Responding to US protectionism, the European Union (EU) struck back at tax breaks given to US exporters yesterday by slapping trade sanctions on the US in a move that could potentially cost US firms, including IT vendors such as Microsoft, millions of dollars.

The EU said the sanctions come in retaliation to $4 billion in annual subsidies enjoyed by major US exporters, such as Microsoft and Boeing, which the World Trade Organization (WTO) deemed illegal in January 2002.

The subsidies come in the form of tax breaks currently given under the Extraterritorial Income Exclusion Act (ETI), which former President Bill Clinton signed into law in 2000 to replace the Foreign Sales Corporation Act, which also granted tax breaks.

Last May the WTO authorized the EU to take counter measures against the subsidies and the US was given a March 1, 2004 deadline to repeal the subsidy provision.

With no resolution in place, the EU retaliated Monday by imposing an additional custom duty of 5 per cent on certain US agricultural, textile, industrial, electronic and paper exports. The duty is due to increase at a rate of 1 per cent a month, to a ceiling of 17 per cent a month by March 1, 2005.

In a statement released Friday the EU said that its objective remains the withdrawal of the subsidy and that it has therefore opted for a "measured and gradual response." The EU estimates that the new custom duties will total $315 million from March 1 to December 31, 2004, and $666 million in additional duties if it is carried through 2005.

If the US responds by repealing the tax breaks, major US exporters, such as Microsoft, could potentially end up paying millions more in taxes.

Representatives for Microsoft in the UK could not immediately comment on the possible effects of the sanctions Monday.

The company's financial statements reflect the advantage the software giant has gained from the tax break, however.

In 2002 for example, Microsoft was allowed a 2.4 per cent reduction in its statutory tax rate under ETI, according to company financial documents.