In the 1950s and 1960s, America’s foreign direct investment was pre-eminent abroad and competition from imports to the United States was scant, with the U.S. international tax rules reflecting this. Then the economic situation changed and the United States’ involvement in trade expanded rapidly. Cross-border investment, both inflows and outflows, rose from 1.1 percent of GDP in 1960 to 15.9 percent of GDP in 2000, and this trend continues. Between 1960 and 2000, the value of goods traded to and from the United States increased more than three times faster than the GDP, rising to more than 20 percent of GDP. The majority of the goods traded, however, were imports which resulted in a huge trade deficit. Over the past few years, due to a weak U.S. economy, exports have surpassed imports, growing at an annual average rate of 8.3 percent from 2003-2006 thereby dropping the trade deficit to $759 billion in 2006. In 2007, exports accounted for more than 40 percent of the growth in the economy with foreign sales of U.S. products reaching a height of $1.6 trillion.

Because of the importance of exports in strengthening the U.S. economy and the need for the U.S., the world’s largest exporter, to remain competitive in the global market, over the past 35 years a number of U.S. Congresses and Administrations have devised and revised U.S. tax laws to encourage exports.

Starting in 1971, the Domestic International Sales Corporation (DISC) was enacted by Congress to level the playing field for U.S. companies - large and small - selling their products overseas. The DISC provisions permitted all of the U.S. tax on the income earned by the DISC to be deferred until it repatriated the income to its shareholders in the form of dividends. Since most DISCs did not pay dividends to their shareholders but rather loaned their accumulated earnings to the U.S. Operating Company, this system allowed for an indefinite deferral of U.S. tax on a portion of the income from foreign sales.

The DISC provisions were challenged by the European Union (EU) as providing an impermissible export subsidy that allowed an indefinite deferral of tax on U.S. exporters without an interest charge, thereby violating the terms of the General Agreement on Tariffs and Trade (GATT). Following this challenge and a counter-challenge to several European tax regimes brought by the United States, a GATT panel in 1976 ruled against all the contested tax measures. This decision led to a stalemate that was resolved with a GATT Council Understanding adopted in 1981.

Pursuant to this 1981 Understanding, the United States revised the DISC provisions and, in 1984, enacted the Foreign Sales Corporation (FSC) provisions to provide U.S. exporters with an exemption from U.S. tax for a portion of the income earned from export transactions. This partial exemption was intended to provide them with tax treatment that was more comparable to the treatment provided to exporters under the tax systems in other countries. In addition, Congress allowed the option of an “interest charge” DISC (IC-DISC) which permitted tax deferral with respect to an annual maximum of $10 million of export receipts, but at the cost of an annual interest charge.

In November 1997, the European Union formally challenged the FSC provisions in the WTO, stating that the FSC tax exemption was a prohibited export subsidy. There was no challenge to the IC-DISC. Consultations to resolve the matter were unsuccessful, and the EU challenge was referred to a WTO dispute resolution panel. In October 1999, the WTO panel issued a report finding that the FSC provisions constituted a violation of WTO rules. The United States appealed the panel report; the European Union also appealed the report. In February 2000, the WTO issued its report substantially upholding the findings of the panel.

In response to the WTO decision against the FSC provisions, the FSC Repeal and Extraterritorial Income Exclusion Act was enacted on November 15, 2000. It repealed the FSC (not the IC-DISC) and, in its place, made qualified U.S. exporters eligible for an exclusion from gross income for qualifying extraterritorial income. This legislation was intended to bring the United States into compliance with the WTO while at the same time ensuring that U.S. businesses remained globally competitive.

Immediately following the enactment of the FSC/ETI Act, the European Union brought a challenge in the WTO. In August 2001, a WTO panel issued a report finding that the ETI provisions were an illegal trade subsidy that violated WTO rules. The United States appealed the panel report, however the WTO Appellate Body generally affirmed the panel’s findings. Congress did not do anything about the WTO’s decision until the EU slapped sanctions on U.S. exports, imposing a graduated penalty that reached 12 percent.

On May 28, 2003, the Jobs and Growth Tax Relief Reconciliation Act of 2003 was signed by the President. This legislation stated that until December 31, 2008 corporate dividends paid to individuals would be taxed at the 15 percent rate instead of the 35 percent rate. Since the IC-DISC was a C corporation, its individual shareholders could receive dividends taxed at the 15 percent rate.

Also in May 2003, in response to clamoring from America’s largest manufacturers and exporters against the EU’s trade sanctions, Congress finally responded to the WTO’s challenge to ETI by proposing the Job Protection Act of 2003 (the Crane/Rangel/Manzullo Bill – HR 1769). This proposed bill contained a general transition relief provision that was not contingent upon future exports and, therefore, was WTO compliant. It also provided a permanent new deduction which would reduce the effective corporate tax rate that would apply to much of a company’s taxable income attributable to the manufacture, production, growth, or extraction of property that had been eligible for the ETI benefit, whether or not actually exported.

On July 25, 2003, the House Ways and Means Committee Chairman William Thomas unveiled sweeping corporate tax reform legislation (HR 2896) that would replace the controversial Extraterritorial Income Exclusion (ETI) with a mix of international tax relief for U.S. multinationals with substantial operations overseas and provisions aimed at assisting the ailing U.S. domestic manufacturing industry. The legislation also provided a package of depreciation relief, relief from the alternative minimum tax, and extension and expansion of the research and development tax credit.

The final result was the American Jobs Creation Act of 2004 which became law on October 11, 2004. This Act repealed ETI, recaptured ETI benefits by amendment, and established the Section 199 Domestic Production Activities Deduction. In order to ease the loss of ETI benefits, the Act phased out ETI over a three year period, with 100 percent of ETI being allowed in 2004, 80 percent in 2005, 60 percent in 2006, and zero percent thereafter. In addition, to compensate for lost export benefits, Congress reduced the top corporate tax rate of 35 percent down to 32 percent for domestic manufacturers, which was broadly defined as traditional manufacturing, construction, engineering, energy production, computer software, films and videotape, and processing of agricultural products. This new deduction actually went far beyond the amount of benefits lost by the repeal of ETI since all qualified U.S. manufacturers, whether or not they exported, were eligible for the deduction.

The most recent legislation related to export tax benefits was the Tax Increase Prevention and Reconciliation Act of 2005, enacted on May 17, 2006. This legislation extended the deadline for the 15 percent dividend tax rate (Jobs and Growth Tax Relief Reconciliation Act of 2003) from the end of 2008 to December 31, 2010. As before, the extension of this favorable tax rate applied to IC-DISC dividends received by individual shareholders.

Currently, the IC-DISC and certain export exceptions and exemptions, such as those in Sections 954 and 956, are the only export tax benefits available under the Internal Revenue Code.