April, 20017
The WTO Status of the Proposed United States Destination Based Cash Flow Tax
Mark K. Neville, Jr.
In February’s discussion we wrote of the possible directions that the Trump Administration might chart for its international trade policy. I briefly referred to the border adjusted tax that has now been acknowledged by many to be the proposed vehicle for the levy of additional burdens imposed on imported goods. We are awash with reactions to and descriptions of the “border tax” and all of the attention that has been paid to the tax by economists, pundits and others at the time of this writing (beginning of February), is helpful. Their analyses will serve to balance many of the proponents’ claims being made for the tax.
What is largely absent from this discourse is any extended discussion of the compliance status of such a tax under the current international trade laws administered by the World Trade Organization (WTO). Any full critique must abide the disclosing of the plan in detail and would have to be several times the length of this piece. The following is intended to be an initial discussion of that WTO status, and most importantly to introduce the actual legal standards by which its degree of compliance would be measured. It is also intended to be read in conjunction with the companion treatment by James McClure.
There are two especially important points to grasp here. The first is that this definition indeed is a “cash flow” concept. The second is that this House bill saw the tax as an income tax. To be certain, the stated purpose was, “To amend the Internal Revenue Code of 1986 to tax business income on a cash flow basis, and for other purposes.” As will be shown later, income tax status is of decisive importance in certain circumstances under the international trade laws.
In the Blueprint, we find a breezy style that is perhaps appropriate for a policy paper but which is too relaxed and imprecise to qualify as a serious expression of a legislative vehicle intended to achieve those policy goals. The lack of the concrete text of an actual proposed bill frustrates a proper analysis.
We find the Blueprint is claimed (at 15) “to represent a dramatic reform of the current income tax system.” Nonetheless, the Blueprint does not suggest at 15 the introduction “of a value added tax (VAT), a sales tax, or any other tax as an addition to the fundamental reforms of the current income tax system.”5 This categorical statement, that it does not represent any other form of tax, certainly appears to lock in an income tax status. For their part, Professors Avi-Yonah and Clausing see the DBCFT as a modified subtraction VAT, especially insofar as it allows a deduction for wages apod by the US taxpayer.6 Apparently only Japan has adopted a subtraction VAT7 and the destination principle as applied to such VAT regimes, as opposed to a credit-invoice VAT,8 has not been the subject of a GATT or WTO review, let alone determined not to have breached GATT/WTO obligations by a GATT or WTO panel.9 This means that, at this point, border tax adjustments (BTAs) for subtraction-type VATs might not be permissible under WTO rules. We revisit this important point below.
But throughout the Blueprint, we find a blurring and a lack of precision that amounts to a staking out of another status altogether. First, all of the references to the corporate income tax rate drop the “income” qualifier as it is only referred to as a “corporate rate.” We find, too, in the highlight summary at 15, and again at 28, references to the cash flow tax as “a move toward a consumption-based approach toward taxation” and “Because this Blueprint reflects a move toward a cash-flow tax approach for businesses, which reflects a consumption-based tax, the United States will be able to compete on a level playing field by applying border adjustments within the context of our transformed business and corporate tax system.” We are left to ponder precisely what a move “toward” and a “reflecting” of a cash-flow tax is supposed to connote. But, importantly, the Blueprint is clear (at 15) about one thing: the DBCFT is not a consumption tax:
The Blueprint further states (at 15) the significance of the cash flow/quasi-consumption tax status,
The motivating force for this characterization of this DBCFT as “consumption tax-like” so as to justify deployment of the destination principle will be even more obvious when we discuss below the WTO trade law norms. For the moment, we should be mindful of the direct vs. indirect tax dichotomy within the international trade agreements that will control any review of the DBCFT.
There are two other especially noteworthy aspects of H. R. 4377. First, the bill (at Section 1423)10 introduced a territorial limit on taxation.11 The Blueprint also contains a territorial limitation.
Second, the bill did not contain any corresponding border adjustment provisions on imported purchases, such that no deduction would be allowed for purchases of goods imported into the US. In other words, section 1421 (d) did not carve out a non-deductibility for import purchases. That would come only with the Blueprint. What will be made clear is that status as a consumption tax and NOT “something-like-a-consumption tax” is a necessary pre-condition for a border adjustment. This has the necessary result that these two features--the “DB” and the “CFT” if you will-- are inseparable.
And with that we can turn to the Blueprint and explore how the cash-flow tax is to be border adjusted.
Why the need for a border adjustment? The Blueprint made a great showing of the presumed disadvantage arising from the failure of the US to have introduced a VAT, which it said had led to “the self-imposed unilateral penalty for exports and subsidy for imports that are fundamental flaws in the current U.S. tax system.”12
The Blueprint reveals a close focus on BTAs,
It is in this connection that we return to the Blueprint, which states (at 28) that
So far, so good. But you can be forgiven if you were to assume that the border adjustment under the DBCFT would function as it does under a VAT and, more specifically a credit-invoice VAT. In this fashion, VAT would be collected on the imported article at the time of importation, along with customs duties, and the VAT would be remitted or exempted on export sales. The Blueprint certainly does not provide any detail and it is only when economists whose work has influenced the drafting of the Blueprint or who support the Blueprint are consulted that we find that the DBCFT does not function at all like that. The differences are threefold.
First, the DBCFT is similar to a subtraction VAT, a type which is employed only by Japan. It is not at all like a credit invoice VAT, with which traders are more familiar.17 Second, the difference between a destination-based subtraction VAT and the DBCFT is marked out by the treatment of labor costs being fully deductible and cash flow losses being fully refunded.18
Third, there is a difference with a credit invoice type VAT, which is, with but a single exception (Japan), the type employed in every nation employing a VAT. This is in respect to the “border adjustment” on imports. Instead of the tax accruing and being levied on imported products at the time of import along with customs duties, as with the credit invoice VAT, the DBCFT adjustment is levied on the imported articles in the form of a disallowance of a deduction for the taxpayer for the purchase price of the imported article.19 Even if the DBCFT is not an income tax, and it may well be characterized as an income tax when all of its details are revealed, then this disallowance of deductions begins to take on income tax, or at least, “direct” tax qualities.
And we shall see what is the likely consequence of that adjustment methodology. First we should sum up what we have learned to this point:
The basic normative principles of the international trade laws are established in the General Agreement on Tariffs and Trade 1994 (hereinafter “GATT 1994”), which was promulgated in 1994 after the Uruguay Round of Multilateral Trade Negotiations. GATT 1994 is an updated and revised version of the original GATT which dated to 1947. There are several underlying principles that embody the GATT’s commitment to free trade. Some of the more relevant of these principles may be summarized
Art. I—most favored nation treatment, whereby concessions granted to one Member are granted to all Members, eliminating special treatment arrangements, whether expressed as benefits granted or withheld
Art. II—there are ceilings to the duties and charges (read: tariffs) that accrue at the time of entry that may be charged; these are the “bound” rates committed to as tariff concessions at the MTNs
Art. III—“national treatment” is afforded to imports, so that there is no discrimination in favor of domestic products
Art. XI—elimination of quantitative restrictions (read quotas)
Art. XVI—elimination of subsidies which increase exports
In addition to GATT 1994, which establishes the various standards against which the DBCFT would be measured, and the Agreement Establishing the World Trade Organization (WTO Agreement), there are multilateral and plurilateral instruments on a number of separate topics, which are attached as Annexes to the WTO Agreement.
These include the Customs Valuation Agreement whose official title is the Agreement in Implementation of Article VII of the General Agreement on Tariffs and Trade (1994). For our purposes the separate substantive agreement that is most relevant is the Agreement on Subsidies and Countervailing Measures (SCM), which promulgates an expansive treatment of the rules that are set forth in Art. XVI of the GATT. To be clear, the SCM establishes directly relevant standards of conduct in the matter of subsidies.
Before we proceed to analyze the DBCFT under the trade agreements we should dilate upon the direct vs. indirect tax binary set that we adverted earlier.
A tax directly “levied on” or “borne by” a product is an indirect tax. This seems paradoxical, until we recall that the direct/indirect determination is from the perspective of the taxpayer. Thus, a sales tax or a VAT is an indirect tax—it is not imposed directly on the taxpayer. It will be seen that identifying a tax or a charge as an indirect tax or not will have implications for Art. III and Art. XVI of the GATT 1994 and for the SCM.
Another significance of the direct vs. indirect tax status for international trade law is that only indirect taxes may be subjected to border tax adjustments (BTAs), the ability to make use of which is the driving force of the DBCFT. As will be seen, BTAs apply the destination principle.
As a parenthetical thought, the Working Party Report observed (at para. 8) that some members felt that the GATT rules favor countries which rely heavily on indirect taxes and discriminate against those countries which rely predominantly on direct taxes. The Blueprint was right. Cf. the Blueprint at 15, 27-28. Importantly, it reached agreement on the susceptibility of many taxes to border tax adjustments (BTAs). The Working Party Report reported (at para. 14)
That does not mean that there were not those who had advocated near-fifty years ago that BTAs should be allowed for direct taxes as well. This argument did not gain traction, however, as is apparent from the Working Party Report text at para. 21 which should be reviewed
The destination principle, as applied to consumption and other indirect taxes, is founded upon BTAs. Its application means that an indirect tax should be assessed in the country where the product is consumed—in the country into which it has been imported--with the correlative result that an indirect tax otherwise due should be exempted or remitted by the country whence it has been exported. Otherwise, there is the risk of double taxation on the exported product.26
The Working Party Report noted that some had questioned the correctness of this economic assumption,27 asserting instead that the burden of indirect taxes was not always forward shifted and that of direct taxes was not always borne in its entirety by the taxpayer but were shifted onto the product. This argument based in “modern” economic theory was advanced in the two 1970s US cases challenging BTAs under the countervailing duty law at the time.28 These were the cases brought by Zenith Radio and by US Steel. The Zenith Radio case was that rare trade and customs case that made it to the Supreme Court, with the court holding in a unanimous 1978 decision that the non-excessive remission of an indirect tax on exports did not confer a bounty or grant (read subsidy).29 Interestingly, the Court referred to the Art. VI.3 of GATT 1947 (at n. 13) as being consistent with this administrative agency interpretation.30
By now it should be clear that the status of the DBCFT is crucial to its status under the international trade laws, which distinguish direct from indirect taxes. Turning to the Blueprint again we recall that the claim was made (at 15) that this “…focus on business cash flow, which is a move toward a consumption-based approach to taxation, will allow the United States to adopt…the same destination-based approach to taxation that has long been used by our trading partners.”
We shall see how the DBCFT squares with those international trade laws.
But first we make a strong disclaimer. Because of the lack of precision in the Blueprint, especially on the status of the tax, which can only be ascertained after all of its features in detail have been revealed, and the exact manner for the border adjustments on imports and exports, we are unable to reach conclusive answers to several questions.
There are three relevant standards that could be invoked if and when the DBCFT is enacted. These are Art. III. paras.1, 2 and 4.
This provision might be implicated if there is a disallowance of deductions for the purchase of imported products, with such a disallowance stifling such purchases and thereby protecting domestic production of the competing goods. Further, the deduction for labor charges involved in producing domestic goods is a further discrimination, as the entire purchase price, including the subsumed amount of labor in its production, is disallowed. We can also point out that there is economic analysis that takes the view that that the border adjustment of the DBCFT amounts to double taxation of imports and non-taxation of exports, clearly violative of Art. III.1.36
The qualifying phrase “applied to like domestic products” marks an important distinction, as it signifies that the internal tax at issue is an indirect tax. In my opinion, the notion that Art. III para. 2 should be read broadly so as to embrace direct taxes (read income taxes) is not correct.38 The reach of the section is to "internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like products." Thus, the prohibition is NOT against discrimination in the levy of any and all internal taxes or internal charges. The all-important qualifying phrase "applied ...to like products" cannot be ignored. The prohibition is only against discrimination in internal taxes or charges applied to like products. Only an impermissibly expansive construction, one that would obviate the qualifying phrase, would hold that an income tax is a tax "applied to a product" for these purposes, and more generally, besides.
Any future move to a "new paradigm" for income tax based upon a destination principle is another matter entirely. Frankly, it would be a matter for a redrafting of the text of the provision. But for the present case, based upon this analysis, we are reassured by the notion that the US Foreign Sales Corporation (FSC) regime, discussed below, was properly challenged under Arts. III. Para. 4 and XVI of GATT 1994, as well as the SCM. Pointedly, there was no claim asserted under Art. III para. 2 of GATT 1994.
There is an inherent discrimination at play here. While attempting to characterize the export exemption/import deduction disallowance as a “border adjustment,” which we examined above, a disallowance of deductions for amounts paid for imported goods is both a discrimination against those imported products and an encouragement to purchase domestic goods. Further, insofar as there is an ability to deduct the cost of salaries in calculating tax liability for the DBCFT on domestically produced goods, there is another discrimination. Indeed, in correspondence with me, Prof. Cui notes that the DBCFT works no differently from a subtraction type VAT on the import side. It is different only in respect of domestic production (whether goods produced are sold domestically or exported), in that domestic labor costs are deductible and losses attract subsidies. This is the discriminatory treatment: domestic manufacturers deduct labor costs but imported goods are taxed on full value, again, by virtue of the non-deductibilty of the amount of the import purchase. This is a treatment absent from the VAT.39
If the DBCFT is classed as an indirect tax, then Art. III 2 will apply. In that case, there is a prima facie showing of a violation of the national treatment standard of Art. III, para. 2. What is striking is a stark showing of discrimination if the manufacturer were able to deduct the amount paid for a domestically produced part "from its corporate tax base" (to use Feldstein's phrase) but would not be able to deduct the price paid for an imported part, with a similar discrimination in the deductibility of domestic labor costs. This is so regardless if the non-deductibility were dressed up as merely a form of BTA.
In this connection, disallowing a deduction from the DBCFT of purchases of imported goods while allowing a deduction for domestically-produced goods would make out a violation, irrespective of the direct vs. indirect tax distinction. Again, this is so regardless if the non-deductibility were dressed up as merely a form of BTA.
It is worthwhile to notice that the WTO has previously held that a US direct tax program, the Extraterritorial Income regime, violated Art. III. 4 because the so-called “fair market value rule” under the ETI Act,40 accorded less favorable treatment to imported products than to like US domestic products. This violated Art. III.4 by providing a “considerable impetus” to use domestic products over imported products for the tax benefit under the ETI Act.41 As we have seen, the Blueprint seeks to invoke the WTO principle of “border adjustment.” This brings us to the issue of subsidies conferred by the DBCFT.
To answer the question, “would this SCM footnote 1 permit the exemption of a consumption tax that is in the nature of a direct tax?” we must interpret the note by reading it closely. First, the use in the note of the term “duties or taxes borne by the like product” is indicative of an indirect tax. It cannot be ignored by someone who would rather focus upon consumption tax status alone, without the limitation. Second, the text should be read in pari materia with other trade law texts that address the topic. The Working Party Report, which we have seen has force, certainly lends no support for such a reading. The important qualifying text “borne by the like product” signifying an indirect tax is also present at Art. VI.4 of the GATT 1994 and in the Note to Art. XVI 1994.
Finally, and most directly, Annex I to the SCM sets forth an Illustrative List of Export Subsidies. Subparagraph (e) (in relevant part) brings us to direct taxes remitted or exempted at export
It is worth quoting the list in its entirety:
The problem with that argument is that it ignores the plain text of Art. 2. 3, “Any subsidy falling under the provisions of Article 3 shall be deemed to be specific.” And when we refer to Art. 3.1 (a), we discover that it envisions 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.” And to be doubly sure, we know that the export exemptions of the FSC regime were successfully challenged by the EC and other trading partners, inter alia, under Art. 3.1 (a). It is reasonable to expect with a high degree of probability that if there were to be a challenge to the DBCFT’s export exemption/remission, a violation of Art. 3.1 (a) of the SCM would be asserted and that the specificity criterion would be met.
And here we must refer to the Blueprint, which states categorically that the DBCFT is not a consumption tax, even if it may be “moving toward” a consumption tax. In another important respect the supposed economic impact of the DBCFT counts for very little. Both Auerbach/Holtz-Eakin and Feldstein argue that any export subsidy effect would be quickly obviated by exchange control movements in the value of the US dollar. Even if that were conceivably true,47 the WTO jurisprudence tells us that an abrogation or nullification of rights is an abrogation or nullification of rights. Any argument that is in essence, “yes, there is a violation but the overall economic effect is neutralized” will surely fail.
Quite apart from the issue of the BTA of a direct tax, the DBCFT confers a subsidy in the form of subsidizing domestic manufacturers’ labor costs, which are fully deductible, while imported goods are taxed in the full value by virtue of the non-deductibility of the labor expense in producing the imported good. That is a separate effect that would be explored in any DSB challenge under the SCM.
Even so, there is already sufficient cause for concern that the DBCFT might be successfully challenged at the WTO for violations arising under Art. III of the GATT 1994 and the SCM. Frankly, the actual experience with the response to the BTAs generated by DISC/FSC/ETI programs at the GATT and WTO, and the literally decades-long contests, should have informed the design of any sweeping tax reform based upon BTAs. I am not convinced that something like the findings of those cases would not apply with equal vigor to the DBCFT if challenged, but I await the actual text rather than a colloquial report or frothy newspaper summaries.
We know that the Blueprint does not claim the DBCFT is a consumption tax, a sales tax or a VAT. We know further that scholarly economists see it as a modified subtraction VAT. Ultimately, the DBCFT, as presently described, may be found to be a stealth direct tax, like a flat tax, or it may be deemed a hybrid creation whose direct tax attributes would be sufficient to remove it from consideration as a pure indirect tax. But it is unlikely to be an indirect tax in its present form. Beyond the issue of the subsidy effect of the BTA of a direct tax, I have identified concerns about national treatment and the labor subsidy.
Beyond these WTO concerns, there is the issue of compatibility of the DBCFT with obligations generated by international tax treaties, which is outside the scope of this discussion.
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What is largely absent from this discourse is any extended discussion of the compliance status of such a tax under the current international trade laws administered by the World Trade Organization (WTO). Any full critique must abide the disclosing of the plan in detail and would have to be several times the length of this piece. The following is intended to be an initial discussion of that WTO status, and most importantly to introduce the actual legal standards by which its degree of compliance would be measured. It is also intended to be read in conjunction with the companion treatment by James McClure.
Border Adjusted Cash Flow Tax
The tax that I will be analyzing is set forth in the so-called “Better Way” tax policy paper that was published by the House Ways and Means Committee June 24, 2016 (the “Blueprint”).1 Amongst many proposed tax reforms, which are not of interest for this treatment, the Blueprint posits a Destination Based Cash Flow Tax (DBCFT). We should parse that by first defining what is meant by a Cash Flow Tax.Cash Flow Tax
The Blueprint never actually defines what a “cash flow” tax but it does (at 25) cite to H.R. 4377, “The American Business Competitiveness Act of 2015,”2 which had been introduced in the 114th Congress, as having introduced the concept of a business cash-flow tax.3 In turn, we find that the bill (at section 1421 (a)) had defined “net business income” for a taxable year with respect to a business entity, as “the amount by which the taxable receipts of the business entity for the taxable year exceed the deductible amounts for the business entity for the taxable year.” Deductible amounts in H. R. 4377 include business purchases, salaries and health insurance paid to employees and loss carryover deductions. The Blueprint also sets out rules for expensing and deductions.4There are two especially important points to grasp here. The first is that this definition indeed is a “cash flow” concept. The second is that this House bill saw the tax as an income tax. To be certain, the stated purpose was, “To amend the Internal Revenue Code of 1986 to tax business income on a cash flow basis, and for other purposes.” As will be shown later, income tax status is of decisive importance in certain circumstances under the international trade laws.
In the Blueprint, we find a breezy style that is perhaps appropriate for a policy paper but which is too relaxed and imprecise to qualify as a serious expression of a legislative vehicle intended to achieve those policy goals. The lack of the concrete text of an actual proposed bill frustrates a proper analysis.
We find the Blueprint is claimed (at 15) “to represent a dramatic reform of the current income tax system.” Nonetheless, the Blueprint does not suggest at 15 the introduction “of a value added tax (VAT), a sales tax, or any other tax as an addition to the fundamental reforms of the current income tax system.”5 This categorical statement, that it does not represent any other form of tax, certainly appears to lock in an income tax status. For their part, Professors Avi-Yonah and Clausing see the DBCFT as a modified subtraction VAT, especially insofar as it allows a deduction for wages apod by the US taxpayer.6 Apparently only Japan has adopted a subtraction VAT7 and the destination principle as applied to such VAT regimes, as opposed to a credit-invoice VAT,8 has not been the subject of a GATT or WTO review, let alone determined not to have breached GATT/WTO obligations by a GATT or WTO panel.9 This means that, at this point, border tax adjustments (BTAs) for subtraction-type VATs might not be permissible under WTO rules. We revisit this important point below.
But throughout the Blueprint, we find a blurring and a lack of precision that amounts to a staking out of another status altogether. First, all of the references to the corporate income tax rate drop the “income” qualifier as it is only referred to as a “corporate rate.” We find, too, in the highlight summary at 15, and again at 28, references to the cash flow tax as “a move toward a consumption-based approach toward taxation” and “Because this Blueprint reflects a move toward a cash-flow tax approach for businesses, which reflects a consumption-based tax, the United States will be able to compete on a level playing field by applying border adjustments within the context of our transformed business and corporate tax system.” We are left to ponder precisely what a move “toward” and a “reflecting” of a cash-flow tax is supposed to connote. But, importantly, the Blueprint is clear (at 15) about one thing: the DBCFT is not a consumption tax:
Movement toward a consumption-based system need not involve a shift to an explicit consumption tax, such as a retail sales tax, but instead could result from reforms which exclude certain features of the income tax base. Those changes would achieve similar economic results albeit through different administrative rules.
The Blueprint further states (at 15) the significance of the cash flow/quasi-consumption tax status,
The focus on business cash flow, which is a move toward a consumption-based approach to taxation, will allow the United States to adopt, for the first time in history, the same destination-based approach to taxation that has long been used by our trading partners.
The motivating force for this characterization of this DBCFT as “consumption tax-like” so as to justify deployment of the destination principle will be even more obvious when we discuss below the WTO trade law norms. For the moment, we should be mindful of the direct vs. indirect tax dichotomy within the international trade agreements that will control any review of the DBCFT.
There are two other especially noteworthy aspects of H. R. 4377. First, the bill (at Section 1423)10 introduced a territorial limit on taxation.11 The Blueprint also contains a territorial limitation.
Second, the bill did not contain any corresponding border adjustment provisions on imported purchases, such that no deduction would be allowed for purchases of goods imported into the US. In other words, section 1421 (d) did not carve out a non-deductibility for import purchases. That would come only with the Blueprint. What will be made clear is that status as a consumption tax and NOT “something-like-a-consumption tax” is a necessary pre-condition for a border adjustment. This has the necessary result that these two features--the “DB” and the “CFT” if you will-- are inseparable.
And with that we can turn to the Blueprint and explore how the cash-flow tax is to be border adjusted.
Destination Based
The Blueprint explains that the border adjustment of the proposed regime works by way of exempting export sales from the DBCFT and subjecting import purchases to the DBCFT. As stated, this is a departure from H. R. 4377, which did not discuss the status of imports.Why the need for a border adjustment? The Blueprint made a great showing of the presumed disadvantage arising from the failure of the US to have introduced a VAT, which it said had led to “the self-imposed unilateral penalty for exports and subsidy for imports that are fundamental flaws in the current U.S. tax system.”12
The Blueprint reveals a close focus on BTAs,
all of our major trading partners raise a significant portion of their tax revenues through value-added taxes (VATs). These VATs include “border adjustability”as a key feature. This means that the tax is rebated when a product is exported to a foreign country and is imposed when a product is imported from a foreign country. These border adjustments reduce the costs borne by exported products and increase the costs borne by imported products. When the country is trading with another country that similarly imposes a border-adjustable VAT, the effects in both directions are offsetting and the tax costs borne by exports and imports are in relative balance. However, that balance does not exist when the trading partner is the United States. In the absence of border adjustments, exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost. This amounts to a self-imposed unilateral penalty on U.S. exports and a self-imposed unilateral subsidy for U.S. imports.”13
Of course, one’s immediate reaction to that point is to ask the question, “Then why not introduce a VAT?”, a question that had been explored seriously last in the late 1980s.14 As would be the case with virtually all countries with a VAT, this would be in addition to an income tax rather than an alternative to or a substitute for an income tax.15 Some economists have argued that border adjustments should not be limited to VAT and other indirect taxes.16 The Blueprint has followed that lead. The Blueprint and commentators who have supported the DBCFT rely on a loosely-stitched definition for border adjustments, and just how loosely stitched will become more clear when it is gauged against the international trade law norms.It is in this connection that we return to the Blueprint, which states (at 28) that
The cash-flow based approach that will replace our current income-based approach for taxing both corporate and non-corporate businesses will be applied on a destination basis. This means that products, services and intangibles that are exported outside the United States will not be subject to U.S. tax regardless of where they are produced. It also means that products, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced.
So far, so good. But you can be forgiven if you were to assume that the border adjustment under the DBCFT would function as it does under a VAT and, more specifically a credit-invoice VAT. In this fashion, VAT would be collected on the imported article at the time of importation, along with customs duties, and the VAT would be remitted or exempted on export sales. The Blueprint certainly does not provide any detail and it is only when economists whose work has influenced the drafting of the Blueprint or who support the Blueprint are consulted that we find that the DBCFT does not function at all like that. The differences are threefold.
First, the DBCFT is similar to a subtraction VAT, a type which is employed only by Japan. It is not at all like a credit invoice VAT, with which traders are more familiar.17 Second, the difference between a destination-based subtraction VAT and the DBCFT is marked out by the treatment of labor costs being fully deductible and cash flow losses being fully refunded.18
Third, there is a difference with a credit invoice type VAT, which is, with but a single exception (Japan), the type employed in every nation employing a VAT. This is in respect to the “border adjustment” on imports. Instead of the tax accruing and being levied on imported products at the time of import along with customs duties, as with the credit invoice VAT, the DBCFT adjustment is levied on the imported articles in the form of a disallowance of a deduction for the taxpayer for the purchase price of the imported article.19 Even if the DBCFT is not an income tax, and it may well be characterized as an income tax when all of its details are revealed, then this disallowance of deductions begins to take on income tax, or at least, “direct” tax qualities.
And we shall see what is the likely consequence of that adjustment methodology. First we should sum up what we have learned to this point:
- The US is smarting from its lack of a VAT, to the extent that its failure to impose a VAT is seen as a subsidy for foreign imports and the lack of a remittable VAT on exports is tantamount to a penalty.
- Some economists have argued that a border adjustment should not be limited to a VAT.
- The Blueprint offers as a solution: if the US moves to a cash-flow tax, which is “like” a consumption tax, then the US can initiate a border adjustment scheme, remitting or exempting the tax on export sales and effectively imposing the tax on imports by disallowing a deduction for the prices paid for imported articles.
Status of the DBCFT under international trade laws
As a matter of dispute resolution protocol, the Members of the World Trade Organization (WTO), in effect the international trade community, have agreed under The Understanding on Rules and Procedures Governing the Settlement of Disputes that grievances should be submitted to the Dispute Settlement Body (DSB) in Geneva for resolution.20 If there are trading partners who claim that their substantive rights arising from the trade agreements have been nullified or abridged, they would submit their claims to the DSB. Based upon our following analysis we predict that is exactly what will ensue: claims will be filed at the DSB if the DBCFT is enacted.The basic normative principles of the international trade laws are established in the General Agreement on Tariffs and Trade 1994 (hereinafter “GATT 1994”), which was promulgated in 1994 after the Uruguay Round of Multilateral Trade Negotiations. GATT 1994 is an updated and revised version of the original GATT which dated to 1947. There are several underlying principles that embody the GATT’s commitment to free trade. Some of the more relevant of these principles may be summarized
Art. I—most favored nation treatment, whereby concessions granted to one Member are granted to all Members, eliminating special treatment arrangements, whether expressed as benefits granted or withheld
Art. II—there are ceilings to the duties and charges (read: tariffs) that accrue at the time of entry that may be charged; these are the “bound” rates committed to as tariff concessions at the MTNs
Art. III—“national treatment” is afforded to imports, so that there is no discrimination in favor of domestic products
Art. XI—elimination of quantitative restrictions (read quotas)
Art. XVI—elimination of subsidies which increase exports
In addition to GATT 1994, which establishes the various standards against which the DBCFT would be measured, and the Agreement Establishing the World Trade Organization (WTO Agreement), there are multilateral and plurilateral instruments on a number of separate topics, which are attached as Annexes to the WTO Agreement.
These include the Customs Valuation Agreement whose official title is the Agreement in Implementation of Article VII of the General Agreement on Tariffs and Trade (1994). For our purposes the separate substantive agreement that is most relevant is the Agreement on Subsidies and Countervailing Measures (SCM), which promulgates an expansive treatment of the rules that are set forth in Art. XVI of the GATT. To be clear, the SCM establishes directly relevant standards of conduct in the matter of subsidies.
Before we proceed to analyze the DBCFT under the trade agreements we should dilate upon the direct vs. indirect tax binary set that we adverted earlier.
Direct vs. Indirect Tax
Status as a direct vs. indirect tax, which will be shown to be equally important in the national treatment and in the subsidy contexts, is normally expressed from the perspective of the taxpayer. In fact, the key distinction made by economists in the 18th century on the question whether a tax was “direct” vs. “indirect” was who bore the ultimate burden of the tax.21 Thus, an income tax is a direct tax—it is imposed directly on the taxpayer.A tax directly “levied on” or “borne by” a product is an indirect tax. This seems paradoxical, until we recall that the direct/indirect determination is from the perspective of the taxpayer. Thus, a sales tax or a VAT is an indirect tax—it is not imposed directly on the taxpayer. It will be seen that identifying a tax or a charge as an indirect tax or not will have implications for Art. III and Art. XVI of the GATT 1994 and for the SCM.
Another significance of the direct vs. indirect tax status for international trade law is that only indirect taxes may be subjected to border tax adjustments (BTAs), the ability to make use of which is the driving force of the DBCFT. As will be seen, BTAs apply the destination principle.
Border Tax Adjustments and Destination Principle
Working Party Report
The WTO trade law on border adjustments is heavily dependent upon the GATT’s Report By The Working Party On Border Tax Adjustments,22 published in 1970 after a two and one-half year study. The status of the Working Party Report is either that of a binding decision under Art. 1 (b) (4) of GATT 1994 or as an acquis under Art. XVI of the WTO Agreement which has created legitimate expectations that its guidance will be followed.23 In either event, its authority is assured, and its teaching would have been reflected in the 1994 amendments to the GATT and to the drafting of the SCM.As a parenthetical thought, the Working Party Report observed (at para. 8) that some members felt that the GATT rules favor countries which rely heavily on indirect taxes and discriminate against those countries which rely predominantly on direct taxes. The Blueprint was right. Cf. the Blueprint at 15, 27-28. Importantly, it reached agreement on the susceptibility of many taxes to border tax adjustments (BTAs). The Working Party Report reported (at para. 14)
The Working Party concluded that there was convergence of views to the effect that taxes directly levied on products were eligible for tax adjustment. Examples of such taxes comprised specific excise duties, sales taxes and cascade taxes and the tax on value added.24
To put the matter plainly, classification of a tax as direct vs. indirect is of the highest consequence. BTAs are permissible for indirect taxes only.That does not mean that there were not those who had advocated near-fifty years ago that BTAs should be allowed for direct taxes as well. This argument did not gain traction, however, as is apparent from the Working Party Report text at para. 21 which should be reviewed
21. In examining the possible effects of tax adjustments in international trade, a study has been made of the nature of indirect taxes and also to some extent direct taxes, and their eligibility for adjustment. The question was raised by some members why only indirect taxes should be eligible for adjustment since the economic basis for such a clear distinction between direct and indirect taxes for adjustment purposes has not been demonstrated. Most delegations stated, however that in their opinion such a distinction was already justified by the fact alone that indirect taxes by their very nature bear on internal consumption and were consequently levied, according to the principle of destination, in the country of consumption, while direct taxes—even assuming that they were partly passed on into prices—were borne by entrepreneurs’ profits or personal income. On the other hand, some members stated that while forward shifting of selective excise taxes could take place under most circumstances according to micro-economic approach, forward shifting in the case of general consumption taxes was according to macro-economic approach, not possible unless one assumes either a sufficient increase in money supply or in velocity of money. Emphasis added.
There are a number of lessons to be drawn here.Tax Burden Assumptions
The first lesson is that the Working Party Report, for these international trade law purposes, equates indirect taxes with consumption taxes--by the very nature of the former designation they bear on internal consumption. Accordingly, references to indirect or consumption taxes should be interchangeable, for the most part.25 The Working Party Report and its accompanying Annex did not fully explore the issue, but the underlying assumption for the acceptability of the remission of indirect taxes on exports was that indirect taxes exerted a burden that was borne exclusively by the product. If there were to be an increase in the indirect tax the economic theory would be that there would be a “full forward shift” of the tax. Thus, remitting taxes on the export of the product conferred no benefit (read subsidy) to the taxpayer because there was no tax burden of the taxpayer that was being relieved.The destination principle, as applied to consumption and other indirect taxes, is founded upon BTAs. Its application means that an indirect tax should be assessed in the country where the product is consumed—in the country into which it has been imported--with the correlative result that an indirect tax otherwise due should be exempted or remitted by the country whence it has been exported. Otherwise, there is the risk of double taxation on the exported product.26
The Working Party Report noted that some had questioned the correctness of this economic assumption,27 asserting instead that the burden of indirect taxes was not always forward shifted and that of direct taxes was not always borne in its entirety by the taxpayer but were shifted onto the product. This argument based in “modern” economic theory was advanced in the two 1970s US cases challenging BTAs under the countervailing duty law at the time.28 These were the cases brought by Zenith Radio and by US Steel. The Zenith Radio case was that rare trade and customs case that made it to the Supreme Court, with the court holding in a unanimous 1978 decision that the non-excessive remission of an indirect tax on exports did not confer a bounty or grant (read subsidy).29 Interestingly, the Court referred to the Art. VI.3 of GATT 1947 (at n. 13) as being consistent with this administrative agency interpretation.30
By now it should be clear that the status of the DBCFT is crucial to its status under the international trade laws, which distinguish direct from indirect taxes. Turning to the Blueprint again we recall that the claim was made (at 15) that this “…focus on business cash flow, which is a move toward a consumption-based approach to taxation, will allow the United States to adopt…the same destination-based approach to taxation that has long been used by our trading partners.”
DBCFT as Modified Subtraction VAT
Let us be clearer still. We have learned that BTAs are acceptable for indirect taxes because those taxes impose a burden on the products. The DBCFT has been described by Ptofesssors Avi-Yonah and Clausing and by Professor Cui, and no doubt by others as well, as a modified subtraction VAT. As a matter of first principles, then, we should ask whether a subtraction VAT in its pure form would be classed as an indirect tax:Under [a subtraction VAT], the tax base is computed as the difference between the business’s taxable sales and its purchases of taxable goods and services. At the end of the reporting period, the tax rate is applied to the difference. The subtraction method VAT is considered to be “account-based,” as it is computed from the business’s books and records of account.31
I am not an economist. But this aggregation of sales and purchases and this matter of it being “account-based” suggest to my amateur eye that the subtraction VAT may not be an indirect tax. In fact, it may be just the opposite, as some have called it “a tax on businesses.” This would mean that the DBCFT is a step away from a subtraction VAT but even if it had somehow fitted neatly into a subtraction VAT classification its direct tax status, or at the least its very lack of indirect tax standing, would pose significant WTO challenges. Recall that the WTO has not reviewed the status of a subtraction VAT. We shall pick this up again later.We shall see how the DBCFT squares with those international trade laws.
WTO standards implicated by the DBCFT
There are two separate normative standards that could apply.32 In colloquial terms, these are allegations that the DBCFT discriminates against imports in violation of Art. III of the GATT 1994 and the DBCFT confers an unfair subsidy to domestic products, in violation of Art. XVI of the GATT 1994 and the SCM.33 Thus, both expressions of the BTAs—imposing the subject tax in imports and exempting/remitting the subject tax on exports-- are the subject of distinct international trade rules. We explore these in their turn.34 We will be identifying multiple issues here--discrimination in not allowing deductions for imports, discrimination in the form of a deduction for labor costs for domestically produced goods, and subsidy, in the form of a deduction for domestic labor costs and an exemption on export of a direct tax.But first we make a strong disclaimer. Because of the lack of precision in the Blueprint, especially on the status of the tax, which can only be ascertained after all of its features in detail have been revealed, and the exact manner for the border adjustments on imports and exports, we are unable to reach conclusive answers to several questions.
Art. III Anti- Discrimination Commitments
Art. III establishes a “national treatment” imperative for internal taxation and regulation on imported products. As the 1958 GATT Panel Report on Italian Discrimination Against Imported Agricultural Machinery observed,If the scope of Art. III were limited…to a specific type of law and regulations, the value of the bindings under Article II of the [GATT} Agreement and of the general rules of non-discrimination as between imported and domestic products could be easily evaded.
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…the intention of the drafters of the Agreement was clearly to treat the imported products in the same way as the like domestic products once they had been cleared through customs. Otherwise indirect protection could be given.35
There are three relevant standards that could be invoked if and when the DBCFT is enacted. These are Art. III. paras.1, 2 and 4.
Art. III, para. 1
The terms of this provision states in general terms that “internal taxes and internal charges…affecting the internal sale, offering for sale, purchase, transportation, distribution or use of products…should not be applied to imported or domestic products so as to afford protection to domestic production.”This provision might be implicated if there is a disallowance of deductions for the purchase of imported products, with such a disallowance stifling such purchases and thereby protecting domestic production of the competing goods. Further, the deduction for labor charges involved in producing domestic goods is a further discrimination, as the entire purchase price, including the subsumed amount of labor in its production, is disallowed. We can also point out that there is economic analysis that takes the view that that the border adjustment of the DBCFT amounts to double taxation of imports and non-taxation of exports, clearly violative of Art. III.1.36
Art. III, para. 2
The second point of potential concern is the narrower commitment at Art. III, para. 2, first sentence, to extend national treatment in respect of “internal taxes or other internal charges of any kind.”37 Each Member must ensure that such internal taxes or internal charges are not applied to imported products in excess of those applied to like domestic products.The qualifying phrase “applied to like domestic products” marks an important distinction, as it signifies that the internal tax at issue is an indirect tax. In my opinion, the notion that Art. III para. 2 should be read broadly so as to embrace direct taxes (read income taxes) is not correct.38 The reach of the section is to "internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like products." Thus, the prohibition is NOT against discrimination in the levy of any and all internal taxes or internal charges. The all-important qualifying phrase "applied ...to like products" cannot be ignored. The prohibition is only against discrimination in internal taxes or charges applied to like products. Only an impermissibly expansive construction, one that would obviate the qualifying phrase, would hold that an income tax is a tax "applied to a product" for these purposes, and more generally, besides.
Any future move to a "new paradigm" for income tax based upon a destination principle is another matter entirely. Frankly, it would be a matter for a redrafting of the text of the provision. But for the present case, based upon this analysis, we are reassured by the notion that the US Foreign Sales Corporation (FSC) regime, discussed below, was properly challenged under Arts. III. Para. 4 and XVI of GATT 1994, as well as the SCM. Pointedly, there was no claim asserted under Art. III para. 2 of GATT 1994.
The Border Adjustment of the DBCFT
It is at this point that we turn to what the Blueprint terms the “Border Adjustment.” Recall that the DBCFT would not be collected on exports, or perhaps more properly it would be correct to note that “products, services and intangibles that are exported outside the United States will not be subject to U.S. tax.” Exactly how this exemption from tax for domestically produced tax is to be effectuated is not made clear in the Blueprint. Equally obscure is the levy of the DBCFT on imported products, which we have seen actually takes the form of a disallowance of a deduction for the US taxpayer of the purchase price of the imported article.There is an inherent discrimination at play here. While attempting to characterize the export exemption/import deduction disallowance as a “border adjustment,” which we examined above, a disallowance of deductions for amounts paid for imported goods is both a discrimination against those imported products and an encouragement to purchase domestic goods. Further, insofar as there is an ability to deduct the cost of salaries in calculating tax liability for the DBCFT on domestically produced goods, there is another discrimination. Indeed, in correspondence with me, Prof. Cui notes that the DBCFT works no differently from a subtraction type VAT on the import side. It is different only in respect of domestic production (whether goods produced are sold domestically or exported), in that domestic labor costs are deductible and losses attract subsidies. This is the discriminatory treatment: domestic manufacturers deduct labor costs but imported goods are taxed on full value, again, by virtue of the non-deductibilty of the amount of the import purchase. This is a treatment absent from the VAT.39
If the DBCFT is classed as an indirect tax, then Art. III 2 will apply. In that case, there is a prima facie showing of a violation of the national treatment standard of Art. III, para. 2. What is striking is a stark showing of discrimination if the manufacturer were able to deduct the amount paid for a domestically produced part "from its corporate tax base" (to use Feldstein's phrase) but would not be able to deduct the price paid for an imported part, with a similar discrimination in the deductibility of domestic labor costs. This is so regardless if the non-deductibility were dressed up as merely a form of BTA.
Art. III. 4
If the DBCFT is not an indirect tax, then Art. III 4 could apply, since the limiting language of the former text does not apply. Instead, we find that imported products “shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements respecting their internal sale....”In this connection, disallowing a deduction from the DBCFT of purchases of imported goods while allowing a deduction for domestically-produced goods would make out a violation, irrespective of the direct vs. indirect tax distinction. Again, this is so regardless if the non-deductibility were dressed up as merely a form of BTA.
It is worthwhile to notice that the WTO has previously held that a US direct tax program, the Extraterritorial Income regime, violated Art. III. 4 because the so-called “fair market value rule” under the ETI Act,40 accorded less favorable treatment to imported products than to like US domestic products. This violated Art. III.4 by providing a “considerable impetus” to use domestic products over imported products for the tax benefit under the ETI Act.41 As we have seen, the Blueprint seeks to invoke the WTO principle of “border adjustment.” This brings us to the issue of subsidies conferred by the DBCFT.
Art. XVI, GATT 1994 and SCM
First let us be certain. The Blueprint acknowledges (at 28) the cogency of the WTO’s direct/indirect tax dichotomy on BTAs:The rules of the World Trade Organization (WTO) include longstanding provisions regarding the use of border adjustments. Under these rules border adjustments upon export are permitted with respect to consumption-based taxes which are referred to as indirect taxes. However, under these rules, border adjustments upon export are not permitted with respect to income taxes, which are referred to as direct taxes. This disparate treatment of different tax systems is what has created the historic imbalance between the United States, which has relied on an income tax—or direct tax in WTO parlance—for taxing business transactions, and our trading partners, which rely to a significant extent on a VAT—or indirect tax in WTO parlance—for taxing business transactions.
Agreement Terms
The two principal normative standards are Art. XVI of GATT 1994 and the SCM. But we should also refer to Art. VI.4 of the GATT 1994, which states (in relevant part) thatNo product …shall be subject to …countervailing duties [to counter a subsidy] by reason of the exemption of such product from duties or taxes borne by the like product when destined for consumption in the country of origin or exportation, or by reason of the refund of such duties or taxes.42
The Note to Art. XVI instructs us thatThe exemption of an exported product from duties or taxes borne by the product when destined for domestic consumption, or the remission of such duties and taxes in amounts not in excess of those which have accrued, shall not be deemed to be a subsidy. Emphasis added.
Again, the qualifying phrase “borne by the product” signifies an indirect tax. The SCM defines a subsidy, in pertinent part, as existing where(ii) government revenue that is otherwise due is foregone or not collected (e.g., fiscal incentives such as tax credits); n.143
At the SCM, footnote 1, there is an express exclusion from the definition of a subsidy any government revenue that is otherwise due that is foregoneIn accordance with the provisions of Article XVI of GATT 1994…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. Emphasis added.
From our earlier discussion we see that this text involves a reference to an indirect tax (duties or taxes borne by the like product) that is destined for domestic consumption. We also saw above that the Working Party Report connotes indirect taxes as those that are for internal consumption.Status of Consumption Tax or VAT as Direct Taxes: No BTAs Permitted
We should be mindful that apparently it is possible to have a consumption tax that is a direct tax. The Hall–Rabushka flat tax is a flat tax proposal on consumption designed by American economists Robert Hall and Alvin Rabushka at the Hoover Institution. The Hall–Rabushka flat tax involves taxing income but excluding investment. The Hall–Rabushka flat tax may include an exemption, which allows the tax to preserve progressivity.To answer the question, “would this SCM footnote 1 permit the exemption of a consumption tax that is in the nature of a direct tax?” we must interpret the note by reading it closely. First, the use in the note of the term “duties or taxes borne by the like product” is indicative of an indirect tax. It cannot be ignored by someone who would rather focus upon consumption tax status alone, without the limitation. Second, the text should be read in pari materia with other trade law texts that address the topic. The Working Party Report, which we have seen has force, certainly lends no support for such a reading. The important qualifying text “borne by the like product” signifying an indirect tax is also present at Art. VI.4 of the GATT 1994 and in the Note to Art. XVI 1994.
Finally, and most directly, Annex I to the SCM sets forth an Illustrative List of Export Subsidies. Subparagraph (e) (in relevant part) brings us to direct taxes remitted or exempted at export
(e) The full or partial exemption remission, or deferral specifically related to exports, of direct taxes (58) or social welfare charges paid or payable by industrial or commercial enterprises.
We next learn that the cited footnote 58 sets forth an illustrative list of both direct and indirect taxes. It is important to understand that the text of footnote 1 to Art. 1 itself recites that the list is an integral part of note 1 itself. The list is not simply a recitation of exemplars but the controlling language is set out at footnote 1. Instead, the text of footnote 1 must be read in harmony with, and indeed it incorporates by reference, the Annex I list. Thus, the full or partial deferral of a direct tax—regardless if it could be theoretically identified as a consumption tax—is a subsidy under the SCM. Stated otherwise, the mere fact that a flat tax or some other direct tax could be classed as a consumption tax will not permit its exemption on exports.It is worth quoting the list in its entirety:
58. For the purpose of this Agreement:
The term “direct taxes” shall mean taxes on wages, profits, interests, rents, royalties, and all other forms of income, and taxes on the ownership of real property;
The term “import charges” shall mean tariffs, duties, and other fiscal charges not elsewhere enumerated in this note that are levied on imports;
The term “indirect taxes” shall mean sales, excise, turnover, value added, franchise, stamp, transfer, inventory and equipment taxes, border taxes and all taxes other than direct taxes and import charges;
“Prior-stage” indirect taxes are those levied on goods or services used directly or indirectly in making the product;
“Cumulative” indirect taxes are multi-staged taxes levied where there is no mechanism for subsequent crediting of the tax if the goods or services subject to tax at one stage of production are used in a succeeding stage of production;
“Remission” of taxes includes the refund or rebate of taxes;
“Remission or drawback” includes the full or partial exemption or deferral of import charges.
WTO Jurisprudence on Prior US BTAs
The United States has direct experience with GATT/WTO challenges to BTAs on direct taxes, as it was unable to defend the exemptions of tax on income on export sales under three successive tax regimes, the Domestic International Sales Corporation (DISC), Foreign Sales Corporation (FSC) and the Extraterritorial Income (ETI) programs.46Intended Effect of the DBCFT
And that background is surely the driving force behind the Blueprint’s characterization of the DBCFT. Finally acknowledging, after a fashion, the WTO longstanding practice on BTAs being tied to indirect tax status, the Blueprint (at 28) sets an aspirational markerUnder WTO rules, the United States has been precluded from applying the border adjustments to U.S. exports and imports necessary to balance the treatment applied by our trading partners to their exports and imports. With this Blueprint move toward a consumption-based tax approach, in the form of a cash flow focused approach for taxing business income, the United States now has the opportunity to incorporate border adjustments in the new tax system consistent with the WTO rules regarding indirect taxes.
But merely saying it is so does not make it so, or as Churchill might have commented, “This is a lot of sail to carry on so small a hull.” It should be clear that the DBCFT, claimed to “reflect a consumption-based tax,” must be actually be classified as an indirect tax in order for the BTAs to be valid. Otherwise, it will be DISC/FSC/ETI redux.Specificity
I have seen some defenses to the DBCFT which refer to the Art. 2, SCM requirement for “specificity,” in the sense that a generally available benefit intended for a regional development effort, for example, should not be an actionable subsidy. The specificity requirement would reserve that actionable status for programs that confer a benefit on a specific basis to certain enterprises. The claim has been made that the DBCFT is generally available, or at least that any subsidy effect is not “specific” as defined in Art. 2, which would this preclude a finding of a violation of the SCM.The problem with that argument is that it ignores the plain text of Art. 2. 3, “Any subsidy falling under the provisions of Article 3 shall be deemed to be specific.” And when we refer to Art. 3.1 (a), we discover that it envisions 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.” And to be doubly sure, we know that the export exemptions of the FSC regime were successfully challenged by the EC and other trading partners, inter alia, under Art. 3.1 (a). It is reasonable to expect with a high degree of probability that if there were to be a challenge to the DBCFT’s export exemption/remission, a violation of Art. 3.1 (a) of the SCM would be asserted and that the specificity criterion would be met.
WTO Treatment
And what do Auerbach and Holtz-Eakin say on this vital issue of the WTO posture? They admit that its compliance posture is “an open question” and then confess (at 15) that,“[i]t is not clear that a DBCFT would be successfully characterized as an indirect tax, even though it is economically equivalent to a policy based on indirect taxes (a VAT and a reduction in payroll taxes), and even though the distinction between direct and indirect taxes has little meaning and no bearing in any economic outcomes.”
The foregoing WTO authorities that we have cited are well-settled and, even dating to the 1970 Working Party Report, there have been those who have argued for a new model, one in which the necessity of indirect tax status would be eliminated for the validity of BTAs. Unless and until there is an adoption of a radically different SCM, let alone a sea change in the practice of BTAs more generally, it is imperative for the US that the DBCFT is to be classed as an indirect tax. Otherwise, the BTA will be struck down as conferring a subsidy.And here we must refer to the Blueprint, which states categorically that the DBCFT is not a consumption tax, even if it may be “moving toward” a consumption tax. In another important respect the supposed economic impact of the DBCFT counts for very little. Both Auerbach/Holtz-Eakin and Feldstein argue that any export subsidy effect would be quickly obviated by exchange control movements in the value of the US dollar. Even if that were conceivably true,47 the WTO jurisprudence tells us that an abrogation or nullification of rights is an abrogation or nullification of rights. Any argument that is in essence, “yes, there is a violation but the overall economic effect is neutralized” will surely fail.
Quite apart from the issue of the BTA of a direct tax, the DBCFT confers a subsidy in the form of subsidizing domestic manufacturers’ labor costs, which are fully deductible, while imported goods are taxed in the full value by virtue of the non-deductibility of the labor expense in producing the imported good. That is a separate effect that would be explored in any DSB challenge under the SCM.
Conclusion
The foregoing analysis is intended to highlight the potential issues surrounding the DBCFT under existing international trade law authorities. A careful analysis at this time is hampered by the degree to which the DBCFT has been described heretofore only in ambiguous or elliptical terms. We eagerly await the actual text of a tax bill so that the terms and functioning of the DBCFT might be first ascertained and its status then measured against the relevant WTO normative standards. And make no mistake, after the direct/indirect status has been fixed, presumed economic effects, such as exchange control movements, will play little or no role in any dispute resolution at the WTO.Even so, there is already sufficient cause for concern that the DBCFT might be successfully challenged at the WTO for violations arising under Art. III of the GATT 1994 and the SCM. Frankly, the actual experience with the response to the BTAs generated by DISC/FSC/ETI programs at the GATT and WTO, and the literally decades-long contests, should have informed the design of any sweeping tax reform based upon BTAs. I am not convinced that something like the findings of those cases would not apply with equal vigor to the DBCFT if challenged, but I await the actual text rather than a colloquial report or frothy newspaper summaries.
We know that the Blueprint does not claim the DBCFT is a consumption tax, a sales tax or a VAT. We know further that scholarly economists see it as a modified subtraction VAT. Ultimately, the DBCFT, as presently described, may be found to be a stealth direct tax, like a flat tax, or it may be deemed a hybrid creation whose direct tax attributes would be sufficient to remove it from consideration as a pure indirect tax. But it is unlikely to be an indirect tax in its present form. Beyond the issue of the subsidy effect of the BTA of a direct tax, I have identified concerns about national treatment and the labor subsidy.
Beyond these WTO concerns, there is the issue of compatibility of the DBCFT with obligations generated by international tax treaties, which is outside the scope of this discussion.
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1. Available at https://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf
2. Available at https://www.congress.gov/bill/114th-congress/house-bill/4377/text
3. The bill was introduced on Jan. 13, 2016 and was referred to the Ways and Means Committee on that same day. Ultimately, the bill had 29 co-sponsors, all Republican Members.
4. These include, inter alia, the immediate expensing of investments, elimination of various deductions: for net interest, special interest deductions and the Section 199 domestic production and a commitment to business credits for R&D.
5. See also Blueprint at 27.
6. Avi-Yonah and Clausing, Problems with Destination-Based Corporate Taxes and the Ryan Blueprint, U of Michigan Law & Econ Research Paper No. 16-029 at 6-7(February 5, 2017) (hereinafter “Avi-Yonah and Clausing”). Available at SSRN: https://ssrn.com/abstract=2884903; so too does Cui, Wei, Destination-Based Cash-Flow Taxation: A Critical Appraisal, 67 U. Toronto L.J. 2 (2017) (excellent discussion, highlighting challenges posed by DBCFT) (hereinafter “Cui”).
7. To be sure, Japan’s federal consumption tax was introduced in 1989. This replaced other indirect taxes, including the commodity tax, a single-stage consumption tax that dated to 1962 and the export remission of which was the subject of the US Supreme Court decision in Zenith Radio Corporation discussed below at nn. 8 and 29.
8. For a useful introductory discussion of the two types of VAT see the US Chamber of Commerce, An Introduction to the Value Added Tax (VAT) (Chamber White Paper) available at https://www.uschamber.com/sites/default/files/legacy/issues/econtax/files/vat_paper_4_25_2010.pdf
9. We note here, and discuss below, the fact that the destination principle as applied to the then-current Japanese commodity tax, whereby the tax was not applied to exports, was the subject of a 1978 Supreme Court decision in the Zenith Radio Corporation case.
10. SEC. 1423. No tax imposed on income derived from trade or business outside the United States.
11. This should not be confused with a border adjustment for exports. The Blueprint makes it clear that the DBCFT relies on three major elements—a 20% corporate rate, territorial vs. worldwide system and border adjustments. Blueprint at 27.
12. Blueprint at 15.
13. Id. at 28.
14. See GAO, Tax Policy Report to the Joint Committee on Taxation, Tax-Credit and Subtraction Methods of Calculating a Value-Added Tax (June 1989) (GAO Report).
15. In this connection we note that the US already has experience with federal-level indirect taxes. Beyond customs duties, the US imposes specific excise taxes, albeit on a handful of products, including products that may have been produced with ozone-depleting chemicals, sport fishing tackle and petroleum products.
16. Auerbach and Holtz-Eakin, The Role of Border Adjustments in International Taxation at 5 (Dec. 2, 2016) (hereinafter “Auerbach and Holtz-Eakin”) available at http://eml.berkeley.edu/~auerbach/The Role of Border Adjustments in International Taxation 12-2-16-1.pdf; Schoen, Destination-Based Income Taxation and WTO Law: A Note, Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2016-3 (hereinafter “Schoen”),available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2727628
17. For the differences between the two, I refer you to the GAO Report.
18. Cui; Avi-Yonah and Clausing.
19. The Blueprint itself is silent on this detail. The mechanism is discussed in Auerbach and Holtz-Eakin at 9 and Feldstein, The House GOP’s Good Tax Trade-Off, Wall St. J., Jan. 6, 2017, at A13, col. 1 (Feldstein).
20. The DSB was established in 1994 through Annex 2 to the Agreement Establishing the World Trade Organization.
21. Taxes are either direct or indirect. A direct tax is one which is demanded from the very persons who, it is intended or desired, should pay it. Indirect taxes are those which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another: such as the excise or customs. The producer or importer of a commodity is called upon to pay a tax on it, not with the intention to levy a peculiar contribution upon him, but to tax through him the consumers of the commodity, from whom it is supposed that he will recover the amount by means of an advance in price. John Stuart Mill, Principles of Political Economy with some of their Applications to Social Philosophy. V.3.1, William J. Ashley, ed. London; Longmans, Green and Co. 1909. Library of Economics and Liberty [Online] available from http://www.econlib.org/library/Mill/mlP65.html; accessed 11 February 2017; Internet.
22. GATT document L/3464, 20 Nov. 1970 (Working Party Report).
23. For a very useful discussion on the status of the Working Party Report see H. Horn and P. Mavroidis, Legal and Economic Principles of World Trade Law (2015).
24. The Working Party Report noted that there were some taxes where there had been a divergence of views on BTA eligibility. Para. 15. There were two categories that were in this state. One of them dealt with property taxes, stamp taxes and registration duties. These were generally considered ineligible. The second were so-called hidden taxes, with the French term “taxes occultes” employed. It was noted that adjustment was not normally made for these taxes occultes except in countries having a cascade tax. In any event, the Working Party Report observed at para. 15 that
25. But see discussion about note 1 to the SCM, below.
26. Note that an origin principle of taxation could be used alternatively, by which the country of importation would impose a tax on imported products at the same rate as applied to domestic products, with a credit or rebate up to the amount of the tax paid in the origin country. Obviously this would require the simultaneous adoption of the origin principle in both countries.
27. The shifting of a tax burden was only briefly treated in the Working Party Report. See paras. 8, 21.
28. 19 USC § 1303, repealed in 1994. At the present time, the US countervailing duty law is codified at 19 USC § 1671 (a).
6. Art. 38 (2) speaks of these two types of AEO only but the DA and IA speak of a combined AEO status, AEO(F). Consistent with this last point, Art. 38 (3) specifically notes that both types of authorizations may be held at the same time.
29. Zenith Radio Corporation v. United States, 437 US 443 (1978) (challenge to Japanese commodity tax system; Treasury Department statutory interpretation since 1898 upheld). For a useful contemporary review, see Note, Zenith Radio Corp. v. United States: Countervailing Duty—Application to Nonexcessive Remission of Indirect Taxes, 4 Md. J. Int’l L. 221 (1979). Without using the term, the Zenith Radio decision noted the avoidance of double taxation worked by the destination principle. The US Steel case, which challenged the exemption or remission of the EC VAT on steel exports, was withdrawn after the Zenith Radio decision was reached. Disclosure—I was the DOJ trial attorney for most of the pendency of the US Steel case.
30. Article VI (3) of the GATT 1994 provides that "[n]o product . . . imported into the territory of any other contracting party shall be subject to . . . countervailing duty by reason of the exemption of such product from . . . taxes borne by the like product when destined for consumption in the country of origin or exportation, or by reason of the refund of such . . . taxes."
31. Chamber White Paper at 5.
32. For completeness’s sake, one could note that the levy of the DBCFT on imports could be examined in connection with Art. II as a species of duty, or more properly an import charge, or as a user fee. In the former case, it is best to bear in mind the distinction drawn between the time an obligation accrues and the time of collection. Note ad Article III, GATT 1994; China - Measures Affecting Imports of Automobile Parts, WT/339/AB/R (adopted 12 Jan.,., 2009) at para. 158. Note, too, the connection between Arts. II and III insofar as Art. III.2 (a) clarifies that charges equivalent to an internal tax that is consistent with Art. III. 2 do not disturb Art. II. In the case of user fees, Art. II.2 (c) imposes a limit on fees and charges, which must be commensurate with the cost of the services rendered.
33. See Working Party Report, Annex, para. 2 (the principal GATT article dealing with border tax adjustments which may be made on the import side is Art. III; the principal article relating to the export side is Art. XVI[today an updated discussion would also need to refer to the SCM]).
34. Conceptually it might be possible to analyze whether the DBCFT levies an import charge that would be cognizable under Art. II.
35. WTO, Panel Report-Italian Discrimination Against Imported Agricultural Machinery, L/833, 7S/60, 63-64, paras. 6, 11.
36. Reichert and Urken, The Border Adjustment: What Companies Need to Know, (Economics Partners White Paper), available at http://files.constantcontact.com/c79ba0ff101/5ffa578e-b527-45ae-bfbb-1ec8af592e1a.pdf
37. The second sentence implies the broader anti-protection principles of Art. III, para. 1. The Notes to Art. III widen the protection by adding the concept of a directly competitive or substitutable product as the basis for comparison.
38. While I find much that is commendable in Schoen, I cannot agree to his view that Art.III, para. 2, sentence 1, would embrace discrimination in income taxation. I further disagree with the statement (at 12) that the direct/indirect tax dichotomy "looks precarious." For reasons stated, there is a complete remedy available under the status quo under Art. III para. 2 for an indirect tax regime for discrimination, under Art. III para 4 for discrimination, inter alia, on direct tax, and in Art. XVI and the SCM for an export subsidy in the form of an excessive refund of an indirect tax or the exemption/remission of a direct tax.
39. Avi-Yonah and Clausing make the same case.
40. Under the “fair market value rule”, any taxpayer that sought an exemption under the ETI Act had to ensure that in the manufacture of qualifying property, it did not “use” imported input products, whose value comprised more than 50 per cent of the fair market value of the end-product.
41. United States — Tax Treatment for “Foreign Sales Corporations” (ARTICLE 21.5 – EC), WTO/DS108/AB/R (adopted 29 Jan., 2002).
42. You will recognize this as another expression of the destination principle.
43. Art. 1.1 (a) (ii).
44. The Vienna Convention on the Law of Treaties [Vienna Convention] would govern the textual analysis of the SCM. As has been noted in the Appellate Body Report in United States — Standards for Reformulated and Conventional Gasoline, WTO/DS2/AB/R (adopted 20 May, 1996) at 17
45. Meanings must be assigned to each iteration of a term in such a manner that each such usage is consistent with the document’s purpose as a whole. In Appellate Body Report, United States — Continued Existence and Application of Zeroing Methodology, WT/DS350/AB/R (adopted 19 February, 2009) we find (at para. 268) the following guidance
46. See CRS Report for Congress, A History of the Extraterritorial Income (ETI) and Foreign Sales Corporation (FSC) Export Tax-Benefit Controversy Updated November 9, 2004, available at http://www.taxhistory.org/thp/readings.nsf/cf7c9c870b600b9585256df80075b9dd/d1e0dcc337b8048385256f860068159e? See (re: DISC), General Agreement on Tariffs and Trade, "United States Tax Legislation (DISC): Report of the Panel Presented to the Council of Representatives on 12 November 1976," Basic Instruments and Selected Documents, 23rd Supp., Jan. 1977, p. 103; re: FSC and ETI, United States — Tax Treatment for “Foreign Sales Corporations” WT/DS108.
47. Professor Cui and apparently several other economists challenge whether the exchange controls would work as quickly or as extensively as DBCFT sponsors would warrant so as to eliminate distortions.
2. Available at https://www.congress.gov/bill/114th-congress/house-bill/4377/text
3. The bill was introduced on Jan. 13, 2016 and was referred to the Ways and Means Committee on that same day. Ultimately, the bill had 29 co-sponsors, all Republican Members.
4. These include, inter alia, the immediate expensing of investments, elimination of various deductions: for net interest, special interest deductions and the Section 199 domestic production and a commitment to business credits for R&D.
5. See also Blueprint at 27.
6. Avi-Yonah and Clausing, Problems with Destination-Based Corporate Taxes and the Ryan Blueprint, U of Michigan Law & Econ Research Paper No. 16-029 at 6-7(February 5, 2017) (hereinafter “Avi-Yonah and Clausing”). Available at SSRN: https://ssrn.com/abstract=2884903; so too does Cui, Wei, Destination-Based Cash-Flow Taxation: A Critical Appraisal, 67 U. Toronto L.J. 2 (2017) (excellent discussion, highlighting challenges posed by DBCFT) (hereinafter “Cui”).
7. To be sure, Japan’s federal consumption tax was introduced in 1989. This replaced other indirect taxes, including the commodity tax, a single-stage consumption tax that dated to 1962 and the export remission of which was the subject of the US Supreme Court decision in Zenith Radio Corporation discussed below at nn. 8 and 29.
8. For a useful introductory discussion of the two types of VAT see the US Chamber of Commerce, An Introduction to the Value Added Tax (VAT) (Chamber White Paper) available at https://www.uschamber.com/sites/default/files/legacy/issues/econtax/files/vat_paper_4_25_2010.pdf
9. We note here, and discuss below, the fact that the destination principle as applied to the then-current Japanese commodity tax, whereby the tax was not applied to exports, was the subject of a 1978 Supreme Court decision in the Zenith Radio Corporation case.
10. SEC. 1423. No tax imposed on income derived from trade or business outside the United States.
11. This should not be confused with a border adjustment for exports. The Blueprint makes it clear that the DBCFT relies on three major elements—a 20% corporate rate, territorial vs. worldwide system and border adjustments. Blueprint at 27.
12. Blueprint at 15.
13. Id. at 28.
14. See GAO, Tax Policy Report to the Joint Committee on Taxation, Tax-Credit and Subtraction Methods of Calculating a Value-Added Tax (June 1989) (GAO Report).
15. In this connection we note that the US already has experience with federal-level indirect taxes. Beyond customs duties, the US imposes specific excise taxes, albeit on a handful of products, including products that may have been produced with ozone-depleting chemicals, sport fishing tackle and petroleum products.
16. Auerbach and Holtz-Eakin, The Role of Border Adjustments in International Taxation at 5 (Dec. 2, 2016) (hereinafter “Auerbach and Holtz-Eakin”) available at http://eml.berkeley.edu/~auerbach/The Role of Border Adjustments in International Taxation 12-2-16-1.pdf; Schoen, Destination-Based Income Taxation and WTO Law: A Note, Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2016-3 (hereinafter “Schoen”),available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2727628
17. For the differences between the two, I refer you to the GAO Report.
18. Cui; Avi-Yonah and Clausing.
19. The Blueprint itself is silent on this detail. The mechanism is discussed in Auerbach and Holtz-Eakin at 9 and Feldstein, The House GOP’s Good Tax Trade-Off, Wall St. J., Jan. 6, 2017, at A13, col. 1 (Feldstein).
20. The DSB was established in 1994 through Annex 2 to the Agreement Establishing the World Trade Organization.
21. Taxes are either direct or indirect. A direct tax is one which is demanded from the very persons who, it is intended or desired, should pay it. Indirect taxes are those which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another: such as the excise or customs. The producer or importer of a commodity is called upon to pay a tax on it, not with the intention to levy a peculiar contribution upon him, but to tax through him the consumers of the commodity, from whom it is supposed that he will recover the amount by means of an advance in price. John Stuart Mill, Principles of Political Economy with some of their Applications to Social Philosophy. V.3.1, William J. Ashley, ed. London; Longmans, Green and Co. 1909. Library of Economics and Liberty [Online] available from http://www.econlib.org/library/Mill/mlP65.html; accessed 11 February 2017; Internet.
22. GATT document L/3464, 20 Nov. 1970 (Working Party Report).
23. For a very useful discussion on the status of the Working Party Report see H. Horn and P. Mavroidis, Legal and Economic Principles of World Trade Law (2015).
24. The Working Party Report noted that there were some taxes where there had been a divergence of views on BTA eligibility. Para. 15. There were two categories that were in this state. One of them dealt with property taxes, stamp taxes and registration duties. These were generally considered ineligible. The second were so-called hidden taxes, with the French term “taxes occultes” employed. It was noted that adjustment was not normally made for these taxes occultes except in countries having a cascade tax. In any event, the Working Party Report observed at para. 15 that
It was generally felt that while this area of taxation was unclear, its importance—as indicated by the scarcity of complaints reported in connexion with adjustment of taxe occulte—was not such as to justify further examination.
We find that the Working Party Report borrowed the then-current OECD definition of taxe occulte—consumption taxes on capital equipment, auxiliary materials and services used in transportation and production of other taxable goods. Taxes on advertising, energy, machinery and transport were among the more important taxes which might be involved.25. But see discussion about note 1 to the SCM, below.
26. Note that an origin principle of taxation could be used alternatively, by which the country of importation would impose a tax on imported products at the same rate as applied to domestic products, with a credit or rebate up to the amount of the tax paid in the origin country. Obviously this would require the simultaneous adoption of the origin principle in both countries.
27. The shifting of a tax burden was only briefly treated in the Working Party Report. See paras. 8, 21.
28. 19 USC § 1303, repealed in 1994. At the present time, the US countervailing duty law is codified at 19 USC § 1671 (a).
6. Art. 38 (2) speaks of these two types of AEO only but the DA and IA speak of a combined AEO status, AEO(F). Consistent with this last point, Art. 38 (3) specifically notes that both types of authorizations may be held at the same time.
29. Zenith Radio Corporation v. United States, 437 US 443 (1978) (challenge to Japanese commodity tax system; Treasury Department statutory interpretation since 1898 upheld). For a useful contemporary review, see Note, Zenith Radio Corp. v. United States: Countervailing Duty—Application to Nonexcessive Remission of Indirect Taxes, 4 Md. J. Int’l L. 221 (1979). Without using the term, the Zenith Radio decision noted the avoidance of double taxation worked by the destination principle. The US Steel case, which challenged the exemption or remission of the EC VAT on steel exports, was withdrawn after the Zenith Radio decision was reached. Disclosure—I was the DOJ trial attorney for most of the pendency of the US Steel case.
30. Article VI (3) of the GATT 1994 provides that "[n]o product . . . imported into the territory of any other contracting party shall be subject to . . . countervailing duty by reason of the exemption of such product from . . . taxes borne by the like product when destined for consumption in the country of origin or exportation, or by reason of the refund of such . . . taxes."
31. Chamber White Paper at 5.
32. For completeness’s sake, one could note that the levy of the DBCFT on imports could be examined in connection with Art. II as a species of duty, or more properly an import charge, or as a user fee. In the former case, it is best to bear in mind the distinction drawn between the time an obligation accrues and the time of collection. Note ad Article III, GATT 1994; China - Measures Affecting Imports of Automobile Parts, WT/339/AB/R (adopted 12 Jan.,., 2009) at para. 158. Note, too, the connection between Arts. II and III insofar as Art. III.2 (a) clarifies that charges equivalent to an internal tax that is consistent with Art. III. 2 do not disturb Art. II. In the case of user fees, Art. II.2 (c) imposes a limit on fees and charges, which must be commensurate with the cost of the services rendered.
33. See Working Party Report, Annex, para. 2 (the principal GATT article dealing with border tax adjustments which may be made on the import side is Art. III; the principal article relating to the export side is Art. XVI[today an updated discussion would also need to refer to the SCM]).
34. Conceptually it might be possible to analyze whether the DBCFT levies an import charge that would be cognizable under Art. II.
35. WTO, Panel Report-Italian Discrimination Against Imported Agricultural Machinery, L/833, 7S/60, 63-64, paras. 6, 11.
36. Reichert and Urken, The Border Adjustment: What Companies Need to Know, (Economics Partners White Paper), available at http://files.constantcontact.com/c79ba0ff101/5ffa578e-b527-45ae-bfbb-1ec8af592e1a.pdf
37. The second sentence implies the broader anti-protection principles of Art. III, para. 1. The Notes to Art. III widen the protection by adding the concept of a directly competitive or substitutable product as the basis for comparison.
38. While I find much that is commendable in Schoen, I cannot agree to his view that Art.III, para. 2, sentence 1, would embrace discrimination in income taxation. I further disagree with the statement (at 12) that the direct/indirect tax dichotomy "looks precarious." For reasons stated, there is a complete remedy available under the status quo under Art. III para. 2 for an indirect tax regime for discrimination, under Art. III para 4 for discrimination, inter alia, on direct tax, and in Art. XVI and the SCM for an export subsidy in the form of an excessive refund of an indirect tax or the exemption/remission of a direct tax.
39. Avi-Yonah and Clausing make the same case.
40. Under the “fair market value rule”, any taxpayer that sought an exemption under the ETI Act had to ensure that in the manufacture of qualifying property, it did not “use” imported input products, whose value comprised more than 50 per cent of the fair market value of the end-product.
41. United States — Tax Treatment for “Foreign Sales Corporations” (ARTICLE 21.5 – EC), WTO/DS108/AB/R (adopted 29 Jan., 2002).
42. You will recognize this as another expression of the destination principle.
43. Art. 1.1 (a) (ii).
44. The Vienna Convention on the Law of Treaties [Vienna Convention] would govern the textual analysis of the SCM. As has been noted in the Appellate Body Report in United States — Standards for Reformulated and Conventional Gasoline, WTO/DS2/AB/R (adopted 20 May, 1996) at 17
The general rule of interpretation [as set out in Article 31(1) of the Vienna Convention on the Law of Treaties: 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 the light of its object and purpose] has attained the status of a rule of customary or general international law. As such, it forms part of the “customary rules of interpretation of public international law” which the Appellate Body has been directed, by Article 3(2) of the DSU, to apply in seeking to clarify the provisions of the General Agreement and the other “covered agreements” of the Marrakesh Agreement Establishing the World Trade Organization (the “WTO Agreement”). That direction reflects a measure of recognition that the General Agreement is not to be read in clinical isolation from public international law.
45. Meanings must be assigned to each iteration of a term in such a manner that each such usage is consistent with the document’s purpose as a whole. In Appellate Body Report, United States — Continued Existence and Application of Zeroing Methodology, WT/DS350/AB/R (adopted 19 February, 2009) we find (at para. 268) the following guidance
The principles of interpretation that are set out in Articles 31 and 32 [of the Vienna Convention] are to be followed in a holistic fashion. The interpretative exercise is engaged so as to yield an interpretation that is harmonious and coherent and fits comfortably in the treaty as a whole so as to render the treaty provision legally effective. A word or term may have more than one meaning or shade of meaning, but the identification of such meanings in isolation only commences the process of interpretation, it does not conclude it. … a treaty interpreter is required to have recourse to context and object and purpose to elucidate the relevant meaning of the word or term. This logical progression provides a framework for proper interpretative analysis. At the same time, it should be kept in mind that treaty interpretation is an integrated operation, where interpretative rules or principles must be understood and applied as connected and mutually reinforcing components of a holistic exercise.
46. See CRS Report for Congress, A History of the Extraterritorial Income (ETI) and Foreign Sales Corporation (FSC) Export Tax-Benefit Controversy Updated November 9, 2004, available at http://www.taxhistory.org/thp/readings.nsf/cf7c9c870b600b9585256df80075b9dd/d1e0dcc337b8048385256f860068159e? See (re: DISC), General Agreement on Tariffs and Trade, "United States Tax Legislation (DISC): Report of the Panel Presented to the Council of Representatives on 12 November 1976," Basic Instruments and Selected Documents, 23rd Supp., Jan. 1977, p. 103; re: FSC and ETI, United States — Tax Treatment for “Foreign Sales Corporations” WT/DS108.
47. Professor Cui and apparently several other economists challenge whether the exchange controls would work as quickly or as extensively as DBCFT sponsors would warrant so as to eliminate distortions.
Mark K. Neville, Jr., LL.M. (International Legal Studies), NYU, is a long-time member of the Board of Advisors. He is Principal of International Trade Counsellors and may be reached at mkneville@itctradelaw.com. He has served as an adjunct professor at The University of California, Berkeley’s Haas School of Business and NYU’s Stern School. He is The Journal’s Customs & Trade correspondent.