incorrect view of the standard of proof in cases brought under Article III:4 of GATT 1994.
234. The US seems to assume 139 that in order to establish its case the EC should supply evidence
that a particular class of imported goods will be accorded less favourable treatment than a class of
domestic “like products”.
235. All the US seems to do for the rest is to point to a “heightened burden” that it alleges to exist
for cases where a measure of general application is challenged.140
236. The foregoing is unsupported by WTO rules, and does not correspond to panel or Appellate
Body pronouncements in cases reviewing Article III:4 claims, including against legislation per se as
in the present proceedings.
237. All the EC has to prove is, based on the terms of the law, that the FSC Replacement Act
provides that an advantage can be obtained by using domestic products but not by using imported
products, even if the measure allows for other means to obtain the advantage.
141
238. On the contrary, the EC does not have to show the “effects” of the FSC Act. The very fact
that it is easier to meet the foreign content limitation and therefore obtain the benefit if domestic
products are used than if imported products are used is sufficient to find that this requirement affects
internal sale.
142
239. Whether or not Article III:4 cases were mostly brought against product specific or horizontal
measures is irrelevant. What is relevant is that where a horizontal measure was challenged, the
standard applied did not differ from that applied for product specific measures.
240. The EEC - Parts and Components case, already referred to by the EC, is in point.
143 T h e
dispute concerned a horizontal measure of genera l application, Article 13.10 of the EEC’s basic anti-
dumping regulation in force at that time.
241. The panel reviewed the words of that provision as such. 144 It noted that they made the grant
of an advantage (the suspension of certain anti-dumping proceedings against finished products)
conditional on limiting the use of foreign (Japanese) components, without imposing similar
limitations on the use of like EEC products, thereby according “treatment to imported products less
favourable than that accorded to like products of [ EEC] origin”. After this analysis of the terms of
the law as such, it also concluded that the individual measures taken on the basis of Article 13.10 of
the basic anti-dumping regulation violated Article III:4 of GATT 1994. The Panel conducted the
whole analysis without the need to compare a cert ain class of domestic products with the same class
of imported products.
145

139 First written submission of the US, paragraph 216.
140 First written submission of the US, paragraph 218.
141 Panel Report, Canada - Automobiles, paragraph 10.82.
142 Id., paragraph 10.83. Evidence is in any event already before the Panel because it is already
included in the Annex to the first written submission of the EC. The EC notes that the US has not made any
attempt to refute this evidence, nor has it brought evidence to the contrary.
143 Panel Report, EEC – Regulation on Imports of Parts and Components , BISD 37S/132, adopted 16
May 1990 (“EEC – Parts and Components”).
144 Id., paras. 5.20-5.21.
145 In this connection the EC would also like to comment on the sentence taken from its first written
submission which the US cites completely out of its context (first written submission of the US, paragraph 217).
That sentence has of course to be read in its context. The EC was arguing that absence of a violation in respect

242. For the above reasons, the US has not refuted the EC’s claim that the foreign content
limitation provides less favourable treatment to imported parts and materials than to domestic goods
with respect to their internal use in the production of goods, contrary to Article III:4 of GATT 1994.
Accordingly, the EC requests the Panel to uphold its claim and find that the FSC Replacement Act
violates Article III:4 of GATT 1994.
4.8. The transitional provisions of the FSC Replacement Act allow companies to
continue to benefit from the WTO incompatible FSC scheme beyond
30 September 2000
243. The EC explained in its first written subm ission that the FSC Replacement Act allows US
exporters to continue to benefit from the WTO-incompatible FSC scheme until 31 December 2001
using FSCs existing on 30 September 2000 and, in certain circumstances, allows them do so for an
indefinite period and therefore perpetuates the violations found to result from the FSC scheme beyond
the period provided for in the Panel Report and confirmed by the Appellate Body.
146
244. The US does not deny these basic facts but tries to argue that its failure to respect its
obligations under Article 4.7 of the SCM Agreement and Article 21 of the DSU is ‘reasonable’ for a
series of reasons on which the EC will now comment.
245. The first of these reasons is that it is necessary to “lessen the administrative burden and
impact on taxpayers’ business operations that might result due to the repeal of the FSC” and that this
is customary in the US.147
246. The EC does not contest the policy arguments in favour of transition rules but that is precisely
why it, and it assumes the Panel, agreed in the or iginal proceedings to allow the US to have a
relatively long period of time to abolish the FSC scheme. This was the transitional period. The Panel
specified “that FSC subsidies must be withdrawn at the latest with effect from 1 October 2000.”148
247. The Panel’s findings were first known to the US on 23 July 1999 (in the Interim Panel
Report) and to the whole world on 8 October 1999 (with the publication of the final Panel Report).
The Panel Report was not adopted until 20 March 2000 due to the appeal, but the date of 1 October
with effect from which the Panel specified that the FSC subsidies must be withdrawn (at the latest),
was not the subject of appeal. That date was chosen, as the Panel will recall, because it was argued
that it would be unduly disruptive to change tax rules in the middle of a tax year.
248. The usual period of time for abolishing a prohibited export subsidy is just 90 days.
149 The US
had more than twice this period, following the adoption of the Panel Report by the DSB and an extra
8 months to prepare itself from the date of the Interim Panel Report.
249. The deadline of 1 October 2000 therefore took into account the need for a transitional period
and the US did not object to the length of this period. Even if the US had raised in the original

of certain products cannot “compensate” or excuse cases where domestic products will or can be preferred.
Article III:4 protects potential competition, not solely actua l competition. This however has nothing to do with
what the EC has to prove, since, as demonstrated in th e text, there is no requirement to show the effects of a
measure challenged under Article III:4.
146 First written submission of the EC, paragraphs 234 to 241.
147 First written submission of the US, paragraphs 224 to 227.
148 Panel Report, paragraph 8.8.
149 Panel Report, Australia – Automotive Leather , WT/DS126/R, adopted 16 June 1999, para. 10.7;
Panel Report, Canada – Aircraft , WT/DS70/R, adopted 20 August 1999, para. 10.4; Panel Report, Brazil –
Aircraft, WT/DS46/R, adopted 20 August 1999, paragraph 8.5.

proceeding in a more explicit way the arguments that it is now making about the need to avoid
disrupting ‘business operations’ this would not have justified any longer period.
250. First, it is well known that tax rules are subject to revision at least every year and companies
are well aware that they cannot assume that tax breaks will be available indefinitely. They therefore
arrange their affairs so as to minimise the disruption that changes may cause. In the present case they
had almost a full tax year in which to adjust.
251. Second, disruption to private contracts has alr eady been rejected by the Appellate Body as
well as panels as a reason for not applying WTO rules. In the Article 21.5 proceeding concerning
Brazil – Aircraft, the Appellate Body rejected an argument that private contractual obligations could
be relevant to the question of fulfilling an obli gation to withdraw a prohibited export subsidy.
150 In
the Article 21.5 proceedings concerning Australia – Automotive leather the panel ruled more generally
that:
Many situations can be envisioned, and not only in the subsidies area, in which a
Member's actions to implement a ruling of the DSB might result in some interference
with private rights, and result in domestic legal claims. This possibility does not, in
our view, limit our interpretation of the text of the SCM Agreement.
151
252. Finally, on this point, the EC would note that the US is perfectly capable of adopting tax
legislation that interferes with private rights. As the US later states itself
152, the FSC Replacement Act
was adopted on 15 November 2000 and prevented the creation of new FSCs retroactively to the
1 October 2000. There were no howls of protest, because taxpayers knew that the rules were likely to
change and took their precautions.
253. The second reason given by the US why the Panel should excuse its failure to withdraw the
FSC subsidies with effect from 1 October 2000 is that WTO rules should, according to it, be
‘construed flexibly’.
153 It cites the Appellate Body Report in Japan – Alcoholic Beverages , as
authority for this proposition. The US is not of course asking for rules to be ‘construed flexibly’ but
to be enforced leniently. The Appellate Body was considering in that case the flexible notions of ‘like
product’ and ‘directly competitive or substitutable product’ which clearly have scope to be construed
flexibly. In the present case, however, the rules are perfectly clear.
254. The final arguments that the US throws into th e pot are that the EC waited a long time before
challenging the FSC scheme and that the year 2000 was a presidential election year.154 The first point
was already made before the Panel and the Panel k nows the EC’s and its won response to it. The
second point is true, but was also known at the time of the original proceeding. If elections can be
relevant at all, the EC would have thought that the fact that the incumbent president was leaving
office and not seeking re-election would have made overcoming vested business interests and
complying with WTO obligations easier rather than more difficult.
255. Accordingly, the EC maintains that the US has failed to implement the relevant DSB
recommendations and rulings.

150 Article 21.5 Appellate Body Report, Brazil – Aircraft , WT/DS46/AB/RW, adopted 4 August 2000,
para. 46.
151 Article 21.5 Panel Report, Australia – Automotive Leather WT/DS126/RW, adopted
11 February 2000, para. 6.23.
152 First written submission of the US, paragraph 231.
153 First written submission of the US, paragraph 227.
154 First written submission of the US, paragraphs 228 and 229.

4.9. The US failed to implement the ruli ngs and recommendations of the DSB by
1 November 2000
256. The US response to the EC’s claim that the US failed to co mply with the DSB
recommendations and rulings within the period of time specified by the DSB and has therefore also
failed to comply with Article 21 DSU is based on a fundamental error. The US claims in
paragraph 231 of its first written submission that:
The DSB recommended that the United States withdraw the FSC subsidies with
effect from 1 October 2000, which the DSB then extended to 1 November 2000.
257. The first part of the quoted sentence is correct because the DSB adopted the Panel’s ruling
that the FSC subsidies must be withdrawn at the latest with effect from 1 October 2000. The second
part of the sentence is not correct. The powers of the DSB under Articles 16.4 and 17.14 of the DSU
and 4.9 of the SCM Agreement are only to adopt or not adopt (that is reject) panel and Appellate Body
reports. It cannot modify them.
258. What the DSB did on 12 October 2000 was to modify the time period for implementing
measures to be adopted, not the date from which they were to take effect, which was specified in the
Panel Report.
259. Accordingly, the retroactive repeal of the FSC scheme with effect from the 1 October 2000
would (if it had really repealed the FSC scheme , withdrawn the FSC subsidies and not introduced
measures inconsistent with the covered agreements) have implemented the Panel’s ruling in paragraph
8.8 of the Panel Report but not the requirement in Article 21 of the DSU to do so within a reasonable
period of time, which the DSB had specified would end on 1 November 2000.
155
260. The US also argues that
Panels typically refrain from examining measures that cease to be in existence or in
effect before a panel’s terms of reference are set.156
261. The EC would simply point out that it is not as king the Panel to examine a measure that is no
longer in effect. It is asking it to find that there was a failure to act by a certain deadline. A finding on
such an issue is necessary to ensure that in future all WTO deadlines are not de facto extended by the
length of time necessary to have a panel established and its terms of reference set.
5. Conclusion
262. For the above reasons, the EC maintains the conclusions set out in its first written submission.

155 Australia states (in paragraph 10 of its Third Part y Submission) that the EC agreed to the extension
to 1 November 2000. This is not correct. The EC simply supported the consensus in the DSB to grant the
extension.
156 First written submission of the US, paragraphs 232 to 233.

ANNEX
The cost of materials as a percentage of the fair market value of products
Section 943(1)(C) of the IRC, introduced by the FSC Repeal and Extraterritorial Income
Exclusion Act, defines qualifying foreign trade property to be, inter alia,
property—
(C) not more than 50 per cent of the fair market value of which is attributable
to—
(i) articles manufactured, produced, grown, or extracted outside the
United States, and
(ii) direct costs for labour (determined under the principles of section
263A) performed outside the United States.
The cost of materials as a percentage of the final price of any product varies according to a
number of factors, e.g. the market price of the materials, the relative cost of other factors of
production (e.g. labour, overheads, depreciation), the level of integration of the producer concerned,
and the expected level of profit.
Nevertheless, there are some products, produced or assembled in certain ways, for which the
materials are so important an input that it is difficult to believe that their contribution to fair market
value could ever be below 50 per cent.
The EC’s main legal argumentation in respect of this requirement is developed in the text of
its submissions to the Panel. In addition, and for purely illustrative purposes of that general
argumentation, the EC gathered some data relating to the production in certain sectors (and has cross-
checked them with information obtained from certain European industries and in the course of various
trade investigations).
The most obvious examples are fairly basic products, with little or no brand value, having a
low level of processing and attracting a low profit margin. Some examples are as follows.
For some products (heavy steel plate, stainless steel fasteners, aluminium household foil and
PET bottle chip) more precise cost figures for individual firms are given. The firms involved are not
identified and the currency is not specified. If the Panel wishes to see the source information, this
could be made available at the meeting with the Panel.
In the calculations for individual firms, the selling price is based on a profit margin of 10 per
cent. This is a generous figure, since it is in excess of target profit for each of the products concerned,
and well above the actual profit margin for the products. It is also above the 8 per cent figure used in
the US Tariff Act of 1930. The 10 per cent profit margin normally results in a more conservative
percentage of raw materials for the individual firms than is found in the section on the general cost
assumptions for the product.

1. The Steel industry
(a) Hot-rolled coils
Hot-rolled coils are manufacturing in steel mills and are the pre-material for many types of
steel products e.g. wide and narrow strips, cold-rolled products, tubes. The normal cost of production
(including SGA expenses) of hot-rolled coils is around 207 Euro per tonne; on this basis fair market
value is around 220 Euro per tonne.
The cost of materials involved in production is:
Iron 109 Euro per tonne
Steel scrap 15 Euro per tonne
Others 8 Euro per tonne
Total 132 Euro per tonne
The contribution of materials to the fair market value of hot rolled coils is around 60 per cent.
(b) Heavy Steel Plate
The normal cost of production (including S GA expenses) of heavy plate is 290 Euro per
tonne; on this basis the fair market value is around 310 Euro per tonne.
The cost of materials involved in production:
Steel slab 200 Euro per tonne
Steel scrap -10 Euro per tonne
(recovered)
Total 190 Euro per tonne
The contribution of materials to the fair market value of steel plate is around 61 per cent.
A cost breakdown in a specific example of a producer of heavy steel plate is as follows:

Cost of production - Heavy steel plate
1999
A. Blast furnace* 51.017.593
 Raw materials 55.324.999
 Total Iron 106.342.592
B. BOF plant* 57.743.638
 Input coefficient (t) 0,8223
 Liquid steel 164.086.230
C. Continuous casting* 36.078.324
 Input coefficient (t) 1,0386
 Slabs 200.164.554
D. Quarto mill
 Rolling mill* 30.427.365
 Input coefficient (t) 1,0132
 Finishing* 43.509.319
 Input coefficient (t) 1,1302
E. Total cost of manufacturing 274.101.238
F. SG+A** 20.776.874
G. Total cost of production 294.878.112
H. Quantity produced to which 57.204
 these costs are related
I. Unit cost per tonne 5.155
* Including direct labour, energy,
maintenance and repair
** Including selling expenses, general
+ administration, financing cost,
depreciation, etc
Thus, the cost of raw materials to the firm concerned is 200 million. Assuming a recovery
rate of 5 per cent for steel scrap, this makes the net total cost of materials 190 million. The total cost
of production is 295 million. Assuming a 10 per cent profit, the selling price is equivalent to 325
million. This means that, in the case of this firm, raw materials account for 58 per cent of the final
selling price.
(c) Stainless Steel Fasteners
The raw material for making stainless steel fasteners is stainless steel wire rod. The cost of
the raw material accounts for between 55 and 61 per cent of the fair market value (normal selling
price) of the final product.

A cost breakdown in a specific example of certain producers of Stainless Steel Fasteners is as
follows:
All companies 1996 1997 1998 1999 Average
Full cost all products 81.619 94.133 102.566 99.691 94.502
Cost of raw material purchases 47.134 64.119 64.843 58.456 58.638
Cost of salaries 8.585 9.696 10.721 10.584
Cost of social benefits 4.058 4.655 4.787 4.748
Depreciation of tangible fixed assets 3.409 3.304 3.663 3.716
Cost of raw material purchases as a % of full cost
57.7% 68.1% 63.2% 58.6%
Cost of salaries as a % of full cost 10.5% 10.3% 10.5% 10.6%
Cost of social benefits as a % of full cost 5.0% 4.9% 4.7% 4.8%
Depreciation of fixed assets as a % of full cost 4.2% 3.5% 3.6% 3.7%
Total 77.4% 86.9% 81.9% 77.7%
Thus, the average cost of raw materials to a number of firms over a four-year period is
58.638. The total cost of production is 94.502. Assuming a 10% profit, the selling price is equivalent
to 103.952. This means that, in the case of these firms, raw materials account for 56 per cent of the
final selling price.
2. Other metal products
Aluminium household foil
The main raw material for aluminium household foil is aluminium slabs. The cost of the raw
material accounts for between 58 and 63 per cent of the fair market value (normal selling price) of the
final product.
A cost breakdown in a specific example of a producer of Aluminium Household Foil is as
follows:

ALUMINIUM HOUSEHOLD FOIL 1999
CONVERTER
SALES TONNES 3.797
GROSS SALES 7.555
DEDUCTIONS 357
NET SALES 7.198
COST 0 Materials 4.900
COST 0 TONNE 1.290
CONT 0 2.298
CONT 0 TONNE 605
COST 1 Variables 1.713
COST 1 TONNE 451
CONT 1 586
CONT 1 TONNE 154
COST 2A Fixed Mftg 303
COST 2B Depreciation 447
COST 3A Selling 61
COST 3B R&D 3
COST 3C Admin 114
CONT 3 (Before Man Fee) (343)
MANAGEMENT FEE 55
CONT 3 (397)
Other
Profit (Loss) (397)
Thus, the cost of raw materials to the firm concerned is 4900. The total cost of production (the
sum of items 1,2&3) is 7596. Assuming a 10 per cent profit, the selling price is equivalent to 8356.
This means that, in the case of this firm, raw materials account for 59 per cent of the final selling
price.
3. Woven glass fibre fabrics
The raw material for producing woven glass fibre fabrics is glass fibre yarn. The cost of the
raw material accounts for between 55 and 60 per cent of the fair market value (normal selling price)
of the final product.

4. Chemicals and synthetic fibres
Polyethylene Terephthalate Bottle Resin
The raw materials for producing this product, which is used for the production of plastic
bottles, are purified terephthalic acid, mono ethylene glycol, di-ethylene glycol and isophthalic acid.
Together these can account for up to 70 per cent of the fair market value (normal selling price) of the
final product.
A cost breakdown in a specific example involving a producer of PET Bottle Chip is as
follows:
Cost of production of product concerned PET Bottle
Chip
FINANCIAL YEARS IP 01/10/98-
30/09/99
Raw materials :
 Terephtalic Acid PTA 59 236 670
 Ethylene Glycol 19 844 039
 Other 3 862 167
Total raw materials 82 942 876
Power and electricity 5 025 906
Direct labour 2 378 949
Total direct costs (a) 90 347 731
Manufacturing overheads
 Indirect labour 9 488 430
 Maintenance 1 437 219
 Depreciation 7 508 704
 Other 154 976
Total overheads (b) 18 589 329
Total manufacturing (a+b) 108 937 061
SG&A expenses
 Transport 3 789 123
 Other selling expenses 2 282 316
 General and administration 2 484 857
 Financial costs 1 551 716
Total SG&A (c) 10 108 013
Research & development (d) 1 435 111
Full cost (a+b+c+d) 120 480 185
Quantity produced 25596
Unit cost per tonne 4706.992703

Thus, the cost of raw materials to the firm concerned is 82.9 million and the full cost of
production (including SGA, finance costs and R&D) is 120.5 million. With a profit margin of 10 per
cent, the selling price of PET is equivalent to 132.6 million. This means that, in the case of this firm,
raw materials account for 63 per cent of the selling price of this product.
5. Aircraft
Even without looking at the aluminium and allo ys used for the production of airframes, the
engines of an aircraft can account for 30 per cent of the final price of the finished product. Similarly,
the avionics and other equipment on a modern aircraft can also cost 30 per cent of the final value.
Engines, avionics and other equipment are typically purchased from outside suppliers.
Together they can account for 60 per cent of the final price.
NOTE
Assembly always involves direct labour costs, which can be quite high. This means that, to
take the example of aircraft where bought-in engines, avionics and other equipment account for 60 per
cent of the final value, the 10 per cent that must be sourced in or from the US in order not to exceed
the 50 per cent limitation is increased by the amount of the foreign direct labour costs also incurred by
the producer.

List of Exhibits
EC-10 Article: US Treasury Official Denies FSC Repeal Signals Move to Territoriality Tax Notes
International, 18 December 2000, pp 2749 to 2752.
EC-11 Extract from the US Treasury Budget estimates for Financial Year 2001 entitled Total
Revenue Loss Estimates in the Income Tax (providing FSC revenue loss figures for financial
years 1999 to 2005).
EC-12 OECD Model Tax Convention on Income and Capital.
EC-13 The US Model Tax Convention.

I. INTRODUCTION
1. In accordance with the scheduled established by the Panel, the United States submits this
second submission in this proceeding arising from the recourse by the European Communities (“EC”)
to Article 21.5 of the Understanding on Rules and Procedures Governing the Settlement of Disputes
(“DSU” ). Because the rebuttal comments of the EC are due to be submitted simultaneously with
these comments, the United States will present its re sponse to the EC’s rebuttal at the Panel meeting.
Thus, these comments are limited to developments that have occurred in this proceeding since the
filing of the first written submission of the United States in this proceeding (“ First US 21.5
Submission”). Specifically, these comments address arguments contained in the third-party
submissions.
2. A number of the arguments and positions expressed in the third-party submissions are the
same or similar to those presented by the EC, arguments to which the United States previously has
responded. To the extent the third parties raise arguments not presented by the EC, such arguments
cannot serve to meet the EC’s burden in this proceeding. With this overriding consideration in mind,
the United States addresses below certain arguments and issues raised in the third-party submissions.
II. ARTICLE 3.1(A) OF THE SCM AGREEMENT
3. In providing their views on Article 3.1(a) of the SCM Agreement, Australia and Canada first
discuss whether the Act’s exclusion constitutes a subsidy under Article 1 of the SCM Agreement, and
then give their views on whether the exclusion is export contingent within the meaning of
Article 3.1(a). Accordingly, the United States first takes up the subsidy issue and then proceeds to
examine export contingency.
A. AUSTRALIA AND CANADA ERR IN THEIR SUBSIDY ANALYSIS
1. Australia's Argument
4. Australia argues that the Act’s exclusion constitutes a subsidy under Article 1 because, in its
opinion, all tax exclusions constitute subsidies. Australia states that “‘foreign trading gross receipts’
[are] excluded from gross income on which tax liability is calculated. The effect of the exclusion is to
reduce the tax liability of the beneficiary corporation."
1 Australia reaches this conclusion based on
the premise that the reduction in tax liability flow ing from the exclusion of extraterritorial income
“represents a departure from the rules of taxation that would otherwise apply to such gross income."2
5. Australia’s analysis is flawed in several respec ts. First, Australia fails to recognize that the
Act’s exclusion of extraterritorial income is an in tegral part of the definition of “gross income”, a
concept which forms the outer boundary of US taxing jurisdiction. The exclusion is, in the words of
the Appellate Body, the “prevailing domestic standard” or “normative benchmark” under US law
against which any particular measures must be evaluated.3 Accordingly, Australia’s assertion that the
Act’s exclusion “represents a departure from the rules of taxation that otherwise apply” is simply
incorrect.
6. Second, Australia’s erroneous characterization of the effects of the Act seem to result from its
misunderstanding of how the US tax system operates. Australia states in its submission that, “[a]s a
general rule, the United States asserts the right to tax all income earned worldwide by its citizens and

2 Id.
3 United States - Tax Treatment for “Foreign Sales Corporations” (“FSC (AB)”), WT/DS108/AB/R,
Report of the Appellate Body adopted 20 March 2000, para. 90.

residents."4 This statement fails to recognize that the Act fundamentally altered the manner in which
the United States treats foreign income. It is incorrect to argue that “the effect of the exclusion is to
reduce . . . tax liability” because no such liability exists in the first place under the US tax system with
respect to excluded extraterritorial income.
7. Third, Australia’s test for subsidization apparently would condemn any tax reform that results
in a contraction of a Member’s tax base. According to Australia, any measure that reduces tax with
respect to a category of income confers a subsidy. Taken to its logical conclusion, this argument
would transform a mere reduction in tax rates into a subsidy because the revenue foregone by the rate
reduction was “otherwise due” before the reduction went into effect. Such reasoning conflicts with
the Appellate Body’s holding in FSC that WTO obligations do not compel any particular kind of tax
system, and that Members have the sovereign authority to tax or not to tax particular categories of
revenue.
5
2. Canada's Argument
(a) Canada Offers No Principled Basis for Applying Article 1
8. Canada begins its analysis of whether the Act’s exclusion confers a subsidy within the
meaning of Article 1 by acknowledging that the Act passes the FSC Panel’s “but for” test.6 Canada
then argues that the “but for” test “is not determinative of whether the [US] government has foregone
revenue otherwise due” and that “a more complete analysis of domestic tax rules must be conducted
in order to determine what situation would apply to the revenues in question absent the contested
measure."7
9. Canada, however, does not provide any framework or principles for conducting such an
analysis, nor does it explain what factors would lead to a determination that revenue “otherwise due”
is foregone. Instead, Canada appears to merely point to aspects of the Act that it does not like, or that
seem unusual to Canada, and from this concludes that the Act’s exclusion comes within the scope of
Article 1.
10. Such ad hoc reasoning cannot be a basis for interpreting and applying provisions of WTO
agreements. The FSC Panel and Appellate Body made clear that the appropriate inquiry is whether
income that is not taxed under a challenged measure would “otherwise” be “due” under other
provisions of the tax laws of the country in question.
8 In order to determine whether taxes would be
“otherwise due,” it is necessary to compare the challenged measure with a “normative benchmark." 9
Canada’s ad hoc approach is especially inappropriate in the present context given the Appellate
Body’s statement that “the word ‘foregone’ suggests that the government has given up an entitlement

5 FSC (AB) , para. 90. In this regard, Australia seems to assume that in the absence of the Act’s
exclusion, excluded income necessarily would be taxed. However, as demonstrated in the First US 21.5
Submission, paras. 100-106, this assumption is not warranted.
6 Canada Third-Party Submission, paras. 27-28.
7 Id., para. 29.
8 The FSC Panel explained that “there is in the WTO Agreement no theoretical ‘correct’ benchmark for
taxes that would represent the norm for taxes and duties ‘otherwise due.’” United States - Tax Treatment for
“Foreign Sales Corporations” (“ FSC (Panel) ”), WT/DS108/R, Report of the Panel, as modified by the
9 FSC (AB), para. 90 (determining whether taxes are “otherwise due” requires a “defined, normative
benchmark against which a comparison can be made between the revenue actually raised and the revenue that
would have been raised otherwise”); see also FSC (Panel), para. 7.43 (“the determination whether revenue
foregone is ‘otherwise due’ must involve a comparison between the fiscal treatment being provided by a
Member in a particular situation and the tax regime otherwise applied by that Member ... .”).

to raise revenue that it could ‘otherwise’ have raised. This cannot, however, be an entitlement in the
abstract, because governments, in theory, could tax all revenues." 10 Thus, the Act must be assessed
against an articulated and clear standard, and not on the basis of conclusory reasoning.
(b) No Negative Inference Can Be Drawn from the Fact that the Act Passes the "But
For" Test
11. Canada does not attempt to make the comparison contemplated by the FSC decisions.
Instead, Canada effectively complains that by revising its laws, the United States was too successful
in satisfying the “but for” test. 11 Although Canada does not appear to dispute the fact that by
excluding extraterritorial income from “gross income” the United States redefined the outer boundary
of its tax system, Canada alleges that this redefinition somehow constitutes a “circumvention” of the
“but for” test. Canada argues that, because the United States does not have “a rule formally taxing the
revenues in question,” the Panel should examine the size and nature of the exclusion.
12
12. Canada is wrong on all counts. First, it was entirely appropriate for the United States to craft
the Act so as to avoid creating a situation where, “but for” the existence of the Act, foregone revenue
would be due. As the United States explaine d in its first submission, complying with the FSC Panel
and Appellate Body decisions was one of the underlying purposes of the Act.
13 Had the United States
not done so, it would have ignored the Panel’s central statement regarding the definition of a subsidy.
WTO Members implementing WTO decisions must be permitted to structure new measures
specifically to comply with those decisions.14
13. Second, it also was entirely appropriate for the United States to modify its tax system by
redefining its jurisdictional boundaries. As the Appellate Body has explained, WTO obligations do
not dictate what type of tax system a Member must have. So long as they do not contravene specific
WTO obligations, Members have “the sovereign authority to tax any particular categories of revenue”
and are “also free not to tax any particular categories of revenue []".
15 By excluding extraterritorial
income from US taxation, the United States simply exercised this sovereign right.
14. Third, despite Canada’s suggestion to the contrary, the absence of “a rule formally taxing the
revenues in question” indicates that the Act does not confer a subsidy. Stated differently, what
matters in the present context is whether the ch allenged measure foregoes revenue when compared
against a “normative benchmark” under US law. Canada has identified no such benchmark and, like
Australia, has failed to explain what provision of US law necessarily would capture income that is
excluded because of the Act.
(c) Canada's Analysis of the Act is Flawed
15. Canada raises several aspects of the Act that are not relevant to determining whether the Act
confers subsidies under Article 1.

10 FSC (AB), para. 90 (emphasis in original).
12 Canada argues that US foreign tax credits were a preexisting benchmark and that the United States
cannot create a “new” benchmark. Id., note 19. However, US foreign tax credits are inappli cable to excluded
extraterritorial income, and therefore cannot be a relevant benchmark in this context. The United States
explains in this section why there is no restriction against a WTO Member modifying its system of taxation and
thereby establishing a “new” benchmark.
13 First US 21.5 Submission, paras. 22-23.
14 If this were not so, then it would be contrary to the role of the dispute settlement system as a central
element in providing security and predictability to the multilateral trading system.
15 FSC (AB), para. 90 (emphasis in original).

(i) It is Irrelevant that Only Certain Categories of Extraterritorial Income are Excluded
from Tax
16. Canada maintains it is inappropriate that “only certain categories of ‘extraterritorial income’
are excluded from tax." 16 However, nothing in the language of Article 1 suggests that the size or
comprehensiveness of a tax exclusion is relevant to whether a subsidy has been provided. Many
exemption systems, for example, impose complicated conditions on the non-taxation of foreign
income. Canada does not explain how the scope of the exclusion is relevant to whether taxes on
extraterritorial income are “otherwise due”.
17. In addition to being irrelevant, Canada’s assertion that the Act’s exclusion is insufficiently
comprehensive is false. The exclusion of extraterritorial income applies broadly to individuals,
partnerships, and corporations, irrespective of whether they are located in the United States or abroad.
The exclusion applies to a broad range of foreign transactions – i.e., foreign sales, foreign leases, and
foreign rentals.
(ii) For Purposes of Article 1, it is Irrelevant Whether the Act Excludes Export-Related
Income or is a Measure to Avoid Double Taxation
18. Canada next contends that the Act confers subsidies under Article 1 because its exclusion
applies to export-related income and that the exclusion of such income does not constitute, in
Canada’s opinion, a measure to avoid double taxation.
17 These considerations are wholly irrelevant to
a determination of whether a measure confers subsidies within the meaning of Article 1. The
Appellate Body has made clear that the definition of a subsidy is free standing – that is, it applies
throughout the SCM Agreement and does not turn on whether the measure at issue involves exports.18
Moreover, Article 3.1(a), the provision of the SCM Agreement specifically focused on exportation,
applies only to subsidies “within the meaning of Article 1”. Article 3.1(a)’s export-contingency is
only relevant to measures that first confer subsidies under Article 1.
19. As for Canada’s assertion that the Act’s exclusion is not a measure to avoid double taxation,
that issue also has no bearing on whether the exclusion constitutes a subsidy. The United States
previously made a similar argument in the FSC dispute, contending that footnote 59, including the
fifth sentence (which deals with measures to avoid double taxation), forms part of the context for
interpreting the “otherwise due” language of Article 1. The Appellate Body, however, rejected that
argument, finding footnote 59 to be relevant to Article 3.1(a) and not Article 1.
19 Therefore, whether
or not the Act constitutes a measure to avoid double taxation is not relevant to determining whether or
not it can be deemed a subsidy.20
(iii) It is Irrelevant Whether the Act Relies on the FSC's "Arithmetic"
20. Finally, Canada contends that the Act constitutes a subsidy because it “corresponds
arithmetically to the exempt foreign source income of the FSC scheme." 21 To the extent Canada is
suggesting that the FSC provisions were not repealed, Canada is wrong, because the Act repealed the

17 Canada Third-Party Submission, paras. 31-35.
18 FSC (AB), para. 89.
19 Id., paras. 93-94. The United States responds to Canada’s contention that the Act is not a measure to
avoid double taxation in section II.C.2, below.
20 Should the Panel find the double taxation argument relevant to the issue of whether the Act confers a
subsidy, the United States renews its argument that the Act does not confer a subsidy under Article 1.1(a)
because it constitutes a measure for the avoidance of double taxation.

FSC provisions. To the extent Canada really is arguing that the Act uses the same percentages as the
FSC provisions, Canada is dwelling upon an irrelevant point. Neither the Panel nor the Appellate
Body in FSC found objectionable the percentages used by the FSC provisions. Moreover, such a
comparison between the provisions of the FSC and the Act is neither accurate nor meaningful. As a
general matter, challenged measures can be modified to remedy WTO deficiencies. In this case, the
FSC provisions have been repealed, and the Act is significantly different.
22
B. THE ACT'S EXCLUSION IS NOT EXPORT-CONTINGENT WITHIN THE MEANING
OF ARTICLE 3.1(A)
21. Canada and Australia argue that the Act’s exclusion is contingent upon export performance
and therefore violates Article 3.1(a) of the SCM Agreement. Together, Canada and Australia present
four main arguments regarding Article 3.1(a). First, both argue that the foreign-use requirement in the
Act, in and of itself, renders the Act and its exclusion of extraterritorial income an export-contingent
subsidy. Second, Canada argues that the application of the exclusion to non-export transactions is not
enough to save the Act from the prohibition of Article 3.1(a). Third, Canada and Australia claim that
the inapplicability of the exclusion to income earned in domestic transactions demonstrates the
export-contingency of the Act. Fourth, Australia claims that the Act’s 50-percent rule on certain
foreign value makes the exclusion of income of fo reign entities export-contingent. None of these
arguments, however, find support in the language of Article 3.1(a), as interpreted by the Appellate
Body.
1. The Foreign-Use Requirement Does Not Render the Exclusion of Extraterritorial
Income Export Contingent
22. Australia and Canada claim that the Act’s foreign-use requirement – i.e., that property
involved in a transaction giving rise to excluded extraterritorial income must be “held for use,
consumption, or disposition outside the United States” – renders the exclusion of extraterritorial
income export contingent.
23 Contrary to these arguments, the foreign-use requirement does not make
the exclusion export contingent.
23. The Act provides in general for the exclusion of income arising in foreign transactions. As
noted in the First US 21.5 Submission , the foreign-use requirement is but one characteristic of a
“foreign” transaction, and the exclusion applies regardless of whether the products involved are
manufactured or produced in the United States. While foreign transactions giving rise to excluded
extraterritorial income include export transactions, they also include transactions that take place
entirely within another country, or that involve multiple countries other than the United States. The
applicability of the exclusion to income earned in a wide range of foreign transactions reflects the
export-neutral principle underlying the exclusion. Exporting is merely one way of conforming to that
principle.
24. Thus, the foreign-use requirement in the Act does not render the exclusion of extraterritorial
income export contingent. If that were not so, then the Panel would in effect be holding that a tax
exemption for foreign sales income is necessarily an export subsidy. Such a result would come as a
quite a surprise to countries employing territorial tax systems or tax systems providing territorial
exemptions.

22 See US First Art. 21.5 Submission , paras. 47-55 for a discussion of the differences between the Act
and the FSC.
23 Canada’s Third Party Submission, para. 40; Australia’s Third Party Submission, para. 16.

2. The Availability of the Exclusion of Extraterritorial Income Earned by Foreign Entities
is Relevant under Article 3.1(a)
25. As discussed above, Canada focuses on export transactions in the context of the foreign-use
requirement, arguing that the availability of the exclusion for income earned in foreign, non-export
transactions is irrelevant.
24 However, bifurcating the Act in this way is not consistent with the way
the Act operates and results in a distorted analysis under Article 3.1(a).
26. With respect to foreign sales transactions, the Act does not distinguish between export
transactions and non-export transactions or between exporters and non-exporters. With one
exception, there is no distinction in reporting by taxpayers, whether they be branches or subsidiaries
of US corporations or foreign corporations. The only distinction in the identity of taxpayers is that
foreign taxpayers must be subject to US tax on their manufacturing income in order to earn excluded
income. As explained in the First US 21.5 Submission , this distinction merely equalizes the US tax
treatment of foreign branches and corporate subsidiaries. The Act applies neutrally and broadly to
income derived from foreign transactions – that is, where the goods subject to the transactions are
purchased and used outside the United States.
27. Contrary to Canada’s argument, the Appellate Body in Canada-Aircraft did not determine
that subsidies provided to non-exporters are irrelevant for purposes of evaluating a measure under
Article 3.1(a).
25 Canada Aircraft was a de facto export-contingency case. As the panel noted in that
case, Brazil did “not claim that the TPC programme is de jure export contingent. Rather, Brazil
asserts that TPC contributions in the regional aircraft sector are ‘contingent . . . in fact . . .upon
exportation’, within the meaning of Article 3.1(a) of the SCM Agreement."26 As support for its claim
of de facto export contingency, Brazil provided extensive factual information relating to particular
TPC contributions and established that these contributions would not have been provided to the
Canadian regional aircraft sector but for the sector’s export orientation. Thus, when the Appellate
Body reviewed the panel’s decision in Canada Aircraft, the Appellate Body confirmed that, in a de
facto export contingency case, only those subsidies claimed to be export-contingent are relevant for
the panel’s consideration.
28. Canada Aircraft is distinguishable from this case. The EC has not made a de facto export
contingency claim or presented any evidence that would support such a claim. The only evidence
presented by the EC is the Act itself. Ignoring the export-neutral aspect of the definition of
extraterritorial income would be to ignore one of the most important issues in this case. In contrast to
the Appellate Body’s finding in Canada Aircraft that the TPC program would not have contributed to
the regional aircraft sector “but for” that sector’s export orientation, the Act is indifferent as to how
any taxpayer earns extraterritorial income. The Act does not create any sub-categories of taxpayers
whose eligibility to earn extraterritorial income is “tied” to actual or anticipated exportation or export
earnings. Thus, the Panel should consider the Act as whole in evaluating whether the exclusion of
extraterritorial income is export contingent.
3. The Inapplicability of the Act's Exclusion to Income Derived from Domestic
Transactions is Irrelevant under Article 3.1(a)
29. Canada and Australia contend that the inapplicability of the exclusion to income earned in
purely domestic transactions renders the exclusion export-contingent.
27 A s C a n a d a s t a t e d i n i t s

25 Canada’s Third Party Submission, paras. 45-47.
26 Canada - Measures Affecting th e Export of Civilian Aircraft , WT/DS70/R, Report of the Panel, as
modified by the Appellate Body, adopted 20 August 1999, para. 9.330.
27 Canada’s Third Party Submission, paras. 43-44; Australia’s Third Party Submission, para. 16.

submission, “the proper basis for comparison must necessarily be with the tax treatment of domestic
sales of domestic goods."28
30. This argument is not grounded in the language of Article 3.1(a) as interpreted by the
Appellate Body. Whether a domestic transaction is eligible for a tax exclusion has no bearing on
whether that exclusion is “contingent on”, “conditioned upon”, or “dependent for its existence on”
export performance. In providing a framework for evaluating a measure under Article 3.1(a), the
Appellate Body has never indicated that any comparison is required, let alone a comparison between
the tax treatment of export transactions and the tax treatment of domestic transactions. If the drafters
of Article 3.1(a) had wished to adopt a test for export contingency that compared the treatment of
foreign sales with the treatment of domestic sales, they would have done so in the text of the
agreement. However, they did not.
4. The 50-per cent Rule Does Not Render the Act's Exclusion Export-Contingent
31. While Canada appears to take the view that the Act’s exclusion is not export-contingent with
respect to sales of foreign-produced property, Australia argues that the Act’s 50-percent rule “requires
the export of United States product” with respect to such transactions. Australia’s argument is based
entirely on the false premise that “at least 50 per cent of [the property’s] fair market value must be
attributable to United States content and United States direct labour costs."
29
32. The 50-percent rule in the Act does not require any US content. Qualifying foreign trade
property may include property with 100 percent foreign content. Furthermore, the 50-percent rule
does not require that any portion of a final product’s fair market value be attributable to US-produced
inputs and US direct labour costs. Instead, the Act provides a cap on the amount of the fair market
value of a product that is attributable to foreign inputs and labour. Thus, Australia’s argument is
based upon a basic misunderstanding of the operation of the Act. As reflected by the attached
statement from a US taxpayer (“X”) intending to rely upon the Act, the 50-percent rule does not
require that US content be included in products subject to the Act. This taxpayer explains that it will
not need to include US content in products whose sale will generate extraterritorial income:
The [merchandise] sold by the foreign branches of this [X] Swiss subsidiary is
considered “qualifying foreign trade property” under the Act. [This merchandise
does] not contain any US-produced inputs and [is] not manufactured with any US
direct labour. The 50-percent rule in the Act is satisfied by the significant amount of
the fair market value of the [] product that is attributable to US intellectual property
rights, notably [X’s] process patents that are licensed to foreign manufacturers. In no
case is [X’s] ability to exclude extraterritorial income dependent or conditioned upon
the use of US goods exported outside the United States.
30
Accordingly, the 50-percent rule does not require the exportation of US goods and the Act cannot be
said, for that reason, to be contingent upon export performance.

28 Canada’s Third Party Submission, para. 44.
29 Australia’s Third Party Submission, para. 18.
30 Exhibit US-9, para. 8. Pursuant to paragraph 3 of the Working Procedures of the Panel , the United
States designates US-9 as confidential. In the quotation from US-9 in the text, the United States has deleted
material – identified in brackets – in order to summarize the information in a manner that can be disclosed to the
public.

C. THE ACT'S EXCLUSION CONSTITUTES A MEASURE TO AVOID DOUBLE
TAXATION WITHIN THE MEANING OF FOOTNOTE 59
33. Australia and Canada both argue that the Act does not constitute a measure to avoid double
taxation pursuant to the fifth sentence of footnote 59 of the SCM Agreement. 31 In reaching this
conclusion, however, they propose conditions and limitations on what constitutes a measure to avoid
double taxation that are not supported by the text of footnote 59 and that are not consistent with
methods used to avoid double taxation around the world.
1. Australia's Argument
34. Australia bases its argument on two points. First, it asserts that the Act’s exclusion cannot be
a measure to avoid double taxation under footnote 59 because “United States tax rules already provide
income tax credits to minimize double taxation” and because “[t]he United States has also entered into
agreements with other countries to avoid double taxation of income." 32 Second, Australia claims that
the Act is not a measure to avoid double taxation because its exclusion is “not calculated on, or
limited to, the amount of foreign taxes paid on ‘extraterritorial income’."33
(a) WTO Members May Rely on Alternative Methods for Avoiding Double
Taxation of Foreign-Source Income
35. In the context of international commerce, relief from double taxation generally is provided
through an exemption of foreign income, through a credit for foreign taxes paid, or through an income
tax convention pursuant to which each jurisdiction cedes taxing rights over particular categories of
income. As the EC has recognized, most if not all Members employ all three of these mechanisms, in
varying proportions, for the relief of double taxation.
36. According to its legislative history, the Act es tablishes an alternative measure for the relief of
double taxation for a particular category of income de fined by the Act. According to that legislative
history, “the extraterritorial income excluded by this legislation from the scope of US income taxation
is parallel to the foreign-source income excluded from tax under most territorial tax systems."
34 In
other words, the Act implements certain aspects of the exemption systems employed by other
countries, including EC member states. Reflective of its nature as an alternative mechanism for the
relief of double taxation, the Act disallows foreign tax credits and deductions otherwise allocable to
excluded extraterritorial income.35
37. Nothing in the SCM Agreement prohibits Members from using this type of alternative
mechanism for the relief of double taxation. To the contrary, the OECD and the UN endorse the use
of this mechanism.
36 Footnote 59 leaves the choice of mech anism to WTO Members, stating that the
ban against export-specific direct tax exemptions, remissions, or deferrals set forth in paragraph (e) of
the Illustrative List of Export Subsidies “is not intended to limit Members from taking measures to
avoid . . . double taxation … . ” (Emphasis added). This language is particularly flexible, imposing

31 Neither Australia nor Canada appears to dispute the legal consequences that would flow from finding
the Act’s exclusion to fall under footnote 59; i.e., that by virtue of footnote 5 of the SCM Agreement, the
exclusion would not be prohibited by any provision of the Agreement.
32 Australia Third-Party Art. 21.5 Submission, para. 21.
33 Id., para. 22.
34 Senate Report (US-2), page 5.
35 The Act § 3, amending IRC § 114(c)-(d).
36 Model Tax Convention on Income and Capital (OECD 1992) (“OECD Model Tax Convention”)
(Exhibit US-7); see also United Nations Model Double Taxati on Convention Between Developed and
Developing Countries, Pub. No. ST/ESA/102 (1980).

no limit on WTO Members in fashioning double tax relief measures.37 Moreover, the Appellate Body
in FSC did not condition the sovereign right of Members to exempt a category of income on some
requirement that they only do so through a unitary measure. Therefore, the United States may adopt
alternative mechanisms for the avoidance of double taxation.38
38. The same is true with respect to US bilateral tax treaties. These treaties provide relief from
double taxation in conjunction with or parallel to US domestic legal provisions, but these agreements
are confined by their terms to circumstances where the two signatory governments can claim the right
to tax the same income. As a general rule, bilateral tax treaties are entered into to supplement
domestic legal measures designed to avoid double taxation. Almost every country entering into such
a treaty has its own mechanism for avoiding double taxation, and these domestic mechanisms often
differ in some way – i.e., in terms of methodology or scope of application – from that of the treaty.
Thus, a treaty might provide relief to taxpayers where the laws of a given treaty party otherwise
would not. However, a treaty does not preclude the need for a domestic measure to avoid double
taxation.
(b) A Measure to Avoid Double Taxation Does Not Have to Be Limited to the
Amount of Foreign Taxes Paid
39. Australia next argues that the Act is not a measure to avoid double taxation because the
exclusion is not limited to the amount of foreign taxes paid. This argument also is meritless.
(i) The Exemption Method is Tied to the Tax Rates of the Countries Involved
40. The premise underlying the exemption method is that the same income of a taxpayer should
not be subjected to the tax systems of two sovereign nations. This stands in contrast to the tax credit
method, which presumes that taxpayers will be taxed twice on the same income but which offsets any
foreign taxes paid after the fact.
41. As the United States explained in its first submission, a natural consequence of the exemption
method is that the overall effect on the tax liability of a given taxpayer is determined by the tax rate
applied by the country of source for exempted foreign-source income. To the extent that the tax rate
applied by the country of source is higher than that of the country of residence, a taxpayer will pay
more in taxes on the income in question than if that income were earned in the country of residence.
Conversely, if the country of source applies a lower rate, then the taxpayer will pay less than if the
income were earned in the country of residence.
(ii) An Example
42. The Commentary to the OECD Model Conventi on demonstrates that an overall savings in
taxes is natural byproduct of the exemption method, but nonetheless is permissible. The Commentary

37 It is instructive that the drafters of the SCM Agreement used the word “measures” in footnote 59 and
did not attempt to identify particular methods of avoiding double taxation. The term “measure” has been found
to be a rather broad term in other contexts. As the Japan Film Panel explained, “GATT panels dealing with the
related issue of what may constitute ‘all laws, regulations and requirements’ . . . under GATT Article III:4 ... .
Panels have taken a broad view of when a governmental action is a law, regulation or requirement ... . Given
that the scope of the term requirement would seem to be narrower than that of measure, the broad reading given
to the word requirement . . . supports an even broader reading of the word measure in Article XXIII:1(b).”
Japan - Measures Affecting Consumer Photographic Film and Paper , WT/DS44/R, Report of the Panel adopted
22 April 1998, para. 10.51.
38 In this regard, the EC previously has acknowl edged that both the credit and the exemption method
are proper methods of avoiding double taxation, and th at it is internationally accepted that both methods may be
used in combination. Annex EC-2, page 2 (US-5).

does so through an example in which a taxpayer obtains a tax savings because the taxpayer’s country
of residence imposes a higher tax rate than the other country involved. The example assumes that (1)
the total income of a taxpayer is $100,000, (2) the first $80,000 of the $100,000 is taxable only in the
country of residence, (3) the other $20,000 is subject to tax in both countries, (4) the tax rate in the
country of residence is 35% at $100,000 and 30% at $80,000, and (5) the foreign country’s rate of
taxation is 20%. Absent a measure to avoid double taxation, the taxpayer would be subjected to taxes
of $35,000 on his worldwide income of $100,000 by the country of residence, plus a tax of $4,000
levied by the country of source on the $20,000 earned there – resulting in a total tax of $39,000.
39
43. The OECD Commentary then explains that under the exemption method 40, the $20,000 in
foreign-source income would not be considered for tax purposes by the country of residence. This
would result in the country of residence taxing the remaining $80,000 at a 30 percent rate, yielding a
tax of $24,000, while the other country would levy its tax of $4,000 on the $20,000 earned within its
territory. The exemption method would thus yield a total tax of $28,000, relieving the taxpayer of
$11,000 in taxes (the double tax of $39,000 minus the revised amount of $28,000).
44. The Commentary shows this example graphically as follows:
Tax in County of Residence (30% of $80,000) $24,000
Plus Tax in Foreign Country $4,000
Total Taxes $28,000
Relief Given by Country of Residence $11,000
45. To summarize these results, under the exemption method, the taxpayer would owe only
$28,000 in combined taxes and $24,000 in country-of-residence taxes. This amounts to a savings of
overall and country-of residence taxes of $11,000.
46. Despite the overall savings in taxes, the OECD approves of the exemption method. The EC
appears to agree, having informed the FSC Panel that, “[t]o the extent that foreign taxes are lower
than domestic taxes, resident taxpayers with exempt foreign-source income are treated more
favourably than other residents."
41
(iii) The Credit Method Does Not Offer Perfect Results
47. It is important to note that, while the credit method may in theory be better suited to
calibrating the impact of double taxation and can more easily prevent a tax savings from occurring 42,
tax credits in practice are not a perfect method for avoiding double taxation. Tax credits are often
complicated in their application, raising substantial questions about their effect in situations where
companies suffer foreign losses, roll credits over to subsequent tax years, or pay taxes in a foreign
jurisdiction that are not subject to crediting ( e.g., payment of excise or value-added taxes instead of
income taxes). Like exemption, credits may not result in an exact dollar-for dollar offset of foreign
taxes paid. However, unlike exemption, credits may result in taxpayers continuing to be subject to
double taxation on the same income by two nations.

39 US-7, pages C(23)-5 to C(23)-7.
40 This example relies on what the OECD refers to as the “full exemption” method. An alternative
method, “exemption with progression”, would yield different but similar results.
41 Annex EC-2 (US-5), page 2. The EC went on to note that some countries apply a partial exemption
system in order to limit the advantages a taxpayer may reap. These countries exempt income only if it is
“derived from countries that are committed to imposing taxes at rates and under conditions that are roughly
comparable to [their] own rates and conditions.” Id.
42 This is because tax credits are applied ex ante and thus can theoretically be calculated with precision
to offset taxes actually paid in the country of source.

48. In view of the complexities in volved with each method, it is not surprising that countries have
adopted one or the other, or both, and that the ma jor model treaties have approved both. The model
treaties in this regard follow the long and widespread acceptance of both methods by nations around
the world, including many EC member states as well as many other WTO Members.
2. Canada's Argument
49. Canada begins its analysis of whether the Act constitutes a measure to avoid double taxation
for purposes of footnote 59 by distinguishing between the treatment of what it refers to as “foreign
income” and “domestic export income”. Canada states that it “agrees that the ‘foreign income’
component of ‘extraterritorial income’ is the type of income typically subject to a measure to avoid
double taxation."43 Canada, however, posits that “the United States has added this new category of
income to the measure in question in an attempt to confuse the domestic tax situation that would
otherwise apply to the ‘domestic export inco me’ component of ‘extraterritorial income’."44 Canada
goes on to say that “income earned from export transactions is income that would generally be taxable
only in the United States. The fact that the proceeds of sales are from foreign sources does not
transform the export income into ‘foreign income’ for tax purposes."
45 Finally, Canada argues that
“[e]xporting goods in a foreign country does not create a sufficient nexus to trigger taxation in the
importing country, even when one takes into consideration the ‘foreign economic processes’ required
under the [Act]."46
50. These unsubstantiated assertions lack a foundation in the text of the SCM Agreement and
reflect a misunderstanding of how measures to avoid double taxation are used throughout the world.
(a) Canada Draws a False Distinction Between "Foreign" and "Domestic Export"
Income
51. At base, Canada is arguing that the mere ap plication of the Act’s exclusion to income from
export sales renders it export-contingent, regardless of the fact that the exclusion applies to a much
broader category of income. As the United States has explained, a broad range of foreign transactions
may give rise to excluded extraterritorial income. To the extent that exporting may give rise to
extraterritorial income, that is merely the result of the fact that export sales are one form of foreign
transaction. The Act in no way treats exports differently or more generously than other types of
foreign sales. A statement from a US taxpayer (“X”) illustrates this point:
None of the extraterritorial income earne d by [X’s] Swiss subsidiary is generated
through exports from the United States. The amount of income that [X] will exclude
under the Act bears no relationship to whether and to what extent [X] engages in
export transactions. Indeed, the Company’s decision to elect to become a US
taxpayer is completely unrelated to whether and to what extent [X] engages in export
transactions.
47
Therefore, Canada’s distinction between “foreign” and “domestic export” income is illusory at best.

44 Id.
45 Id.
46 Id.
47 US-9, para. 7.

(b) The United States Did Not Include Wholly Foreign Transactions to "Confuse the
Situation"
52. Canada admits “that the ‘foreign income’ component of ‘extraterritorial income’ is the type of
income typically subject to a measure to avoid double taxation.” Canada nevertheless objects to the
application of the Act’s exclusion to foreign income derived from export transactions. Among other
things, this statement fails to recognize how US taxpayers can rely on the Act’s exclusion for
non-export transactions.
53. The United States explained in its first submission and above that the Act applies to a wide
array of foreign transactions.
48 All of these transactions can be performed without any goods or
services originating in the United States; i.e., these transactions need not involve exportation from the
United States at all. As one company has explained, extraterritorial income can be earned by foreign
companies and can be “earned exclusively through non-US or foreign transactions".49
54. Thus, contrary to Canada’s assertion to the contrary, the Act applies meaningful double
taxation relief with respect to non-export transactions. It applies with full force to non-export
transactions and will be used by US taxpayers earning income from sales occurring entirely outside
the United States, including foreign companies.
(c) Canada Improperly Narrows the Fifth Sentence of Footnote 59
55. In its submission, Canada attempts to narrow the meaning of the fifth sentence of footnote 59
or add conditions that are not contained in its text. Canada first argues that foreign-source income for
purposes of footnote 59 is only income attributable to economic processes occurring outside a
taxpayer’s country of residence. Canada also argues that double taxation relief may be provided only
to taxpayers having “permanent establishments” in jurisdictions other than their country of residence.
As the United States demonstrates below, neither proposition is correct.
(i) Canada's Definition of Foreign-Source Income is Erroneous
56. Canada appears to disagree with the definition of foreign-source income advanced by the
United States – that is, an assessment based on all facts and circumstances that could lead to
characterizing income as foreign. Canada appears to be arguing that income is “foreign source” only
to the extent that it is attributable to economic processes occurring outside a taxpayer’s country of
residence. Canada even goes so far as to assert th at the United States is arguing that extraterritorial
income is “foreign source income” within the mean ing of footnote 59 just from “[t]he fact that the
proceeds of sales are from foreign sources."
50 Canada oversimplifies the US position, and offers no
explanation for how its definition comports with the relevant text.
57. As the United States explained in its first submission, a foreign source of payment is but one
of many factors that could make income “foreign source”. The ordinary meaning of the term
“foreign-source income” for purposes of footnote 59 is profits or proceeds originating outside the
borders or territory of the WTO Member instituting a measure to avoid double taxation. 51 T h e
United States further explained that the essential characteristics that would indicate whether profits or
proceeds originate outside the borders or territory of a country might include: the goods or services in
question are sold outside the territory of the taxing authority, the purchaser is located outside the
territory of the taxing authority, title to the merchandise is transferred outside the territory of the

48 The Act § 3, amending IRC § 941(a)(1), describes the types of transactions covered.
49 Exhibit US-9, para. 6.
50 Canada’s Third-Party Submission, para. 34.
51 See US First Art. 21.5 Submission, para. 166-67.

taxing authority, payment is made or issued outside the territory of the taxing authority, or economic
activities giving rise to the sale occur (at least in part) outside the territory of the taxing authority.
These attributes are factors that can render income subject to taxation in two jurisdictions. It is
important to note that this definition includes income attributable to foreign economic processes, but
the language of the fifth sentence of footnote 59 does not appear to make foreign economic processes
the sole factor for determining what is, or is not, meant by “foreign source income”.
58. “Extraterritorial income” under the Act involves all of these foreign attributes that can result
in such income being subjected to double taxation.
52 The central premise of the Act is to provide a tax
exclusion for income from foreign transactions. W ith regard to the types of transactions that may
generate excluded income, the Act provides that the goods involved must be used, consumed, or
disposed of outside the United States. 53 As such, the purchasers of these goods typically will be
located outside the United States, they generally will authorize or make payment for the goods in
another country, and in many instances title will pass in that country as well. The goods may be
produced outside the United States 54, and certain required levels of foreign economic activities must
be performed with respect to the sales and distribution functions associated with qualifying
transactions.55
59. To find that the Act’s exclusion does not constitute a measure to avoid double taxation, there
must be something more than a bald assertion that foreign economic processes are the sine quo non of
“foreign source income”. There would have to be a showing as to why extraterritorial income, which
has a number of foreign characteristics, cannot be subjected to tax in two jurisdictions, cannot give
rise to double taxation, and in turn cannot be protected from such double taxation through the Act.
(ii) There is no Requirement for a "Permanent Establishment"
60. Canada appears to argue that, even if extraterritorial income is sufficiently foreign in nature, it
is not subject to double taxation because US taxpayers relying on the Act are not required to maintain
a “permanent establishment” in a foreign taxing jurisdiction. Canada argues that, absent a “permanent
establishment” requirement, the Act’s mandated foreign economic processes “do not create a taxable
presence abroad, and, therefore, would not be considered foreign business income subject to double
taxation."
56
61. Canada’s argument glosses over the fact that, just as there is no international consensus on
what constitutes foreign-source income, there are divergent views and practices among countries as to
what brings a non-resident enterprise within a country’s taxing authority. The United States, for
example, does not, as a general matter, subscribe to the requirement that a non-resident enterprise
must have a “permanent establishment” within the United States in order to be subjected to US
taxation. Instead, the United States looks to see if there is a sufficient amount of business activity
occurring within the United States with respect to a given transaction or series of transactions to find
that a taxpayer has engaged in “a trade or business in the United States."
57 Income “effectively

52 For example, one company has stated, “[t]he extraterritorial income earned by this [X] Swiss
subsidiary is subject to tax in Switzerland. The election of the Swiss subsidiary to become a US taxpayer does
not relieve the Swiss subsidiary from paying taxes to the government of Switzerland. However, because
extraterritorial income is excluded from gross income under the ETI Exclusion Act, excluded income earned by
this [X] Swiss subsidiary will not be subject to double taxation but, rather, subject only to Swiss tax.” US-9,
para. 10.
53 The Act § 3, amending IRC § 943(a)(1)(B).
54 The Act § 3, amending IRC § 943(a)(1)(A).
55 The Act § 3, amending IRC § 942(b).
57 All that is required to establish a US trade or business is “considerable, continuous and regular”
economic activity. For example, a US trade or busine ss has been found to exist where a foreign individual’s

connected” with that trade or business is subject to US taxation. In short, the United States does not
require the existence of a fixed or enduring business operation.
62. The United States is not alone in relying on a standard more flexible than something
amounting to a “permanent establishment”. Section 253 of the Canadian Income Tax Act provides
that soliciting orders or offering items for sale in Canada through an agent or servant (whether or not
the contract or transaction is to be completed inside or outside of Canada) may be deemed to be
carrying on business in Canada for tax purposes.
58 S i m i l a r l y , t o u s e o n e E C m e m b e r s t a t e a s a n
example, UK. tax laws take into account a number of factors, including where a contract is made, in
determining whether “trading income” is taxable by the United Kingdom.59
63. The Act takes account of the varied approaches for determining tax jurisdiction throughout
the world. It recognizes that other countries rely on different standards that can turn on subtle factual
distinctions in determining whether income is subject to their tax regimes. The Act therefore requires
that transactions giving rise to extraterritorial income must have a variety of foreign attributes that can
result in a sufficient nexus to a foreign taxing regime as to render US taxpayers subject to foreign
taxation.
64. It is true, as Canada asserts, that certain US bilateral tax treaties rely on the OECD standard
that a non-resident is not to be subject to taxatio n in the absence of a “permanent establishment”.
However, as explained above, bilateral tax treaties serve as an additional layer of double tax
avoidance in addition to domestic laws. A number of nations have broader jurisdiction under their
domestic tax laws to reach income of non-residents than that prescribed by most tax treaties. In fact,
one reason for a nation to enter into a bilateral tax treaty is to secure double tax relief from these more
aggressive standards. That nations rely on bilateral tax treaties to prevent their businesses from being
subjected to a foreign tax in the absence of a “permanent establishment” does not in any way mean
that lower thresholds cannot be relied upon in domestic double tax avoidance measures (especially
with regard to situations in which no such treaty exists).
(iii) The FSC Decisions Cast Doubt on Foreign Economic Processes as the Test of
"Foreign Source Income"
65. One reason the United States adopted the foregoing approach – and chose not to rely
exclusively on foreign economic processes as the test of “foreign source income” under footnote 59 –
is that the FSC Panel and Appellate Body decision s cast doubt on whether such a narrow standard is
appropriate.
66. As the Panel may recall, the United States predicated its arguments in the FSC dispute in
large part on the 1981 Understanding of the GATT Council. The Understanding begins by stating:

export business in the United States solicited orders, inspected merchandise, made purchases, completed sales,
and maintained an office and a bank account. United States v. Balanovski, 236 F.2d 298 (2nd Cir. 1956), cert.
denied, 352 U.S. 968 (1957) (Exhibit US-10). The mere ownership and active management of US real estate
has been found to constitute a US trade or business. See De Amodio v. Commissioner, 34 T.C. 894 (1960),
aff’d, 299 F.2d 623 (3rd Cir. 1962) (Exhibit US-11); Lewenhaupt v. Commissioner, 20 T.C. 151 (1953), a ff’d,
221 F.2d 227 (9th Cir. 1955) (Exhibit US-12). Moreover, the US taxing jurisdiction generally reaches a broader
category of income with respect to a US trade or busi ness (“effectively connected” income) than the category of
taxable income attributable to a US permanent establis hment. See Rev. Rul. 91-32, 1991-1 C.B. 107 (Exhibit
US-13); Rev. Rul. 81-78, 1981-1 C.B. 604 (Exhibit US-14), amplified by Rev. Rul. 84-17, 1984-1 C.B. 308
(Exhibit US-15).
58 See Exhibit US-16.
59 Tax Management, Foreign Income Portfolios, Business Operations in the United Kingdom, 989-2nd
(1999 Bureau of National Affairs), at A-80 to A-81 (Exhibit US-17).

“The Council adopts these reports on the understanding that with respect to these
cases, and in general, economic processes (including transactions involving exported
goods) located outside the territorial limits of the exporting country need not be
subject to taxation by the exporting country and should not be regarded as export
activities in terms of Article XVI:4 of the General Agreement."60
The United States cited this language in support of the proposition that footnote 59 allowed WTO
Members to refrain from taxing export-related income attributable to foreign economic processes and
the failure to tax such income does not constitute an export subsidy.
67. The FSC Panel and Appellate Body, though, rule d that the Understanding has no relevance to
the SCM Agreement in general or to footnote 59 in particular. As the Appellate Body stated, “[t]he
1981 Council action related to a different provision, Article XVI:4 of the GATT 1947, and not to the
export subsidy disciplines established by Articles 1.1 and 3.1(a) of the SCM Agreement."
61
68. As a result, the notion that “foreign source income” under footnote 59 can be directly equated
to income derived from foreign economic processes, as Canada appears to contend, cannot be derived
from the language of the 1981 Understanding. Such an interpretation must emanate from the
language of footnote 59 itself. However, as the United States has explained in its first submission and
above, the text of the fifth sentence of footnote 59 is not susceptible to such a narrow construction.
III. THE FIFTY-PER CENT RULE DOES NOT VIOLATE ARTICLE 3.1(B) OF THE
SCM AGREEMENT
69. Australia argues that the Act makes the exclusi on of extraterritorial income contingent on the
use of domestic over imported goods and thus violates Article 3.1(b) of the SCM Agreement. 62 As
discussed above, this argument is based on an erroneous description of the Act. Australia states:
for property to constitute “qualifying foreign trade property” under the Act, at least
50 per cent of its fair market value must be attributable to articles manufactured,
produced, grown or extracted within the United States ... . Given the tax exemption
only arises on the meeting of a 50 per cent local content requirement, it is contingent
upon the use of domestic over imported goods.63
70. However, contrary to Australia’s argument, the Act does not require that any portion of the
value of a final product be “attributable to articles manufactured . . . within the United States.” In
addition, the Act does not contain a “local content requirement.”
71. The Act defines “qualifying foreign trade property” as “property not more than 50 percent of
the fair market value of which is attributable to articles manufactured, produced, grown, or extracted
outside the United States, and direct costs for labour . . . performed outside the United States."
64
Australia appears to be misreading this language to state that 50 percent of the fair market value of
property be attributable to articles manufactured within the United States. Rather, the 50-percent rule
takes into account only the value of foreign articles and foreign direct labour used in producing a
finished product. The rule does not limit other foreign value. Thus, property can meet the
fifty-percent rule even if 100 percent of its content is foreign.

60 Tax Legislation Cases, adopted December 7-8, 1981, BISD 28S/114 (1982) (emphasis added).
61 FSC (AB), para. 119.
62 Australia’s Third Party Submission, para. 19.
63 Id. (emphasis in original).
64 The Act § 2, amending IRC § 943(a)(1)(C).

IV. THE UNITED STATES COMPLIED WITH THE DSB'S RECOMMENDATIONS
AND RULINGS
72. Australia argues that the United States has not withdrawn the FSC subsidies by the
1 November 2000 deadline, as extended by the DSB. The United States explained in its first
submission that the Act complies with the DSB’s recommendations and rulings because the Act
repeals the FSC provisions with effect from 30 September 2000, and provides that no FSCs may be
created after that date.
73. The Act provides limited transition relief to lessen the administrative burden and impact on
taxpayers’ business operations that might result due to the repeal of the FSC provisions. As the
United States explained in its first submission, providing limited transition rules to allow taxpayers to
adjust to a new regime is customary practice in the United States and in other countries when
repealing significant tax legislation. In addition, permitting limited transition rules is reasonable in
this case in light of the reliance of taxpayers on the FSC rules – reliance caused, in part, by the EC’s
delay of thirteen years after the FSC was enacted before challenging it.
74. Australia completely ignores the arguments presented by the United States in its first
submission with respect to the appropriateness of the Act’s transition rules. Consequently, the
United States respectfully refers the Panel to these arguments in its first submission.
65
V. CONCLUSION
75. For the reasons set forth above and in the First US 21.5 Submission , the United States
respectfully requests that the Panel reject the EC’s claims and arguments, and make the findings
requested in paragraph 239 of the First US 21.5 Submission.

65 First US 21.5 Submission, paras. 37-38, 223-39.

US EXHIBIT LIST
Number Document
9 Confidential Taxpayer Statement
10 United States v. Balanovski, 236 F.2d 298 (2nd Cir. 1956)
11 De Amodio v. Commissioner, 34 T.C. 894 (1960)
12 Lewenhaupt v. Commissioner, 20 T.C. 151 (1953)
13 Rev. Rul. 91-32, 1991-1 C.B. 107
14 Rev. Rul. 81-78, 1981-1 C.B. 604
15 Rev. Rul. 84-17, 1984-1 C.B. 308
16 Section 253 of the Canadian Income Tax Act
17 Tax Management, Foreign Income Portfolios, Business
Operations in the United Kingdom, 989-2nd (1999 Bureau of National Affairs), pages A-80 to A-81

ANNEX D
Oral Statements of the Parties
Contents Page
Annex D-1 Oral Statement of the European Communities D-2
Annex D-2 Closing Oral Statement of the European Communities D-16
Annex D-3 Oral Statement of the United States D-23
Annex D-4 Closing Statement of the United States D-54

Mr Chairman, Members of the Panel,
1. The EC knows that you have carefully studied the submissions in this case and will be brief in
its introductory remarks.
2. We will endeavour to assist the Panel by highlighting what we consider to be the most
important points.
1. What are we discussing
3. First, to put the other issues in context, the EC would like to recall that the matter before this
Panel is whether the US has correctly implemented the recommendations of the Panel in the original
proceeding – indeed whether it has withdrawn the subsidy – within the time period set by the DSB.
4. The immediate and easy answer to this question is clearly No. The FSC subsides have not
been withdrawn with effect from the 1 October 2000 and are, indeed, still available in their original
form - and will remain so indefinitely. It is not clear that anyone is yet relying on the FSC
Replacement scheme. The implementing regulations and guidance have not yet been issued and there
is no date fixed for this to happen.
5. The latest news that the EC disposes of is a report in BNA Daily tax report of 8 March 2001,
where Dirk Suringa of the International Tax Counsel’s Office at the US Department of Treasury is
reported as saying: 1
… it was too early to say when proposed regulations would be issued but assured
practitioners that Treasury considered them an important project and would be
seeking public input on their development.
6. The EC is reminded of the statement in the Australia-Salmon 21.5 proceeding, where the
panel said:
In our view, a new regime of implementing measures can be said to " exist" when this
regime sets out all requirements and criteria under which the product concerned can
enter the market of the implementing member. For products to be able to enter the
market, the new measures setting out these requirements and criteria also have to be
in force. We do not consider a framework regulation setting out the basic, but not all,
requirements and criteria sufficient for a new regime to "exist"..."
2
7. That is why the EC is of the view that the FSC subsidies have not been withdrawn.
8. But the Panel's mandate also covers the consistency of the new measures with the WTO and
its is therefore also confronted with a less immediate but, in the view of the EC not much less easy
question: would the new FSC Replacement scheme, when truly operational, be compatible with the
WTO.

1 Attached as Exhibit EC-14.
2 Article 21.5 Panel Report, Australia – Measures Affecting Importation of Salmon (“Australia –
Salmon”), WT/DS18/RW, adopted 20 March 2000, paragraph 7.28 (emphasis added).

9. If one stands back from the detail and examines what the US has done, this question can be
put in other terms. That is: does the WTO simply prohibit export subsidies that are packaged in a
certain way; can a prohibited export subsidy be repackaged – or rebundled – so that its effects are
the same but it is no longer prohibited; is the WTO about form over substance? The answers to these
questions are, the EC submits, obvious. The rest of this statement will be devoted to explaining that
one reaches the same answers when looking at the detail.
2. Exclusion or Exemption
10. It seems to the EC that the US is not attempting to argue that the mere presentation of the FSC
Replacement scheme as an “exclusion” rather than an “exemption” is determinative of its status as a
subsidy. The US states in paragraph 88 of its first written submission that:
… the semantic distinction between an exclusion and an exemption would not, in any
event, be determinative. Rather, the test under subparagraph (ii) is whether tax on the
income now excluded would be otherwise legally owed to the government.
11. That is indeed the test, as the EC has insisted in its written submissions. The EC awaits with
interest to see whether the US will finally admit the existence of a subsidy when it comes to answer
the first question to it from the Panel, in which the Panel correctly points out that the term “qualifying
foreign trade income” – and thus the exclusion from tax – is defined as an amount “which, if
excluded, will result in a reduction of the taxable income of the taxpayer” by a defined amount.
(These amounts being, as the EC has explained
3, arithmetically identical to the amounts excluded
under the FSC scheme.)
3. What is a category of income?
12. The FSC Replacement Act is constructed around the statement of the Appellate Body 4 that
A Member, in principle, has the sovereign authority to tax any particular categories of
revenue it wishes. It is also free not to tax any particular categories of revenues.
13. The Panel may have noticed that the US omits 5 the words “in principle” when quoting the
Appellate Body and that it also omits to mention that the Appellate Body immediately went on to say:
But, in both instances, the Member must respect its WTO obligations.
14. The US contention is therefore that “extraterritorial income” is a category of income and that
it has the sovereign authority not to tax it.
15. The EC does not accept that “extraterritorial income” can be considered a “category of
income” in the sense this term was used by the Appellate Body. It does not agree that any arbitrarily
defined category of income can be excluded from tax, since otherwise Article 1.1(a)(1)(ii) of the SCM
Agreement, which makes “revenue forgone” a form of subsidy, would be devoid of meaning.
16. As we have said in our second written submission 6, the correct meaning of “category” in this
context is “classes of income” or “types of income”. For the EC, this means income created in
different ways.

4 Appellate Body Report, paragraph 90.
5 See e.g. first written submission of the US, paragraphs 64 and 74.

17. Textual support for this position can be found in the SCM Agreement where different types of
direct taxes are listed as:
taxes on wages, profits, interests, rents, royalties, and all other forms of income, and
taxes on the ownership of real property; 7
18. The EC notes that a similar categorisation of different types of income is found in section 61
of the IRC. 8
19. These are the different types of income that WTO Members have in principle the sovereign
authority to tax or not to tax.
20. For example, if a Member decides not to levy taxes on the ownership of real property – or
even business profits – it would not in this way be creating a subsidy.
21. But “extraterritorial income” is not such a category of income. Even less so is the truly
“excluded income”, “qualifying foreign trade income”. In reality, the US has introduced a conditional
exemption – or exclusion – from tax on some of the business profits that would otherwise be taxable
under the US system.
4. He who can do more cannot always do less
22. The next fundamental error of the US is to assume that if it can exclude the whole of a
category of income – in its view “extraterritorial income”, in the EC’s view business profits – then it
must be able to exclude part of it. This leads the US to proclaim a fundamentally erroneous principle
when it states
That an exclusion is qualified or moderated, however, does not convert it into a
subsidy under Article 1.
 9
23. As the EC has pointed out, the very essence of a subsidy is that a government gives to some
but not to others. The principle “he who can do more can do less” may apply to the amount of an
exemption but it does not apply to the scope of exemptions - or, indeed to the conditions attached to
an exemption (just as it cannot justify discrimination). 10
5. What is the correct analytical framework (or benchmark) for assessing export
contingency?
24. The US is correct when it says that there is a difference in “ analytical framework” 11 between
the EC and the US in considering whether the new scheme is contingent upon export performance or
not.
25. As the EC has explained in its second written submission, it is the US analytical framework
that does not correspond to the SCM Agreement, not that of the EC. 12

7 Footnote 58 to the SCM Agreement, which reads:
For the purpose of this Agreement:
The term "direct taxes" shall mean taxes on wage s, profits, interests, rents, royalties, and all
other forms of income, and taxes on the ownership of real property;
8 See Exhibit US-4.
9 Second written submission of the US, paragraph 91.
10 Second written submission of the EC, paragraphs 79 to 80.
11 First written submission of the US, paragraph 130.

26. Just as the essence of a subsidy is a difference of treatment, and it is necessary to compare one
situation to a relevant benchmark, so can contingency only be understood if one situation is compared
with another.
27. The US claims that there is no textual basis in Article 3.1(a) of the SCM Agreement for the
EC approach of comparing the treatment of an export transaction with a domestic sale. But the US
approach also requires a comparison. The comparison the US is urging the Panel to make is between
the sale of US-produced goods for export and the sale of foreign-produced goods for final
consumption outside the US. Where, the EC would ask, is it said in the text of Article 3.1(a) that this
is the relevant comparison?
28. It is clear there must be a comparison. Both parties in fact accept this.
29. The correct approach must be established by correctly construing the SCM Agreement and
correctly applying it to the circumstances of the case.
30. The EC will not repeat its detailed arguments but simply develop its point that one must
compare like with like. The US is comparing like with unlike. Let us explain.
31. The FSC Replacement scheme is a transaction-based subsidy. The subsidy operates through
the reduction in the amount of tax payable on the profit arising from a particular transaction. In
addition, a taxpayer is entitled to choose transaction by transaction whether or not to use the FSC
Replacement scheme at all
 13 and which method he will use to calculate the amount of “excluded
income”. 14
32. Accordingly, it is necessary to look to the transaction that the taxpayer is conducting. A US
producer of goods has, in the normal course of its business, a choice between selling to a domestic
purchaser or to a foreign purchaser. In the former case he does not receive the subsidy, in the latter,
he does. That is the correct analysis and clearly shows the export contingency of the subsidy; the
subsidy is only received if the goods are exported.
33. The US would have you compare the sale by the US taxpayer of a good he has produced in
the US to a foreign purchaser with the sale by the US taxpayer of a foreign-produced good to a
foreign purchaser in order to conclude that there is no export contingency.
34. That this is not the correct comparison is already evident from the fact that, if the US taxpayer
opts to sell the foreign-produced good, he still has the US-produced good. What is he to do with it?
The answer is simple. He will either sell it domestically or export it and so is confronted with the real
choice – that which the EC has argued is rele vant! Accordingly, the subsidy is contingent upon
export performance.
6. There may be export-contingent subsidies within a broader programme
35. The US would have us believe that because there are, at least in theory, a number of ways to
obtain the FSC Replacement subsidy, other than by exporting, this absolves the whole programme
from a finding of export contingency. However, the SCM Agreement prohibits “subsidies” which are
contingent upon export performance as well a subsidy programmes. In the case of the FSC

12 First written submission of the EC, Section 3.3.2 (paragraphs 74 to 103) and second written
submission of the EC, Section 4.3.1 (paragraphs 98 to 110).
13 See new section 942(a)(3) of the IRC.
14 See new section 941(a)(2) of the IRC.

Replacement subsidy, the EC does not dispute the theoretical possibility for the benefit to become
available without exporting. However, the fact that this possibility exists does not mean that all
subsidies granted under the Act are not export-contingent.
36. The Appellate Body, in Canada-aircraft15, stated that benefit does not exist in the abstract. In
the same way, export contingency does not exist in the abstract; it must be analysed with regard to the
recipient, transaction and product concerned. The US approach would render the SCM disciplines
completely ineffective.
37. The EC has cited the example of the Technology Partnerships Canada programme, the subject
of the Canada –Aircraft proceeding, as an illustration of a case where an export contingent subsidy
was included within a broader programme. The US, having ignored this argument when responding to
the EC’s first written submission, replied to the same argument brought by Canada saying that that the
TPC was a de facto export contingent subsidy and asserting, wrongly, that the EC has not brought a
de facto claim. 16 But the US argument is misconceived in any event. For one thing the Appellate
Body has said that the standard of contingency is the same for both de jure and de facto cases.
Further, how would the US have analysed the Technology Partnerships Canada programme if there
had been a de iure requirement for aircraft manufacturers to export?
38. The Panel will recall that the EC gave further hypothetical examples in its first written
submission to illustrate the how untenable the US position is.
7. Article 3.1(b) of the SCM Agreement must be given meaning
39. The EC’s main point relative to its Article 3.1(b) claim is that Article 3.1(b) must be given
meaning in all its constituent parts.
40. The meaning of Article 3.1(b) must be assessed having regard to the objective pursued by the
drafters when they proposed to include it in the SCM Agreement – namely to avoid the use of
subsidies to promote the substitution of domestic goods for imported goods. 17
41. Article 3.1(b) starts from the notion of “contingency”, and the EC has explained the meaning
of this term. 18 However, the crucial question before you is: contingency on what?
42. The word “contingent” is not isolated in Article 3.1(b), but is immediately qualified by the
clause “upon the use of domestic over imported goods”.
43. That clause - to which the US has given no meaning - means: “use of domestic in preference
to imported” (“de préférence à des produits importés” in the French version of the SCM Agreement;
“con preferencia a los importados” in the Spanish version). The EC has made this clear in its first
written submission as well. 19
44. Accordingly, “contingent … upon the use of domestic over imported goods” means that for a
subsidy scheme to be caught by Article 3.1(b), such scheme must be contingent upon a requirement
that gives preference to the use of domestic goods.
45. In this case, the foreign content limitation is a requirement that gives rise to a preference.

16 Second written submission of the US, paragraph 28.
17See MTN/GNG/NG10/W/29, 22 November 1989; MTN/GNG/NG10/W/ 25, 28 June 1989;
MTN/GNG/NG10/W/27, 6 October 1989.
18 First written submission of the EC, paragraphs 199 and 83.
19 First written submission of the EC, paragraph 165.

46. Under the foreign content limitation the use of US goods will be necessary in some cases .
This flows as a matter of simple logic from the words, the structure and the design of the measure in
dispute. As the Appellate Body found in Canada – Aircraft, contingency in law “is demonstrated on
the basis of the words of the relevant legislation or other legal instrument ”. 20 Therefore, the fact that
the use of US goods will be necessary in some cases is sufficient for a de iure violation of
Article 3.1(b) to be found. Furthermore, the EC has shown with the examples in the Annex to its first
written submission cases where use of US goods will indeed be necessary.
47. In addition to the cases where the cost structure for the finished products is such that use of
US articles will be necessary, there are cases where, to minimise the risk of not meeting the foreign
content limitation, for example because the price of the final product may decrease, or because the
price of foreign component “articles” may increase, the foreign content limitation will make US
producers prefer US “articles”.
48. This “preference” is also covered by Article 3.1(b)’s prohibition, through the language “use of
domestic over imported goods”.
49. The EC has given a meaning to all the clauses in Article 3.1(b), as required by the Vienna
Convention on the Law of Treaties and by the principle of effective treaty interpretation. The EC
notes that the US has not given meaning to the clause “use of domestic over imported goods”. It has
merely replied that (in some cases) the FSC Replacement Act does not require the use of domestic
products 21 and this, in its view, is enough to rule out a case under Article 3.1(b).
50. If a maximum limitation on the use of foreign “articles” were found not to be caught by
Article 3.1(b), WTO Members would be given a clear indication on how to circumvent the prohibition
that they themselves wanted to be written in the SCM Agreement. It would not be difficult at all to
repackage an “affirmative” requirement to use domestic goods into a requirement not to use more than
a certain amount or value of foreign goods.
8. The double taxation defence – international practice
51. We come now to the US’ double taxation defence. The EC gave in its first written submission
a whole series of reasons why the FSC Replacement scheme is a measure to avoid single taxation
rather than double taxation. It will not repeat them now but will respond to the arguments that the US
has added in its second written submission.
52. First, the US suggests in its second written submission that the OECD, the UN, the WTO and
the EC approve or “endorse” the use of both the credit and exemption methods for the avoidance of
double taxation and that the US is thus entitled to use them in any combination.
 22
53. The US forgets to mention the context in which the use of these methods is accepted or
“endorsed.” None of the quoted parties endorse th e use of either of these two methods in situations
where there is no international double taxation present. The aim of the “endorsed” methods is to avoid
such double taxation where there is such double taxation of the same income by two or more
sovereign taxing jurisdictions, not to provide subsidies by using one or the other or both.
54. What is unprecedented in the FSC Replacement scheme, and turns it into a subsidy, is to grant
double taxation relief in situations where there is no such double taxation. As the EC has explained in

20 Appellate Body Report, Canada - Aircraft, paragraph 167.
21 Second written submission of the US, paragraph 200.
22 Second written submission of the US, paragraphs 35 to 37.

its written submissions, the FSC Replacement Act excludes income from tax where other countries do
not seek to tax that income. 23
55. It is true that income excluded from tax as a result of the extended FSC Replacement subsidy,
may be liable to foreign taxation in some cases. The unprecedented aspect of the extended FSC
Replacement subsidy is not only that it also applies where the economic activity is in the US but that
it can give rise to overcompensation of foreign taxes paid and therefore not only constitutes a subsidy
but also cannot be considered a measure to avoid double taxation.
 24
56. Moreover, although countries sometimes consider it more appropriate to use one or the other
method for different types of income or in diff erent circumstances, it seems unprecedented to allow
taxpayers to choose transaction by transaction to use one or other method.
9. The Purpose of the last sentence of footnote 59
57. The last sentence of footnote 59 to Item (e) of Annex I to the SCM Agreement speaks of
“measures to avoid the double taxation of foreign-source income ” not “measures that avoid the
double taxation of foreign-source income”. The word “to” implies a purpose that is pursued by the
measure and, for the EC, it goes without saying that this must be a bona fide purpose.
58. What, the EC would ask, would be the bona fide purpose of allowing taxpayers to choose
transaction by transaction between two systems of double taxation relief? And if there should be a
good reason for this, why subject the right to make a choice to conditions such as the obligation to sell
“not for ultimate use in the US” and the obligation not to exceed a 50 per cent foreign content, or
exclude from the scheme sales of oil gas or unprocessed timber? The US has supplied no answers to
these questions, which confirms that the purpose of the FSC Replacement scheme is not double
taxation avoidance but the provision of a tax exemption - single taxation avoidance.
10. The fact that some countries might tax some extraterritorial income is no excuse to use
such a system against WTO Members that do not
59. Another argument to which the US has attempted to respond is that the FSC Replacement
scheme cannot be a measure to avoid the double taxation because it provides relief from tax on
business profits that is not generated by a foreign “permanent establishment,” the standard used in
double taxation treaties, and therefore could not be subject to taxation in the other jurisdiction.
 25
60. Here, the US argues that “there are divergent views and practices among countries as to what
brings a non-resident enterprise within a country’s taxing authority” and that therefore it is entitled to
exempt from tax a broad category of income, suggesting that it may somewhere be subject to tax. 26
61. The EC notes that the US has not cited a single example of a country that would tax
“extraterritorial income” earned by US companies. The references that it makes to the tax systems of
the UK and Canada are unconvincing since both of these countries have bilateral tax treaties with the
US.
62. In any event, the legal position in the only EU Member States mentioned, the UK, would not
lead it to tax “extraterritorial income” even if there were no tax treaty with the US.

23 Second written submission of the EC, Section 4.6.2, (paragraphs 186-198).
24 Second written submission of the EC, section 4.6.4, (paragraphs 213 to 218 and 220).
25 Third Party Submission of Canada, paragraph 34; second written submission of the EC,
paragraphs 193 to 198.
26 Second written submission of the US, paragraphs 61 to 64.

63. It can already be seen from a more careful reading of the extract from the treatise which the
US attached to its second written submission 27 that, whatever the situation may have been in the 19 th
Century:
The approach now generally taken by the courts is to ask whether "the operations
from which the profits in substance arise" take place in the United Kingdom".
64. Thus the principle applied in the UK is that a non-resident may be liable to tax on business
profits if its profits “in substance arise” in the UK. The conclusion of sales contracts in the UK may
still be one indicator of trading and therefore of liability to pay tax on business profits in the UK but
the same treatise goes on to say:
if a foreign company sets up an office in the United Kingdom which merely carries
out administrative activities (e.g., the preparation of the foreign company's internal
accounts in respect of sales and purchases) or representative activities (e.g., the
supply of information to potential customers, but not the making of offers for sale or
the negotiation or execution of contracts), the foreign company will not be regarded
as carrying on a trade within the United Kingdom.
65. It does not therefore appear that US “extraterritorial income” would be taxable in the UK
even if the double taxation treaty were to disappear.
66. Finally, the EC would note that even if the US is able to find a country somewhere in the
world that would tax extraterritorial income, this would only justify measures for the avoidance of
double taxation with respect to that country – not with respect to the vast majority of countries that
have committed themselves by treaty not to tax business profits unless there is a nexus in the form of
a permanent establishment in their territory.
11. The last sentence of footnote 59 is limited to foreign-source income
67. An even clearer reason why the FSC Replacement scheme cannot benefit from the alleged
defence in the last sentence of footnote 59 is that this can in any event only apply to foreign-source
income.
68. The limitation in footnote 59 to foreign-source income is clearly no accident. It is only
foreign-source income that is susceptible to being subject to double taxation and therefore this is the
only case in which the clarification is needed.
69. It is interesting to note that the US definition of foreign-source income 28 is inspired by
precisely the desire to describe a category of foreign-generated income that is likely to be taxed by
foreign countries. Thus the General Explanation of the Tax Reform Act of 1986 by the Staff of the
US Congress’ Joint Committee on Taxation states that Congress intention was:
to ensure that … with respect to US persons, [the US] will treat as foreign-source
income only that income which is generated within a foreign country and which is
likely to be subject to foreign tax.
 29

27 Exhibit US-17.
28 There is no express definition of this notion in US law but it is implicit in sections 861 to 865 of the
US IRC.
29 See Exhibit EC-15, at page 918.

70. In answering the arguments of Australia and Canada, the US persists in confusing income and
receipts. 30 The fact that the price for goods sold “not for ultimate use in the US” is received from
foreigners may mean that the receipts are foreign but not that the income, that is profit, from such
sales is foreign.
71. This confusion is all the more puzzling when one considers that the FSC Replacement Act
distinguishes itself between income and receipts by providing in new section 941(a)(1) that the tax
exclusion can be calculated either as 1.2 per cent of receipts or as 15 (or 30) per cent of income, that is
profit.
72. This deliberate confusion between income and receipts allows the US to pretend that the
profit which it is sheltering from tax somehow has its source outside the US. Again it is only the
receipts that may have a foreign source (because th ey derive from sales “not for ultimate use in the
US”), whereas the profit is allowed to be generated entirely from economic activities conducted in the
US.
12. Article III:4 of GATT prohibits incentives to domestic products
73. Mr Chairman, distinguished Members of the Panel, since in our view the foreign content
limitation violates Article 3.1(b), we may be relatively brief in our discussion of Article III:4 of
GATT 1994.
74. It seems to us that there is not much to add on the EC claim under Article III:4 of GATT
1994. The US has hardly replied to it. To the extent that it replied, it has not addressed the substance
of the EC claim, but has rather (1) alleged that the EC incorrectly described the foreign content
limitation – in fact itself mischaracterizing the EC’s arguments, and (2) alleged lack of evidence – in
fact setting a standard of proof both vague and unsupported. We will thus only mention the following
points:
• Article III:4 applies to incentives to the use of domestic products
• There is no “heightened evidentiary burden” for Article III:4 claims addressing a
measure of general application
• The local content limitation is a requirement concerning goods, not firms. As this
latter issue is touched upon by one of your questions, we will further elaborate on it in
our reply.
75. The US takes the view that the FSC Replacement Act does not “require” the use of US
manufactured goods.
 31
76. The US however does not deny that there is a foreign content limitation, which it calls itself
the “50 per cent rule”, 32 or even “requirement”. 33 The US has also not contested that the tax benefit
provided for in the FSC Replacement Act can only be obtained if this rule is observed.
77. As we have recalled in the EC first written submission, the term “requirement” in
Article III:4 does not only cover measures whereby “an enterprise is legally bound to carry out” a

30 The US goes as far as saying that “export sales are one form of foreign transaction” – second written
submission of the US, paragraph 57.
31 Second written submission of the US, paragraph 200.
32 Second written submission of the US, Sections E and F.
33 Second written submission of the US, paragraph 200.

requirement, but also cases where “an enterprise voluntarily accepts [to do something] in order to
obtain an advantage from the government”. 34 Requirements falling within the latter group were
reviewed e.g. in EEC – Parts and Components , Canada – FIRA and most recently Canada –
Automobiles. 35
78. Given that there is no dispute that the “50 per cent rule” must be met in order to obtain the tax
benefit, there is thus no disagreement between the parties that there is a “requirement” within the
meaning of Article III:4 of GATT 1994.
79. For the record we would like to correct the US quotations from the EC’s first written
submission. 36 The first two of these quotations use the word “requirement” in the sense that this
word is given under Article III:4. The third quotation does not refer to the FSC Replacement Act, as
the US indicates, but to one of the items in the TRIMS Agreement Annex.
80. The EC in any event has made clear that in its view the Act dos not contain an express
obligation for US producers to use US “articles”.
 37 Its arguments quoted by the US cannot therefore
be taken to mean the contrary.
81. The foreign content limitation is a requirement that affects the “sale … purchase … or use”
of goods and affords less favourable treatment to imported goods than US goods. The EC has shown,
in connection with its claims under Article 3.1(a) and 3.1(b) of the SCM Agreement, that limiting the
use of foreign articles will, in fact, effectively necessitate the use of US products for goods for which
the value of raw materials and components accounts for more than 50 per cent of the total price. But
it would recall that Article III:4 also covers hypotheses where, short of a necessity to use domestic
goods, a producer will be induced to do so. Any requirement that “affects” the sale .. purchase ... or
use” of goods is caught by Article III:4. As indicated by the Appellate Body in EC – Bananas , the
word “affecting” “implies a measure that has ‘an effect on’, which indicates a broad scope of
application.”
 38
82. The foreign content limitation affords “less favourable treatment” to foreign “articles” which
can compose “qualifying foreign trade property” because it places “articles” of US origin at a
competitive advantage vis-à-vis the like products of foreign origin. When all other competitive
conditions are equal, the purchase of domestic products will offer the additional advantage of
facilitating the US production to be considered as “qualifying foreign trade property” and obtain the
benefit of the FSC replacement scheme.
83. A similar situation was before the panel in the Canada - FIRA case. At issue there were
certain purchase undertakings, the offering of which was a condition for foreign investors to have
their investments in Canada authorized.
 39 Some of these undertakings concerned offers to source
Canadian products only if available at competitive conditions with the like imported products
(“competitively available”). The panel found these undertakings contrary to Article III:4 because
where the imported and domestic product are offered on equivalent terms, adherence
to the undertaking would entail giving preference to the domestic product. Whether

34 Panel Report, EEC - Parts and Components , quoted in footnote 69 of the First written submission of
the EC; First written submission of the EC, paragraphs 191 to 195.
35 First written submission of the EC, paragraph 201.
36 First written submission of the US, paragraph 213, referring to paragraphs 203, 206 and 217 of the
first written submission of the EC.
37 See e.g. in paragraph 194 of the first written submission of the EC.
38 Appellate Body Report, EC - Bananas, paragraph 220.
39 Panel Report, Canada – FIRA, paragraph 5.4.

or not the foreign investor chooses to buy Canadian goods in given practical
situations, is not at issue. 40
84. These considerations can a fortiori apply in this case. As explained, the fact that, by using
domestic inputs, a US producer is sure not to be excluded from the possibility to obtain the tax
benefit, is an advantage that is conferred by the government to US products and that discriminates
against like imported products.
85. The only other reply of the US to the EC’s Article III:4 claim is the creation of a new standard
of proof for cases involving measures of general application (as opposed to product specific
measures). Contrary to the US contention, however, there is no “heightened evidentiary burden”
for challenges of general measures under Article III:4 of GATT 1994.
86. The EC will simply refer the Panel to previous panel reports which it has relied upon in its
first written submission
 41 and which likewise reviewed measures of general application. These are:
• Canada - FIRA
• US - Section 337
• EEC - Parts and Components
87. In none of the above cases did a panel set out a different, let alone “heightened”, evidentiary
burden of the type advocated by the US in its first written submission. At any rate, Panels addressing
claims under Article III:4 have referred indifferently to previous cases where general measures or
product specific measures had been reviewed. Moreover, they have pointed out that
the requirement of Article III:4 is addressed to ‘relative competitive opportunities
created by the government on the market …’;
and that
“a determination of whether there has been a violation of Article III:4 does not
require a separate consideration of whether a measure affords protection to domestic
production” 42
It is not by chance that the US has not been able to refer to any authority in support of its newly
created standard of proof.
88. Even assuming, arguendo, that some reference to the functioning of a “requirement” of
general application in respect of classes of products were to be provided, the EC has furnished
evidence in its Annex as to sectors where the use of US inputs is necessary. A fortiori this evidence
will be enough to support beyond doubt that the “requirement” under review affords less favourable
treatment because it makes, all other conditions being equal, domestic inputs more attractive than
foreign ones.

40 Panel Report, Canada – FIRA, paragraph 5.4 (emphasis added).
41 First written submission of the EC, paragraphs 191 ff.
42 Panel Report, Canada – Automobiles , paragraph 10.78; first written submission of the EC,
paragraph 201 and footnote 73.

13. Confidential Exhibit US-9
89. The EC’s immediate reaction to confidential Exhibit US-9 is: So what?
90. The EC does not doubt that there must be one or other company in the world that might
consider domesticating, depending on the precise conditions that are eventually adopted by the US.
The EC’s case on Article 3.1(a) is, as the Panel well knows by now, not that no foreign company will
use the extended FSC Replacement subsidy but that the basic FSC Replacement subsidy is still
contingent upon exportation and that in many cases the use of the extended FSC Replacement subsidy
will require the use of US articles by foreign companies.
91. If the Panel does consider the information in exhi bit US-9 to be relevant to its decision in this
case, the EC has a number of clarifications and questions to ask on it which it would ask the Panel to
put to the US and to the company making the statement in Exhibit US-9 under the powers available to
it under Article 13 DSU.
92. For the time being, the EC would simply note that the US has only produced a statement from
one company with an intent to use the extended FSC Replacement subsidy and that that company is
only one of 50 significant foreign subsidiaries43 of the US parent.
Thank you for your attention.

43 Source: The US parent corporation’s report to the US Securities and Exchange Commission, files
29 March 2000.

List of Exhibits
EC-14 Extract from the BNA Daily tax report of 8 March 2001 (quoting Dirk Suringa of the
International Tax Counsel’s Office at the US Department of Treasury).
EC-15 Extract from the General Explanation of th e Tax Reform Act of 1986 by the Staff of the US
Congress’ Joint Committee on Taxation.

ANNEX D-2
CLOSING STATEMENT OF THE EUROPEAN COMMUNITIES
(16 March 2001)
Mr Chairman, Members of the Panel,
1. Thank you for listening to us so carefully these last days and for your stimulating questions.
We attach a written version of the answers that we have already given and will provide fuller and
more refined answers by your deadline of 27 March.
2. We would like to make a number of concluding remarks to highlight a number of key issues
arising out of the debate.
1. The objectives and effects of the FSC Replacement Act
3. One frustrating – yet illuminating – feature of our debate has been the extent to which the US
has responded that it does not know the reasons for and the effects of many provisions of the FSC
Replacement Act.
4. It is worth passing in review these US avow als of lack of justification, explanation and
analysis:
• The estimated effects on tax revenue of the new legislation; 1
• The factors that were considered to give rise to the increased tax expenditure; 2
• The reasons certain products cannot give rise to excluded income; 3
• The reasons why is the President allowed to exclude other categories of products in short supply; 4
• The reasons for and anticipated effects of the so-called 50 per cent rule; 5

1 [Question 2] How does the increased expendit ure compared to the FSC indicated by the
Congressional Budget Office arise? Answer: The US does not know.
2 [Question 3] What part of the increased tax expend iture is attributed to a wider product coverage of
the current law (defence products), and how much to other factors (e.g. transactions involving goods
manufactured abroad)? The US does not know.
3 [Question 6a] Why are there five categories of products (e. g. such as oil and softwood timber) which
cannot give rise to excluded income? The US does not know.
4 [Question 6b] Why is the President allowed to exclude other categories of products in short supply?
The US does not know.
5 Question 12: What are the objectives of the 50 per cent rule? The US does not know.
[Question 13] What are then the effects of the 50 per cent rule? The US does not know.

• Whether and how the FSC Replacement Act applies to foreign-produced agricultural products, in
particular crops and commodities. 6
5. The legislative history makes clear however that the US administration was closely involved
in the passage of this bill and should have been able to provide explanations of the purposes and
effects of the FSC Replacement Act. This is already evident from the following statement of US
President Clinton on signing the FSC Replacement Act into law:
…Enactment of this legislation is possible due to extraordinary bipartisan cooperation
between the Congress and my Administration and the strong involvement of the
business community.
 7
6. In the light of this unhelpful attitude of the US, the EC provides the Panel with the following
elements of legislative history contained in the documents we have attached to this statement which
further illustrate the attention that was paid to the provisions, their objectives and intended effects:
7. First, Government Press Release “Committee passes FSC Repeal and Extraterritorial Income
Exclusion Act of 2000 ”, 27 July 2000 (Exhibit EC –17).
We are considering one of the most important bills of this Congress. It is critical for
continued US competitiveness in the global marketplace. It is critical for our
economy. And most important, it is critical to preserve tens of thousands of jobs for
American workers and their families. I believe the approach in this legislation is the
best way to comply with the decisi on, continue honour our trade agreements
consistent with the obligations they impart, and maintain our global competitiveness.
This is a complex issue, but we must succeed for the most basic reason,” said
Chairman Bill Archer (R-TX).
We’ve had a group of top tax and trade experts led by Deputy Secretary Eizenstat
working non-stop for months to find a way to satisfy the WTO dispute resolution
body…” said ranking Minority Member Charles Rangel (D-NY).
 8
8. Second an extract from Worldwide Tax Dail y, 24 July 2000, “US Congressional taxwriters
discuss FSC legislation”, Goulder, Robert; Donmoyer, Ryan J; Tax Analysts (Exhibit EC – 18).
US Treasury Department officials met with US Congressional taxwriters late on
21 July to discuss the draft legislation that would revise the foreign sales
corporations (FSC) statutes and make the tax regime WTO-compliant.
The purpose of the closed-door discussions was to advice key legislative assistants on
the details of the FSC draft before the House Ways and Means Committee considers
the measure…
The draft legislation is largely based on the proposed FSC replacement that US
Deputy Secretary Stuart Eizenstat presented to EU Trade officials in May. During the

6 [Question 16] Is there any guidance on how the FSC Replacement Act applies to foreign-produced
agricultural products, in particular crops and commodities? US does not have any guidance.
7 Exhibit EC–16: Clinton Statement on signing FSC Repeal Legislation into law – The White House
office of the Press Secretary, Hanoi (Vietnam), 17 November 2000.
8 Exhibit EC-17 – Government Press Release “C ommittee passes FSC Repeal and Extraterritorial
Income Exclusion Act of 2000”, 27 July 2000.

past week, the US Joint Committee on Taxation has translated Treasury’s proposal
into statutory language… 9
9. Next the exhibit we distributed this mornin g, an extract from the Congressional Record,
House of Representatives, 14 November 2000 (Exhibit EC-19)
On page H11891, Congressman Levin explains:
“At the same time, and I emphasize this, as it is clear from the bill itself in the
committee report, this bill does not provide an incentive for US producers to move
their operations overseas. It carefully defines the property that can be involved in
transactions subject to the new tax regime. No more than 50 per cent of the fair
market value of such property can consist of (a) non US components, plus (b) non-US
direct labour. This provision has been carefully reviewed by those of us on the
Committee on Ways and Means as well as the Department of Treasury, and I might
add, minority leader.”
On Page H11893, Congressman Rangel explains:
“Mr Speaker, let me thank the chairman of the Committee on Ways and Means, the
gentleman from Texas (Mr Archer), my fellow Democrats, and join my colleagues on
the floor in asking support for this piece of legislation, which is supported by the
President and which our official Secretary Stuart Eizenstat, assistant Secretary Jon
Talisman, have worked on, as well as the Senate, which has made some changes.”
On page H11894, Congressman English states:
“This is a critical legislation to protect the jobs of working families who have
members who work in some of our best paying export oriented jobs in America…”
On page H11896, Congressman Defazio states:
“Apparently not bothered by the hypocrisy, immediately after the ruling by the WTO
appeals panel, the Clinton Administration, a few members of Congress, and the
business community openly declared the need to maintain the subsidy in some form
and began meeting in secret to work out the details on how to circumvent the WTO
ruling and maintain these valuable, multi-billion dollar tax incentives."
2. The Existence of a Subsidy
10. The US is asking the panel to accept the proposition that a WTO Member has an apparently
unlimited right to exempt any type of income from taxation and then claim that it is not granting a
subsidy because it has changed the prevailing benchmark against which the existence of a subsidy
must be measured. Taken to its logical conclusion, this approach would mean that revenue would
never be foregone under Article 1 of the SCM Agreement, because such revenue would never be
“otherwise due”, the Government in question having already moved the “outer boundary” of its tax
jurisdiction to accommodate it. In these circumstances, there would be no subsidies derived from tax
exemptions, which would come as quite a shock to many people in the US, notably the Import
Administration of the Department of Commerce, which regularly imposes countervailing duties

9 Exhibit EC-18 – Worldwide Tax Daily, 24 July 2000, “US Congressional taxwriters discuss FSC
legislation”, Goulder, Robert; Donmoyer, Ryan J; Tax Analysts.

against such measures taken by third countries. The EC has given examples of such measures in its
questions to the US.
11. The US claims that by exempting extraterritorial income (or at least some of it) from US tax,
it is exercising its sovereign right not tax certain income. What it is in fact doing is exercising its
sovereign authority to grant a subsidy. There is nothing inherently wrong with this, except that, as
explained later, these subsidies fall into the prohibited category.
3. The Export Contingency
12. The Act requires goods to be sold for ultimate us e outside the US. The US continues to
overlook the obvious fact that there is only one way for the subsidy to be obtained in respect of
transactions involving US goods - by exporting. In its oral statement, the US even went as far as
saying that US producers are not obliged to export in order to obtain the subsidy, since they could, for
example, decide to produce abroad and thus generate excluded income.
13. On the basis of this logic, all SCM Agreement disciplines would be reduced to inutility. For a
start, no subsidy would ever be specific. There would be no regional specificity, since any firm could
move to an eligible region. There would be no sectoral specificity, since any firm could diversify into
the eligible sector. Yet the US Department of Commerce, in its CVD practice, maintains that
subsidies limited to certain regions or sectors are specific. We have no reason to disagree with their
approach.
14. As we have said, contingency, like benefit, does not exist in the abstract. The question of
export contingency has to be determined with regard to the actual recipients of the subsidy.
15. The US, in adopting this law, knew that it was adopting a measure to promote exports – as
evidenced by the statements above. This is also clear from the terms of the Act. The US has not been
able to explain why products in short supply are excluded. The answer we submit is simple – because
the US does not want to promote the export of such products.
4. The Foreign Content Limitation
16. We have noted above that an explanation for th e foreign content limitation is contained in the
legislative history - Mr Levin’s statement that:
… this bill does not provide an incentive for US producers to move their operations
overseas. It carefully defines the property that can be involved in transactions subject
to the new tax regime. No more than 50 per cent of the fair market value of such
property can consist of (a) non US component s, plus (b) non-US direct labour. This
provision has been carefully reviewed by those of us on the Committee on Ways and
Means as well as the Department of Treasury, and I might add, minority leader.
5. The Act mandates the granting of prohibited subsidies
17. This brings us to a more legal point. That is that the Act is inconsistent with the SCM
Agreement because it mandates the granting of prohibited subsidies if taxpayers fulfil the conditions.
The text does not preclude that these subsidies will be granted. The US tax authorities have no
discretion not to allow it where, for example, the subsidy would be contrary to Article 3.1(b).

6. The Double Taxation defence
18. The first point the EC has highlighted in connection with the US double taxation defence is
the absence of any indication in the legislative history of any double taxation problem. The EC would
refer you again to the extracts from the legislative history in the exhibits; nowhere is there any talk of
a double taxation problem.
19. One reason why the defence is untenable because of the fact that under the FSC Replacement
Act a US exporter does not need to perform any activities outside the US that could give rise to
income that other countries would seek to tax.
20. In this context, the EC has emphasised the significance of the internationally recognised rule
that business profits of non-resident enterprises may only be taxed if they arise in connection with a
‘permanent establishment.’
21. This rule is evidenced by Articles 5 and 7 of the OECD Model Tax Convention, which both
the EC and the US rely on as evidence of international practice.
22. Since excluded income may only arise from business activities, countries other than the
country of the taxpayer’s country of residence may only legitimately tax the profits from such
activities if they are derived from business activities carried on through a permanent establishment.
23. The US has suggested that Article 5.5 of the Convention would somehow establish a lower
threshold for the existence of a permanent establ ishment, even in the absence of a permanent
character of the foreign activities. In support of these arguments the US has made incomplete
quotations of the said paragraph of Article 5 and its Commentary. The EC considers that both
Article 5.5 and its Commentary merit to be read in full.
Notwithstanding the provisions of paragraphs 1 and 2, where a person – other than an
agent of an independent status to whom paragraph 6 applies – is acting on behalf of
an enterprise and has, and habitually exercises, in a Contracting State an authority to
conclude contracts in the name of the enterprise, that enterprise shall be deemed to
have a permanent establishment in that State in respect of any activities which that
person undertakes for the enterprise, unless the activities of such person are limited to
those mentioned in paragraph 4 which, if exercised through a fixed place of business,
would not make this fixed place of business a permanent establishment under the
provisions of that paragraph. (Article 5.5 emphasis added)
24. In addition, the Commentary to Article 5.5
 10 clearly points out that
The use of the term ‘permanent establishment’ in this context presupposes, of course,
that that person (the dependent agent) makes use of his authority repeatedly and not
merely in isolated cases. 11
25. The Commentary further notes that
It should be borne in mind, however, that paragraph 5 simply provides an alternative
test of whether an enterprise has a permanent establishment in a State” 12.

10 Exhibit US-18.
11 Commentary to Article 5.5 (paragraph 32).
12 Commentary to Article 5.5 (paragraph 35).

26. Thus, Article 5.5 only establishes an alternative test to that present in paragraphs 1 and 2, and
by no means suggests that a permanent establishment would exist without a substantial degree of
permanence.
27. Contrary to the US claim that the EC in its second written submission had omitted parts of
Article 5 and implied that the concept of permanent es tablishment in it is limited to the existence of a
fixed place of business the EC, when making its second written submission, had carefully considered
the full scope of Articles 5 and 7 of the Convention and concluded that the FSC Replacement Act
does not in any way require the performance of su ch foreign activities which would constitute a
permanent establishment for a US taxpayer eligible for the subsidy.
28. It is indeed of utmost importance to bear in mind that the foreign economic processes
requirement in the FSC Replacement Act is based on a percentage cost test and that it can be met
without undertaking any activities outside the US. In this context it is equally important to bear in
mind that US taxpayers wishing to be eligible for the subsidy can outsource to independent third
parties all the activities, if any, that are to be performed outside the US. It follows that foreign
jurisdictions would not seek to assert any taxing rights on the excluded income as defined under the
FSC Replacement Act, and that it is not meant to serve as a measure to avoid double taxation.
7. Footnote 59
29. The EC has explained that the exact status and meaning of footnote 59 does not have to be
established in this case. It is sufficient to note that the FSC Replacement Act is not a measure for the
avoidance of double taxation and is not limited to foreign-source income.
30. Whether one considers that this is a reference to a WTO standard or must be assessed, like
revenue forgone, by reference to the tax system of the country concerned, the FSC Replacement Act
does not satisfy the condition.
8. Article 3.1(b) of the SCM Agreement and Article III:4 of GATT 1994
31. The best way to sum up on Article 3.1(b) is to recall what you have asked the US in
question 9.
32. Article 3.1(b) as we have said, prohibits conditions that give preference to domestic products
in any cases.
33. The US itself admitted that there can be cases where use of US articles will be needed.
34. This a fortiori will mean that the foreign content limitation will provide an incentive to
domestic products within the meaning of Article III:4.

List of Exhibits
EC-16 President Clinton Statement on signing FSC Repeal Legislation into law – The White House
office of the Press Secretary, Hanoi (Vietnam), 17 November 2000.
EC-17 Government Press Release “Committee passes FSC Repeal and Extraterritorial Income
Exclusion Act of 2000”, 27 July 2000.
EC-18 Worldwide Tax Daily, 24 July 2000, “US Congress ional taxwriters discuss FSC legislation” ,
Goulder, Robert; Donmoyer, Ryan J; Tax Analysts.
EC-19 Congressional Record, House of Representatives, 14 November 2000.
EC-20 US Regulation on the operation of the FSC scheme dated 6 March 2001.

ANNEX D-3
ORAL STATEMENT OF THE UNITED STATES
(13 March 2001)
I. INTRODUCTION
1. Mr. Chairman, Members of the Panel: On behalf of the US delegation, I want to thank you
for the opportunity to appear before you today. We are aware of the large number of issues before the
Panel, the volume of materials submitted to the Pa nel, and the gravity of the issues the Panel must
weigh. We are grateful for your willingness to take on this considerable challenge and appreciate
your service in trying to resolve this dispute and advance the aims of the multilateral system.
2. As the Panel well knows by now, the United St ates does not believe that the EC has met its
burden of establishing that the FSC Repeal and Ex traterritorial Income Exclusion Act of 2000 –
which I will hereafter refer to as "the Act" – is inconsistent with US WTO obligations. From our
perspective, the EC appears to view the Act as somewhat unusual and for that reason maintains that it
must somehow be inconsistent with WTO rules. Th e EC appears to think that the Act is different
from measures it is familiar with that attempt to achieve similar ends. The EC objects to the fact that
it borrows aspects of European tax regimes only in part, or follows OECD guidelines only in part.
And, the EC just doesn’t think the Act is sufficiently different from the FSC.
3. However, these are not reasons to find a measure to be incompatible with treaty obligations.
Instead, they are ad hoc, ex post facto justifications for reaching a desired outcome.
4. This type of “I know it when I see it” approach advocated by the EC, while convenient for the
EC in terms of its immediate objectives, cannot serve the DSU’ s objective of providing "security and
predictability to the multilateral trading system."
1 It also is ill-suited to "achiev[e] a satisfactory
settlement of the matter".2
5. For these reasons, the DSU requires that disputes be governed by the “customary rules of
interpretation under public international law”.
3 Indeed, it is extremely ironic that in the first round of
this dispute, the EC insisted on strictly adhering to the text of the relevant agreements as interpreted in
accordance with customary rules of interpretation. The EC chided the United States for relying on
material other than the text, such as the 1981 Understanding. The Panel and the Appellate Body
essentially agreed with the EC.
6. Now, however, the situation appears to be reversed, and it is the United States, not the EC,
that is adhering to the text. As discussed in the US submissions, the United States followed the text
and the decision of this Panel and the Appellate Body in designing the Act. Yet, after doing so, the
United States finds itself subjected to arguments that are non-textual or extra-textual in nature. These
arguments attempt to expand WTO rules beyond their ordinary meaning and, if accepted, would add
new requirements and conditions to WTO provisions that simply do not exist.

1 DSU, Article 3.2.
2 DSU, Article 3.4.
3 DSU, Article 3.2.

II. FUNDAMENTAL ISSUES RAISED BY THIS CASE
7. To reach a decision in this case that comports with proper methods of interpretation and that
will promote the aims of the dispute settlement system, the United States respectfully submits that the
Panel must answer certain essential questions posed by this case about the meaning of the relevant
WTO provisions. The United States will discuss these key questions briefly, and then will respond to
some of the specific arguments raised by the EC in its submissions.
8. In the view of the United States, the major issues are these
First, does the Act confer a subsidy within the meaning of Article 1 of the SCM Agreement
because, while it generally excludes extraterritorial income from taxation, it taxes some
extraterritorial income?
Second, is the Act export contingent under Article 3.1(a) of the SCM Agreement because
exporting is one way, but not the only way, of generating excluded extraterritorial income?
And third, does the Act not constitute a measure to avoid double taxation under footnote 59
of the SCM Agreement because it does not limit its exclusion to the amount of foreign taxes paid?
9. The United States respectfully submits that the answer to each of these questions is no.
A. A TAX EXCLUSION MAY BE PARTIAL AND NOT A SUBSIDY
10. Turning to the question of the partial nature of the Act’s exclusion of extraterritorial income,
it appears to be beyond dispute that a WTO Member can refrain from taxing any category of income it
chooses. As the Appellate Body has explained, Members have “the sovereign authority . . . not to tax
any particular categories of revenue."
4 The question before the Panel, though, is whether a Member
can choose not to tax a category of revenue in part.
11. The difficulty in answering this question is how to define what is a category of income and
under what circumstances might a partial exclusion of a category result in the conferral of a subsidy.
The Appellate Body noted the difficulty of resolving these issues in the abstract, stating that “the word
‘foregone’ suggests that the government has given up an entitlement to raise revenue that it could
‘otherwise’ have raised. This cannot, however, be an entitlement in the abstract, because
governments, in theory, could tax all revenues."
5 The Appellate Body explained that a tax exclusion
must be compared against the “prevailing domestic standard” of the Member in question in order to
determine whether revenue “otherwise due” has been foregone. 6 Therefore, if the “prevailing
domestic standard” of a Member’s tax system would not tax a category of income that is excluded by
a challenged measure, then no revenue can be said to be “otherwise due”.
12. The Act does not forego revenue when compared against any prevailing US standard. There
is no “normative benchmark” that would tax extraterritorial income, unless one presumes in
contravention of the Appellate Body’s reasoning that the United States taxes all income. The Act
provides a definition of excluded extraterritorial income, and that definition, like all definitions,
implies a category of items that meet its terms and a category of items that do not. However, the mere
fact that the statutory definition of excluded extraterritorial income does not describe all income that
the United States could theoretically subject to tax does not render the Act a subsidy. If the Panel
were to conclude otherwise, then any defined cate gory of income that is not subject to tax would

4 FSC (AB), para. 90 (emphasis in original).
5 FSC (AB) , para. 90 (emphasis in original).
6 Id.

constitute a subsidy. A 95 per cent participation exemption for repatriated foreign dividends would be
a subsidy since it results in a tax on the remaining five per cent. And certainly a 75 per cent
exemption for foreign branch income would appear to be a subsidy because the remaining 25 per cent
is subject to tax.
13. If the Panel were to adopt the EC’s circular test of "general rule" versus "exception," the
consequences would be far reaching. Accordingly, if the Panel were to accept the EC’s reasoning, it
would be incumbent upon the Panel to articulate some standard for determining when a rule of
taxation is a "general rule" and when it is not.
14. With respect to the Act, its structure and legislative history indicate that the United States
intended to make the extraterritorial income excl usion part of its "general rule" for US income
taxation. Therefore, it would be necessary for the Panel to explain why the United States did not, or
could not, amend its domestic laws in this manner. In other words, it would be incumbent on the
Panel to provide guidance to the United States – as well as to other WTO Members – as to the criteria
to be applied in writing domestic tax legislation in order to ensure that measures are sufficiently
"general" to avoid an inadvertent subsidy classification. Only in this way would the United States and
other WTO Members have the benefit of understanding where the boundaries of Article 1 begin and
end in this regard.
B. EXPORTING MAY BE ONE WAY OF SATISFYING A NEUTRAL PRINCIPLE
15. Turning next to the question of whether exporting may be one way of satisfying a neutral
principle without creating an export contingency, the United States has explained that the Act applies
to a broad array of foreign transactions involving goods destined for use or consumption outside the
United States, regardless of where such goods are manufactured. It would seem that this aspect of the
Act, without more, is not sufficient to implicate Article 3.1(a). Exportation may be one way of
satisfying the prerequisites for a number of subsidies that presumably all Members of the WTO would
agree are not prohibited export subsidies.
16. It is unclear to what extent any companies would necessarily have to export in order to satisfy
the requirements of the Act, but that is an incide nce of a tax exclusion for foreign or extraterritorial
income. The fact that exporting may be one way of satisfying the export-neutral conditions of the Act
does not make the Act “conditioned” or “dependent for its existence” on export performance.
17. The EC, however, has suggested that the group of companies who will export in order to earn
extraterritorial income is relatively large because the EC believes non-export transactions under the
Act are limited by the 50-per cent value rule. The United States has disputed this unsubstantiated
assertion. However, if the Panel were to give the EC’s allegations credence, and were to find that it
results in a violation of Article 3.1(a), the United States submits that the Panel must make clear
whether any such violation is the result of the application of the 50-per cent rule or whether the
exclusion of extraterritorial income in and of itself is export contingent.
18. One last point on export contingency must be raised. The EC has alternatively complained
that the Act’s exclusion of extraterritorial income is improper because, in the EC ’s view, the
United States has merely added a limited class of non-export transactions to the exports covered by
the FSC. The EC maintains that this is inadequate because a WTO Member cannot remedy an export
subsidy by expanding its application. At the same time, the EC charges that the Act is deficient
because it also is not broad enough, since it does not apply to imports.
19. Clearly, one of these arguments cannot be correct. The United States has explained that
neither is correct. The Act does not require exportation at all and therefore is not export contingent.
Because these issues go to the heart of this case, the United States requests that the Panel clarify:

(a) whether the fact that exporting is merely one way of earning excluded income under the Act is not
enough to condemn the Act under Article 3.1(a); or (b) whether the fact that the Act does not apply to
imports does condemn the Act under Article 3.1(a).
C. A MEASURE TO AVOID DOUBLE TAXATION MAY BE PREVENTIVE IN NATURE
20. Another area that demands full and reasoned analysis by the Panel is the question of what
footnote 59 means when it refers to measures to avoid double taxation of foreign-source income. As
is the case with regard to subsidies and export contingency, clear guidance is needed in this important
area in order to secure a quick and final resolution of this dispute.
21. The EC has asked the Panel to impose a number of conditions on what constitutes a measure
to avoid double taxation that cannot be found in the text of footnote 59. It has said that such measures
must require taxpayers to have “permanent establishments” in foreign jurisdictions. It has claimed
that such measures can only apply to income directly attributable to foreign economic processes of
taxpayers. It has argued that WTO Members cannot use both exemptions and credits. It has even
gone so far as to maintain that a Member must show a “necessity” for instituting such a measure and
that Members must adhere to the details of the OECD Model Convention.
22. The United States will address these points later but, at the risk of oversimplifying things, the
issue may be reduced to the following: are Members precluded by the SCM Agreement from taking
prophylactic steps to prevent their taxpayers from being subjected to taxation both at home and in a
foreign jurisdiction? The language of the fifth sentence of footnote 59 suggests that such a preventive
approach is permitted, because that sentence begins by saying that paragraph (e) of the Illustrative
List does not “limit the ability of Members” to “avoid” double taxation.
23. The United States does not contend that the Act provides a narrowly tailored, dollar-for-dollar
offset of foreign taxes paid. However, such limited relief is not all that is allowed by footnote 59, and
measures to avoid double taxation around the wo rld are not so limited. The United States has
explained that the exemption method is prospective in nature and provides for exemption irrespective
of the amount of foreign tax actually imposed. The United States is unaware of any country applying
the exemption method that requires taxpayers to show that they have been taxed on all income eligible
for exemption and that application of the exemption wo uld not result in an overall tax savings. It is
instructive to note that in this dispute, only Australia – a third party – has proposed such a narrow
reading. EC member states do not prevent their taxpayers from netting an overall tax savings, and, for
that reason, it is not surprising that the EC has not advocated Australia’s argument. Instead, the EC
has attempted to read into footnote 59 narrowing conditions that cannot be found in the ordinary
meaning of the relevant text.
24. The key issue in this context is whether a meas ure comes within the scope of footnote 59 if it
excludes from taxation income that could be subjected to foreign taxation and thus doubly taxed. The
United States believes that excluded extraterritorial income legitimately could be subject to taxation in
a foreign jurisdiction. At the same time, the Act is sufficiently flexible to meet the varying criteria
that foreign nations rely upon in asserting taxing jurisdiction. Accordingly, the United States believes
that the Act comes within the fifth sentence of footnote 59.
25. To the extent that the Panel finds that footnote 59 does not allow Members to take a
preventive approach to avoiding double taxation, the United States respectfully requests that the Panel
explain what conditions or limitations it finds to be in the footnote. In particular, the United States
requests that the Panel explain whether WTO Members must ascertain on a transaction-by-transaction
basis whether income has in fact been subjected to foreign taxation and whether relief from double
taxation is capped by the amount of foreign taxes paid.

III. THE UNITED STATES HAS RESPONDED TO ALL OF THE EC’S CLAIMS
26. The United States now will address specific points raised by the EC, beginning with a rebuttal
of the EC’s unfounded assertions in its Second Submission that the United States has failed to address
certain EC claims and arguments.
A. THE AVAILABILITY OF THE EXCLUSION OF EXTRATERRITORIAL INCOME TO
NON-EXPORTING TAXPAYERS DEMONSTRATES THE ACT’S EXPORT-
NEUTRALITY
27. The EC incorrectly alleges that the United States did not respond to its argument that the
inclusion of non-export income within the Act’ s ex clusion of extraterritorial income does not place
the Act beyond the reach of Article 3.1(a).
28. To the contrary, the United States explained in its First Submission that the availability of the
exclusion of extraterritorial income for exporters and non-exporters alike reflects the export neutrality
of the Act and that this export neutrality means that the Act does not involve an export contingency
under Article 3.1(a). More specifically, the United States explained at paragraphs 115 to 127 of its
First Submission that the Act applies to a wide array of foreign transactions and that the rationale for
the Act’s exclusion is to treat all foreign transactions alike, regardless of where goods involved in the
transaction are manufactured. The United States al so explained that the amount of the exclusion was
in no way dependent on the existence of export sales.
29. In addition, at paragraphs 133 to 136 of its First Submission, the United States explained that
it is not sufficient for the EC to allege that exportation may be one way of earning excluded income.
Because the Act provides for an exclusion even where no exportation is involved, the Act’s exclusion
is not contingent, either “solely or as one of several other conditions”, upon export performance.
Therefore, the United States clearly responded to the EC’s claim that application of the exclusion to
non-exporters was irrelevant to export contingency.
B. US PERSONS CAN EARN EXTRATERRITORIAL INCOME WITHOUT EXPORTING
30. The EC further claims that the United States left unanswered the EC’s argument that “goods
produced in the US can only obtain the benefit in one way – if exported”.
7
31. The United States has explained that US taxpayers need not export in order to earn
extraterritorial income. Paragraphs 118-120 and accompanying footnotes of the US First Submission
describe the wide range of foreign transactions that give rise to extraterritorial income. In this regard,
the United States explained that US-based taxpayers may earn extraterritorial income through export
sales and wholly foreign transactions involving offshore branches of those US-based taxpayers.
32. In these paragraphs, the United States also explained that the mere fact that exporters may
avail themselves of the exclusion of extraterritorial income does not render the Act export-contingent.
The United States illustrated this point by way of analogy. The United States explained that the
presence of exporters in the universe of beneficiar ies of a general production or sales subsidy would
not transform that production or sales subsidy into one that is export contingent. Indeed, footnote 4 of
the SCM Agreement confirms this analysis as it makes clear that the mere receipt of a subsidy by
exporters does not render such subsidy export contingent.

7 EC First 21.5 Submission, para. 125.

C. THE UNITED STATES ESTABLISHED THAT THE 50-PER CENT RULE DOES NOT
RENDER THE EXCLUSION OF EXTRATERRITORIAL INCOME EARNED BY
FOREIGN CORPORATIONS EXPORT CONTINGENT
33. The EC claims that the United States “fails to comment at all” on the EC’s argument that the
50-per cent rule makes the tax exclusion for foreign manufacturers export contingent. However, the
United States, in footnote 102 of its First Submission, directly responded to this point by stating that
the 50-per cent rule does not involve an export contingency because it does not require the use of any
goods exported from the United States. The United States elaborated on the EC’s misunderstanding
of the 50-per cent rule in paragraphs 199-203 of its First Submission, explaining why no US inputs
need be included in qualifying foreign trade property and, thus, why no exports of US goods is
required by the rule.
D. THE UNITED STATES REBUTTED THE EC’S CLAIMS UNDER THE AGRICULTURE
AGREEMENT
34. The EC’s final complaint regarding issues the US purportedly did not respond to concerns the
EC’s claims under the Agriculture Agreement. Th e EC argues that the US defense is “limited”
because the United States did not dispute the EC’s position that the analysis under the Agriculture
Agreement is for present purposes the same as under the SCM Agreement.
35. No matter how the US response is characterized, the United States made clear at
paragraphs 220 and 221 of its First Submission that the Act is not an export subsidy within the
meaning of Articles 8 and 10.1 of the Agriculture Agreement. The United States, however, agrees
with the EC that the SCM analysis does apply to the Agriculture Agreement.
IV. THE EC’S COMPLAINTS REGARDING THE FACTUAL BACKGROUND
PROVIDED BY THE UNITED STATES
36. The United States would now like to draw the Panel’s attention to certain errors in the EC’s
Second Submission regarding the EC’s critique of the description of the Act contained in the US First
Submission.
A. THE EXCLUSION UNDER THE ACT IS NOT ESSENTIALLY THE SAME SUBSIDY AS
THE FSC
37. The first such error is one that the United States has pointed out previously. The EC
continues to claim that the Act provides “essentially the same subsidy” as the FSC. As support for its
position, the EC cites to the size of the exclusion and the presence of transition rules.
38. The United States would first note that the FSC decisions did not address the size of the
"subsidies" granted by the FSC and in no way did these decisions suggest that the formulae contained
in the FSC legislation were relevant to whether revenue was otherwise due or whether the FSC was
export contingent. Thus, even assuming the EC is correct in its arithmetic, the formulae used in the
Act do not render the exclusion an export subsidy.
39. The United States would also point out that the formulae in the FSC legislation served a
different purpose than they do in the Act. Th e formulae in the FSC legislation allocated income
between related parties in the same transactions. Taxes were then calculated upon such allocated
income based on applicable rates. Under the Act, formulae are used to determine what portion of a
taxpayer’s extraterritorial income may be subject to tax. If related parties are involved in a

transaction, US arm’s-length pricing practices under section 482 of the Internal Revenue Code are
used.8
40. With respect to the transition rules, the EC st ates that the presence of such rules in the Act
proves that the Act “replaces the FSC.” To the extent that the United States repealed the FSC and
enacted different, WTO-consistent tax legislation in its place, the United States does not dispute the
argument that the Act “replaces the FSC.” Stated more simply, the United States replaced a measure
found to be an export subsidy with a tax exclusion that is not an export subsidy. Indeed, if the United
States had in fact enacted “essentially the same subsidy”, no transition rules would have been
necessary.
B. THE ACT FUNDAMENTALLY CHANGES THE US TAX SYSTEM
41. The EC also challenges the US position that the Act makes a “fundamental change” to US tax
laws by amending the definition of the key term “gross income” to exclude extraterritorial income. In
support of this allegation, the EC states that the United States continues to maintain a “fundamentally
worldwide” approach to taxation and excludes, subject to certain conditions, only part of
extraterritorial income.
42. First, the United States has not argued that it now has a territorial tax system. Instead, the US
position is that it has incorporated elements of the territorial system of taxation. The fundamental
change embodied by the Act was the incorporation of territorial limitations on US worldwide taxing
authority where essentially none previously existed. As the United States explained in its First
Submission, the US Congress made clear in two legi slative reports that the imposition of territorial
limitations constituted “fundamental” changes to US taxing authority.
43. Second, whether an exclusion is partial and whether it is subject to certain conditions is
irrelevant to whether the exclusion itself represents a fundamental change in the US tax system. As
we will discuss later, a limited or conditional exclusion does not render that exclusion a subsidy.
44. In addition, the EC cites to an article appearing in Tax Notes International to support its claim
that the Act’s exclusion “is a narrow exception from the traditional US tax model based on reaching
the worldwide income of each tax payer, regardless of where such income is derived."
9 The EC’s
reliance on this selected quotation is misplaced.
45. First, the quotation provided by the EC is a quotation of an editorial comment by a journalist,
not a quotation of the US Treasury representative, who never made the statement quoted by the EC.
Second, the EC takes the quotation out of context. As the article notes, the Treasury representative in
question was in the process of dispelling the suggestion “that the new law replacing the foreign sales
corporation tax regime should be interpreted as suggesting that the United States will abandon its
global tax structure and move to a purely territorial system."
10 Thus, the Treasury representative was
stating that the United States does not intend, in effect, to repeal the foreign tax credit and adopt a
purely territorial tax system. Thus, the Treasury official’s statement does not endorse the view that
the Act represents an exception to otherwise applicable US tax law.
46. Third, the EC’s comment suggests that the EC would bar Members from adopting aspects of
both a "worldwide" and a "territorial" tax system, notwithstanding that it previously has
acknowledged that its own members states have mi xed systems. Apparently, if a Member were to
adopt aspects of both systems, the EC would charac terize one as an "exception" to the other and,

8 See, e.g., Senate Report, page 4 (US-2).
9 EC Second 21.5 Submission, para. 29.
10 EC-10, page 2749 (emphasis added).

therefore, a potential subsidy. The Appellate Body, however, has rejected this approach, thereby
permitting Members to adopt any tax system they choose, including a hybrid tax system.
C. THE ACT EXCLUDES EXTRATERRITORIAL INCOME EVENHANDEDLY
47. The EC also contests the US statement that all foreign sales are treated alike and believes that
the US confuses terms like “foreign transactions ”, “foreign sales”, “foreign goods”, “exports”, and
“foreign source income”. To the contrary, it is the EC that seeks to inject an element of confusion.
48. The United States has made clear that the exclusion of extraterritorial income applies to
income earned in a wide range of foreign transactions, regardless of where the goods involved are
manufactured. The Act treats all US taxpayers earning such income alike. The Act applies equally to
individuals, partnerships, and corporations that earn excluded extraterritorial income. The Act applies
to these taxpayers irrespective of whether they are located in the United States or abroad, the only
requirements being that these persons be subject to US taxation and earn extraterritorial income.
11
49. With regard to the EC’s statement that the Un ited States attempts to blur the distinction
between “extraterritorial income” and “excluded” income, the United States has explained that all
income excluded under the Act is extraterritorial in come, and that all extraterritorial income, except
non-qualifying foreign trade income, is excluded from gross income. The United States has not
attempted to blur any categories of income and believes that its position is clear.
D. THE EC MISSES THE POINT WITH RESPECT TO THE US DESCRIPTIONS OF
EUROPEAN TAX SYSTEMS
50. Having misconstrued the US position regarding its own tax system, the EC proceeds to
misportray the US description of European territorial tax systems. In particular, the EC challenges the
US statement that European manufacturers may obtain the benefits of a territorial exemption only by
exporting. The EC attempts to disprove this point by describing how a “foreign distribution
subsidiary of a Dutch producer” can benefit from a territorial exemption by sending goods into the
Netherlands.
51. The United States finds this point of argument utterly perplexing. First, the point the United
States is making is that, if the EC is correct and a US manufacturer must export to rely on the Act,
then so, too, must a company operating under an EC exemption system export to secure the benefits
of the exemption. Thus, the correct frame of reference would be a Netherlands company operating in
the Netherlands Antilles, and in such a case, exportation would be required to earn exempt income.
The EC’s use of a company in the Antilles sending products to the Netherlands is simply beside the
point. If the goods in question initially were exported from the Netherlands to the Antilles, there
would be two exportations. Either way, the EC’s example merely serves to reinforce the point that the
Act in its operation resembles the exemption system employed by many EC member states.
52. What the EC fails to acknowledge, however, is that under its own arguments a European
manufacturer in a country with a territorial system can earn exempt foreign source income only
through exporting. This is not something the United States has made up on its own. The panel in the
Tax Legislation Cases established as a factual matter that Belgium, France, and the Netherlands tax
exports more favorably than comparable domestic transactions, the EC’s preferred choice for a
benchmark in this dispute. This factual finding of the panel was never seriously disputed by any of
the European countries involved in the General Council deliberations that eventually led to the 1981
Understanding. To the best of our knowledge, the panel’s factual finding remains valid today.

11 The Act § 3, amending IRC § 942(a)(2).

53. The United States has explained why the EC’s arguments are misguided, because the decision
to export is one left to private actors and exporting is just one way of earning excluded income.
Nonetheless, the EC has failed to explain why its systems are distinguishable from the Act insofar as
the treatment of export transactions versus domestic transactions is concerned. The United States
reiterates its view that the drafters of the SCM Agreement would not have intended to incriminate tax
measures, such as the Act, which resemble the exemption system used by many EC member states.
V. BURDEN OF PROOF
54. Moving to the EC’s legal arguments, the EC began its analysis in its Second Submission by
attempting to lighten its burden of proof and even to shift its burden to the United States. It is by now
clearly established in the WTO that, as the complaining party, the EC is obligated to present adequate
arguments and supporting evidence to establish a prima facie case for each element of each violation
that has purportedly taken place. Absent such a showing, the United States, as the responding party in
this proceeding, need not rebut the allegations. Th e Appellate Body has explained that “[o]nly after
such a prima facie determination has been made by the Panel may the onus be shifted to the
[responding party] to bring forward evidence and arguments to disprove the complaining party’s
claim."
12
55. This requirement has been adopted in recent Article 21.5 proceedings 13, and the EC appears to
concede the point at paragraph 51 of its Second Submission. However, the EC claims that the United
States is attempting to raise its evidentiary burden and, in doing so, the United States somehow
concedes that the EC already has established a prima face case. The EC bases this position on a
statement made by the United States that in “cases involving a generally applicable measure, there
must be a heightened evidentiary burden for the complaining party.”
56. The EC’s analysis is faulty for several reason s. First, the EC fails to acknowledge that the
United States made this statement only in the context of GATT Article III:4, and not as a general
proposition. The EC itself recognized that the quantum of evidence required for each alleged claim
can vary. It cited to the Appellate Body in US Wool Shirts for the proposition that, “precisely how
much and precisely what kind of evidence will be required to establish . . . a presumption will
necessarily vary from measure to measure, provision to provision, and case to case."
14 Therefore, the
quantum of evidence required to make a prima facie case under Articles 1 or 3 of the SCM
Agreement may differ from the quantum of evidence required under Article III:4 of the GATT 1994.
As a result, the EC’s burden of proof argument is inapposite and should be rejected by the Panel.
57. Second, the EC argues that, pursuant to Argentina Textiles and Apparel , it need only show
that the Act’s “structure and design” violate a WTO provision in order to satisfy its burden of proof.15
However, the EC misquotes the Appellate Body’s de cision in that case. Specifically, the Appellate
Body stated that, “we agree with the Panel that there are sufficient reasons to conclude that the
structure and design of the DIEM will result, with respect to a certain range of import prices within a

12 European Communities - Measures Affec ting Meat and Meat Products (Hormones) (“ EC
Hormones”), WT/DS26/AB/R, WT/DS48/AB/R, Report of the Appellate Body adopted 13 February 1998,
para. 109. See United States - Measure Affecting Imports of Woven Wool Shirts and Blouses (“ U.S. Wool
Shirts”), WT/DS33/AB/R, Report of the Appellate Body adopted 23 May 1997, page 14.
13 See, e.g., Canada – Measures Affecting the Export of Civilian Aircraft - Recourse by Brazil to
Article 21.5 of the DSU , WT/DS70/RW, Report of the Panel, as modified by the Appellate Body, adopted
4 August 2000, para. 5.14.
14 EC Second 21.5 Submission, para. 52, quoting United States - Wool Shirts, page 14.
15 EC Second 21.5 Submission, para. 54.

relevant tariff category , in an infringement of Argentina's obligations under Article II ... ." 16 T h e
Appellate Body made that statement based upon a su bstantial amount of evidence supplied by the
United States showing how Argentina broke its tariff bindings because products previously imported
had been, and future imports necessarily would be, assessed duties greater than the maximum
amounts allowed. Therefore, while the structure and design of the Argentine measures were factors in
that case, the US claims were supported by specific and relevant evidence that the Panel found
credible.
58. Third, the EC implicitly asserts that, whether or not it has made its prima facie case, the Panel
may draw adverse inferences against the United States to the extent it has failed to furnish information
requested by the Panel. It did so in paragraph 56 of its Second Submission, where it discusses such a
negative inference drawn in the Canada Aircraft case. However, to date, this Panel has not requested
any information from the United States. Therefore, it is wholly improper for the EC to suggest that
the Panel draw adverse inferences against the United States.
59. Finally, the EC erroneously claims that the Un ited States has “accepted . . . the burden to
establish its defence under footnote 59." 17 That statement is patently incorrect. There are instances
where a responding party may have to bear the burden of establishing an affirmative defense – for
example, under GATT Article XX. However, the relationship between violations under other
provisions of the GATT and Article XX of the GATT is fundamentally different from the relationship
between footnote 59 and Article 3.1(a) of the SCM Agreement. Footnote 59 “simply excludes from
its scope of application the kinds of situations covered by [Article 3.1(a)] of that Agreement." 18 Even
if footnote 59 were characterized as an “exception”, such characterization would not shift the burden
of proof or dictate a narrower or stricter approach to treaty interpretation. 19 In addition, footnote 59
merely “recognizes the autonomous right of a Member"20 to take measures to avoid double taxation of
foreign-source income. Therefore, unlike GATT Article XX, which is implicated only after a
violation under another GATT article is established, footnote 59 narrows the scope of SCM
Article 3.1(a), as opposed to providing a justification for a violation. Thus, the EC continues to bear
the burden of proof on all aspects of its export subsidy claims.
60. The United States respectfully suggests that the Panel should follow Appellate Body guidance
with respect to the burden of proof and require the EC to make a prima facie case for each element of
each alleged violation under review.
VI. THE UNITED STATES DOES NOT PROVIDE A SUBSIDY THROUGH THE ACT
61. We now will address the main legal arguments, beginning with the question of whether the
Act’s exclusion constitutes a subsidy under Article 1 of the SCM Agreement.
62. In its First Submission, the United States explained that the definition of gross income
represents the outer boundary of US taxing jurisdiction. The exclusion of extraterritorial income from
gross income therefore constitutes the “normative benchmark” or “prevailing legal standard” relevant
to determining whether the exclusion constitutes a subsidy under Article 1. Because this benchmark
establishes that taxes on extraterritorial income are not “otherwise due”, the exclusion of such income
does not constitute foregone revenue and is, therefore, not a subsidy.

16 Argentina - Certain Measures A ffecting Imports of Footwear, T extiles, Apparel and Other Items
(“Argentina Textiles ”), WT/DS56/AB/R, Report of the Appellate Body adopted 22 April 1998, para. 62
(emphasis added).
17 EC Second 21.5 Submission, para. 45.
18 EC Hormones, para. 104.
19 Id.
20 Id.

63. The EC’s arguments to the contrary are not grounded in the text of Article 1. To the United
States, these arguments are attempts to demonstrate that, while the United States has met the letter of
the SCM Agreement and the FSC decisions, they somehow do not meet the "spirit" of the Agreement
and those decisions, as interpreted exclusively by the EC.
A. THE ACT DOES NOT “CIRCUMVENT” THE “BUT FOR” TEST
64. The first way the EC tries to do so is by arguing that through the Act the United States has
attempted to circumvent the Panel’s “but for” test. The United States has explained that the Act was
intended to comply with both the Panel and Appellate Body decisions in the FSC case. Contrary to
the EC’s suggestions, the Appellate Body did not preclude the application of a “but for” test to any
new legislation. As a result, the United States sought to ensure that the Act would satisfy the “but
for” test.
65. The Act passes the “but for” test because the Act’s exclusion is the US “normative
benchmark” with regard to tax treatment of extraterritorial income. The EC has not been able to show
that but for the exclusion the United States would ta x extraterritorial income, other than to make the
general assertion that if the United States had not acted to limit its taxing jurisdiction, that jurisdiction
might be broader than it actually is.
66. It is unclear to the United States why a good faith attempt to adhere to the language of the
Panel’s decision is inappropriate. The Appellate Body may have expressed reservations about the
language, but it did not reject it in all cases. Indeed, if the United States had not sought to comply
with the "but for" standard, the EC likely woul d be complaining that such a failure to comply
constituted a WTO violation.
67. The real question the EC sidesteps is why the “but for” test is not at least a relevant
consideration with regard to the Act. In a type of "heads I win, tails you lose" argument, the EC has
given the impression that any US legislative enactment that satisfies the “but for” test in this case
would constitute “circumvention.” The United States respectfully submits that the fact that the Act
satisfies the “but for” test is relevant evidence indicating that the Act does not confer a subsidy under
Article 1.
B. GROSS INCOME REPRESENTS THE OUTER BOUNDARY OF US TAXING
JURISDICTION
68. Having attempted to cast aside the Panel’s “but for” test, the EC then misapplies the
Appellate Body’s statement that it is appropriate to compare the tax treatment under the contested
measure with the tax treatment that would be due in “some other situation.” While the EC correctly
notes that the tax treatment in “some other situation ” must be the tax treatment under a relevant
normative benchmark, the EC contests the US posi tion that the definition of gross income, which
includes the exclusion of extraterritorial income, represents the relevant benchmark in this case.
69. The EC contends that the classification of income as gross income cannot be the appropriate
benchmark because it “would allow Members to provide any subsidy they like . . . by excluding the
income concerned from the definition of ‘gross income.’"
21 The United States believes that the Act is
distinguishable from a measure that, for example, rebates the taxes of a particular company or
industry. At the same time, however, the EC’s "s lippery slope" conjectures must be reconciled with
the text of Article 1 and the Appellate Body’s recognition that Members have the sovereign authority
“not to tax any particular categories of revenue” without necessarily providing a subsidy.

21 EC Second 21.5 Submission, para. 67.

70. As the United States explained in its First Submission, the semantic distinction between an
exclusion and an exemption is not determinative of whether the Act confers subsidies under the SCM
Agreement. Rather, the test under Article 1 is whether taxes on excluded income would be otherwise
legally owed to the government. Under that st andard, the EC must identify some “prevailing
domestic standard” that would tax extraterritorial income. The only provision of US tax law the EC
cites is the exception to the general rule that extraterritorial income is excluded from US taxation.
Given that the Act specifically redefines the prevailing domestic standard, the EC points to no other
specific measure to which the Act constitutes an exception. Rather, the EC appears to argue that the
prevailing domestic standard for the United States is worldwide income taxation, regardless of what
laws the United States may enact. Viewed from this perspective, the EC member states are fortunate,
indeed, to have benefitted from the historical accident of having commenced income taxation using
the exemption method.
71. What the EC ignores is that the Appellate Body chose “the tax rules applied by the Member in
question” as the basis for determining the existence of a subsidy. The EC is in effect asking the Panel
not only to make the tax-raising exception the general rule, it also is asking the Panel to apply the US
concept of “gross income” without an integral part of its definition.
C. THE EC IDENTIFIES AN ERRONEOUS BENCHMARK
72. Alternatively, the EC appears to be arguing that the appropriate benchmark in this case is that
“corporate income from a commercial activity . . . may be taxed if it is earned by a US corporation or
is ‘effectively connected’ with a US trade or business."
22 The “benchmark ” the EC is asking the
Panel to rely on is a combination of two distinct concepts – the taxation of US corporations and the
taxation of income effectively connected with a US trade or business, neither of which applies here.
73. The reference to income earned by US corporations from commercial activity reflects the
EC’s reliance on the US worldwide tax system as it existed prior to the Act. Prior to the Act, the
worldwide income of US corporations was generally subject to US tax regardless of whether the
source of income was foreign or domestic. The Act, however, imposes limitations on the US
worldwide tax system. Under the Act, extraterrito rial income earned by US corporations is not
subject to US tax because it is generally outside the taxing jurisdiction of the United States. Thus, the
benchmark identified by the EC – general worldwide taxation of income earned by US corporations –
no longer exists.
74. Thus, to the extent that the EC argues that the appropriate benchmark in this case is the
taxation of income earned by US corporations on a worldwide basis, or is income effectively
connected to a US trade or business, the EC is incorrect.
D. THE EC INCORRECTLY ATTEMPTS TO INCORPORATE SPECIFICITY INTO
ARTICLE 1
75. In its Second Submission, the EC continues to argue that the Act provides a subsidy because
the scope of the exclusion is too narrow. This argument is grounded in a fundamental misconception
of Article 1, perhaps best reflected in the EC’s statement that “the very essence of a subsidy is that a
government gives to some but not to others." 23 Simply as a technical matter, this assertion is
incorrect, because a government could provide a grant to every legal person in its jurisdiction and
each such grant would still be a subsidy under Article 1, albeit a non-specific subsidy. More

22 EC Second 21.5 Submission, para. 68.
23 EC Second 21.5 Submission, para. 80.

generally, the EC is saying that the Act is a subsidy because it allegedly does not apply neatly and
cleanly to a category of income; i.e., without conditions.
76. The EC’s position with respect to the scope of the Act’s exclusion, however, is inconsistent
with the language of the SCM Agreement. The definition of a subsidy under Article 1 does not
concern the breadth or narrowness of a government measure. Specificity becomes relevant under
Article 2 of the SCM Agreement only after a subsidy has been found to exist under Article 1.
E. THE EC’S CLAIM THAT EXTRATERRITORIAL INCOME MUST BE DEFINED
GENERALLY, OBJECTIVELY, AND NEUTRALLY IS NOT SUPPORTED BY THE
TEXT OF ARTICLE 1
77. The EC attempts to back up its specificity argument by claiming that extraterritorial income is
an arbitrarily defined category of income. The EC asserts that only categories of excluded income
that are defined “generally, objectively, and neutrally” can avoid being deemed a subsidy. Not only is
there no basis for such a position in the SCM Agreement, but this position runs directly counter to the
Appellate Body’s statement that “[a] Member, in principle, has the sovereign authority not to tax any
particular categories of revenues it wishes.” The Appellate Body made clear that the “particular
categories” that are not taxed is not a question of international law but a determination for WTO
Members, stating that this is not an issue that can be resolved “in the abstract, because governments in
theory could tax all revenues”. A measure that does not tax a category of income – however defined –
is only a subsidy if such income would be taxed by a “prevailing domestic standard” under the tax
laws of that Member. Whether or not that category would be “generally, objectively, and neutrally”
defined in the eyes of the EC or another Member is irrelevant.
78. Nonetheless, even if the EC were correct in arguing that only categories of income defined
“generally, objectively, and neutrally” may be taxed differently, the EC has not established that the
Act does not do so in defining extraterritorial income. The United States has explained that
extraterritorial income is earned on all foreign transactions involving goods used or consumed outside
the United Stated, no matter where manufactured. The EC has not shown why this category is not
"general", "objective", or "neutral."
F. THE CONGRESSIONAL BUDGET AND TREASURY REPORTS CITED BY THE EC DO
NOT INDICATE THAT A SUBSIDY HAS BEEN PROVIDED
79. The United States reiterates its objection to the misuse by the EC of the Congressional Budget
Office study to support the allegation that the Act fo regoes revenue that is otherwise due. The “cost”
cited by the EC is actually a comparison of the revenue consequences under the Act versus the FSC
and the former US worldwide tax system. Because the United States has established a new normative
benchmark for the taxation of extraterritorial income, the cost cited by the EC does not reflect
“revenue foregone.” Mere repetition of this flawed argument by the EC does not render it valid.
VII. THE EXCLUSION OF EXTRATERRITORIAL INCOME IS NOT EXPORT
CONTINGENT
80. Turning to the issue of export contingency, in the same way that the EC misconstrues the
definition of subsidy under Article 1, it errs in its interpretation of Article 3.1(a). Significantly, the
EC’s arguments are bereft of references to the language of Article 3.1(a) or the Appellate Body’s
consistent interpretation of the term “contingent”. Even after the US First Submission pointed out
these shortcomings, the EC has continued to ignore the ordinary meaning of Article 3.1(a). The EC’s
failure to take account of the legal standards applicable to Article 3.1(a) should be fatal to its claims
thereunder.

A. ARTICLE 3.1(A) DOES NOT REQUIRE A COMPARISON BETWEEN THE TAX
TREATMENT OF EXPORT AND DOMESTIC SALES INCOME FOR PURPOSES OF
DETERMINING EXPORT CONTINGENCY
81. A central argument made by the EC is that the test for determining whether a tax subsidy is
export contingent is whether that subsidy provides more favorable treatment to export income than
income earned in comparable domestic transactions.
82. However, Article 3.1(a) does not contemplate th at such a comparison be made, and the EC is
unable to point to anything in the language of Article 3.1(a) that indicates that such a comparison is
proper. In fact, the EC even tries to steer the analysis away from the text of Article 3.1(a), saying that
the ordinary meaning of the term “export” is “not of much help."24 Likewise, the EC has not cited any
WTO panel or Appellate Body reports that interpret Article 3.1(a) in the manner proposed by the EC.
83. The language of Article 3.1(a) focuses its attention on whether a WTO Member makes the
availability of a subsidy contingent on export performance. For this reason, the Appellate Body has
explained that export contingency is demonstrated where the provision of a subsidy is “conditioned”
or “dependent for its existence” on exporting. In addition, the Appellate Body has stated that a
subsidy is export contingent where “the subsidy is available only upon fulfilment of the condition of
export performance.”
84. The EC points to several paragraphs of the Illustrative List of Export Subsidies that do
indicate that a comparison between export and domestic income may be relevant in determining the
existence of an export subsidy. However, the part of the Illustrative List relevant to this dispute,
paragraph (e), contains no such comparison. There is simply no basis to assume, as the EC does, that
a comparison test can be generally applied to Article 3.1(a) because some items in an Illustrative List
do so.
85. In any event, as the United States pointed out in its First Submission, a number of the items in
the Illustrative List relied on by the EC seem to propose a comparison more for determining whether
an indisputably export-specific class of beneficiar ies receives a subsidy at all than for determining
whether a subsidy is export contingent. Clearly, the exemption or remission of indirect taxes on
exported products referred to in paragraph (g) of the List would be export-specific, but the
requirement that any such exemption or remission must be “in excess of those” provided for domestic
products clearly is aimed at determining whether a subsidy exists at all.
B. EXPORTING IS NOT “ONE OF SEVERAL OTHER CONDITIONS”
86. In another instance in which the EC fails to address the ordinary meaning of the language of
Article 3.1(a), the EC informed the Panel that it “takes no position on the meaning of the word
‘other’” in the phrase “one of several other conditions."
25 The United States submits that this is not an
adequate response to the US argument regarding th e meaning of Article 3.1(a)’s requirement that a
subsidy must be contingent, either “solely or as one of several other conditions, upon export
performance”, in order for it to be a prohibited export subsidy. In its First Submission, the
United States explained that the term “one of several other conditions” means that export performance
may be an additional condition to others that also apply, but export performance must be satisfied to
receive the subsidy. Article 3.1(a)’s export contingency requirement cannot be satisfied merely by
showing that exporting is one of several ways of obtaining a subsidy.
87. The EC’s failure to respond to this point is a major defect in its case.

24 EC First 21.5 Submission, para. 86.
25 EC Second 21.5 Submission, para. 112.

C. US MANUFACTURERS NEED NOT EXPORT
88. Rather than attempting to address the text of Article 3.1(a), the EC simply claims that US
manufacturers must export their goods in order to earn excluded extraterritorial income, and that this
is enough to demonstrate that the exclusion is export contingent. However, the EC fails to recognize
that US manufacturers can, and often do, manufacture abroad through offshore branches to service
foreign markets, thereby earning extraterritorial income without exporting. US manufacturers have
the option of producing and selling outside the United States. To the extent that the Act provides any
incentives that might affect where a manufacturing company chooses to produce its goods, the Act
offers just as much incentive to manufacture goods outside the United States as to do so within it.
This is another manifestation of the Act’s export neutrality and its evenhanded treatment of taxpayers.
89. The EC attempts to deflect this argument by saying that, even if US manufacturers have a
choice in where to manufacture and thus need not export to rely on the Act, this is not the case where
parties have goods in the United States to sell. This argument, though, suffers from the same defect.
Parties that sell goods in the United States can choose to source their goods from outside the United
States and can choose to engage in wholly non-US transactions. Moreover, as the Appellate Body
explained in the United States - Lead Bar case, subsidies are provided to natural or legal persons and
not to productive operations or, we assume, the goods resulting from such operations.
26
90. Thus, the relevant issue here is whether there is a condition imposed under the Act on US
persons or businesses to export in order to earn excluded extraterritorial income. We submit that there
is not. The Act does not require any taxpayer to export in order to invoke its exclusion for
extraterritorial income.
91. It is important to note that the EC’s interpretation would mean that territorial exemptions in
most European countries provide export-contingent subsidies – a point the EC has steadfastly refused
to respond to. This is because, under the EC’s analysis, manufacturers in European countries that use
the exemption method can benefit from such an exemption only by exporting. Income from sales by
these manufacturers on the domestic market is not eligible for a comparable exemption. Under the
EC’s framework for analyzing export contingency, it is irrelevant that EC territorial exemptions cover
income earned in wholly foreign transactions an d imports because, according to the EC, export
transactions are taxed more favorably than comparable domestic transactions.
D. THE EC CANNOT SUBSTANTIATE A CLAIM OF DE FACTO EXPORT
CONTINGENCY
92. In what the EC now terms as “subsidiary arguments” 27, the EC claimed in its First Submission
that the Act was de facto export contingent because foreign corporations would rarely elect to become
US taxpayers, thus leaving only exporters to benefit from the exclusion of extraterritorial income.
The United States responded that such an election is not necessary where the foreign manufacture and
sale of goods is performed by an offshore branch of a US corporation.
93. Presumably in recognition of the large hole in its argument, the EC now contends that the
situations in which a US corporation will choose to establish a branch “are in relative terms bound to
be far less common than those where the US corporation decides to establish a subsidiary in the

26 See United States - Imposition of Countervailing Duties on Certain Hot-Rolled Lead and Bismuth
Carbon Steel Products Originating in the United Kingdom , WT/DS138/AB/R, Report of the Appellate Body
adopted 7 June 2000, para.58.
27 EC Second 21.5 Submission, para. 114.

foreign jurisdiction." 28 Thus, the EC’s “ de facto ” argument has expanded such that the EC now
claims that only exporters can and will benefit from the exclusion because, for different reasons,
neither branches nor foreign subsidiaries will actually use the exclusion. However, the EC’s
arguments with respect to both branches and subsidiaries are erroneous and unsubstantiated.
1. Branches
94. The EC does not contend that US corporations cannot establish branches that manufacture
and sell abroad and earn extraterritorial income, and the EC does not contend that the Act limits
opportunities for US corporations to establish offs hore branches. Instead, the EC simply makes the
unsubstantiated assertion that “there are a number of both tax and commercial reasons for the general
preference for the legal form of a subsidiary."29
95. In paragraphs 117 through 125, the EC produces a list of factors supposedly indicating that
US companies would rarely, if ever, choose to operate through branches, as opposed to subsidiaries.
The EC admits that “[u]ndoubtedly, the choice of the legal form for the foreign manufacturing
operations depends on the particular circumstances present in each individual case,"
30 but then
proceeds to ignore its own admonition and offers sweeping generalizations about individual business
decisions.
96. The EC offers no support for its lopsided list of factors, and studiously avoids mentioning the
many countervailing considerations. Contrary to the EC’s assertions, there are a number of factors
supporting the use of a branch. They include:
• Operation through a foreign branch offers much greater flexibility than operation
through a subsidiary. A branch can be formed and dissolved often without any
formalities. By contrast, there are significant transaction costs associated with
forming a corporation, such as minimum capitalization requirements and
incorporation and registration fees. The process of meeting these requirements often
results in legal expenses.
• There are additional transaction costs associated with maintaining a corporation, such
as paying a separate set of directors and executives, holding regular board meetings,
and maintaining a separate set of books and records. None of these requirements
apply to the conduct of business through a branch.
• Apart from the transaction costs of establishing and maintaining a separate
corporation, corporations often are subject to more burdensome reporting
requirements than branches. For example, they must prepare their own tax returns and
financial accounting statements.
97. From a tax perspective, the use of a corporation results in two levels of taxation, one at the
corporate level and one at the shareholder level. Adding further layers of corporations may
compound this problem unless the tax law provides for relief mechanisms, such as group
consolidation. Group consolidation generally is not available for foreign corporations under US law.
Moreover, with respect to the foreign tax credit, a US corporation would be entitled to a direct,
current foreign tax credit with respect to branch income that is not excluded under the Act. By
contrast, a US corporation would only be entitled to an indirect foreign tax credit upon receiving a
dividend from its foreign subsidiary.

28 EC Second 21.5 Submission, para. 118.
29 EC Second 21.5 Submission, para. 118.
30 Id.

98. In addition to being incomplete, the EC’s list of factors is misleading. For example, the EC
notes that foreign subsidiaries of US corporations generally may defer payment of US taxes on their
active income. However, deferral of US tax is meaningless if the foreign jurisdiction imposes tax
currently on the foreign subsidiary’s profits. Deferr al also is meaningless if the US parent company
currently needs the cash generated by its foreign subsidiaries. Finally, deferral is entirely unavailable
for income that is subpart F income. Thus, the supposed vaunted benefits of deferral are not as
significant as the EC suggests.
99. The EC also cites the limited liability offered by corporations. In the real world of business,
however, the only real liability protection is afford ed by the sovereign protection of maintaining the
home office in another jurisdiction – not through local operation through a subsidiary. Moreover,
jurisdictions frequently afford limited liability protection to non-corporate entities, such as limited
liability corporations in the United States. Thus, a US business often can operate in a foreign
jurisdiction in branch form for US tax purposes while retaining limited liability protection offered
through local law.
100. The EC claims that transfer pricing presents a greater problem for branches than for
corporations. This statement is untrue. Transfer pricing is just as significant an issue between
incorporated entities as between a corporation and its branch. With respect to incentives, branch form
also carries certain tax advantages. For example, French branches of US corporations generally may
deduct their allocable share of the expenses of the home office against their French income, while
French subsidiaries of US corporations cannot take this deduction.
101. In sum, the EC’s list of reasons why US businesses would prefer operating through
subsidiaries rather than branches is oversimplified and, in some respects, just plain wrong.
2. Foreign Subsidiaries
102. The EC now agrees with the United States that foreign corporations can and will elect to
become US taxpayers. While the EC maintains that such situations will be “rare”
31, the United States
is pleased that the EC now recognizes that foreign corporations are a legitimate class of taxpayers that
may exclude extraterritorial income. Of course, wh ether in fact it is rare or common remains to be
seen, and the EC provides absolutely no evidence either way to support its arguments.
103. By contrast, the United States has provided ev idence indicating that foreign corporations will
elect to become US taxpayers and exclude extraterritorial income. The statement by a foreign
corporation appended to the US Second Submission as US-9 describes one situation in which a
foreign corporation would make the domestication election and exclude extraterritorial income. The
significance of this statement is enhanced by the fact that it comes from one of the largest companies
in the world, and it was made prior to the issuance of administrative guidance by the US Government
with respect to the process by which companies will ultimately be permitted to make such an election.
104. The EC’s argument that it cannot be expected to provide the Panel with evidence in support
of its de facto theory is unavailing. If it does not have or cannot obtain sufficient evidence to back up
what otherwise appears to be mere supposition and prediction, then it ought not to have asserted these
claims. As the Appellate Body stated in Canada Aircraft , the very essence of a de facto export
contingency claim is that it must be proven with ev idence other than the challenged measure itself. It
is not sufficient for the EC to make unsupported assertions and then ask the United States to disprove
them. Absent the requisite quantum of proof, the Panel should reject the EC’s de facto arguments.

31 EC Second 21.5 Submission, para. 131.

E. PARAGRAPH (E) OF THE ILLUSTRATIVE LIST DOES NOT EXPAND
ARTICLE 3.1(A)
105. In its First Submission, the EC stated that paragraph (e) of the Illustrative List expands the
definition of “contingent . . . upon export performance ” under Article 3.1(a). In response, the
United States demonstrated that paragraph (e) cannot broaden the meaning of export contingency
because that concept serves to define the scope and applicability of Article 3.1(a). Items included in
the Illustrative List are simply examples of prohibited export subsidies. They clarify the meaning of
Article 3.1(a), but do not identify prohibited subsidies that are not export contingent within the
meaning of Article 3.1(a).
106. In its Second Submission, the EC appeared to back away from its initial position. The EC
seemed to recognize that paragraph (e) does nothing more than identify a particular type of export
subsidy that is relevant to direct taxes. The EC acknowledged that the Illustrative List is connected to
Article 3.1(a) through the phrase “including those [export subsidies] illustrated in Annex I ” and the
plain meaning of the word “including” is to be contained within, to take into account in an inclusive
way, or to incorporate. All of these definitions suggest just what the United States has maintained all
along – that the Illustrative List provides examples of subsidies that satisfy the standard of
Article 3.1(a)..
107. Despite recognizing this, the EC continues to hold to the notion that paragraph (e) provides “a
separate source of prohibition of export subsidy”.
32 To the extent that the EC is suggesting that a
measure can come within paragraph (e), but not Article 3.1(a), and constitute a prohibited export
subsidy, the United States disagrees. If that were the case, then the Illustrative List would do far more
than illustrate subsidies contingent upon export performance.
108. Furthermore, the United States cannot understand how a measure, like the Act, that makes no
reference to exportation, does not require exportation, and applies to a broad range of non-export
transactions can be said to be “specifically related to exports”. Yet again, the EC makes arguments
that are completely untethered from the text of the provision at issue.
VIII. THE EC HAS FAILED TO DEMONSTRATE THAT THE ACT IS NOT A MEASURE
TO AVOID DOUBLE TAXATION
109. Thus far, the United States has highlighted a number of areas in which the EC has made
arguments that are not grounded in the text of relevant WTO provisions and that are not in conformity
with the correct method of interpretation under public international law. Nowhere is the EC’s creative
approach to interpretation more in evidence than in the context of its arguments regarding whether the
Act is a measure to avoid double taxation within the meaning of the fifth sentence of footnote 59. The
EC asks the Panel to ignore the language of footnote 59 and instead attempts to incorporate into the
WTO tax principles that have not been considered and adopted by the WTO’s Members. The Panel
should reject the EC’s attempt to redraft footnote 59.
A. THE EC’S FLAWED APPROACH TO INTERPRETING FOOTNOTE 59
110. The EC’s approach to divining the meaning of the fifth sentence of footnote 59 is so
extraordinary, it merits repeating here. The EC stated in its Second Submission that “the terms
‘double taxation’ and ‘foreign-source income’ are terms of art with special meanings."
33 From this,
the EC concluded that “an analysis of the particular meanings these terms have acquired in the field of

32 EC Second 21.5 Submission, para. 149.

taxation is a more useful starting point than the dictionary definitions of the individual words of which
they are composed."34
111. The EC is wrong in all respects. First, while it may be true that the terms “double taxation”
and "foreign-source income” are terms used widely in the tax area, it is not clear that they have
obtained universally agreed upon “special meanings”. More importantly, there are no “special
meanings” for these terms that have been accepted by the WTO. Had the Members of the WTO
agreed upon such “special meanings”, these definitions would have been reflected in some way in the
text of the SCM Agreement or other WTO agreements. Of course, no such definitions have been
included for these terms.
112. The EC’s statement that the “particular meanings these terms have acquired in the field of
taxation is [sic] a more useful starting point than the dictionary definitions of the individual words"
35
is not only a radical departure from the principles of interpretation established by the Appellate Body,
but it also is misleading. The EC does not revert to the ordinary meaning of the language of the fifth
sentence of footnote 59 at any point in its analysis, let alone as a starting point.
113. By starting – and finishing – with non-textual “special” definitions, the EC has failed to
adhere to multiple pronouncements by the Appellate Body regarding treaty interpretation. The
Appellate Body has explained that “the words of a treaty . . . are to be given their ordinary meaning,
in their context and in the light of the treaty’ s object and purpose."
36 The Appellate Body has further
explained that “the words of a treaty form the foundation for the interpretive process: ‘interpretation
must be based above all else upon the text of the treaty.’"
37
114. Moreover, under Article 31(4) of the Vienna Convention on the Law of Treaties, in order for a
"special meaning" to prevail over the ordinary mean ing of a term, it has to be "established that the
parties so intended." Thus, the EC, as the proponent of a "special meaning", has the burden of
demonstrating that the drafters of footnote 59 intended the "special meaning" it suggests. The EC has
not even attempted to make such a demonstration.
115. An interpretation that begins with an extrinsic and unsupported “special meaning” – and that
never attempts to analyze the ordinary meaning of the text – simply cannot be correct.
B. THE EC ERRS IN TRYING TO RELY ON OECD RULES TO GIVE MEANING TO WTO
PROVISIONS
116. The EC appears to claim that the “special meanings” it ascribes to “double taxation” and
“foreign-source income” emanate from the OECD Model Convention. The EC, though, attributes
significance to the Convention it cannot have in relation to the WTO. Moreover, the EC misconstrues
the Convention itself.

34 Id.
35 EC Second 21.5 Submission, para. 183.
36 United States – Standards for Reformulated and Conventional Gasoline , (“Reformulated Gasoline”),
WT/DS2/AB/R, Report of the Appellate Body adopted 29 April 1996, page 16. WTO panels and the Appellate
Body are instructed to rely on “customary rules of interpretation under public international law”. DSU
Article 3.2.
37Japan - Taxes on Alcoholic Beverages , (“ Japan Alcoholic Beverages ”), WT/DS8/AB/R,
WT/DS10/AB/R, WT/DS11/AB/R, Report of the Appellate Body adopted 1 November 1996, page 29.

1. The OECD Convention’s Relevance
117. The United States referred to the OECD C onvention to illustrate different approaches to
double taxation and, more specifically, to bring to the Panel’s attention the fact that the exemption (or
non-taxation) method is a commonly used and widely accepted method for avoiding double taxation.38
In doing so, the United States took care to point out that it did not consider these conventions (or any
other agreements, for that matter) to be substitutes for the text of relevant WTO provisions. The
United States relied on the Convention solely as an example. 39 The United States just as easily could
have relied on the U.N. Model Convention, or the United States could have undertaken a review of
various measures to avoid double taxation in use around the world, to achieve the same ends.
118. In contrast, the EC is invoking the OECD Conv ention to literally supply definitions of terms
used in the SCM Agreement. In effect, the EC is asking the Panel to accept every detail of the OECD
Convention as if it were incorporated into the SCM Agreement. There is no basis for doing so.
Nowhere does the SCM Agreement provide that the definition of a measure to avoid double taxation
of foreign-source income for purposes of footnote 59 may be supplied by the rules of another
organization. Whatever the merits of the OECD Convention, its provisions cannot be engrafted in
toto upon the SCM Agreement where there is no indication that this was the intention of the
Agreement’s drafters. The fact that the second paragraph of item (k) to Annex I incorporates by
reference the OECD Arrangement on Guidelines for Officially Supported Export Credits indicates
that the drafters of the SCM Agreement knew how to incorporate OECD standards when they desired
to do so.
119. Moreover, only some WTO Members have agreed to adhere to the Convention. The fact that
“practically all industrialised countries” follow the Convention, as the EC asserts 40, is not a basis on
which the rights and obligations of WTO Members may be altered. Undoubtedly, more than a few
WTO Members would be surprised to learn that, in joining the WTO, they undertook to implement
and abide by the OECD Convention. This would include the United States. As the EC noted in its
Second Submission, the United States relies on ce rtain concepts from the OECD in its own tax
treaties, but not all.
41
120. As a way to get the OECD Convention in "thr ough the back door", the EC proposes recourse
to supplemental means of interpretation. However, such recourse is appropriate only after the
ordinary meaning of the text is established and only if such interpretation leaves the meaning of the
provision in question “ambiguous or obscure” or leads to a result which is “manifestly absurd or
unreasonable."42 The United States respectfully submits that there is nothing in words such as
“avoid”, “double”, “taxation”, “foreign” or “source” that renders the fifth sentence of footnote 59
incompatible with the general rule of interpretation such that supplemental means are needed. Simply
put, the ordinary meaning of these terms is readily ascertainable and should guide the Panel in its
deliberations.
121. Even if such supplemental means were ne eded, the OECD Convention would not be the
source to rely on. Supplemental means might include “the preparatory work of the treaty or the
circumstances of its conclusion”, or perhaps other relevant sources of the drafters’ intentions.
43
However, there is no indication in the negotiating history that the drafters had the OECD Convention

38 US First 21.5 Submission, paras. 178-86.
39 Id., note 153.
40 EC Second 21.5 Submission, para. 187.
41 EC Second 21.5 Submission, para. 186.
42 Vienna Convention, Article 32.
43 Id.

in mind, and the OECD is not one of the WTO’s covered agreements and as such it does not form part
of the context for interpreting footnote 59.44
122. Furthermore, the OECD Convention serves only as a model for bilateral treaties between
nations seeking common rules for avoiding taxation of income earned by their nationals. The
Convention is not a multilateral agreement that all signatories directly follow. It is merely a model
that is followed in part in bilateral tax treaties th at are based upon it. Significantly, the Convention is
not necessarily intended to be a model for domestic legislation. Domestic measures to avoid double
taxation often do not follow the OECD model. Bilateral tax treaties are often entered into, at least in
part, to limit the reach of domestic tax practices.
2. The EC Misstates the Definition of a Permanent Establishment Under the OECD
Convention
123. Even if the OECD Convention were a model fo r domestic tax laws, and even if it provided
guidance for interpreting WTO provisions, it would not support the narrow reading of footnote 59
advanced by the EC.
124. The EC notes that the OECD Conventio n requires the existence of a “permanent
establishment” in a country in order for that country to assert taxing jurisdiction over a business
taxpayer’s income. The EC maintains that a “permanent establishment” is in effect a fixed and
continuously operating place of business.
45
125. The EC, though, cites only part of the OECD’s definition of a “permanent establishment”.
The EC cites Articles 5.1 and 5.2 of the Convention, which identify the most burdensome types of
“permanent establishment”. Articles 5.1 and 5.2 refer to a business “establishment” that is in some
sense “permanent” – that is, “a fixed place of business”. They also list the most “permanent” types of
businesses that could create taxable income: an office, factory, workshop, or mine.
126. What the EC omitted from its discussion is the fact that the Convention includes an
alternative, lower threshold for establishing a “permanent establishment”. This alternative standard
reflects a divergence of opinion among countries as to what may constitute a “permanent
establishment”. Article 5.5 of the Convention provides that a “permanent establishment” may exist
where a person acts on behalf of a non-resident business and that person is authorized to “conclude
contracts in the name of the enterprise”. The Commentary to the Convention explains with respect to
Article 5.5 that “[i]t is a generally accepted principle that an enterprise should be treated as having a
permanent establishment in a State if there is under certain conditions a person acting for it, even
though the enterprise may not have a fixed place of business in that State … ."
46 The Commentary
goes on to explain that the party acting on behalf of a non-resident business may be a person or a
corporation and such authority need only be ex ercised more than in an isolated instance.
47 It is thus
clear that what constitutes a “permanent establishment” under OECD rules may lack permanence and
even a fixed place of business.

44 See European Communities - Measures Affec ting Importation of Certain Poultry Products ,
WT/DS69/AB/R, Report of the Appellate Body adopted 23 July 1998, paras. 79-81 (Oilseeds Agreement was
not a “covered agreement” and, as such, did not cont ain the relevant obligations of the European Community
under the WTO Agreement).
45 EC Art. 21.5 Second Submission, paras. 193-97.
46 Article 5.5 and Commentary to the OECD Model Convention, at C(5)-13. A copy of the
Commentary is submitted as Exhibit US-18.
47 Id.

3. The Act Properly Requires Sufficient Contacts with a Foreign Taxing Jurisdiction
127. While the United States and a number of other countries rely on the concept of a “permanent
establishment” in their bilateral tax treaties, they do not necessarily use that same standard in
determining whether a business is to be subjected to their national income taxes. As the United States
explained in its Second Submission, bilateral tax treaties serve as an additional layer of double tax
avoidance in addition to domestic laws. A number of nations have broader jurisdiction under their
domestic tax laws to reach income of non-residents than that prescribed by the concept of “permanent
establishment” used in some tax treaties. Bilateral tax treaties requiring a “permanent establishment”
provide double tax relief from these more aggressive standards. That nations rely on bilateral tax
treaties to prevent their businesses from being subjected to a foreign tax in the absence of a
“permanent establishment” does not in any way mean that lower thresholds cannot be relied upon in
establishing domestic taxing jurisdiction and, as a result, in domestic double tax avoidance measures.
128. There are differing views and practices among countries as to what brings a non-resident
enterprise within a country’s taxing authority. The United States, for example, does not, as a general
matter, subscribe to the requirement that a non-resident enterprise must have a “permanent
establishment” within the United States in order to be subjected to US taxation. Instead, the
United States looks to see if a taxpayer has sufficient contacts with the United States with respect to a
given transaction or series of transactions to find that a taxpayer has engaged in “a trade or business in
the United States.” Income “effectively connected” with that trade or business is subject to US
taxation. In short, the United States does not require the existence of a fixed or enduring business
operation. As the United States explained in its Second Submission, other countries, such as Canada,
also do not require a “permanent establishment” to tax non-resident enterprises.
48
129. The Act takes account of the fact that, like the United States, countries around the world may
attempt to impose taxes upon foreign businesses even though they do not maintain a “permanent
establishment” within the taxing country. It recognizes that countries rely on different standards that
can turn on subtle factual distinctions in determin ing whether income is subject to their tax regimes.
The Act therefore requires that transactions giving rise to extraterritorial income must have a variety
of foreign attributes that can result in a sufficient nexus to a foreign taxing regime so as to render US
taxpayers potentially subject to foreign taxation.
130. The EC makes a bald assertion that the foreign economic processes and other foreign
attributes built into the Act are inadequate to give rise to double taxation.
49 The EC, though, is simply
incorrect when it states that the Act “excludes from tax income that cannot be taxed by any other
country."50 The transactions and activities from which extraterritorial income may be derived can
indeed subject US taxpayers to taxation abroad. Indeed, some transactions under the Act may occur
entirely outside the United States. To prove the contrary, the EC must do more than give its opinion.
131. Indeed, the EC relies on suppositions that are inaccurate. In paragraph 197 of its Second
Submission, the EC asserts that “it is in principle possible that the above enumerated activities are
carried out through a permanent establishment situated in a country other than the United States
but . . . it is much more likely that such operations are carried out from within the territorial limits of
the US”. However, as the United States has pointed out repeatedly, the Act requires that a minimum
level of foreign economic processes must occur outside the United States for each and every
transaction.
51

49 EC Art. 21.5 Second Submission, paras. 196-98.
50 Id., para. 191.
51 The Act § 3, amending IRC § 942(b)(3).

C. THE OECD CONVENTION DOES NOT DEFINE “FOREIGN SOURCE INCOME”
132. Not only does the EC attempt to give the deta ils of the OECD Convention greater weight than
they are due, the EC also tries to extrapolate rules from the Convention that are not even there. In an
about face from its prior position in this dispute that "foreign source income" and "foreign economic
activities" are not the same thing, the EC now argues that, as a result of the OECD Convention,
“foreign source income” under footnote 59 means income directly and exclusively attributable to
foreign economic activities.
52 The EC concedes that the Convention contains no such definition, but
maintains that it can be “deduced from the provisions of the Convention."53
133. The United States has explained to the Panel that it disagrees with such a narrow approach.
The United States respectfully refers the Panel to paragraphs 190 to 192 of its First Submission and
paragraphs 56 to 59 of its Second Submission where it explains why the term “foreign source
income”, as it is used in the fifth sentence of foot note 59, is not limited solely to income attributable
to foreign economic activities. The United States has explained that the language of footnote 59 does
not call for such a cramped interpretation of footnote 59 and instead suggests a more flexible
approach that takes into account different types of income and the complexities of determining what
may make income “foreign”.
134. Ironically, the provisions of the OECD C onvention the EC cites do not support the EC’s
narrow construction, but rather confirm the US position. Article 10, which addresses dividend
income, calls for double tax avoidance on a form of passive income – that is, income for which there
are no directly related foreign economic processes. Like interest income and other forms of passive
income, dividend income may be exempted to avoid double taxation under Articles 10.5 (and 23.2) of
the Convention even though the party earning such income performs no economic activities in
relation to such income – whether foreign or domestic. What can make dividend and other types of
passive income “foreign” is that it is received from a foreign company or bank. In other words, the
source of payment is foreign. The OECD Conven tion does not specify where the business activities
of a company paying dividends must occur.
135. The same is true with respect to the OECD’s treatment of “business profits” pursuant to
Article 7 of the Convention. It applies to essentially all profits of an enterprise, not merely to profits
directly attributable to economic processes of the enterprise itself that take place outside the country
of residence of that enterprise.
136. Accordingly, the OECD provis ions the EC cites do not support the EC’s proposition that only
income attributable to foreign economic processes can be “foreign source income” under footnote 59.
D. THE US CONGRESS DID INTEND FOR THE ACT TO SERVE AS A MEASURE TO
AVOID DOUBLE TAXATION
137. In its zeal to see the Act struck down, the EC does not confine itself to rewriting provisions of
the Act, WTO rules, and Articles of the OECD Convention. The EC goes so far as to substitute its
opinion for that of the United States Congress as to the legislative intent underlying the Act. The EC
not once, but twice, asserts that the US Congress did not intend for the Act to serve as a measure to
avoid double taxation.
54
138. The United States recognizes that ascertaining the specific intent of a legislative body is not
always easy, but in this case there is strong and unmistakable evidence on the point in question. Each

52 EC Second 21.5 Submission, paras. 203-04.
53 Id., para. 201.
54 Id., paras. 41 and 209.

of the two congressional committees responsible for reviewing US tax policy and for drafting US tax
laws stated unequivocally that the Act was intended and designed to serve as a measure to avoid
double taxation. The report of the Ways and Means Committee of the US House of Representatives,
which has been submitted to the Panel as US-3, states, on pages 10, 19, and 21, that “the exclusion
of . . . extraterritorial income is a means of avoiding double taxation.” The report also includes a
discussion on page 11 noting that the Act’s exclusion is to some extent designed to move the
United States away from its predominant reliance on tax credits as a means for avoiding double
taxation and toward the European model of exemption. Likewise, the report of the Finance
Committee of the US Senate, which has been submitted as US-2, states, on pages 2, 6, and 8, that the
Act’s exclusion serves to avoid double taxation.
139. Furthermore, the structure of the Act demonstrates how it serves as a measure to avoid double
taxation. The Act, at section 114(d), disallows tax credits on excluded income in order to avoid what
the EC refers to as “’double relief’ from ‘double taxation’”.
55 In this way, the exclusion provides the
only method of double tax avoidance that is avai lable under US law for excluded extraterritorial
income. If the Act did not disallow tax credits, then US taxpayers could rely on the exclusion and
credits for the same income, which might result in too much relief. To the same end, the
United States limits the amount of foreign tax credits that US taxpayers may apply with respect to
non-excluded income under the Act through its sourcing rules in section 943. This prevents what the
EC terms “over-compensation” of taxpayers.
56 While it is true that application of such rules may
result in less than full relief for double taxation under the credit method, the United States has
explained that credits typically result in only partial relief of double taxation.
E. IT IS IRRELEVANT THAT THE UNITED STATES ALSO RELIES ON TAX CREDITS
140. In yet another effort to create a rule that cannot be found in the WTO agreements, the EC
claims that the United States may not rely on an exclusion as a method to avoid double taxation
because it also uses tax credits. This is one more contention that is completely divorced from the
relevant language of the SCM Agreement and from common international tax practice.
141. As the United States has previously explaine d, it is widely accepted that relief from double
taxation generally may be provided through an exemption of foreign income, through a credit for
foreign taxes paid, or through an income tax co nvention pursuant to which participating countries
cede taxing rights over particular categories of income. As the EC has recognized, most if not all
Members employ all three of these mechanisms, in varying degrees, to avoid double taxation.
57 This
is reflected in the fact that the Commentary to Article 23 of the OECD Convention provides with
respect to alternative use of exemption and credits, “Contracting States may use a combination of the
two methods."58 The Commentary even goes further, stating that there are instances in which credits
should be used even though exemption is the general rule of a given tax system.59
142. The OECD Commentary is relevant only in that it reflects the fact that many countries are
like the United States and offer a mix of exemptions and exclusions as well as foreign tax credits.
Even France, which is reputedly the most territorial of EC tax systems, offers its taxpayers a choice of
a territorial exemption or foreign tax credits. If offering such a choice constituted an independent
basis for violating Article 3.1(a), as the EC alleges, then many choices available under tax laws
around the world would be improper.

55 Id., para. 218.
56 Id., para. 213.
57 Annex EC-2, page 2 (US-5).
58 US-7, page C(23)-10.
59 Id.

143. However, this is not the case, because nothing in the SCM Agreement prohibits Members
from using this type of alternative mechanism for the relief of double taxation. Footnote 59 leaves the
choice of mechanism to WTO Members, stating that the ban against export-specific direct tax
exemptions, remissions, or deferrals set forth in paragraph (e) of the Illustrative List of Export
Subsidies “is not intended to limit Members from taking measures to avoid . . . double taxation”.
(Emphasis added). This language is particularly flexible, imposing no limit on WTO Members in
fashioning double tax relief measures.
144. In contrast to what the EC asserts, footnote 59 does not allow Members to institute a measure
to avoid double taxation only where such a measure is “necessary”. 60 Footnote 59 in no way
conditions the right to avoid double taxation on the basis of necessity. It is not a provision, like
GATT Article XX, that makes certain practices allowable only upon a showing that a measure is
“necessary”. Footnote 59 makes clear that this right is not limited and that the method of achieving
this permissible end is left to each Member to decide.
F. THE EC’S ARM’S-LENGTH PRINCIPLE ARGUMENT IS MISPLACED
145. There is one additional point that the EC make s with respect to the double taxation issue that
calls for a response. The EC argues that the Act is improper because, according to the EC, it does not
rely on the arm’s-length principle in calculating taxes on non-qualifying foreign trade income. The
EC confuses two distinct concepts.
146. The arm’s-length principle is relevant for WTO purposes only in attributing income between
related parties in export transactions. This derives from the second sentence of footnote 59, which
provides that “Members reaffirm the principle that prices for goods in transactions between exporting
enterprises and foreign buyers under their or under the same control should for tax purposes be the
prices which would be charged between independent enterprises acting at arm’s length.” The
arm’s-length principle is not relevant to the manner in which the amount of taxes is calculated or the
tax rate is set once the income of a given taxpayer is established.
147. However, that is what the EC is complain ing about here. The EC feels that the tax
calculations in section 3 of the Act, which amends IRC § 941(a)(1), are somehow inconsistent with
the arm’s-length principle. But these calculations simply establish the amount of income that may be
subject to taxation. These calculations have nothing to do with how income is allocated between
related parties. To the extent any such allocations are relevant or necessary in connection with
extraterritorial income, they are made in accordance with a strict arm’s-length test under IRC § 482.
As one legislative report accompanying the Act explains, even though neither the Panel nor the
Appellate Body ruled on the propriety of the FSC administrative pricing formulas for allocating
income between related parties, “because there is no separate entity required, there are no transfers
required between related domestic and foreign companies. If there are transfers between related
parties, general arm’ s-length principles apply."
61
G. THE ACT DOES NOT PROVIDE FOR DOUBLE NON-TAXATION
148. In paragraphs 214 through 218 of its Second Submission, the EC contends that the Act
provides for a "cumulation" of the foreign tax credit and the exclusion with respect to the same
income – income subject to foreign withholding taxes. This contention is false.
149. The EC misstates the definition of a withholding tax. A withholding tax is a direct,
source-based tax imposed upon certain types of passive income; for example, interest, dividends and

60 EC Second 21.5 Submission, section 4.6.4.
61 House Report (US-3), page 18.

royalties. Section 943(d) of the IRC is consistent with this definition because: (a) withholding taxes
are direct taxes and sections 901 and 903 of the IRC provide a credit for direct taxes; and (b)
withholding taxes are source-based taxes, and, thus, are imposed on "a basis other than residence."
The term "withholding tax" in section 943(d) does not refer to taxes on business profits, as noted in
the legislative history of the Act, which indicates that withholding taxes in section 943(d) "would be
similar in nature to the gross-basis taxes described in sections 871 and 881." Sections 871 and 881 of
the IRC are US gross-basis withholding taxes on passive income. Accordingly, the hypothetical
presented by the EC in paragraph 217 is based upon a false premise.
150. Even if the EC were correct in its definition of withholding taxes, which it is not, the Act does
not permit double non-taxation of income subject to withholding taxes. With respect to excluded
extraterritorial income, the Act represents the only method for the relief of double taxation.
Accordingly, the Act denies a foreign tax credit with respect to excluded extraterritorial income.
Extraterritorial income that is not excluded, however , may be subject to both US tax and foreign tax.
Therefore, foreign tax credits are available with respect to income that is not excluded.
151. Section 943(d) states that withholding taxes are attributable to extraterritorial income that is
not excluded extraterritorial income. Thus, taxpayers may claim a foreign tax credit with respect to
the withholding taxes imposed on this income. There is no cumulation of "benefits", as alleged by the
EC, because the income with respect to which a credit is claimed is not excluded extraterritorial
income.
IX. THE ACT’S EXCLUSION IS NOT CONTINGENT ON THE USE OF DOMESTIC
OVER IMPORTED GOODS IN VIOLATION OF ARTICLE 3.1(B)
152. Turning to the EC’s arguments regarding Article 3.1(b) of the SCM Agreement, Article 3.1(b)
is relevant only if the Panel first finds: (a) that the Act’s exclusion constitutes a subsidy; and (b) that
the Act does not constitute a measure to avoid double taxation within the meaning of the fifth
sentence of footnote 59. The United States respectfully submits that, for the reasons previously
discussed, neither finding would be warranted.
153. Nevertheless, should the Panel reach Article 3.1(b), the United States has demonstrated that
the Act’s exclusion is not contingent on the use of domestic over imported goods. The 50-per cent
rule does not require that US goods be substituted for foreign goods. In fact, products involved in
transactions earning extraterritorial income need not incorporate any US-produced inputs and can
consist entirely of foreign inputs. Simply put, the exclusion of extraterritorial income is not
contingent, conditioned, or dependent for its existence on the use of domestic over imported goods.
154. The EC has challenged the United States’ positi on in four respects. First, the EC argues that
Article 3.1(b) does not require a complaining party to prove a local-content contingency in all cases.
Second, the EC contends that the Appellate Body decision in Canada Autos is inapposite to this case.
Third, the EC contends that the information cont ained in its Annex substantiates its claim under
Article 3.1(b). Fourth, the EC challenges the Unit ed States’ argument that the principle of origin
diminishes the impact of the 50-per cent rule.
A. THE EC’S ARTICLE 3.1(B) CLAIM IS BASED ON AN ERRONEOUS LEGAL
STANDARD
155. As to the EC’s first point – that it does not have to establish a local-content contingency on a
product-by-product basis – the EC states that “Art icle 3.1(b) prohibits local-content contingency to
any degree, even a slight bias in favour of domestic goods."
62 The EC continues by stating that it

62 EC Second 21.5 Submission, para. 160.

“merely has to establish, based on the wording of the [Act], that the Act in the abstract , or in some
cases, will give rise to the use of US over imported goods."63
156. These statements by the EC are clearly at odds with the applicable legal standard embodied
by Article 3.1(b). The Appellate Body has confirmed that Article 3.1(b) requires a complainant to
establish that a subsidy is contingent, conditioned, and dependent for its existence on the use of
domestic over imported goods. Demonstrating a “slight bias” in favor of domestic goods or that in
some cases domestic goods will be used over imported goods does not make the exclusion of
extraterritorial income “contingent” on the use of such domestic goods.
157. The fact that the EC is challenging the Act “as such” and “is not making any claim in respect
of its application in a particular sector or to a particular product” does not diminish the EC’s burden of
establishing contingency within the meaning of Artic le 3.1(b). The EC must establish that the 50-per
cent rule, as written, renders the exclusion of extraterritorial income contingent on the use of domestic
over imported goods. The fact that the 50-per cent rule is crafted in such a manner that it is every bit
as permissible for foreign goods to be used as domestic goods confirms that the Act is not de jure
contingent on the use of domestic over imported goods.
B. CANADA AUTOS IS DIRECTLY APPLICABLE TO THIS DISPUTE
158. The EC contends that Canada Autos is inapposite to this case because the measures at issue in
that case related to a closed class of beneficiaries, not the “undetermined and unlimited series of
instances and beneficiaries"
64 that are covered by the Act. Thus, while the EC recognizes that the
Appellate Body considered how the local requirements operated at an individual-company level, the
EC claims this is irrelevant because the scope of the measures in that case are different from the scope
of the Act.
159. The EC’s argument misses the most significant feature of the Canada Autos decision. That is,
the Appellate Body concluded that it could not determine whether a value-based requirement was de
jure contingent on the use of domestic over imported goods without understanding how the measure
actually operated. Without this “vital information,” a panel cannot know “enough about the measure
to determine whether the [domestic value] requirements were contingent ‘in law’ upon the use of
domestic over imported goods." 65 In this regard, the Appellate Body concluded that a measure
requiring 60 per cent domestic value does not necessarily lead to a conclusion of de jure contingency.
160. Thus, the Appellate Body’s decision in Canada Autos makes clear that it is not enough for the
EC to merely demonstrate that the Act “in the abstract, or in some cases, will give rise to the use of
US over imported goods.”
C. THE EC’S ANNEX DOES NOT SUPPORT A CLAIM UNDER ARTICLE 3.1(B)
161. To the extent that the EC relies on the information provided in the EC’s Annex to support its
de jure claim, this information is insufficient.
162. The EC’s “evidence” does not describe how the Act’s 50-per cent rule actually operates with
respect to US taxpayers that are eligible to excl ude extraterritorial income. Second, the EC relies on
data from European industries that include EC cost data and mere estimates of profit. No justification
is provided for why this information would be representative of the costs and profits of a US taxpayer

63 Id., para. 175.
64 EC Second 21.5 Submission, para. 173.
65 Id.

that is likely to make use of the Act’s exclusion. Moreover, there is no basis for concluding that a
given manufacturer necessarily would have to rely on domestic instead of imported goods.
163. Given the limited nature of the “evidence” provided, this Panel should reject the EC’s attempt
to diminish its burden of establishing de jure export contingency.
D. RULES OF ORIGIN FURTHER DIMINISHES THE IMPACT OF THE 50-PER CENT
RULE
164. The EC challenges the proposition described by the United States that applicable rules of
origin diminish the practical effect of the 50 per cent rule on components incorporated into
manufactured products. The United States explained that an input sourced from a US supplier may be
deemed US-origin for purposes of the 50 per cent rule, despite the fact that the goods from which that
component was manufactured may have been primarily, or even entirely, imported goods. The EC
attacks this point as irrelevant, yet it simultaneously concedes that, as a result of rules of origin,
companies may comply with the 50 per cent rule and still incorporate foreign value in excess of
50 per cent.66
165. The EC may not like the fact that the 50-per cent rule can be satisfied in this manner, but it is
nonetheless the manner in which the rule is applied by the US Government. As a result, inputs that
are nominally US in nature could in fact be essentially comprised entirely of foreign content. In this
way, rules of origin and their relation to the 50-per cent rule further demonstrate that there is no basis
to conclude that the Act is contingent upon use of domestic over imported goods.
X. THE ACT DOES NOT VIOLATE ARTICLE III:4 OF THE GATT
166. With respect to the EC’s claim that the United States has violated Article III:4 of the GATT,
the United States recalls its arguments under Article 3.1(b) of the SCM Agreement that the EC fails to
understand how the 50-per cent rule operates and why it requires no substitution of US goods for
imported goods. The same rationale applies to GATT Article III:4. No less favorable treatment is
afforded to imported goods because the 50-per cent rule does not change the conditions of
competition. Taxpayers are under no obligation to use domestic content, and the EC has not shown
that any US manufacturers will do so.
167. In addition, the United States explained in its First Submission that the Act is a law of general
application and, as such, complaining parties must show that there is a meaningful nexus between the
measure and adverse effects on competitive conditions in order to make a prima facie case. In turn,
this requires a showing that the measure has had more than a de minimis impact on the treatment of
imported goods.
67
168. The EC cites to a number of cases in response to this argument to try to convince the Panel
that the Act on its face violates Article III:4. In the alternative, the EC states that, if it must submit
evidence, it has proffered enough evidence to support its claim. However, the United States believes
that a prima facie case for an Article III:4 violation in this case cannot be made based solely on the
face of the Act, and that the EC has failed to submit probative factual evidence adequate to support its
claims.

66 EC Second 21.5 Submission, para. 162.
67 Japan-Measures Affecting Consumer Photographic Film and Paper (“Japan Film”) , WT/DS44/R,
Report of the Panel adopted 22 April 1998, paras. 10.381, 10.84.

A. THE ACT DOES NOT ON ITS FACE VIOLATE ARTICLE III:4
169. The EC argues that all laws, regulations and requirements are subject to the same Article III:4
analysis whether or not the measure is one of general applicability or one affecting only a particular
class or category of imports. As such, the EC need only show that, “based on the terms of the law”,
an advantage can be obtained using domestic products.
68
170. However, the EC cannot refute the case law cited by the United States that shows that
generally applicable measures engender a greater evidentiary burden than laws involving a specific
class of imported products.69 In fact, rather than respond to the cases cited by the United States, the
EC relies on EEC Parts and Components for the proposition that generally applicable measures are
subject to the same Article III:4 test as product- or class-specific measures.
171. The EC’s reliance on this case, though, demonstrates its fundamental misunderstanding of the
US argument. That case clearly involved a specific class of imported products – imported component
parts subject to an anti-dumping measure. That law, just like in the vast majority of Article III:4 cases
that have come before GATT and WTO panels (including Canada Autos), had a clear and direct affect
on certain imported products. Alternatively, laws of general applicability have, at most, an indirect
impact on imported products and therefore, as in Japan Film , a heightened burden is required to
demonstrate an Article III:4 violation.
B. THE EC FAILS TO PROFFER ADEQUATE EVIDENCE TO SUPPORT ITS
ARTICLE III:4 CLAIM
172. In addition to its legal argument, the EC claims that it has proffered factual evidence to
support its claim, despite its position that it can meet its burden without such evidence. However, this
“evidence,” which was submitted in its Annex to the EC’s First Submission, merely reflects general
conclusions about production processes in various sectors based on “some data relating to production
in certain sectors” within the European Union. 70 Not only is there no evidence to support these
conclusions, the data provided by the EC reflect only costs within the European Union, rather than
costs within the United States or in other countries in which qualifying foreign trade property may be
produced. Such data has little or no value in this case.
173. The absence of adequate factual support for th e EC’s Article III:4 claim should be viewed by
this Panel with a high degree of scepticism and, without more, the EC’ s claim should be rejected.
XI. THE UNITED STATES HAS COMPLIED WITH THE DSB’S
RECOMMENDATIONS AND RULINGS
174. As this Panel is aware, the measures contested by the EC in the FSC case no longer exist.
The US explained in its First Submission, however, that the Act does provide limited transition relief
by providing one tax year for those FSCs in existence as of 30 September 2000 to continue in
operation.
71 In addition, the Act does not alter the tax treatment of long-term, binding contracts
between FSCs and unrelated parties entered into before 30 September 2000 7272 These rules are
narrow and apply only in highly particularized circumstances.

68 EC Second 21.5 Submission, para. 237.
69 US First 21.5 Submission, paras. 217-218.
71 The Act § 5(c)(1)(A).
72 The Act § 5(c)(1)(B).

175. However, the EC contends that the United States has not complied with the DSB’s
recommendations and rulings because: (1) the Act contains transition rules that extend the FSC
regime beyond 30 October 2000; and (2) the Act was not signed into law until after
1 November 2000. However, the United States has complied fully with the DSB’s recommendations
and rulings.
A. THE ACT’S TRANSITION RULES CONSTITUTE A REASONABLE METHOD OF
COMPLYING WITH THE DSB’S RECOMMENDATIONS AND RULINGS
176. The EC alleges that the Act’s transition rules allow US exporters to benefit from the FSC
measures for “an indefinite period" 73 and that the FSC Panel already gave the United States a
“transition” period until 1 October 2000 to change its laws. The EC cites to prior WTO cases for the
proposition that this Panel may not consider business realities when it determines whether the
United States has fulfilled its obligations.
177. None of these assertions, however, detract from arguments presented by the United States in
this case. The United States has properly requested that the Panel find that the Act complies with the
DSB’s recommendations, and the Panel has the authority to make such a finding.
178. First, the Act does not provide US exporters with an “indefinite” transition period. Only in
those cases where US exporters have engaged in long term contracts entered into under the FSC
regime will the ability to use the FSC extend beyond 31 December 2001. The FSC tax regime will
remain in effect only for those contracts.
179. Second, the EC recognizes that sound policy reasons underlie the promulgation of transition
rules when repealing significant tax legislation. In th is light, it would be unfair for the United States
to provide no transition period as of the time the FSC tax regime was repealed. The EC claims that
the WTO decision itself served notice on taxpayers that the FSC rules may be repealed, but taxpayers
did not know until the legislation was passed exactly what new rules they would need to adjust to.
180. The cases cited by the EC do not limit this Panel’s authority to uphold the Act’s transition
rules. These cases involved narrow legal provisions that impacted only a few private parties. The
overall impact of repealing those provisions was relatively small.
181. That situation does not exist in this proceeding. The scope of the FSC regime was broad, and
a quite large number of businesses were impacted by its repeal. Therefore, the cases cited by the EC
should not control the Panel’s actions in assessing whether the United States has properly
implemented the DSB’s recommendations.
182. Finally, it is worth recalling that the FSC provisions had been in place for a long time and the
EC waited thirteen years before challenging it. Du ring that time, US taxpayers came to rely on the
FSC provisions in structuring their foreign transactions. Furthermore, the United States promulgated
and maintained the FSC tax provisions in relian ce on the 1981 Understanding adopted by the GATT
Council. Such reliance was not unjustified.
B. THE UNITED STATES COMPLIED WITH THE TIME PERIOD SPECIFIED BY THE
DSB
183. The EC also argues that the United States failed to comply with the DSB’s recommendations
in the FSC case because the Act was not signed until 15 November 2000. The EC’s argument fails
for two reasons.

73 EC Second 21.5 Submission, para. 243.

184. First, the DSB did not recommend that the United States enact legislation by 1 October 2000.
Instead, the DSB recommended that the United Stat es withdraw the FSC subsidies with effect from
1 October 2000, which the DSB then extended to 1 November 2000. The Act’s provisions apply
retroactively and repeal the FSC provisions before 1 November 2000. The Act in fact provides that
the “amendments made by this Act shall apply to transactions after 30 September 2000."
74 Thus, the
United States complied with the DSB’s recommendation by repealing the FSC with effect from
1 October 2000. None of the EC’s arguments to the contrary support an alternative conclusion.
185. Second, the EC’s arguments with respect to whether the United States complied with the
DSB’s recommendations and rulings within a reasonable period of time are moot. As reflected in
Article 19.1 of the DSU, the WTO does not provide retroactive relief for alleged past wrongs.
186. In this case, the EC alleges that the United States failed to act by 1 November 2000.
However, once the United States signed the Act into law on 15 November 2000, the allegation that the
United States “failed to act” ceased to exist. In other words, by the time the EC made its panel
request to commence this Article 21.5 proceeding, the violation – that is, the purported “failure to act”
– it ostensibly was challenging no longer existed. Panels typically refrain from examining measures
that cease to be in existence or in effect before a panel’s terms of reference are set.
75 Therefore, the
EC’s claim that the United States has failed to properly comply with the DSB’s time line should be
rejected.
XII. CONCLUSION
187. In closing, the United States thanks the Panel for its patience in listening to a rather detailed
discussion of the issues. The United States would like to end this statement where it began: focusing
on the most important issues before the Panel.
188. To reiterate, the United States believes that the Panel must determine whether the partial
exclusion of extraterritorial income under the Act constitutes a subsidy within the meaning of
Article 1. The United States submits that it does not.
189. The Panel also must determine whether the fact that exporting is one way, but not the only
way, of generating excluded extraterritorial income renders the exclusion export contingent within the
meaning of Article 3.1(a). The United States submits that it does not.
190. And, finally, the Panel must determine whether the fact that the Act’s exclusion is not limited
to the amount of foreign taxes paid precludes the Act from constituting a measure to avoid double
taxation under footnote 59 of the SCM Agreement. The United States submits that this is not the
case.
191. Whichever way the Panel rules, the United States urges the Panel to avoid the EC’s "I know it
when I see it" approach. Instead, the United States encourages the Panel in the strongest possible way
to provide guidance as to what the relevant provisions mean and what they do and do not permit.
Only in this way will the parties be able to do more than know the outcome when they see it. They
will be able to understand and apply the principles on which that outcome is based. Thank you

74 The Act § 5(a).
75 See, e.g., Argentina Textiles, paras. 6.13-15.

ANNEX D-4
CLOSING STATEMENT OF THE UNITED STATES
(16 March 2001)
1. Mr. Chairman, members of the Panel, on behalf of the United States, I first would like to
express our gratitude for your willingness to serve in this matter, and your patience and attention in
listening to our arguments. It is clear from the questions you have posed over the last several days
that you understand the issues in this case and the US positions with respect to them.
2. With respect to the European Communities’ closing statement, we will address the points
made and the new information attached to the statement in our written answers to the Panel’s
questions, to the extent that any of the points and new information are relevant. The only specific
observation I would make at this time concerns paragraph 33 of the EC’s closing statement, where the
EC asserts that the United States has admitted that there can be cases where use of US articles will be
needed. Of course, all the United States has said is that while it is possible to construct hypotheticals
under which US articles would be needed, we are un aware of any actual situations where US articles
would be needed.
3. Now, this proceeding involves legislation adopted by the United States in response to, and in
order to comply with, findings by this Panel and the Appellate Body. This was the first occasion on
which a WTO decision required the United States to change one of its statutes, and the repeal of the
FSC and the adoption of the Act now under review were accomplished under the pressure of a
relatively short deadline, during an election year, as nearly unprecedented free-standing tax
legislation, and in the face of a consistent refusal by the EC to offer any input on what types of
changes might be acceptable to it and, in its view, WTO-consistent. Despite the fact that the case was
brought under circumstances considered dubious by many, the United States acted expeditiously and
in good faith to comply.
4. This case is complex not only because the tax principles and provisions are complex, but also
because the decisions in this dispute could have far-reaching implications. The measure found to be
WTO-inconsistent in the original proceeding had been adopted, as had been its predecessor, to offset
an underlying tax advantage that a difference in tax systems creates. The challenge for the
United States has been to produce a replacement measure that both addresses that underlying
economic issue while at the same time achieving WTO consistency. One of the challenges for this
Panel, we respectfully submit, is to issue a rulin g that fairly implements WTO principles, including
the principle, reflected in the preamble to the WTO Agreement itself, that arrangements be "reciprocal
and mutually advantageous." The United States submits that a decision fails to honour this principle
if it produces an outcome that discriminates between tax systems even though the systems generate a
similar economic result.
5. In developing its replacement measure, the United States was mindful not only of the
customary rules of interpretation reflected in the Vienna Convention and their emphasis on the
ordinary meaning of the relevant textual provisions, but also of the decisions of this Panel and the
Appellate Body. Those decisions rigorously a dhered to the textual prescriptions of the SCM
Agreement, to the exclusion of prior precedents on which the United States had relied and to which
the United States, at least, attached considerable importance.

6. As a result, the United States’s defense of the Act is, like the critiques of the Act’s
predecessor, highly textual. In this proceeding, it is the EC that advocates principles not found in the
text of the applicable agreements and that advances arguments for which the relevant text provides no
support. Having been in a similar position in connection with this same dispute, the United States
understands the EC’s problem, but is understandably unsympathetic.
7. The emphasis on the ordinary meaning of the text of the agreements – a constant feature of
the Panel’s original decision and the EC’s original arguments – brings us first to Article 1 and the
issue whether the Act constitutes a subsidy within the meaning of Article 1. That inquiry is based on
a definition of “financial contribution” that is defined in three of its four prongs by affirmative
governmental acts in providing money or goods and services. The fourth prong, at issue here,
involves financial contributions that entail not collecting or foregoing revenue that is due and owing
to the government, as in the case of a credit against taxes that are owed to the government.
8. By re-defining the concept of “gross income” in the US tax code, the United States Congress
re-drew the outer boundary of its own taxing authority, and it expressly noted that that was what it
was doing. It expressly modified the “prevailing domestic standard” under US law, and consciously
changed the “normative benchmark” by which the Panel and Appellate body opined that provisions
coming under subparagraph (ii) of Article 1.1(a)(1) would be measured. The result is a new measure
that is not a “financial contribution” as that term is defined by the ordinary meaning of the language
of subparagraph (ii). Although the EC is critical of that solution, it is one that is faithful to the text of
the Agreement and to the findings of the Panel and the Appellate Body.
9. In addition, the Congress of the United States designed a replacement measure that is not
“contingent” on exports as that term is used in Article 3.1(a). Following Appellate Body guidance on
this very point in recent decisions emphasizing the definition of "contingent," the Congress created an
exclusion that is not “contingent” on export performance. To the contrary, US taxpayers can take
advantage of the new exclusion without ever exporting. Indeed, there is no US taxpayer who can take
advantage of the exclusion only by exporting, because every such US taxpayer could also take
advantage of the exclusion through foreign production and foreign sales. Indeed, there are even
certain domestic transactions (domestic sales of products that are to be used outside of the
United States) for which the exclusion is available. While exporters are plainly among those
taxpayers who can utilize the exclusion, the exclusion does not meet the ordinary meaning of the test
set out in the text of Article 3.1(a).
10. On this point, the EC asks the Panel to depa rt completely from the applicable text of the
Agreement. Rather than consider whether the US exclusion is “contingent” on export performance –
the test that is set out in Article 3.1(a) itself – the EC advocates a comparison test that appears
nowhere in the text of Article 3.1(a). Article 3.1(a) does not call for or require a comparison; instead,
the test is the one that Article 3.1(a) states – whether a subsidy is “contingent” on export performance,
a test that the US exclusion does not meet.
11. The conclusion that the new US exclusion does not offend Article 3.1(a) is confirmed by
recalling, as we have done in our preliminary answer to Panel question 21, that export subsidies are a
type of specific subsidies. Article 2.3 expressly so provides. Thus, assuming for the moment that the
exclusion is a subsidy within the meaning of Article 1, in analyzing whether it is export-contingent,
one should consider how the analysis would be made if the question were: Is a subsidy specific
because some sub-set of the users of the subsidy constitutes, for example, a specific group of
industries while the remainder of the users are not a specific group? In that context, we submit, we
would all be unlikely to find the subsidy specific on the basis that a subset of the beneficiaries of that
subsidy constitute a specific group of industries. The answer must be the same if a subset of the
beneficiaries consists of exporters.

12. The third main issue in this dispute involves the principle, articulated in footnote 59 of the
SCM Agreement, that paragraph (e) of the Annex to Article 3.1(a) is “not intended to limit a Member
from taking measures to avoid the double taxation of foreign-source income.” This issue, which was
not addressed in the prior proceeding regarding the FSC, is clearly before this Panel. It is at issue
because this was an explicit, stated objective of the Congress in adopting the new US measure.
13. The EC would have the Panel decree that this was not the purpose of the US Congress in
adopting its new legislation, a proposition that would be arguable had the Congress been silent with
respect to its intent, but an extraordinary proposition in the face of a clearly expressed Congressional
purpose. The EC further contends that even if this were the purpose, that purpose was unnecessary
because there are other means available to avoid double taxation, a proposition better suited for a
policy debate than for an analysis of footnote 59. And the EC finally argues that a measure to avoid
double taxation can be justified only through country-by-country determinations of whether there is
an applicable foreign tax, a proposition that would be laughable were anyone to similarly suggest that
territorial limits found in tax systems of EC member states should be permissible vis-a-vis certain
foreign countries, but not others.
14. In fact, an exclusion is a widely recogn ized means of avoiding double taxation. OECD
principles make clear that exclusions or exemptions need not provide dollar-for-dollar or
pound-for-pound protection from double taxation, as Eu ropean exemption systems demonstrate. The
text of footnote 59, which does not limit measures to just offsets and does not use the term
"permanent establishment", authorizes measures designed to avoid double taxation on "foreign-source
income", a broader term on which the exclusion in the Act is based.
15. As a factual matter, it is clear that the income covered by the Act’s exclusion is income that
faces the legitimate possibility of taxation outside the United States. Foreign taxes will apply to the
excluded income of foreign producers who take advantage of the new US exclusion, both in cases
where there is a foreign permanent establishment and where there is foreign economic activity that
does not meet the strict standard of a permanent establishment. Many countries do not limit their
taxing authority to "permanent establishments", among them the United States, Canada, certain
European countries, and a wide variety of developing nations. Income from electronic commerce
transactions is just one recent example of income that may be subject to tax without regard to the
"permanent establishment" standard. Nor does the fact that a country has tax treaties with certain
other countries nullify the final sentence of footnote 59, as again, European exemption systems show.
16. For all of these reasons, the new US exclusion is a legitimate, indeed conventional, measure
“to avoid the double taxation of foreign-source income,” as the text of footnote 59 allows.
17. With respect to all three of the core issues in this case, there is an underlying question of the
general applicability of rulings that this dispute generates. It is, of course, true that European tax
systems are not at issue here; they are not within the terms of reference of this Panel. It also is true
that the existence of a corresponding subsidy in a European tax system is not a defense in a challenge
to a United States measure. At the same time, though, it is equally true that any WTO principles
articulated in this case are equally applicable to all WTO Members, European countries included. It is
also true that European tax systems that incorpor ate territorial limits confer, without question, a tax
benefit on exporters who realize both domestic and offshore income from export sales. And it is true
that with the new exclusion, the United States has inco rporated a measure that is similar to, albeit not
identical to, features found in European tax systems.
18. It is not the intent of the United States to condemn European tax systems or to justify its own
by pointing to similar practices in other countries. It is our intent, however, to suggest that this
dispute has moved a considerable distance from its original posture, that the measure at issue and
territorial limits found in many European systems are different mechanisms for achieving a

fundamentally similar result, and that it is unlikely that the drafters of the SCM Agreement intended
to invalidate all of those systems. The ordinary meaning of the text they drafted does not support that
result.
19. In conclusion, the United States submits that this measure, like its predecessor, should be
measured by the ordinary meaning of the text of the provisions that apply to it. Such an analysis, we
believe, leads to the conclusion that in its central respects the United States measure is not
inconsistent with the SCM Agreement.
20. The United States recognizes that it has voluntarily assumed the obligations of the WTO
Agreement. At the same time, the United States understands, as this Panel undoubtedly also
understands, that neither it nor the other proponents of the SCM Agreement contemplated that their
obligations under the SCM Agreement would sharply circumscribe their ability to make their own tax
policy decisions or to maintain rough tax parity with respect to the competitive advantages and
disadvantages that different national tax systems confer. Thank you.

ANNEX E
Oral Statements of the Third Parties
Content Page
Annex E-1 Oral Statement by Canada as Third Party E-2
Annex E-2 Oral Statement by India as Third Party E-4
Annex E-3 Oral Statement by Japan as Third Party E-7

ANNEX E-1
ORAL STATEMENT BY CANADA
(14 March 2001)
Mr. Chairman, Members of the Panel.
Thank you for the opportunity to provide Canada’s views in this proceeding. We would take
this opportunity to highlight briefly some of the key points made in our written submission.
As we stated in our submission, we agree with the EC that the FSC Repeal and
Extraterritorial Income Exclusion Act of 2000 does not bring the United States into compliance with
the DSB recommendations and rulings in this dispute.
In support of this position, we would advance two principal arguments.
First, in our view, the FSC replacement scheme provides a “subsidy” to US-based enterprises
within the meaning of Article 1.1 of the SCM Agreement.
Second, the subsidy provided under the FSC replacement scheme to US-based enterprises is
contingent upon export performance, in violation of SCM Article 3.1(a).
Turning briefly to the first argument:
In our view, there is a “financial contribution” to US-based enterprises within the meaning of
Article 1.1(a)(ii) of the SCM Agreement. The FSC replacement scheme continues to provide a
financial contribution to US-based enterprises by excluding from taxation domestic income that they
earn from export transactions.
As the Appellate Body stated earlier in this dispute, the “foregoing” of revenue “otherwise
due” implies that less revenue has been raised by th e government than would have been raised in a
different situation, and that the government has given up an entitlement to raise revenue that it would
otherwise have raised.
The basis for comparison must be the tax rules applied by the Member in question.
 In this
case, the income earned by US-based enterprises on export transactions, which is part of the income
excluded from taxation under the definition of “extrat erritorial income”, would otherwise be subject
to tax in the absence of the FSC Replacement scheme. Moreover, as the EC has noted, the income
earned from export transactions under the FSC replacement scheme corresponds arithmetically to the
exempt foreign source income of the FSC scheme. The United States continues to provide subsidies
to US-based enterprises earning this type of income.
The revenue or tax that would otherwise be due on “income earned from export transactions”,
which is part of the income excluded from taxation under the FSC replacement scheme, would be the
tax applicable to such income under US law. Thus , in our view, the United States is providing a
financial contribution to US-based enterprises earning this type of income by foregoing revenue that

would otherwise be due within the meaning of Article 1.1(a)(ii) of the SCM Agreement. Moreover,
as noted in our submission, since income earned from export transactions cannot by definition face
double taxation, the exclusion from taxation provided for this income under the FSC replacement
scheme can only reduce US tax otherwise payable.
In addition, the financial contribution clearly confers a “benefit” to US-based enterprises
earning domestic income from export transactions.
Therefore, in our view, there is a “subsidy” within the meaning of SCM Article 1.1, since
there is both a “financial contribution” and a “benefit.” Both components of the definition have been
met.
Turning to our second point:
Canada also submits that the “subsidy” provided to US-based enterprises is “contingent upon
export performance.” In order to benefit from the subsidy, the Act states that goods must not be sold
“for ultimate use in the United States.” As noted in our written submission, we agree with the EC that
this is another way of saying, with respect to domestic goods, that the goods must be exported. As
such, the subsidy is de jure export contingent.
The FSC replacement scheme, when applied to income earned from exports of domestic
goods of US-based enterprises, results in the permanent reduction of US taxes otherwise payable. The
export-contingent nature of the scheme leaves no doubt that the only way that income derived from
the sale of a domestic good can qualify under the scheme is if the good is exported.
In conclusion, Canada respectfully requests that the Panel find that the United States has not
complied with the recommendations and rulings of the DSB and that the United States continues to
provide prohibited export subsidies under th e FSC replacement scheme, inconsistently with
Article 3.1(a) of the SCM Agreement.
Thank you.

ANNEX E-2
THIRD PARTY STATEMENT BY INDIA
(14 March 2001)
India is appreciative of this opportunity to present its views on this dispute.
The issue before this Panel is whether the FSC Repeal and Extraterritorial Exclusion Act of
2000 (hereinafter "FSC Replacement Act") is consistent with the recommendations and rulings of the
DSB to withdraw the FSC measure found to be a prohibited export subsidy and thus inconsistent with
the US obligations under Articles 3.1(a) and 3.2 of the Agreement on Subsidies and Countervailing
Measures (SCM Agreement) and under Articles 10.1 and 8 of the Agreement on Agriculture.
We confine our presentation to the claims under the SCM Agreement, especially
Article 3.1(a).
US failed to withdraw the original FSC subsidies "without delay"
India invites the Panel's attention to the transitional provisions of the FSC Replacement Act.
Section 5(c)(1) (A) of this Act provides that for any FSC in existence on 30 September 2000 and at all
times thereafter, the Act shall not be applicable to any transaction occurring:
- before 1 January 2002; or
- after 31 December 2001, pursuant to a binding contract
• with unrelated parties; and
• in effect on 30 September 2000.
It is submitted that the above provisions of the FSC Replacement Act would allow the US
companies to continue to benefit from the WTO incompatible FSC scheme beyond the expiry of the
reasonable period of time. Therefore, India requests the Panel to find that the US has failed to
withdraw the FSC subsidies as required by Article 4.7 of the SCM Agreement and recommendations
and rulings of the DSB, and has also failed to co mply with its obligations under Article 21 of the
DSU.
DSB Rulings and SCM Agreement
On 24 February 2000, the Appellate Body upheld the Panel’s finding that various exemptions
for certain types of income under the US Internal Revenue Code of 1986 (Code) earned by foreign
sales corporations (i.e., FSC scheme), taken together, constituted a prohibited export subsidy under
Article 3.1(a) of the SCM Agreement. The Appellate Body agreed with the Panel that having decided
to tax foreign-source income, the US could not exclude certain types of this income from taxation
without foregoing government revenue that would otherwise be due, and, therefore, without providing
a financial contribution under Article 1.1(a)(1)(ii) of the SCM Agreement. Having also agreed with

the Panel that the FSC measure provided a “benefit” to the recipients of the exemption, the Appellate
Body agreed that the FSC measure represented a “subsidy” within the meaning of Article 1.1 of the
SCM Agreement. Finally, the Appellate Body upheld the Panel’s finding that the “subsidy” was
contingent upon export performance and, therefore, prohibited under Article 3.1(a) of the SCM
Agreement.
The Appellate Body recommended that the DSB request the United States to bring the FSC
measure into conformity with its WTO obligations.
The Appellate Body emphasised that its ruling was in no way a judgement on the consistency
or the inconsistency of the relative merits of the tax system chosen by the US. The Appellate Body
observed that:
"[a] Member of the WTO may chose any kind of tax system it wishes - so long as, in
so choosing, that Member applies that system in a way that is consistent with its
WTO obligations. Whatever kind of tax system a Member chooses, that Member will
not be in compliance with its WTO obligations if it provides, through its tax system,
subsidies contingent upon export performance that are not permitted under the
covered agreements." (para 179 of AB report)
These findings and conclusions of the Appellate Body were adopted by the DSB on
20 March 2000.
FSC Replacement Act
The US has enacted the FSC Replacement Act and amended its Internal Revenue Code
relating to taxation of FSCs purporting to comply with the recommendations and rulings of the DSB.
The Act excludes "extraterritorial income" from gross income on which tax liability is calculated.
"Extraterritorial income" is defined as gross income attributable to "foreign trading gross receipts".
Foreign trading gross receipts include gross receipts from sale, exchange, lease or rental of
"qualifying foreign trade property", and related and subsidiary services.
Under Section 114 of the Code as amended by the Act, not all-extraterritorial income is
eligible for exclusion from tax liability. Only the "qualifying foreign trade income" is eligible for
such exclusion. Such income encompasses (1) income earned from export transactions by the US
based companies; and (2) foreign source income earned by US company through a branch or
subsidiary abroad. The income earned from the export transaction is excluded from tax.
Under Article 1.1(a)(1)(ii) of the SCM Agreement, a financial contribution by the
Government exists where government revenue that is otherwise due is foregone or not collected. The
term “otherwise due” implies a comparison between the revenues due under the contested measure
and revenues that would be due in some other situation. As stated by the panel and Appellate Body in
the examination of the original FSC measure, the basis of comparison is the tax rules applied by the
US. (AB report, para 90).
The effect of the exclusion is to reduce tax liability of the beneficiary corporation. This
represents a departure from the rules of taxation that would “otherwise” apply to such gross income.
Accordingly, government revenue otherwise due is foregone or not collected within the meaning of
Article 1.1(a)(1)(ii) of the SCM Agreement. A benefit is also conferred under Article 1.1(b) in the
form of a reduction in tax liability.
It is submitted that the “subsidy” provided to US-based enterprises is clearly “ contingent
upon export performance”, as in order to benefit from the “subsidy”, goods must not be sold “for

ultimate use in the United States." (Section 942(a)(2)(A) of the FSC Replacement Act). India agrees
with Canada and the EC that this is simply “anothe r way of saying that they must be exported", and
that these words are sufficient to make the subsid y de jure export contingent. As stated by the
Appellate Body in Canada – Certain Measures Affecting the Automotive Industry (DS139-142):
"a subsidy is … properly held to be de jure export contingent where the condition to
export is clearly, though implicitly, in the instrument comprising the measure. Thus,
for a subsidy to be de jure export contingent, the underlying legal instrument does not
always have to provide expressis verbis that the subsidy is available only upon
fulfilment of the condition of export performance. Such conditionality can also be
derived by necessary implication from the words actually used in the measure."
US argues that this extraterritorial income is excluded from the definition of "gross income"
as a measure to avoid double taxation. In this connection it is submitted that the income earned from
export transactions is income that would generally be taxable only in the US, since it arises from
economic activities taking place in the US. The fact that the proceeds of sales are from foreign
sources does not transform the export income into “foreign income” for tax purposes. Exporting
goods in a foreign country does not create a sufficient nexus to trigger taxation in the importing
country, even when one takes into account the “foreign economic processes ” required under the FSC
Replacement Act. It is submitted that such processes do not create a taxable presence abroad and,
therefore, would not be considered as foreign business income subject to double taxation. Therefore,
no double taxation needs to be relieved with respect to this component of “extraterritorial” income.
India therefore submits that by maintaining these provisions in the FSC Replacement Act, the
US is continuing to provide prohibited export subsidies inconsistent with Article 3.1(a) of the SCM
Agreement.
Conclusion
Therefore, India respectfully requests the Panel to find that the US has not complied with the
recommendations and rulings of the DSB and that the US continues to provide prohibited export
subsidies under the FSC Replacement Act inconsistent with Articles 3.1(a) of the SCM Agreement.

ANNEX E-3
ORAL STATEMENT BY JAPAN
(14 March 2001 )
I. INTRODUCTION
1. Japan wishes to focus its comments on two specific legal issues: the violations by the
United States of its obligations under Article 3.1(a) of the SCM Agreement and under Article III:4 of
GATT 1994. By focusing on these two issues, however, it does not mean that Japan agrees with the
United States on other issues raised by the EC before the panel.
2. Japan recognizes the principle confirmed by the Appellate Body in Japan-Alcohol
1 case that,
as far as the rights and obligations under WTO Agreement are concerned, every sovereign Member
has the authority to administer its own taxation system as it wishes, provided that its actions are
consistent with the Member’s obligation under the WTO Agreement. While respecting such
sovereignty of Members, Japan would like to express its views to the extent that it considers relevant
for the Panel’s deliberation on certain issues concerning the proper interpretation of relevant
provisions of the SCM Agreement and the GATT 1994, particularly as those provisions relate to the
specific measure of the United States, the new tax law to replace the old FSC provisions (hereinafter
referred to as “the FSC Replacement Scheme”).
II. THE FSC REPLACEMENT SCHEME STILL CONFERS THE BENEFIT TO THE
EXPORTS, AND STILL FALLS WITHIN ARTICLE 1 OF THE SCM AGREEMENT
3. In defence of the FSC Replacement Scheme, the United States asserts that the Scheme
“modified the normative benchmark” that was in place under the previous FSC regime, in order to
comply with the ruling of the Panel and the Appellate Body; the Replacement Scheme therefore does
not constitute a subsidy within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement; the
Replacement Scheme is a measure to avoid double taxation.
A. T
HE ACT DOES NOT PROVIDE THE NORMATIVE BENCHMARK AS THE UNITED STATES
ALLEGES
4. The United States extensively asserts in its first submission that the Act creates a new
normative benchmark which replaces the old one, and this new benchmark excludes “Extraterritorial
Income” from the “Gross income”, thereby rendering “extraterritorial income” outside the territorial
limit of the US taxing authority. Moreover, the United States asserts that the replacement of the
benchmark for taxation is within the sovereign authority of Member states which is not affected by
any provision of the WTO Agreement.
5. Japan nevertheless believes that the concept of “otherwise due” of Article 1 of SCM
Agreement and the normative benchmark which th e Appellate Body employed for determining
whether it is “otherwise due”, must reflect the real nature of the exclusion and its relations with the
underlying subsidy. In this case, the relevant normative category should be all foreign trade income,

1 Japan – Taxes on Alcohol Beverages WT/DS8/AB/R, p.16

which includes export income. Since the United States has not excluded this entire category of
income from taxation, but only a part, then it is with in the category of foreign trade income to which
the “otherwise due” criteria must be applied. Therefore, the question is whether tax is “otherwise
due” in connection with foreign trade income under the US system.
6. Under the FSC Replacement Scheme, within the category of foreign trade income, the
majority of foreign trade income is taxable. Thus, the taxation of most foreign trade income
establishes that, from a normative standpoint, income tax on foreign trade income is “otherwise due”
under the US tax system. It is only by virtue of the FSC Replacement Scheme that a small portion of
that income (i.e., “qualifying foreign trade income”) is excluded.
7. In this regard, Japan would like to draw the Panel’s attention to the submission of Canada. As
Canada correctly points out in footnote 19 of Canada ’s submission, “the foreign tax credit provisions
of the US Internal Revenue Code have not been repealed by the FSC Replacement Act and still
provide the basic approach used by the United States to relieve double taxation with respect to income
subject to tax in other countries.”
2
8. Being a third party, Japan has not received a copy of rebuttal submission of the United States.
So Japan has not learned of the US rebuttal on this point. But based on the materials and argument
disclosed to Japan so far, the United States is yet to establish that the Act provides a new benchmark
for the taxation of foreign income in the United States in place of the old one. Unless proven
otherwise by the United States, Japan believes that the Act still confers a subsidy within the meaning
of SCM Agreement Article 1.1(a)(1)(ii), and the “exclusion” from the Gross Income provided under
the Act does not create a new benchmark as the United States alleges, but instead closely emulate the
tax exemption that was available to FSCs under the previous scheme.
B. T
HE US DEFENCE BASED ON FOOTNOTE 59 LEAVES MANY ELEMENTS OF THE REPLACEMENT
SCHEME UNACCOUNTED FOR
9. Now I would like to address the argument of the United States based on Footnote 59. As I
mentioned at the outset of this statement, Japan fully respects the sovereign authority of Members to
administer their respective system of taxation. In the following, I would therefore only like to point
out the elements of the Replacement Scheme that are worthy of close scrutiny, and leave the final
judgment to the Panel.
10. First, based on references to anecdotal legislative history connected to the passage of the FSC
Replacement Scheme, the United States implies that the primary objective of the programme is to
assist US companies in avoiding double taxation. If the intention of the programme were simply to
avoid double taxation, the FSC Replacement Scheme would apply to 100 per cent of foreign trade
income bar legitimate exceptions such as those for prevention of tax evasion. Instead, the programme
allows companies to exclude only a small portion of foreign trade income from taxation. If the
programme were genuinely designed to avoid doub le taxation, why then would the programme only
solve this problem for only a small portion of a company’s exports, as opposed to all sales that might
be subject to double taxation?
11. Second, if the Replacement Scheme is indeed a measure to avoid the double taxation, how
could it be reconciled with the US stating in its submission that “the only requirement is that these
persons be subject to US taxation”?
3 Judging from this US statement, the existence of double taxation
does not seem to be a prerequisite to obtain benefits under the programme. In other words, a
company may benefit from the FSC Replacement Scheme, whether or not the company is subject to

2 Canada Third Party Submission to 21.5 Panel, para. 33
3 US First Submission to 21.5 Panel, para 34

double taxation. The phrase “measures to avoid” suggests a strong linkage between the measures and
the elimination of double taxation. The United States has so far failed to fully account for such
absence of clear linkage between its claim under Footnote 59 and what it claims in its own
submission.
12. Finally, while Footnote 59 does sanction “measures to avoid the double taxation,” this
Footnote does not confer upon Members carte blanche to introduce any measure under the name of “a
measure to avoid double taxation” As is the case with any exception permitted under the WTO
Agreement, exceptions are permitted only to the extent necessary so as not to deviate from the
generally binding principles applicable to all Members, which in this case includes, prohibition of
export subsidies.
13. If the United States is to invoke Footnote 59 in justifying the Act as a measure to avoid
double taxation, it must be demonstrated that the measures introduced under the Act contain clear
linkage, both in letter and substance, to what is necessary for avoiding the double taxation. Thus the
scrutiny for the invocation of exceptions must be conducted not only for the titles or categories of
income used in the law in question, but also for the substance of those elements and the law – which is
in this case a number of conditions attached to so-called “Extraterritorial Income” including the
conditions attached to Qualifying Foreign Trade Property.
14. Such scrutiny leaves us puzzled as to why the Act attaches such conditions as:
“qualifying foreign income” would have had to be earned by an “eligible
corporation,” from the sale, lease, or rental of goods - when such “eligible
corporations” may be generating taxable income through activities other than the sale,
lease, or rental of goods.
Or
not more than 50 per cent of the fair market value of which is attributable to foreign
content - when the double taxation could occur irrespective of how much is
attributable to domestic content.
15. In the eye of Japan, the Untied States has not met the burden of proof in demonstrating the
clear linkage between the Act and what it claims under Footnote 59. Unless the United States meets
this burden, the US effort to interpret footnote 59 to immunize measures that provide export subsidies,
provided those measures also may possibly assist some companies in avoiding double taxation, should
be rejected.
III. ADDING A SEPARATE CATEGORY OF ACTIVITIES THAT CAN ALSO BENEFIT
FROM THE SUBSIDY DOES NOT ELIMINATE THE BENEFIT CONDITIONED
ON EXPORTS.
16. Article 3.1(a) of the SCM Agreement explains that where export performance is solely or one
of several other conditions, the subsidy will be prohibited. The fundamental point of Article 3.1(a)
is whether export performance itself is one of th e underlying conditions for receiving benefits. The
addition of another category of activities eligible for subsidy benefits does not change the benefit for
exports.
17. The United States tries to defend the FSC Replacement Scheme through such a device, by
adding a new category to the old benefits for exports. This new category simply means that the FSC
Replacement Scheme now provides subsidies to more than one category of activities: one directly
related to export income, and another related to foreign-produced goods. Since eligibility for benefits

under the FSC Replacement Scheme for foreign produced goods is a separate and independent
condition from eligibility for direct export from the United States, two benefits are distinct. The
benefit contingent on exporting goods is analytically unrelated to the subsidy related to foreign-
produced goods. That the benefit is also available to the foreign-produced goods category does not in
any way make the subsidy, as it is available to exporters, consistent with the SCM Agreement.
18. The panel should reject any argument that the addition of a foreign-produced category to the
activities eligible for the FSC tax exemption somehow transforms the FSC Replacement Scheme from
a prohibited subsidy into a generally available and permissible subsidy. If Members needed simply to
add some new category of activity, no matter how inconsequential, to an export subsidy to remove the
subsidy from the scope of Article 3.1(a), then any Member could easily circumvent the disciplines of
Article 3.
19. The United States argues that Article 3.1(a) requires a finding that when there are several
conditions that establish eligibility for an export subsidy, export performance must be a required
condition. According to the United States, the phrase “several other conditions” in Article 3.1(a)
means a “series of conditions precedent, all of which must be satisfied.”4 The implication is that if the
conditions are alternative, and a company may obtain the benefit of the subsidy without satisfying the
export performance condition, then the entire programme somehow escapes scrutiny as providing an
export subsidy to companies.
20. This interpretation of Article 3.1(a) must be rejected. First, the US argument has no basis in
the text. The United States reads into the text the critical requirement that “all” of the conditions must
be met. But the text provides no such language or idea. Rather, the text of Article 3.1(a) speaks only
of conditioning the benefit on exports, which may be one of several requirements.
21. Second, this interpretation ignores the context of Article 3.1(a) as creating a discipline against
export subsidies. The mere fact that a company happens to export does not trigger the discipline. But
when a government offers some benefit conditioned on the fact of exportation, then the discipline
must apply. The mere existence of other conditions, and other categories of activities that will allow
company to benefit from the subsidy by means othe r than exports, does not magically render the
programme WTO-consistent as a whole. The export condition remains an export condition. That
others may also benefit does not change the export condition.
22. Third, the US argument would render Article 3.1(a) largely meaningless. Under the US
interpretation, a programme could provide benefits to 99 companies meeting the export condition, and
a single company meeting some other non-export condition. Yet the programme itself would be
permissible, because not every recipient received benefits based on the export condition. This
approach makes no sense as a means to discipline export subsidies, and cannot reflect the purpose of
Article 3.1(a).
23. Finally, as both the EC and Canada correctly pointed out in their submissions
5, the Appellate
Body for the Canada-Autopact case made clear that “a subsidy is held to be de jure export contingent
where the condition to export is clearly, though implicitly, in the instrument comprising the measure.”
Japan believes that the very language used in the conditions attached to the “foreign trade income”
under the Act cannot escape the disciplines of this test.
24. In this dispute, the crux of the EC’s challenge relates to the fact that the FSC Replacement
Scheme still authorizes a category of activity – exports -- to qualify for subsidy benefits. The
fundamental purpose of this Article 21.5 proceeding is to examine whether the same commercial

4 US First Submission to Article 21.5 Panel, para. 135.
5 EC First Submission to 21.5 Panel, para. 84, Canada Third Party Submission to 21.5 Panel, para. 40.

activities – exports -- are still eligible for subsidy benefits under the FSC Replacement Scheme. If so,
then the fundamental problem from the initial panel proceeding has not changed, and the Replacement
Scheme still violates Article 3.1(a).
IV. THE FSC REPLACEMENT SCHEME’S 50 PER CENT RULE IS INCONSISTENT
WITH ARTICLE III OF GATT 1994
25. The United States argues the FSC Replacement Scheme does not require the use of domestic
product, and therefore must be consistent with Article III of GATT 1994. This argument, however,
misses the essential point of Article III. A measure violates Article III whenever an imported product
is accorded less favourable treatment than the domestic product. A measure can accord “less
favourable” treatment whether or not there is a specific legal requirement to use domestic goods.
Article III prohibits government measures that create legal incentives that disrupt the “effective
equality of opportunities between imported products and domestic products.
6
26. The scope of the FSC Replacement Scheme is wider than just domestic products, but the
measure nevertheless covers domestic products. As long as such disparity in treatment between
imported products and domestic products exists, the violation of Article III occurs. The FSC
Replacement Scheme creates such a disparity. Under this tax programme, an eligible corporation may
increase its use of domestic product to any level without affecting whether the income can be deemed
“qualifying foreign income,” and thus may generate tax benefits. In sharp contrast, an eligible
corporation does not have such flexibility with rega rd to foreign content. Once the foreign content
exceeds 50 per cent of the fair market value of the income, the income can no longer be deemed
“qualifying foreign income,” and the tax benefit is lo st. This differential treatment, which skews the
incentive to use domestic products over foreign products, violates the “effective equality of
competitive opportunities” guaranteed by Article III.
27. Adding new ways to impute value does not change this fundamental problem. The
United States may be correct in stating that the FSC Replacement Scheme does not impose any legal
“limitation” requiring only products to be used in determining the value. Eligible corporations, when
imputing the value, may use not only products but also services, labor, intellectual property rights, and
other intangibles, or even elect to forfeit the qual ification as “qualifying foreign income”, if it so
wishes. These additional features, however, do not change the fundamental fact that the FSC
Replacement Scheme creates an incentive to use domestic goods, thereby giving domestic goods
preferential status under the law. The disparity between imported products and domestic products
does not disappear just because these alternative means of imputing the value is introduced. The FSC
Replacement Scheme therefore violates Article III:4.
V. CONCLUSION
28. After a rather lengthy dispute settlement process, the largely unchanged US FSC scheme is
before the panel once again. The already long process was made even longer by the US-EC
Procedural Agreement of September 29
th. Japan believes that the need to reach this temporary
Agreement, which was applicable only to this sp ecific case, highlights the urgent need for all
Members of the WTO to engage in a process leading to permanent resolution of the outstanding
issues. Otherwise, this dispute may continue indefinitely, requiring additional derogations from the
normal DSU procedures for resolving disputes.

6 Canada – Certain Measures Affecting the Automotive Industry , WT/DS139/R, WT/DS142/R,
Report of the Panel, as modified by the Appellate Body, adopted 19 June 2000, para. 10.78.

29. For all of the foregoing reasons, this Panel should determine that the United States has not
complied with the recommendations of the original Panel and the Appellate Body.

ANNEX F
Answers to Questions and Comments on these Answers
Content Page
Annex F-1 Answers of the European Communities to Questions of the Panel F-2
Annex F-2 Answers of the European Communities to Questions from the US F-30
Annex F-3 Answers of the United States to Questions from the Panel F-33
Annex F-4 Answers of the United States to Questions from the European
Communities
F-60
Annex F-5 Comments on the European Communities on the Answers of the
United States to the Questions put following the Meeting of the Panel
F-68
Annex F-6 Comments of the United States on the European Communities
Answers to Questions from the Panel
F-83
Annex F-7 Comments of the United States on the European Communities
Answers to United States Questions
F-100

ANNEX F-1
ANSWERS OF THE EUROPEAN COMMUNITIES
TO THE QUESTIONS OF THE PANEL
(27 March 2001)
Q1 In section 3.2.5. of its first submission, the European Communities expresses the view
that the FSC Replacement scheme gives rise to two distinguishable subsidies : the “basic FSC
Replacement subsidy” and the “extended FSC Replacement subsidy”.
• Does this mean that the EC is requesting the Panel to make two separate rulings, one on
each of the alleged subsidies?
• Does the EC consider that the application of a different portion of the FSC Replacement
scheme may involve different types of subsidies under the SCM Agreement?
• Please identify the relevant portion of the FSC Repeal and Extraterritorial Income
Exclusion Act (“the Act”) framing these two "distinguishable" alleged subsidies.
• Does the EC believe that the status of a subsidy under the SCM Agreement is
determined by the particular legal circumstances in which it is granted on a case-by-case
basis?
Reply
1. The EC does not consider that the Panel need necessarily make two separate rulings on each
of the subsidies. It is not requesting two independen t rulings in the way that it had asked for separate
and independent rulings on the FSC subsidies resulting respectively from the tax exemptions and the
special administrative pricing rules. But the EC does consider that the Panel’s analysis and reasoning
will have to consider the subsidies separately.
2. The first reason for this is that the two subsidies cover different situations. Furthermore,
doing so allows a proper understanding of what the contingency laid down in the FSC Replacement
Act means in respect of the different situations covered by the Act. Although the basic and the
extended subsidy are both prohibited export subsidies, the reasons for this are different.
3. The basic FSC Replacement subsidy is prohibited because it is only applicable to profits
arising from export transactions. The extended FSC Replacement subsidy is prohibited because it
will often be necessary to use US articles (and therefore exports) in order to satisfy the foreign content
limitation. Also, although the amount of both subsidies is the same, the conditions to be fulfilled to
obtain it are different in each case (export of US goods in one case - export of US inputs and
domestication in the second one).
4. Turning to the Panel’s other precise questions:
• the subsidies arise from interconnected legal provisions.
• The EC is contesting a subsidy scheme (or programme to use the word employed in the SCM
Agreement), rather than individual subsidy payments. It is therefore the conditions of the law

that need to be considered, not the “legal circumstances in which it is granted on a case-by-case
basis.” However these conditions may differ from one category of cases to another (and do
differ in the case of the FSC Replacement scheme between the basic FSC Replacement
subsidy and the extended FSC Replacement scheme).
• As regards the legal condition under which subsidies are granted, the EC would add that the
benchmark for the extended FSC Replacement subsidy would be the situation prevailing if the
conditions (notably sale “not for use within the US” and the foreign content limitation) were
not fulfilled. Generally applicable US tax rules would then require more tax to be paid.
5. With regard to the EC’s Annex, the EC stresses that this was provided for the purposes of
illustration. Although this relates to EC compan ies, the EC considers that, in view of the
comparability and openness of the EC and US economies, the same cost structures can be presumed to
also be illustrative of conditions in the US.
Q2 The European Communities claims that the FSC Replacement scheme is de facto export
contingent and therefore contrary to Article 3.1(a) of the SCM Agreement.
1 Please explain how
the legislation as such -- which, by its terms, at least in the case of FSCs in existence on
30 September 2000, does not apply to transactions occurring before 1 January 2002 -- can
constitute a de facto violation of Article 3.1(a) of the SCM Agreement. Can the EC cite any
GATT/WTO reports in which legislation as such was found to be a de facto violation of any
obligations under the GATT/WTO Agreement?
6. The precise boundaries of de facto violations are not entirely defined. All the arguments of
the EC can be considered to relate to de jure subsidies because, as the question puts it, the EC is
attacking the law as such.
7. The EC would further note that the Appellate Body has considered that a de jure condition is
one that arises from the words of the law or by necessary implication from those words.2 That is the
case here. The term de facto export contingent subsidy is probably best reserved for cases where the
export contingency is not apparent at all from the text of the law or even a necessary implication but
arises out of the exercise of some separate power – for example when a discretion to grant a subsidy is
exercised in a way that means that the grant “is in fact tied to actual or anticipated exportation or
export earnings” (see the terms of footnote 4 to the SCM Agreement).
8. The EC would also observe that the Appellate B ody has held that the standard of contingency
is the same, whether the subsidy arises de facto or de jure.3
.9. The EC would also refer the Panel to what it said on the requirements of proof regarding
factual issues in cases such as this in its second written submission.4
10. A complaint against a mandatory law that is not yet fully applied can in any event only be
judged on the basis of the text and evident facts.
11. The EC has argued in the alternative that there is a de facto violation for the case that the
Panel should take a different view of the distinction.

1 EC first submission, para. 145.
2 Appellate Body Report, Canada – Certain Measures Affecting the Automotive Industry (“Canada –
Automotive Industry”), WT/DS139/AB/R, WT/DS142/AB/R, adopted 19 June 2000, para. 99.
3 Appellate Body Report, Canada – Measures Affecting the Ex port of Civilian Aircraft (“Canada –
Aircraft”), WT/DS70/AB/R, adopted 20 August 1999, para. 167.
4 Second written submission of the EC, Section 4.1 (paras 41 to 58).

Q3. The European Communities states that it “… sees no reason to contest that the last
sentence of footnote 59 may be an exception to Article 3.1(a).” 5 Does this mean that the EC is of
the view that measures satisfying the requirements for the last sentence of footnote 59 constitute
“[m]easures referred to in Annex I as not constituting export subsidies” under footnote 5 of the
SCM Agreement?
Reply
12.. The EC was not stating that it considers that the last sentence of footnote 59 is an exception to
Article 3.1(a). The precise requirements for a statement in Annex 1 to be considered as falling within
the terms of footnote 5 have not yet been clarified by cases. The EC was merely stating that it does
not consider it necessary for the Panel to address this question since the conditions of the last sentence
of footnote 59 are in any event not fulfilled.
13. The EC would also emphasise that the last sentence of footnote 59 only applies to measures
falling under the terms of item (e).
14. The EC considers that the last sentence of footnote 59 can be considered to be declaratory.
The simple exemption of foreign source income is not in the view of the EC a subsidy at all, or at
least not specific. This matter is discussed further in response to question 45 below.
Q4. Please provide further clarification of the point made in paragraph 161 of the EC
second submission, if possible, with reference to actual cases addressing Article III:4 of the
GATT.
Reply
15. The EC was making the point that an analys is of the origin of sub-components would have
made the cases impossibly complicated.
16. The point, made in response to a paragraph of the US first submission (para. 203), is that,
when a claim concerning a local content requirement is reviewed (under Article III:4 of the GATT as
well as other WTO provisions), the domestic status of a given product depends on its origin as a
"unitary" good. Whether this input, is in turn, made out of sub-components that were originally
foreign is not relevant.
17. Likewise, when comparing the use of 'domestic ' over 'imported' products in Article 3.1(b),
one has to look at a product as a whole - if that is domestic, the previous (foreign) origin of some of
its sub-components is irrelevant to assess whether there is preference for domestic products.
18. Regard must be paid to the current origin of the products (domestic and foreign) being
compared. There are no longer individual sub-components distinguishable from the domestic
products that are being compared to the 'imported' ones.
19. The sub-components would further not be “like” or “directly competitive to” the foreign
products to which the “qualifying foreign trade property” would be preferred.
20. There are, to the EC’s knowledge, no cases under Article III:4 of the GATT where, in
comparing domestic and imported products, panels looked beyond the domestic origin of products to
check (and give relevance) to the former foreign origin of the sub-components of domestic products.

5 EC second submission, para. 181.

Q5. Please provide further clarification of the point made in paragraph 227 of the EC
second submission.
Reply
21. The EC was simply pointing out that (contrary to what Canada appeared to believe) the
income benefiting from the extended FSC Replacement subsidy need not be foreign-source. The
example it gave was that of a US company distributing foreign-made goods. The reference to the FSC
Replacement Act should be to Section 943(c), not Section 943(e)(4)(C).
Q6. The European Communities claims that the FSC Replacement scheme is a prohibited
export subsidy contrary to Article 3.1(a) and item (e) of Annex 1 of the SCM Agreement. Are
these alternative claims? In the EC’s view, which claim must be addressed first by the Panel?
Reply
22. The claims are alternative.
23. The item (e) claim is also an Article 3.1(a) claim. It is Article 3.1(a) that brings the practices
described in the Annex within the prohibition. The examples in the Annex are particular examples of
prohibited subsidies.
24. It is a matter for the Panel whether it looks to the general terms of Article 3.1(a) or the Annex
first. The EC has addressed the Article 3.1(a) claim first but does not consider that the Panel “must”
do so.
Q13. Regarding the relationship between Article 3.1(a) of the SCM Agreement and item (e) of
Annex I, would it be possible that a certain measure is not within the scope of the latter, but
nonetheless within the scope of the former, and vice versa?
Reply
25. The EC believes it is possible that a measure could fall within the scope of Article 3.1(a) of
the SCM Agreement but not item (e) of Annex I and also vice versa.
26. For example:
• Tax exemptions to export promotion or shipping companies (rather than the exporters themselves)
may not fall under the general terms of Article 3.1(a) but would fall under item (e).
• A tax advantage that is not an exemption remission or deferral (e.g. a deduction) would not fall
under item (e) but would fall under the general terms of Article 3.1(a) if contingent upon export
performance.
Q14. The Panel is well aware that the WTO-conformity of income tax regimes of European
countries is outside the scope of our terms of re ference for this case. In paragraph 96 of the US
first submission, the US introduces examples of a few European tax systems which “refrain
from taxing foreign income in a qualified or conditional manner.” 6 Among those systems, is
there one which excludes foreign income from the scope of taxable income on the following
conditions:

6 US first submission, para. 97.

(i) the property for sale from which income arises must be held for ultimate use
outside the country, (and not be sold for final consumption in that country); and
(ii) the same property must have foreign content of not more than a certain
percentage of its fair market value.
Reply
27. The EC is confident that none of its Member States has such a tax system.
28. The US is apparently of the view that the term "foreign-source income" should be interpreted
widely so as to signify export income. The EC would comment that if this had been intended, the last
words of footnote 59 would have been “export income.”
Q15. Is the term “foreign-source income,” “f oreign-source” or “source” used elsewh ere in
any provisions of other WTO Agreements than the SCM Agreement? What guidance, if any,
may be drawn as to the meaning of these terms from the SCM Agreement or other WTO
Agreements?
Reply
29. The term “foreign-source income” or “foreign-source” is only used in footnote 59. The word
source is used elsewhere, notably in the trade defence agreements, including the SCM Agreement to
refer to the origin of imports or of information.
30. As the EC has explained, the term “foreign-source income” is used as a taxation term of art in
footnote 59.
31. At the hearing on the Panel also asked whether this expression was used in panel or Appellate
Body reports.
32. The term foreign-source income was indeed used extensively by the US in the DISC and Tax
Legislation cases to describe income arising outside the territory of the taxing country. For example,
the US explained that:
Prior to 1962 the United States did not tax the foreign source income of a foreign
corporation organized outside the United States. Taxes on that income were deferred
until the income was repatriated. When "sub-part F" was enacted in the Revenue Act
of 1962, the United States began taxing currently to the United States shareholders of
controlled foreign corporations the income from certain sales and services of these
foreign subsidiaries.
7
33. The US was using the term "foreign-source income" in the sense of "income from sources
without the US" in Section 862 of the IRC.
8
Q16. The European Communities claims that 9:

7 United States - Income tax legislation (DISC) (BISD 23S/98), para.8.
8 Text in Exhibit EC-21.
9 EC second submission, paras. 221-222.

"Even if it were a measure to avoid the double taxation of foreign-source
income, the FSC Replacement Act would in any event be contrary to
Article 3.1(a) of the SCM Agreement because it gives exporters a choice that
is not available to other operators…. This additional advantage would also
be a subsidy,…. This unwarranted overcompensation is also a subsidy….
(For the EC): Please provide a textual anal ysis of how the alleged additional advantage
and overcompensation constitute subsidies under Article 1 of the SCM Agreement.
(For the US): How does the US respond to this allegation?
Reply
34. The argument that there is an additional subsidy is really just another way of stating what was
already said (in the previous section 4.6.4, paragraphs 213 to 218 and 220) that a measure that gives
rise to ‘double’ double taxation relief cannot be said to be “to avoid double taxation”.
35. The EC is further arguing in paragraph 222 of its second written submission that the ‘double’
double taxation relief to which the FSC Replacement scheme can give rise (as explained in the section
4.6.4, paragraphs 213 to 218 and 220) is also a subsidy in that revenue is forgone that would be due
under the generally applicable system of double taxation relief (the foreign tax credit system) which
gives rise to a corresponding benefit.
36. It appears to the EC that Section 943(d) must, if it has any meaning, provide a possibility for
such double double taxation relief.
Q17. The EC seems to argue that a Article 3.1(b) violation may exist if a certain measure
gives an “incentive” to domestic production for export. 10 In the same vein, the EC argues that
“Article 3.1(b) prohibits local-content contingency to any degree,… [and] there is no de minimis
rule for prohibited subsidies in the SCM Agreement.”.11
(For the EC): How would this argument be supported by a textual analysis of
Article 3.1(b) in accordance with Articl e 31 of the Vienna Convention? Can the
European Communities cite any Appellate Body or panel reports in which the term
“incentive” was explicitly used in the cont ext of Article 3.1 of the SCM Agreement, or
Article XVI:4 of the GATT Agreement?
(For the US): Would a textual analysis of Article 3.1(b) lead to a conclusion that the
EC’s above argument is without merit? If so, why and how? Would the US take the
view that there is de minimis rule for pr ohibited subsidies in the SCM Agreement? If
so, what is the qualitative or quantitative threshold for that rule? Is the Appellate Body
Report in Canada - Certain Measures Affecting the Automotive Industry
12 relevant to
this question? Please give reasons for your responses.
Reply
37. The two quotes are in a sense "in the same vein", even though they relate to separate points.

11 EC second submission, para. 160.
12 WT/DS130/AB/R, WT/DS142/AB/R.

38. The first sentence concerns the main EC argument, that the foreign content rule is inconsistent
with Article 3.1(b) because it gives rise to a requirement in any case, and is also related with a further
question (no. 26).
39. The second sentence responded to the US argument about the origin of sub-components, and
the response can be outlined as follows. The presence of sub-components in domestic articles is not
relevant for the purposes of applying Article III:4 of GATT to a situation where more favourable
treatment of foreign articles is alleged.
40. Furthermore, there is not a de minimis rule in the sense that there is not a minimum threshold
of domestic sub-components for a US good to be caught by Article 3.1(b).
41. Article 3.1(b) applies to all US goods (and compares all of them to foreign products), no
matter what they are made of. It is an unqualified prohibition.
42. By contrast, the first sentence quoted by the Panel (paragraph 165, EC's first written
submission) does not address the meaning of the word "contingent", nor the meaning of the world
"domestic", but rather the meaning of the clause "use of domestic over imported".
43. For the textual analysis of Article 3.1(b), the EC would refer to its Oral Statement. The EC
has clarified the meaning of Article 3.1(b) in its entirety, whereas the US continues to provide a
selective interpretation. In interpreting Article 3.1(b), the Panel is called to give meaning to all its
words, including the clause "use of domestic over imported" products.
44. As to previous reports, we would point out that in Canada – Automobiles the Appellate Body,
when comparing Article 3.1(b) and Article III:4 of GATT 1994, noted that the latter “also addresses
measures that favour the use of domestic over imported good”.13
Q18. Relating to Article III:4 GATT, EC has cited 14, inter alia, the Panel Report on Italian
Discrimination against Imported Agricultural Machinery.15 We note that two other documents
-- GATT Doc. L/695 (1957) and GATT Doc. L/740 (1957) -- address similar issues. Are these
relevant to the question of whether Article III:4 of the GATT in the first place covers
exemptions to the tax on the "firm"? Please comment on whether and how these reports are
relevant to our case.
Reply
45. The EC referred to Italian Discrimination Against Imported Agricultural Machinery in
paragraph 198 and in footnote 69 to paragraph 192 of its first written submission.
46. The Panel seems to raise a preliminary question as to whether the EC considers that the
relevant question is not whether Article III:4 of the GATT "covers exemptions to the tax on the firm".
47. The EC wishes to clarify that it is not cl aiming that the tax exemption as such is a
"requirement affecting internal sale" within the meaning of Article III:4 of GATT 1994.

13 Canada – Automobiles, Appellate Body Report, para. 140.
14 EC first submission, para. 98.
15 GATT Doc. L/833 (1958), adopted 23 October 1958, BISD 7S/60.

48. As clearly results from the EC’s first written submission, 16 the EC’s claim under Article III:4
of GATT 1994 is focusing on the foreign content limitation, which affects the sale or use of products
on the US market and discriminates against foreign products.
49. This has been correctly understood by the US in its first written submission, 17 and there is
thus no difference between the parties in this respect.
50. More specifically, the EC submits that the foreign content limitation is a "requirement" not
because "an enterprise is legally bound to carry [it] out", but because "an enterprise voluntarily
accepts [it] in order to obtain an advantage from the government". 18
51. The above quotes from EEC - Parts and components show that for the analysis under Article
III:4 of the GATT the 'advantage' ultimately sought from the government when voluntarily accepting
a certain "requirement" is not relevant. In particular it is not relevant whether it is an advantage to the
"firm".
52. The situation was similar in the Italian Discrimination Against Imported Agricultural
Machinery case. 19 In that case, Italian farmers (the "firms") received an advantage (the special
purchase credit terms) on condition that they met a certain requirement (the purchase of domestic
products - agricultural machinery).
53. The two documents referred to by the Panel appear to confirm that requirements like the
foreign content limitation are covered by Article III:4 of GATT 1994. Doc. L/693 in particular related
to a benefit to purchasers of agricultural machinery (the “firms”), which benefit had become
conditional on the purchase of domestic machinery since the entry into force of decree no. 57,904.
The UK government precisely challenged the discrimination resulting from inducing French farmers
to buy domestic products in order for them to be eligible for the benefit.20
Questions of 13 March
Q23. The EC argues that, "for owners of US produced goods, export is a condition for
obtaining the benefits under the scheme for those goods" 21 and that there is accordingly an
export subsidy. Assume the existence of an exclusion from taxation for all foreign-source
income based upon application of a pure territorial system. Would export not be a condition
for owners of domestically-produced goods to obtain the exclusion in that case as well? Does
this mean that the application of a pure territorial system would also involve an export subsidy?
Please explain.

16 See e.g. EC first submission, para. 188.
17 US first submission, para. 211, where the US notes “[t]he EC claims that the 50 per cent rule of the
Act provides less favourable treatment to imported products than to like domestic products in violation of
Article III:4 of GATT.”
18 EEC - Parts and components, Panel Report, para. 5.21; see also EC first submission, paras. 191-195;
EC second submission, paras. 240 ff.
19 Panel Report, Italian Discrimination Against Imported Agricultural Machinery , adopted on
23 October 1958, BISD 7S/60.
20 Guide to EC Law and Practice, Analytical Index, Geneva, 1995, Vol. 1, p. 173.
21 EC rebuttal submission, para. 102.

Reply
54. In a pure territorial system, business profits from domestic sales and exports are taxed in
exactly the same way. Income tax is paid on all income generated in the country concerned. If a firm
located in a country with a territorial system sells to unrelated customers on the domestic and export
market, and obtains the same level of profit on both sales, they will be taxed the same.
55. If the same firm sells to a foreign subsidiary taking responsibility for the distribution (and
therefore resale) of the goods on the domestic market, the parent will pay tax on the profit earned by it
in selling to the foreign subsidiary in the transa ction but not on the profit of the foreign subsidiary.
The situation is the same where the firm to the foreign subsidiary for subsequent distribution on
export markets; the parent will pay tax only on the profit earned by it in selling to the foreign
subsidiary. Thus, in both cases, the profit earned by the foreign subsidiary in these transactions
through its activities in the country where it is located is not subject to income tax on this profit in the
country that has a pure territorial system. This is because countries with territorial systems tax only
income earned from activities in their territory. The separation (attribution) of income is made on an
objective basis – at arm’s length (i.e. as if the transaction was concluded according to commercial and
financial terms, which would apply between unrelated parties). Unlike the FSC Replacement Act, a
pure territorial system does not exempt income generated by activities undertaken within the territory,
be it export or any other activity. Therefore, there is no revenue forgone and no subsidy.
56. The US regularly states that the EC has accepted that territorial systems provide better
treatment to export sales. The US has misunderstood the EC position. As explained above, a pure
territorial system does not treat export sales more favourably. More favourable treatment of export
sales through a foreign distribution compared with domestic sales through a domestic distribution
subsidiary may arise out of the fact that the foreign country has a lower tax rate (but not when the
foreign tax rate is higher). However, when like is compared with like, there is, as explained above, no
more favourable treatment of such export sales compared with domestic sales.
57. The US has also stated that the 1981 tax legislation cases have made "factual findings" that
territorial systems provide better treatment to export sales. The EC does not agree that this is so and
does not consider these cases, which dealt with a different legal provision in a different agreement and
under very different dispute settlement arrangements, to be pertinent to the present dispute.
Q24. Would a measure that exempted foreign-source income from taxation (i.e., a pure
territorial system) be a measure to avoid the double taxation of foreign-source income within
the meaning of footnote 59?
Reply
58. The EC considers that because the prevailing benchmark in territorial tax system is the
taxation of income generated on the territory in question, the exemption of foreign source income
does not involve revenue forgone and is not a subsidy under Article 1 of the SCM Agreement. It is
also not contingent upon export performance or specifically related to exports. It is however
undeniably a measure to avoid the double taxation of foreign-source income.
Q25. The EC argues that "the fact that th e extension of the FSC replacement scheme to
foreign produced goods is subject to a foreig n content requirement creates in many cases a
requirement for exports to be made from the US. This renders the extended FSC Replacement
subsidy also export contingent and thus prohibited."
22 Is it the EC's view that the measure is
contingent de jure on export performance? Or de facto? Is it export-contingent only in those

22 EC first submission, para. 119.

cases where compliance requires the export of US good s, or does the fact that the export of US
goods may sometimes be required render the "extended FSC replacement scheme" export-
contingent in its totality?
Reply
59. As the EC stated in reply to question 2, it considers that its claim is of de jure export
contingency but appreciates that some may consider it de facto contingency.
60. The Appellate Body has made clear that a de jure condition is one that arises from the words
of the law or by necessary implication from those words. 23 That is the case here. It was clear from
evident facts known to all at the time the law was adopted that respecting the foreign content
limitation would require the use of US articles in many cases.
61. As also mentioned above, the EC considers that the term “ de facto export contingency
subsidy” is probably best reserved for cases where the export contingency is not apparent at all from
the text of the law or even a necessary implicatio n but arises out of the exercise of some separate
power – for example when a discretion to grant a subsidy is exercised in a way that means that the
grant “is in fact tied to actual or anticipated exportation or export earnings” (see the terms of
footnote 4 to the SCM Agreement.)
62. Thus, turning to the Panel’s precise questions: it is the EC's view that the extended FSC
Replacement scheme is contingent de jure on export performance; the fact that the export of US
goods may sometimes be required renders the “extended FSC replacement scheme” export-contingent
in its totality.
Q26. The EC states that the basic FSC subsidy is contingent upon the use of domestic over
imported goods because domestic US articles wi ll "often" be necessary to ensure that the
foreign content limitation is not exceeded.
24 Is it the EC's view that the frequency with which
this will be the case is relevant to whether th e 50% foreign content rule is inconsistent with
Article 3.1(b)? Would the rule be inconsistent with Article 3.1(b) if domestic US goods were
"sometimes" necessary? Occasionally? Rarely?
Reply
63. The EC considers the “50% foreign content rule” to be inconsistent with Article 3.1(b) by the
reason of the fact that it give rise to a requirement to use US article in any case.
64. The FSC Replacement scheme is a subsidy programme – that is it is a general measure that
gives rise to prohibited subsidies, and mandates the bestowal of such subsidies if certain conditions
are met. The EC is contesting it as a general measure that mandates, and does nothing to preclude, the
grant of individual subsidies which are contingent upon the use of domestic over imported products.
A subsidy programme that gives rise to such subsidies is also prohibited under Article 3.1(b).
Q27. Is the Panel correct in its assumption that the EC's GATT Article III:4 claim is limited
to the application of the "foreign content li mitation" in the context of the "basic FSC
replacement subsidy"? If not, please explain how Article III.4 could be applicable to the
"extended FSC replacement subsidy" in light of the fact that Article III:4 relates to less

23 Appellate Body Report, Canada – Certain Measures Affecting the Automotive Industry (“Canada –
Automotive Industry”), WT/DS139/AB/R, WT/DS142/AB/R, adopted 19 June 2000, para. 99.
24 EC first submission, para. 174.

favourable treatment for imported products in relation to laws, regulations and requirements
affecting the internal use of such a product.
Reply
66. Yes.
Q28. Is it possible to establish on the basis of the Act itself, and without reference to external
facts relating to the manufacture of particular products, that the 50% foreign content rules
require a beneficiary in some cases to use domestic over imported goods? If not, and taking into
account the view of the Appellate Body in Canada – Certain Measures Affecting the Automotive
Industry25 that contingency in law is demonstrated "on the basis of the words of the relevant
legislation, regulation or other legal instrument", please explain how the Act could be
contingent in law on the use of domestic over imported goods.
Reply
67. The Appellate Body went on to say, after the sentence quoted in the question, that “[a]s we
have already explained, such conditionality can be derived by necessary implication from the words
actually used in the measure” and referred in its footnote to para. 100 of the Report.
68. Paragraph 100 of the Appellate Body Report states:
The simplest, and hence, perhaps, the uncommon, case is one in which the condition
of exportation is set out expressly, in so many words, on the face of the law,
regulation or other legal instrument. We believe, however, that a subsidy is also
properly held to be de jure export contingent where the condition to export is
clearly, though implicitly, in the instrume nt comprising the measure. Thus, for a
subsidy to be de jure export contingent, the underlying legal instrument does not
always have to provide expressis verbis that the subsidy is available only upon
fulfilment of the condition of export performance. Such conditionality can also be
derived by necessary implication from the words actually used in the measure.
69. Thus, de iure export contingency can result “clearly, though implicitly, in the instrument
comprising the measure.” In the case before you, on the basis of the words of the law, that is on the
basis of the words of the 50 per cent rule, it can be derived that one producer with a given cost
structure will have to use US articles.
70. The implications of a law always require knowledge of certain facts (for example that
companies want to make profits, that other countries impose taxes etc.). The EC considers that the
fact that in the case of some products the value of articles used for production will account for more
than half the final value of the product is such a known fact that a requirement to use US articles in
such case arises by necessary implication from the terms of the FSC Replacement Act.
71. Identification of the producers who, in practice, need to use US articles is a question of fact,
which need not be decided in reviewing a de iure claim. At any rate, the EC has provided indications
on this matter relative to certain sectors.
Q29. The EC argues that, "if the Panel should not agree that the foreign content limitation
applied to foreign producers [leads to the "extended" subsidy being a prohibited export
subsidy], the EC argues in the alternative that Article 3.1(b) should be interpreted as also

25 Appellate Body Report, WT/DS139/AB/R, WT/DS142/AB/R, adopted 19 June 2000, para. 123.

prohibiting the imposition of a foreign content limitation on foreign producers".26 Article 3.1(b)
prohibits subsidies contingent upon the use of do mestic over imported goods. In the case of the
application of the "foreign content limitation" to foreign producers, the alleged subsidy could
be viewed as contingent upon the use of imported over domestic goods. Please comment.
Reply
72. Article 3.1(b) is drafted on the assumption that a government is providing a subsidy to its own
companies, which would usually be located within its territory. The words “domestic” and
“imported” therefore refer to “national” and “foreign” products. In the unusual case of a subsidy
granted to a foreign company, taking these words literally would give rise to absurd results that do not
correspond to the evident intent of the parties.
73. An illustration of the fact that the terms of Article 3.1 must be interpreted from the point of
view of the granting authority, rather than that of the recipient, is provided by the Brazil – Aircraft
case. There the subsidies were granted to foreign airlines contingent upon the purchase of Brazilian
aircraft. They were export contingent only from the point of view of the granting authority. From the
point of view of the recipient they were rather import contingent.
74. Once it is accepted that the SCM Agreement applies to subsidies granted to foreign
beneficiaries, a literal interpretation of the words “domestic” and “imported” in Article 3.1(b) gives
rise to absurd results, manifestly contrary to the intent of the parties. As explained in the EC’s second
written submission, these words must therefore be interpreted, in the context of subsidies to
foreigners, as meaning “national” and “foreign” (see also question 29). This is justified under the
Vienna Convention on the Law of Treaties by the fact that treaties are to be interpreted in good faith.
An absurd interpretation is not in good faith.
Q30. The EC states that the Act's foreign content limitation constitutes a "requirement"
within the meaning of Article III:4 of GATT 1994. 27 Is the Panel correct in understanding that
the EC does not assert that the foreign content limitation constitutes a "law" or "regulation"
within the meaning of that provision?
Reply
75. It is a requirement contained in a law. The word “requirement” is sufficiently broad to
encompass requirements that are contained in legislative measures, and this is the reason why the EC
used it.28 Of course, this does not mean that the EC is denying, or not asserting, that it is legislative in
nature, that is of general application – just as the rest of the FSC Replacement Act, as made clear in
the whole of the EC’s argumentation.
Q31. The reference in Article III:4 of GATT 1994 to "laws" and to "regulations" appears to
relate to the form of certain measures. By cont rast, the term "requirements" could be taken to
have implications with respect to the nature of the measures. Please comment.

26 EC first submission, paras. 181-182.
27 EC first submission, Section 3.7.1.
28 See e.g. the review of subsidies and other benefits as “requirements” in the Guide to EC Law and
Practice, Analytical Index, Geneva, 1995, Vol. 1, p. 173, which covers i.a. the legislative requirements
addressed in Italian Discrimination against Imported Agricultural Machinery and in GATT Doc. L/695 (see
supra, Question 18).

Reply
76. Indeed, the word “requirement” is focusing on the content of the measure under review.
77. The use of the word “requirement” confirms that Article III:4 also applies to measures that are
not in the form of laws or regulations.29
78. The EC does not consider that the nature of the prohibition in Article III:4 depends on the
form of the measure.
79. In any event, the standard laid down in Article III:4 of GATT 1994 is the same both for
"laws" and "requirements".
80. There is some degree of overlap in the words “laws, regulations or requirements” in
Article III:4, in the sense that laws and regulations will typically lay down “requirements”.30 The use
of the broad term “requirement” aims presumably to avoid loopholes in Article III:4 coverage, thus to
avoid that Members could escape its prohibition by selecting a particular form for their discriminatory
measures.
Q32. What is the relationship, if any, between the scope of Article III:4 of the GATT and
Article 3.1(b) of the SCM Agreement -- is one necessarily broader than the other-- could a
measure fall within the scope of one of these provisions, but not within the scope of the other?
Please substantiate your response with reference to past GATT/WTO dispute settlement reports
and other materials.
Reply
81. Article 3.1(b) of the SCM Agreement has its roots in Article III:4 of GATT. The negotiating
history of Article 3.1(b) indicates that the decision to prohibit subsidies covered therein was based on
past experience under Article III:4 of GATT.
82. The EEC – Animal Feed Proteins case31 was brought by the US under Article III:4 of GATT
and concerned EEC legislation providing for a payment of subsidies to processors of oilseeds
whenever they established by documentary evidence that they had transformed oilseeds of
Community origin.
83. In the EC’s view there is a difference in scope in the sense that of course, Article III:4 is
broader than Article 3.1(b). For example, many meas ures in breach if Article III:4 (i.e. local content
requirements) do not involve a subsidy. It is hard to see how a measure violating Article 3.1(b) of the
SCM Agreement would not be caught by Article III:4 of GATT 1994.
84. There is one paragraph of the Appellate Body Report in Canada – Automobiles that somehow
sums this up. The Appellate Body considered Article III:4 as relevant “context” to interpret
Article 3.1(b) of the SCM Agreement and took the following view:

29 For example, in Canada - Autos the panel found violation of Article III:4 of GATT 1994 with regard
to the Canadian value added requirements contained in the Letters of Undertaking from private companies (see
para. 10.130 of the Report).
30 For example, para. 1 of the Annex to the TRIMs Agreement states: "TRIMs that are inconsistent with
… paragraph 4 of Article III of GATT 1994 include those which are mandatory or enforceable under domestic
law or under administrative rulings, or compliance with which is necessary to obtain an advantage, and which
require… "
31 Panel Report, adopted 25 January, 1990, 37S/86.

First, we note that Article III:4 of the GATT 1994 also addresses measures that
favour the use of domestic over imported goods, albeit with different legal terms and
with a different scope. Nevertheless, both Article III:4 of the GATT 1994 and
Article 3.1(b) of the SCM Agreement apply to measures that require the use of
domestic goods over imports.32
Q33. The EC states that "… the US review of its subpart F legislation is yet to be
completed".33 Please explain whether and how this statement is relevant to the current
proceeding.
Reply
85. It simply refutes the US contention that the FSC Replacement Act represented the fruit of a
review of US taxation of foreign income. It was simply a reformulation of the FSC scheme.
Questions of 16 March
Q34. Is the Panel to understand from Section 4.3.2 of the EC's rebuttal submission that the
EC is not relying on the language "whether sole or as one of several other conditions" as a basis
for its argument that the existence of "alternatives" to exportation as a means to gain
entitlement to the alleged subsidy provided under the Act does not eliminate the alleged export
contingency?
Reply
86. That is correct. The EC argument does not depend on these words. The presence of these
words does however confirm the EC position.
Q35. Please comment on paragraphs 91, 108, 159 and 170-171 of the US Oral Statement.
Reply
Paragraph 91
87. In paragraph 91 the US argues that the EC arguments would make territorial tax systems
export contingent subsidies.
88. This is incorrect. As already explained in the EC’s answer to question 23 from the Panel,
34
under a territorial tax system, taxation depends on where income is earned. Income can be earned

32 Para. 140 of the Report (emphasis added).
33 EC rebuttal submission, para. 29.
34 EC’s answer to Panel’s question 23:
In a pure territorial system, business profits from domestic sales and exports are taxed in exactly the
same way. Income tax is paid on all income generated in the country concerned. If a firm sells to
unrelated customers on the domestic and export market, and obtains the same level of profit on both
sales, they will be taxed the same.
If the firm sells through a foreign subsidiary on the domestic market, the parent will pay tax on the
profit earned by it in selling to the related subsidiary in the transaction. Similarly, if the firm sells
through a foreign subsidiary on the export market, the parent will pay tax on the profit earned by it in

abroad even where goods are sold into the territory of the taxing country. (See also paragraph 40,
second bullet of the second written submission of the EC).
89. Thus, the allegation by the US that export sales are taxed more favourably than domestic sales
is incorrect. In addition, in a territorial system, the exemption of foreign-source income from tax does
not require that ultimate use of a product (following resale or processing) to be outside the domestic
market. A territorial system taxes income from economic activity – the final destination of the
product is irrelevant.
90. Under the FSC Replacement scheme, taxation depends on whether goods are sold not “for
ultimate use in the US”. In the case of US goods, this necessarily means that they have to be
exported.
91. Such export contingency is not a necessary feature of a worldwide tax system. Both
territorial and worldwide systems are normally export neutral. Both are based on perfectly defendable
and yet conflicting desires to achieve tax equity.
92. As the EC explained during the course of the original proceeding, the worldwide approach is
sad to seek capital-export neutrality and the territorial approach capital-import neutrality.
93. According to the principle of capital-export neutrality, it is considered inequitable that
taxpayers should pay less tax when establishing themselves abroad and a country should design its
international tax rules so as to neither encourage nor discourage outflows of capital. According to the
principle of capital-import neutrality, it is considered inequitable for companies establishing
themselves abroad to be subject to a higher tax bu rden because of their links to the capital exporting
country and a country should therefore adopt international tax rules that seek to avoid its multinational
companies bearing a higher effective tax burden in foreign markets than the local domestic companies
or the multinational companies of other countries.
94. Both systems have a rational basis and choosing one or the other cannot by itself, in the view
of the EC, give rise to a subsidy. As the Panel observed in the original proceedings:
35
Thus, the United States is free to maintain a world wide tax system, a territorial tax
system or any other type of system it sees fit. This is not the business of the WTO.
What it is not free to do is to establish a regime of direct taxation, provide an
exemption from direct taxes specifically related to exports, and then claim that it is
entitled to provide such an export subsidy because it is necessary to eliminate a
disadvantage to exporters created by the US tax system itself.
36 In our view, this is no

selling to the foreign subsidiary in the export transaction. In both case, the profit earned by the foreign
subsidiary in these transactions through its activities in the country where it is located is not subject to
tax on this profit in the country that applies the pure territorial system. This is because territorial
systems tax only income earned from activities in its territory. The separation (attribution) of income is
made on an objective basis – at arm’s length (i.e. as if the transaction was concluded according to the
commercial and financial terms, which would apply between unrelated parties). Unlike the FSC
Replacement Act, a pure territorial system does not exempt income generated by activities undertaken
within the territory, be it export or any other activity. Therefore, there is no revenue forgone and no
subsidy.”
35Panel Report, paragraph 7.122.
36 The Panel’s footnote reads:
As the Appellate Body has stated, "Members of the WTO are free to pursue their own domestic policy
goals through internal taxation or regulation so long as they do not do so in a way that violates
Article III or any of the other commitments they have made in the WTO Agreement " (emphasis added).

different from imposing a corporate income tax of, say, 75 per cent, and then arguing
that a special tax rate of 25 per cent for exporters is necessary because the generally
applicable corporate tax rate in other Members is only 25 per cent.
Paragraph 108
95. In paragraph 108, the US claims, in answer to the EC claim under item (e), not to understand
how a measure that makes no reference to exportation, does not require exportation, and applies to a
broad range of non-export transactions can be said to be “specifically related to exports.”
96. The EC has already explained that the FSC Replacement scheme does require exportation
even though it does not use the word “exportation” or “exports”.
37
97. The word “specifically” does not mean “expressly”. It means, “having a special, precise or
clearly defined relationship or connection to exports.”
38
98. The basic FSC Replacement subsidy (relating to US goods) has such a relationship to exports
because it is necessary to export in order to benefit from the scheme. The extended FSC Replacement
subsidy (relating to foreign-produced goods) has such a relationship because in many cases it will be
necessary for US goods to be exported as components or raw materials in order to respect the foreign
content limitation.
Paragraph 159
99. In paragraph 159 the US seeks to respond to the EC argument that the statements of the
Appellate Body in Canada – Automotive Products (where the Appellate Body considered that a
measure requiring 60 per cent domestic value does not necessarily lead to a conclusion of de jure
contingency) were not pertinent in the present case, since the FSC Replacement Act is a legislative
measure applying to an undetermined and unlimited series of instances whereas the Canada –
Automotive Products case concerned individual measures, each one applying a specific local content
requirement to individual companies.
39
100. The US argues that the EC “misses the most significant feature” of the Canada – Automotive
Products decision which is, according to the US, that “the Appellate Body concluded that it could not
determine whether a value-based requirement was de jure contingent on the use of domestic over
imported goods without understanding how the measure actually operated.”
101. The US simply fails to respond to – indeed misses – the EC’s point. That is that the FSC
Replacement scheme is attacked a legislative measure as such not in its application to particular goods
or companies. In such a case all that the EC has to s how is that contingency on the use of domestic
over imported goods can arise – or is not precluded.

Japan – Taxes on Alcoholic Beverages , WT/DS8/AB/R-WT/DS10/AB/R-WT/DS11/AB/R, Report of
the Appellate Body adopted on 1 November 1996, p. 16.
37 E.g. first written submission of the EC, paragraph 71. It is worth noting that the definition of
“qualifying foreign trade property” in the FSC Replacement Act is in this respect identical to the definition of
“export property” under the FSC, which read “The term ''export property'' means property …(B) held primarily
for sale, lease, or rental, in the ordinary course of trade or business, by, or to, a FSC, for direct use, consumption,
or disposition outside the United States .” (emphasis added) The US had therefore no difficulty in using the
word “export” to designate property “for disposition outside the United States”.
38 First written submission of the EC, paragraph 153.
39 Second written submission of the EC, paragraph 171 to 173.

Paragraphs 170 – 171
102. In paragraph 170 the US refers back to paragraphs 217-218 of its first written submission and
to the panel and Appellate Body reports cited therein, allegedly supporting the US contention that
“generally applicable measures” give rise to a higher evidentiary burden than measures concerning a
“specific class of imported products”.
103. In its second written submission the EC has refuted the US contention about two evidentiary
standards under Article III:4 GATT of 1994, which has no basis in the text of that provision, and has
shown that the standard required is the one most recently articulated by the Panel in Canada –
Autos.
40 Previous panels have relied indifferently on panel reports dealing with product-specific and
with general measures.41 This is most logical since otherwise WTO Members could easily circumvent
the prohibition in Article III:4 of GATT 1994 by turning a series of product-specific measures –
allegedly easier to challenge - into one single measure of general application.
104. Whatever its content, the US categorization is therefore plainly irrelevant to review the EC’s
Article III:4 claim.
105. Nonetheless, in view of the Panel’s request the EC wishes to recall the following. In
paragraphs 217-218 of its first written submission (referred to in paragraph 170 of the US oral
statement) the US had exemplified its newly created category of requirements applicable to a
“particular class of imported products” by referring to the Canada – Autos and US – Gasoline panel
reports.42 These reports were clearly concerned with product-specific measures (relating to cars and
other motor vehicles in the former case, and to gasoli ne in the latter one). It follows that the phrase
“particular class of imported products” means “product-specific measures”, as those at issue in the
two panel reports cited. The US then contrasted this category with that of “generally applicable
measures”.
106. In paragraph 171 of its Oral Statement the US appears to have changed the meaning of its
self-created category of measures relating to “particular class of imported products”, since it now
employs that term to designate the measures reviewed in EEC - Parts and Components.
107. As explained by the EC, 43 the measures reviewed in EEC - Parts and Components did not
relate to a “particular class of imported products”, but applied horizontally to all possible components
used in the production of all possible products s ubject to anti-dumping measures. Indeed, those
measures were strikingly similar to the foreign content limitation laid down in the FSC Replacement
Act, which applies to all possible products that can be exported from the US and used for the
production of qualifying foreign trade property. 44

40 Referred to in the first written submission of the EC, paras. 201-204; second written submission of
the EC, para. 232.
41 First written submission of the EC, para. 201; Oral Statement of the EC, para. 87. For example, in
Canada - Autos the panel refered to US - Section 337 (where a general measure was at issue) in para. 10.78 of
its report.
42 Similarly, in para. 218 the US refers to “like class of imported goods”.
43 Second written submission of the EC, paras. 240 ff.
44 In any event, it is hard to see how a measure involving “imported component parts” could be termed
as “involv[ing] a specific class of imported products”, or indeed a “class of products” at all. There are products
which can indifferently be sold and used in the state as they are or used as components in the production of other
products. Thus, a category of that type would be undefined and open-ended.

108. As a last point, the EC notes that the US keeps referring to the panel report in Japan - Film45
in support of its argumentation for a “heightened evidentiary burden”. The EC would point out that in
the very paragraph referred to by the US46 the panel found that the measures challenged by the United
States were origin-neutral and that the US ha d not shown that, notwithstanding their not being
discriminatory on their face, these measures had a differentiated impact on imported products (i.e., it
had not established a de facto case).
109. The situation before the panel in Japan - Film was therefore opposite to the present case. The
EC has brought a de iure claim against a statutory requirement which is origin-based, since it
specifically places a limit on foreign products only.
110. Therefore, referring to the “disparate impact” of these measures “in their application” on
imported products is totally inapposite in this dispute. As noted by the panel in Canada - Automotive
Products
a measure which provides that an advantage can be obtained by using domestic
products but not by using imported products has an impact on the conditions of
competition between domestic and imported products and thus affects the "internal
sale,… or use" of imported products, even if the measure allows for other means to
obtain the advantage, such as the use of domestic services rather than products.
Consequently, the CVA requirements, which confer an advantage upon the use of
domestic products and deny that advantage in case of the use of imported products,
must be regarded as measures which "affect" the "internal sale,… or use" of imported
products, notwithstanding the fact that the CVA requirements do not in law require
the use of domestic products.
47
111. The EC would further point out that the only “m eaningful nexus” referred to in that paragraph
of the Japan – Film panel report is between two of the measures challenged by the US and the pre-
existing market structure. Examination of the market structure pre-existing the adoption of a measure
is not relevant to review a de iure claim.
112. The Panel will have also noticed that the phrase “heightened evidentiary burden” is nowhere
used in the Japan – Film panel report.
113. The EC would also note that the Japan – Film report also supports its conclusions by
referring to the US - Section 337 panel report - that is, a report reviewing a measure which can
genuinely be defined “of general application” .
Q36. In regard to the "extended" FSC Repl acement subsidy scheme, is there “revenue
forgone" that is "otherwise due”? What is th e US legal rule that would apply to the foreign
beneficiary of the extended scheme in the absence of the "extended" scheme? What is the
“some other situation” for foreign beneficiaries of the "extended" regime, in which their income
would be subject to the US taxation? If, in the EC’s view, it is different from the legal rule --
normative benchmark -- applicable to the "basic" subsidy scheme, please specify.

45 Panel Report, Japan – Measures Affecting Consumer Photographic Film and Paper (“ Japan -
Film”), WT/DS44/R, adopted 31 March 1998.
47 Canada - Automotive Products, Panel Report, para. 10.82.

Reply
114. The “some other situation” or applicable benchmark in the case of the extended FSC
Replacement subsidy is that which would prevail if the conditions for obtaining the benefit of the FSC
Replacement scheme were not fulfilled. That is the situation that would prevail if the goods were “for
ultimate use in the United States” or if the foreign content limitation were not respected.
115. In these cases, the income from the transactio ns would not be “excluded” from tax but would
be taxable under the generally applicable rules.
48
116. In the case of US taxpayers (i.e. where a transaction is carried out by a foreign branch of a US
corporation or involves distribution activities carried out in the US relating to foreign produced
goods), the income would be taxable under Section 11 of the IRC
49 in conjunction with Section 61
(see further the answer to question 37 below).
117. If a foreign corporation conducts the transaction, the income produced from the transaction
would, if the FSC Replacement scheme did not apply, not normally be directly taxable in the US.
118. Foreign corporations only pay tax in the US on income "from sources within the US" (i.e. US
source income) under section 881 of the IRC and on income "effectively connected with a US trade or
business" under section 882 of the IRC. In this connection it may be noted that the definition of what
is US source and foreign source (i.e. from "sources without the United States") is contained in
sections 862 of the IRC.
19. Thus the foreign-source income of a foreign corporation that is not effectively connected with
a trade or business in the US is not directly taxable in the US.
120. If the foreign corporation is a subsidiary of a US corporation, the income would be taxable when
remitted to the US as dividends (section 61(a)(7) makes dividends received part of gross income).
The dividends received deduction in section 243 of the IRC does not apply to dividends received from
non-taxpayers such as the foreign subsidiary. The parent corporation may even have to pay tax earlier
on deemed dividends if the anti-deferral provisions of sub-part F of the IRC are applicable.
121. The corporation may however, under the generally applicable US rules, claim a foreign tax
credit for the tax borne outside the US but this is limited to foreign source income (section 904 of the
IRC).
122. If a foreign corporation that is not a subsidiary of a US corporation conducts the transaction,
the income would not be taxable in the US either directly or indirectly. In this case the application of
the FSC Replacement scheme would not give rise to a subsidy because no revenue would be forgone.
123. The EC accepts that the extended FSC Replacement subsidy will in many cases not give rise
to revenue forgone, in fact that it might only rarely do so. That is because deferral of tax on the
income of a foreign subsidiary may, when it is available under US rules, often be more advantageous
than the FSC Replacement scheme and because foreign corporations that are not subsidiaries of US
corporations will not be subject to tax in the US on their foreign source income and will not therefore
have any interst in using the (extended) FSC Replacement scheme. However, the extended FSC

48 In this and the next question, the EC will refer to provisions of the US law. The US has provided
some of the provisions in its Exhibit US-4. Others are supplied in Exihibit EC-21. If the Panel wishes to consult
other provisions of the IRC, it may wish to know that they are available on the internet (e.g. at
www.fourmilab.ch/ustax/www/contents.htlm).
49 Extracts from the IRC that are not already before the Panel are contained in Exhibit EC-21.

Replacement scheme is elective and it is clear that companies will only invoke it where it gives rise to
a reduction in taxation. That is why it is a subsidy no matter how rarely it may be used.
Q37. What is the US “norm” which can constitute a “normative benchmark” for the purpose
of Article 1 of the SCM Agreement? Can the EC specifically identify any US tax rules in
addition to the new Section 941(a)(1) of the IRC, which defines the term “qualifying foreign
trade income”? In other words, what is the statutory basis for the EC’s argument that the US is
still maintaining its "worldwide" tax system?
Reply
124. One starting place for this analysis could be the US Constitution. The power to impose
income taxes is derived from the Sixteenth Amendment to the Constitution. 50 It states in pertinent
part that:
The Congress shall have power to lay and collect taxes on incomes, from whatever
source derived... .
125. From the earliest days of the income tax, the Supreme Court has made it clear that this
includes the power to tax the foreign source income of US citizens.51
126. Section 61 of the Internal Revenue Code 52 embodies the exercise by Congress of the broad
power given to it by the Sixteenth Amendment. Section 61 states in pertinent part that
Except as otherwise provided in this subt itle, gross income means all income from
whatever source derived... .
127. The Supreme Court has commented on the "sweep ing scope" and "pervasive coverage" of the
provision now codified in section 61, stating that "the Court has given a liberal construction to this
broad phraseology in recognition of the intention of Congress to tax all gains except those specifically
exempted."
53
128. It should be noted that "taxable income" is defined in section 63 of the IRC as "gross income
minus the deductions allowed by this chapter... ." And section 11 of the IRC specifies that
corporations are subject to tax on their "taxable income." Thus US corporations are subject to tax on
income "from whatever source derived... ."
129. This state of affairs is recognized by the various treatises on US taxation of foreign
operations. For example, one treatise states that:54
The United States generally taxes U.S. citizens, resident alien individuals, and
domestic corporations on their worldwide incomes.
130. Another states that US domestic corporations:
55

50 The full text of amendment XVI is
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived,
without apportionment among the several states, and without regard to any census of enumeration.
51 See Cook v. Tait, 265 US 47 (1924).
52 Text in Exhibit US-4.
53 Commissioner v. Glenshaw Glass Co., 348 US 426 (1955).
54 Kuntz and Peroni, U.S. International Taxation, vol. 1, at p. A1-19 (1992).

are taxed by the United States on their worldwide incomes.
131. The maintenance of the world-wide taxation system by the US is also recently (in
December 2000, that is, after the adoption of the FSC Replacement scheme) clearly recognised in a
study prepared by the US Treasury on “the Deferral of Income Earned Through US Controlled
Foreign Corporations”
56. The fact that the US continues to have a tax system which is fundamentally
based on current taxation of world-wide income of US taxpayers is in fact and according to the study
the underlying reason for the need of anti-deferral measures (Subpart F of the IRC). This state of
affairs is reflected throughout the study, of which the conclusions also suggest that as the US tax
system continues to be based on the principle of current taxation of the world-wide income of US
taxpayers and as corporations are treated as separate taxpayers and separate legal entities from their
owners, there is a continuous need for anti-deferral regime in the US tax system. By way of example,
in Chapter 8 of the study (Restatement of Conclusions) in relation to the background of the subpart F
legislation it is stated:
…subpart F was, more generally, one in a series of measures addressing tax
avoidance problems caused by a structural tension in the tax system. This tension is
caused by the incompatibility of certain fundamental features of the U.S. tax system,
principally the current taxation of worldwide income and the treatment of
corporations as taxpayers and legal person separate from their owners. These
incompatible features are still a fundamental part of the U.S. tax system.
57
132. A relatively short list of items specifically excluded from gross income is set forth in sections
101 through 139 of the Code. The FSC Replacement Act added section 114 to that list. In keeping
with their view that, in enacting the Internal Re venue Code, Congress intended to exercise quite fully
its power to tax income, the Courts have long held that provisions granting deductions or exclusions
of items from gross income are "matters of legislative grace" and are therefore to be "strictly
construed."58
133. The EC has explained that section 114(a), in conjunction with the other conditions set out in
the FSC Replacement Act, creates a fairly narrow exception to the general rule of US taxation of
worldwide income.
134. In some respects, section 114 is similar to section 911 of the IRC. Section 911(a) states, in
seemingly expansive terms, that the foreign earned income of a US citizen residing abroad is, at the
election of such individual, to be excluded from such individual's gross income. Section 911(c),
however, limits the amount that may be excluded to a stated annual amount ($78,000 in 2001).
135. Just as the US section 911 does not create a normative benchmark of non-taxation of the
foreign earned income of US citizens resident abroad (particularly in light of the limitation and the
elective nature of the exclusion), so also the new section 114(a) does not do so. Indeed, in both cases
the existence of a limited exclusion or exemption in fact confirms the general rule of taxation.

55 Isenbergh, International Taxation: U.S. Taxation of Foreign Persons and Foreign Income , vol. 1, at
p. 2:32 (2nd ed. 2000).
56 The Deferral of Income Earned Through US Controlled Foreign Corporations; A Policy Study .
Office of Tax Policy Department of the Treasury, December 2000, Chapter 8 (Restatement of Conclusions of
this voluminous study is attached as Exhibit EC-22 – the EC would be happy to provide a complete copy if the
Panel wishes).
57 Id., page 96, emphasis added.
58 See, e.g., Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943); Jones v. Kyle, 190 F.2d 353
(10th Cir. 1951), cert. denied, 342 US 886.

136. The term "qualifying foreign trade income" is a creation of the new legislation. It is not a
concept used elsewhere in the Code. Thus the statutory provisions that would apply to “qualifying
foreign trade income” in the absence of the FSC Replacement scheme is section 11 of the IRC
specifies that corporations are subject to tax on their "taxable income."
137. Finally, the EC would refer the Panel to the many reasons that the EC gave in paragraphs 40
to 52 and 55 of its first written submission to show that the exclusion of income from under the FSC
Replacement scheme was in reality an exception and not the general rule. 59 Most significant perhaps
is the fact that under the FSC Replacement Act (new section 941 of the IRC) provides that only a
certain portion of US taxpayers income attributable to foreign trading gross receipts qualifies for the
exclusion, i.e. the exclusion is only partial.
138. The EC submits that it is therefore clear that the FSC Replacement scheme does not represent
the benchmark or the general rule but is an exception to it.
Q38. In paragraph 185 of the US Oral Statemen t, the US argues that “[a]s reflected in
Article 19.1 of the DSU, the WTO does not provide retroactive relief for alleged past wrongs.”
Please comment, in particular, on the US refe rence to DSU 19.1 and its relevance to the instant
case.
Reply
139. Panel reports inevitably relate to facts that lie in the past. In some cases violations may be
continuing and in others they will have terminated.
140. There is no general principle in the WTO that panels cannot rule on violations that have
terminated. Not only is there no provision in the WTO to this effect, panels regularly do rule on
terminated violations. The EC will give two recent examples:
/g227in Korea – Dairy violations of the notification deadlines in the Safeguards Agreement
were found despite the fact that the notifications had been made prior to the request for
the establishment of the panel;60
/g227In United States – Import Measures 61 violations of a series of WTO provisions were
found despite the fact that the measure (provisional suspension of liquidation on
certain imports from the EC) had ceased to exist prior to the request for the
establishment of the panel.
141. The US seeks to derive such a principle from the fact that the WTO does not provide for
retroactive remedies which it considers is reflected in Article 19.1 of the DSU.

59 An additional reason which the EC did not mention in its first written submission is the fact that the
FSC Replacement scheme does not apply to property which is considered in short supply (and of which the Us
does not want to encourage the export). See paragraph 15 of the closing statement of the EC to the meeting of
the Panel.
60 Panel Report, Korea – Definitive Safeguard Measure on Imports of Certain Dairy Products (“Korea
– Dairy Safeguards”) , WT/DS98/R, adopted 12 January 2000, as modified by the Appellate Body Report,
WT/DS98/AB/R, para. 8.1.
61Panel Report, United States – Import Measures on Certain Products from the European Communities
(“United States – Import Measures”), WT/DS165/R, adopted 10 January 2001, WT/DS165/AB/R, para.7.1.

142. However, the EC is not requesting any “remedy” in this proceeding. It is asking for a
disagreement to be adjudicated. The DSB adopted the Panel and Appellate Body reports declaring the
FSC scheme to be inconsistent with the obligations of the US under the WTO Agreement on 20 March
2000. It required the US to withdraw the subsidy a nd bring itself into conformity with its obligations
with effect from 1 October 2000 and ultimately required the US to adopt the necessary measures by 1
November 2000.
143. Although the US failed to adopt the necessary measures by 1 November 2000, it persists in
arguing that it “complied with the time period specified by the DSB.”
62 The EC disagrees and asks
the Panel to rule on this disagreement.
144. If the US were correct in its contention, panels would in particular never be able to rule on
disputes concerning exclusively the timeliness of any measure (rather than its existence) since such
disputes would relate to violations that have terminated. The timeliness of implementation is one of
the matters that a panel is required to decide under Article 21.5 of the DSU.
145. The question of what, if any, recommendation a panel makes in such a case is a separate
matter that only arises once it has decided the nature and extent of the violations. This is
demonstrated by the fact that panels can make findings and then not find it necessary to make any
recommendations, as the Appellate Body did, for example, in United States – Import Measures.63
146. Generally, panels established under Article 21.5 DSU are not called upon to make
recommendations under Article 19.1, but simply to make findings and adjudicate the disagreement
relating to implementation. As the Article 21.5 panel in Canada – Aircraft stated (when requested to
make a suggestion under Article 19.1):64
In our view, Article 19.1 envisions suggestions regarding what could be done to a
measure to bring it into conformity or, in the case of Article 4.7 of the SCM
Agreement, what could be done to "withdraw" a prohibited subsidy. It does not
address the issue of surveillance of those steps. For that reason, we decline to make
the suggestion requested by Canada.
147. The EC would remind the panel that Mr Suring a's statements reported by the BNA Daily tax
report (see EC-Exhibit 14), and confirmed during th e hearing, indicate that implementing regulations
and guidance about three primary elections under the FSC Replacement Act are not issued yet. This
statements put into question whether in fact the US has implement the DSB recommendations and
rulings at all and leaves open the question of when the US will do so.
Q39 In the EC’s view, would the Act be consistent with the SCM Agreement if the United
States eliminated the requirements that the property be held for use “outside the United States”
and the “foreign content limitation”?
Reply
148. Yes, there would no longer be a prohibited subsidy within the meaning of Article 3 of the
SCM Agreement.

62 First written submission of the US, Section V. H. 2 (esp. heading).
63 Appellate Body Report, United States – Import Measures on Certain Products from the European
Communities (“United States – Import Measures”), WT/DS165/AB/R, adopted 10 January 2001, para. 129.
64 Article 21.5 Panel Report, Canada – Measures Affecting the Export of Civilian Aircraft (“Canada –
Aircraft”), WT/DS70/RW, adopted 4 August 2000, as upheld by the Appellate Body Report,
WT/DS70/AB/RW, para. 6.4.

Questions for both parties
Q43. Can a measure of a Member provided in re spect of the production of a good outside the
territory of that Member be a subsidy within the meaning of Article 1 of the SCM Agreement?
Please explain your answer, taking into account any relevant provisions of the SCM Agreement.
Reply
149. Article 1.1(a)(1) of the SCM Agreement provides that:
For the purpose of this Agreement, a subsidy shall be deemed to exist if:
there is a financial contribution by a government or any public body within the
territory of a Member
150. The italicised words in Article 1.1(a)(1) above qualify the nature of “public body” that may
also give a subsidy. It does not imply a territorial limitation on where a “financial contribution” may be
given or received. If this had been meant a different word order would have been used.
151. The ordinary meaning of the text is confirmed by the negotiating history. The original
Chairman’s text of 18 July 199065 referred only to a “financial contribution” in defining a subsidy in
the then Article 3.1(a). The next revision of the text 66 clarified the definition as “a financial
contribution by a government or any public body within the territory of a signatory (hereinafter
referred to as "government").
152. This definition, while clarifying and arguably expanding the definition of government,
qualified the definition of subsidy by making it clear that a financial contribution by a public body
outside the territory of the Member concerned did not constitute a subsidy.
153. In any event, a financial contribution from a government, at least when created through the
forgoing of revenue collected by that government, will always arise in the territory of the granting
Member, since that is where the government in question is situated.
154. There is, on the other hand, no limitation in the text of the other component of a subsidy in
Article 1 of the SCM Agreement, as to where this benefit should be conferred.
155. Where a taxpayer that benefits from the FSC Replacement scheme is situated outside of the
US, it may be considered that the benefit is conferred outside the US. But nothing in the text of
Article 1.1(b) of the SCM Agreement suggests that only benefits conferred within the territory of the
granting Member are relevant. On the contrary the fact that the words “within the territory of a
Member” do not apply to benefit in Article 1.1(b) although they are a feature of “financial
contribution” in Article 1.1(a), implies that there is no territorial limitation on where the benefit can
be enjoyed.
156. This was also, as the EC observed in paragraph 65 of its first written submission, the view
taken by all the parties, the panel and the Appellate Body in the Brazil-Proex case, which also
involved a subsidy granted to foreigners (foreign airlines).

65 Doc. MTN.GNG/NG10/W/38 of 18 July 1990.
66 Doc. MTN.GNG/NG10/W/38/Rev of 4 September 1990.

157. The EC is aware that the US treats so-called "t ransnational subsidies" as being in principle
non-countervailable under section 351.527 of the US countervailing duty legislation.
158. The EC doubts whether this non-countervailability of “transnational subsidies” is required
under Part V of the SCM Agreement on countervailing duties. It notes that Part V does not limit
participation in countervailing duty investigations but extends this to all “interested Members,” so that
the non-subsiding country of export would also be able to participate. The EC takes no position on
this question but would only point out that the difficulties that arise when applying a countervailing
duty in such circumstances do not exist in the case of prohibited or actionable subsidies. This is
because a countervailing duty can only be imposed on the country exporting the goods in question,
which in the hypothesis under consideration is not responsible for the grant of the subsidy. A WTO
dispute settlement proceeding concerning a prohib ited or an actionable subsidy would however be
brought against the country granting the subsidy (in this case, the US), not against the country in
which the primary beneficiary of the subsidy is si tuated (in this case, the country of the foreign
corporation).
159. Even if one were to construe Article 1 of the SCM Agreement as only relating to subsidies for
the production of goods within the territory of the Member responsible for the measure, it would still
be necessary to consider that the extended FSC Replacement subsidy was a prohibited export subsidy.
160. The FSC Replacement scheme is a direct subsidy to the production not “for ultimate use
within the US” of qualifying foreign trade property. But the foreign content limitation also makes it
an indirect subsidy to the production in the US of raw materials and components (“articles” in the
words of the FSC Replacement Act) of all kinds that can be utilised in making qualifying foreign
trade property while respecting the foreign content limitation.
161. In the case of the extended FSC Replacement subsidy, the indirect subsidy to the production
in the US of articles of all kinds that can be utilised in making qualifying foreign trade property is
contingent upon export. It is contingent upon export because in those cases where articles make up
more than 50% of the fair market value of the foreign produced goods, it will be necessary for goods
to be exported from the US in order for the foreign content limitation to be respected.
162. It may also be noted that, according to the US itself, the extended FSC Replacement subsidy
is also available to US companies that distribute from the US qualifying foreign trade property
manufactured outside the US.
Q44. Assume for the sake of argument that th e answer to question 43 is no. What relevance,
if any, would such a conclusion have in respec t of the issues of export contingency which are
before the Panel in this dispute?
Reply
163. As explained in the answer to the last question, the extended FSC Replacement subsidy would
still be an indirect subsidy to US articles which is contingent upon them being exported.
164. It would also have no effect on the export contingency of the basic FSC Replacement subsidy.
165. As the EC has argued at length, the fact that an advantage can in some circumstances be
obtained without exporting does not stop it being export contingent in those circumstances where
export is a necessary condition for obtaining the subsidy.
67 An export contingent subsidy does not

67 First written submission of the EC, paragraphs 62 to 66 and 123 to 127, second written submission of
the EC, paragraphs 8 to 15 and the oral statement of the EC, paragraphs 35 to 38.

cease to be so if it is included in a wider measure whereby a similar advantage is granted in an
unobjectionable manner.
166. The extended FSC Replacement subsidy and the basic FSC Replacement subsidy are
available in mutually exclusive circumstances – a good is either produced within the US or outside the
US.
167. These arguments only become stronger if the tax advantage given to transactions involving
foreign-produced goods is not considered to be a subsidy at all (and therefore not relevant for the
purposes of the SCM Agreement). After all, the “advantage” of not paying tax can also be obtained by
not producing any goods at all or by not making an y profit on the sale of goods that are produced.
This is clearly not a subsidy and is irrelevant for the purposes of the SCM Agreement.
Q45. Is export income foreign source income? Some may take the view that the “foreign-
source income” referred to in footnote 59 shou ld include export income since the footnote is
accompanying item (e) that is dealing with a ty pe of subsidy specifically related to export.
Please comment.
Reply
168. The last sentence of footnote 59 is written in declaratory language:
Paragraph (e) is not intended to limit a Member from taking measures to avoid the
double taxation of foreign-source income earned by its enterprises or the enterprises
of another Member.
169. It makes clear, for the case that there should be any doubt, that such measures are not
prohibited export subsidies. This can be understood from the historical context represented by the
decision in the panel reports in the Tax Legislation cases, which suggested that such measures could
in some cases be export subsidies for the purpose of Article XVI:4 of GATT 1947.
170. If the sentence were intended to derogate from item (e) it would have been drafted
differently, for example:
Measures to avoid the double taxation of foreign-source income earned by its
enterprises or the enterprises of another Member shall not be considered export
subsidies.
171. Indeed, to have the effect argued by the US item (e) it should have been drafted to read:
The exemption, remission, or deferral of tax specifically on export income shall not
be considered an export subsidy if related in some way to measures to avoid the
double taxation of [foreign-source] income earned by its enterprises or the enterprises
of another Member.
172. And clearly the foreign-source reference would have to be omitted as well.
173. Export income is not, by definition, foreign-source income. Export income represents the
difference between the price of a product sold to a customer in a foreign country and the cost of
producing that product. Therefore, although the customer is foreign, the costs are incurred by
domestic economic activity and the income is therefore generated domestically. This point has been
made in paragraph 206 of the EC’s second submission and by Canada in its third party submission
(paragraph 34). Indeed, Canada aptly describes it as “domestic income from export transactions”.

174. It is hard to conceive of a situation in which such income would be subject to taxation by
another Member, because none of the economic activity has been carried out in a foreign country.

List of Exhibits
EC-21 Extracts from US legal texts
EC-22 Extract from The Deferral of Income Earned Through U.S. Controlled Foreign
Corporations; A Policy Study . Office of Tax Policy Department of the Treasury, December 2000.
Chapter 8, Restatement of Conclusions.

ANNEX F-2
ANSWERS OF THE EUROPEAN COMMUNITIES
TO THE QUESTIONS OF THE UNITED STATES
(27 March 2001)
Q1. What is the "prevailing standard" or "general rule" of taxation in a country which
taxes some persons on a worldwide basis and some persons on an exemption basis, in some cases
at their election (and subject in such cases to the discretion of the government)? Please explain
the basis for your answer.
Reply
1. The EC finds it impossible to answer this question. It is not possible to extract a “general
rule” or a prevailing standard” from one isolated feature of a tax system.
Q2. Is the tax exemption by a country of "foreign-source income" (for purposes of
footnote 59) permissible under the SCM Agreement only if all "foreign-source income" is
exempt from tax? Please explain the basis for your answer.
Reply
2. The last sentence of footnote 59 to the SCM Agreement does not require that all foreign-
source income be exempted from tax.
3. However, as the EC has explained 1 , a tax system that a provides a more advantageous means
of avoiding double taxation restricted to certain privileged taxpayers may be providing a subsidy and
it may be that this subsidy is not covered by the terms of the last sentence of footnote 59 to the SCM
Agreement.
Q3. Would the Act confer subsidies contingent upon export performance in the absence of
§§ 942(a)(2)(A)(i) and 943(a)(1)(B) and (C)? Please explain the basis for your answer.
Reply
4. The EC refers the US to its answer to the same question from the Panel (number 39).
Q4. Are the EC member States prepared to reli nquish all source-based taxation with respect
to business profits in the absence of a "permanent establishment," as that term is defined in
Article 5 of the OECD Model Income Tax Convention?
Reply
5. Nothing in the WTO Agreement prevents Members from taxing whatever they wish so long
as they do not grant prohibited or specific and injurious subsidies.

1 First written submission of the EC, paragraph 221 and EC answer to Panel question number 16.

6. However, the definition of a permanent establishment in Article 5 of the OECD Model Tax
Convention is the basis of the respective provisions taken into all modern bilateral or multilateral tax
treaties concluded by EC Member States with other c ountries, that is to say, into the vast majority of
all tax treaties entered into by the EC Member States. The EC Member States do observe these
treaties and thus, do not seek to tax business profits of enterprises of their treaty partners unless these
maintain permanent establishments in the EC Member States in question. The business profits in such
cases are only taxed to the extent that they are attributable to such permanent establishments.
7. Accordingly, for example, where a US ente rprise exports goods to a EC Member State,
without maintaining a permanent establishment in this EC Member State the profits derived from the
export activities of the US enterprise are not charg eable to tax in that EC Member State. Similarly,
even if the US enterprise did maintain a permanent establishment in the EC Member State in question
but no part of the profits derived from the exports to that EC Member State were attributable to that
permanent establishment, the EC Member State w ould not tax the business profits derived from the
export activities of the US enterprise.
Q5. Do most countries, under their own domestic statutes and regulations, condition source-
based taxation of business profits upon the maintenance by a foreign enterprise of a
"permanent establishment," as that term is defined in Article 5 of the OECD Model Income
Tax Convention, within their territorial limits? Please explain the basis for your answer.
Reply
8. Not only is not possible for the EC to verify the concordance of the jurisdictional standards
contained in all countries domestic statutes and regulations with the ‘permanent establishment’
standard, it is also not necessary for the resolution of the present dispute.
9. It is a well-known fact that Article 5 of the OECD Model Tax Convention and its
commentary have had a significant ‘harmonising’ effect on the definition and the interpretation of the
concept of a permanent establishment both in the bilateral tax treaties and in the national legislation of
a large number of countries. This is in particular the case in industrialised countries with relatively
sophisticated tax systems but also in many developing countries, either because of the endorsement of
Article 5 of the OECD Model as such or because it has served as the basis for the equivalent Article
(Article 5) of the UN Model Tax Convention. It is therefore that under these national provisions the
permanent establishment concept is commonly used for the purpose of determining the limits of the
taxing rights of a source country over the business profits of an enterprise resident in another country.
10. More importantly, the vast majority of the approximately 2000 mainly bilateral tax treaties
which exist world-wide rely, as far as the definition of a permanent establishment and thus the source
country’s right to tax the business profits of an enterprise resident in the other Contracting State is
concerned, on the standard definition of the permanent establishment concept in Article 5 of the
OECD Model Tax Convention. As these bilateral (or multilateral) treaties are agreements between
independent countries, they are subject to the rules of public international law, in particular to the
Vienna Convention.
2 Their status as a matter of national law varies but as a main rule they prevail
over any conflicting national rule. In cases where under a particular legal system the national
legislators have, in principle, the freedom to override such treaties, they are careful not to do so and in
the absence of clear intention to override a treaty the national courts tend to assume an intention to
observe it.
11. Given the large number of existing bilateral tax treaties and the fact that they cover the vast
majority of such bilateral relationships in which the greater part of international trade and investment

2 The Vienna Convention on the Law of Treaties of 22 May 1969.

take place, the significance of the national rules of countries in respect of the conditions under which
a source country may tax the business profits of an enterprise resident in another country is very
limited. This is because conflicting national rules, if any, would and could not be enforced wherever
there is a treaty.
12. Additionally, many countries have incorporated into their national legislation rules defining
the existence of a permanent establishment that is based on the definition in Article 5 of the OECD
Model. Thus, for example many European Member States apply the same standards for the purpose of
defining their taxing rights over the business profits of enterprises resident in countries with which
they have not concluded bilateral tax treaties as they do in treaty situations.
Q6. Does the OECD Model Income Tax Convention contain a definition of the term
"foreign-source income"? If so, please identify the provision containing such definition.
Reply
13. The OECD Model Income Tax Convention does not use the term "foreign-source income" as
such. The OECD Model Convention expresses the same concept in different ways – as does the US
IRC, which uses the expressions “sources within the US” and “sources without the US”.
14. Thus, for example, Article 4 of the OE CD Model Convention (Resident) states:
For the purposes of this Convention, the term "resident of a Contracting State" means any person
who, under the laws of that State, is- liable to tax therein by reason of his domicile, residence, place of
management or any other criterion of a similar nature, and also includes that State and any political
subdivision or local authority thereof. This term , however, does not include any person who is liable
to tax in that State in respect only of income from sources in that State or capital situated therein.

ANNEX F-3
ANSWERS OF THE UNITED STATES
TO QUESTIONS FROM THE PANEL
(27 March 2001)
Preliminary Comment
1. Before addressing the Panel’s questions, the United States first would like to comment briefly
on the exhibits attached to the EC’s closing statement of 16 March 2001. If the Panel were to
consider this information, it tends to support, rather than undermine, the US position.
2. With respect to EC-19, which consists of a copy of pages from the 14 November 2000 edition
of the Congressional Record dealing with the floor debate in the US House of Representatives on the
bill that became the FSC Replacement and Extraterritorial Income Exclusion Act of 2000 (“the Act”),
the United States should clarify for the Panel the significance of floor statements in discerning
legislative intent under US law. While in appropriate situations courts may consider floor statements,
as a general proposition, floor statements are treated as decidedly inferior to committee reports. This
proposition was best expressed by the US Suprem e Court – the highest court in the US judicial
hierarchy – in Garcia v. United States , 469 US 70, 76 (1984) (copy attached as Exhibit US-19), in
which the Court stated:
In surveying legislative history we have repeatedly stated that the
authoritative source for finding the Legislature’s intent lies in the Committee Reports
on the bill, which “represent[t] the considered and collective understanding of those
Congressmen involved in drafting and studying proposed legislation.” We have
eschewed reliance on the passing comments of one Member, and casual statements
from the floor debates. In O’Brien, we stated that Committee Reports are “more
authoritative ” than comments from the floor, and we expressed a similar preference
in Zuber ... . (Citations omitted; bracket in original).
3. A similar principle was articulated by Justice Jackson – of Nuremberg Trial fame – in
Schwegmann Bros. v. Calvert Distillers Corp. , 341 US 384, 395-96 (1951) (concurring) (copy
attached as Exhibit US-20), in which he stated:
Resort to legislative history is only justified where the face of the Act is inescapably
ambiguous, and then I think we should not go beyond Committee reports, which
presumably are well considered and carefully prepared. . . . [T]o select casual
statements from floor debates, not always distinguished for candour or accuracy, as a
basis for making up our minds what law Congress intended to enact is to substitute
ourselves for the Congress in one of its important functions.
4. Moreover, even when US courts do consider floor statements, they discount statements made
by opponents of the legislation. As the Supreme Court stated in Bryan v. United States, 524 US 184,
196 (1998) (copy attached as Exhibit US-21): “As we have stated, however, ‘[t]he fears and doubts of

the opposition are no authoritative guide to the construction of legislation.’ ‘In their zeal to defeat a
bill, they understandably tend to overstate its reach.’” (Citations omitted).
5. Thus, if a US court were to consider the floor statements contained in EC-19, the statements
to which a court most likely would give weig ht would be those of Representative Archer,
then-chairman of the House Committee on Ways and Means, and Representative Crane, chairman of
the Subcommittee on Trade of the House Committee on Ways and Means, who were important
proponents of the Act. The EC does not quote the statements of these gentlemen. Here is what
Representative Archer had to say:
Mr. Speaker, I rise simply to say that the gentleman from California says that
it is a corporate subsidy if we do not double tax all of the earnings overseas. We are
one of the very few developed countries in the world that double taxes earnings
overseas. So if we eliminate partially, only partially, the double taxation of those
earnings to be only partially competitive with our foreign competitors, he calls it a
subsidy. I do not believe the American people would agree with that.
1
This statement provides further evidence that Congress intended that the Act serve as a measure to
avoid double taxation.
6. With respect to Representative Crane, he made the following statement: “H.R. 4986 moves
the US closer to a territorial tax system, more like the one governing the international activities of so
many European businesses. 2 This statement provides further evidence that, by means of the Act,
Congress consciously intended to incorporate territorial features into the US system of taxation.
7. In a similar vein, the EC’s assertions regarding the reluctance of the US Executive Branch
officials to speculate on Congress’ motives in passing the Act are equally misplaced. To be clear, this
reluctance does not stem from the fact that those officials have no knowledge regarding the drafting of
the Act, but rather from the fact that any such k nowledge is irrelevant for purposes of identifying
Congress’ intent. Instead, what is relevant is the legislative record created by Congress itself.
8. The Supreme Court has held that post hoc observations made by individuals involved in the
drafting of legislation carry little weight with respect to discerning statutory meaning. Bread Political
Action Committee v. FEC , 455 US 577, 582 (1982) (copy attached as Exhibit US-22). According to
the Court, these statements have no probative weight because they only “represent the personal views
of [the drafter]” and “the statements [a]re made after passage of the Act.” Id . This is true even if
such post hoc observations are made by a member of Congress. Quern v. Mandley, 436 US 725, 736
(1978) (copy attached as Exhibit US-23).
9. Thus, any post hoc speculation of the sort sought by the EC as to what Congress intended
would be nothing more than that: mere, and legally irrelevant, speculation.

1 EC-19, page H11892.
2 Id., page H11891.

QUESTIONS FOR THE UNITED STATES
Question 7. The United States argues that, with the Act, it changed the general rule of US
taxing jurisdictio3, and thus, in regard to “ extraterritorial income”, there is no general rule of
taxation that would apply "but for" the definition of gross income 4 The new Section 941(a)(1)
of the IRC provides in relevant part:
"The term ‘qualifying foreign trade income’ means, with respect to any
transaction, the amount of gross income which, if excluded, will result in a
reduction of the taxable income of the taxpayer from such
transaction…."(emphasis added)
How can the US argument be reconciled or harmonized with the underlined words quoted
above?
10. The above statements do not conflict. The reduction of taxable income referred to in the
statute is the intermediate step in a formula fo r computing the amount of excluded income. Use of
that intermediate step does not indicate that excluded income would be otherwise subject to tax in the
United States.
11. A basic principle of US tax law is that a taxpayer may deduct the expenses it incurs in
producing taxable income. A corollary to that principle is that a taxpayer may not deduct the
expenses it incurs in producing income that is excluded from the tax base. To permit otherwise would
allow a taxpayer to underpay its taxes.
12. The exclusion for extraterritorial income is an exclusion from gross income, not a reduction in
taxable income. Under the US tax system, gross inco me refers to the income of the taxpayer without
taking into account any deductions. Because excluded extraterritorial income is excluded from the
US tax base, however, the Act denies deductions attributable to such income. This presents a
computational problem: how are disallowed deductions to be removed if the excluded amount is
based on gross income, which does not account for any deductions? The problem is solved by first
computing taxable income, then denying deductions allocable to excluded extraterritorial income, and
then “grossing up” the resulting figure into a gros s income exclusion by attributing to the taxable
income amount any allocable deductions. The legisl ative history of the Act provides the following
summary: “[I]n order to calculate the amount that is excluded from gross income, taxable income
must be determined and then "grossed up" for allocable expenses in order to arrive at the appropriate
gross income figure."
5 A comprehensive numerical example of this process is contained in the
legislative history of the Act.6
13. Thus, the exclusion for extraterritorial income is an exclusion from gross income, and the step
of converting the amount of the exclusion into a reduction in taxable income is only a mechanism for
determining the amount of the gross income exclusion.
14. More generally, one practical effect of any exclusion is that it has the ultimate effect of
reducing taxes from what they would have been without the exclusion. This same issue arises in
connection with exemption systems. To recognize this fact is separate from the question whether
exclusion is part of a country’s general rule of taxation.

3 US first submission, para. 72.
4 US first submission, para. 77.
5 Senate Report (US-2), page 12.
6 Id., pages 11-14.

15. In this regard, in an oral follow-up question, the Panel asked whether Question 33 is relevant
to Question 7. The United States does not believe that the Treasury subpart F study is relevant to the
formula for calculating excluded extraterritorial income.
Question 8. The European Communities states th at, in order for extraterritorial income to
be excluded from taxation, “US articles must be used whenever the cost of other inputs (not
articles or direct labour) (C) and profit (D) are less than 50% of the selling price (or more
exactly the US-assessed fair market value) of the goods”. 7 Is this a correct characterisation of
Act? If not, could the US provide what it considers to be the correct description?
16. This is not a correct characterization of the Act. US articles do not have to be used in this
situation because US labour could be used to meet the 50 per cent limitation without increasing the
amount of US articles. For example, assume that the EC’s (C) and (D) account for 49 per cent of the
fair market value, leaving 51 per cent to be accounted for by articles and labour. Under the Act, all
but 1 per cent of that 51 per cent could be accounted for by foreign labour and articles, while the
remaining 1 per cent could be accounted for by US labour.
17. More generally, however, the EC has narrowed inappropriately the scope of the relevant
question. The more appropriate question is whether the Act contains an affirmative requirement to use
US articles. There is no such requirement in the Act.
18. This inaccurate description of the Act reflects the EC’s limited understanding of the Act’s
structure and design. In this regard, the EC’s algebraic breakdown fails to reflect the Act’s distinction
between the foreign labour and US labour components.
Question 9. In the Annex to its first and second submissions, the European Communities
identifies cases where the cost of “articles” us ed to produce finished goods exceeds 50% of the
value of the finished product, a situation in which the “requirement to use US articles must arise
in practice”.8 How does the US respond to this allegation? Are such situations precluded by
virtue of the Act ?
19. It is clearly possible to construct a hypothetical showing that the 50 per cent rule might not be
satisfied in some situations. The EC claims that its hypotheticals are based on actual data, but, not
having access to the data, the United States is unable to respond to the accuracy of the data or the
validity of the conclusion derived by the EC from the data. The United States would note that it has
been informed by a reliable source that the EC’s percentage figures for aircraft engines and avionics
are too high. From that, the United States can only assume that the other figures cited by the EC also
may be inaccurate.
20. In an oral follow-up question, the Panel asked whether, if a particular company can only
satisfy the 50 per cent rule by using US articles, the taxpayer is automatically entitled to the
exclusion? The answer to this question is “no”, satisfaction of the 50 per cent rule through the use of
US articles would not guarantee eligibility for the Act’s exclusion with respect to income from the
sale of the finished product. The taxpayer still would have to satisfy all of the other requirements of
the Act, such as the foreign economic process requirements of section 942(b).

7 EC first submission, para. 112.
8 EC first submission, para. 116.

Question 10. The European Communities submits 9 that "the term “export” in Article 3.1(a) of
the SCM Agreement refers to the sale of:
• Goods;
• Originating in the country providing the subsidy;
• Destined for the market of, that is for final consumption in, another country."
Does the US agree with this definition of the term "export" for the purpose of the SCM
Agreement?
21. The United States does not agree with this definition. The United States believes that the EC
got the definition right the first time, when it followed the dictionary definition: “Send (esp. goods) to
another country“.10 Thus, based on the ordinary meaning of "export", where a good is ultimately
consumed is irrelevant to whether it is exported, and a product can be exported multiple times until it
is finally consumed. The EC offers no support for its assertion that the ordinary meaning of "export"
should be ignored.
Question 11. Where qualifying foreign trade pr operty is manufactured, produced, grown or
extracted within the United States, is there a possibility under the Act for a taxpayer to exclude
any amount of gross income earned from the sale of a good - thus resulting in the reduction of
its taxable income - if such a transaction does not involve the exportation of the said good from
the United States into any other country?
22. Yes. A manufacturer of goods can earn excluded income by sales to domestic buyers,
provided that the goods in question are used outside the United States. Use outside the United States
could occur, for example, if the good in question is a fishing boat sold to a United States person for
use outside the territorial waters of the United Stat es. In that case, income from the sale of the boat
could qualify notwithstanding that the boat was not “consumed” within a foreign jurisdiction. Use
outside the United States also could occur in certain circumstances if the article is incorporated into a
good that is sold for use outside the United States. Thus, for example, extraterritorial income could be
earned if a US manufacturer sells an aircraft engine to a US aircraft manufacturer for incorporation
into a finished aircraft to be used outside the Unit ed States. The foregoing examples follow from the
language of the statute, but the precise scope of these rules will be the subject of proposed regulations
to be issued in the future.
23. In an oral follow-up question, the Panel asked whether there is no way to benefit from the
exclusion if the final destination of a good is the United States, and whether a good must cross the
border before final use?
24. With respect to the first question, taxpayers may earn excluded extraterritorial income with
respect to some transactions in which the “final destination” of the property is the United States. The
legislative history provides as follows:
[P]roperty that is sold to an unrelated person as a component to be incorporated into a
second product which is produced, manufactured, or assembled outside of the United
States will not be considered to be used in the United States (even if the second
product ultimately is used in the United States), provided that the fair market value of
such seller’s components at the time of delivery to the purchaser constitutes less than

9 EC first submission, para. 91.
10 EC submission, para 85.

20 per cent of the fair market value of the second product into which the components
are incorporated (determined at the time of completion of the production,
manufacture, or assembly of the second product).11
Thus, for example, a US manufacturer of car tires may earn excluded extraterritorial income from the
sale of tires to an unrelated US car manufacturer with a plant in Canada, even if the tires are installed
on cars for sale in the US domestic market.
25. In addition, the foreign use requirement only requires predominant foreign use. Thus, some
domestic use is permitted. According to the legislative history,
property is considered to be used predominantly outside the United States for any
period if, during that period, the property is located outside of the United States more
than 50 per cent of the time.12
26. With respect to the second question, the Act does not generally require any border crossing.
For example, a taxpayer may earn excluded income with respect to foreign-produced property that is
produced and consumed within the same foreign jurisdiction.
Question 12. Where qualifying foreign trade pr operty is manufactured, produced, grown or
extracted within the United States by a US corporation or an individual permanently
established in the United States, and where that corporation or individual does not maintain
any permanent establishment outside the Unit ed States, are there situations in which
extraterritorial income earned from the sale of such property can be taxed by another country
than the United States ?
27. The United States believes that there are such situations, and the Act was designed to account
for them. The United States, for example, subjects foreign persons to tax that do not have a permanent
establishment in the United States.
28. The United States unfortunately is not in a position to opine regarding all the tax laws of the
world. The United States would cite, however, certain examples of countries with which the
United States has no income tax treaty and which may impose source-based taxation under domestic
law in the absence of a permanent establishment:
• Brazilian domestic law does not contain a proper definition of the term “permanent
establishment.” In fact, there are no rules providing for special tax treatment of
permanent establishments in Brazil.
13
• Chilean source income is taxable in Chile even if it is earned by a non-resident with
no establishment or agency in Chile. Chilean law does not provide for the concept of
a permanent establishment. Chilean-source income is taxable even on occasional
transactions.14

11 Senate Report (US-2), page 19.
12 Id., page 20.
13 International Bureau of Fiscal Documentation, Taxation in Latin America , Section C, Brazil 21-23
(LA, Suppl. No. 121, September 2000) (copy attached as Exhibit US-24).
14 International Bureau of Fiscal Documentation, Taxation in Latin America , Section C, Chile 23, 26
(LA, Suppl. No. 117, September 1999) (copy attached as Exhibit US-25).

• Malaysia taxes non-residents on income accruing in or derived from Malaysia. The
concept of permanent establishment is not part of Malaysian internal revenue law.15
• Panamanian-source income is subject to tax in Panama even if it is earned by a
non-resident with no establishment or agency in Panama. Such income paid to
non-residents is subject to a withholding tax. Whether or not income is
Panamanian-source income does not depend on the nationality, domicile, or residence
of the recipient, nor on the location at which the contract is concluded. Panamanian
law does not recognize the concept of “permanent establishment”.
16
• Taiwan imposes income tax on all income derived from sources within Taiwan,
whether earned by residents or non-residents. Taiwanese law does not use the term
“permanent establishment”. If a foreign individual or foreign “profit-seeking
enterprise” without a “fixed place of business” or a “business agent” earns income in
Taiwan, the income is subject to a final withholding tax.17
• Saudi Arabia levies tax on all income from Saudi Arabian sources. This is the case
even in cases where the foreign entity has no presence in Saudi Arabia, and thus the
government has no power to compel the foreign entity to file a tax return. In such
cases, the payor of the income is liable for the tax, which is thus essentially
transformed into a withholding tax. There is no concept of “permanent
establishment” in Saudi Arabian law.18
The United States emphasizes that these are only a few examples of countries that do not provide for
the concept of a permanent establishment in their domestic tax law.
29. Thus, the concept of a “permanent establishment” is not a universally adopted standard, as the
EC suggests. Territorial systems do not define the scope of the exemption based upon the amount of
income attributable to a foreign permanent establis hment. Territorial systems simply exclude income
earned outside the territorial boundaries of the country in question.
30. There are additional, independent reasons to reject the EC’s approach. First, the United States
recalls that it has income tax conventions with only 63 countries, leaving US business to face the
domestic tax laws of all other countries without the benefit of a permanent establishment article.
31. Second, the EC’s argument is internally inconsistent. If the concept of permanent
establishment were an internationally accepted standard, as the EC alleges, then there would be no
need for Article 7 of the OECD model, which is designed to override the domestic laws of the
signatories to a tax treaty.
32. Third, the EC’s argument is counter-textual. Even assuming that the concept of a permanent
establishment were an internationally accepted standard, which it is not, footnote 59 nowhere refers to
the term “permanent establishment”, and nothing in footnote 59 states that a measure qualifies as a

15 International Bureau of Fiscal Documentation, Taxation and Investment in Asia and the Pacific ,
Malaysia 33-34, 38, 43 (AP, Suppl. No. 189, May 2000) (copy attached as Exhibit US-26).
16 International Bureau of Fiscal Documentation, Taxation in Latin America , Section C, Panama 4, 13,
14-16 (LA, Suppl. No. 113, March 2000) (copy attached as Exhibit US-27).
17 International Bureau of Fiscal Documentation, Taxation and Investment in Asia and the Pacific ,
Taiwan 17, 19 (AP, Suppl. No. 111, November 1993) (copy attached as Exhibit US-28).
18 International Bureau of Fiscal Documentation, Taxation and Investment in the Middle East , Saudi
Arabia 43-46 (ME, Suppl. No. 90, August 2000) (copy attached as Exhibit US-29).

measure for the relief of double taxation only if it conditions relief upon the existence of a permanent
establishment.
33. Fourth, validation of the EC’s argument woul d be unwise, given the evolving standards for
when double taxation may arise. Take the example of the recent developments in e-commerce. With
respect to cross-border electronic transactions, the definition of permanent establishment is the subject
of an ongoing debate. Different countries have taken different positions on what degree of activity
constitutes a permanent establishment, giving rise to the spectre of double taxation despite the absence
of a permanent establishment.
34. Accordingly, the approach suggested by the EC is unwise and unwarranted.
QUESTIONS FOR BOTH PARTIES
Question 13. Regarding the relationship betw een Article 3.1(a) of the SCM Agreement and
item (e) of Annex I, would it be possible that a certain measure is not within the scope of the
latter, but nonetheless within the scope of the former, and vice versa?
35. The United States explained its position on the relationship between paragraph (e) of Annex I
and Article 3.1(a) at paragraphs 157-61 of its First Submission. There, the United States pointed out
that paragraph (e) identifies a particular type of prohibited export subsidy - that is, a particular type of
subsidy made contingent on export performance.
36. The United States made its comments in response to the EC argument that paragraph (e)
broadens Article 3.1(a) and prohibits export subsidies that are not within the scope of 3.1(a). The
United States recalled that, as a part of the Illustrative List of Export Subsidies, paragraph (e) provides
an example of a prohibited export subsidy. The United States maintained, and remains of the view,
that paragraph (e) helps to clarify and apply 3.1(a), but it does not prohibit something that 3.1(a) does
not. The United States notes that the panel in the Canada Autos case appears to have taken a similar
view.
19
37. The key issue seems to be that the EC wants the Panel to find that the fact that a measure is
available to exports is enough to violate the SCM Agreement. The United States submits that this
cannot be the case. A tax exemption, remission, or deferral that is "specifically related to exports"
requires a much closer connection to exportation than mere availability. The Panel need not even
explore the relationship between paragraph (e) and Ar ticle 3.1(a) if that is the EC's theory. Even if
such an attenuated connection could equal "specifically related to exports", the United States believes
the connection to exports must still amount to a contingency. If not, then no violation of
Article 3.1(a) can be shown.
Question 14. The Panel is well aware that th e WTO-conformity of income tax regimes of
European countries is outside the scope of our terms of reference for this case. In paragraph 96
of the US first submission, the US introduces examples of a few European tax systems which
“refrain from taxing foreign income in a qualified or conditional manner."
20 Among those

19 Canada - Certain Measures Affecting the Automotive Industry , WT/DS139/R, WT/DS142/R, Report
of the Panel, as modified on other grounds by the Appellate Body, adopted 19 June 2000, para. 10.196 (“Indeed,
the use of the words ‘including’ and ‘illustrated’ makes it clear that, while all practices identified in the
Illustrative List are subsidies contingent upon export pe rformance, there may be other practices not identified in
the Illustrative List that are also subsidies contingent u pon export performance.”). This particular aspect of the
panel report was not appealed.
20 US first submission, para. 97.

systems, is there one which excludes foreign inco me from the scope of taxable income on the
following conditions:
(i) the property for sale from which income arises must be held for ultimate use
outside the country, (and not be sold for final consumption in that country); and
(ii) the same property must have foreign content of not more than a certain
percentage of its fair market value.
38. With respect to condition (i), every country that declines to tax income that domestic
corporations earn outside the territory as fully as the income they earn domestically provides those
companies a tax incentive to export. This is because any domestic corporation that exports and that
can attribute some portion of the export income to offshore activities can, by virtue of territorial
features found in certain European tax systems, be taxed at lower rates in the foreign jurisdiction.
Exporters throughout Europe are keenly aware of this benefit and plan their business activities
accordingly.
39. The conditions for taking advantage of this tax incentive in these European countries are
similar, but not identical, to those in the Act. If a domestic corporation manufactures products
domestically, it can earn exempt income only by exporting (a condition that is similar, but not
identical, to the Act’s requirement of a foreign sale). As a practical matter, in European countries that
use the exemption method, it is undoubtedly the case that the primary beneficiaries of the exemption
are exporters.
40. With respect to (ii), which is a feature of the Act that rarely comes into play, the United States
is not aware of a similar provision in a European country. The US provision is probably unique.
Question 15. Is the term “foreign-source in come,” “foreign-source” or “source” used
elsewhere in any provisions of other WTO Ag reements than the SCM Agreement? What
guidance, if any, may be drawn as to the mean ing of these terms from the SCM Agreement or
other WTO Agreements?
41. We have found two places in the Covered Agreements in which some or all of the above
words are used. In paragraph 1(a) of the Annex to the Agreement on Trade-Related Investment
Measures, the word “source” is used in reference to domestic content requirements. Specifically, the
reference is to “the purchase or use by an enterprise of products of domestic origin or from any
domestic source ... .” (Emphasis added). The use of “source” in this context appears to refer not to a
situation in which a Member conditions an investment opportunity based on a requirement that goods
be manufactured within its borders, but rather that goods be purchased from a domestic business or
person (regardless of where the goods are made).
42. This use of “source” is consistent with the US position regarding the fifth sentence of
footnote 59. The United States has noted that one attribute of income that may render it
“foreign-source income” is that the purchaser of the good is foreign or the source of payment is
foreign. The use of the term “source” in the TRIMs Agreement parallels this understanding of
“source” in footnote 59.
43. Another reference is found in Article XIV of the General Agreement on Trade in Services,
which provides as follows:
[N]othing in this Agreement shall be construed to prevent the adoption or
enforcement by any Member of measures:

(d) inconsistent with Article XVII [nat ional treatment], provided that the
difference in treatment is aimed at ensuring the equitable or effective [6]
imposition or collection of direct taxes in respect of services or service
suppliers of other Members.
21
44. Footnote 6 to Article XIV(d) states in relevant part as follows:
Measures that are aimed at ensuring the equitable or effective imposition or collection
of direct taxes include measures taken by a Member under its taxation system which:
(i) apply to non-resident service suppliers in recognition of the fact that the tax
obligation of non-residents is determined with respect to taxable items
sourced or located in the Member’s territory ; or

(iv) apply to consumers of services supplied in or from the territory of another
Member in order to ensure the imposition or collection of taxes on such
consumers derived from sources in the Member’s territory; or

(vi) determine, allocate or apportion income, profit, gain, loss, deduction or credit
of resident persons or branches, or between related persons or branches of the
same person, in order to safeguard the Member’s tax base.
Tax terms or concepts in paragraph (d) of Article XIV and in this footnote are determined according
to tax definitions and concepts, or equivalent or similar definitions and concepts, under the domestic
law of the Member taking the measure. (Emphasis added.)
45. The purpose of paragraph (d) and its explanatory footnote is to make clear that, with respect
to the taxation of service income, Members are entitled to depart from the normal rule of national
treatment to ensure the “equitable or effective imposition of direct taxes”. In other words, Members
are permitted to take special measures to prevent evasion that might otherwise occur as a result of the
foreign location of service suppliers or the foreign performance of services. A key point in footnote 6
for purposes of the present dispute is the fact that the final sentence provides that the tax terms used in
the relevant text do not have universally agreed upon meanings. Thus, the final sentence indicates
that the negotiators of GATS wanted to provide fl exibility to capture the various instances in which
income can be regarded as “sourced” within a Member.
46. An equally important point is that the drafters understood that taxes can be derived from
sources in myriad ways. They recognized that WTO Members use different sourcing rules and have
different jurisdictional boundaries. Thus, what one country might deem to be taxable income, another

21 “Direct taxes” is defined in GATS Article XXVIII to “comprise all taxes on total income, on total
capital or on elements of income or of capital, including taxes on gains from the alienation of property, taxes on
estates, inheritances and gifts, and taxes on the total amoun ts of wages or salaries paid by enterprises, as well as
taxes on capital appreciation.” This definition of “direct taxes” is slightly different from, but not inconsistent
with, the definition of “direct taxes” found in footnote 58 of the SCM Agreement.

might view as outside the scope of its tax system. At a minimum, this language in the GATS
indicates that the EC’s “foreign economic processes test” is too narrow. For example, subpart (iv)
makes clear that Members may tax income of foreign service providers by levying taxes on domestic
customers where the services in question are “supplied in or from the territory of another Member”.
That such a service can be “sourced” within the country of the customer means that a “foreign
economic processes test” is too rigid to capture the complexities of modern international business and
taxation.
47. In other words, the drafters of the GATS, like the drafters of the SCM Agreement, wanted the
term “source” to be given its ordinary meaning. “Source ” may mean different things depending on
the context in which it is used. They did not intend for it too have one unique meaning to be applied
in all cases.
22 They also did not intend to incorporate an extrinsic definition of the term, including the
“special meaning” of “foreign source income” th e EC claims exists in the OECD Convention. The
United States has previously noted that the OECD Convention contains no definition of
foreign-source income and recognizes that income that is not attributable to any foreign economic
processes – i.e., passive income derived from foreign “sources” – may be exempted from taxation.23
48. Finally, the United States notes that Article XIV(e) and Article XXII:3 of GATS confirm the
flexibility built into the fifth sentence of footnote 59. Article XIV(e) provides an exception from
Article II (MFN) where “the difference in treatment is the result of an agreement on the avoidance of
double taxation or provisions on the avoidance of double taxation in any other international agreement
or arrangement by which the Member is bound.” Article XXII:3 provides that a Member may not
invoke Article XVII (national treatment) under the GATS dispute settlement provisions “with respect
to a measure of another Member that falls within the scope of an international agreement between
them relating to the avoidance of double taxation.” These provisions create an exception to GATS
non-discrimination rules only to the extent that the relief of double taxation is provided for or allowed
by another agreement. Footnote 59 contains no such limitation. Whether and how to avoid double
taxation are questions left to individual WTO Members.

22 Because the fifth sentence of footnote 59 speaks of not imposing limits on the ability of a WTO
Member to take measures to avoid double taxation, the United States believes that the term “foreign source
income” in the context of footnote 59 should be interpreted broadly. A broad interpretation in this case would
account for the real possibility that a foreign jurisdiction could tax excluded extraterritorial income. As noted
before, the United States believes that extraterritorial income has many attributes that make it “foreign” and, as a
result, it could be subject to foreign tax. If the Panel were to adopt the EC’s cramped interpretation of
foreign-source income here, the Panel ’s ruling would have the effect of preventing Members from relieving
double taxation in certain cases as a matter of WTO law.
23 If the drafters of the SCM Agreement had intended to incorporate the OECD Convention in the fifth
sentence of footnote 59, they would not have done so silently. By contrast, item (k) of Annex 1 contains a
specific reference to extrinsic sources. Item (k) of Annex I refers to “an international undertaking on official
export credits to which at least 12 original Members to this Agreement are parties as of 1 January 1979 (or a
successor undertaking which has been adopted by those original Members)”. The United States is aware of only
one undertaking that meets this description, and it is the OECD Arrangement on Guidelines for Officially
Supported Export Credits. Thus, the fact that the drafters of the SCM Agreement did not tie the fifth sentence of
footnote 59 to extrinsic documents cannot be assumed to be “merely accidental or an inadvertent oversight on
the part of either harassed negotiators or inattentive draftsmen.” United States - Restrictions on Imports of
Cotton and Man-made Fibre Underwear , WT/DS24/AB/R, Report of the Appellate Body adopted
25 February 1997, page 17.
In this regard, at the meeting with the Panel, the Panel asked whether the reference in the fourth
sentence of footnote 59 to bilateral tax treaties and th e OECD suggests that the drafters intended extrinsic
documents to apply for purposes of the fifth sentence. In the view of the United States, the answer to this
question is “no.” Indeed, the absence of a similar reference in the fifth sentence suggests the opposite
conclusion; i.e., that the drafters did not intend to incorporate standards or definitions from extrinsic sources.

49. In an oral follow-up question posed at the Panel meeting, the Panel asked whether the
Appellate Body’s references to “foreign-source income” in its report in the FSC case have any
relevance to the instant proceeding?
50. While the Appellate Body did not define the te rm “foreign-source income” within the context
of footnote 59, it did apply the term broadly and did not tie the concept to a particular Member’s tax
law. More generally, the Appellate Body reaffirmed that Members have the right not to tax a
particular category of foreign-source income.24 This reaffirmation supports the US position, which is
that excluded extraterritorial income is a category of “foreign-source income” that the United States
has chosen not to tax. By contrast, the EC appears to argue that a Member cannot refrain from taxing
foreign-source income unless it decides to refrain from taxing all foreign-source income. Under the
EC view, anything less than a full exclusion would give rise to an “exception” from a “general rule”
of taxation. The Appellate Body’s opinion demonstrates that the EC’s argument is without merit.
51. Moreover, the EC’s approach is incoherent at best. The EC seems to ask the Panel to rule that
the term “foreign-source income” has whatever meaning assigned to it by US domestic law. This
approach proves the US case, because excluded extraterritorial income would be foreign-source
income under US sourcing rules, as set forth in section 862(a)(4) and 863(b) of the IRC.
Nevertheless, the United States notes that the EC’s approach is internally inconsistent because the EC
simultaneously asserts that the income in question must be subject to tax under foreign law. Unless
the EC is prepared to assert that the entire world employs the US domestic-law sourcing rules, then
the EC must admit that these two approaches to determining source often will generate different
results. The difference between US sourcing rules and foreign sourcing rules reflects the basic fact
that no general international consensus exists on how best to source income from cross-border
transactions, transactions such as those that generate excluded extraterritorial income. Despite the
absence of such a consensus, the EC is inviting the Panel to impose one rule – with no relevant
theoretical justification – upon the tax authorities of all WTO Members.
Question 16. The European Communities claims that
25:
"Even if it were a measure to avoid the double taxation of foreign-source
income, the FSC Replacement Act would in any event be contrary to
Article 3.1(a) of the SCM Agreement because it gives exporters a choice that is
not available to other operators…. This additional advantage would also be a
subsidy,…. This unwarranted overcompensation is also a subsidy….
(For the EC): Please provide a te xtual analysis of how the alleged additional
advantage and overcompensation constitute subsidies under Article 1 of the SCM
Agreement.
(For the US): How does the US respond to this allegation?
52. The United States explained in paragraphs 35-38 of its Second Submission why countries can
and do rely on alternative methods of avoiding double taxation. This is a common and well-accepted
practice. For example, in France, with the permission of the Ministry of Economy and Finance, a
French company may elect to be taxed on its worldwide income and obtain relief from its worldwide
losses. Thus, in the context of export subsidies, alternative methods of double taxation relief should
be irrelevant, especially where no unique or special benefits are provided exclusively to exporters.
This is the case with respect to the Act, which is not uniquely applied to exporters or export income.

24 FSC (AB), para. 99.
25 EC second submission, paras. 221-222.

Question 17. The EC seems to argue that a Article 3.1(b) violation may exist if a certain
measure gives an “incentive” to domestic production for export. 26 In the same vein, the EC
argues that “Article 3.1(b) prohibits local-content contingency to any degree,… [and] there is no
de minimis rule for prohibited subsidies in the SCM Agreement.”.27
(For the EC): How would this argument be supported by a textual analysis of
Article 3.1(b) in accordance with Article 31 of the Vienna Convention? Can the
European Communities cite any Appellate Body or panel reports in which the
term “incentive” was explicitly used in the context of Article 3.1 of the SCM
Agreement, or Article XVI:4 of the GATT Agreement?
(For the US): Would a textual analysis of Article 3.1(b) lead to a conclusion that
the EC’s above argument is without merit? If so, why and how? Would the US
take the view that there is de minimis rule for prohibited subsidies in the SCM
Agreement? If so, what is the qualitative or quantitative threshold for that rule?
Is the Appellate Body Report in Canada - Certain Measures Affecting the
Automotive Industry
28 relevant to this question? Please give reasons for your
responses.
53. The EC’s "textual" analysis of Article 3.1(b) is incomplete. The EC notes that the dictionary
(which for some reason known only to the EC is usef ul here but not in connection with other parts of
the SCM Agreement) defines "over" as "in preference to". However, instead of interpreting "in
preference to", the EC decides to abandon the dictionary and simply equates "preference" with
"incentive" or "boost." However, the same dictionary relied on by the EC – The New Shorter Oxford
English Dictionary – defines "in preference to" as "rather than."
54. Thus, a textual analysis would lead to the conclusion that the EC’s argument is without merit.
The key words in Article 3.1(b) are "contingent" and "use." "Contingent upon the use of domestic
goods" simply is not the same thing as "incentive to use domestic goods."
55. With respect to the second part of the question, the question omits part of the quoted phrase;
i.e., the phrase "even a slight bias in favour of domestic goods." In the view of the United States, "a
slight bias" is not a contingency. A measure – at least a measure challenged on a de jure basis – either
is contingent or it is not. The United States is not arguing that a de minimis contingency is
permissible under Article 3.1(b); rather, the United States is arguing that a “slight bias” or incentive
does not amount to a contingency. For these reasons, the United States does not see how the de
minimis concept relates to a determination of contingency.
56. As for Canada Autos , the United States considers the Appellate Body report extremely
relevant. In that case, the Appellate Body said that value-based requirements cannot automatically be
deemed as creating a contingency within the meaning of Article 3.1(b). Instead, there must be an
analysis of how the requirements operate for indivi dual manufacturers. In the view of the United
States, the EC has failed to demonstrate that the 50-per cent rule actually requires any manufacturer,
whether located in the United States or abroad, to use US articles.
57. In this regard, the EC is making the same argument regarding Article 3.1(b) as the one
rejected in Canada Autos; namely, that the standard of Article 3.1(b) is satisfied if a measure "favors

27 EC second submission, para. 160.
28 WT/DS130/AB/R, WT/DS142/AB/R.

or gives preference to the use of domestic over imported goods." 29 Neither the panel nor the
Appellate Body accepted this interpretation. Although the Appellate Body did not expressly reject
this interpretation, it is clear from the report that the Appellate Body implicitly rejected it. The
Appellate Body’s analysis set forth in paragraphs 126-131 indicates that a “slight bias” is not enough
to establish a contingency for purposes of Article 3.1(b). Instead, it is necessary to analyze how
value-based requirements operate for individual manufacturers.
Question 18. Relating to Article III:4 GATT, EC has cited
30, inter alia, the Panel Report on
Italian Discrimination against Imported Agricultural Machinery. 31 We note that two other
documents -- GATT Doc. L/695 (1957) and GATT Do c. L/740 (1957) -- address similar issues.
Are these relevant to the question of whether Arti cle III:4 of the GATT in the first place covers
exemptions to the tax on the "firm"? Please comment on whether and how these reports are
relevant to our case.
58. These cases appear distinguishable on their face from the present dispute. At the most basic
level, these cases involved programmes that applie d directly to products. The governments provided
subsidized financing or grants that could only be used for the purchase of domestic products. Because
like imported products were ineligible for similar financing, the programmes violated the national
treatment provisions of GATT Article III:4. By c ontrast, the present case does not deal with a
measure that directly affects products, but rather, income taxes. A closer analogy to the agricultural
machinery financing cases would exist if a country imposed differing levels of excise tax on imported,
as opposed to domestic, products; such a case would properly be brought under Article III:2, rather
than Article III:4.
59. Indeed, there is support in the history of the GATT that Article III:4 was never intended to
apply to income taxes. The Reports of the Havana Convention, at which Article 18 of the Havana
Charter
32 (the immediate predecessor to GATT Article III, with essentially identical text) was drafted,
specify that “neither income taxes nor import duties fall within the scope of Article 18 which is
concerned solely with internal taxes on goods." 33 It is striking that in over 50 years of GATT and
WTO jurisprudence, few cases have been brought that alleged that income tax measures violated
Article III:4 34, and there have been no panel decisions on the issue. A WTO panel, expounding
generally on the scope of Article III, noted in passing that, “subsidies granted in respect of direct taxes
are generally not covered by Article III:2, but may infringe Article III:4 to the extent that they are
linked to other conditions which favor the use, purchase, etc. of domestic products." 35 This statement
is purely dicta, because none of the measures within the panel’s terms of reference involved an
income tax.

29 This argument is reflected in para. 10.214 of the panel report and para. 119 of the Appellate Body
report in Canada Autos.
30 EC first submission, para. 98.
31 GATT Doc. L/833 (1958), adopted 23 October 1958, BISD 7S/60.
32 Final Act of the United Nations Conference on Trade and Employment, March 24, 1948.
33 Interim Committee for the International Trade Organization, Report of Committees and Principal
Sub-Committees, Report of Sub-Committee A of the Third Committee on Articles 16, 17, 18 and 19,
E/CONF./2/C.3/59, para 44, page 63, Geneva, 1948.
34 The Analytical Index, Guide to GATT Law and Practice, Vol. 1, Geneva, 1995 cites a 1952
complaint by Austria that Italy granted a remission of income tax to firms that used domestically-produced
ship’s plate, L/875; a 1971 Working Party on the United States Temporary Import Surcharge held an exchange
of views on the Job Development Tax Credit, a credit against United States income taxes which was allowed
only on domestically-manufactured equipment, L/3575; and a 1987 EEC complaint concerning the temporary
extension of tax credits and depreciation for passenger aircraft assembled in certain US states, L/6153.
35 Indonesia - Certain Measures Affecting the Automobile Industry, WT/DS54/R, WT/DS55/R,
WT/DS59/R, WT/DS64/R, Report of the Panel adopted 23 July 1998, para. 14.38.

QUESTIONS FOR THE UNITED STATES
Question 19. The United States appears to co ntend that, when a company manufactures goods
in the United States and sells them abroad, the income generated may be partly domestic-source
and partly foreign-source. If so, is it not equally true that, when a company manufactures
goods abroad and sells them in the United Stat es, the income generated may also be partly
domestic-source and partly foreign-source? If so, and given your assertion that the Act is a
measure to avoid the double taxation of foreign-source income, please explain why the exclusion
provided by the Act for "extraterritorial" income is limited to instances where property is sold
or leased for use outside the United States.
60. Depending on the circumstances, a portion of the income would be US-source income and a
portion would be foreign-source income. The extraterritorial income exclusion, however, is limited to
the foreign-source income that arises when property is sold or leased for use outside the United States
because the United States has determined not to cede primary taxing jurisdiction over US-source
income. Thus, in the case of a foreign person that earns US-source income from sales in the US
domestic market, the United States would retain pr imary taxing jurisdiction over such income, and
relief from double taxation would be left to the foreign jurisdiction to provide. In this respect, the Act
provides parallel treatment with the exemption method. Just as the United States generally cedes
taxing rights over excluded extraterritorial income, so, too, would a foreign exemption system
generally cede taxing rights over US-source income in the case of a foreign person earning US-source
income from sales in the US domestic market.
61. More generally, however, nothing in footnote 59 requires that a measure for the relief of
double taxation resolve the problem of double taxation completely or precisely. Footnote 59 provides
that paragraph (e) “is not intended to limit” a Member from taking measures to avoid double taxation.
Indeed, it is highly unlikely that any system fo r the relief of double taxation would result in the
complete elimination of double taxation without creating instances of double non-taxation. Such
precision is probably impossible, given the many di fferences in taxation systems from one country to
another and the many different ways that international commerce can be structured. This persistent
problem in melding different systems is one reason that the OECD has provided only general
guidelines regarding the relief of double taxation. It is also the reason that the United States suggests
that the panel should not attempt to impose a single interpretation of the term “foreign-source” income
in footnote 59. To interpret footnote 59 in the way suggested by the EC would effectively dictate to
countries the manner in which they must structure their domestic tax systems with respect to
international activities. It is safe to say that the drafters of the footnote had exactly the opposite goal,
which was to allow Members to continue to determine how best to avoid double taxation of income.
Question 20. Assume that the US legislation provided that: "Gross income does not include
income generated from export activities". Would there be revenue foregone which is
"otherwise due" such that there was a financia l contribution within the meaning of Article 1?
How, if at all, would you distinguish this situation from the exclusion of "extraterritorial
income" from gross income under the Act?
62. The ordinary meaning of the terms of Article 1.1(a)(ii) suggests that in such a situation there
would not be a financial contribution within the meaning of Article 1.1(a)(1). This is because the tax
revenue on export activities would not be “otherwise due” under the law of the Member, which is the
normative benchmark for an Article 1 analysis. Although this would arguably permit countries to
exclude narrow categories of income from tax if th ey were willing to so modify their general rule of
taxing authority, it is the reading that the ordinary meaning of the terms most directly suggests.
63. If the Panel believes that it is necessary to depart from the ordinary meaning of Article 1 and
to interpret it more broadly, the only defensible broader interpretation, we believe, would be that gross

income (or a comparable concept in a country other than the United States) can be defined in any
manner that a sovereign state chooses, except that if the general rule creates an exclusion that is
expressly specific within the meaning of the meaning of Article 2, then that exclusion would
constitute a financial contribution within the meaning of Article 1.1(a). Under this interpretation, an
exclusion that was applicable only to a specific universe of firms, as defined by Article 2, would
constitute a financial contribution, and thus a subsidy, within the meaning of Article 1.
64. The reason that a broader interpretation would not be defensible is that if the exclusion were
not expressly specific, then panels would have to determine what generic exclusions, of which some
specific group was a part, would cause the exclusion to be a financial contribution. This would be
impractical because in any given case, the mix of users from a specific group and users from a
non-specific group could range from one end of the spectrum to the other. Would, for example,
territorial limits constitute a financial contribution if it were shown that 30 per cent of the
beneficiaries of territorial limits were exporters? 70 per cent? 95 per cent? There would be no
criteria by which rational line-drawing in such a situation could be done.
65. Hence our answer is: (a) the ordinary meaning of the text suggests that the answer to the
Panel’s question 20 is “no”; (b) if the ordinary meaning is considered unacceptable, a broader reading
of the text could find that an exclusion incorporated into a general rule would constitute a financial
contribution if the exception were expressly applicable to only a specific group; and (c) any broader
rule would not be principled or workable.
66. If the Panel were to apply our alternative broader principle to this case, we do not believe that
the Act’s exclusion would be specific within the meaning of Article 2.3, because, for the reasons
previously articulated, the exclusion is neither export contingent nor contingent upon the use of
domestic over imported goods. Similarly, there has been no allegation made, or evidence submitted,
that the exclusion is specific within the meaning of Articles 2.1 or 2.2, and we do not believe that any
sort of credible case could be made that it is.
Question 21. Assume that the " qualified" exemptions from taxation of foreign-source income
described in paragraph 96 of the United States' first submission are "subsidies" within the
meaning of Article 1 of the SCM Agreement. Would such subsidies be specific within the
meaning of Article 2?
67. The United States has two answers: one based on the US approach and one based on the EC
approach.
68. The qualified exemptions created by territorial limits in European tax systems are, for
purposes of specificity, similar to the new US legislation. In our opinion, neither the European
exemptions nor the exclusion in the US Act is specific, for the reasons that follow.
69. For purposes of discussion let us assume, as the EC asserts will be the case, that most of the
US taxpayers that will take advantage of the Act’s exclusion are exporters. Let us also assume for
purposes of discussion, as the United States believes the case to be, that most of the European
taxpayers that benefit from the qualified exemptions created by territorial limits are also exporters.
This would mean, as a factual matter, that most of the universe of beneficiaries for both the
exemptions and the exclusion would be exporters who would realize the advantage of the exemption
or exclusion by exporting.
70. The issue of law would then be whether, under those assumed facts, the exemption and
exclusion are specific within the meaning of Article 2. In each case, a significant subgroup of the
universe of beneficiaries would be exporters who could realize the benefit by exporting. As a matter

of law, then, would the entire exemption or the entire exclusion be specific because a significant
subgroup of the beneficiaries of each consists of exporters?
71. The answer to this question becomes clearer when one recalls that exporters are one type of
“specific” group. Part II of the SCM Agreement is reached only in the case of programmes that are
“subsidies” under Article 1 and “specific” under Article 2. Article 1.2 expressly provides that if these
two standards are not met, one does not reach Article 3. Exporters come within the Article 2
definition of “specific” because Article 2.3 expressly provides that subsidies that are contingent on
export performance are “deemed to be specific.” Thus, subsidies contingent on export performance
are subsidies that are deemed to be subsidies that are “specific to an enterprise or industry or group of
enterprises or industries” (“certain enterprises”).
72. This construct, which the structure and the language of Articles 1 and 2 make clear, is helpful
then in answering the Panel’s question. If, as Article 2 specifies, export subsidies are one form of
“specific” subsidy, then the question of law set forth above becomes easier to answer. Assume, for
example, that the sub-group of the universe of be neficiaries was not exporters but rather was a group
of industries, say, service industries, or natural resources industries. Assume also that the remainder
of the universe of users was not a specific group of industries or enterprises. Would the subsidy be
“specific” because one subgroup of the universe of beneficiaries, considered in isolation, was
“specific”? The answer is, of course, no. To the contrary, the conventional way of making a specific
subsidy non-specific is to expand the universe of users or beneficiaries. Once it is expanded beyond a
specific group of “certain enterprises,” it ceases to be specific.
73. For precisely the same reasons, a subsidy that is provided to a broad group of users is not
specific because a subset of the users consists of exporters. Rather, the way to cure an export subsidy
is to ensure that the benefit is provided to a larger group than just exporters; that is, to a non-specific
group. (This was a question raised by the Panel in the original proceeding that the EC essentially
refused to answer.)
36 It would be no more appropriate to find a subsidy specific by parsing the
universe of users until one finds a subset of exporters than it would be to find a subsidy specific by
parsing the universe of its users until one finds a subset of “certain enterprises.” To do either would
have the effect of draining all content from the Article 2 concept of specificity.
74. For these reasons, the qualified exemptions created by territorial taxing limits should not be
considered specific, for the same reasons that the new US exclusion should not be considered specific.
75. On the other hand, if one were to accept the EC’s standard for export contingency – which is
that export transactions are taxed more favorably than comparable domestic transactions – then the
United States believes that the subsidies described in the question would be specific, because these
measures result in exports being taxed more favorably than comparable domestic transactions. Under
Article 2.3 of the SCM Agreement, "[a]ny subsidy falling under the provisions of Article 3 [ e.g., any
subsidy that is export contingent] shall be deemed to be specific."
Question 22. In the case of a FSC in existenc e on 30 September 2000, at what point in time
would the unconditional legal right of a FSC-beneficiary to receive the tax reduction arise --
before or after 30 September 2000?
76. In the case of a FSC in existence on 30 September 2000, section 5(c) of the Act confers the
legal right to a tax exemption by allowing the exemption despite the repeal of the FSC provisions
effective on that date. This right, however, is not unconditional because it is subject to the conditions
described in the Act.

36 FSC (Panel), para. 4.1068, note 468.

QUESTIONS FOR BOTH PARTIES
Question 32. What is the relationship, if any, between the scope of Article III:4 of the GATT
and Article 3.1(b) of the SCM Agreement -- is on e necessarily broader than the other-- could a
measure fall within the scope of one of these provisions, but not within the scope of the other?
Please substantiate your response with reference to past GATT/WTO dispute settlement reports
and other materials.
77. Article III:4 is broader than Article 3.1(b), so that a measure could fall within Article III:4,
but not Article 3.1(b). This follows from the or dinary meaning of the terms used in the two
provisions. Article III:4 speaks of "treatment no less favorable" and of requirements "affecting"
internal sale, while Article 3.1(b) speaks of subsidies "contingent upon the use of domestic over
imported goods." Based on the Appellate Body’s interpretation of "contingent", this would seem to
be a more difficult standard to satisfy than the standard of Article III:4.
78. The panel in Canada Autos reached a similar conclusion, stating in paragraph 10.215 as
follows:
We recognize that Article 3.1(b) in some sense has its roots in Article III:4 of GATT
and in certain interpretations of that provision, which relates to non-discrimination.
We do not consider however that Article 3.1(b) ipso facto has the same scope as
Article III:4. To the contrary, while Arti cle III:4 of GATT speaks of “treatment no
less favorable” and of requirements “affecting” internal sale, Article 3.1(b) speaks of
subsidies “contingent upon the use of domestic over imported goods.” We are
unwilling to import into Article 3.1(b) legal principles derived from the interpretation
of a text which differs so markedly from that of Article 3.1(b).
This particular aspect of the report was not appealed.
Question 33. The EC states that "… the US review of its subpart F legislation is yet to be
completed".
37 Please explain whether and how this statement is relevant to the current
proceeding.
79. The statement by the EC is incorrect. The subpart F study was published in December 2000.
If the EC had actually read the study, moreover, th e EC would have recognized its irrelevance. The
study deals with US anti-deferral mechanisms, which have no particular relationship to any of the
issues in this case.
QUESTIONS FOR THE UNITED STATES
Question 40. Please comment on par agraph 36 of the EC oral statement.
80. In paragraph 36, the EC made the following statement:
The Appellate Body, in Canada-aircraft, stated that benefit does not exist in the
abstract. In the same way, export contingency does not exist in the abstract; it must
be analyzed with regard to the recipient, transaction and product concerned. The US
approach would render the SCM disciplines completely ineffective.
81. To the extent that the EC is saying nothing more than that the existence of an export
contingency under Article 3.1(a) of the SCM Agreement can be determined only on the basis of the

37 EC rebuttal submission, para. 29.

measure or facts before a Panel, the United States cannot disagree with the proposition. However, the
EC’s claim that the Panel must focus on “the recipient, transaction and product” in a case it styles as a
de jure one seems rather strange. Indeed, the quoted passage reflects a significant flaw that permeates
the EC’s case: its inability to base its argument s on the relevant text of WTO provisions and its
resulting need to incorporate concepts and principl es not found in that text to compensate for this
fundamental deficiency.
82. For example, in paragraph 36, the EC cites a st atement made by the Appellate Body regarding
the term “benefit” and tries to apply it to “export contingency”. This statement is reflective of a
circular argument that flows from the schizophre nic approach taken by the EC in interpreting
Article 3.1(a).
83. In paragraph 35 of its oral statement, the EC explained that:
In the case of the FSC Replacement subsidy, the EC does not dispute the theoretical
possibility for the benefit to become available without exporting. However, the fact
that this possibility exists does not mean that all subsidies granted under the Act are
not export-contingent.
Thus, paragraph 35 suggests that the EC is attacking the Act because (allegedly)
particular transactions qualifying for the Act’s exclusion may be export contingent.
84. However, in paragraph 4 of the Preliminary Answers of the European Communities to the
Questions of the Panel (16 March 2001) (“ EC Preliminary Answers ”), the EC says that this is not
what it is doing. In paragraph 4, the EC stated as follows:
The EC is contesting a subsidy scheme (or programme) to use the word employed in
the SCM Agreement ), rather than individual subsidy payments. It is therefore the
conditions of the law that need to be considered, not the “legal circumstances in
which it is granted on a case-by-case basis.” (Italics in original).
85. Fundamentally, the EC is trying to have it both ways. In one breath, it says its challenging the
Act as a whole, but in the next breath tries to divi de the Act into separate alleged subsidies. The EC
needs to do this, of course, because the Act, when taken as a whole, simply cannot be regarded as
export contingent, as that term has been interpre ted by the Appellate Body, because a taxpayer can
earn excluded income without ever exporting.
86. Moreover, as the United States previously has explained, the EC’s analysis is analogous to an
application of the “specificity” standard of Article 2 under which a government measure would be
found specific because some subset of users within the universe of users constitutes a specific group.
Such a result would be clearly erroneous.
87. Finally, the EC’s assertion that “[t]he US approach would render the SCM disciplines
completely ineffective” is circular and incorrect. It is circular because it assumes the answer to the
question posed; i.e., whether a “subsidy” that is not limited to exporters is export contingent because
exporters are eligible. It is incorrect because one method of curing a prohibited export “subsidy” is to
broaden eligibility so that the “subsidy” is no longer export contingent, as that term has been defined
by the Appellate Body. Thus, SCM disciplines are not “ineffective” to the extent that they do not
prohibit non-export contingent “subsidies.”
Question 41. In paragraphs 110-114 of the US or al statement, the US argues that the EC’s
approach to interpreting footnote 59 “never atte mpts to analyze the ordinary meaning of the

text”. Why and how would the US analysis of “the ordinary meaning of the text” lead to a
different conclusion?
88. The differing approaches taken by the EC and the United States to interpreting the fifth
sentence of footnote 59 lead to different conclusions regarding the application of that provision to this
dispute. The EC attempts to narrow the scope of the fifth sentence of footnote 59 in ways that its
language simply does not allow. The EC tries to do so in a number of ways:
• First, the EC asks the Panel to adopt wholesale the provisions of the OECD Model
Convention.
• Second, as a result of the EC’s undue reliance on the OECD Convention, the EC
maintains that a measure to avoid double taxation must require taxpayers to maintain
a “permanent establishment” with respect to every country and every transaction that
results in extraterritorial income.
• Third, the EC claims that foreign-source income is limited only to income that is
directly attributable to foreign economic processes performed by the taxpayer.
• Fourth, the EC argues that a country may institute a measure to avoid double taxation
only upon a showing that it is “necessary” to do so.
• Fifth, the EC suggests that a measure that allows an overall tax savings does not come
within the fifth sentence of footnote 59 because it permits improper
“overcompensation”.
89. The United States disagrees with all of these points. This disagreement stems from the fact
that the United States and the EC have taken very different approaches in interpreting the fifth
sentence of footnote 59. Unlike the EC, which has turned to extrinsic sources for supplying meaning
to the provision in question, the United States has focused on the ordinary meaning of the relevant
text.
38 It is the United States rather than the EC that is employing the correct method of interpretation
under public international law. This is not merely a theoretical distinction. It results in a starkly
different meaning of the fifth sentence of footnote 59 as applied in this case.
90. The United States submits that the text of the fifth sentence of footnote 59 does not prescribe
the types of measures that may be measures to avoid dou ble taxation. It leaves it to individual WTO
Members to determine the nature and methodology of measures to avoid double taxation. It also
allows Members to take a prophylactic approach, rather than waiting for a double tax actually to be
levied and providing relief only after the fact. This can be seen in the language of the fifth sentence of
footnote 59, which says that paragraph (e) of Annex I does not “limit” the “ability” of Members” to
take “measures” to “avoid” double taxation. Footnote 59’s focus is on not limiting the ability of
members to fashion double tax relief.
91. The flexibility accorded to Members is also reflected by the fact that the ordinary meaning of
the fifth sentence of footnote 59 essentially says in one sentence what treatises and treaties are written
to achieve. These topics are the subject of considerable debate among WTO Members.
92. As a result, the United States does not believe that there are internationally accepted “special
meanings” that can be used to fill in any perceived “gaps ” in footnote 59. It may be convenient for
the EC to point to the OECD Convention to supply requirements and conditions that are not contained
in the SCM Agreement, but such reasoning is simp ly not in accordance with a proper interpretation

38 See US First 21.5 Submission , paras. 166-167.

under the Vienna Convention and the DSU. In contra st to the EC, the United States has cited these
agreements only as evidence in support of its textual arguments. It has not attempted to substitute
them for the text of the SCM Agreement.
93. Thus, respectfully, the Panel cannot assume that the concept of “permanent establishment” is
a part of footnote 59. As the United States has explained, many countries do not rely on “permanent
establishments” and have more aggressive tax systems. Even if it were part of footnote 59, there is no
one internationally accepted definition of a “permanent establishment”. The term “permanent
establishment” as used in the OECD Convention can mean a fixed and enduring place of business, but
it also can mean an agent acting on behalf of a non-resident. Moreover, it has a different meaning in
the U.N. Model Agreement.
94. Indeed, one of the main reasons these agreements impose some “permanent establishment”
requirement is because many countries tax non-residents who do not have “permanent
establishments”. WTO members should be able to protect their taxpayers from double taxation even
where those taxpayers do not have a “permanent establishment ” in a foreign country.
95. Likewise, the Panel should not read “foreign source income” as meaning only income directly
attributable to foreign economic processes. Such a test is incompatible with the ordinary meaning of
those words, which would seem to apply to income that has a foreign origin or comes from or is
attributable to a foreign source. The EC not only is unable to explain why the words “foreign source
income” have the unique meaning it advances, bu t the EC also cannot explain how foreign economic
activities are to be valued or allocated. Furthermore, the wide application of double tax avoidance
measures to passive income (dividends, interest, etc.), including in the EC, would not be proper under
the EC’s argument because there are no economic activities associated with such income.
96. The EC also is unable to explain why a WTO Member must demonstrate “necessity” to
institute a measure to avoid double taxation. The SCM Agreement does not impose such a
requirement. The drafters of the WTO agreements clearly knew how to impose a “necessity”
requirement – they did so elsewhere – but did not in the fifth sentence of footnote 59. Moreover, the
fact that a Member has one method to avoid do uble taxation does not mean that it cannot adopt
another. That is a matter left to the Member to decide. Many countries, including France, offer
taxpayers alternative methods.
97. Finally, the fifth sentence of footnote 59 does not require that Members provide double tax
relief in manner that is precisely calibrated to offset – dollar-for dollar, pound-for-pound, or
euro-for-euro – foreign taxes actually paid. The essence of the fifth sentence of footnote 59 is that it
leaves Members unlimited in their ability to avoid double taxation. This means that such relief can be
preventive in nature. That is why a number of countries rely on the exemption method for avoiding
double taxation. Unlike the credit method, which provides relief based on the amount of foreign taxes
paid, the exemption method looks to whether income could be taxed elsewhere. As the Commentary
to the OECD Convention explains, “[f]undamentally, the difference between the methods is that the
exemption methods look at income, while the credit methods look at tax”.
39
98. Accordingly, the Act is a measure to avoid double taxation for purposes of the fifth sentence
of footnote 59 because the ordinary meaning of that provision allows the United States to exclude
from taxation income that could be taxed by another country. The transactions that give rise to
extraterritorial income must involve the sale, use, or disposition of products outside the United States.
The purchasers of such products may be foreign, title to the products may be transferred abroad, and
any contracts involved may be executed outside the United States and may be subject to foreign law.
In addition, the Act requires that at least a minimum amount of economic activities must occur

39 US-7.

abroad. In so crafting the Act, the United States has adopted a flexible approach to providing relief
for its taxpayers against the myriad ways in which they might face double taxation.
Question 42. Is the EC correct in its statem ent that the "foreign economic process"
requirements in Section 942(b) of the Act may be satisfied even where the functions were in fact
performed within the United States? Please explain.
99. The EC is incorrect. Section 942(b) expressly provides that the Act’s exclusion applies with
respect to a particular transaction “only if economic processes with respect to such transaction take
place outside the United States”.40 The Act does not allow this requirement to be met by performing
the enumerated functions within the United States, as the EC asserts. As one of the legislative reports
accompanying the Act’s enactment explains:
[u]nder the bill, gross receipts from a transaction are foreign trading gross receipts
only if certain economic processes take place outside the United States. The foreign
economic processes requirement is satisfied if the taxpayer (or any person acting
under a contract with the taxpayer) participates outside of the United States in the
solicitation (other than advertising), negotiation, or making of the contract relating to
such transaction and incurs a specified amount of foreign direct costs attributable to
the transaction. For this purpose, foreign direct costs include only those costs
incurred in the following categories: (1) advertising and sales promotion; (2) the
processing of customer orders and the arranging for delivery; (3) transportation
outside of the United States in connection with delivery to the customer; (4) the
determination and transmittal of a final invoice or statement of account or the receipt
of payment; and (5) the assumption of credit risk.
41
100. Merely because the taxpayer can arrange by contract for an agent to perform the activities on
its behalf does not mean that the agent may perform the activities within the United States. That
agent, for example, still must negotiate or solicit sales outside the United States on behalf of the
taxpayer. Accordingly, the United States is at a loss as to why the EC would contend that this
requirement can be satisfied exclusively through domestic (US) activities. The EC’s assertion is
contradicted by the language of the Act and the legislative report explaining it.
QUESTIONS FOR BOTH PARTIES
Question 43. Can a measure of a Member provid ed in respect of the production of a good
outside the territory of that Member be a subsid y within the meaning of Article 1 of the SCM
Agreement? Please explain your answer, taking into account any relevant provisions of the
SCM Agreement.
101. Yes. Although the provisions of the SCM Agreement that address this issue in general terms
are not entirely clear, certain paragraphs of Annex I clearly contemplate the provision of subsidies to
recipients located outside the territory of the Member providing a subsidy. Thus, the United States
does not disagree with the statement made by the EC in paragraph 65 of its First Submission.
102. At the outset, the United States notes that the reference in the question to “in respect of the
production” may be somewhat inaccurate in light of the Appellate Body’s recent decision in

40 Section 3 of the Act, amending IRC Section 942(b)(1).
41 Senate Report , pages 8-9, US-3.

United States - Lead Bar.42 Although the United States previously was of the view that subsidies are
provided to productive operations, the Appellate Body rejected this approach, finding instead that
subsidies are provided to natural or legal persons.43
103. With this as a background, there are several provisions of the SCM Agreement that arguably
touch upon the question posed by the Panel. Article 1.1(a)(1) refers to “a financial contribution by a
government or any public body within the territory of a Member (referred to in this Agreement as
‘government’) ... .” The phrase “within the territory of a Member” arguably could modify either
“financial contribution” or “any public body”. However, the location of the parenthetical suggests
that “within the territory of a Member” modifies “any public body”, so that the public body providing
a financial contribution must be within the territory of the Member allegedly providing a subsidy, but
that the recipient of a financial contribution need not be within the territory of that Member. If the
latter had been intended, the provision presumably would have read “a financial contribution within
the territory of a Member by a government, etc.”
104. Article 8.2(b) – which is no longer in effect – refers to “assistance to disadvantaged regions
within the territory of a Member ... .” However, this provision does not shed any light on the Panel’s
question, because the reference to “territory of a Member” arguably simply limited the circumstances
under which a subsidy could be considered non-actionable, as opposed to the question of whether a
subsidy existed at all.
105. Article 28.1 refers to “[s]ubsidy programmes which have been established within the territory
of any Member ... .” However, this reference does not preclude the possibility that the recipient of a
subsidy could be outside the territory of a Member.
106. Paragraph 6 of Annex IV – which also is no longer in effect – provided that subsidies
provided by “different authorities in the territory of a Member shall be aggregated.” However, this
provision, like Article 1.1(a)(1), arguably refers to the location of the entity providing the subsidy, as
opposed to the location of the recipient.
107. Finally, insofar as the concept of “territory” is concerned, paragraph 2 of Annex IV, which
deals with the calculation of an overall rate of subsidization, provided inter alia that “the value of the
product shall be calculated as the total value of the recipient firm’s sales ... .” Footnote 63 to this
paragraph stated that “[t]he recipient firm is a firm in the territory of the subsidizing Member.” One
can interpret this footnote two different ways. One interpretation is that it simply restates what is
assumed in the remainder of the SCM Agreement; i.e., that the recipient of a subsidy must be located
within the territory of the subsidizing Member. Another interpretation, however, is that the footnote
is necessary because it is not assumed in the remainder of the Agreement that the recipient must be
located within the territory of the subsidizing Memb er. This latter interpretation would appear to be
more in accordance with the principle of effectiveness of treaty interpretation.
108. Another relevant term is “jurisdiction”, which in Article 2.1 refers to enterprises, industries or
groups thereof “within the jurisdiction of the granting authority ... .” In the case of an alleged subsidy
taking the form of a tax measure, it would seem appropriate to interpret the term “jurisdiction” as
referring to the taxing jurisdiction of the Member in question.
109. Finally, certain provisions of Annex I involve practices that frequently entail the provision of
a subsidy to a recipient located outside the territory of the Member providing the subsidy. In the case

42 United States - Imposition of Countervailing Duties on Certai n Hot-Rolled Lead and Bismuth
Carbon Steel Products Originating in the United Kingdom , WT/DS138/AB/R, Report of the Appellate Body
adopted 7 June 2000.
43 Id.

of export credits covered by paragraph (k), credits frequently are provided in the form of “buyer
credits” that are received by a foreign person. Similarly, the types of subsidies covered by
paragraph (j) often are provided to foreign persons.
110. Although US countervailing duty practice is not binding on the Panel, the United States notes
that the practice of the US Department of Commerce is generally to treat what it calls “transnational
subsidies” as non-actionable. In other words, a subsidy may exist when the government of one
country provides a financial contribution to a recipient in another country, but Commerce does not
countervail it. However, this policy is subject to certain exceptions.
Question 44. Assume for the sake of argument that the answer to question 43 is no. What
relevance, if any, would such a conclusion have in respect of the issues of export contingency
which are before the Panel in this dispute?
111. This conclusion would seem to be irrelevant for purposes of analyzing export contingency,
and, indeed, could have unintended adverse consequences if it were considered relevant.
112. The fact that a particular financial contribution may be labelled as a “subsidy” when provided
to certain recipients and as not a “subsidy” when provided to others would seem to have little
relevance to the question of whether the measure is export contingent. Again, referring to the concept
of specificity – of which export contingency is a part – helps to clarify things.
113. Assume a government loan programme that provides loans to thousands of firms in a wide
variety of industries at a standard interest rate of, say, 10 per cent. For all loan recipients but one, the
government financial contribution – in the form of a loan – does not provide a “subsidy” because
there is no “benefit.” More specifically, for all recipients but one, a 10 per cent interest rate does not
result in a difference between what the recipient pays on the government loan and the amount it would
pay on a comparable commercial loan within the meaning of Article 14(b) of the SCM Agreement.
114. However, for one firm – which is in worse financial straits than other participants in the
programme – the interest rate of 10 per cent does result in a difference, so that a subsidy exists. In
analyzing whether this subsidy is specific, would one ignore the fact that loans on the same terms
were provided to thousands of other industries, even though these loans did not technically satisfy the
definition of “subsidy” under the SCM Agreement? The answer clearly has to be “no.”
115. Thus, an analysis of specificity or export contingency which focused solely on those
government outlays (or foregone revenue) that satisfied the technical definition of “subsidy” would
generate peculiar and unintended results. In all probability, measures that previously were regarded
as non-specific would be suddenly transformed into specific subsidies.
116. Indeed, insofar as the taxation of foreign-source income is concerned, an approach which
focused on only one category of transactions capable of earning foreign-source income, such as
exports, to the exclusion of other categories could result in labeling the tax regimes of most Members
as subsidies. This follows from the fact that if, of the categories of transactions capable of generating
foreign-source income, one excludes all categories involving products produced abroad, all one may
be left with is the category of export transactions. Under the logic assumed in the question, the
non-taxation (in whole or in part) of foreign-source income earned in export transactions
automatically would be export-contingent, notwithstanding the fact that the tax rule applied to
foreign-source income earned in export transactions is the same as the rule applied to foreign-source
income earned in other types of transactions. The absurdity of this result demonstrates that this
approach must be incorrect.

Question 45. Is export income foreign source income? Some may take the view that the
“foreign-source income” referred to in footnote 59 should include export income since the
footnote is accompanying item (e) that is dealin g with a type of subsidy specifically related to
export. Please comment.
117. Export income can and usually does involve some amount of foreign-source income. By their
very nature, exports involve more than two countri es in a business transaction. They can involve
foreign purchasers, foreign use of the product, foreign sales and promotion activities, foreign
distribution, foreign formation and execution of contracts, foreign passage of title, foreign origin of
payment, and other foreign attributes. Some or all of these attributes can give rise to income being
subjected to tax by a taxpayer’s country of residence as well as another, or foreign, country.
118. Whether or not a country considers income taxable or not turns on domestic law. Countries
around the world employ two sets of widely varying rules that may bear on this question: taxing
jurisdiction rules and sourcing rules. With regard to jurisdiction, some countries tax businesses only
if they have a fixed and enduring place of business that has active and even profitable operations,
while others require some lesser presence and some require no fixed or established presence at all.
With regard to sourcing, some countries would view a large portion of an export transaction as being
“foreign”, others a smaller part, and some relatively little. There is no internationally accepted rule
establishing under what circumstances exporters may be taxed in the country to which their products
are sent, and there is no rule governing which parts of income earned in an export transaction can be
said to be “foreign”.
119. Footnote 59’s connection to paragraph (e) confirms that export income may be foreign-source
income, at least in part. Paragraph (e) makes clear that “the full or partial exemption, remission, or
deferral specifically related to exports, of direct taxes” is prohibited by Article 3.1(a). That the fifth
sentence of footnote 59 provides that paragraph (e) does not limit the ability of Members to take
measures to avoid double taxation of foreign-source income means that Members may do so even
through an exemption, remission, or deferral that is “specifically related to exports”. If export
transactions do not produce “foreign source income” within the meaning of footnote 59, then it is hard
to understand why the drafters inserted the fifth sentence into a footnote attached to paragraph (e).
QUESTIONS TO THE EC
120. The United States would like to comment on the following questions posed by the Panel to
the EC.
Question 1. In section 3.2.5. of its first submi ssion, the European Communities expresses the
view that the FSC Replacement scheme gives rise to two distinguishable subsidies : the “basic
FSC Replacement subsidy” and the “extended FSC Replacement subsidy”.
• Does this mean that the EC is requestin g the Panel to make two separate rulings,
one on each of the alleged subsidies?
• Does the EC consider that the application of a different portion of the FSC
Replacement scheme may involve diffe rent types of subsidies under the SCM
Agreement?
• Please identify the relevant portion of the FSC Repeal and Extraterritorial
Income Exclusion Act (“the Act”) framing these two "distinguishable" alleged
subsidies.

• Does the EC believe that the status of a subsidy under the SCM Agreement is
determined by the particular legal circumstances in which it is granted on a
case-by-case basis?
121. In the view of the United States, it would be inappropriate for the Panel to bifurcate the Act in
the manner suggested by the EC. The EC would like the Panel to examine the Act as if it has one
category for income derived from export transactions and another for income from all other types of
transactions. As the United States has explained, the Act does not treat exports differently than other
transactions that may give rise to extraterritorial income. There is a single exclusion that applies to
different types of foreign transactions.
122. Instead of the artificial analysis the EC advances, the United States proposes that the Panel
examine the measure as it is. The United States submits that the Panel should determine whether
excluding (at least in part) extraterritorial income from a wide array of foreign sales, leases, and other
transactions is a subsidy or an export subsidy (am ong other things). If the Panel were to adopt the
EC's approach, it would in effect signal that the appropriate method for analyzing any tax exclusion or
exemption of foreign income would be to first ex amine how it applies solely to exports, and then
examine how it applies to other transactions. This approach would condemn many export-neutral tax
measures simply because a sub-category of taxpayers subject to the measure happen to be exporters.
This approach also would create an artificial distin ction that is not supported by the text of the SCM
Agreement and that does not exist with respect to the measure at issue.
123. Ironically, while the EC asks the Panel to divide what the Act does not, it takes the 50-per
cent value rule and attempts to integrate it into all as pects of the Act. Whereas there is no part of the
Act that treats qualifying transactions differently, there is a separate provision of the Act that imposes
the 50-per cent rule. Because the Act institutes the rule through a stand-alone provision, the United
States suggests that it is appropriate for the Panel to rule on the EC's claims concerning the rule
separately. For example, if the Panel were to find that the Act confers subsidies or exports subsidies
because of the 50-per cent rule, the Panel should say so. The Panel should not condemn all provisions
of the Act merely because it finds one potentially severable part to be problematic.
124. Thus, in reviewing the Act, the Panel should distinguish among its provisions where those
provisions are separate within the architecture and design of the measure. The United States does
object to imposing distinctions that the EC claims exist, but that cannot be found in the Act.
Question 3. The European Communities states that it “… sees no reason to contest that the
last sentence of footnote 59 may be an exception to Article 3.1(a)."
44 Does this mean that the EC
is of the view that measures satisfying the requirements for the last sentence of footnote 59
constitute “ [m]easures referred to in Annex I as not constituting export subsidies” under
footnote 5 of the SCM Agreement?
125. The United States respectfully refers the Panel to paragraphs 170-76 of its First Submission
where it explained why, by virtue of footnote 5, a measure to avoid double taxation under footnote 59
is not prohibited by Article 3.1(a) or any other pr ovision of the SCM Agreement. Neither the EC nor
any third party has disputed this point.
45

44 EC second submission, para. 181.
45 The United States notes that in its first submission in Brazil - Export Financing Programme for
Aircraft - Second Recourse by Canada to Article 21.5 of the DSU , WT/DS46 (2 March 2001), para. 54, note 42,
Canada takes the position that footnote 59 is one of four provisions in Annex I that are subject to footnote 5.
The United States adds that Canada, like the United States, routinely makes public its submission in WTO
dispute settlement proceedings.

126. In this regard, several of the follow-up questions posed by the Panel to the EC appear to relate
to the following: if the Act should be found export contingent by virtue of Article 3.1(a), rather than
paragraph (e), would footnote 59 apply? In the view of the United States, the answer clearly is “yes.”
127. Footnote 5 of the SCM Agreement reads as foll ows: “Measures referred to in Annex I as not
constituting export subsidies shall not be prohibited under this or any other provision of this
Agreement.” “[M]easures to avoid the double taxation of foreign-source income” are “referred to in
Annex I [specifically, in footnote 59] as not constituting export subsidies ... .” Therefore, such
measures are subject to footnote 5, regardless of the particular paragraph in Annex I to which
footnote 59 is attached.
128. Any other outcome would have the absurd and perverse result that double taxation avoidance
measures that are “specifically related to exports”, within the meaning of the narrower standard of
paragraph (e), are permitted, but comparable measures that are not “specifically related to exports”
but nonetheless are export contingent under Article 3.1(a) are prohibited.
Question 5. Please provide further clarificatio n of the point made in paragraph 227 of the
EC second submission.
129. It is unclear to the United States how, under the Act, “income earned by a US company by
distributing foreign goods may in large part be earned in the US.” It would seem to the United States
that, if a company is distributing foreign goods, it is doing so outside the United States. If a company
is earning income by distributing goods for use within the United States, that income may not be
excluded.
130. The United States is at a loss to understand how income earned from wholly-foreign
transactions would not give rise to income subject to tax in a foreign jurisdiction and thus be subject
to double taxation. The United States notes that Canada has agreed with the United States on this
point. As it stated in its submission, “the ‘foreign income’ component of ‘extraterritorial income’ is
the type of income typically subject to a measure to avoid double taxation.” Accordingly, it is entirely
appropriate for the United States to provide relief from double taxation with respect to this income.
131. The United States also would note that the EC has focused throughout these proceedings on
the case where the taxpayer’s activities in the foreign jurisdiction do not amount to a permanent
establishment. What the EC has ignored is that taxpayers can earn excluded extraterritorial income
when the taxpayer’s activities do amount to a permanent establishment. The Act would provide relief
from double taxation in such a case, even under the EC’s argument.
Question 6. The European Communities claims that the FSC Replacement scheme is a
prohibited export subsidy contrary to Article 3.1(a) and item (e) of Annex 1 of the SCM
Agreement. Are these alternative claims? In the EC’s view, which claim must be addressed
first by the Panel?
132. In the view of the United States, there is only a single obligation – not to provide export
subsidies – and a single claim – that the United States has not abided by this obligation. The EC
simply may be making alternative arguments to support what is really a single claim.

ANNEX F-4
ANSWERS OF THE UNITED STATES
TO QUESTIONS FROM THE EC
(27 March 2001)
Q1. The US does not contest that the benefit to taxpayers available under the FSC scheme is
arithmetically equivalent it [ sic] that available under the Act. Is their [ sic] any reason why
transactions and taxpayers that would have benefited from the FSC scheme would not in future,
obtain equivalent benefits under the Act?
Reply
The “benefit” of the FSC regime is not “arithmetically equivalent” to the computation of
excluded extraterritorial income, because the numbers used to determine the quantitative component
of the Act’s exclusion are not identical to the numbers used in the FSC regime. Even if there were
arithmetic equivalence, moreover, this issue is irrelevant. Neither the Panel nor the Appellate Body in
FSC found objectionable the percentages contained in the FSC provisions. The EC’s attempts to
compare the provisions of the FSC and the Act therefore are neither accurate nor meaningful.
Under the Act, the category of income excluded from US gross income is defined based on
both a quantitative component and a qualitative component. The percentages contained in section 941
supply the quantitative component. The qualitative component defines a broader category of income
subject to the exclusion than would have been eligible for the FSC exemption under the prior FSC
regime. Most significantly, the qualitative definition of the category of income the United States has
chosen not to tax applies without regard to whether the income is earned from exports, and without
regard to whether the income is earned by a US or foreign individual, a US or foreign corporation, or
a partnership or other pass-through entity. Accordingly, it is misguided to attempt to compare the
prior FSC regime to the Act based on similarities in the quantitative measures.
Q2. According to the Congressional Budget Offi ce, the new scheme will involve an increase
in tax expenditure compared to the FSC. Please provide details as to how this increased tax
expenditure arises?
Reply
The Act defines a category of income that is excluded from gross income and thus is not
subject to tax. Because, unlike the FSC regime, the Act applies to a defined category of income,
without regard to whether the income arises from an export sale and without regard to the taxpayer
earning the income, the estimated revenue loss for the Act is independent of and greater than the
revenue loss for the former FSC regime. In this regard, the CBO would publish the same type of
projected revenue loss if Congress were to reduce the general corporate income tax rate.
More generally, the EC consistently misuses the term “tax expenditure.” This misuse appears
to stem from the EC’s misunderstanding of the term. The determination of whether a provision is a
tax expenditure is made on the basis of a broad, theoretical concept of “income” that is larger in scope
than is “income” as defined under US income tax law. The Appellate Body in FSC rejected the use of
benchmarks based upon what income theoretically could be subject to tax, in favour of the benchmark

established by the member’s actual law. Accordingly, the EC’s use of tax expenditure analysis is not
particularly helpful to the resolution of this case.
Q3. What part of that estimated increased tax expenditure is attributed to transactions
involving goods manufactured abroad? What a re the other sources of the increase in tax
expenditure?
Reply
See answer to questions 2 and 4.
Q4. Has the US government produced any other studies or estimates of the impact of the
Act?
Reply
The United States is not aware of any other published studies or estimates of the impact of the
Act.
Q5. Why does Section 942(a)(3) of the Act allow taxpayers the option to exclude any
transaction from being Foreign Trade Income under the Act and therefore from the exclusion
of extraterritorial income from tax?
Reply
The following reason is set forth in the legislative history of the Act: “A taxpayer may elect
to treat gross receipts from a transaction as not foreign trading gross receipts. As a consequence of
such an election, the taxpayer could utilize any related foreign tax credits in lieu of the exclusion as a
means of avoiding double taxation.” Senate Report (US-2), page 8; see also House Report (US-3),
page 21.
Q6. Why does Section 943(a)(3) of the Act exclude five categories of property from being
capable of giving rise to excluded income under the Act? Why does Section 943(a)(4) allow the
President to exclude other property that he determines to be in short supply from being capable
of giving rise to excluded income under the Act?
Reply
Neither the Act nor the legislative history of the Act, as set forth in the reports of the relevant
congressional committees, articulates the legislative intent behind sections 943(a)(3) and (4).
Q7. Why does the new Section 943(d)(1) provide that: “For purposes of section 114(d), any
withholding tax … shall not be treated as paid or accrued with respect to extraterritorial
income which is excluded from gross income under section 114(a).”? Why does new Section
943(d)(2) make an exception for the case that qualifying foreign trade income is calculated
under 941(a)(1)(A)?
Reply
Neither the Act nor the legislative history of the Act, as set forth in the reports of the relevant
congressional committees, articulates the legislative intent behind section 943(d).

Q8. What guidance or regulations relating to the Act has the US government produced or is
planning to produce?
The US Department of the Treasury (“Treasury”) and the US Internal Revenue Service
(“IRS”) already have released Form 8873, for use in calculating the amount of the exclusion. Treasury
and the IRS currently intend to release the following additional guidance: (i) a revenue procedure
providing guidance with respect to elections under the Act, (ii) a notice containing guidance with
respect to specific issues under the Act, and (iii) proposed regulations interpreting the Act.
Q9. When imposing countervailing duties on pasta from Italy (Case C-475-819 ; 14 June
1996), DOC found that the Italian government was granting a subsidy because it exempted
firms in the South of Italy from local income tax for a period of 10 years, while firms in the
North of Italy had to pay such taxes. If the Italian government were to contract its taxing
authority, and exclude the relevant profits of firms in the South of Italy from its definition of
gross income (thus modifying its prevailing domestic benchmark), does the US consider that no
subsidy would exist ?
Reply
See answer to Question 11.
Q10. Under section 80HHC of the Income Tax Act of India, the Government of India allows
exporters to deduct profits derived from the export of merchandise from taxable income. In a
number of countervailing duty investigations e.g. Certain Iron-Metal Castings From India:
Preliminary Results of Countervailing Duty Administrative Review (Case C-533-063, 64 FR 61592
12 November 1999 ), the DOC has countervailed this exemption from income tax on export
profits as an export subsidy. If the Indian government were to contract its taxing authority, and
exclude the relevant profits derived from exports from its definition of gross income (thus
modifying its prevailing domestic benchmark), does the US consider that no subsidy would
exist ?
Reply
See answer to Question 11.
Q11. More generally, how would the US react if a WTO Member were to exclude all profits
from sales of goods for final consumption abroad from its jurisdiction to tax?
With respect to Question 9, the Italian measure in question constituted an exception to the
prevailing domestic benchmark. Similarly, with respect to Question 10, the Indian measure provided
a special deduction with respect to income that would be taxed under India’s prevailing domestic
benchmark. Questions 9-11 essentially ask the same question: how would the United States react if
another Member altered its prevailing domestic benchmark.
With respect to these questions, the United States refers the EC to the US answer to Question
20 from the Panel.
Q12. In discussing export subsidies in Section 351.514 of its CVD regs, DOC states :
However, under the new standard contained in Section 351.514, if exportation or
anticipated exportation was either the sole condition or one of several conditions
for granting Pioneer status to a firm, we would consider any benefits provided
under the program to the firm to be export subsidies unless the firm in question

can clearly demonstrate that it had been approved to receive the benefits solely
under non-export-related criteria. In su ch situations, we would not treat the
subsidy to that firm as an export subsidy.
Does the US consider that this practice is in conformity with the SCM Agreement?
Reply
Just as the EC has declined to address in detail how the tax regimes of its own member states
would fare under the interpretations of the SCM Agreement that the EC has advanced in this case, the
United States declines to speculate on the status of section 351.514 under the SCM Agreement. The
United States simply notes that this regulation was promulgated prior to any of the Appellate Body
reports elaborating on the meaning of the term “contingent” as used in Article 3.1(a) of the SCM
Agreement.
The United States also would add that the quoted language refers to exportation being a
“condition” for the granting of Pioneer status, and, in fact companies can be required to agree to
export a certain percentage of their production in return for Pioneer status, as reflected in the portion
of the DOC notice that the EC omitted.
1 This is quite different from the Act, under which a given
taxpayer can earn excluded income through export transactions, but is not required to export in order
to earn excluded income.
Q13. A firm based in Texas produces only farm tractors and sells them directly to two
unrelated customers. One customer is in Califor nia, the other in France. The firm makes the
same profit on each transaction. On which of these transactions can the firm claim the benefit
of the FSC Replacement Act? Please explain why.
Reply
The firm can earn excluded extraterritorial income on sales to both the customer in California
and the customer in France. As the United States explained in response to question #11 from the
Panel, the Act permits a US manufacturer of goods to earn excluded income from sales to domestic
buyers, provided that the goods in question are used outside the United States. As long as the farm
tractors are used outside the United States, the firm can earn excluded extraterritorial income in the
sale to the customer in California and the customer in France.
This can occur in a number of ways. For example, a customer in southern California may
purchase farm tractors for use in farming operations across the border in Mexico. The hypothetical
firm’s sale of the farm tractors under such circumstances would generate excluded income under the
Act, assuming that the Texas firm satisfied the other requirements of the Act.
Q14. The same firm then begins producing lawn tractors. In what circumstances can it use
this product to obtain further benefits under the Act?
Reply
The Act provides significant flexibility to the Texas firm in its production decision. The firm
could earn excluded extraterritorial income by (i) selling or leasing tractors produced in the United
States (ii) selling or leasing tractors purchased from a related or unrelated US company with a foreign

1 To be technically correct, the EC has not quoted the regulation itself, but rather the preamble to the
regulation which explains the regulation and addresses comments from the public submitted in the course of the
rulemaking proceeding that led to the regulation.

production facility, (iii) selling or leasing tractors produced under a consignment arrangement with a
related or unrelated US company with a foreign production facility, (iv) selling or leasing tractors
purchased from a related or unrelated foreign manufacturing corporation that has made a
domestication election, (v) selling or leasing tractors produced under a consignment arrangement with
a related or unrelated foreign manufacturing corporation that has made a domestication election, or
(vi) establishing its own foreign production facility and selling or leasing tractors produced in that
facility.
More generally, it is immaterial whether the firm in question makes farm tractors, lawn
tractors, or a totally different line of production.
Q15. Can the US explain the economic, social, political or fiscal objectives/goals that the 50
per cent foreign content limitation aims to achieve?
Reply
Neither the Act nor the legislative history of the Act, as set forth in the reports of the relevant
congressional committees, articulates the legislative intent behind the 50 per cent rule.
Q16. What effects does the US anticipate that the 50 per cent foreign content limitation will
produce?
Reply
It is not clear what the EC means by “effects” in this question. Moreover, the provision in
question is not properly referred to as “the 50 per cent foreign content limitation” because it imposes
no general restriction on foreign content; “qualifying foreign trade property” could consist of a
product composed entirely of foreign content. In th e context of the issues raised by the EC regarding
the 50 per cent rule, the United States does not anticipate that the rule will have the “effect” of
requiring taxpayers to use domestic over foreign goods in order to earn extraterritorial income.
Q17. Does the US agree that where more than 50 per cent of the fair value of a product is
attributable to articles and direct labour cost s within the meaning of section 943(a)(1)(C) IRC
then not all of that 50 per cent may be foreign?
Reply
See the US answer to Question 8 from the Panel.
Q18. Does this not mean that some of it must be US-origin?
Reply
To the extent that the “it” the EC is referring to is articles, the answer is “no.” See the US
answer to Question 8 from the Panel.
Q19. How does the FSC Replacement scheme apply to the sale of foreign-produced
agricultural products. How is the foreign conten t limitation applied to growing crops, freshly
harvested crops and graded and cleaned agricultural commodities?
Reply
The Act contains no special provisions in respect of agricultural products.

In this regard, the EC appears to take the position that statements made by the United States
in the initial phase of this proceeding regarding the FSC definition of “export property” and the
application of that definition to agricultural products somehow constitutes an admission by the United
States in the instant proceeding that an agricultural product produced abroad could never satisfy the
50 per cent limit on certain foreign value, and, thus, could never be eligible for the Act’s exclusion.
EC First 21.5 Submission , paras. 220-221. Of course, in the statement quoted by the EC, the
United States merely was expressing its opinion that, given the likely sourcing patterns of US
producers of agricultural products, the FSC definition of “export property” was unlikely to have any
practical effect.
To be clear, however, the United States has never made the admission ascribed to it by the
EC, and the EC’s assertion ignores the difference s between the FSC definition of “export property”
and the Act’s 50 per cent rule. Under the FSC, one of the criteria for “export property” was that no
more than 50 per cent of the property’s fair market value could be attributable to imports. Under the
Act, however, the criteria for “qualifying foreign trade property” is that no more than 50 per cent of
the fair market value of a good may be attributable to the sum of foreign articles and foreign direct
labour. The United States believes that agricultural products produced abroad are capable of
satisfying this rule, and, thus, are capable of earning excluded extraterritorial income.
Of course, as the complainant, the burden of proving that agricultural products could not
satisfy the definition of qualifying foreign trade property is on the EC, and the EC has submitted no
evidence whatsoever on this point. Although the United States does not bear the burden of
disproving the EC’s unsubstantiated assertions, the United States nonetheless would note that a
available data demonstrates that agricultural products produced abroad would be capable of satisfying
the 50 per cent rule.
For example, based on data from the US Department of Agriculture (USDA) for US
production in 1999, the “total gross value of production”
2 for soybeans (in dollars per planted acre)
was $178.00. The cost of items that arguably could be considered “articles” (seed, fertilizer, soil
conditioners, manure, and chemicals) amounted to $52.98. The cost for hired labour and the
opportunity cost of unpaid labour amounted to $20.90. Thus, the total cost of articles and labour was
$73.88, a figure well below 50 per cent of $178. In fact, this figure is below the single biggest item of
cost, which was the opportunity cost of land (rental rate), which amounted to $77.66.
Of course, these are US data, but they are no more nor less representative than the purported
European data provided by the EC in the annexes to its submissions. And, of course, it bears
repeating that it is the EC, not the United States, that bears the burden of proof.
Q20. The US argues that the exclusion of ‘extraterritorial income’ from tax is justified as a
measure to avoid double taxation. This necessarily implies that such income could be taxed in
foreign countries. Therefore, would the US agree that foreign countries, which either have no
bilateral tax treaties with the US or terminat e them, may require US exporters to pay tax the
profits made by them from exporting to their territories.
Reply
As the United States explained in its prior submissions to the Panel, the Act requires that
transactions giving rise to extraterritorial income must have a variety of foreign attributes that can

2 “Gross value of production” may not correspond precisely to “fair market value” as used in the Act,
but it is the closest term used in the data.

result in a sufficient nexus to a foreign taxing regime so as to render US taxpayers potentially subject
to foreign taxation.
Transactions giving rise to extraterritorial income involve goods that must be used,
consumed, or disposed of outside the United States. Thus, the purchasers of these goods typically will
be located outside the United States, they generally will authorize or make payment for the goods in
another country, and in many instances title will pass in that country as well. In addition, certain
required levels of foreign economic activities must be performed with respect to the sales and
distribution functions associated with qualifying tr ansactions. These foreign attributes can lead a
foreign taxing regime to tax the profits earned on sales of goods sold by US exporters to foreign
customers. The United States, in response to Question 12 from the Panel, has provided several
examples of foreign taxing regimes that may tax extraterritorial income earned in export sales.
Accordingly, the United States believes that a significant risk of double taxation exists with
respect to excluded extraterritorial income, which is why the Act provides necessary relief with
respect to this category of foreign-source income. The question of whether foreign tax jurisdictions
should seek to impose tax upon excluded extraterritorial income is a question more appropriately
addressed to foreign tax policy officials.
Q21. If a US producer sells a good directly to a customer in a third country, is the income
derived from this transaction foreign sourced?
Reply
See the US answer to question 45 from the Panel.
Q22. How can the exemption of such income be a measure to avoid double taxation?
Reply
The extraterritorial income exclusion is a measure for the relief of double taxation precisely
because excluded extraterritorial income may be subject to tax in a foreign jurisdiction. See the US
answers to questions 12 and 45 from the Panel and 20 from the EC.
Q23. If the intention of the Act is to avoid double taxation, why is the foreign content
limitation present?
Reply
That the 50-per cent rule may operate so as to narrow the class of transaction producing
excluded extraterritorial income is irrelevant to whether the exclusion comes within footnote 59. As
the United States explained in response to question 19 from the Panel, nothing in footnote 59 requires
that a measure for the relief of double taxation must resolve the problem of double taxation
completely or precisely. Stated differently, all income that may be subject to double taxation need not
be covered by a particular double taxation avoidance measure for that measure to be “intended” to
avoid double taxation or for that measure to come within the scope of the fifth sentence of footnote
59. This is most clearly evident in the use of tax credits, which apply only to certain foreign taxes
and, even where they do apply, often provide less than full relief.
Therefore, the United States submits that the 50-per cent rule has no bearing on the
interpretation and application of footnote 59.

Q24. According to the US, is it compatible with the SCM Agreement for a WTO Member to
allow its favoured companies the right to opt for a more generous system of double taxation
relief, that is not available to other taxpayers?
Reply
The United States does not know what the EC means when it refers to “favoured companies”.
The United States submits that the Act in no way applies to a limited or “favoured” group of
taxpayers.
Similarly, while the United States is pleased to see the EC acknowledge once again the
advantages of the exemption method, the United States does not believe it is accurate to say that the
exemption method is always “a more generous syst em of double taxation relief.” Depending on the
circumstances of a particular taxpayer, there may be situations where the use of the credit method is
more favorable from the perspective of the taxpayer.
To the extent that this question is another way of the EC again raising its point that the
United States should not be allowed to provide different mechanisms for avoiding double taxation, the
United States notes that it explained in paragraphs 35-38 of its Second Submission why countries can
and do rely on alternative methods of avoiding double taxation. This is a common and well-accepted
practice. For example, in France, with the permission of the Ministry of Economy and Finance, a
French company may elect to be taxed on its worldwide income and obtain relief from its worldwide
losses. Thus, in the context of export subsidies, alternative methods of double taxation relief should
be irrelevant, especially where no unique or special benefits are provided exclusively to exporters.
In the view of the United States, the key point is that US foreign tax credits are not available
for excluded income. Thus, there is no “more generous system of double taxation relief.”
Q25. According to the US is it compatible with the SCM Agreement to allow favoured
companies to double the amount of benefit that is available under the Member’s system for the
relief of double taxation for certain beneficiaries?
Reply
See answer to question 24.
Q26. Does the US legislation contain any such anti-avoidance rules that were designed to
prevent unwarranted exclusion of “qualifying foreign trade income” in all those cases where no
other country will tax that income and thus, where there is no double taxation? The US Subpart
F rules are designed to prevent unwarranted tax deferral but is the US contemplating any
measures to prevent possible abuse of the FSC Replacement Act?
Reply
The Act does contain certain measures to prevent tax avoidance. For example, under section
943(e)(1), a foreign corporation that elects to be treated as a US corporation under the Act must waive
all treaty benefits. If the electing foreign corporation could claim US treaty benefits, then it could
claim under a US treaty that it remained a resident of its original jurisdiction under the “tie-breaker”
rule of the treaty, thus obtaining an exemption for all of its income that is covered by the treaty. This
would defeat the very purpose of the domestication election, which is to place all foreign
manufacturing activities on par with respect to the US tax system. Although the EC has voiced its
strenuous objection to this rule, it is a rule designed to prevent tax avoidance and to prevent the
double non-taxation of income.

ANNEX F-5
COMMENTS OF THE EUROPEAN COMMUNITIES ON THE
ANSWERS OF THE UNITED STATES TO THE QUESTIONS
PUT FOLLOWING THE MEETING OF THE PANEL
(3 April 2001)
1. The EC 1 believes that the Panel is aware of the EC position on most of the points made by the
US in its answers to the questions of the EC and the Panel following the meeting of the Panel with the
parties. It will confine its comments to the following brief observations on matters where the EC
position may not be fully clear to the Panel or where the EC considers that a comment on its part may
be of assistance to the Panel.
1. Pertinence of the Legislative History
2. The US prefaces its answers to the Panel’s questions with some remarks on the elements of
legislative history that the EC presented at the meeting of the Panel in its Closing Statement.2
3. The US argues that US courts do not attach much importance, when interpreting US laws, to
floor statements in the US Congress, but consider more important Committee reports in discerning the
will of Congress. It concludes by stating that:
Thus, any post hoc speculation of the sort sought by the EC as to what Congress
intended would be nothing more than that: mere, and legally irrelevant, speculation.
3
4. The EC would simply recall that it was not invoking legislative history for the purposes of
interpreting the FSC Replacement Act. The terms of that measure are quite clear. The EC was
responding to the US’ refusal to respond to a series of questions about the purposes pursued by the
US (not only Congress) in adopting this measure. (The US has invoked an alleged purpose of the
FSC Replacement Act in its defence when it claimed that the FSC Replacement Act was “influenced
by ongoing congressional review” of the US tax system.
4 )
5. The US claims not to know why the FSC Replacement Act contains a foreign content
limitation, why it excludes from its benefit products in short supply and why an alleged double
taxation measure only applies to goods with limited foreign content “not for ultimate use in the US." 5
The legislative history demonstrates that the US in fact knew the reasons why these provisions were
carried over from the FSC regime or inserted in the FSC Replacement scheme.

1 In the interests of conciseness, the European Communities abbreviates both its own name and that of
the United States to EC and US respectively. It would request however that the term “European Communities”
be used in the Panel Report.
2 Closing Statement of the EC to the meeting of the Panel, paragraphs 3 to 9 and exhibits EC-16 to 19.
3 Answers of the US to the questions from the EC, preliminary comments.
4 First written submission of the US, paragraphs 24 and 25.
5 As noted in paragraphs 3 to 9 of the Closing Statement of the EC to the meeting of the Panel and
confirmed in the US’ answers to Questions 2, 3, 4, 6,7, 15 and 16 from the EC.

2. US Erroneous statements about the FSC Replacement Act
6. The US has made some erroneous factual allegations concerning its FSC Replacement Act.
The EC is astounded that the US should do this at such a late stage in the proceedings.
7. In paragraph 51 of its Answers to the Questions from the Panel the US states that:
… excluded extraterritorial income would be foreign-source income under US
sourcing rules, as set forth in section 862(a)(4) and 863(b) of the IRC.
In the same vein the US claims in paragraph 60 that:
The extraterritorial income exclusion, however, is limited to the foreign-source
income that arises when property is sold or leased for use outside the United States
because the United States has determined not to cede primary taxing jurisdiction over
US-source income.
8. These statements are demonstrably wrong and contradict what the US stated during the
meeting with the Panel. 6 The EC feels obliged to explain why foreign-source income and
extraterritorial income are entirely unconnected concepts.
9. Extraterritorial income is a new creation of the FSC Replacement Act. The foreign-source
income concept is well established in the US tax law as a means of addressing primary tax jurisdiction
for purposes of the statutory provisions that have the effect of eliminating or at least alleviating
double taxation. Thus, a foreign corporation is generally subject to US tax on its US-source income,
but not its foreign-source income.
7 A US corporation, while subject to tax on its worldwide income,
is generally eligible for foreign tax credit based on the portion of its income that is sourced outside of
the US.8
10. Extraterritorial income could be entirely US-source, entirely foreign-source or a mixture of
the two. If a product were manufactured in the US and then sold by the manufacturer to another
party for use outside the US in a transaction in which title passed from the manufacturer to the buyer
within the US, the income realised by the manufacturer would be entirely US-source. Conversely, if
the product were manufactured and sold in Europe by a US corporation or an electing foreign
corporation, the income realised by the manufacturer would be sourced entirely outside the US. As a
middle case, if the product were manufactured in the US but sold in a transaction in which title passed
to the buyer outside the US, the transaction w ould produce a combination of US-source and foreign-
source income. All three scenarios could produce the same extraterritorial income, provided that the
other requirements of the Act were satisfied.
3. Existence of a subsidy – qualifying foreign trade income defined as a reduction in
taxable income
11. Question 7 from the Panel to the US asked the US to comment on the fact that the new
section 941(a)(1) of the IRC defined qualifying foreign trade income as “the amount of gross income
which, if excluded, will result in a reduction of taxable income of the tax payer from such transaction”
by a defined amount.

6 In its oral answer to what became EC Question 21 to the US, the US replied (correctly) and repeated a
number of times that the source of income is not relevant for determining extraterritorial income. In its written
answers the US avoids responding to this question.
7 IRC, sections 881 and 882 (Exhibit EC-21).
8 IRC, section 904 (Exhibit EC-21).

12. This formulation is effectively converting a given reduction in taxable income into an
equivalent reduction in gross income. The US explanation of why it does this is revealing. It states
that:9
Because excluded extraterritorial income is excluded from the US tax base, however,
the Act denies deductions attributable to such income. This presents a computational
problem: how are disallowed deductions to be removed if the excluded amount is
based on gross income, which does not account for any deductions? The problem is
solved by first computing taxable income, then denying deductions allocable to
excluded extraterritorial income, and then “grossing up” the resulting figure into a
gross income exclusion by attributing to the taxable income amount any allocable
deductions.
13. In other words, the above formulation is necessary because extraterritorial income is excluded
from gross income and therefore taxable income must be “grossed up” in order to allow expenses to
be deducted correctly. It refers to the explanation in the legislative history:
[I]n order to calculate the amount that is excluded from gross income, taxable income
must be determined and then "grossed up" for allocable expenses in order to arrive at
the appropriate gross income figure."
10
14. The US explanation serves to demonstrate the fact that the US is excluding part of a category
of income from tax. Expenses are normally associated with a type of income or arise out of the
activities required to produce the income. The reason why the “computational problem” arises is that
the US is excluding from tax only part of a “category” of income, properly so-called.
15. The FSC Replacement scheme “exclusion” is in fact a formula-derived fraction of a type or
category of income. Looking at the example contained in the Committee Report referred to by the
US, it appears that the best measure of the actual taxable income derived from the sale of qualifying
foreign trade property is “foreign trade income.” In fact, the IRC defines “foreign trade income” as
“the taxable income of the taxpayer attributable to the foreign trading gross receipts of the
taxpayer."
11 In the example, this is $100. Yet the exclusion in the example is $60. Thus, the IRC is
not excluding or giving up jurisdiction over all of the income attributable to a defined economic
activity.
16. Thus, the US answer to this question simply underlines that qualifying foreign trade income
cannot be regarded as a true category of income.
4. Could other countries tax extraterritorial income?
17. Question 12 of the Panel to the US asked whether
Where qualifying foreign trade property is manufactured, produced, grown or
extracted within the United States by a US corporation or an individual permanently
established in the United States, and where that corporation or individual does not
maintain any permanent establishment outsid e the United States, are there situations
in which extraterritorial income earned from the sale of such property can be taxed by
another country than the United States?

9 US answers to the questions from the Panel, paragraph 12.
10 The US refers to the Senate Report in Exhibit US-2, page 12.
11 Section 941(b) of the IRC.

18. The US replies by referring to the laws of 6 countries, Brazil, Chile, Malaysia, Panama,
Taiwan and Saudi Arabia, which it claims do not rely on the concept of “permanent establishment” as
a basis for taxation of income. The US statements are inaccurate. Even based on the partial
quotations from the documents of the International Bureau of Fiscal Documentation 12, it can be
understood that many of the countries mentioned by the US do have rules that are based on or
analogous to the “permanent establishment” notion as far as taxation of business profits of foreign
enterprises is concerned. For example:
• Brazil: under Brazilian legislation foreign enterprises pay tax on income derived through branches
or agencies. As to the former, according to point 4.04 of exhibit US-24 branches are commonly
understood to be registered (that is, to be “permanent” offices, or in other words, “fixed places of
business” through which a foreign corporation carries out business operations). Thus, a branch is
within the permanent establishment concept as defined in Article 5 of the OECD Model
Convention). As to agencies, the rules set out in the third paragraph of point 4.05 are clearly
based on Article 5.5 of the OECD Model Convention. A “dependent agent” under the OECD
Model Convention constitutes a “permanent establishment”.
Moreover, in point 4.06 (direct trading) it is said: “payments for imported goods to non-resident
sellers are not subject to income tax since imported goods are not from Brazilian sources”.
• Chile: in point 4.04 of Exhibit US-25 it is stated that “the tax administration has declared that a
foreign enterprise acting in Chile through a person who is not a representative with authority to
conclude contracts and who rather makes contacts and provides information on potential clients,
is not deemed to have a permanent establishment in Chile” (emphasis added). This language
closely resembles that of Article 5 of the OECD Model Convention. Still in the same point (4.04)
it is stated that “The Chilean income of agencies, branches and other permanent establishments of
foreign enterprises operating in Chile is established...” This language also strongly suggests that
Chile indeed is recognising the same or a very similar standards to the OECD Model Convention.
• Malaysia: in point 11.3 of Exhibit US-26 it is stated: “The OECD model definition of permanent
establishment is generally used in Malaysian double taxation treaties”.
19. More fundamentally, the EC would note that:
• The US does not identify any double taxation problem with these or any other country that the
FSC Replacement scheme is designed to solve. It simply suggests that there may be a theoretical
possibility of double taxation.
• It is clear from the US description of these tax regimes and the annexes that all of these six
countries only tax the domestic-source income of foreign corporations.
20. Even if it is true that some countries may not rely on an easily identifiable concept of
“permanent establishment” as a basis for taxation, it is clear that no country tries to tax foreign
corporations on foreign-source income. Countries only seek to tax the domestic source income of
foreign corporations.
21. The question is therefore really whether qualifying foreign trade income of US exporters
would be considered domestic-source income by foreign countries.

12 Exhibits US-24 to US-29.

22. The FSC Replacement Act excludes from US tax income that would never be considered
domestic source income in any other country – that is does not arise from economic activity or
processes conducted in another country. The FSC Replacement scheme foreign economic process
requirements simply require a certain minimal amount of foreign costs – not any foreign income at all.
Countries tax the income arising from activities – not the costs!
23. The US has not identified any country in the world which considers that taxes the income of
foreign exporters simply because they sell goods to customers in its territory and have some minimal
costs in its territory. So far as the EC is aware, all countries only tax the domestic source income of
foreign corporations and this requires that the income arises in their territories, not simply that some
costs are incurred in their territories.
24. The US is effectively inviting WTO Members to impose a novel kind of tax on imports – to
require foreign exporters to pay tax in their territories on the profits they make from exporting to those
territories!
25. Finally, the EC would repeat that it is not relying on the OECD Model Convention to fill a
“gap” in footnote 59 as alleged by the US13 but simply as evidence of international practice. The EC
and the US in fact agree on that the OECD Model Convention is only relevant as evidence of
international tax practice. Reference to the concept the “permanent establishment” as a basis for
taxation of business income is relevant as:
• A description of how most countries with developed taxation systems agree to apportion taxation
authority;
• A demonstration that for income to be considered to arise in a country, that is have its source in
that country, and to be taxable when earned by foreigners, there must be physical presence by
which the income can be earned;
• A recognition of the fact that, in practice, countries cannot collect tax on foreign business income
if there is no lasting physical presence on which the tax can be levied and against which
enforcement procedures can be directed.
5. The use of alternative means for the avoidance of double taxation
26. In reply to Question 16 from the Panel, the US argues that other countries do provide
alternative mechanisms for the avoidance of double taxation.
27. The EC is not in a position to comment on whether and to what extent the tax systems of
other countries do provide alternative mechanisms for the avoidance of double taxation.
28. The EC would only comment that allowing certain companies a choice of mechanisms for the
avoidance of double taxation gives rise to revenue forgone that would otherwise be due and thus a
subsidy under Article 1 SCM Agreement, at least where this is allowed transaction by transaction,
since it can be assumed that companies will use this possibility to reduce their tax burden in a way not
available to other companies.
29. The subsidy element in the FSC Replacement scheme, even if it is accepted as a mechanism
for the avoidance of double taxation, is even clearer due to an additional feature – that it is not
confined to foreign-source income. US taxpayers may, under general US tax rules, only obtain

13 Answers of the US to the questions of the Panel, paragraph 92.

double taxation relief on their foreign-source income.14 The FSC Replacement scheme allows what is
claimed to be double taxation relief on both foreign-source income and domestic-source income. That
is an advantage that no other US taxpayers are allowed, gives rise to revenue forgone and is
contingent upon export performance.
30. The availability of double taxation relief on domestic-source income under the FSC
Replacement scheme is also not covered by the last sentence of footnote 59. First, such an advantage
is not an “exemption, remission or deferral of tax”. Second the last sentence of footnote 59 is
specifically limited to measures for the avoidance of double taxation on foreign-source income.
31. As a final comment in this Section, the EC would like to formally refute, again 15, the US
suggestion in its response to question 24 from the EC 16 where it states "the US is pleased to see the
EC acknowledge once again the advantages of the exemption method..." To be clear, the EC
recognises that each system has its own advantages for taxpayers and tax authorities in different
circumstances. It does not however acknowledge that either system in itself presents any advantage
for exports.
6. The meaning of the term “foreign-source income”
32. The EC has already set out its views on the meaning of the term foreign-source income in
footnote 59 but would like to make two comments on the US answer to Question 15 from the Panel.
33. First, the US refers the Panel 17 to the use of this term in footnote 6 to Article XIV of GATS,
which states in its final paragraph that
Tax terms or concepts in paragraph (d) of Article XIV and in this footnote are
determined according to tax definitions and concepts, or equivalent or similar
definitions and concepts, under the domestic law of the Member taking the measure.
34. The US seeks to use this text to assert that:
18
A key point in footnote 6 for purposes of the present dispute is the fact that the final
sentence provides that the tax terms used in the relevant text do not have universally
agreed upon meanings. Thus, the final sentence indicates that the negotiators of
GATS wanted to provide flexibility to capture the various instances in which income
can be regarded as “sourced” within a Member.
35. The EC does not agree that this text reflects a desire to allow flexibility in the sense desired
by the US – that foreign-source income can mean whatever suits at any time. It provides, on the
contrary, precise meanings to taxation terms and concepts – those used in the tax system of the
Member.
36. The EC does not consider that the fact that something is stated expressly in one of the WTO
agreements means that the same must necessarily be considered to apply under another agreement.

14 Section 904(a) of the IRC (exhibit EC-21).
15 See also answers of the EC to Questions 23 and 35 from the Panel (esp. paragraphs 56 and 94).
16 Answers of the US to the questions from the EC, paragraph 39.
17 The US also refers the Panel to the use of the term “source” in the TRIMS agreement. Since this is
not referring to income or taxation, the EC does not consider that it adds anything to the use of the term in the
trade defence agreements referred to by the EC; They all simply demonstrate that “source” has a similar
meaning to “ origin”.
18 US answers to the questions from the Panel, paragraph 45.

Particular caution is required in the case of footnote 6 to the GATS because of the different concerns
that it was addressing, arising out of the special features of trade in services.
37. However, if the approach reflected in the last sentence of footnote 6 to Article XIV GATS
were to apply to footnote 59 to the SCM Agreement, the FSC Replacement scheme would not come
within its scope because the benefit it grants is not limited to foreign-source income, within the
meaning that term is given under the US tax system.
38. The US seems to have misunderstood paragraph (iv) of footnote 6 to Article XIV GATS. 19
This appears to relate to measures to ensure the collection of taxes of income of consumers derived
from sources in the Member’s territory. It does not support the apparent US view that the “source” of
income can be the place where the customer is located.20
39. Equally irrelevant is the US argument that “source” must be given a “broad” meaning in
footnote 59 so as to cover the different ways in which passive income can arise. Footnote 59, being
attached to item (e), relates to tax exemptions etc that are “specifically related to exports”. It therefore
applies to income derived from trade in goods, not to “passive income”.
40. Second, the US refers to the use of the term “foreign-source income” by the Appellate Body
in the original proceedings. The US misrepresents the Appellate Body report.
41. The Appellate Body did not “apply the term broadly;” it was clearly referring to income
arising abroad. Also, although it did not expressly refer to the meaning of the term in the tax system
under consideration, it did not exclude this interpretation. Indeed, elsewhere in the Report the
Appellate Body says that:
We also agree with the Panel that the basis of comparison must be the tax rules
applied by the Member in question.
21
7. The US Specificity Argument
42. In response to Questions 20 and 21 from the Panel and in particular the fact that according to
the US interpretation of Article 1 of the SCM Agreement the exclusion of all export income from
gross income and therefore tax would not constitute a subsidy, the US invents, as an alternative
argument, a novel theory according to which an exclusion of certain income from “gross income” (or
an equivalent notion) would become a subsidy within the meaning of Article 1 of the SCM Agreement
if it is specific in the sense of Article 2 of the SCM Agreement.
22
43. The EC considers this argument completely misguided because the SCM Agreement clearly
provides that the question of specificity only arises once it has been established that a subsidy exists.
44. The argument also appears pointless since Article 2.3 of the SCM Agreement deems all
subsidies falling under the provisions of Article 3 to be specific. It cannot therefore save the FSC
Replacement scheme.

19 US answers to the questions from the Panel, paragraph 46.
20 The US also quotes but does not comment on paragraphs (i) and (vi) of the footnote. Paragraph (i)
also does not support the US theory, but on the contrary is simply referring to the place income arises, and
therefore supports the EC view of “source.” Paragraph (vi) does not refer to the notion of source at all.
21 Appellate Body report, paragraph 90.
22 US answers to the questions from the Panel, paragraph 63.

45. The US is effectively arguing that an exception be made from Article 3 the SCM Agreement
for prohibited subsidies that are non-specific within the meaning of Article 2.1 and 2.2 of the SCM
Agreement. There is no basis for this in the text of the Agreement; indeed the text says the opposite.
In any event, the EC does not accept that the FSC Replacement subsidies are non-specific.
8. The EC’s Demonstration of the effect of the 50 per cent rule (Question 8)
46. Question 8 from the Panel to the US asked the US:
The European Communities states that, in order for extraterritorial income to be
excluded from taxation, “US articles must be used whenever the cost of other inputs
(not articles or direct labour) (C) and profit (D) are less than 50 per cent of the selling
price (or more exactly the US-assessed fair market value) of the goods”.
23 Is this a
correct characterisation of Act ? If not, could the US provide what it considers to be
the correct description?
47. Apart from repeating its view that the EC can only prevail if it demonstrates that “the Act
contains an affirmative requirement to use US articles," 24 the US response is limited to alleging that
the EC’ statement is inaccurate because:25
… the EC’s algebraic breakdown fails to reflect the Act’s distinction between the
foreign labour and US labour components.
48. The reason for this is simply that the EC made the simplifying assumption that there would be
no US direct labour costs in foreign production.
49. The US does not respond to the Panel’s request to provide an alternative description of the
effect of the Act. A more sophisticated description of the effect of the Act that entirely takes account
of the US criticism is easy to formulate, as the EC stated at the meeting with the Panel. It is simply
necessary to split the component representing direct labour costs into two parts, B1 representing US
direct labour and B2 representing foreign direct labour. Paragraph 112 of the first written submission
of the EC can then be rewritten as follows:
Since A2 + B2 may not exceed 50 per cent of SP, (i.e. A2 + B2 must be = or < SP/2),
then mathematically,
A1+B1+C+D must constitute at least 50 per cent of SP (i.e. A1+ B1+C+D must be =
or > SP/2 which can be expressed as A1 = or > SP/2-C-D -B1). This means that A1
will be positive whenever SP/2 > C+D+B1
In other words, US articles must be used whenever the cost of US labour (B1) and
other inputs (not articles or direct labour) (C) and profit (D) are less than 50 per cent
of the selling price (or more exactly the US-assessed fair market value) of the
goods.
26
50. With this correction, the EC’ description of the effect of the Act meets the only criticism the
US has made. It can then also be used to demonstrate in what circumstances the Act requires the use
of US articles in the production of qualifying foreign trade property in the US.

23 The Panel referred the US to EC first submission, para. 112.
24 US answers to the questions from the Panel, paragraph 17.
25 US answers to the questions from the Panel, paragraphs 16 and 18 (quotation from paragraph 18).
26 Bold type indicates changes from the original description to take account of the US criticism.

9. Export Contingency
51. In its first written submission, the EC offered a relatively detailed discussion of the meaning
of the terms “export” or “exportation” in the SCM Agreement.27 The EC sought to go beyond the
dictionary definition stating that the definition “send (esp. goods) to another country” was not of
much help, that is, did not fully exhaust the question.
52. The Panel invited the US to comment on this issue in its Question 10 to the US. The US does
not attempt to debate the issue but states that
The United States believes that the EC got the definition right the first time, when it
followed the dictionary definition: “Send (esp. goods) to another country“.28
53. The EC does not consider that this can be an exhaustive definition of the meaning of the terms
“export” in the SCM Agreement or in the WTO Agreement. But it can at least agree that it may not be
necessary for the Panel to examine all the nuances of the term for the purposes of the present case.
54. Since, in order to qualify for the FSC Replacement scheme, a transaction involving US-
produced goods must not be “ for ultimate use in the US,” it follows that these goods must be sent
across the border of the US in order for the transaction to qualify.
55. Conscious that this means naturally that the goods must therefore be sent to another country,
the US claims in answer to the Panel’s next question, Question 11, that export may not always be
necessary since a fishing boat could be not for ultimate use in the US even though it never arrives in a
foreign country.
56. It is noteworthy that the US is unable to definitively assert that such a transaction would
benefit from the FSC Replacement scheme stating that:
… the precise scope of these rules will be the subject of proposed regulations to be
issued in the future.
29
57. But even if the US were to adopt rules that allowed transactions involving fishing boats and
the like to benefit from the FSC Replacement scheme and even if it were accepted that such
transactions are not “exports”, it would remain the case that goods which are destined to be used in
the territory of a country (the vast majority of goods) need to be exported in the sense of being sent to
another country in order to benefit from the FSC Replacement scheme. For those goods, the FSC
Replacement scheme is, even on the basis of the US definition, contingent upon export performance.
58. The other arguments of the US in relation to these questions relate to goods that may return to
the US after exportation in the sense of being sent to another country, such as aircraft and tyres
installed on foreign produced cars.
59. The EC would point out that these examples need not concern the Panel if it adopts the simple
definition of export advanced by the US. Being sent to another country is in any event a condition
that must be fulfilled by such goods if the FSC Replacement scheme is to apply.

27 First written submission of the EC, paragraphs 85 to 92.
28 US Answers to the questions from the Panel, paragraph 21.
29 US Answers to the questions from the Panel, paragraph 22.

60. The EC would draw the Panel’s attention to one final point that simplifies the debate on this
issue. It is that the requirement of not “for ultimate use in the US” in the FSC contained in the
definition of “qualifying foreign trade property” in the FSC Replacement Act is in all material
respects identical to the definition of “export property” under the FSC scheme.30
61. Thus, the FSC Replacement scheme is just as export-contingent as was the FSC scheme.
10. The applicability of Article III:4 of GATT 1994 to local content requirements contained
in tax measures
62. In its reply to Question 18 from the Panel the US takes the view that income tax measures do
not fall within the scope of Article III:4 of GATT 1994.
63. Article III:4 of GATT 1994 is concerned with laws, regulations of requirements affecting the
internal sale, purchase, use of products. However, Article III:4 does not specify, and therefore does
not limit, where the requirements (including legislative ones) must be written in order to be caught by
its prohibition.
64. As indicated since its First Written Submission, the EC has not challenged under Article III:4
the tax benefit, but rather one of the conditions to obtain it (the foreign content limitation).
65. The passage of the Panel Report in Indonesia - Cars to which the US refers correctly
analyzed the issue and is not an obiter dictum. Assessing the meaning and scope of Article III was
necessary for the Panel in order to dispose of Indonesia’s defence, which turned on Article III as a
whole.
66. If the measure in which a local content requirement is written were to be relevant in deciding
whether it is covered by Article III:4, it would be quite easy to circumvent the prohibition in that
provision of providing advantages to domestic products.
67. As recalled by the EC at the hearing, subsidies embodying a local content condition have
indeed been reviewed under Article III:4. 31 There has been no discussion on, nor limitation to, this
possibility of review. The US even recognizes in its reply that there have been cases where claims
against income taxes benefits were brought.
68. The US tries to belittle this practice by referring to the drafting history of GATT 1947. Even
if the drafting history could be relevant in the presence of a clear and unqualified prohibition in the
text of Article III:432, and even if the drafting history of GATT 1947 meant what the US contends, this
would not entail that such history be relevant to interpret Article III:4 of GATT 1994. GATT 1994
was negotiated after some practice was developed – including the cases that the US itself now brings
to the Panel’s attention – in the sense of making claims against subsidies and income tax measures
under Article III:4. The EC would add that the in United States – Taxes on Automobiles
33 the Panel

30 See comparative table in paragraph 160 of the EC’s first written submission.
31 EEC – Animal Feed Proteins (see EC’s reply to Question 32 from the Panel).
32 Article 32 of the Vienna Convention on the Law of Treaties provides that
“Recourse may be had to supplementary means of inte rpretation, including the preparatory work of the
treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the
application of article 31, or to determine the meaning when the interpretation according to article 31:
(a) leaves the meaning ambiguous or obscure; or
(b) leads to a result which is manifestly absurd or unreasonable.” (emphasis added)
33 DS31/R, 11 October 1994.

reviewed i.a. a US measure (the “CAFE" requirement) which did not concern products, but which was
a penalty imposed on persons (enterprises). That dispute, started on 20 May 1992, further shows that
the scope of Article III:4 was not viewed as being limited to measures directly concerning products,
inasmuch as these embodied “requirements” favouring the sale, purchase or use of domestic products.
69. In the light of the practice recalled by the Panel in its question, by the EC and by the US, it is
clear that if the drafters of the Uruguay Round agreements were on notice that such interpretations
were possible and if they had intended to limit the scope of Article III:4 they would have been able to
do so – for example by annexing an Understanding on that specific provision. The text of and
footnote to Article XIV (d) of GATS, also recalled by the US, further show that the drafters did
provide for specific rules to address direct taxation when they so wanted.
70. Thus, there is no reason why Article III:4’s unqualified prohibition would not cover other
measures directly concerning persons, like direct taxes subsidies, inasmuch as these embodied a
“requirement” favouring the use of domestic products.
11. Applicability of FSC Replacement scheme to Agricultural production
71. The EC has argued that the FSC Replacement scheme is a prohibited export subsidy,
regardless of its extension to foreign- produced goods. The EC also argued that the alleged alternative
means of obtaining the subsidy, i.e. production abroad, is also export contingent. The EC has argued
that the extension of the FSC Replacement scheme to foreign produced goods is subject to a 50 per
cent rule which creates in many cases a requirement for exports to be made from the US.
72. As regards agriculture, specific characteristics inherent to agricultural production and in
particular to commodities make the qualification of foreign-grown agricultural products for the FSC
Replacement scheme fraught with additional obstacles. The US example in fact illustrates very well
the EC’s point.
73. In question 19, the EC asked how the FSC repl acement scheme is applied to foreign-produced
agricultural products. The US gives no specific indi cation (which is hardly surprising, as the US has
provided no guidelines on how it will apply the 50 per cent rule). It provides an example, using US
data, whose stated objective is to demonstrate that foreign-grown agricultural products could qualify
as qualifying foreign trade income and benefit from the extended FSC Replacement subsidy.
74. Even taken at their face value
34, the US methodology and data highlight very clearly the
obstacles to benefiting from the scheme by growing agricultural products abroad. A more complete
look at the USDA set of data cited as regards US production of soybeans immediately reveals that,
based on the exact application of the US methodology, the limitation of 50 per cent value attributable
to “articles” and labour is reached and surpassed in several regions of the US both in 1998 and 1999.
In 1999 for example, articles + labour > 50 per cent in the US regions of the Southern Seaboard
(76.59 per cent) and Mississippi Portal
35 (59.9 per cent). In 1998, 50 per cent was surpassed in the
Eastern Uplands (57.27 per cent) and Mississippi Portal ( 52.6 per cent).36

34 The EC will not enter into a discussion of the methodology used by the US, as it judges that an
examination of the US example as it stands is sufficient at this stage to illustrate the EC’s point.
35 These are regions defined by USDA, each including several States.
36 The US proceeds as follows in paragraph 29 of its reply to EC Question 19 (emphasis added):
based on data from the US Department of Agriculture (USDA), for US production in 1999, the ‘total
gross value of production’ for soybeans (in dollars for planted acre) was $178.00. The cost of items that
arguably could be considered ‘articles’ (seed, fertilizer, soil conditioners, manure, and chemicals)

75. What is also extremely revealing is that th e same producers, for the same commodity, for the
same US region could one year hypothetically “qualify” for the exemption and the following year find
themselves well above the 50 per cent ceiling. In one region, the Southern Seaboard, articles and
labour jumped from 43 per cent in 1998 to 76 per cent of value of production in 1999.
76. Similar patterns can be found in other commodities in the USDA set of data. As regards
wheat, for instance, the US-wide data show th at, between 1998 and 1999, the proportion of the
identified factors passed from 45.56 per cent to 50.44 per cent. As regards specific areas, the
proportion was always above 50 per cent in the Basin and Range region (54.97 per cent in 1998 and
53.43 per cent in 1999), in the Heartland region (57.7 per cent in 1998 and 56.5 per cent in 1999), and
in the Southern Seaboard region (83.7 per cent in 1998 and 87.6 per cent in 1999). It was above 50 per
cent in the Fruitful Rim region (50.08 per cent) in 1998, and in 1999 in the Northern Great Plains
region (50.49 per cent).
37

amounted to $52.98. The cost for hired labour and the opportunity cost of unpaid labour amounted to
$20.90. Thus, the total cost of articles and labour was $73.88, a figure well below 50 per cent of $178 ”.
For “articles” (seed, fertiliser, soil conditioners, manure and chemicals) and “labour” the EC has taken the
same factors as identified by the US, and the same gross value of production in $/planted acre.
Eastern Uplands:
1998: “articles” + labour = 100.43$; value of production = 175.36$; percentage of sum of articles and
labour = 57.27
Southern Seaboard:
1998: “articles” + labour = 94.29$; value of production = 217.20$; percentage of sum of articles and labour
= 43.4
1999: “articles” + labour = 92.65$; value of production = 120.96$; percentage of sum of articles and labour =
76.59
Mississippi Portal:
1998: “articles” + labour = 75.51$; value of production = 143.50$; percentage of sum of articles and labour
= 52.6
1999: “articles” + labour = 72.40$; value of production = 120.75$; percentage of sum of articles and labour
= 59.9
37 US-wide data:
1998: “articles” + labour = 50.55$; value of production = 110.95$; percentage of sum of articles and
labour = 45.56
1999: “articles” + labour = 48.04$; value of production = 95.23$; percentage of sum of articles and labour =
50.44
Basin and Range region:
1998: “articles” + labour = 87.19$; value of production = 158.6$; percentage of sum of articles and labour =
54.97

77. A situation in which the factors identified by the US are above 50 per cent is thus very
common even in the very data set cited by the US. The actual proportion of the relevant factors may
vary from region to region of the same country, and what’s more, from year to year for the same
region. The US set of data thus precisely illustrates another obstacle to the application of the scheme
to foreign-grown agricultural products - the impossi bility for producers to predict with any certainty
whether they will be able to qualify for the exemption.
78. Price variation is of course at the heart of this situation. This is an inherent aspect of
agricultural production. It is well known that the price volatility of agricultural commodities is very
high, and bears little or no relation to cost variations.
38
79. The practical consequence of this is that producers cannot be certain that they will meet their
cost target to qualify for the FSC replacement, as the final price will not normally be known until after
costs are incurred.
80. The US example proves the EC’s point because prices and costs vary, not only by region
within the same country but also in time. Even if in some areas and/or at some times a producer may
be tempted to believe that its foreign-grown agricultural product could conceivably qualify, the
certainty will escape him because of the inherent characteristics of agricultural production such as the
relationship between agricultural prices and costs. Taxpayers will therefore be well advised to turn to
US production if they wish to be able to rely on the benefits of the FSC Replacement scheme.

1999: “articles” + labour = 82.74$; value of production = 154.84$; percentage of sum of articles and labour
= 53.43
Heartland region:
1998: “articles” + labour = 72.73$; value of production = 125.97$; percentage of sum of articles and labour
= 57.7
1999: “articles” + labour = 68.28$; value of production = 120.69$; percentage of sum of articles and labour
= 56.5
Southern Seaboard:
1998: “articles” + labour = 92.33$; value of production = 110.25$; percentage of sum of articles and labour
= 83.7
1999: “articles” + labour = 89.30$; value of production = 101.91$; percentage of sum of articles and labour
= 87.6
Fruitful Rim:1998: “articles” + labour = 84.87$; value of production = 169.44$; percentage of sum of
articles and labour = 50.08
Northern Great Plains:
1999: “articles” + labour = 42.76$; value of production = 84.69$; percentage of sum of articles
and labour = 50.49
38 Going no further that the USDA data cited by the US, soybeans gross value of production in 1999
fell 37 per cent from 1997 and 21 per cent from 1998 levels. The above-cited increase in percentage of the US-
identified relevant factors in the Southern Seaboard soybean production from 43.4 per cent in 1998 to 76 per
cent was in fact accompanied by a decrease of costs of these factors.

12. The foreign process requirements
81. Question 42 of the Panel to the US concerned the foreign economic process requirements in
the FSC Replacement Act.39
82. The EC had not devoted much attention to the foreign economic process requirements so far
in this proceeding merely noting that they bore no relationship with the amount of excluded income. 40
The US had also said little about the foreign economic process requirements and has not contested
that they bear no relation to the amount of the excluded income.
83. The EC statement that may have given rise to the Panel’s question was in its closing
statement to the meeting of the Panel:
41
... the foreign economic processes requirement in the FSC Replacement Act is based
on a percentage cost test and that it can be met without undertaking any activities
outside the US. In this context it is equally important to bear in mind that US
taxpayers wishing to be eligible for the subsidy can outsource to independent third
parties all the activities, if any, that are to be performed outside the US.
84. In view of the US’ answer to Panel Question 42, and in case the Panel may consider it
relevant, the EC will now set out its views on the foreign economic process requirements of the FSC
Replacement Act in some more detail.
85. The foreign economic process requirements, now found in section 942(b) of the IRC are not
materially different from the corresponding FSC scheme requirements found in section 924(d) of the
IRC and are more symbolic than substantive. The Conference Committee Report specifically
mentions the foreign economic process rules as one of the areas in which the existing FSC rules are to
apply until rules are issued under the new statute.42
86. The FSC regulations state that
Any person, whether domestic or foreign, and whether related or unrelated to the
FSC, may perform any activity required to satisfy this section, provided that the
activity is performed pursuant to a contract for the performance of that activity on
behalf of the FSC.43
And that:
If no direct costs are incurred by the FSC in a particular category, that category shall
not be taken into account for purposes of determining satisfaction of either the 50-per
cent or the 85-per cent foreign direct cost test. If any amount of direct costs is

39 Question 42 reads:
Is the EC correct in its statement that the "foreign economic process" requirements in Section 942(b) of
the Act may be satisfied even where the functions were in fact performed within the United States?
Please explain.
40 First written submission of the EC, paragraph 59 and second written submission of the EC,
paragraph 220.
41 Paragraph 28.
42 Technical Explanation of the Joint Committee on Taxation, 1 November 2000, page 22 (Exhibit EC-
5A).
43 Reg. § 1.924(d)-1(b)(1).

incurred in a particular category, that category shall be taken into account for
purposes of the foreign direct costs test.44
87. Thus, while costs cannot literally be zero, they can be small. If one satisfied the 85 per cent
test with respect to any two categories set forth in section 942(b)(3) of the IRC, one would satisfy the
requirement of section 942(b)(2)(B) even if the costs involved in each of those two categories were
minimal.
88. For example, a US company could satisfy the foreign direct cost requirement with respect to
advertising costs by placing an advertisement in a foreign trade journal. Incurring a cost of this nature
would certainly not cause the income realised from a sale of the advertised product to be foreign-
source income.
89. One of the treatises regarding FSCs states that:
Some exporters satisfy the advertising costs requirement by taking out an annual
advertisement in a foreign trade journal which includes all export products marketed
by it. Although the foreign direct costs allocated to each export transaction will be
minimal, this fact will not prevent the FSC from meeting the foreign direct costs test.
If there are no domestic sales promotion expenses attributable to the export
property…, then this activity will satisfy the advertising and sales promotion direct
cost category for those products.
45
90. The regulations make this test even easier to satisfy, because they provide that:
Costs relating to advertising in United States publications are not treated as direct
costs even if the publication also has a foreign edition in English.46
91. The EC would also remind the Panel that, as under the FSC scheme, there is no requirement
to incur any cost for “foreign economic processes” for taxpayers whose foreign trading gross receipts
do not exceed US$ 5 million in any taxable year.47
92. For further illustration of how minimal the foreign economic process requirements are in
practice, the Panel may wish to refer back to the explanations provided in the original proceedings,
including Exhibit EC-31.

44 Reg. § 1.924(d)-1(d)(1).
45 BNA Tax Management Portfolio No. 934, Foreign Sales Corporations, at A-29 (1998).
46 Reg. § 1.924(e)-1(a)(1)(iii)(C).
47 Section 942(c)(1) of the IRC.

ANNEX F-6
COMMENTS OF THE UNITED STATES ON
THE EC’S ANSWERS TO QUESTIONS FROM THE PANEL
Q1. In section 3.2.5. of its first submission, the European Communities expresses the view
that the FSC Replacement scheme gives rise to two distinguishable subsidies : the “basic FSC
Replacement subsidy” and the “extended FSC Replacement subsidy”.
• Does this mean that the EC is requesting the Panel to make two separate rulings, one on
each of the alleged subsidies?
• Does the EC consider that the application of a different portion of the FSC Replacement
scheme may involve different types of subsidies under the SCM Agreement?
• Please identify the relevant portion of the FSC Repeal and Extraterritorial Income Exclusion
Act (“the Act”) framing these two "distinguishable" alleged subsidies.
• Does the EC believe that the status of a subsidy under the SCM Agreement is determined by
the particular legal circumstances in which it is granted on a case-by-case basis?
Reply
1. With respect to the EC’s answer to this question, the United States refers the Panel to the US
answer to this question,1 and reiterates that there is a single exclusion that applies to different types of
foreign transactions. To restate in an accurate manner the first sentence of paragraph 2 of the EC’s
answers, “there is a single exclusion that covers different situations.”
2. In this regard, the lengths to which the EC will go in its attempt to bifurcate the Act is
revealed in paragraph 3 of the EC’s answers, where the EC asserts that “domestication” is a condition
of what the EC refers to as the “extended FSC Replacement subsidy”. Of course, the EC conveniently
omits the fact that a foreign branch of a US corporation can earn the “extended subsidy” without any
“domestication”.
3. Also in paragraph 3, the EC slips in the assertion that “it will often be necessary to use US
articles” under the “extended subsidy.” (Emphasis added). Of course, the EC has provided no
evidence whatsoever to support the assertion that the necessity to use US articles will arise “often.”
The EC has not provided evidence that such a necessity actually will arise even once.
4. Finally, in paragraph 4 of the EC’s answers, se cond bullet, the EC reiterates the argument that
the United States quoted in paragraph 84 of its own answers to the Panel’s questions. The United
States refers the Panel to paragraphs 80-87 of the US answers, which explain how the EC is trying to
have it both ways in this dispute; i.e., in one breath, it says its challenging the Act as a whole, but in
the next breath tries to divide the Act into separate alleged subsidies.
Q2. The European Communities claims that the FSC Replacement scheme is de facto export
contingent and therefore contrary to Article 3.1(a) of the SCM Agreement.
2 Please explain how

1 US Answers to Questions from the Panel, paras. 121-124; see also id., paras. 67-75 and 80-87.
2 EC first submission, para. 145.

the legislation as such -- which, by its terms, at least in the case of FSCs in existence on
30 September 2000, does not apply to transactions occurring before 1 January 2002 -- can
constitute a de facto violation of Article 3.1(a) of the SCM Agreement. Can the EC cite any
GATT/WTO reports in which legislation as such was found to be a de facto violation of any
obligations under the GATT/WTO Agreement?
Reply
5. With respect to paragraph 8 of the EC’s answer to Question 2 and the EC’s statement that the
“standard of contingency is the same, whether the subsidy arises de facto or de jure ”, the United
States reiterates that throughout this case the EC has ignored the meaning of the term “contingent” as
interpreted by the Appellate Body. The relevant de cisions of the Appellate Body are discussed in the
First US 21.5 Submission at paragraphs 109-110, which for the convenience of the Panel, the United
States reproduces here:
109. According to the Appellate Body, the “key word” in Article 3.1(a) is
“contingent.” The Appellate Body has explained that the term “contingent” has an
ordinary meaning of “conditional” or “dependent for its existence on something else.”
Thus, an export subsidy within the meaning of Article 3.1(a) is a subsidy that requires
recipients to export in order to obtain it. Or, in the words of the Appellate Body, “the
subsidy is available only upon fulfilment of the condition of export performance.”
110. It is not enough for a subsidy to be granted upon the mere expectation that the
subsidy will lead to new or additional exports; the grant of the subsidy in and of itself
must be conditioned on export performance. As the Appellate Body has said, “It does
not suffice to demonstrate solely that a government granting a subsidy anticipated
that exports would result. The prohibition in Article 3.1(a) applies to subsidies that
are contingent upon export performance ... . A subsidy may well be granted in the
knowledge, or with the anticipation that exports will result. Yet, that alone is not
sufficient, because that alone is not proof that the granting of the subsidy is tied to the
anticipation of exportation.” (Footnotes omitted).
6. By contrast, the EC standard for export contingency in this case ignores applicable Appellate
Body teachings. Because the Act, on its face, clearly allows a taxpayer to earn excluded income
without exporting, it cannot be regarded as “conditional”, “dependent” or “tied to” exportation. As
discussed above in connection with the EC’s response to Question 1, in an effort to avoid the
Appellate Body’s teachings, the EC improperly bi furcates the Act’s exclusion into two separate
exclusions.
7. With respect to paragraph 11 of the EC’s answer, if the EC actually is making an alternative
claim of de facto export contingency, it has provided absolutely no evidence to support such a claim.
Significantly, the EC does not even cite to any evidence that it has submitted which would support a
claim of de facto export contingency.
Q3. The European Communities states that it “¼ sees no reason to contest that the last
sentence of footnote 59 may be an exception to Article 3.1(a).”
3 Does this mean that the EC is of
the view that measures satisfying the requirements for the last sentence of footnote 59 constitute
“[m]easures referred to in Annex I as not constituting export subsidies” under footnote 5 of the
SCM Agreement?
Reply

3 EC second submission, para. 181.

8. The EC assertion in its answer to Question 3 that footnote 59 is simply a hortatory reminder
that double taxation avoidance measures are not subsidies is implausible. First, if this is what the
drafters had intended, they would have made footnote 59 a footnote to Article 1, as they did in
footnote 1 with respect to the exemption of indirect taxes.4
9. Second, the EC’s answer to Question 3 is inconsistent with its prior position in this dispute.
Previously, the EC took the position that the “last sentence of footnote 59 may well guide the
interpretation of Item (e) in a manner that is narrower than an alternative interpretation that might
prevail in its absence.”5 Translated, this constitutes an admission by the EC that the fifth sentence of
footnote 59 qualifies the scope of paragraph (e). The United States will address footnote 59 further in
its comments on the EC’s answer to Question 45.
Q5. Please provide further clarification of the point made in paragraph 227 of the EC
second submission
Reply
10. The EC does not adequately explain why it believes that extraterritorial income earned in a
wholly foreign transaction is not foreign-source income. The EC merely refers to an example in
which a US company distributes foreign-made goods. This example would result in extraterritorial
income if the US company distributed foreign-made goods to foreign purchasers or for foreign use. In
fact, this example would almost certainly involve distribution outside the United States. It is unclear
why such activities would be “domestic source” or would involve exportation at all.
Q13. Regarding the relationship between Article 3.1(a) of the SCM Agreement and item (e) of
Annex I, would it be possible that a certain measure is not within the scope of the latter, but
nonetheless within the scope of the former, and vice versa?
Reply
11. In the view of the United States, the EC did not answer the Panel’s question, which was
aimed at whether the standard of “contingency” is narrower in paragraph (e) than in Article 3.1(a).
12. The United States also notes that the example provided by the EC in paragraph 26,
first bullet, is incorrect. The United States does not know what the EC means by its reference to
“export promotion”, but in the case of “shipping companies”, shipping companies provide a service.
Thus, if a tax exemption constituted a subsidy to shipping companies, such a subsidy would not fall
under the SCM Agreement at all.
Q14. The Panel is well aware that the WTO-conformity of income tax regimes of European
countries is outside the scope of our terms of re ference for this case. In paragraph 96 of the US
first submission, the US introduces examples of a few European tax systems which “refrain
from taxing foreign income in a qualified or conditional manner.” 6 Among those systems, is
there one which excludes foreign income from the scope of taxable income on the following
conditions:
(i) the property for sale from which income arises must be held for ultimate use
outside the country, (and not be sold for final consumption in that country); and

4 See FSC (AB), para. 93.
5 FSC (Panel), para. 4.949.
6 US first submission, para. 97.

(ii) the same property must have foreign content of not more than a certain
percentage of its fair market value.
Reply
13. The United States refers the Panel to the US answer to Question 14, and our comments on the
EC’s answer to Question 23. In the view of the United States, the fact that exports are taxed more
favourably than domestic transactions under European tax regimes cannot be seriously contested.
14. With respect to paragraph 28 of the EC’s answer to Question 14, the United States has not
argued that “the term ‘foreign-source income’ should be interpreted widely so as to signify export
income.” The United States merely has argued that export transactions are one type of foreign
transaction that typically generates foreign-source income. As an evidentiary matter, the EC has not
established that the types of transactions capable of earning excluded income under the Act do not
have a “foreign-source income” component, nor has the EC established that the Act somehow
excludes domestic-source income.
Q15. Is the term “foreign-source income,” “for eign-source” or “source” used elsewhere in
any provisions of other WTO Agreements than the SCM Agreement? What guidance, if any,
may be drawn as to the meaning of these terms from the SCM Agreement or other WTO
Agreements?
Reply
15. The United States notes what the Panel probably has figured out on its own; namely, that with
respect to the Panel’s question regarding the use of the term “foreign-source income” in the FSC
panel and Appellate Body reports, the EC did not answer the Panel’s question, but instead engaged in
a seemingly irrelevant discussion of the Tax Legislation Cases. The United States respectfully refers
the Panel to the US answer to Question 15.
16. The European Communities claims that 7: "Even if it were a measure to avoid the
double taxation of foreign-source income, th e FSC Replacement Act would in any event be
contrary to Article 3.1(a) of the SCM Agreement because it gives exporters a choice that is not
available to other operators. This additional advantage would also be a subsidy,. This
unwarranted overcompensation is also a subsidy.
(For the EC): Please provide a te xtual analysis of how the alleged additional advantage
and overcompensation constitute subsidies under Article 1 of the SCM Agreement.
(For the US): How does the US respond to this allegation?
Reply
16. The United States is pleased to note that in its answer to this question, the EC appears to have
abandoned its specious argument that the existence of a choice between the use of foreign tax credits
and the exclusion somehow constitutes a subsidy. This argument is not credible given that: (1) the

7 EC second submission, paras. 221-222.

OECD Convention considers it acceptable to use credits, exemptions, or both methods of double
taxation avoidance,8 (2) the EC previously has acknowledged that most countries use a combination
of methods to avoid double taxation, 9 and (3) EC member states, such as France, allow for such a
choice.10
17. The United States also reiterates that the Act and its legislative history make clear that there is
no “double double taxation relief”, as the EC puts it. Foreign tax credits may not be used with respect
to excluded extraterritorial income.
11 As the United States has explained previously, the Act does not
provide a special advantage to a privileged class of taxpayers. Instead, it merely provides an
alternative form of double taxation relief that is broadly available to taxpayers. The availability of an
alternative in this context is no different than similar choices found in tax systems around the world.
Either the Act’s incorporation of the exemption method itself is problematic under WTO rules or it is
not. To hold, as the EC suggests, that the Act can be a prohibited export subsidy because it provides
an alternative mechanism of relief – even if that method is otherwise unobjectionable – simply cannot
be correct.
Q17. The EC seems to argue that a Article 3.1(b) violation may exist if a certain measure
gives an “incentive” to domestic production for export.
12 In the same vein, the EC argues that
“Article 3.1(b) prohibits local-content contingency to any degree, [and] there is no de minimis
rule for prohibited subsidies in the SCM Agreement.”.13
(For the EC): How would this argument be supported by a textual analysis of
Article 3.1(b) in accordance with Article 31 of the Vienna Convention? Can the
European Communities cite any Appellate Body or panel reports in which the
term “incentive” was explicitly used in the context of Article 3.1 of the SCM
Agreement, or Article XVI:4 of the GATT Agreement?
(For the US): Would a textual analysis of Article 3.1(b) lead to a conclusion that
the EC’s above argument is without merit? If so, why and how? Would the US
take the view that there is de minimis rule for prohibited subsidies in the SCM
Agreement? If so, what is the qualitative or quantitative threshold for that rule?
Is the Appellate Body Report in Canada - Certain Measures Affecting the
Automotive Industry 14 relevant to this question? Please give reasons for your
responses.
Reply
18. With respect to paragraph 43 of the EC’s answer to this question, the United States believes
that it is the EC that has provided a selective inte rpretation that fails to give meaning to all of the
words used in Article 3.1(b). For reasons previously expressed, the EC has ignored the meaning of
“contingent.” Similarly, the EC’s interpretation of the phrase “domestic over imported goods” is not

9 See US Oral Statement, para. 141, citing to EC-2, page 2 (US-5).
10 See US Answers to Questions from the Panel, para. 52.
11 See the Act § 3, amending IRC § 114(c)-(d) (US-1); Senate Report, page 2 (US-2); House Report,
page 10 (US-3); First US 21.5 Submission , para. 26; Second US 21.5 Submission , paras. 36-38; and US Oral
Statement, paras. 148-151.
13 EC second submission, para. 160.
14 WT/DS130/AB/R, WT/DS142/AB/R.

based on the ordinary meaning of the words used, and the conclusion the EC draws from the phrase
already has been rejected by the Appellate Body.15
19. With respect to paragraph 44 of the EC’s answ er, the EC quotes the Appellate Body statement
that Article III:4 “also addresses measures that favour the use of domestic over imported goods.” 16
From this, the EC appears to draw the conclusion th at the Appellate Body has found that the standard
for Article 3.1(b) is one of “favouring” domestic products.
20. This is a classic non sequitur. A measure that is “contingent” upon the use of domestic over
imported goods, within the meaning of Article 3.1(b), would “favour” domestic goods, but that does
not mean that the standard under Article 3.1(b) is transformed from “contingent” into “favour.”
Moreover, the next sentence in Canada Autos that immediately follows the sentence quoted by the EC
states: “Nevertheless, both Article III:4 of the GATT 1994 and Article 3.1(b) of the SCM Agreement
apply to measures that require the use of domestic goods over imports.” 17 The 50 per cent rule does
not “require” the use of domestic goods over imports.
Q23. The EC argues that, "for owners of US produced goods, export is a condition for
obtaining the benefits under the scheme for those goods" 18 and that there is accordingly an
export subsidy. Assume the existence of an exclusion from taxation for all foreign-source
income based upon application of a pure territorial system. Would export not be a condition
for owners of domestically-produced goods to obta in the exclusion in that case as well? Does
this mean that the application of a pure territorial system would also involve an export subsidy?
Please explain.
Reply
21. The EC contends that export transactions under a territorial system are taxed the same way as
non-export transactions.19 This contention is incorrect.
22. For a taxpayer to earn excluded income under a territorial system, the taxpayer must export
the goods to a foreign jurisdiction. It is irrelevant what happens to the goods after they are exported.
Certain goods may be imported back into the home jurisdiction in a “round-trip” sale for consumption
in the domestic market. 20 Other goods may be sold through the taxpayer’s foreign branch or
subsidiary for consumption in a foreign market. Regardless of their ultimate destination, however, the
goods first must be exported to the taxpayer’s foreign branch or subsidiary in order for the taxpayer to
earn exempt income.
23. When the goods are exported – which again they must be to qualify for the exemption – they
are taxed more favourably than comparable domestic sales, as the EC admits: “More favourable
treatment of export sales through a foreign distribution [ sic] compared with domestic sales through a
domestic distribution subsidiary may arise out of the fact that the foreign country has a lower tax rate

15 See US Answers to Questions from the Panel, paras. 53-57.
16 As a technical point, the United States observes that the EC failed to note that it added emphasis to
the quotation that is not in the original.
17 Canada - Certain Measures Affecting the Automotive Industry , WT/DS139/R, WT/DS142/R, Report
of the Appellate Body adopted 19 June 2000, para. 140 (underscoring added).
18 EC rebuttal submission, para. 102.
19 EC Answers to Panel Questions , para. 54. The United States also respectfully notes that the Panel’s
question is based on a false premise; i.e., in the real world, there are no “pure” territorial systems. Indeed, as the
United States previously has demonstrated, the territorial exemptions applied by various EC member states are
all subject to various qualifications and conditions. First US 21.5 Submission, para. 96.
20 Second EC 21.5 Submission, para. 112.

(but not when the foreign tax rate is higher).” 21 Accordingly, the EC’s defence of its member states’
use of the territorial exemption method conflicts with its own attack on the Act’s exclusion of
extraterritorial income.
24. The EC’s attempt to treat the export-related activities of foreign subsidiaries as non-export
activity is not new. The panel in the Tax Legislation Cases saw through the same artificial distinction
the EC is now attempting to draw. As one leading scholar has explained regarding those cases:
Given that the three European defendants had chosen not to assert the bilevel pricing
defence [under GATT Article XVI], the only real issue in the three counterclaims was
whether the failure to tax foreign earnings was an export subsidy in the first place.
The key to the panel’s finding on this point was its decision to treat the two parts of
the tax-haven transaction – the exporter’s initial export to its foreign alter ego and the
alter ego’s resale to the ultimate buyer – as a single export transaction ... . The
implication was that what went on outside the country – the resale – was also part of
the same ‘process’. By not taxing the income from second sale, therefore,
governments were granting a tax exemption to the exporting process.
22
25. The EC most significantly errs in asserting that sourcing determinations for tax purposes must
be based strictly upon arm’s-length transfer prices. This assertion is invalid, and, in the present case,
dangerous. Although broadly consistent with economic activities, sourcing determinations apply
numerous rules of administrative convenience. For example, many jurisdictions simply rely upon the
residence of the payor to determine the source of income, regardless of where the income was
economically generated.

21 Id., para. 56. When the foreign tax rate is higher, taxpayers presumably will choose not to route
sales through the foreign distribution subsidiary.
22 Robert E. Hudec, Reforming GATT Adjudication Procedures: The Lessons of the DISC Case ,
78 Minn. L. Rev. 1443, 1482 (1988) (copy attached as Exhibit US-30). Professor Hudec added: “Everyone in
the tax business knew that a territorial tax system could be used to make the taxation of export operations
significantly lower than the taxation of identical domestic operations. Id.
In paragraph 57 of the EC’s answer to this question, the EC disputes the fact that the panel in the Tax
Legislation Cases “made ‘factual findings’ that territorial syst ems provide better treatment to export sales.”
However, if the panel did not make such findings, then the post-1976 behaviour in the GATT Council of the EC
and the member states involved becomes inexplicable, and it is difficult to fathom why they insisted on the
adoption of the 1981 Understanding. In order to be clear on this point, here is what the panel in the Tax
Legislation Cases found:
The Panel found that however much the practices may have been an incidental consequence of
Belgian taxation principles rather than specific policy intention, they nonetheless constituted a
subsidy on exports because the above-mentioned benefits to exports did not apply to domestic
activities for the internal market . . . .
In circumstances where different tax treatment in different countries resulted in a smaller total
tax bill in aggregate being paid on exports than on sales in the home market, the Panel
concluded that there was a partial exemption from direct taxes ... .
Income Tax Practices Maintained by Belgium , L/4424, BISD 23S/127, paras. 35, 37. The panel made similar
findings in Income Tax Practices Maintained by France , L/4423, BISD 23S/114, paras. 48, 50, and in Income
Tax Practices Maintained by the Netherlands, L/4425, BISD 23S/137, paras. 35, 37.
The EC’s observation in paragraph 57 that the Tax Legislation Cases involved different legal
obligations and different dispute settlement arrangements is irrelevant to the nature of what the panel found as a
matter of fact. The GATT Council adopted those factual findings, and the only alteration the Council made was
to adopt the 1981 Understanding, which changed the legal conclusions that flowed from the panel’s factual
findings.

26. Nevertheless, the EC invites the Panel: (1) to define the term “foreign-source income” using
the domestic laws of the alleged subsidizing party, and (2) to rule that “foreign-source income” for
purposes of those very laws must be determined on the basis of arm’s-length transfer prices. Such a
finding might suit the EC’s present convenience, but it would contravene the intent expressed in
footnote 59, which was to avoid placing any “limit” on the ability of Members to take measures to
avoid double taxation of foreign-source income, rather than forcing them to adopt strict arm’s length
transfer pricing into their source rules.
Q24. Would a measure that exempted foreign-source income from taxation (i.e., a pure
territorial system) be a measure to avoid the double taxation of foreign-source income within
the meaning of footnote 59?
Reply
27. The United States submits that territorial tax systems should be viewed in the same way as the
Act in the context of footnote 59.23 They should pass muster or fail for the same reasons.
28. The EC, however, attempts to distinguish the systems of its member states from the Act in a
way that simply has no basis in reality. The EC states that the “prevailing benchmark” in a territorial
tax system is to tax income generated within the territory of the taxing authority. However, this
benchmark only exists because the EC says it exists . The EC’s response is simply inconsistent with
the way EC “territorial” systems actually operate. The EC explained to the FSC Panel that its
member states generally apply taxes on business income on a worldwide basis, but then provide an
exemption for foreign-source income. 24 The United States previously has explained how five
European tax systems make an exception for foreig n-source income in relation to their otherwise
applicable tax rules.25
29. As discussed above in the US comments on the EC’s answer to Question 23, so-called
territorial systems tax income from export transactions more favourably than comparable domestic
transactions because exporters can exempt part of their income from tax. Where exporters in a
country providing a territorial exemption run their transactions through a lower-tax jurisdiction, they
net an overall tax savings. According to the EC’s argument in this dispute, this constitutes a subsidy
contingent upon export performance.
30. The Panel’s question raises the further interesting question, which the EC has consistently
refused to answer:
26 whether a country that taxes some persons on an exemption basis and other
persons on a worldwide basis (at their election) confers subsidies within the meaning of Article 1.1. 27
Under the EC’s argument, it would appear that the answer to this question is “yes.”
31. The United States also notes the EC’s assertion that the territorial exemption “is however
undeniably a measure to avoid the double taxation of foreign-source income.” Given that countries
that rely on the exemption method typically do not require that the exempted income actually be
taxed, the United States considers this assertion irreconcilable with the position that the EC has taken
with respect to the Act.

23 Again, the United States notes that there are no such things as “pure” territorial tax systems.
25 First US 21.5 Submission, paras. 42 and 96.
26 EC Answers to Questions from the United States, para. 1.
27 As the United States has noted previously, France is an example of such a country. US Answers to

Q25. The EC argues that "the fact that th e extension of the FSC replacement scheme to
foreign produced goods is subject to a foreig n content requirement creates in many cases a
requirement for exports to be made from the US. This renders the extended FSC Replacement
subsidy also export contingent and thus prohibited." 28 Is it the EC's view that the measure is
contingent de jure on export performance? Or de facto? Is it export-contingent only in those
cases where compliance requires the export of US good s, or does the fact that the export of US
goods may sometimes be required render the "extended FSC replacement scheme" export-
contingent in its totality?
32. The United States disputes the EC’s assertion in paragraph 60 of the answer to this question
that “[i]t was clear from evident facts known to all at the time the law was adopted that respecting the
foreign content limitation would require the use of US articles in many cases.” The EC cites nothing
to support this assertion, and the United States does not believe that there is anything in the record of
this case that would substantiate the assertion. The EC does not even identify what the “evident facts”
were or the identity of the “all concerned” to which it refers. The EC essentially is asking the Panel to
take “judicial notice” of a key fact which, under established WTO jurisprudence, the EC has the
burden of proving, and for which it has failed to satisfy that burden.
33. The United States also disputes the EC’s assertion in paragraph 62 of its answer to this
question that “the fact that export of US goods may sometimes be required renders the ‘extended FSC
replacement scheme’ export-contingent in its totality”. The United States does not agree that it is ever
a necessity for a taxpayer to use US, as opposed to imported, articles in order to qualify for the Act’s
exclusion. The United States also does not believe that, because some taxpayers choose to use US
goods to satisfy the 50 per cent rule, this renders the Act export contingent. There are a host of
reasons underlying private decisions to use domestic goods – or to export – in order to satisfy certain
requirements, but these decisions do not create an export contingency per se. If that were the case,
then every broadly applicable production subsidy would be export contingent if one manufacturer
decided that it “needed” to export in order to obtain the subsidy.
Q26. The EC states that the basic FSC subsid y is contingent upon the use of domestic over
imported goods because domestic US articles wi ll "often" be necessary to ensure that the
foreign content limitation is not exceeded.
29 Is it the EC's view that the frequency with which
this will be the case is relevant to whether th e 50% foreign content rule is inconsistent with
Article 3.1(b)? Would the rule be inconsistent with Article 3.1(b) if domestic US goods were
"sometimes" necessary? Occasionally? Rarely?
Reply
34. With respect to paragraph 63 of the EC’s answer to this question, the United States is not sure
what to make of the EC’s assertion that the Act is inconsistent with Article 3.1(b) “by the reason [sic]
of the fact that it give [ sic] rise to a requirement to use US article [ sic] in any case.” (Emphasis in
original). The United States assumes that this statement is merely the product of hasty drafting, and
that the EC argument remains that the Act would violate Article 3.1(b) if in a single, actual case the
use of US articles was required. If this remains the EC argument, the EC has not presented any
evidence that this is the case, but simply has offered hypotheticals allegedly based on “actual” data to
which only the EC has had access.
35. On the other hand, if the EC statement reflects a shift in the EC argument to the effect that the
Act requires the use of US articles in all cases, the EC has not presented any evidence to support this
assertion either.

28 EC first submission, para. 119.
29 EC first submission, para. 174.

Q28. Is it possible to establish on the basis of the Act itself, and without reference to external
facts relating to the manufacture of particular products, that the 50 per cent foreign content
rules require a beneficiary in some cases to use domestic over imported goods? If not, and
taking into account the view of the Appellate Body in Canada – Certain Measures Affecting the
Automotive Industry30 that contingency in law is demonstrated "on the basis of the words of the
relevant legislation, regulation or other legal instrument", please explain how the Act could be
contingent in law on the use of domestic over imported goods.
Reply
36. The EC’s answer to this question ignores the key portion of the Appellate Body report in
Canada Autos, which runs from paragraphs 126-131 of the report. There, the Appellate Body found
that the mere existence of a content requirement is not enough to violate Article 3.1(b). Instead, given
the “multiplicity of possibilities”, one must examine how such requires “operate for individual
manufacturers.” The United States does not believe that the EC has met its burden of proof with
respect to the standard articulated in Canada Autos.
Q32. What is the relationship, if any, between the scope of Article III:4 of the GATT and
Article 3.1(b) of the SCM Agreement -- is one necessarily broader than the other-- could a
measure fall within the scope of one of these provisions, but not within the scope of the other?
Please substantiate your response with reference to past GATT/WTO dispute settlement reports
and other materials.
Reply
37. The United States is pleased to note that the EC agrees with the United States that the scope
of Article III:4 is broader than that of Article 3.1(b).
38. In addition, with respect to paragraph 84 of the EC’s answer to this question, the United
States also is pleased to see the EC finally refer to a relevant portion of the Appellate Body report in
Canada Autos, which states that the standard of contingency under Article 3.1(b) is that a measure
must “require the use of domestic goods over imported goods.” (Emphasis added). Of course, the
EC has failed to demonstrate that the Act requires the use of domestic over imported goods, but
instead, relying on an incorrect legal standard, has alleged that the Act violates Article 3.1(b) because
it allegedly “favours” or “gives preference to” domestic over imported goods.
Q33. The EC states that "the US review of its subpart F legislation is yet to be completed". 31
Please explain whether and how this statement is relevant to the current proceeding.
Reply
39. The EC asserts that the Treasury Department study of subpart F refutes the US statement that
the Act represented, in part, the results of a review by the US Senate of the international provisions of
the US Internal Revenue Code.
32
40. The EC assertion proves nothing of the sort, and in making the assertion, the EC appears to be
projecting on to the United States the relative powers of European Union institutions. However, in

30 Appellate Body Report, WT/DS139/AB/R, WT/DS142/AB/R, adopted 19 June 2000, para. 123.
31 EC rebuttal submission, para. 29.
32 This statement was made in the First US 21.5 Submission , para. 24, citing to Senate Report, page 5
(US 2).

the United States, the Congress and the Executive are separate and co-equal branches of government
(along with the Judiciary), and the fact that the bureaucracy may have been studying subpart F does
not negate the fact that the US Senate was conducting its own, independent review of the international
provisions of the Internal Revenue Code. The Senate stated that the Act was, in part, a product of its
review, 33 and the EC’s assertion to the contrary is presumptuous, as well as unsubstantiated.
Q34. Is the Panel to understand from Section 4.3.2 of the EC's rebuttal submission that the
EC is not relying on the language "whether sole or as one of several other conditions" as a basis
for its argument that the existence of "alternatives" to exportation as a means to gain
entitlement to the alleged subsidy provided under the Act does not eliminate the alleged export
contingency?
Reply
41. The EC’s answer that its “argument does not depend on these words” is reflective of the fact
that the EC has ignored these words. In the view of the United States, however, these words cannot
be ignored, and the US explanation of what these words mean and their significance to this case is set
forth in the First US 21.5 Submission , paras. 133-136. For the reasons set forth in prior US
submissions, the United States believes that these words confirm the US – not the EC’s – position,
and the EC never has rebutted the US arguments regarding the meaning of these words.
42. Furthermore, the United States understands the EC’s answer to mean that its Article 3.1(a)
claim is not based on the notion that the Act is export contingent for one category of transactions but
not others. The EC’s answer indicates that its argument is premised on the theory that the Act is
export contingent in its entirety. That is, there is one export contingency in the Act that applies
equally in all circumstances. As a practical matter, this means that the EC is not arguing that the Act
violates Article 3.1(a) because it requires exporting or some other type of activity. Rather, the EC is
arguing that the Act requires exporting in all cases. As the United States has demonstrated, however,
the Act does not require exporting at all, let alone in all cases. The EC has failed to prove otherwise.
Q35. Please comment on paragraphs 91, 108, 159 and 170-171 of the US Oral Statement.
Paragraph 91
Reply
43. The United States respectfully refers the Panel to the US comments on the EC’s answer to
Question 23.
44. The United States would add to those comments that it does not see how the EC’s discussion
regarding what it terms “capital-export” and “capital-import” neutrality is relevant to the present
dispute. Nevertheless, with respect to the EC’s statement in paragraph 93 regarding capital-import
neutrality – in which the EC said that such neutrality pertains to not influencing whether a taxpayer
establishes operations at home or abroad – the United States notes that the Act applies equally to
foreign transactions irrespective of whether goods are produced in the United States or abroad.
45. In its answer, the EC continues to maintain that the tax systems of its member states are not
export contingent under Article 3.1(a) because export income is not treated better than domestic
income. The United States again notes, as it did in its comments regarding question 23, that domestic
manufacturers can benefit from a territorial exemption only by exporting. The EC’s attempts to
distinguish between export sales made by domestic manufacturers to their subsidiaries on the one

33 Senate Report, page 5 (US-2).

hand, and income earned by these subsidiaries in selling exported products on the other, ignores the
reality of such transactions and the reasoning of the Panel and the Appellate Body in FSC. There, the
Panel and the Appellate Body found that the US partial exemption of income earned by foreign sales
subsidiaries – and the tax-free repatriation of dividends from such income – constituted prohibited
export subsidies. The fact that foreign subsidiary income was involved was irrelevant.
Paragraph 108
46. With respect to the EC’s answer regarding paragraph 108, in footnote 37 the EC states that
the definition of “qualifying foreign trade property” in the Act is “identical” to the definition of
“export property” in the former FSC provisions. In doing so, the EC conveniently ignores the fact
that the FSC definition required that covered products must be made, produced, or extracted in the
United States. In contrast, the most significant aspect of the definition of “qualifying foreign trade
property” is that the term means, inter alia , “property . . . manufactured, produced, grown, or
extracted within or outside the United States .” The Act § 3, amending IRC § 943(a)(1)(A) (US-1)
(emphasis added).
47. In paragraph 97, the EC asserts that “specifically”, as used in paragraph (e) of Annex I, means
“having a special, precise or clearly defined relationship or connection to exports.” Assuming
arguendo that the EC’s interpretation is correct, the United States is at a loss to understand how an
exclusion applicable to income earned from goods that can be manufactured and sold outside of the
United States, and without incorporating any US articles, can have a “special, precise or clearly
defined relationship or connection to exports.”.
48. With regard to the EC’s statement in paragraph 98 that the “extended subsidy” is export
contingent “because in many cases it will be necessary for US goods to be exported as components
and raw materials in order to respect the foreign cont ent limitation”, the United States notes that: (1)
the EC has failed to prove that US goods will be used over imported goods in any instance, let alone
“in many cases”, and (2) the fact that private actors may choose to use US goods does not amount to
the type of condition that renders the so-called “extended subsidy” export contingent under Article
3.1(a).
Paragraph 159
Reply
49. In paragraph 101 of its answers, the EC appears to have introduced yet another standard for
Article 3.1(b) that deviates from the actual language of that provision. The EC now argues that
Article 3.1(b) is violated if a contingency on the use of domestic over imported goods “is not
precluded.” Because the United States is not even sure what the EC means by this phrase, our
comments necessarily are limited to the observation that this new standard is not supported by the text
of Article 3.1(b) itself or applicable panel and Appellate Body jurisprudence regarding the meaning of
the term “contingent”.
Q36. In regard to the "extended" FSC Repl acement subsidy scheme, is there “revenue
forgone" that is "otherwise due”? What is th e US legal rule that would apply to the foreign
beneficiary of the extended scheme in the absence of the "extended" scheme? What is the
“some other situation” for foreign beneficiaries of the "extended" regime, in which their income
would be subject to the US taxation? If, in the EC’s view, it is different from the legal rule --
normative benchmark -- applicable to the "basic" subsidy scheme, , please specify.

Reply
50. The United States is pleased to note that the EC now agrees that the normative benchmark in
the United States is determined by the definition of “gross income” contained in section 61 of the
IRC.34 This answer, however, disproves the EC’s own position because the Act, in section 114,
excludes a category of income from the section 61 definition of gross income. The EC, therefore,
seems to be arguing either (1) that section 114, despite its plain language, somehow is ineffective in
amending section 61, or (2) that any amendment to section 61 automatically confers a subsidy.
51. Section 61 can be understood only in light of th e other provisions of the IRC that define its
terms and application. Section 114 is an integral part of section 61. The EC would disconnect section
114 from section 61. It in effect is asking the Panel to assume that the United States normative
benchmark is to tax all income earned by parties that may be subject to US tax. However, in the US
system, “gross income” is a term with a special meaning. It does not apply to all income. It applies
only as defined by the IRC.
52. In any event, despite the EC’s rhetoric, th e EC’s answer to the Panel’s question shows how
much this case differs from the FSC case. In that case, the Panel found that the FSC provisions
conferred exceptions to three specific, otherwise applicable tax measures: subpart F (sections 951(e)
and 954(d)), the tax on effectively connected earnings (section 921(a)), and the limitation on the
dividends received deduction for foreign corporations (section 245(c)).
35 The EC points to no such
exceptions in this case. Rather, the EC declares that the income would be taxable under section 61 if
the Act had not amended section 61. However, Article 1.1 is not so broad as to sanction such circular
reasoning.
Q37. What is the US “norm” which can constitute a “normative benchmark” for the purpose
of Article 1 of the SCM Agreement? Can the EC specifically identify any US tax rules in
addition to the new Section 941(a)(1) of the IRC which defines the term “qualifying foreign
trade income”? In other words, what is the statutory basis for the EC’s argument that the US is
still maintaining its "worldwide" tax system?
Reply
53. The EC’s answer to this question contains an assortment of misleading and irrelevant citations
and quotations.
54. First, the EC cites certain historical documents to suggest that US Constitution requires the
United States to maintain a “worldwide” tax system. This suggestion is false. The Sixteenth
Amendment to the US Constitution gives the US Congress the power to levy an income tax “without
apportionment among the several States, and without regard to any census or enumeration.” 36 Th e
Sixteenth Amendment does not require Congress to levy an income tax at all, much less an income
tax on extraterritorial or foreign-source income. The same can be said about the EC’s citation of
Cook v. Tait , 265 US 47 (1924), and Commissioner v. Glenshaw Glass Co ., 348 US 426 (1955).
Neither case states that the United States is bound to tax extraterritorial or foreign-source income.
55. Second, the EC cites two treatises for the false proposition that the United States still taxes its
citizens and residents on a worldwide basis despite the extraterritorial income exclusion. However,

34 EC Answers to Questions from the Panel, paras. 116, 126, 127.
35 FSC (Panel), para. 7.100.
36 The Sixteenth Amendment was adopted to override the rule, in Article III of the US Constitution,
that “[n]o Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein
before directed to be taken.” US Const., art. III, § 9.

both treatises pre-date the Act, and therefore fail to reflect the Act’s change to the normative
benchmark for taxation in the United States.37
56. The EC next quotes the Treasury Department’s Subpart F Study for the same, false
proposition that the United States still adheres to a “worldwide” tax system. The EC, however, omits
the statement, contained in the Study, that “[t]he United States also has elements of a territorial
regime. For example, section 911 modifies US worldwide taxation by allowing US individuals
working overseas to exclude from their US income certain amounts of foreign earned income and
housing costs. Similarly, section 114 excludes from gross income extraterritorial income of a
taxpayer.”38 The EC’s selective citation of the Study undermines both its argument and its credibility.
57. Fourth, the EC cites two cases, Interstate Transit Lines v. Commissioner, 319 US 590 (1943),
and Jones v. Kyle , 190 F.2d 353 (10th Cir. 1951), for the proposition that “provisions granting
deductions or exclusions of items from gross income are ‘matters of legislative grace’ and are
therefore to be ‘strictly construed.’” Regardless of whether the Act is construed strictly or
expansively, excluded extraterritorial income is no longer part of the US tax base. Moreover, the
cited cases do not support the proposition advanced by the EC. Interstate Transit Lines only
discussed deductions, not exemptions or exclusions, and Jones v. Kyle merely reiterated the rule in
Cook v. Tait that the United States may tax foreign-source income if it so decides. The United States
has decided not to tax foreign-source income that is excluded extraterritorial income.
58. Thus, the only true statement in paragraph 132 of the EC’s answers is the statement that
section 114 is one of several, specific exclusions from the section 61 definition of gross income.
However, the EC still refuses to acknowledge the legal effect of this stubborn fact.
59. Fifth and finally, the EC cites the section 911 earned-income exclusion as support for its self-
created “general rule” that the United States continues to tax on a purely worldwide basis. To the
contrary, as noted above in connection with the Subpart F Study, section 911 represents another
aspect of territoriality adopted by the United States. Thus, the EC’s citation of section 911 disproves
the EC’s “general rule”.
60. More generally, it is unclear to the United States how the foregoing use of misleading and
irrelevant citations and quotations will assist the Panel in resolving this case.
Q39. In the EC’s view, would the Act be cons istent with the SCM Agreement if the United
States eliminated the requirements that the property be held for use “outside the United States”
and the “foreign content limitation”?
Reply
61. The United States is pleased to finally learn the specific provisions of the Act to which the EC
actually objects – sections 942(a)(2)(A)(i) and 943(a)(1)(B) and (C) . The EC’s answer confirms that
the EC’s lengthy critique of other provisions of the Act is irrelevant.
62. Given the significance the EC attaches to these provisions, the United States believes that it is
essential for the Panel to explain the relative importance of each of these provisions in its decision.
For example, if the Panel were to find the “foreign content limitation” to be problematic, the Panel
should clarify whether the requirement that property be held for use “outside the United States” is

37 The EC’s citation to the Isenbergh treatise, “International Taxation: US Taxation of Foreign Persons
and Foreign Income, vol. 1, at p. 2:32 (2nd ed. 2000),” appears to date from after the effective date of the Act.
In fact, the quotation comes from a November 1997 insert to the treatise.
38 Subpart F Study, at p. xi, n.18.

problematic only because of the existence of the “foreign content limitation” or is inherently
problematic on its own. The United States has explained that it believes that neither is improper
under WTO rules.
63. Furthermore, the United States submits that the EC’s answer to question 39 highlights the
superficial approach it has taken in this case. The EC, for example, does not address the fact that
there are at least two types of income under the Act that would appear to satisfy even the EC’s
erroneous interpretation of the fifth sentence of f ootnote 59. First, with respect to wholly foreign
transactions – that is, transactions taking place entirely outside the United States 39 – none of the
income arising from such transactions can be said to be US or domestic income. All of the income
earned in such transactions occurs outside the United States and can thus be subject to tax in another
jurisdiction.
64. Moreover, with respect to transactions originating in the United States, new IRC section
941(a)(1)(A), as added by the Act, provides that 30 per cent of "foreign sales and leasing income” is
excluded from taxation. According to new section 941(c), ‘‘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 [under the Act’s “foreign economic processes
requirements”]. Under the Act, these are activities that must be performed outside the United States
and, as a result, comport fully with the EC’s unduly narrow “foreign economic activities” definition of
“foreign source income”.
65. One of the legislative reports accompanying the Act gives the following example of “foreign
sales and leasing income”: “For example, a distribution company’s profit from the sale of qualifying
foreign trade property that is associated with sales activities, such as solicitation or negotiation of the
sale, advertising, processing customer orders and arranging for delivery, transportation outside of the
United States, and other enumerated activities, would constitute foreign sale and leasing income.”
40
That report goes on to say that, where related parties are involved,
foreign sale and leasing income may not exceed the amount of foreign sale and
leasing income that would have resulted if the taxpayer had acquired the leased
property in a hypothetical arm’s-length purchase and then engaged in the actual sale
or lease of such property. For example, if a manufacturer leases qualifying foreign
trade property that it manufactured, the foreign sale and leasing income derived from
that lease may not exceed the amount of foreign sale and leasing income that the
manufacturer would have earned with respect to that lease had it purchased the
property for an arm’s-length price on the day that the manufacturer entered into the
lease.
41
66. This means that section 941(a)(1)(A) of the Act provides an exclusion for 30 per cent of
income directly attributable to a defined class of foreign economic activities based on arm’s-length
values. Such income appears to be precisely the type of income that would fall within the fifth
sentence of footnote 59 even under the EC’s interpretation. Indeed, it is the type of income that the
EC claims its member states exempt through their “territorial” systems.
67. The United States, of course, does not agree with the tests and standards the EC has advanced
regarding footnote 59. However, assuming arguendo that such tests and standards apply, the EC
should at the very least explain why provisions of the Act that appear to be fully consistent with

39 This includes circumstances in which no US goods are included the products at issue.
40 Senate Report (US-2), pages 10-11.
41 Id.

standards advocated by the EC are improper. The EC has ignored wholly foreign transactions and
section 941(a)(1)(A) completely.
68. Therefore, the United States respectfully requests that, should the Panel adopt the EC’s
interpretation of footnote 59, the Panel should make findings as to whether the Act’s treatment of
income derived from wholly foreign transactions and “foreign sales and leasing income” are measures
to avoid double taxation of foreign-source income under that interpretation. An abstract discussion of
the “foreign content limitation” and the “foreign destination test”, without more, would not promote
resolution of this particular dispute or the aims of the multilateral system more generally.
Q43. Can a measure of a Member provided in re spect of the production of a good outside the
territory of that Member be a subsidy within the meaning of Article 1 of the SCM Agreement?
Please explain your answer, taking into account any relevant provisions of the SCM Agreement.
Reply
69. With respect to paragraph 157 of the EC’s answ er to this question, the United States merely
recalls that the policy reflected in section 351.527 of the US Department of Commerce countervailing
duty regulations is subject to certain exceptions.42
Q45. Is export income foreign source income? Some may take the view that the “foreign-
source income” referred to in footnote 59 shou ld include export income since the footnote is
accompanying item (e) that is dealing with a ty pe of subsidy specifically related to export.
Please comment.
Reply
70. In its answer to this question, the EC appears to take the position that the fifth sentence of
footnote 59 does not qualify paragraph (e) of Annex I. As noted above in connection with the US
comments on the EC’s answer to Question 3, the EC position is contradicted by the fact that footnote
59 is attached to paragraph (e) rather than Article 1. In addition, the EC position is inconsistent with
prior EC statements regarding the meaning of the fifth sentence.
71. The EC position appears to be based on the use of the phrase “is not intended to” in the fifth
sentence. According to the EC, if the drafters had intended that the fifth sentence qualify
paragraph (e), they would have used different language. However, there are many, many ways to
draft effective treaty provisions, and the universe of the WTO agreements provides numerous
examples of different drafting styles. In the view of the United States, the phrase “is not intended to”
constitutes a perfectly acceptable (and conventional) way of expressing the drafters’ intent as to the
scope of paragraph (e).
72. In this regard, the phrase “is not intended to” also appears in footnote 56 of the SCM
Agreement, a footnote attached to Article 32.1. Article 32.1 provides as follows:
No specific action against a subsidy of another Member can be taken except
in accordance with the provisions of GATT 1994, as interpreted by this Agreement.
On its face, Article 32.1 arguably might limit action against a subsidy to action under the SCM
Agreement or GATT Articles VI and XVI to which the SCM Agreement relates.
73. However, footnote 56 provides as follows:

42 US Answers to Questions from the Panel, para. 110.

This paragraph is not intended to preclude action under other relevant
provisions of GATT 1994, where appropriate.
The meaning of this footnote was at issue in the Indonesia Autos case in connection with Indonesia’s
argument that the SCM Agreement provided the exclusive remedy against measures that could be
characterized as subsidies. In rejecting Indonesia’s argument, the panel gave meaning to footnote 56,
and cited it for the proposition that actions against subsidies remain possible under GATT 1994.43
74. Finally, other portions of footnote 59 belie the EC’s claim that the fifth sentence is merely
“declaratory” of principles that the drafters articulated elsewhere. In the second sentence of
footnote 59, Members “reaffirm the principle” regarding arm’s length pricing between related parties.
Given the use of this language in the second sentence, if the fifth sentence was merely “declaratory”
of a principle articulated in Article 1, as claimed by the EC, the drafters would have written the fifth
sentence as follows:
Members reaffirm the principle in Article 1 that a measure taken by a
Member to avoid the double taxation of foreign-source income earned by its
enterprises or the enterprises of another Member is not a subsidy.

43 Indonesia - Certain Measures Affecting the Automobile Industry , WT/DS54/R, WT/DS55/R,
WT/DS59/R, WT/DS64/R, Report of the Panel adopted 23 July 1998, para. 14.36, note 659.

ANNEX F-7
COMMENTS OF THE UNITED STATES
ON EC'S ANSWERS TO US QUESTIONS
Q1. What is the "prevailing standard" or "g eneral rule" of taxation in a country which
taxes some persons on a worldwide basis and some persons on an exemption basis, in some cases
at their election (and subject in such cases to the discretion of the government)? Please explain
the basis for your answer.
Reply
1. The EC’s inability to respond to this question is rather peculiar. The EC has had little
reluctance in characterizing what it perceives to be the “prevailing standard” or “general rule” of the
US tax system. Indeed, the EC has even gone so far as to reject US descriptions of its own tax
system, including descriptions made by the US Congress contemporaneous with passage of the Act.
2. It is difficult to escape the conclusion that the EC wants to avoid answering a rather difficult
question. In particular, the EC does not want to acknowledge the fact that certain countries, including
France, allow taxpayers to choose between a territorial/ exemption system and a worldwide/credits
system. More generally, the EC appears reluctant to acknowledge the fundamental similarities
between the US tax system after adoption of the Act and the tax systems of its own member states.
Q2. Is the tax exemption by a country of "foreign-source income" (for purposes of
footnote 59) permissible under the SCM Agreement only if all "foreign-source income" is
exempt from tax? Please explain the basis for your answer.
Reply
3. The EC’s answer is incomplete and difficult to understand. In response to the US question of
whether an exemption of foreign-source income under footnote 59 must be for all such income, the
EC merely says “no,” and then says that the proble m with the Act in this re gard is that it offers a
choice to a limited number of privileged taxpayers. This makes no sense for two reasons.
4. First, the EC’s answer of “no” to the question is directly contradictory to many of its
arguments in this case – in particular, that the Act’s exclusion is improper because it is conditioned on
a number of factors and does not apply to products imported into the United States. The EC’s
arguments regarding Article 1 of the SCM Agreement are predicated on the contention that the Act’s
exclusion, unlike EC territorial exemptions, allegedly does not adhere to a neat and clean formula or
principle but is subject to numerous exceptions and requirements. The EC’s arguments regarding
Article 3 of the SCM Agreement similarly are based on the notion that the exclusion, in the EC’s
view, applies to exports, a near empty set of wholly foreign transactions, and no imports. It would
appear to be impossible to reconcile these EC’s arguments with its answer of “no” to the question.
5. Second, as the United States has explained, the Act does not apply solely to “privileged
taxpayers”, and it does not provide such taxpayers with “a more advantageous means of avoiding
double taxation”. The Act applies to all US taxpayers that engage in transactions giving rise to
extraterritorial income. These taxpayers can be individuals or businesses, corporations or
partnerships, and subsidiaries or branches. In fact, these taxpayers need not even be American, since
the Act applies equally to non-US enterprises.

6. Moreover, the Act does not provide more generous relief than US tax credits, but rather an
alternative means of relief. For some taxpayers, the Act may be more advantageous. For others, tax
credits would be better. This outcome might change for taxpayers from transaction to transaction. In
providing alternative options, the United States is doing precisely what many other countries do
(including France, as noted in our comments on the EC’s answer to U.S Question 1). As evidence of
this fact, the Commentary to Article 23 of the OECD Convention notes that countries may use credits,
exemptions, or both.
Q4. Are the EC member States prepared to re linquish all source-based taxation with respect
to business profits in the absence of a "permanent establishment," as that term is defined in
Article 5 of the OECD Model Income Tax Convention?
Reply
7. The EC’s response fails to acknowledge four fundamental facts relevant to this dispute.
First, countries draw their taxing boundaries differently, and many impose taxes on non-residents in
the absence of a permanent establishment. Second, one reason countries enter into tax treaties is to
avoid double taxation that can arise when other countries tax income earned within their borders even
if no permanent establishments are involved. Third, no country has tax treaties with all other
countries with which its citizens and businesses do business. And fourth, many if not most countries
have domestic double taxation avoidance measures that operate in conjunction with, or in addition to,
tax treaties.
8. Thus, it is difficult to understand how the EC can argue, as it does by implication in response
to US Question 4, that a measure to avoid double taxation under footnote 59 can only apply to
permanent establishments. The EC appears to be arguing that footnote 59 encompasses only tax
treaties based on the OECD Convention or domestic double taxation avoidance measures that follow
OECD principles. The OECD C onvention is evidence of certain ways a number of countries have
agreed to avoid double taxation in limited circumstances. However, it cannot be correct that the fifth
sentence of footnote 59 applies only in instances where the OECD Convention calls for the use of the
exemption or credit methods.
9. Because the EC seems to consider the concept of a permanent establishment to be so central
not only to the right of a country to avoid double taxation, but also to the right of a country to tax
income in the first place, the United States aske d if the EC was taking the position that countries
should not or cannot impose tax on non-residents in the absence of a permanent establishment. The
first paragraph of the EC’s answer – stating that countries are generally free to tax whatever income
they wish – indicates that the EC recognizes that taxes may be levied even where there is no
permanent establishment. Given this reality, countries may need flexible approaches to protect against
double taxation. The EC’s seemingly rigid adherence to the concept of a permanent establishment
does not coincide with the more far-reaching approaches of many tax systems and would not allow for
double taxation avoidance where these more far-reaching approaches are employed.
10. The United States respectfully refers the Panel to its answer to Panel Question 12, in which
the United States provides examples of a number of countries that do not rely on the concept of a
permanent establishment in establishing taxing jurisdiction.
Q6. Does the OECD Model Income Tax Convention contain a definition of the term
"foreign-source income"? If so, please identify the provision containing such definition.

Reply
11. It is noteworthy that the EC has conceded that the OECD Convention does not use, let alone
define, the term “foreign source income”. The EC, however, continues to cling to the baseless notion
that the Convention somehow can supply a definition to this term by implication.
12. The passage from Article 4 of the Convention quot ed by the EC merely reflects that two bases
on which countries may claim the right to tax income are residency and source. Residency refers to
whether a taxpayer resides in a country and thus can be subjected to tax on that basis. Source reflects
whether income has a nexus to a country and thus can be subjected to tax. The former focuses on the
location of the taxpayer; the latter focuses on the “location” of the income.
13. The EC does not explain how the quoted passage “expresses the same concept” as “foreign
source income” in “a different way”. The passage merely refers to taxing jurisdiction based on
“sources” in a particular country. What those “sources” are or may be is not defined.
14. The United States respectfully refers the Panel to paragraphs 132-36 of its Oral Statement, in
which it explained “that the provisions of the OECD Convention the EC cites do not support the EC’s
narrow construction [of the term “foreign source income”], but rather confirm the US position.”.