Introduction.

1. The United States appeals certain issues of law and legal interpretations developed in the Panel Report, United States – Tax Treatment for "Foreign Sales Corporations", Second Recourse to Article 21.5 of the DSU by the European Communities (the "Panel Report").[1] The Panel was established to consider a complaint by the European Communities regarding the American Jobs Creation Act of 2004 (the "Jobs Act") and the United States' compliance with the recommendations and rulings of the Dispute Settlement Body (the "DSB") adopted on the basis of the Panel and Appellate Body Reports in United States – Tax Treatment for "Foreign Sales Corporations" ("US – FSC")^[2] and United States – Tax Treatment for "Foreign Sales Corporations", Recourse to Article 21.5 of the DSU by the European Communities ("US – FSC (Article 21.5 – EC)").[3] Relevant aspects of the Jobs Act are described in paragraph 6 below, as well as in paragraphs 2.13 to 2.17 of the Panel Report.

2. The panel in US – FSC (the "original panel") concluded that the "FSC measure", consisting of Sections 921 to 927 of the United States Internal Revenue Code (the "IRC") and related measures establishing special tax treatment for foreign sales corporations ("FSC"), was inconsistent with the United States' obligations under the Agreement on Subsidies and Countervailing Measures (the "SCM Agreement") and the Agreement on Agriculture.[4] The Appellate Body upheld the original panel's finding that the FSC measure was inconsistent with the United States' obligations under the SCM Agreement and modified the original panel's findings under the Agreement on Agriculture.

3. On 20 March 2000, the DSB adopted the reports of the original panel and the Appellate Body. The DSB recommended that the United States bring the FSC measure into conformity with its obligations under the covered agreements and that the FSC subsidies found to be prohibited export subsidies within the meaning of the SCM Agreement be withdrawn without delay, pursuant to Article 4.7 of the SCM Agreement, namely, "at the latest with effect from 1 October 2000".[5] At its meeting held on 12 October 2000, the DSB agreed to a request made by the United States to modify the time period to comply with the recommendations and rulings of the DSB so as to expire on 1 November 2000.[6] The United States promulgated on 15 November 2000, the FSC Repeal and Extraterritorial Income ("ETI") Exclusion Act of 2000 (the "ETI Act")[7]in order to comply with the recommendations and rulings of the DSB.[8]

4. The European Communities considered that the ETI Act did not comply with the DSB recommendations and rulings in the original dispute, because the ETI Act was not consistent with the United States' obligations under the SCM Agreement, the Agreement on Agriculture, and the General Agreement on Tariffs and Trade 1994 (the "GATT 1994"). As a result, the European Communities had recourse to Article 21.5 of the Understanding on Rules and Procedures Governing the Settlement of Disputes (the "DSU").[9] On 20 December 2000, the DSB referred the matter to a panel under Article 21.5 of the DSU.[10] The first Article 21.5 panel report was circulated to the Members of the World Trade Organization (the "WTO") on 20 August 2001.

5. The panel in the first Article 21.5 proceedings concluded that the ETI Act was inconsistent with the United States' obligations under the SCM Agreement, the Agreement on Agriculture, and the GATT 1994. In addition, it also held that, by making available indefinitely the FSC tax benefit for certain transactions by virtue of Section 5(c)(1)(B) ("Section 5") of the ETI Act, the United States "ha[d] not fully withdrawn the FSC subsidies found to be prohibited export subsidies [in the original proceedings] and ha[d] therefore failed to implement the recommendations and rulings of the DSB [in the original proceedings] made pursuant to Article 4.7 [of the] SCM Agreement."[11] The Appellate Body upheld those findings of the first Article 21.5 panel. The Appellate Body also recommended that the DSB "request the United States to bring the ETI measure ... into conformity with its obligations ... and ... to implement fully the recommendations and rulings of the DSB in US – FSC, made pursuant to Article 4.7 of the SCM Agreement."[12] On 29 January 2002, the DSB adopted the reports of the first Article 21.5 panel and the Appellate Body.[13]

6. On 22 October 2004, the United States, with a view to bringing its measures into conformity with its WTO obligations, enacted the Jobs Act, repealing the tax exclusion of the ETI Act.[14] The Jobs Act applies from 1 January 2005. Section 101 of the Jobs Act is entitled "Repeal of exclusion for extraterritorial income". Section 101(a) provides that "Section 114 [of the IRC] is hereby repealed." Section 101(b) is entitled "Conforming Amendments" and provides, in sub-paragraph (1): "Subpart E of Part III of subchapter N of chapter 1 (relating to qualifying foreign trade income) is hereby repealed." At the same time, Section 101(d) contains a "transition provision", pursuant to which the ETI tax scheme remains available, on a reduced basis, for certain transactions in the period between 1 January 2005 and 31 December 2006. Further, Section 101(f) contains a "grandfathering provision", pursuant to which the ETI tax scheme remains available indefinitely with respect to certain transactions.[15] Finally, Section 101 of the Jobs Act does not repeal or otherwise make reference to Section 5 of the ETI Act, which "grandfathered" indefinitely FSC subsidies with respect to certain transactions.[16] A more detailed description of the Jobs Act is contained in paragraphs 2.13 to 2.17 of the Panel Report.

7. The European Communities considered that the United States had failed to withdraw its prohibited subsidies as required by Article 4.7 of the SCM Agreement, had failed to bring its scheme into conformity with its WTO obligations, and had therefore failed to implement the recommendations and rulings of the DSB of 20 March 2000 and 29 January 2002. The European Communities also considered that the United States continued to violate certain provisions of the SCM Agreement, the Agreement on Agriculture, and the GATT 1994. The European Communities therefore had recourse to Article 21.5 of the DSU for a second time.[17] On 20 December 2000, the DSB referred the matter to a panel under Article 21.5 of the DSU.[18] The Panel Report was circulated to WTO Members on 30 September 2005.

8. The Panel found that:

The panel and Appellate Body findings in the first 21.5 compliance proceedings, as adopted by the DSB, established that the ETI scheme was in violation of Articles 3.1(a) and 3.2 of the SCM Agreement, Articles 10.1, 8 and 3.3 of the Agreement on Agriculture and Article III:4 of the GATT 1994. Pursuant to Articles 101(d) and (f) of the Jobs Act, the ETI benefits remain available throughout 2005 and 2006 (albeit at reduced percentages), and indefinitely (in the case of certain transactions). The inconsistencies with Articles 3.1(a) and 3.2 of the SCM Agreement, Articles 10.1, 8 and 3.3 of the Agreement on Agriculture and Article III:4 of GATT 1994 remain.

We further note the indefinite grandfathering of the original FSC subsidies for certain transactions, through the continued operation of [S]ection 5[] of the ETI Act. As confirmed by the United States in response to Panel questioning, nothing in the legislative language of the Jobs Act modifies, implicitly or explicitly, these transition rules for the FSC subsidies.^[19] (footnotes omitted)

9. The Panel concluded that:

... to the extent that the United States, by enacting Section 101 of the Jobs Act, maintains prohibited FSC and ETI subsidies through the transition and grandfathering measures at issue, it continues to fail to implement fully the operative DSB recommendations and rulings to withdraw the prohibited subsidies and to bring its measures into conformity with its obligations under the relevant covered agreements.[20]

10. The Panel also stated that:

Since the original DSB recommendations and rulings in 2000 remain operative through the results of the compliance proceedings in 2002, we make no new recommendation.[21]

11. On 14 November 2005, the United States notified the DSB of its intention to appeal certain issues of law covered in the Panel Report and certain legal interpretations developed by the Panel, pursuant to Article 16.4 of the DSU, and filed a Notice of Appeal[22] pursuant to Rule 20 of the Working Procedures for Appellate Review (the "Working Procedures").[23] On 21 November 2005, the United States filed an appellant's submission.[24] On 28 November 2005, the European Communities notified the DSB of its intention to appeal certain issues of law covered in the Panel Report and certain legal interpretations developed by the Panel, pursuant to Article 16.4 of the DSU, and filed a Notice of Other Appeal[25] pursuant to Article 23(1) of the Working Procedures. On 29 November 2005, the European Communities filed an other appellant's submission.[26] On 9 December 2005, the European Communities and the United States each filed an appellee's submission.[27] On the same day, Australia and Brazil each filed a third participant's submission[28] and China notified its intention to appear at the oral hearing as a third participant.[29] On 16 December 2005, the Director of the Appellate Body Secretariat informed the parties that Mr. John Lockhart was prevented from continuing to serve on the Division for serious personal reasons falling within Rule 12 of the Working Procedures. In accordance with Rule 13 of the Working Procedures, the Appellate Body selected Ms. Merit E. Janow to replace Mr. Lockhart. The oral hearing in this appeal was held on 9 January 2006.

Findings and Conclusions.

12. For the reasons set forth in this Report, the Appellate Body:

upholds the Panel's finding, in paragraph 7.87 of the Panel Report, that Section 5(c)(1)(B) of the FSC Repeal and Extraterritorial Income Exclusion Act of 2000, grandfathering prohibited FSC subsidies, was within its terms of reference[30]; and

upholds the Panel's finding and conclusion, in paragraphs 7.65 and 8.1 of the Panel Report, that "to the extent that the United States, by enacting Section 101 of the American Jobs Creation Act of 2004, maintains prohibited FSC and ETI subsidies through [the] transitional and grandfathering measures, it continues to fail to implement fully the operative DSB recommendations and rulings to withdraw the prohibited subsidies and to bring its measures into conformity with its obligations under the relevant covered agreements."

Signed in the original in Geneva this 26th day of January 2006 by:

[1]WT/DS108/RW2, 30 September 2005.

[2]WT/DS108/R; WT/DS108/AB/R.

[3]WT/DS108/RW; WT/DS108/AB/RW.

[4]Original Panel Report, US – FSC, para. 8.1. A detailed description of the FSC measure is contained in paragraphs 2.1-2.8 of the Original Panel Report, and in paragraphs 11-18 of the Original Appellate Body Report, in US – FSC.

[5]Original Panel Report, US – FSC, para. 8.8.

[6]WT/DSB/M/90, paras. 6-7. See also Panel Report, para. 1.1.

[7]United States Public Law 106-519, 114 Stat. 2423 (2000).

[8]Panel Report, US – FSC (Article 21.5 – EC), para. 1.5. A detailed description of the ETI Act is contained in paragraphs 2.2-2.8 of the Panel Report, and in paragraphs 15-25 of the Appellate Body Report, in US – FSC (Article 21.5 – EC).

[9]WT/DS108/16.

[10]WT/DS108/19.

[11]Panel Report, US – FSC (Article 21.5 – EC), para. 9.1(e).

[12]Appellate Body Report, US – FSC (Article 21.5 – EC), para. 257.

[13]On 17 November 2000, the European Communities had requested authorization to take "appropriate countermeasures" and to suspend concessions pursuant to Article 4.10 of the SCM Agreement and Articles 22.2 and 22.7 of the DSU for an amount of US$ 4043 million per year. (WT/DS108/13) The United States objected to the appropriateness of the countermeasures proposed by the European Communities, as well as to the level of suspension of concessions proposed by the European Communities, and requested that the matter be referred to arbitration. The arbitrator, acting pursuant to Article 4.11 of the SCM Agreement and Article 22.6 of the DSU, determined that the countermeasures sought by the European Communities "would constitute appropriate countermeasures within the meaning of Article 4.10 of the SCM Agreement". (Decision by the Arbitrator,
US – FSC (Article 22.6 – US), para. 8.1)

[14]Panel Report, para. 1.6.

[15]More specifically, to transactions made in the ordinary course of trade or business occurring pursuant to a binding contract between the taxpayer and an unrelated person, which contract was in effect on
17 September 2003 and at all times thereafter. (Ibid., footnote 29 to para. 2.16)

[16]Ibid., para. 2.17. These transactions are transactions pursuant to a binding contract between the FSC and an unrelated person, which contract was in effect on 30 September 2000. (Ibid., para. 2.12)

[17]Request for the Establishment of a Panel by the European Communities, WT/DS/108/29 (attached as Annex III to this Report).

[18]WT/DS108/30.

[19]Panel Report, para. 7.60-7.61.

[20]Ibid., para. 8.1. See also para. 7.65.

[21]Panel Report, para. 8.2.

[22]WT/DS108/32 (attached as Annex I to this Report).

[23]WT/AB/WP/5, 4 January 2005.

[24]Pursuant to Rule 21(1) of the Working Procedures.

[25]WT/DS108/33 (attached as Annex II to this Report).

[26]Pursuant to Rule 23(3) of the Working Procedures.

[27]Pursuant to Rules 22 and 23(4) of the Working Procedures.

[28]Pursuant to Rule 24(1) of the Working Procedures.

[29]Pursuant to Rule 24(2) of the Working Procedures.

[30]Panel Report, para. 7.87.