WTO Law: SCM Agreement as a new possibility to
combat tax noncompliance
August 10, 2015
Master Thesis in Trade and Investment Law
Author: Bermet Dordoeva Supervisor: prof. Esther Kentin
Abstract
Tax avoidance and tax evasion by multinational enterprises is a well-known problem. The driving force for tax noncompliance is tax incentives provided by low-tax regime countries. Nowadays many international organizations, such as OECD, UNCTAD and IMF deal with this issue and try to help developing countries/low-tax regime countries to manage their tax policies better. This study examines the possibility of the WTO law to be a part of the international force in prevention of tax noncompliance. In order to reveal this possibility relationship between tax noncompliance, international trade and WTO law discussed in this paper. By applying different WTO regulations and using case studies, I found that the Agreement on Subsidies and Countervailing Measures is the closest to address the issue. To investigate the relevance of the Agreement on Subsidies and Countervailing Measures its provisions applied to hypothetical low-tax regime member state of the WTO. This research contributes to the prevention of tax avoidance and tax evasion studies by finding a new possible way to combat this problem.
Table of Contents
1. Introduction ... 3
2. Problem of tax noncompliance ... 6
2.1. Tax evasion and tax avoidance: different terms, same issue ... 7
2.2. International and European activities in the prevention of tax noncompliance ... 9
2.3. Case studies: the Amazon and Apple cases ... 14
3. The WTO law possibly related to tax noncompliance ... 22
3.1. Application of Articles I, III GATT to the problem of tax noncompliance ... 24
3.2. SCM Agreement and tax noncompliance ... 25
3.2.1. Objectives of the SCM Agreement ... 27
3.2.2. The concept of a subsidy ... 28
3.2.3. Prohibited subsidies under the SCM Agreement ... 33
3.2.4. Actionable subsidies under the SCM Agreement ... 35
3.3. The US-FSC case and SCM agreement ... 35
Conclusion ... 38
1.
Introduction
Tax is not the sole determinant of rapid development but it is one pillar of an effective state, and may also provide the basis for accountable and responsive democratic systems.1
There is no internationally agreed definition of tax havens. A tax haven in this paper refers to any jurisdiction that allows companies or individuals to avoid or evade tax. This happens when tax havens offer low or no tax, or offer special structures for corporations that help them to transfer profits tax-free, i.e. tax incentives.2 Tax
incentives are usually provided by low-income countries and aimed to achieve a variety of objectives. The primary motive is to stimulate investment and attract foreign investment. Investments are believed to bring capital and jobs to a country, increase the efficiency of domestic markets by spurring the competition and thus contribute to a country’s overall economic development.3
When these positive effects of tax incentives’ provision became clear, the tendency to compete for having the most favorable tax regimes started to be seen in some countries behavior.4 But tax incentives often bring negative effects, especially
when managed poorly. Negative side of tax incentives provision is tax noncompliance by multinational companies, which try to optimize their tax burden using tax havens. Multinational enterprises incorporate companies in countries with low tax regimes thus mitigating its tax burden. It results in situation when countries where the ultimate parent company established or where ultimate beneficial owner is residing do not receive taxes due to different structure and profit shifting schemes. The use of tax mitigation methods have led to a growing concern regarding tax compliance of multinational companies.
United Nations Conference on Trade and Development (‘UNCTAD’) in its World Investment Report in 2013 highlighted the increasing importance of foreign
1
Taxation and Accountability: Issues and Practices [2008] OECD, Paris DCD/DAC/GOVNET(2007)3/FINAL.
2 Ilona Hartlief et al. ‘Fool’s Gold: How Canadian firm Eldorado Gold destroys the Greek Environment
and Dodges Tax through Dutch Mailbox Companies’ [2015] SOMO 14ff.
3
Tax Incentives for Investment – Options for LICs: Options for Low Income Countries Effective and Efficient Use of Tax Incentives for Investment [2015] OECD Report 5ff.
direct investments flowing through tax havens.5 Moreover the consequences of tax
noncompliance may be seen as an impediment of a government’s ability to collect tax revenue and thus serve its obligations.
Pursuant to Post-2015 Development Agenda presented by the Organisation for Economic Co-operation and Development (‘OECD’), strengthening domestic tax collection will be essential to provide governments with sustainable revenue sources to finance the post-2015 Sustainable Development Goals6 and to deliver public
services.7 The United Nations Working Group (‘OWG’) on Sustainable Development
Goals considers strengthening domestic resource mobilization through taxation a key means of implementation. In its Outcome Document the OWG calls the donor community8
to step up its international support to strengthen domestic resource mobilization, including through international support to developing countries to improve domestic capacity for tax and other revenue collection (OWG, 2014). Tax revenues already make up a significant proportion of developing countries’ gross domestic product, but have the potential to contribute much more if they are mobilized effectively.9
Greek crisis is one of many other examples how the tax noncompliance could bring harm to countries. According to the International Monetary Fund (‘IMF’) working paper of 2013, annual unreported income in Greece exceeded 28 billion euros in 2012.10 This research found that there are many exemptions in the tax code
that erode the tax base.11 Tax avoidance schemes used to reduce tax obligations are
commonly used by Greek companies to route profits to low-tax jurisdictions.12 At the
present time Greece commits, among other things, to modify the taxation of collective investment, modernize the income tax code and eliminate from it exemptions, improve legislation on transfer pricing and work toward creating a new culture of tax
5 Global Value Chains: Investment and Trade for Development (United Nations Conference on Trade
and Development, World Investment Report 2013) iv.
6 Sustainable development goals (‘SDG’) are a new, universal set of goals, targets and indicators that
UN member states will be expected to use to frame their agendas and political policies over the next 15 years. SDGs follow the millennium development goals, which were agreed by governments in 2000 and are due to expire at the end of 2015.
7 OECD and post-2015 reflections, Element 11, Paper 2 http://www.oecd.org/dac/post-2015.htm (last
accessed August 10, 2015).
8 Developed countries are seen to be donor community. 9 OECD and post-2015 reflections (n7).
10 Greece: Selected Issues [2013] IMF Country Report No.13/155, 19. 11
Ibid., 20. For instance, super-reduced rate of 6,5 percent applies to hotels, medicine, books and newspapers. For all Aegean islands the VAT rates reduced by 30 percent.
compliance.13 There is no public data yet on the costs of enforcement of Greek action
plan. However, enforcement activities are usually wasteful and in times of crisis, due to complex character of problems, governmental costs for combatting tax noncompliance could be even higher.14 For this reasons the call to force low tax
regime countries and multinational companies play by fair rules became evident, important and clear.
Tax incentives provided by low tax regime countries could affect international trade in several ways. Recently, tax avoidance cases involving large companies as Amazon, Google, Starbucks and Apple made clear that international trade could be distorted by tax policies of different countries. Please see subchapter 2.3. for case studies.
International tax system has its weaknesses and needs changes. One of the weaknesses is the absence of appropriate judicial fora. For instance, countries other than countries of residency of multinational enterprises could hardly bring a claim towards foreign companies for tax non-compliance. However, tax authorities of countries can initiate an investigation and claim taxes but this will be dependent on national legislation - whether there are reasons to treat the multinational company as a tax resident of this particular country.
Moreover lack of international law instruments which states can use to collect avoided taxes is also an issue that needs attention.15 The question of this paper is
whether the World Trade Organization (‘WTO’) Member states could invoke the Agreement on Subsidies and countervailing measures (or other WTO rule) to force low tax regime countries to amend their tax legislation?16 The role of the WTO in the
prevention of tax noncompliance constitutes the core of this paper. The research also deals with possible effectiveness of such methods in case of their implementation.
Although prevention of tax avoidance is not among the objectives of the WTO, raising standards of living, ensuring a large and steadily growing volume of
13
Greek Finance’s Minister’s Letter to the Eurogroup (February 24, 2015)
http://www.reuters.com/article/2015/02/24/us-eurozone-greece-text-idUSKBN0LS0V520150224 (last accessed July 30, 2015)
14 Government of the Netherlands: Combatting tax and benefit fraud
http://www.government.nl/issues/combating-tax-and-benefit-fraud/income-tax-and-corporation-tax-fraud (last accessed June 12, 2015)
15 Michael Lang, Introduction to the Law of Double Taxation Conventions (IBFD and Linde, 2011) 16 Agreement on Subsidies and Countervailing Measures [1994] Marrakesh Agreement Establishing
the World Trade Organization, Annex 1A, THE LEGAL TEXTS: THE RESULTS OF THE
URUGUAY ROUNG OF MULTILATERAL TRADE NEGOTIATIONS 231 (1999), 1869 U.N.T.S. 14.
real income and effective demand, and expanding the production of and trade in goods and services are.17 Moreover, negative effects on standards of living, income
and demand, as well as on the expansion of production and, consequently, expansion of trade itself, are reported.18
In section 2, the problem of tax noncompliance is described. This section describes the various terms used in literature, such as tax evasion and tax avoidance, and explains the differences. The current work of international organizations in the prevention of tax noncompliance is described in the subchapter 2.2. The work of the OECD on prevention of tax evasion analyzed as an example of the framework, largest by the number of countries involved.
The issue of tax noncompliance by multinational corporations is widely dealt by the OECD, the IMF, the UNCTAD and number of other international organizations. The WTO could possibly play a greater role in the prevention of tax noncompliance by influencing its member states.
The OECD has a long history of dealing with issues of tax noncompliance. On the contrary, the WTO, while dealing with taxation systems of Member States, interferes only when and where there is a threat to international trade. For the purposes of this paper the WTO practice related to taxation of foreign companies the
United States – Tax Treatment for “Foreign Sales Corporations”19 (‘US-FSC’) case
analyzed in the third chapter.
In order to research the relativeness of the WTO system to the problem of international tax noncompliance and to find an appropriate WTO regulation, relevant WTO rules will also be addressed in the third chapter of this paper. Due to the fact that prevention of tax noncompliance is not a purpose of the WTO, only provisions related to this problem are found in the Agreement on Subsidies and countervailing measures (‘SCM Agreement’). The SCM Agreement is assessed in details in the second chapter.
2.
Problem of tax noncompliance
17 WTO Agreement: Marrakesh Agreement Establishing the World Trade Organization (1994) THE
LEGAL TEXTS: THE RESULTS OF THE URUGUAY ROUNG OF MULTILATERAL TRADE NEGOTIATIONS 4 (1999), 1869 U.N.T.S. 154, 33 I.L.M. 1144.
18 ‘Financing Development: Tax Them and They Will Grow [2015] The Economist July 11th 2015, 63. 19 T/DS108/R, Report of the Panel, ¶ 3.2(a), October 8, 1999.
The problem of tax noncompliance is not a new issue that arose only with expansion of multinational companies – this problem is as old as taxes themselves.20
But this fact does not undermine an importance of the problem. Techniques used by multinational companies today allow them to minimize (sometimes even to zero rate) their tax responsibilities that affect negatively on revenues of states. 21 Tax
noncompliance is closely linked to the preferential tax treatment systems provided by low-tax regime countries. These countries tend to establish preferential tax treatment to foreign companies due to the fact that they deemed as a source of foreign direct investments.22
The problem of tax noncompliance is triangular and involves economical, behavioral and legal aspects. This legal research will consist of analysis of the WTO rules, the EU legislation, legislation of common law system countries, case law of the WTO panels and European Commission investigations.
2.1. Tax evasion and tax avoidance: different terms, same
issue
The difference between tax avoidance and tax evasion is the thickness of a prison wall.23
To address the issue of this paper the term ‘tax noncompliance’ is used. However there is no certainty in usage of terms ‘tax evasion’ and ‘tax avoidance’, which together constitute the term ‘tax noncompliance’. Tax evasion is an illegal and usually criminal economical act and tax avoidance stays within the legal area of activities. Difference between these terms is blurry and therefore needs to be clarified for the purposes of this paper. An evaded tax remains a payment, owed by law and avoided tax is a tax liability that has never existed. In other words, in tax avoidance no rules and regulations are breached, taxes are avoided by means of loopholes in
20
Teik Hai O. ‘Intention of Noncompliance to Examine Gaps’ [2011] International Journal of Business and Social Science (vol 2) No.7.
21 Olatunde Julius Otusanya ‘The role of Multinational Companies in Tax Evasion and Tax Avoidance:
The case of Nigeria’ [2011] Critical Perspectives on Accounting, Volume 22, Issue 3, 316–332.
22
OECD Report 2015 (n3).
23 Interview with Denis Healey, former UK Chancellor of the Exchequer (The Economist Volume 354,
legislation or special structures creation. Tax evasion occurs when the legislative act prescribes to pay taxes and liability to pay occurs, but taxpayer does not pay it.
In order to reveal the use of these terms in practice a recourse to the case law and legislation of different countries has been made. For instance, in the US the term tax evasion defined in 1916 in Bullen v. Wisconsin case: ‘when an act is condemned as an evasion, what is meant is that is on the wrong side of the line indicated by the policy, if not by the mere letter, of the law’.24
English courts followed approach of the US courts. In the IR v. Willoughby case a definition of the term tax avoidance is given: ‘the hallmark of tax avoidance is that the taxpayer reduces his liability to tax without incurring the economic consequences that the Parliament intended to be suffered by any taxpayer’.25
Thus, in English practice, tax avoidance is a course of action designed to conflict or defeat the evident intention of the Parliament.
These terms are also defined in states’ legislative acts. For example in the US, pursuant to the Internal Revenue Code, fines could be imposed on ‘any person who willfully attempts in any manner to evade or defeat any tax imposed by law’.26 In the
European Union there is no legislative definition of tax avoidance. Member states have the right to build and apply their own anti-avoidance rules. However, some boundaries for such rules are set in the European legislation.27 For instance, under the
Article 1.2. of the Parent-Subsidiary Directive (90/435/EEC) Member States are allowed to apply domestic or agreement-based provisions required for the prevention of fraud or abuse of law.28
In judicial and legislative practice of countries terms ‘tax avoidance’ and ‘tax evasion’ used in a similar way. In the OECD analytical data both terms are used. On the latest meeting of G20 Finance Ministers and OECD in Istanbul on September 22, 2014, it was decided to pursue efforts to combat multinational tax avoidance and offshore tax evasion in developing countries.29
24
Bullen v. Wisconsin [1916] 240 U.S. 625 (U.S. Supreme Court)
25 Commissioners of Inland Revenue v. Willoughby [1997] Opinion of the Lords of Appeal (HL) 26 Internal Revenue Code [2006] 26 U.S.C. section 7201, para 61 Bluebook R. 12.9.1.
27
Ruiz V. Almedral ‘Tax avoidance and the European Court of Justice: what is at stake for European anti-avoidance rules?’ [2005] Intertax Vol.33 (12), 562.
28 Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the
case of parent companies and subsidiaries of different Member States [1990] Official Journal L225, 20/08/1990 P.0006-0009.
29 OECD Centre for tax policy and administration: OECD and G20 pursue efforts to curb multinational
http://www.oecd.org/ctp/oecd-and-g20-2.2. International and European activities in the prevention
of tax noncompliance
a) OECD
One of the main organizations working in the area of taxation is the OECD. The OECD was established in 1961 and now comprises of 39 countries from North and South America to Europe and Asia-Pacific. Members of this organization are responsible for 80% of the world trade and investments.30
The mission of the OECD is to promote policies that will improve the economic and social wellbeing of people around the world. The OECD provides a forum in which governments can work together to share experiences and seek solutions to common problems.31
Already in 1963 the OECD presented a Model Tax Convention on Income and Capital aimed to eliminate double taxation (‘Model Convention’). It has been amended several times since then.32 Also the present 2014 OECD Model Convention
is widely used by countries in their bilateral relations to manage international tax issues.33
Current network of bilateral tax treaties has emerged as a response to the globalization of business and therefore treaties being amended from time to time to follow development of business relations.34
Nowadays we face abuse of these treaties: arrangements and transactions made between physical and legal persons in different countries are often artificial and are entered into solely for the purpose of tax benefit under the treaties.35 For this
reason in the Model Convention specific anti-abuse provisions included, such as, among others:
pursue-efforts-to-curb-multinational-tax-avoidance-and-offshore-tax-evasion-in-developing-countries.htm (last accessed 12 June 2015)
30 Anthony Ginsberg International tax planning (1994 ISBN-13: 978-9065447142) 396; OECD: The
history http://www.oecd.org/about/history/ (last accessed 9 August 2015).
31 OECD: About the OECD www.oecd.org/about (last accessed June 12, 2015).
32 Updates were published in 1994, 1995, 1997, 2000, 2003, 2005, 2008, 2010 and 2014. 33 Model Convention with respect to taxes on Income and Capital [2014] OECD. 34
Mariet van Duijn ‘What role do tax advisors play in attracting international companies to Netherlands?’ (Master thesis, University of Amsterdam, 2014) 11.
- Activity provision – to prevent situations when legal entities established just with a view to make use of a treaty without real economic activities;36
- Amount of tax provision – to prevent situations when reduction of tax is greater that the tax actually imposed;37
- Bona fide provision – where benefits shall only be given to persons motivated with sound business reasons, i.e. persons whose goal is not only benefits under the double taxation treaty.38
However these clauses cannot prevent abuse of treaties because double taxation treaties do not provide enough instruments for enforcement. The Article 25 of the Model Convention provides to the contracting states only the possibility to negotiate in cases when states do not agree on taxation matters under the Treaty.39
It means that when state finds taxation of a particular company in the other contracting state not right or not fair it can begin negotiations with regard to make changes in taxation principles of that state. This process could be time consuming and even not effective due to the fact that Model Convention provides only general framework for states to create its legislation. The situation when both contracting states not fully aware of taxation of particular companies in another state could lead to situation when taxes by such company paid nowhere, and lead to so called double non-taxation problem.
International law has general principle of prohibition against the abuse of law. But when tax abuse cases concern multinational companies, international tax law cannot be enforced simply because natural and legal persons are not subjects of double taxation law for the purposes of enforcement.40 In these cases states shall meet
36 The Article 5(4) of the 2014 Model Convention is an example of an activity provision:
‘4. Notwithstanding the preceding provisions of this Article, the term ‘permanent establishment’ shall be deemed not to include: a) the use of facilities solely for purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for purpose of storage, display or delivery …’
37
The Article 23A(2) of the 2014 Model Convention is an example of amount of tax provision: ‘2. Where a resident of a Contracting State derives items of income which, in accordance with the provisions of Articles 10 and 11, may be taxed in the other Contracting State, the first-mentioned State shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in that other State. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income from that other State’.
38 Lang (n15) 69.
39 Extract from the Article 25 (Mutual Agreement Procedure) of 2014 Model Convention:
‘3. The competent authorities of the Contracting States shall endeavor to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. …’
and negotiate problems and changes in their systems. Thus, the pattern of actions is state to state, not state to foreign company.
Consequently, double taxation treaties are lacking of provisions for holding multinational enterprises (‘MNE’) liable for tax noncompliance.41 In recent years the
OECD strengthened and intensified its work in prevention of tax noncompliance involving more and more countries in this work. In February of 2015 the OECD Secretary General reported to G20 Finance Ministers that in the global fight against tax evasion developing countries should take more active part. It shall be noted that members of the OECD are mostly developed countries. The Secretary General revealed in his report that MNEs contribute higher proportion of revenues to governments in developing countries than in the OECD member countries.42
More and more developing countries, as well as regional organizations are becoming active participants of different OECD actions aimed to prevent the tax noncompliance.
The OECD members regularly meet with a view to discuss ongoing topics within the organization to which number of non-member countries are also involved. In July of 2002, the Forum on Tax Administration (‘Forum’) was established within the OECD to develop a global response to tax administration issues. The forum consists of 45 OECD and non-OECD countries that publish study reports as Information or Guidance Notes in the tax administration series. On the Forum meeting held in 2014, Ireland its members stated in the final communique:
We are taking a significant step forward in global tax co-operation. We have agreed a strategy for systematic and enhanced co-operation between our tax administrations, based on existing legal instruments, that will allow us quickly understand and deal with global tax risks whenever and wherever they arise. Along with the strategy, we have created a new international platform called Joint International Tax Shelter Information and Collaboration Network to focus specifically on cross border tax avoidance, which is open to all FTA
41 Lang (n15) 146. 42
OECD: Secretary-General report to the G20 Finance Ministers and Central Bank Governors [2015]
http://www.oecd.org/ctp/oecd-secretary-general-tax-report-g20-finance-ministers-february-2015.pdf
members on a voluntary basis. This new network integrates with existing cooperation amongst some of us into the larger FTA framework.43
Today the OECD’s prevention of tax evasion action plan involves step by step implementation of plan addressing such matters as base erosion and profit shifting, harmful tax practices, “tax inspectors without borders” plan and others. Among the most powerful instruments available is the Multilateral Convention on Mutual Administration Assistance in tax matters (84 signatories), which was developed by the OECD and Council of Europe and open to all states. This convention includes Common Reporting Standard (93 jurisdictions), using which signatories will be able to automatically exchange information on revenues and taxation of MNEs. Some countries will implement this Reporting Standard in 2016, some in 2017. Pursuant to this system MNEs incorporated in the countries-signatories to this standard will be required to send reports to state authorities. States after receiving these reports would have to send them to other countries in which a particular MNE also operates.44
Although this might be a step in the right direction, the failure to comply by several states is a continuous worry.45
b) WTO
The WTO was established in 1995 and apparently, this is the youngest of all major international organizations. Besides that the WTO is the one of the most influential organizations in the sense of economic globalization.46 At the present time
the WTO comprises of 161 countries. The latest country to be accessed to the WTO is Seychelles, parliament of which ratified WTO’s accession protocol on March 24, 2015. Quite remarkable that Seychelles, a low-tax regime country, became the recent member of the WTO.
43 OECD: Forum on Tax Administration, Final Communique (Meeting 24 October 2014, Dublin,
Ireland) http://www.oecd.org/ctp/administration/fta-2014-communique.pdf (last accessed August 9, 2015)
44 OECD: Automatic Exchange of Information
http://www.oecd.org/tax/exchange-of-tax-information/automaticexchange.htm (last accessed 10 August 2015).
45
OECD Secretary-General Report (n42).
46 Peter van den Bossche and others The Law and Policy of the World Trade Organization (3d ed.,
The WTO, when compared to the OECD, does not deal with a problem of tax noncompliance. The only cases related to tax avoidance by foreign entities falling under the WTO law are cases of export or import subsidization. In other words, the WTO might be relevant to this question only when international trade is distorted or serious threat of distortion exists due to the actions taken by a particular WTO Member State. Whereas the OECD has special forum and programs aimed to prevention of tax noncompliance and one of the OECD’s objectives is to help states to administer better, which includes better tax administration.
c) European Union
European Union created a framework for anti tax avoidance rules Member States are free to use. The Sixth VAT Directive (77/388/EEC) which allows Member States ‘to introduce special measures for derogation from the provisions of this Directive, in order to simplify the procedure for charging the tax or to prevent certain types of tax evasion or avoidance’ was amended in 2006 by Council Directive 2006/69/EC.47 This amendment was introduced to combat tax evasion and tax
avoidance and to simplify the procedure for charging value added tax. A special clause on ‘fraud and abuse’ can be found in the Council Directive on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member states (2003/49/EC):
1. This Directive shall not preclude the application of domestic or agreement-based provision required for the prevention of fraud or abuse. 2. Member States may, in the case of transaction for which the principal motive or one of the principal motives is tax evasion, tax avoidance or abuse, withdraw the benefits of this Directive or refuse to apply this Directive.48
Thus, the EU leaves to states to implement legislation aimed to prevent tax noncompliance. Not all countries of the EU do that in the same way. For instance,
47 Council Directive 2006/69/EC of 24 July 2006 amending Directive 77/388/EEC as regards certain
measures to simplify the procedure for charging value added tax and to assist in countering tax evasion or avoidance, and repealing certain Decisions granting Derogations [2006] OJ L221/9 12/08/2006.
48
Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different member states [2003] Official Journal L157 26/06/2003 P.0049-0054.
investment data show that the Netherlands and Luxembourg, both the OECD and the EU members, are two of the most important global financial conduit countries.49
Dutch Central Bank points out in that matter that whilst it is ‘not surprising to find countries like the US and the UK in the top ten of positions [of countries serving financial conduit companies], in view of the size of their economies and the presence of financial centers within their borders […] Luxembourg’s share is large because it acts as financial turntable, just like Netherlands’.
2.3. Case studies: the Amazon and Apple cases
In the following paragraphs case studies on tax noncompliance of Amazon and Apple companies analyzed as an example of tax noncompliance by multinational enterprises. Research question of this paper is whether the WTO could be a tool for prevention of tax noncompliance. However, the WTO law shall be used only where international trade distorted or threat of distortion exists because of its member state’s legislation. These two cases show how trade could be distorted by tax noncompliant behavior of multinational enterprises.
a) Amazon case50
The United Kingdom’s House of Commons Public Accounts Committee (hereinafter the ‘Committee’) questioned taxation of corporate structure of Amazon group in 2012. The Committee is appointed by the House of Commons to examine ‘the accounts showing the appropriation of the sums granted to Parliament to meet the public expenditure, and of such accounts laid before Parliament as the Committee
49 Hartlief (n2) 64. The term ‘financial conduit entity’ implies the channeling of funds through this type
of entity (also called ‘special purpose entity’); they used to finance the corporate group.
50 Annual report of Amazon group, 2014 pp.3, 25, 38. Amazon.com, Inc. was incorporated in 1994 in
the state of Washington and reincorporated in 1996 in the state of Delaware. Main corporate offices of Amazon are located in Seattle, Washington state. Amazon operates 13 global web sites and its business is divided into two segments: North America and International. Primary market segments of Amazon are consumers, sellers, content creators and enterprises. In 2014 Amazon had worldwide net sales of USD 88 988 million and a post tax net profit of USD 241 million.
may think fit’.51 The Committee focuses on value-for-money criteria, which are based
on economy, effectiveness and efficiency.52
Thus, the Committee has the right to examine costs and revenues of the state and assess whether costs and revenues meet public expenditure. Therefore on November 12, 2012 representatives of Amazon, Google, and Starbucks were invited to the hearings of the Committee and were suspected in diverting profits gained in the UK to tax havens.53 Hearings end up with Committee’s report on that matter and no further
complaints or investigations were brought against those companies. The aim of the hearings was to call large companies’ top executives to the stand and to make them feel their social responsibility. The goal, to call companies for social responsibility, was achieved in case of Amazon – it started to pay more taxes in UK, please see below for more details.
In 2014 the European Commission began its investigation on the matters concerning taxation of Amazon companies located in Luxembourg. Investigation brought by the European Commission concerned the tax ruling on advance pricing arrangements (‘APA’) concluded between Luxembourgish authorities and the Amazon Group in 2003.54 Namely, European Commission examined whether the tax
ruling issued by the Luxembourgish authorities could be considered as state aid in the sense of the Article 107 of Treaty on Functioning of European Union (‘TFEU’).55 An
APA, conclusion of which is the core of the European Commission investigation is formally initiated by taxpayer and requires negotiations between taxpayer and tax administrators.
For the Amazon group incorporated in Luxembourg please see the Structure chart 1 below. Amazon group consists of one operational company – Amazon EU S.ar.l. (‘Lux OpCo’) which functions as European head office of the Amazon and its
51
Standing orders of House of Commons [2005] Public Business No 148
http://www.publications.parliament.uk/pa/cm200506/cmstords/416/41605.htm (last accessed June 12, 2015)
52 UK Parliament: Public Accountants Committee – Role
http://www.parliament.uk/business/committees/committees-a-z/commons-select/public-accounts-committee/role/ (last accessed June 12, 2015)
53 Syal Rajeev ‘Amazon, Google and Starbucks accused of diverting UK profits’ [2012] The Guardian. 54 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations
Guidelines for conducting Advance Pricing Arrangements under the Mutual Agreement Procedure (1999) para 4.132. APAs generally deal with factual issues, which are the subject of thorough analysis and investigation by tax administrators. An APA usually covers several transactions, several types of transactions on a continuing basis, or all of a taxpayer’s international transactions for a given period of type.
55 Consolidated version of the Treaty on the Functioning of the European Union [2012] OJ C 326, 47–
subsidiaries. Parent company of Lux OpCo is Amazon Europe Technologies Holding SCS (‘Lux SCS’) – company that owns intellectual property and licenses it to Lux OpCo to operate European websites in return for a tax-deductible royalty payment (‘License fee’). Lux SCS in its turn is owned by the US companies: Amazon.com Int’l Sales, Inc., Amazon.com, Inc., and Amazon Europe Holding, Inc. Basically, through the Lux SCS the EU entities of Amazon pay for using Amazon’s technology and intellectual property, which is primarily developed in the US.56
The Lux OpCo has subsidiaries (as depicted in the structure chart), which are liable to corporate income tax in Luxembourg and deemed to be a fiscal unity. In a fiscal unity a parent company may be taxed as a group together with its subsidiaries. The advantage of this system is that losses of the one group company can be offset against profits of another group company.57
Luxembourgish authorities thus, by means of tax ruling for APA’s issuance, approved a transfer pricing arrangements between group companies of Amazon. According to the Amazon’s request for this approval, Lux SCS would own the intangibles and license them to Lux OpCo on arm’s length prices. Royalty rates and license fee computations were also presented in the request. However, at the same time Lux SCS is considered to be a transparent entity for Luxembourgish tax purposes and therefore shall not be taxed in Luxembourg. Transparent entity for tax purposes means that this entity is not subject to taxes in Luxembourg. Lux SCS thus is liable to taxes in the US, as country of residence of the parent companies, to which profits of Lux SCS are allocated on a yearly basis.
At the same time, according to the Luxembourgish law, the non-resident and associated with Lux SCS entities may nevertheless be taxed in Luxembourg if they operate in Luxembourg through permanent establishments. For this reason in addition to the tax ruling request Amazon provided also another request to confirm that none of the associated with Lux SCS entities are acting on the territory of Luxembourg through permanent establishments.
According to the Article 107(1) TFEU any aid granted by Member State in any form leading to distortion of competition by favoring certain undertakings shall
56 Written evidence to the United Kingdom House of Commons Public Accountants Committee of
Amazon EU S.a r.l.
http://www.publications.parliament.uk/pa/cm201213/cmselect/cmpubacc/716/716we06.htm (last accessed June 12, 2015).
57 Article 164bis of Luxembourgish income tax law (loi modifiee du 4.12.1967 concernant l’impot sure
be incompatible with the internal market. The Article 107(1) TFEU also applies in the field of taxation even if the competence of the Union to regulate direct taxation is limited under TFEU.
In order to determine whether the measure of the Member State constitutes state aid all conditions set in the Article 107 TFEU shall be met:58
a) the measure must be imputable to the state and financed through state resources;
b) it must confer an advantage on its recipient; c) that advantage must be selective; and
d) the measure must distort or threaten to distort competition and have potential to affect trade between member states.
The Luxembourgish tax authorities provided Amazon with the tax ruling for APA, which means that the first condition of the Article 107 TFEU is met. This tax ruling then was found to confer an advantage to Amazon because, as European Commission noted, any result that deviates from the outcome and lowers the tax basis has the effect of providing an advantage to the taxpayer concerned.59 Moreover, the
advantage given to Amazon is in a selective manner due to the fact that not all companies located in Luxembourg could use similar tax rulings.60 Therefore, the tax
ruling of 5 November 2003 by Luxembourg in favor of Amazon constitutes state aid within the meaning of Article 107(1) TFEU.
The Commission issued preliminary ruling while the final ruling is still on its way.61 Results of this investigation will have a crucial meaning to many other
multinational entities acting through tax rulings for APAs and other legal instruments provided by states like Luxembourg or the Netherlands.
58 Article 107(1) TFEU:
1. Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.
59 Commission Decision of 16 October 2002 on the State aid scheme C 49/2001 (ex NN 46/2000) —
Coordination Centres — implemented by Luxembourg (Text with EEA relevance) (notified under document number C (2002) 3740)
60 Decision of the European Commission 7156 07.10.2014, 20.
61 Internal deadline for the ruling will be missed and as the Commission chief Margrethe Vestager said
they cannot ‘sacrifice the rule of law or quality of [the Commission’s] work to speed up the process’. ‘European Commission Apple, Amazon anti-trust ruling will miss deadline’ MacNN [2015]
http://www.macnn.com/articles/15/05/05/multinational.tax.haven.ruling.will.wait.to.prevent.sacrificing .the.rule.of.law.128481/ (last accessed 10 August 2015).
Meanwhile, as became evident from quarterly reports, the Amazon group has already begun paying tax on its retail sales in individual European countries, instead of funneling all sales through Luxembourgish companies, in a restructuring of its European business practices. Amazon has begun booking revenue by country in some of its biggest markets, including the UK, Germany, Italy and Spain. This practice began on May 1, 2015 and will roll out across other European operations.62 This move
of Amazon shows its willingness and readiness to comply with international tax law.
Structure chart 1
b) Apple case63
62 ‘Amazon.com moves away from tax-shifting in Europe’ CBC News
http://www.cbc.ca/news/business/amazon-com-moves-away-from-tax-shifting-in-europe-1.3086413
(last accessed June 14, 2015)
63
Quarterly Report of the Apple group to Securities Exchange, form Q-10 [2015 March] 3. Apple designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players. It sells different related software, services, peripherals, networking solutions and third-party digital content and applications. Apple sells its products worldwide through its retail stores, online stores and direct sales force, as well as through third-party cellular networks carriers, wholesalers, retailers and value-added resellers. In addition, Apple sells a variety of third-party products compatible with Apple products, including application software and various accessories, through its online and retail stores. In 2014 Apple had worldwide net sales of USD 103,240 million and a net income of USD 39,793 million. In 2013 and 2012, net sales amounted to USD 170,910 million and USD 156,508 million respectively.
The Committee on Homeland Security and Governmental Affairs of the US Senate (‘US Senate Committee’) questioned taxation system of the Apple group in May of 2013. The Apple group of companies is composed of Apple Inc. (US-incorporated mother company) and companies owned by the Apple Inc. (hereinafter collectively referred to as ‘Apple’). For the group structure please see the Structure chart 2 below.
The main concern of the US Senate Committee was alleged tax avoidance by the Apple. Pursuant to the report of the US Senate Committee this tax avoidance became possible due to the cost-sharing agreement concluded between the US incorporated Apple companies and Irish incorporated companies. The US Senate Committee also alleged the Tax Revenue Code to be full of ‘tax loopholes’.6465
At the present time the US Internal Revenue Service is examining Apple for 2010 - 2012 years corporate income tax payments. As was stated in the Apple’s quarterly report to the US Securities and Exchange Commission for the first quarter of 2015, the company is subject to audits by state, local and foreign tax authorities.66 Investigation of the US
Senate Committee ended with report of that Committee, which was transferred to the Internal Revenue Commission for further proceedings.
The European Commission also investigated the taxation system of the Apple group of companies incorporated in Ireland. Decision on this investigation was published in June of 2014.67 The main question the European Commission had to
answer is whether the tax rulings of Irish Revenue in favor of two Apple group companies incorporated in Ireland constituted state aid in terms of the Article 107(1) TFEU. By the end of this investigation the European Commission requested Ireland to submit its comments and provide with additional documentation. The final decision on this case has been delayed as well as decisions for cases of Amazon and
64 By ‘tax loopholes’ in US Tax Revenue Code US Senate meant ‘check-the-box’ rule (entity
classification election – Internal Revenue Service Form 8832) and ‘look through rule’ (I.R.C. Section 954(c)(6) provides that dividends, interest, rents and royalties that one CFC receives or accrues from a related Controlled Foreign Corporation are not treated as foreign personal holding company).
65 Hearing before the Permanent Subcommittee on Investigations of the Committee on Homeland
Security and Governmental Affairs US Senate – 113 Congress, first session pp.3, 6-7.
66
Apple’s quarterly report (n63) 29.
67 European Commission decision of 11.06.2014 C(2014) 3606 final (Subject: State aid SA.38373
Starbucks.68 However, the Apple already included in its report probability of payment
up to 10 years’ worth of back taxes to Ireland.69
Ireland-incorporated companies of the Apple consist of one parent company – Apple Operations International (‘AOI’), direct subsidiary of the US based Apple Inc. and its subsidiaries. Subsidiaries of AOI are under investigation: Apple Operations Europe70 (‘AOE’) and AOE’s subsidiary Apple Sales International71 (‘ASI’).72 These
companies are not residents of Ireland for tax purposes. All decisions taken by them are taken outside Ireland, thus the condition for non-residency provided for in Irish tax legislation is fulfilled. According to the information provided by the Irish authorities, the territory of tax residency of AOE and ASI is not identified.73
AOE is a party to a cost sharing agreement whereby together with other Apple Inc. subsidiaries it shares research and design costs and risks of developing of certain Apple products. Apple Inc. holds the legal title to all Apple intellectual property, while AOE has intellectual property rights under that cost sharing agreement.
With regard to 1991 tax ruling issued by the Irish Revenue a basis to determine net profit was agreed as 65% of operational expenses up to annual amount of USD 60-70 million and 20% if operating expenses will exceed USD 60-70 million for AOE and 12,5% of operational costs for ASI. In 2007 basis for determination of net profit was modified as 10-20% of operating costs and 1-9% to intellectual property return for AOE and 8-18% for ASI.
Furthermore, the European Commission investigated negotiations between Irish Revenue and tax advisor of the Apple. From those negotiations it was clear that no substantive or scientific information was used to set the basis for net profit determination. As the employee of the Apple’s tax advisor stated, rates and figures
68 For more information on the delay of the European Commission’s decision please see p.12 of this
paper.
69 Apple’s quarterly report (n63) 26.
70 The main activity of AOE is manufacture of specialized line of personal computers. The company
purchases materials from related companies and sells manufactured products to related company. The AOE also provides shared services to the Apple companies in Europe, the Middle East and Africa region, including payroll services, centralized purchasing and customer call center.
71 European Commission decision (n67) 8.The ASI’s main activities are: procurement of Apple
finished goods from third-party manufacturers, onward sale of those products to Apple-affiliated companies and other customers, logistics operations involved in supplying Apple products from the third-party manufacturers to Apple-affiliated companies and customers.
72 Hearing before the US Senate (n65). Pursuant to the data provided by the representatives of the
Apple to the abovementioned US Senate Committee, the ASI’s sales revenues for fiscal years 2009, 2010, 2011 and 2012 were USD 12,4 billion, USD 28,8 billion, USD 47.5 billion and USD 63.9 billion respectively. This represents a 415% increase of sales revenues over the period 2009 to 2012.
were set up that way because it seemed ‘bona-fide’ proposal towards Irish Revenue.74
Moreover, special tax treatment granted by Irish authorities was of a very long and unusual term – 15 years without any revision (to the period from 1991 to 2007). Also the 2007 ruling did not factor evolution of sales and therefore could not be deemed as proper revision of tax ruling.
To find whether the tax rulings of Irish revenue are a state aid, European Commission first found Irish tax ruling in favor of Apple to be a selective advantage, because other companies incorporated in Ireland did not receive such tax treatment. Second, the tax ruling in question was an act of government due to the involvement of Irish Revenue. Third, as far as Apple operates in various Member states of European Union, trade was affected and distorted within the Union. Four, by lowering the tax liability the advantage was given to Apple. Thus, the measure applied by the Irish Revenue was found to be a state aid under terms of Article 107(1) TFEU.
Structure chart 2
3. The WTO law, possibly related to tax noncompliance
Multinational enterprises are not members to the WTO, states are. Therefore there is no direct link between the WTO and multinational enterprises involved in tax noncompliance. The WTO law addresses states and has no direct impact to operation of enterprises. However, it does not mean that private parties do not have any access to the WTO regulations. Large corporations or associations of enterprises may lobby their interests to their state authorities and thus may be heard by the WTO Members.75
In this chapter the WTO law in relation to tax noncompliance by multinational enterprises is analyzed. Case studies in the previous chapter show that tax noncompliance became possible due to certain tax policies of states and different corporate structures used by multinational enterprises. These tax policies and multinational group’s structures are usually in line with the letter of law, although tax policies of Ireland and Luxembourg related to provision of favorable tax rulings alleged to be prohibited under the Article 107 TFEU, as state aid.
Governmental tax policies that make possible the tax noncompliance can also be in form of lower tax rates, tax holidays and various agreements with tax authorities for foreign companies. Tax holidays mean an exemption to pay certain tax, usually to corporate income or tax to mineral resources for some limited period of time.76
Scholars and practitioners use different definitions for states with low, preferential or, also called, favorable tax regimes. Definitions vary from ‘offshore financial centers’ and ‘tax havens’ to ‘offshores’.77 For instance, Olatunde Otusanya
defined a tax haven as
(…) places or countries (not all being sovereign states) which have sufficient autonomy to write their own tax, finance and other laws and regulations. They all take advantage of this autonomy to create legislation designed to assist non-resident persons or corporations to avoid the regulatory obligations imposed on them in the places where non-resident people undertake the substance of their economic transactions.’
75 Gregory Shaffer ‘What’s new in EU trade dispute settlement? Judicialization, public-private
networks and the WTO legal order’ [2006] Journal of European Public Policy, 2006, Vol.13(6) 832-850.
76
Francis Weyzig and others ‘Incoherence between Tax and Development Policies: the case of the Netherlands’ [2009] Third World Quarterly Vol.30(7) 1259-1277.
How the WTO could address tax havens? The main objective of the WTO law is to preserve and promote international trade between Member states without hindrances and barriers.78 Thus, a first matter to which the WTO law refers is customs
duties, charges, requirements and formalities. The Article III:4 GATT refers to other laws and regulations.79 Therefore, to assess whether international trade distorted or
not, customs and tax policies of the WTO Member states’ shall be examined with a view to import and export performance characteristics.
With a view to assess the WTO law impact to the issue of tax noncompliance, a hypothetical state with a favorable tax regime for foreign owned multinational corporations is taken and certain provisions of the WTO law will be applied to it further. Such hypothetical state in this paper defined as ‘tax haven’ whereas the group of companies called ‘multinational enterprise’ or MNE. These definitions are used without prejudice to any other definition, meaning a state with a special favorable tax regime for foreign entities. Foreign entities for the purposes of this research shall mean entities controlled from abroad by beneficial owner(s) or ultimate parent company80 and comprise a part of multinational group of companies.81 One of the
main purposes of such group of companies shall be to gain tax advantages.
One of the main difficulties with applying the WTO law to such group of companies, which arises at first glance and might be the serious one, is that it is usually hard to define the place from where the MNE is controlled. It is worth to note that state of incorporation, state of a seat, state of residency and state of control in multinational corporations could mean different states. State of incorporation is a state in which the company is incorporated whereas place of a seat means the state where board of directors taking strategic decisions is located. The state of residency could differ from the state of incorporation and means the state in which the entity is liable to pay taxes. The state in which the controlling entity is located is important for tax
78
Preamble of the Marrakesh Agreement Establishing the World Trade Organization (1994).
79 Article III:4 GATT (General Agreement on Tariffs and Trade [1994] Marrakesh Agreement
Establishing the World Trade Organization, Annex 1A).
80
This distinction in controlling persons made because in some cases controlling entities, namely ultimate parent companies, may be listed on a public stock exchange and therefore do not have any physical person holding more than 10% of shares in such entity. Thresholds for defining a person as an ultimate beneficial owner vary from country to country, but the lowest threshold is 10% of interest in the entity.
81 Such entities could be incorporated in a tax haven or elsewhere, the main condition for them is to be
purposes. For example, controlling entity may be found liable for losses and failed obligations of controlled entity.82 It can be seen from the above that in complex
corporate structures of multinational enterprises it is very hard to identify the state responsible for taxation of such enterprise.
In order to find a ‘responsible’ state a beneficial owner of the group of companies or an ultimate parent company shall be identified.83 For instance, the
beneficial owner can establish the top-tier entity in a country with lowest rates for taxation of dividends, other entities of the group in countries with lowest interest tax rates and operational company in a country with lowest corporate tax rates. Therefore an entity established in a tax haven for tax purposes, which does not operate and thus not involved in international trade directly, would hardly be found as impeding sales of domestic products of such tax haven. Moreover, the foreign entity incorporated in the tax haven for tax purposes would itself become a domestic company for the tax haven state due to incorporation in it. Thus, it is very hard to prove that such multinational corporation is liable of international trade distortion.
Consequently the question of finding a state responsible for multinational corporation has no answer yet. The latest OECD Plan on Base Erosion and profit shifting proposes to identify the ultimate parent company of a group.84 Various
countries solve this issue differently. For the purposes of the present research I would like to urge the reader to keep in mind these difficulties while reading the following subparagraphs where the WTO law in relation to tax noncompliance is analyzed.
3.1. Application of Articles I, III GATT to the problem of
tax noncompliance
GATT articles I and III dealing with prohibited tax and customs policies can not be applied to the tax noncompliance in question. 85 These articles deal with
products. As discussed above, there is no direct link between products produced by
82
Ryan Moulder ‘Controlled group liability: the private equity’s side of the story’ [2011] Journal of Deferred ompensation Vol.16(4) 19.
83 Ultimate parent company shall be found in case when there is no physical person holding more than
10% of shares of the top tier entity identified.
84 OECD/G20 Base Erosion and Profit Shifting Project: Action 13 – Country-by-Country Reporting
Implementation Package [2015] http://www.oecd.org/ctp/transfer-pricing/beps-action-13-country-by-country-reporting-implementation-package.pdf (last accessed 10 August 2015).
85
General Agreement on Tariffs and Trade [1994] Marrakesh Agreement Establishing the World Trade Organization, Annex 1A, the legal texts: the results of the Uruguay Round of Multilateral Trade Negotiations 17 (1999), 1867 U.N.T.S. 187, 33 I.L.M. 1153.
the multinational enterprise and impact to the international trade by the tax noncompliance of a multinational enterprise exercised through a holding company incorporated in a tax haven. Article III GATT formulates a possibility to apply GATT provisions to laws and regulations of Member States that distort trade by giving advantage to domestic products. But in this case, the question of residency of a multinational enterprise arises. Will the holding company incorporated in a tax haven be deemed as domestic or foreign for the purposes of the Article III GATT? By the fact of incorporation a holding company could be found domestic. However, if to take into the account the fact that such companies are not operational and were incorporated merely for tax purposes, they could be deemed as foreign entities. In the following paragraphs I refer to Articles I and III GATT in more details.
The GATT Article I - most-favored-nation treatment (‘MFN clause’) prescribes that any advantage, favor, privilege or immunity granted by any Member state to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other Member states. The favorable tax regime given to foreign entities by tax havens is definitely a privilege or/and a favor. But this favor is indeed given to all entities from abroad without giving the advantage to any particular state. Therefore MFN clause could not be applied here.
Article III:1 GATT – national treatment clause - lays down rules prohibiting any charges, laws, regulations and requirements affecting the internal sale, offering for sale, purchase, transportation, distribution or use of products in specified amounts or proportions, to be applied to imported or domestic products so as to afford protection to domestic production. By giving preferential tax treatment to foreign owned companies tax havens do not aim to exercise domestic protection because products of a multinational enterprise produced elsewhere and no domestic product thus involved. Therefore there is no violation of national treatment clause.
3.2. SCM Agreement and tax noncompliance
Pursuant to the Article 1.1.(a)(1) of the Agreement on subsidies and countervailing measures (‘SCM Agreement’), subsidy shall be deemed to exist if there is a financial contribution by a government or any public body within the territory of a Member. The Article 1.1. of the SCM Agreement than lists examples of
a financial contribution. Behavior of tax havens fall under the Article 1.1.(a)(1) – ‘where government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits)’. When tax havens give advantages to entities allowing them to pay less tax or to not pay at all the government revenue that should be collected is foregone. This entails that MNEs and tax havens behavior in question falls under the Article 1.1.(a)(1)(ii).
Moreover, the SCM Agreement has non-exhaustive Illustrative List of Export Subsidies (‘List’), subparagraph (e) of which refers to the full or partial exemption remission, or deferral specifically related to exports, of direct taxes or social welfare charges paid or payable by industrial and or commercial enterprises.86 This could be
applied to tax havens giving the advantages to foreign companies, but, pursuant to this subparagraph an incentive shall be related to exports. The difficulty with application of this subparagraph to the matter in question is that MNEs behavior in avoiding taxes is not directly linked to export performance. This happens because foreign entities use favorable tax regimes and their aim is not entering the internal market of the tax haven. Purpose of MNEs in the tax haven is to use tax incentives to operate, produce and/or sell/distribute goods using other companies elsewhere. Therefore MNEs are not in fact entering the internal market of tax haven state using the tax incentives; they might enter the market but through other operating companies in a way not distorting trade following current international trade rules.
The footnote 58 to the subparagraph (e) of the List gives the definition of direct taxes: ‘taxes on wages, profits, interests, rents, royalties, and all other forms of income, and taxes on the ownership of the property’. Incentives to foreign entities are usually given in the form of tax exemptions or deferral to pay corporate income taxes, taxes on interests, profits and royalties and therefore could be covered by this definition of the List.
Thus, the SCM Agreement could potentially be applied to the subject matter and it is essential to look at the historical background of the SCM Agreement. The next session will discuss the objectives of the SCM Agreement through the process of negotiations. Negotiations phase is very important to the interpretation of the aim of the agreement whereas finding the aim of the SCM Agreement is a step forward in
86 See Annex 1 to the SCM Agreement. Export subsidies are prohibited pursuant to Article 3 of the
research of the possibility of the SCM Agreement’s application to the matter in question.
3.2.1. Objectives of the SCM Agreement
Matters on subsidies and countervailing measures were first addressed in Articles VI and XVI GATT. Use of subsidies is usual and normal practice for every state to pursue and promote important and fully legitimate objectives of economic and social policy.87
This entails that governments use subsidies very often. Therefore Member states soon realized that Articles VI and XVI GATT are not enough to effectively deal with subsidies and countervailing measures. Thus, during the Tokyo Round (1973-1979) GATT Contracting Parties negotiated and concluded the Agreement on Interpretation and Application of Articles VI, XVI and XXIII GATT, commonly referred to as Tokyo Round Subsidies Code.88
Afterwards number of disputes on subsidies has arisen during 1980s and it became clear that Subsidies Code did not bring the degree of clarification and elaboration of the rules on subsidies and countervailing duties sought by Contracting Parties. Eventually, the Uruguay Round Negotiations resulted in the SCM Agreement, which now forms part of Annex 1A of the Agreement establishing the World Trade Organization. The history of the SCM Agreement shows that it has been a matter of a Contracting Parties’ concern for a long time and they did their best to adapt the SCM Agreement to the needs of changing government policies.
The SCM Agreement does not contain special provisions or the preamble on purpose and aim of it. With respect to the object and purpose of the SCM Agreement, the panel in Brazil-Aircraft (1999) stated that:
‘the object and purpose of the SCM Agreement is to impose multilateral disciplines on subsidies which distort international trade’.89
The panel in Canada-Aircraft (1999) further clarified that:
87
van den Bossche (n46) 745.
88 Ibid. (n46) 746
the object and purpose of the SCM Agreement could […] be summarized as the establishment of multilateral disciplines ‘on the premise that some forms of
government intervention distort international trade [or] have the potential to distort [international trade].90
Thus, the broad meaning of the SCM Agreement’s aim is to protect international trade from distortions that could be caused by subsidies. Prohibited subsidies under the SCM Agreement shall be linked to export performance. If they would not be strictly linked to export performance, the issue to consider would be the following: ‘Is international trade distorted by the behavior of MNEs, which receive and use advantages given by tax havens?’ The answer to this question could also lie within the economical field and most probably would require empirical research and use of statistical data.
3.2.2. The concept of a subsidy
The SCM Agreement contains, for the first time in the GATT/WTO context, a detailed and comprehensive definition of the concept of a subsidy.91 As the panel in
US-FSC stated: ‘the inclusion of this detailed and comprehensive definition of a term
‘subsidy’ is generally considered to represent one of the most important achievements of the Uruguay Round in the area of subsidy disciplines’.92
Definition of a subsidy is given in Article 1.1. of the SCM Agreement which can be broadly interpreted as a financial contribution by a government or public body, which confers a benefit. Article 1.2. further provides that the WTO rules on subsidies and subsidized trade only apply to ‘specific’ subsidies, i.e. subsidies granted to an enterprise or industry, or a group of enterprises and industries.93 Rules on specificity
are laid down in the Article 2 of the SCM Agreement. Provisions of those articles contain the concept of a subsidy, constituent elements of which are: 1) a financial contribution 2) by a government or any public body 3) conferring a benefit.94
90 Canada-Aircraft (1999), Panel Report, para. 9.119 (emphasis added). 91 van den Bossche (n46) 747.
92
US-FSC (2000), Panel Report, para. 9.119 (emphasis added).
93 van den Bossche (n46) 747. 94 Article 2 of the SCM Agreement.
Article 1.1. of the SCM Agreement gives an exhaustive list of types of financial contributions. As was discussed above tax havens’ behavior could fall under the Article 1.1.(a)(1)(ii): ‘government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits)’.
In the US-FSC the Appellate Body held:
In our view, the ‘foregoing’ of revenue ‘otherwise due’ implies that less
revenue has been raised by the government than would have been raised in a
different situation, or, that is, ‘otherwise’. Moreover, the word ‘foregone’ suggests that the government has given up an entitlement to raise revenue that it could ‘otherwise’ have raised. This cannot, however, be an entitlement in the abstract, because governments, in theory, could tax all revenues. There must, therefore, be some defined, normative benchmarks against which a comparison can be made between the revenue actually raised and the revenue that would have been raised ‘otherwise’. We, therefore, agree with the Panel that the term ‘otherwise due’ implies some kind of comparison between the revenues due under the contested measure and revenues that would be due in some other situation. We also agree with the Panel that the basis of a comparison must be the tax rules applied by the Member in question … A Member, in principle, has the sovereign authority to tax any particular categories of revenue it wishes. It is also free not to tax any particular
categories of revenues. But, in both instances, the Member must respect its
WTO obligations. What is ‘otherwise due’, therefore, depends on the rules of taxation that each Member, by its own choice, establishes for itself.95
In the US – FSC Appellate Body referred to the main difficulty of the Article 1.1.(a)(1)(ii) - conditions to apply when to find a particular taxation system of a Member State as not receiving the ‘right’ amount of revenues. From the quote above it is clear that the term ‘otherwise’, as used in ‘government revenue, otherwise due, that was foregone’, refers to a normative benchmark as established by the tax rules applied by the Member concerned.96
Thus, if applied to the matter in question, to find
95 US – FSC (2000) Appellate Body Report para.90 96 van den Bossche (n46) 753.
