VALUE ADDED TAX IN THE CONTEXT OF THE GENERAL AGREEMENT ON TARIFFS AND TRADE – INSIGHT AND PRACTICE

(1)

VALUE ADDED TAX IN THE CONTEXT OF THE GENERAL AGREEMENT

ON TARIFFS AND TRADE – INSIGHT AND PRACTICE

University of Amsterdam, Faculty of Law

International and European Union Law: International Trade and Investment Law (LLM Track 2016-2017)

Ralitsa Boykova Mileva, St. № 11314176 17 July 2017

Regulation of international trade will not be effective without a normative symbiosis between GATT rules and tax systems of the WTO member states. Taxes either direct or indirect are subject to many binding rules of the GATT along with other measures that might have negative impact on trade liberalization regime provided for therein. Many authors consider the VAT taxation system more advantageous than a fiscal system relying primarily on direct taxes. This advantage is assessed based on the distinction that GATT makes between direct and indirect taxes with respect to border tax adjustment rules. Whether this position is justifiable depends on a number of factors. VAT taxation works through a complex ‘charge-deduct mechanism’ on a multiple stage basis. The complex VAT machinery may provide for certain measures which violate different GATT articles, not necessarily those concerning immediately taxation.

Introduction

The entry into force of the General Agreement on Tariffs and Trade (GATT) in 1947 represents a milestone in the liberalization of world trade. GATT is recognized in the doctrine as “the first successful agreement to generate multilateral trade liberalization”1. It does so by establishing a set of rules (most of which prohibiting in nature) directed at the reduction of tariffs and other trade barriers and at the elimination of any discriminatory treatment in international commerce. An explicit objective of the liberalized trade regime under the GATT, introduced in the preamble of the treaty among other proclamations, is “developing the full use of the resources of the world and expanding the production and exchange of goods”. The EU customs union is indeed a customs union within the meaning of Article XXIV GATT and it has been established under the conditions thereof. It, therefore, creates a liberalized regional trade microclimate. However, in order to remove any obstacle to the free movement of goods within the territory of the single market, the EU regime provides for harmonization of the law of the member states relating to turnover taxes and more specifically for the application of a common system of value added tax

1

(3)

(VAT)2. This is illustrative of the fact that VAT might be of a concern for liberalizing trade practices. And this concern has the same validity when transferred to WTO level. VAT regulation at the international level is of utmost importance not only because of the possibility of double taxation but also because of its potential to discriminate or to treat less favorably imported products in protection of domestic production. Moreover, under certain hypotheses it might distort pricing of the same goods when consumed in different states via the grant of state subsidies in the form of VAT-credit. The current paper aims to discuss whether and to what extent the complex mechanism of VAT taxation offers margin for states to WTO-inconsistent practices. For this purpose, brief explanation of legal and economic nature of VAT will be introduced and its eligibility for border adjustment. Reference will be made to the debate whether border adjustable taxes provide competitive advantage in international trade to WTO members and how this advantage might be used in trade distorting practices. As relevant to this topic a short reference will be made to the United States ongoing debate for restructuring of the tax system by introduction of a border-adjustable tax. A reference will be made with this regard to tax occultes, to which although falling within the definition of indirect taxes, also posse characteristics of direct taxes. To illustrate that border adjustment of VAT on export might be used to subsidize domestic industries and also to result in different pricing for domestically consumed products and exported domestic products, a brief explanation will be presented of the China VAT rebate/export tax policy which regulate the aluminum foil market (considered WTO inconsistent by world’s largest aluminum exporters – Russia, Japan, EU, Canada and the USA) and of the Bulgarian VAT regime for the motor vehicle, the application of which allows for lower prices in the export countries. To illustrate that a VAT regime, through its multi-stage mechanism, provides opportunities for countries to disguise excessive taxation of the like imported products, a review of the findings of the WTO dispute settlement panels and the Appellate Body will be made a few disputes that address VAT measures.

Legal and Economic Features of VAT

Any discussion of VAT in the context of GATT rules would not be the least contributive without proper insight into the VAT legal and economic identity. Since the rationale behind the trade liberalization in the framework of WTO and GATT is purely economic – to facilitate trade

2

Council Directive 2006/112/EO establishing a common system of value added tax system to replace the pre-existing other turnover taxes in the member states.

(4)

between countries and regions and to eliminate trade distortions3, the knowledge of what is VAT and what economic purposes it serves to the states should be a starting point for any further analysis of VAT consistency with GATT rules. In view of the objectives, a parallel might be made between the GATT rules and the respective rules of the Treaty on the Functioning of the European Union which aims at eliminating fiscal barriers, quantitative restrictions and all measures having equivalent effect for the purposes of the single market and the free movement of goods therein (Art. 28 – 35 TFEU).

1. Legal aspects

VAT is a type of tax – a financial obligation for consumers of goods and services to make contribution to state revenue on grounds of law. The Organization of Economic Cooperation and Development (OECD) provides for the following definition: "value added taxes (VAT) are consumption taxes. They have three distinctive characteristics: they are levied on a broad base (as opposed to excise taxes which cover specific products), the collection system is organized in stages where each agent may deduct input taxes on purchases and must account for output tax on sales, and, ultimately, the burden will be borne by consumers who, as end-users, cannot operate immediate deduction operations. In practice, three tax collection mechanisms are mainly used: (a) under a registration system, the vendor registers with the tax authorities and is responsible for paying/collecting the tax; (b) the tax may, alternatively, be collected directly by the customs authorities at the border; (c) under the reverse charge/self-assessment system, the customer pays directly to the tax authorities"4.

The operation of the deduction mechanism attributes to the VAT the characteristics of an indirect tax. Indirect taxes are taxes charged directly on the price of goods and services where the tax burden is shifted from the taxpayer to the consumer5. VAT is charged as a percentage of the

3_{The preface of GATT proclaims that the arrangements therein are directed to the substantial reduction of tariffs}

and other barriers to trade and to the elimination of discriminatory treatment in international commerce with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income and effective demand, developing the full use of the resources of the world and expanding the production and exchange of good. The GATT entered into force shortly after the end of the Second World War to boost post-war economic recovery. For the origins of GATT see Irwin, Mavroidis and Sykes (2007), The Genesis of the GATT, 5 – 95.

4

OECD, International VAT/GST Guidelines, February 2006, p. 7.

5

(5)

whole sale price. The tax rates vary between countries6 and between certain types of products7. Although VAT is charged at each stage in the production and distribution chain, the taxable person is entitled to deduct all the tax already paid at the preceding stage and thus, tax is paid only on the value added at each stage separately, as the tax name itself suggests.

This can be illustrated by the following example presenting how VAT operates in a country which apply 20% VAT rate: Company B pays to company A the price of 120 € (incl. 20 € VAT) for the purchase of 30 kg. sugar. Company A pays 20 € VAT on the sugar price to the government. Company B uses the purchased sugar in the production of sweets. It thus increases the value of the sugar by adding other products in the production of sweets. It then sales the produced sweets for a price of 180 € (incl. 30 € value added tax) to company C. For the sale of the sweets company B pays 30 € to the government. In the operation of the tax credit mechanism, company B, as intermediary in the subsequence of transactions, has the right to deduct the 20 € VAT paid for the purchase of sugar from the 30 € VAT that it owes to the state for the sale of sweets (30 € - 20 € = 10 €). The effect of this will be that the VAT obligation of B for the sale of sweets will not be 30 € VAT (as it charged to C) but 10 € instead. And 10 € VAT is exactly 20% of the amount of the value added to the sugar by company B in the production of sweets (150 € – 100 € = 50 € / 50 € x 20 % = 10 €). This example is illustrative of that although VAT is charged on the whole sale price (on 100 € for the A-B transaction and 150 € for the B-C transaction), it is paid only for the value added at each stage in the production and distribution chain – 50 € in the considered case. The deduction of input VAT (also called tax credit) avoids the occurrence of double taxation of the same product. It also ensures that VAT payments that are made at each stage of production and sale are not cumulated in the state budget as long as the taxpayer is registered taxable person and has the right of deduction. Once it reaches the stage at

6

According to the information available here: http://www.vatlive.com/vat-rates/international-vat-and-gst-rates, the standard VAT rate as of 1st of July 2017 is: in China 17%, in Austria 20%, in Denmark 20%, in Norway 25%, in Argentina 27%, in the Philippines 12% etc. Even within the EU there is no single rate applicable between all member states even though Council Directive 2006/112/EC of 28 November 2006 establishes a common VAT policy.

7

In China for example the standard VAT rate for financial services and insurance; telephony and internet data; IT; technology; consulting is 6%, for retail, entertainment services, hotel, restaurant and catering services, real estate and construction, telephony calls, postal services, transport and logistic is 11%, for certain agriculture production, cereals, edible vegetable oils, books, newspapers, magazines, public water supplies and heaters is 13% and for all other taxable goods and services is 17%.

(6)

which the products in question are sold to a non-taxable person (final consumer) VAT enters the state budget finally and irrevocably and is not subject to further deduction or refund.

2. Economic aspects

In economic discourse VAT represents an important pricing factor in the trade of goods and services8. It is a significant component of a product’s purchase price and determines the total cost of consumption for the final consumers, since they pay non-deductible VAT included in the price. From a point of view of the states, VAT has predominantly fiscal purposes. The fiscal rationale behind the VAT is the considerable degree of revenue increase as a result of VAT inflows. Many of the world’s most industrialized countries have introduced VAT9

. Through its multiple-phase collection, VAT ensures constant cash inflows for the government. It works as a form of interest-free pecuniary loan from businesses to the government for the time between payment and deduction.

Border adjustability of VAT

Where products are produced and consumed in one country, VAT is levied by this country. Where, however, the products of one country are exported for sale in another country, VAT is collected by the latter, since it is the country of consumption. As stated above VAT is a consumption tax to the burden of final consumers. Exported products are to be consumed outside their country of origin; therefore, exports are not subjects to tax with refund of input taxes. This principle is known as “the destination principle”10 in the Tax doctrine. In the country of import, the products with foreign origin are subject to taxation according to the rules applicable for domestic products. By reason of the above principle of collection applied in cross-border sales, VAT is widely accepted to be inherently and by its nature border adjustable and procompetitive. The issue of border tax adjustment was first addressed by GATT in 1970. Border tax adjustment (BTA) is defined by OECD 11 as “any fiscal measure put into effect, in whole or in part, the destination principle (i.e. which enable exported products to be relieved of some or all of the tax

8_{VAT affects the pricing in a way it raises the production cost at each stage along the production process. The}

higher the value added in the production, the higher the VAT and respectively the sale price.

9

Among these are: Russia, Germany, South Korea, United Kingdom and France.

10_{See OECD (2017), International VAT/GTS Guidelines, p. 16} 11

"Border Tax Adjustments and Tax Structures in O.E.C.D. member countries" by the Organization for Economic Cooperation & Development (O.E.C.D.).

(7)

charged in the exporting country in respect of similar domestic products sold to consumers on the home market and which enable imported products sold to consumers to be charged with some or all of the tax charged in the importing country in respect of similar domestic products”. This definition has been used by the GATT Working party on Border Tax Adjustments12 when the issue of border adjustment was first addressed in 1970. Border adjustment ensures that goods exported from one country to another are neither subject to the same taxes in both countries nor equally tax-relieved, thus maintaining competition in international trade.

There is no single section in GATT dedicated particularly to border adjustment. GATT rules dealing with border adjustment are found in several Articles of the Agreement, the main being the provisions of Article III (concerning imports) and Article XVI (concerning exports). Other articles considered relevant by the Working Party include Article I, II, VI and VII13. The indicated GATT rules treat differently indirect and direct taxes by applying the destination principle to the former and the origin principle14 to the latter. This distinction is based on the economic assumption that indirect taxes, by increasing the price of the product, shift forward the tax burden to the final consumer while direct taxes, having more complex relationship to price, remain to the burden of the manufacturer or producer.

VAT as a classical indirect tax is the most common form of border adjustable tax. The 1970 GATT Working Party Report expressly concluded “the convergence of views to the effect that taxes directly levied on products were eligible for tax adjustment” and provides VAT as an example thereof15. This statement was later referred to by the GATT panel in United States – Taxes on Petroleum and Certain Imported Substances to reaffirm that “the tax adjustment rules of the General Agreement distinguish between taxes on products and taxes not directly levied on products”16

. According to the panel in the Superfund case, the purpose of the tax is irrelevant for border-adjustment eligibility: “Whether a sales tax is levied on a product for general revenue purposes or to encourage the rational use of environmental resources, is therefore not relevant for

12

GATT (1970), Report by the Working Party on Border Tax Adjustments, BISD 18S/97, adopted Dec. 2, 1970, p. 2, para 4.

13

Ibid, Annex, The GATT Rules on Border Tax Adjustment, Note by Secretariat, p. 12

14

Products are subject to taxation in the country they were produced – country of origin (exporting country).

15_{Ibid, para 14, p. 3 and 4.} 16

GATT Panel Report, United States – Taxes on Petroleum and Certain Imported Substances (known as the

(8)

the determination of the eligibility of a tax for border tax adjustment.”17

The issue of border adjustment eligibility of taxes was further addressed by the non-adopted GATT panel in the United States – Restrictions on Imports of Tuna where the panel found that "under the national treatment principle of Article III, contracting parties may apply border tax adjustments with regard to those taxes that are borne by products, but not for domestic taxes not directly levied on products”18

. The 1970 GATT Working Party Report also states that the philosophy behind the provisions reflecting border adjustments was the achievement of trade neutrality between imported and domestically-produced goods19.

However, the question as to whether GATT border tax adjustment rules does promote trade neutrality has been the focus of a continuing debate ever since 1970 bringing into consideration the disadvantage that countries relying mainly on direct taxes face under GATT. Back to 1970, some members of the Working Party on Border Tax Adjustment expressed the view that “the GATT rules favour countries which rely heavily on indirect taxes and discriminate against countries which rely predominantly on direct taxes”20

. In more recent years, the trade neutrality of VAT and indirect taxes in general continues to be argued. Some authors disclaim the assumption, on which border adjustability of indirect taxes is based, that indirect taxes are completely shifted forward and represented in the final price of the product while direct taxes completely lack forward shifting21, by stating that some studies indicate full or partial forward shifting of direct taxes and correspondingly that indirect taxes are not necessarily fully shifted to consumers. Other commentators share the view that indirect taxes in general and VAT in particular is not trade neutral for at least two reasons: first because “VATs are a substitute for other taxes, especially income taxes, that do affect trade” and second because distributional issues and administrative difficulties “inevitably leads to a tax whose rate varies substantially across industries” 22

. Also, an argument has been mooted by those commentators who disagree with the VAT trade neutrality that VAT is not borne only by the products but is rather a proportionate tax on the factors of production – human resources, capital services etc., because it

17_{Ibid. para. 5.2.4.} 18

GATT Panel Report, United States – Restrictions on Imports of Tuna, 1991, un-adopted, para. 5.13.

19

GATT (1970), Report by the Working Party on Border Tax Adjustments, para 9, p. 3.

20_{Ibid. para 8, p. 2.} 21

J.C. Phillips, Border Tax Adjustment in International Trade, The University of Queensland Law Journal, Vol. 9.

22

(9)

is levied at each stage of production and distribution until the products reach the final consumer and tends to be absorbed more than a tax imposed only at the final stage23.

For all the reasons above, and many others equally24, countries relying largely on direct taxation to raise revenue25 consider themselves at a trade disadvantage in comparison to countries relying more heavily on VAT taxation like EU countries.

The USA debate on the GATT advantage of VAT systems

Perhaps the sharpest criticism of the GATT rules on border adjustment is made by the U.S.A. The U.S.A are to the opinion that WTO allows their trading partners to impose disguised under VAT tariffs to block US exports and backdoor subsidies to enter US markets. This issue has been in the center of the debate on the needs for restructuring of the US tax system which has been on the agenda for decades so far.

The main argument in support of the statement that USA trade face disadvantage in the WTO framework is that WTO allows VAT relief of foreign exports into the US market while prohibiting relief of income taxes paid by US exporters, and by doing so affects negatively on trade flaws and contribute for the trade deficit by stimulating offshoring of capital investment. The US federal government relies predominantly on income taxes to raise revenue. Under the WTO rules however, US exporters are not allowed to refund the income tax paid. This would represent a prohibited subsidy under Article XVI:4 GATT. The practical effect of this is the tendency of US corporations to move their production in countries with VAT taxation, where they will enjoy the benefit of tax rebate, and then to export their products back to the U.S.A. Such exports to the USA markets made by off-shored US companies facilitates trade deficit26. Since exports generate income which is taxable by the USA federal government, offshoring of the productions leads to the reduction of exports and the taxable income therefrom and consequently to the increase of imports and the cost of consumption. As a result of this, USA pays more on imports than it gets from exports and this lead to negative trade balance. The USA

23

OECD, "Border Tax Adjustments and Tax Structures in O.E.C.D. member countries", Part II, para.145.

24_{Many arguments have been launched in support of the view that indirect taxes, incl. VAT are not trade neutral}

but for the purposes of the current paper only the most common of them have been addressed.

25

The USA and Australia are the two main industrialized countries relying predominantly on indirect taxation.

26_{A trade deficit occurs when a country imports more than it exports, because either it does not produce all}

commodities it needs or its production is manufactured in foreign countries. It is also called a negative balance of trade.

(10)

has had a large trade deficit for the last decades. In 2016 the imports were $2.7 trillion and exports were only $2.2 trillion thus having a trade deficit of $502 billion according to the U.S. Census Bureau, Economic Indicator Division’s Balance of Payments Basis27

. The WTO unequal treatment which gives US major trading partners28 unfair tax advantage in international trade is considered attributable to this trade deficit. USA also consider it a competitive advantage of its VAT trading partners that US exporters, by paying VAT to foreign governments, take part in the financing of health care systems of the countries they have moved their production, thus paying both for social insurance of the USA own workers and also a part of the healthcare costs of those countries.

As a response to these concerns, some US policymakers29 proposed the introduction of US VAT to replace or supplement the current income system. This is one of the most controversial issues on the ongoing debate on the redesign of the US tax system. More recently, Ben Cardin – a member of the Senate Finance Committee, introduced an updated version of his Progressive Consumption Tax Act under which a 10 percent value-added tax would be imposed in the United States and the individual and corporate income tax rates would be reduced. Many arguments have been mooted against the assumption that a US VAT would overcome the trade disadvantage that US manufacturers suffer under WTO rules. One of these has been that the US has already introduced a consumption tax in its fiscal system – the sales tax30 and correspondingly that VAT countries in their turn also use income taxes. Moreover, it is considered that the sales tax is more likely to be shifted forward to final consumers than VAT because it is imposed only once in the final stage when the product reaches the final consumer 31. A contra argument, however, is that the sales tax employed in the USA is not subject to export rebates namely because it is applied only once, at the final sale.

27

U.S. Trade in Goods and Services – Balance of Payments (BOP) Basis from 1960 to 2016), U.S. Census Bureau, Economic Indicator Division, June 2017, available at: https://www.census.gov/foreign-trade/statistics/historical/gands.pdf

28

China, Japan, Germany and NAFTA partners – Canada and Mexico.

29

The best-known VAT proposals were introduced in the U.S. Congress are Senators Boren and Danforth's Comprehensive Tax Restructuring and Simplification Act of 1994 and Congressman Sam Gibbons' Revenue Restructuring Act of 1996.

30

Although both are consumption taxes, the sales tax differs from VAT in that it is levied only once on the total value of goods and services purchased unlike VAT which is imposed on every value added to the product at every stage of production and distribution.

31

(11)

On 26.04.2017 US president Donald Trump’s administration released its tax reform plan. The centerpiece of the reform is the proposal to replace the current tax on corporate income with a border-adjustable tax on corporations that excludes taxation of exports sales and levies tax on imports. I Many lawyers experienced in WTO disputes are of the opinion that the application of the proposed tax will be inconsistent with WTO rules on more than one legal basis. There is a widespread outcry among trade experts and EU business groups to the proposed tax. Nonetheless, Kevin Brady, head of the tax-writing House of Representatives Ways and Means Committee, believes that the reformed tax will be consistent with WTO rules. Whether the tax will be WTO compliant at the end depends on the content of the final legislative act. In all cases, it will be considered fully consistent with WTO rules unless it is challenged by another WTO contracting party and a ruling of a panel or the Appellate Body which is adopted by the Dispute Settlement Body finds otherwise.

VAT infrastructure within WTO

The World Trade Organization today is a forum for the governments of 164 countries32. Not all 164 member-states however have VAT taxation introduced in their fiscal policies and legislation. VAT system is traditional for the European countries. Most EU member states already had a system of VAT before joining the Union, but there were a few33 that have not had VAT introduced before they joined the European Union. For those countries VAT introduction was a premise for membership. The establishment of the single market34 guaranteeing free movement of goods makes it compulsory for EU member states to adopt a common VAT policy of the Union. In present, there is a coordinated of value added tax within the EU VAT area which is an important part of the single market. VAT legislations of member states are harmonized by Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax35 which is commonly referred to as the Sixth Directive. Under the current regime, the application of VAT is decided by national tax authorities but it shall be compliant to standard EU rules established by the directive. As a legislative instrument to regulate VAT policy on EU level

32_{More information on membership in the WTO is available at the homepage of the organization:}

https://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm

33

Spain for example had not had a VAT taxation before joining the EU.

34_{The foundations of the single market of the EU were laid down by the Sigle European Act (1986) and functions as}

of 1 January 1993.

35

(12)

the Sixth directive provides for some discretion for the member states to implement VAT legislation36. On 7th of April 2016 the Commission of the EU adopted and Action Plan37 that provides clear orientations towards a single European VAT area in relation to the definitive VAT system for cross-border supplies.

In other parts of the world, value added tax is known as good and services tax although it has the same characteristics. Such is the case with Australia, New Zealand, Malaysia and Canada.

The US tax law does not provide for VAT taxation. Instead, sales tax is levied on the sale or lease of goods and services. US sales tax is applied at the state level and there is no general sales tax applicable to all states. The federal government of the US levies only a few selective taxes on the sale or lease of particular goods and services. While sales tax is predominantly collected at state and local level, income taxes38 are levied at federal level by the federal government.

VAT consistency with GATT rules

As an indirect tax on consumption VAT is recognized as border-adjustable tax39. This means that VAT on imports is permitted under Article III:2 GATT40 and so is the rebate of VAT accrued on exported products41. Within WTO policy discourse this is justified for the purpose of leveling the playing field42 and avoiding double taxation in spite of the revenue reduction occurring for the government thereof. GATT/WTO regime for border-adjustment of VAT and indirect taxes in

36

Ibid.

37_{Communication from the commission to the EU Parliament, the Council and the European Economic and Social}

Committee on action plan on VAT Towards a Single EU VAT Area – Time to decide, available at: https://ec.europa.eu/taxation_customs/sites/taxation/files/com_2016_148_en.pdf

38

Alternative minimum tax, Capital gains tax, Corporate tax, Estate tax, Excise tax, Gift tax, Income tax, Payroll tax.

39

GATT (1970), Report by the Working Party on Border Tax Adjustments, para 14, p. 3 and 4 and

40_{Article III:2 of GATT enables the contracting parties to impose internal taxes on imported products. The Panel}

report in Argentina - Measures Affecting the Export of Bovine Hides and the Import of Finished Leather case informs that the fact that VAT is collected at the time and point of importation does not preclude it from qualifying as an internal tax measure under III:2, first sentence of GATT.

41

The Note Ad Article to GATT Article XVI allows 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 of taxes in amounts not in excess of those which have been accrued, shall not be deemed to be a subsidy." This also restated the SCM Agreement.

42

(13)

general protects the equality in treatment between domestically produced and the like imported goods43.

However, the GATT provisions on border adjustment set “maxima limits” for adjustment to which VAT taxation shall be compliant44. Article III: 2 of GATT permits internal taxation of imported products which however is not in excess of that applied to the like domestic products45. Under article XVI:4 of GATT (the Note Ad Article to GATT Article XVI) read in conjunction to Agreement on Subsidies and Countervailing Measures (SCM Agreement) and footnote 1 thereof46, rebate of taxes borne by the like domestic products when destined for domestic production is permissible provided that the amount of rebate does not exceed the actual amount of tax accrued. Therefore, VAT taxation will be GATT-consistent to the extent that it is not applied beyond the limits of border adjustment rules. Where VAT on imports is applied in a way that imported products are treated less favorably than the like domestic products or where the amount of VAT rebate for exports exceeds the tax collected by the government, VAT application will be in breach of GATT/WTO rules, because it will exceed the limits of Article III:2 and Article XVI:4 GATT respectively.

VAT under XVI: 4 “Subsidies”

As defined by the OECD, one of the three distinctive features of VAT is its collection mechanism, whereby each agent at each step of the production of a commodity may deduct input taxes on purchases and must account for output tax on sales, so that the burden is borne by the end-user who does not have the right of deduction. Thus, the VAT operates under the tax-credit mechanism. Tax credit itself is the right of the taxpayer to refund the VAT paid for taxable purchases by reducing the total VAT they owe the state with respect to sales. This mechanism operates the same way when products are destined for consumption in a foreign country and VAT is refundable on exports.

43

GATT (1970), Report by the Working Party on Border Tax Adjustments, para. 13, p. 3.

44_{Ibid. para. 11, p. 3. This was also stressed by the Panel in the Superfund case.} 45

See GATT Article III:2, first sentence.

46

Footnote 1 of the SCM Agreement stipulates: “In accordance with the provisions of Article XVI of GATT 1994

(Note to Article XVI) 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.”

(14)

As suggested above, the question of excessive rebate is the main context in which VAT rebates are typically analyzed in terms of GATT/WTO consistency. Putting aside the “excessiveness” inconsistency, the following paragraphs will analyze whether VAT refund policies might be used to disguise protectionist measures in favor of domestically based producers.

Article XVI:4 GATT stipulates that: “contracting parties shall cease to grant either directly or indirectly any form of subsidy on the export of any product other than a primary product which subsidy results in the sale of such product for export at a price lower than the comparable price charged for the like product to buyers in the domestic market.”

Article XVI GATT itself does not contain any definition whatsoever of the term “subsidy”. A definition as to what constitutes a “subsidy” by the meaning of Article XVI GATT is provided for in the Agreement on Subsidies and Countervailing Measures (ASCM)47. Under Article 1.1(a)(1)(ii) of the ASCM, any financial contribution by a government or any public body in the form of government revenue which when being due is foregone or not collected (e.g. fiscal incentives such as tax credits) shall be deemed to be a subsidy. Annex I of the ASCM provides an illustrative list of subsidies, among which “The exemption or remission, in respect of the production and distribution of exported products, of indirect taxes in excess of those levied in respect of the production and distribution of like products when sold for domestic consumption”48. The illustrative subsidies in Annex I are prohibited by Part II, Article 3 ASCM. According to footnote 1 to Article 1.1(a)(1)(ii) of the ASCM, however, exemption or remission of exported product from indirect taxes (such as VAT) shall not be deemed to be a subsidy49. Based on the above cited provisions, the exemption or remission at the border of VAT accrued on exported products is accepted to be permitted Art. 1.1(a)(1)(ii) and footnote 1, and Annex I, paras. (g) of the ASCM. Nevertheless, some state practices challenge the credibility of this generalization.

47

WTO Agreement on Subsidies and Countervailing Measures, one document of Annex 1A to the Marrakesh

Agreement Establishing the World Trade Organization, adopted in the final session of the Trade Negotiations

Committee at Ministerial level held at Marrakesh, Morocco from 12-15 April 1994.

48

Ibid. paragraph (g).

49

(15)

China’s aluminum “complex export subsidy program”

For several decades China has been shifting economic policies by manipulating VAT rebates and export taxes. It has been introducing export taxes on certain raw products and simultaneously eliminating VAT rebates to discourage the export of those products and to reduce their cost in the domestic market while in the same time promoting the export of the finished products that are not subject to export taxes and thus enjoy VAT-rebate advantage.

Example of this policy shifting by means of VAT rebates and export taxes variations is the Chinese aluminum foil market50. China had applied a 15% VAT rebate on the export of primary aluminum products for many years to promote development of its aluminum industry and exports of aluminum products until 2003. Since 2003 China has been phasing-out the 15% VAT rebate on the export of primary aluminum products and made a shift in policy by introducing a 15% export tax on those products aimed to encourage the exports of downstream aluminum products. Meanwhile, China maintains a 13% VAT rebate of aluminum foil. In 2007 China phased-out the VAT rebate for certain aluminum products – bars, rod and wire and replaced it with 15% export tax. These policy shifts result in lower production costs for domestic producers. The export of foil is encouraged by the 13% rebate. The 15% export tax on primary aluminum products has the effect of subsidizing foil production by reducing the exports of the primary products used in foil production. China has been reported to be the largest global producer of aluminum foil and the second largest exporter.

The question arising out of this example is whether the application of different VAT rebate rates among products combined with different rates of export taxes together constitute a subsidy to certain industries. The first Trade Policy Review of China51 made by the Secretariat in 2006 expressly stated that such practices “may implicitly subsidize domestic downstream processing"52 Furthermore, the report acknowledges with respect to agriculture exports that such practices “are potentially distorting and implicitly subsidize downstream processing by resulting

50_{This example is used by Matthew R. Nicely, Partner, Thompson Hine LLP in his paper "Counteracting Distortive}

Export Tax and VAT Rebate Policies at the WTO: A Downstream Industry Perspective" for Trade and Raw Materials

– Looking Ahead Conference on the EU's Trade Policy and Raw Materials, 29 September 2008.

51_{WTO Secretariat, Trade Policy Review of the People’s Republic of China, June 2006, available at:}

WT/TPR/S/161/Rev/1, 26 June 2006.

52

(16)

in their provision as inputs at below world prices, thereby encouraging domestic value added” and that they “may contribute to an inefficient use of resources”53.

On 12 January 2017, the United States notified the WTO Secretariat that it has requested dispute consultations with China54 regarding alleged subsidies provided by China to its producers of primary aluminum. The current status of the dispute is “in consultation”. Requests to join the consultations have been made by the world’s largest producers and exporters of aluminum – Canada, Russian Federation, Japan and the European Union55 This is the first WTO complaint made against Chinese aluminum. So, whether China aluminum policy of subsidizing aluminum exports inconsistent with WTO regime, as stated by the Secretariat, is yet to be decided by WTO panel, is such will be established.

The example of China reveals that although VAT rebate in itself is not prohibited by the ASCM and is consistent with WTO rules, it can be inconsistent with international trade law rules where it is applied together with other measures (such as export taxes) thus forming a “complex export subsidy program” (as US Trade representative Michal Froman calls China aluminum exporting policy).

Bulgarian automobile VAT rebates

Article XVI, as it is formulated, aims to avoid price distortions for like products from a point of view of the byers. The meaning of article XVI:4 is that countries shall cease to grant those subsidies on exports which result “in the sale of such product for export at a price lower than the comparable price charged for the like products to buyers in the domestic market.” VAT refund, however, has the potential to induce such imbalance in the market price of the same products in the exporting and importing state.

In the normal course of VAT taxation, as we discussed above, exports of goods are VAT-exempted and imports are VAT-taxable. Thus, the price of the goods in the country of origin is influenced by the VAT legislation of this country and the price of imported goods is influenced

53_{Ibid. p. 171} 54

China - Subsidies to Producers of Primary Aluminium - Request for consultations by the United States, WT/DS519/1, 12 January 2017

55_{Communications from Canada, Japan, Russian Federation and the EU are available at}

https://docs.wto.org/dol2fe/Pages/FE_Search/FE_S_S006.aspx?Query=(%40Symbol%3d+wt%2fds519%2f*)&Langu age=ENGLISH&Context=FomerScriptedSearch&languageUIChanged=true

(17)

by the legislation of the country where the goods are destined for consumption. The VAT regime of a state might, however, approach certain categories of goods distinctively in terms of the right to deduct tax credit – for example to limit the right to deduct input tax for the purchase of these goods. The purposes of such a measure may reflect various considerations specific to the state. Such is the case with the Bulgarian VAT regime. Bulgarian VAT legislation - Value Added Tax Act (VATA)56 does not permit deduction of input tax for the acquisition or import of motorcycles and passenger cars. Article 70 of the VATA stipulates that:

“Article 70. (1) The right to deduct credit for input tax shall not be exercisable even though the conditions under Articles 69 or 74 herein are fulfilled, where: …

4. (amended, SG No. 94/2012, effective 1.01.2013) a motorcycle or a passenger car has been acquired, or imported;”

The reason for introducing this non-creditability treatment to passenger cars is related to EU Pilot 2781/11 aimed at resolving compliance problems with Council Directive 2006/112 without having to resort to infringements proceedings.

Which cars are qualified as passenger cars is defined in §1 (18) of the Supplementary Provisions of the Value Added Tax Act:

“18. (Amended, SG No. 95/2009, effective 1.01.2010, SG No. 94/2012, effective 1.01.2013) "Passenger car" shall be any automobile designed to seat no more than five persons (excluding the driver). Any automobile intended to carry cargo or any passenger car with permanently in-built technical equipment for the purposes of the activities carried out by the registered person shall not be treated as passenger car.”

Eexceptions to this rule are provided for in article 70 (2) of VATA:

(2) Items 4 and 5 of Paragraph (1) shall not apply where:

56

English version of VATA is available on the website of the National Revenue Agency of Bulgaria at the following address: http://www.nap.bg/en/page?id=522

(18)

1. the means of transport referred to in Item 4 of Paragraph (1) are used solely for transport and security services, taxi transport, rental, courier services or motor vehicle driving instruction, including upon their subsequent resale;

2. the means of transport referred to in Item 4 of Paragraph (1) are intended solely for resale (merchandise in stock);

3. the goods or services are intended solely for re-sale (merchandise in stock), including after processing;

4. the goods or services are linked to the maintenance, repair, improvement or operation of the means of transport referred to in Item 1.

5. (new, SG No. 94/2012, effective 1.01.2013) the vehicles under Item 4 of Paragraph (1) and the goods or services under Item 5 of Paragraph (1) shall furthermore be used in activities other than those referred to in Items 1 - 4 in the cases where one or more of the activities referred to in Items 1 - 4 comprise core activity for the person; in these cases the right to deduct credit for input tax shall be in place from the beginning of the month following the month for which the core activity requirement is complied with.

As can be seen from the cited provisions, the Bulgarian VAT legislation prohibits the exercise of the right to deduction with respect to all motorcycles and to all cars which fall within the category of ‘passenger cars’ and for which the conditions of art. 70(2) VATA are not present. Thus, if a taxable person purchase passenger car and use it in its economic activity for purposes different from those enlisted in art. 70(2) VATA, they will not have the right to deduct the input tax paid for the purchase of the car on the ground of Article 70 (1), paragraph 4 VATA. Therefore, the purchase cost for this car will include the VAT paid. For example, if the taxable person purchases a car for the price of 10 000 BGN and pays 20% VAT57 on this price, the final purchase cost of the car for this consumer will be 12 000 BGN, because the tax paid will not be refunded (due to a lack for the exceptions providing for this right). Thus, if the car is intended for consumption in the domestic market of Bulgaria, its purchase cost will amount to 12 000 BGN. If, however the car is intended to export to another country, it might prove to have lower purchase cost in the importing country, if the latter does not limit the right to deduct tax credit

57

(19)

for this category of cars on similar grounds. In dynamic perspective, this is achieved by the following events: in Bulgaria, the exporter will pay 12 000 BGN for the purchase of the car but will have the right to deduct 2 000 BGN because exports are VAT-deductable under the provision of Article 70(2) – paragraph 2 VAT which provides for exception from the general rule of Art. 70(1) – 4 prohibiting refund where the cares “are intended solely for resale”. In the country X the imported cars will be subject to VAT taxation on the import. And if the VAT regime in this country, unlike Bulgaria, gives the right to tax-credit for the VAT paid on important (which is the classical case) and does not pose any limits for its exercise similar to those in the VATA, the importing taxable person will deduct the VAT paid and the effect will be equal to zero-liability. This will result in a lower purchase cost for the importing entity of the same car on the X market - 10 000 BGN, regardless of the tax rate. This difference in the purchase costs for consumers in different states may occur only when it pertains to business entities which in the normal course of VAT taxation have the right to deduct (hadn’t it been for the limitations). It is not possible to occur in a view of final consumer, who normally bears the burden of VAT and cannot refund the tax under no circumstances.

The example provided above illustrates that VAT refund on exports of certain categories of goods might indeed constitute a subsidy which result in “the sale of such product for export at a price lower than the comparable price charged for the like product to buyers in the domestic market.” in breach of Article XVI:4. This stems from the fact that VAT systems are unified in all countries which apply VAT taxation. Even though this hypothesis is concerned with a very specific VAT regime pertaining to particular types of goods, it is still noteworthy because it might be ground for reconsideration of the conclusive interpretation of Article XVI:4 GATT which is provided for by the interpretative note and by ASCM. The expressed point of view might be of relevance in future discussions on the application of Article XVI ‘Subsidies’. This concern is even more credible when the objectives of GATT in general and of Article XVI (informed by Article XVI:2 and XVI: 3) in particular are taken into account.

VAT on imports

As a border adjustable tax, VAT on imported products shall be levied at a rate no higher than the rate levied on the “like” domestic products. The general rule of GATT Article II:1(b) is that, other than customs duties, imports must "be exempt from all other duties or charges of any kind."

(20)

Nevertheless, GATT Article II:2(a) allows a government to impose at imports "a charge equivalent to an internal tax imposed… on a like domestic product," as long as the internal charge is imposed in conformity with "national treatment" principle Article III. The imposition of VAT on imported products will, therefore, be consistent with the GATT non-discrimination rules where it conforms to the provisions of GATT Article III:2, i.e., that the imported good is "not subject, directly or indirectly to internal taxes or other internal charges of any kind in excess of those applied directly or indirectly to like domestic products" (emphasis added).

Article III of the GATT 1994 establishes the National Treatment Principle which along with the Most Favored Nation principle is the core of the fundamental non-discrimination pillar of the WTO. The National Treatment principle forbids regulation of a WTO member state protective of domestic production and treating less favorably the like imported products. VAT as a tax on imports of goods and as internal tax equally applied to domestic and imported goods is indisputably targeted by Article III:2 GATT58. The formulation of Article III:2 unambiguously refers to “internal taxes” either imposed ‘directly or indirectly’, so among all it also addresses VAT which is imposed “indirectly”59 on the consumption.

Leading authority in respect to the criteria of Article III:2 is the Appellate Body Report on Japan – Alcoholic Beverages. Although the dispute in this case is not concerned with VAT, it gives guidelines for the interpretation of this provision, which are followed in the subsequent practice of the panels and the appellate body (including the practice in VAT cases). The Appellate Body (AB) in its report on the case clarifies (on the basis of interpretation made in accordance with the customary rules of interpretation of international public law and by reference to the fundamental rules of the Vienna Convention) that the first sentence of Article III:2 is, in effect, an application of the general principle informed by Article III:1 that internal measures should not be applied so as to afford protection to domestic production. Examination of conformity with internal tax measure, the AB states, requires first – consideration of the ‘likeness’ of the taxed imported and domestic products and second – whether he taxes applied to the imported products are "in excess

58

The provision of Article III:2 GATT stipulates that: “The products of the territory of any contracting party imported into the territory of any other contracting party shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products. Moreover, no contracting party shall otherwise apply internal taxes or other internal charges to imported or domestic products in a manner contrary to the principles set forth in paragraph 1.”

59

For the precise meaning of the terms “directly” and “indirectly” see paragraph 14 of the 1970 GATT Working Party Report on Border Tax Adjustments.

(21)

of" those applied to the like domestic products. So, two-tiered test shall be applied. The definition of ‘like products’ shall be construed narrowly on a case-by-case basis in accordance with the Report of the Working party on Border Tax Adjustment adopted by WTO contracting parties in 1970 which sets out the basic approach for interpreting "like or similar products". With respect to the ‘in excess of’ criterion, the AB highlights that “Even the smallest amount of "excess" is too much. The prohibition of discriminatory taxes in Article III:2, first sentence, is established to be not conditional on a trade effects test nor to be qualified by a de minimis standard.

What type of VAT tax measure might be applied in a manner such as to afford protection to domestic production thus being in violation Article III:2? Two different types of VAT measures were considered in Thailand – Customs and Fiscal Measures on Cigarettes from the Philippines and in Argentina - Measures Affecting the Export of Bovine Hides and the Import of Finished Leather.

In Thailand - Customs and Fiscal Measures on Cigarettes from the Philippines60 the Panel found that Thai VAT system is operating in such a manner as to afford protection to domestic production of cigarettes. It does so by exempting from VAT liability resellers of domestic cigarettes, together with the imposition of VAT on resellers of imported cigarettes when they do not satisfy prescribed conditions (administrative formalities as to the submission of VAT return form to the tax authorities) for obtaining input tax credits necessary to achieve zero VAT liability. Thus, the Panel found that the exemption from VAT of resellers of domestic cigarettes is inconsistent with Article III:2. In finding this, the Panel first applied the ‘likeness’ test, which is not of such importance for the purposes of the current report, and then proceeded to ‘excess taxation’ analysis. In evaluating the ‘in excess taxation’ premise for violation of Article III:2 of Thai VAT law the Panel made a few very important findings which take into account the mechanism of operation VAT taxation. The Panel found first that imported cigarettes will be VAT taxed in excess of like domestic cigarettes in violation of Article III: 2, first sentence, where the VAT tax base for imported cigarettes is fixed higher by the government by using different methodology61. The Panel clarified that in VII.494 that WTO member states’

60_{Thailand - Customs and Fiscal Measures on Cigarettes from the Philippines - Final Report of the Panel,}

WT/DS371/RO

61

(22)

governments are free to fix a tax base but the tax base thus fixed will be WTO-consistent “as long as the government determines the tax base in the same manner for both imported and like domestic goods concerned”. VAT is a classical ‘proportionate’ tax with respect to the determination of the tax rate, which means that VAT taxation operates through a single flat tax rate applicable to different taxable bases. Having this in mind, an excess VAT taxation with respect to imported goods might come as a result of a higher tax base for imported products, compared to domestic, to which the same tax rate applies. In this case even though prima facie the same tax (in terms of the tax rate) is applied to both domestic and imported goods, this tax rate related to higher tax base will result in higher taxation.

The Panel found that the nature of VAT as consumption tax to the burden of final consumers does not exclude its potential to be excessive with respect to imported goods under a state’s specific VAT system where resellers of imported cigarettes in the distribution chain are held liable for the VAT obligations and also that VAT exemption granted only to the resale of domestic products is not a typical feature of VAT or a common practice shared by other countries. According to the Panel62 excess taxation in violation of Article III:2, first sentence GATT might take the form of VAT exemption for domestic products. Accordingly, when assessing whether VAT on imports is levied within the maxima limits of Article: III GATT, it is the “VAT burden” of the like imported products that shall be regarded rather than the tax burden of the final consumer. VAT is a tax on consumption thus shifting the tax burden on the final consumers. Although, the tax burden for the final consumers of both imported and the like domestic products might be the same, the VAT exemption of domestic resellers only will have the effect of less-favorable treatment for the like imported products. By referring to Indonesia – Autos Panel Report63, the Panel found that the VAT exemption for domestic resale is not a de jure violation of Article III:2, first sentence, because the VAT measure in question does not provide explicitly for the words that result in a violation of this obligation. Consequently, VAT exemption shall be considered de facto violation of Article III:2.

62

Ibid. para. VII.608

63_{Indonesia – Autos Panel Report: "[A]n origin-based distinction in respect of internal taxes suffices in itself to}

violate Article III:2, without the need to demonstrate the existence of actually traded like products. This is directly in accord with the broad purposes of Article III:2, as outlined by the Appellate Body.”

(23)

The Appellate Body Report on the case upheld the Panel's finding in the Panel Report that Thailand acts inconsistently with Article III:2, first sentence, of the GATT 1994 by subjecting imported cigarettes to VAT liability in excess of that applied to like domestic cigarettes. In his analysis, the Appellate Body first confirmed that Article III GATT in general serves anti-protectionist purposes as setting out prohibitions of internal tax and regulatory measures operating in such a manner as to afford protection of domestic production, thus promoting competitive conditions for imported products in relation to domestic products in their internal markets (110). The Appellate Body then continued with analysis of the scope of Article III:2 stating that obligations under this provision, as referred by its text, encompass a broad range of measures – directly or indirectly imposed internal taxes or any kind of internal charges. The Appellate Body reaffirmed the Panel’s finding that ‘inconsistency under Article III:2, first sentence, is not conditional on a "trade effects test", and that even the smallest amount of "excess" is too much’.

One would reasonably suggest that the VAT mechanism of tax credit always results in VAT liability of zero and in this sense that it has the effect of exemption from an economic standpoint. The emphasis put by the Panel and the AB in their findings is that this is not necessarily the case in all possible hypothesis, because failing to meet some administrative requirements will deprive the reseller of imported goods of the right to tax credit and they will be held tax liable unlike the resellers of domestic products which in no case will be VAT liable. Thus, the Panel and AB Report in Thailand - Customs and Fiscal Measures on Cigarettes from the Philippines proclaim any VAT measure subjecting the reseller of imported goods to a risk (even slightest), that on grounds of law is not present for the resellers of domestic production, in breach of Article III:2 GATT. It should be highlighted with this respect that the tax policy of a state is under the absolute control of the state government. Practices whereby VAT tax credit is denied to the reseller of imported goods by the tax authorities of the respective country shall not be treated as uncommon. Such practices accompanied by explicit VAT exemption for the sale of domestic products might serve as an efficient mean of protectionism. With its complex mechanism, VAT taxation provides many comfortable ways for the protection of domestic production by treating it more VAT-favorably.

(24)

In Argentina - Bovine Hides case64 two particular measures of Argentinian VAT law were successfully challenged for breach of article III:2 which consists of the following:

- The internal sales by non-registered taxable persons to non-registered taxable persons are not subject to VAT taxation and accordingly no pre-payment obligations are applicable to them, while imports by non-registered taxable persons are VAT-taxable at a rate of 12.7% and the tax shall be prepaid on the date of import. The advanced paid VAT cannot be deducted as tax credit. - In the case of internal sales by registered taxable persons to non-registered taxable persons, goods are subject to additional non-creditable VAT of 10.5%. In the same time, non-registered taxable person shall pay VAT on imports at 12.7% tax rate.

The Panel held that in both situations, imported products are subject to a heavier tax burden than like domestic products thus violating article III:2. The Panel further clarifies65 that the heavier tax burden leading to less favorable treatment of the like imported products might take the form of forgone interest on working capital in the interval between the advanced payment of the tax and its crediting and even of an interest on the capital that the taxable persons who do not have disposable working capital should raise to finance the tax prepayment. The panel qualified the financial burden with respect to the two measures in question as an opportunity "cost" in one case and a debt financing "cost" in the other. The Panel therefore concluded that by subjecting imported products to a heavier tax burden and by requiring VAT pre-payment on imports by non-registered taxable persons when no such pre-payment or additional VAT payment of equal amount is required on internal sales to non-registered taxable persons, the Argentinian law is inconsistent with Article III:2. In reaching this conclusion, the Panel finds that: “It is well-established that Article III:2, first sentence, calls for a comparison of tax burdens, and not merely of tax rates187. Thus, in assessing whether imported products are taxed “in excess of” domestic like products, it is necessary to consider not only the applicable rates, but also any other element of the tax which may have an impact on the fiscal burden imposed on the products, including the rules for the collection of the tax. Indeed, if the distinction drawn by Argentina between “substantive” tax measures and measures for the collection of the tax were upheld, it would become extremely easy for WTO Members to circumvent the requirements of Article

64_{Argentina - Measures Affecting the Export of Bovine Hides and the Import of Finished Leather, Report of the}

Panel.

65

(25)

III:2.188”.66

According to Panel conclusions in this case, “Article III:2, first sentence, requires a comparison of actual tax burdens rather than merely of nominal tax burdens”67. Consequently, even where imported and like domestic products are subject to identical tax rates, the actual tax burden can still be heavier on imported products. This could be the case, for instance, where different methods of computing tax bases lead to a greater actual tax burden for imported products.

When considering the argument advanced by Argentina that “the mechanism subject to the dispute is not tax in itself but constitute a measure pertaining to the administration and the collection of the tax (VAT) which do not impact the tax liability arising out of the law and that measures of such nature (collection measures) are outside the scope of the GATT”, the Panel confirmed that a measure might be such of collection in nature but nevertheless encompassed by the prohibitions of article III:2, if it results in imposition of charges which are in themselves covered by this provision.

The Panel summarized that in order to assess whether certain measure infringes III:2, apart from the applicable tax rates, the methods of taxation (e.g. indirect taxation through taxes on the raw material used in the product at the different stages of its production) and the rules on tax collection (e.g. tax bases) shall also be considered.

The Panel finds that a VAT measure which imposes an obligation for VAT prepayment without any compensation on behalf of the government in the form of interest on the amounts prepaid upon crediting, has the effect of depriving the tax payer of its capital which they input into tax prepayment for the period between the effective prepayment and its crediting and that this lack of capital induces a tax burden. Moreover, even heavier tax burden is caused where taxable persons raise capital from other sources requiring interest to be paid in order to cover the amount of the prepayment debt. The Panel made the following noteworthy considerations in support of its finding68

As can be seen from the above, VAT consistency with Article III:2, first sentence, necessarily includes the application of the two-tiered test under which ‘likeness’ of the imported and

66_{Ibid. VIII.314} 67

Ibid. XI.8551

68

(26)

domestic products shall be established as well as internal taxation of imported goods ‘in excess of’ that of domestic goods. On the background of the Panel and AB findings in those two cases, it might be concluded that VAT mechanism, as it is construed, leaves many flexibilities for imposing taxation on the imported products in excess of that applicable to the like domestic products thus going beyond the maxima limits of Article III:2 GATT.

In both cases the actual VAT burdens rather than the nominal ones were assessed. VAT consistency with GATT rules presupposes comparison of actual tax burdens rather than merely of nominal tax burdens, which makes account not only for the tax rates, but also for the different methods for calculation of tax base and weighing of the tax burden alone regardless of the allowance for tax credit which result in zero-rate through the creditability of the paid VAT. Furthermore, In Thailand - Customs and Fiscal Measures on Cigarettes from the Philippines GATT the VAT measure at issue was additionally found violating Article III:4 GATT. the Appellate Body found that by exempting from VAT the resellers of domestic cigarettes Thailand also exempts these resellers from three sets of VAT related administrative requirements which are otherwise imposed on resellers of imported cigarettes – 1. the obligation to file a tax return on a monthly basis regardless of the type of goods and services provided, in order to enjoy the 0% VAT tax rate and null VAT liability; 2. The obligation for resellers of imported cigarettes to prepare and maintain input tax and output tax records, and goods and raw materials records as well as to file revenue and expense reports; and 3. The imposition of penalties and other sanctions in case resellers of imported cigarettes will suffer in case they fail to comply with VAT-related administrative requirements such as those under points 1 and 2. Since resellers of domestic cigarettes are VAT exempted, they are also relieved of the obligation to comply those VAT-related requirements. Thus, based on these findings, the Panel concluded that Thai VAT law imposes an additional administrative burden only on resellers of imported cigarettes and that this represents ‘less favorable treatment’ prohibited by the provision of Article III:4 of GATT. The above review of the case law infers that VAT regimes, although border adjustable, leave flexibilities for countries to apply otherwise WTO inconsistent measures with protective purposes. A VAT system appears to be a convenient means for the application of such protective measures. Countries apply same VAT rates both for domestics and for the like imported products thus providing equal tax treatment. At least on the surface. Nevertheless, practices like those

VALUE ADDED TAX IN THE CONTEXT OF THE GENERAL AGREEMENT ON TARIFFS AND TRADE – INSIGHT AND PRACTICE