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International Trade Subsidy Rules and Tax and Financial Export Incentives

AuthorHouse

Chapter One

This book is a revised and expanded version of my Harvard Law School LL.M. Long Paper, which had the careful guidance and supervision of my advisor, Professor Alvin C. Warren Jr. It is an inquiry into the interrelations between the international trade rules concerning subsidies and the use of tax and financial export incentives by developing countries. Its central claim is that developing countries should be allowed to adopt such incentives without violating those rules, based on their right to development. The logic behind the body of international law governing trade, in the context of the WTO, has been that of free trade and liberalization, without the necessary concern to the developing needs of developing countries. Except for some isolated "special and differentiated treatment" provisions of dubious effectiveness, the profound differences between developed and developing countries are largely ignored, which contributes to maintaining or widening the gap between them. In particular, international trade subsidy rules bar developing countries from adopting more aggressive development policies grounded on the concession of tax or financial export incentives. Such policies can be conducive to progress, leading to a national welfare gain, if their overall return exceeds their costs and the developing countries are able to enhance their competitive position. However, the success of these strategic trade policies often depends on the adoption of specific export incentives, targeted to certain key sectors and conditioned to performance goals, as the east Asian experience shows. Therefore, the current WTO subsidy rules are incompatible with the developing needs of developing countries, impairing their right to development - a human right universally recognized under international law. Although international trade law prevails over domestic law, the issue of how far it can meddle with fiscal sovereignty is still an unresolved one. But it is clear that trade rules cannot interfere with a country's development sovereignty, and as far as tax and financial policies are instrumental to developing countries' development goals, they should be immunized from the reach of the subsidy concept, through the introduction of a built-in exception for developing countries in the text of the Agreement on Subsidies and Countervailing Measures (ASCM).

1.1. Export incentives: tensions between taxation, international trade and development.

The reciprocal implications between the subsystems of taxation, international trade and development are undeniably multiple and have been growing, in number and intensity, over the past few decades. I intend to investigate a particular aspect of this intricate configuration: tax and financial incentives, insofar as they constitute a privileged connecting point between those areas.

As Victor Thuronyi notes, "in a number of countries, tax expenditures have assumed an increased importance. The use of tax laws to accomplish subsidy purposes has obviously led to complexity." of course, a chain of causation might be discerned within this process: each sovereign country designs its tax incentives through fiscal policies, aimed at promoting economic activity, improving employment rates, attracting foreign investment and enhancing international competitiveness. Even though seeking these goals, which are prima facie legitimate under the right to development, national tax incentive programs may be deemed forbidden subsidies under international trade law provisions - particularly under the ASCM.

When this kind of conflict erupts, a fragile equilibrium is jeopardized. Questions of fiscal sovereignty in a progressively interdependent world would inevitably arise: do tax incentives constitute a "fundamental tax policy issue" that does not fall within the jurisdiction of the WTO, or should trade regulations prevail over domestic policies? In either case, the idiosyncratic interactions between taxation, WTO rules and the right to development are completely exposed, deserving a better understanding.

A. T. Tavolaro, former IFA Vice-President, argues that the imbrications between the aforementioned areas exert a strong influence on international competitiveness, foreign direct investment flows and economic development policies, irradiating effects over several crucial fields of international relations. Considering the vast array of topics to explore in this area, I narrowed the focus of the research, by concentrating my efforts on three closely related sub-themes: national policies concerning fiscal or financial incentives, international trade rules on subsidies and the right to development. These sub-themes will be unified by one common underlying problem, which is the characterization of tax and financial export incentives as subsidies in general and in exceptional, development-related situations.

I have been interested in these issues since 08.27.2004, when Prof. Vera Thorstensen, the then Special economic Advisor for the Brazilian Mission to the WTO, gave a special lecture in Professor Umberto Celli's Dispute Resolution course at the University of São Paulo Law School (USP). Her speech shed an analytical light on the fundamental reasons of international trade conflicts on subsidies and brought questions of fiscal sovereignty into the discussion, emphasizing details of the "United States - Tax Treatment for Foreign Sales Corporations (US-FSC)" case: although US subsidies have been deemed inconsistent with international trade laws, the country argued that the WTO should not interfere with national tax policies, a matter of internal affairs which does not affect third countries and cannot, consequently, be reached by WTO jurisdiction.

Since then, I have cultivated a vivid academic interest in investigating the existence of limitations to fiscal sovereignty imposed by international trade law, and also of exceptions to those limits (such as the right to development of both developing and Least Developed Countries - LDCs). By adopting a perspective that goes beyond a strictly legal-positivist one, these exceptions should not be circumscribed to those set forth in the Article 27 ("Special and Differential Treatment of Developing Country Members"), nor should the countries to which they apply be restricted to those listed in Annex VII ("Least-developed countries designated as such by the United Nations which are Members of the WTO") of the SCM Agreement.

The relevance of studying the conflict between international trade law and domestic export tax and financial subsidies is indisputable. As an example of such relevance, one should mention the US-FSC decision itself, which involved a complex, slow-paced and costly proceeding, whereby the WTO authorized the E.U. to impose the largest sanction in the history of that international organization: approximately USD 4,000,000,000.00, according to Carrie Anne von Hoff. This figure suggests, undoubtedly, the existence of a sword of Damocles hanging over Euro-American relations.

Commenting on the potentially unbearable consequences of the effective adoption of the measure, G. Campkin, from the Confederation of British Industry, said: "there is a real danger of significant damage - not just to transatlantic relations but to the WTO itself." In other words, since the US refused to immediately comply with the WTO determinations in that ruling, had the European Union decided to impose at once all the countervailing measures it was entitled to, the very existence of the WTO would be at risk. Therefore, the relevance of studying vital disputes like this one is evident, under multiple facets: (i) economic, considering the huge amounts involved; (ii) legal, reflected in the relations between the subsystems of international public law (general theory of sovereignty), tax law (fiscal sovereignty and incentives), international trade law (the concept of subsidy) and development law (use of tax incentives as a way of overcoming poverty); (iii) political, due to the potential menace to the US-E.U. relations; and (iv) institutional, since the very existence and the functionality of the WTO as an international organization are at stake.

It is the purpose of this book to evaluate to which extent it is legitimate for the WTO to decide upon a domestic fiscal policy (particularly in a case such as the US-FSC) without inflicting an excessive loss of sovereignty - either in the field of tax sovereignty or in the area of development sovereignty. Accordingly, the study will seek to investigate when fiscal policies would be deemed forbidden subsides under international trade regulations and under which circumstances incentives could be validly adopted by developing countries, in the light of their right to development.

1.2. Methodology: an interdisciplinary approach.

The research covers a whole spectrum of perspectives associated with one central topic: the treatment of fiscal and financial subsidies under international trade law, using the right to development as a background. This way, among the diverse aspects of a world scene marked by multilateral relations, this work focuses on the intersection between fiscal sovereignty and international trade law, as far as the concession of subsidies or other support measures is concerned, always taking the right to development into consideration.

For that purpose, despite having an unambiguous object, the research counts on several analytical research tools. It resorts not only to international tax and trade, but also to development studies. The adoption of a precise object of analysis has, of course, restricted the scope of the study to an assessment of the degrees of freedom enjoyed by sovereign states to design their own fiscal policies, specially when it comes to incentives, vis-à-vis the regulations of international trade, and to possible "escape valves" granted by the right to development. While the study has a defined target, divided into three intentionally overlapping sub-areas, it has applied several methodological tools to describe, explain and criticize the current state of affairs in this particular point of confluence of a progressively integrated global economy. These tools, as will be seen, pertain to different areas of knowledge, such as law, economics, international relations and political science. Hereinafter, a more detailed description of each sub-area is presented.

1. International tax. One important question to be tackled relates to the concept of fiscal sovereignty, which, even though deriving from the general idea of state sovereignty, has several peculiarities that must be clarified. After all, the world is currently witnessing a reconceptualization of the notion of fiscal sovereignty, triggered by the emergence of a new source of normative production - the WTO, an international organization which personifies the targets and goals of globalization, and its multilateral trade rules. This is a noticeable phenomenon, for a recently created international organization has caused, with its rules and decisions, a profound change on the juridical, political and economic relations among many sovereign states. As McLure states, "not all voluntary limitations on national sovereignty in taxation are market-induced, nations sometimes agree voluntarily to negotiated limits on their exercise of sovereignty. The GATT is the most extensive system of negotiated limits on taxing power and the only important multinational tax agreement, aside from those between the E.U. Member States. The GATT pertains primarily to import duties and export subsidies (...). The key point about the GATT is that potential gains are so great - and the potential harm from widespread resort to 'beggar-thy-neighbour' tariffs so enormous - that nations agree to forego the national benefit that might result from unilateral departures from free trade." Therefore, the power to tax (or to grant incentives) is no longer unlimited, and cannot be completely understood as an isolated concept, without being placed in an international perspective. Along the same line, the effects of international competition on the fiscal and trade areas constitute a crucial component of the current global framework.

2. International trade. After a brief description of relevant multilateral trade rules, their appropriate forum of enforcement (the WTO) and their relative position regarding national legal systems, this work explores the underlying rationale of the concept of subsidy, from the viewpoint of international trade law. This step comprises an in-depth study of the goals of the international trade regulation (free versus fair/just trade) and of the general concept of subsidy, using insights from scholars, international law commentators, as well as decisions rendered by national courts and international dispute settlement bodies. It also includes an investigation on how this international trade legal concept affects, in practice, the degree of fiscal sovereignty at a national level. It will be necessary, therefore, to clarify the definition of subsidy, its core components and its typology, according to the ASCM. For the purposes of this book, suffice it to note that the concept involves two basic elements: "first, to become subject to the rules in the SCM Agreement, a subsidy must confer a benefit on the recipient; second, it must be specific, i.e., available only to an enterprise or industry or group of enterprises or industries." Of particular interest to the research is the notion of prohibited subsidies, i.e., those contingent upon "export performance" (Article 3.1.a) or upon "the use of domestic over imported goods" (Article 3.1.b). Although this section begins with an analysis of the normative text, it will not be limited to the clearly unsatisfactory grammatical method of legal interpretation. For this reason, my hermeneutic efforts extended beyond the boundaries of legal positivism. Moreover, throughout this academic endeavor, it was necessary to develop innovative legal approaches, given that the traditional methods for solving antinomies cannot be uncritically adopted when dealing with sophisticated transnational problems.

In order to illustrate the theoretical discussions, and specially to elucidate their practical implications and the links between international taxation and trade, the US-FSC case is analyzed in a separate chapter. The study discusses the mechanism and dynamics of the FSCs, the benefits they were entitled to, their requirements and the reasons why the WTO Dispute Settlement Body (DSB) concluded that they constituted an unlawful subsidy ("a foregoing of revenue otherwise due to the government that was based on export performance") under international trade rules. Building on such discussion, this book shows that the touchstone to ascertain an antinomy between national tax legislation and the rules of international trade lies precisely in the concept of subsidy. By adopting this point of view, the research resorts to the notion of subsidy as defined by the WTO, but only as an initial standard for assessing the extent of sovereignty left to each member country and finding means of enlarging this space for developing countries and LDCs. It also critically reviews the WTO decisions concerning subsidies, in order to refine the current understanding of the concept. This two-step analysis procedure yields not only a theoretical reflection on subsidies in general, but also enables a better understanding of the applied concept of subsidy, as evoked in real cases. Consequently, this book tries to investigate a part of the reality profoundly affected by the globalization of taxation and trade practices.

(Continues...)

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Excerpted from International Trade Subsidy Rules and Tax and Financial Export Incentives by Paulo Penteado Neto Copyright © 2012 by Paulo Penteado Neto. Excerpted by permission of AuthorHouse. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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