RESTRICTED
WORLD TRADE WT/CTE/W/47
2May1997
ORGANIZATION(97-1913)
Committee onTrade andEnvironment
TAXES AND CHARGES FOR ENVIRONMENTAL PURPOSES -
BORDER TAX ADJUSTMENT
Note bytheSecretariat
I. INTRODUCTION
Thefollowing Notehasbeenprepared bytheSecretariat onrequest bytheCommittee onTrade
andEnvironment. Itisorganized inthreeparts: (a)abriefpresentation ofvarious policy instruments
toaddress environmental problems; (b)adiscussion ofthewider economic andtrade implications
ofeco-taxes and-charges; and(c)anoverview ofWTO provisions anddispute settlement practice
pertaining totheapplication ofdomestic taxes andcharges totraded goods.
II. CURRENT USEOFENVIRONMENT-RELATED TAXES AND CHARGES
A. General features
1. Environmental policies inmany countries continue toshiftfrom relying predominantly on
remedial actions tocontrolling pollution andother environmental effects. There isanincreasing focus
oncorrecting thecauses underlying environmental problems andpreventing over-intensive resource
use,rather thanoncuring symptoms. Thecauses areoftenassociated withthefailure ofmarket prices
tocorrectly reflect environmental scarcities and/or social values.1
2. While governments mayuseawide array ofmeasures topursue public policy objectives,
including environmental goals, twoprinciple approaches canbedistinguished: command-and control
measures suchasprohibitions orquantitative controls ontheonehand, andprice-based instruments
suchastariffs, taxes orsubsidies ontheother. Inpractice, bothapproaches maybecombined.
Quantitative limits maybeemployed, forexample, tocircumscribe maximum permissible levels of
anactivity, e.g.therelease ofeffluents intoaneco-system, while price-based instruments areto
encourage behavioural changes within suchlimits. Ideally, thesanctions (orpremiums) usedinthis
connection should reflect thesocial damages (benefits) resulting fromanaction and/or theinvestment
costs associated withenvironmental rehabilitation.
3. From aneconomic perspective, price-based measures aregenerally preferable toquantitative
controls. While suchmeasures areintroduced andmodified through government decree, i.e.ona
mandatory basiswithin ajurisdiction, theensuing economic changes aredecided uponanddischarged
1Togiveasimple example: theconsiderations involved inclearing astanding forest forcommercial usetraditionally
hinge oncomparing revenues associated withdifferent economic alternatives suchastimber sales, agricultural output, housing
rents, orimproved industrial siting. From thatperspective, thebenefits offorestry clearing maysignificantly outweigh the
benefits ofconservation since indirect economic andecological functions -e.g.preventing landdegradation, providing ahabitat
forrarespecies, acting asasinkforcertain gasemissions -aredisregarded or,atleast, insufficiently valued.WT/CTE/W/47
Page2
byindividual market participants. Contrasting withcommand-and-control systems, consumers and
producers arefreetoidentify andtaketheactions deemed tobemost economically attractive or,
alternatively, leastunattractive. Rather thanbeing subject torigidadministrative criteria, requiring
forexample behavioural changes onapro-rata basis, theyremain incharge of,andaccountable for,
theirpersonal response.
4. Aneco-tax onindustrial emissions, forexample, leaves ittotheindividual firmtobalance
thecostofpollution abatement -through investment innewequipment, process innovation, etc.-with
itstaxliability under status quoconditions. Adjustments arelikely tooccur inparticular inthose firms
where theabatement costs arerelatively lowcompared tothetaxsavings and,correspondingly, the
environmental benefits achieved. From aneconomy-wide perspective, agiven environmental effect
canthusbeattained atlower costthanunder asystem ofadministrative controls which ignores the
individual polluter 'scapacity torespond. Hence, price-based sanctions make better useofaneconomy 's
overall potential forinvestment, innovation andadjustment. However, theydonotobviate theneed
forquantitativecontrolsorevenbanstopreventseriousandirreversibleenvironmentaldamageassociated
with, forexample, thedischarge oftoxic wastes.
5. Market-basedmeasures(e.g.tariffs)aregenerallymoretransparentintheiroperationandprovide
lessscope fordiscriminatory application, intentionally orotherwise, thanadministrative controls
(e.g.importquotas).Theyarelesspronetoinformalinformationanddecision-makingchannelsoperating
tothedetriment ofcompanies, sectors orgroups without astrong domestic base. Ideally, allmarket
participants -regardless oflocation, nationality, pasteconomic performance, etc.-arebeing conveyed
thesame price information andafforded thesame opportunities torespond. Inturn,thetransparency
andpredictability associated withsuchsystems tendtofacilitate foreign access, encourage longer-term
consumption andinvestment planning and,thus, promote overall economic expansion.
6. Inatextbook economy, there isnoprinciple difference between using monetary incentives
(subsidies) orsanctions (taxes andcharges) toencourage adjustment. Subsidies maybeemployed,
forexample, topromote environmentally-beneficial product orprocess innovation or,asinagriculture,
tocompensate forproduction cuts.However, apartfromlegal, fiscal orinstitutional constraints, polluter
subsidies mayruncounter topublic perceptions ofjustice andaccountability -itisgenerally heldthat
theperpetrator should compensate thevictim rather thanviceversa.Inaddition, withnolimits on
market access, subsidies riskenticing newproducers orusers intotheareas concerned.2
7. Thefollowing section isintended togiveastylized summary andsome examples ofdifferent
typesofenvironmentaltaxesandotherprice-basedinstruments.Theymaybeappliedtoeitherproduction
inputs, technologies, equipment, finalproducts orpollutants released during theproduction process.
2However, temporary adjustment aidmaybeviewed inadifferent light. Under theWTO Agreement onSubsidies and
Count ervailingMeasur es,assistancetopromoteadaptationofexistingfacilitiestonewenvironment alrequirement sisconsidered
tobenon-actionable ifspecified conditions aremet(itmustbeaone-time non-recurring measure; belimited to20percent
ofadaptation cost; must notcover thecostofreplacing andoperating theassisted investment; bedirectly linked toand
proportionate totheenvironmental results andmustnotcover manufacturing costsavings; andbeavailable toallfirms which
canadopt thenewequipment andprocesses).WT/CTE/W/47
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B. Types ofinstruments
(a) Taxes andcharges
(i) Emission Taxes orCharges
8. Emission taxesandcharges havebeenusedbyseveral countries tolimitthedischarge ofvarious
pollutants and,possibly, raisefunds forremedial action. Taxlevels aregenerally levied inrelation
tothequantity aswellasquality (e.g.toxicity) oftheemissions concerned.
Waste:Themostcommonly-usedemissionchargesareimposedongeneration,storage,treatment
anddisposal ofvarious kinds ofindustrial orhousehold waste. Comparable totraditional usercharges,3
theymayhelptocover thecostsassociated withtherelevant operations, including landfill, incineration,
etc.
Agriculture-related Pollutants: Farmers inseveral countries areallocated allowable baseline
emission levels fornutrients, withexcess emissions triggering acharge. Forsimilar reasons, charges
arealsoapplied onvarious agricultural inputs, inparticular agro-chemicals.
AirPollutants: Emission charges andtaxes havebeenusedforover30years tohelpreduce
airpollution. They areapplied tosulphur dioxide, nitrogen oxides, volatile organic compounds,
particulate matter, hydrochloric acidand,more recently, carbon dioxide. Taxratesareoftencalculated
onavolume basis, withincreasing ratesapplied overandabove pre-determined baselines ofallowable
emissions. Inseveral countries, sulphur dioxide bears thehighest per-tonne rate. Insome schemes,
taxrevenues areusedtofinance enforcement activities, encourage research intoabatement technologies,
compensate individuals forpollution damages (e.g.asthma, bronchitis) orassist industries inpurchasing
pollution abatement equipment.
(ii) Product taxes andcharges
9. Eco-taxes andcharges arelevied ongoods usedasinputs attheproduction stage or,more
commonly, attheconsumption level. They tendtoconcentrate onproducts suchasautomobiles,
lubricants, pesticides andagro-chemicals, tires, feedstocks, batteries, plastic bags, non-returnable
beverage containers, ozone depleting chemicals, andproduct packaging. Suchtaxes andcharges may
alsobelinked toperformance standards. Forexample, numerous countries apply differential taxrates
onautomobiles, according tofactors suchasfuelefficiency ortypeofequipment (e.g. catalytic
converters). AnOECD country recently introduced anenvironmental rating system forautomobiles
based oncomparative environmental performance, withthetaxratereflecting fuelefficiency andsimilar
criteria.
(b) Subsidies
10. Subsidies andtheenvironment maybelinked byalternative causation mechanisms. Thefirst
involves theimpact ofcertain subsidies, forexample onfarminputs, onenvironmental degradation.4
Thesecond relates totheuseofsubsidies topromote environmental protection. Suchsubsidies may
beextended viagrants, rebates, softloans, taxallowances, deferrals andexemptions (forconservation
3User charges have longbeen applied forparkvisitors, etc.
4With thisinview, aSoutheast Asian country recently revised itspolicy onpesticides, cutting farm support schemes
which included thesubsidization ofpesticides byoverone-half andbanning theuseofnumerous pesticides particularly harmful
totheenvironment.WT/CTE/W/47
Page4
measures, research anddevelopment andthelike), investment refund schemes oraccelerated write-offs
(e.g.foranti-pollution equipment). Several countries haveintroduced energy taxallowances, including
taxrebates forenergy-efficient oralternative energy technologies. Awiderange ofsectors maybe
covered, including agriculture, forestry, energy, mining, andfisheries.
11. Arelated approach relies onincentive instruments, suchastax-free environmental bonds,
environmental mutual funds, flow-through shares orafter-tax financing instruments, which areintended
tolower afirm'senvironmental capital andoperating costs.
(c)Deposit-refund schemes
12. Deposits maybedemanded frombuyers ofpotentially polluting products. They arerefunded
when theproducts ortheirresiduals arereturned withaviewtoencouraging recycling and/or covering
thecostsofwaste disposal. Refund schemes havebeenapplied innumerous countries toabroad range
ofconsumer goods, including glass beverage containers, metal cans(primarily consumer beverage
cansforsoftdrinks andbeer), plastic consumer andother goods (e.g.plastic reusable bottles, PET-
bottles, beerandsoftdrink containers), automobile parts (e.g.carhulks), batteries (e.g.automobile
andconsumer batteries) andautomobile lubricating oils.
(d) Tradeable emission schemes
13. Atpresent, tradeable emission schemes areusedprimarily toaddress airpollution atthenational
level. They arenormally based onquotas ofallowable emissions fordefined substances. According
toprescribed formulae (e.g.past,current andprojected emissions), quotas maybeallocated toindividual
polluters whothusexertaproperty rightsubject tomarket pricing. Quotas orpermits canberetained
tomeettheallocatedemissionlevel,oradditionalpermitsmaybepurchasedwithinspecifiedtimeperiods
tocover additional needs. Therelevant zones where permits canbepurchased orsoldaregenerally
defined along political orgeographical demarcations.
III. ENVIRONMENTAL TAXES AND CHARGES: ANECONOMIC PERSPECTIVE
A. Limits toeco-taxation -apparent andreal
14. Corresponding tothepolluter-pays-principle, eco-taxes andcharges operate asdisincentives.
Their purpose isessentially twofold. Ontheonehand, theyaimtodiscourage, through changes in
thepricestructure, theuseofproducts orprocesses deemed tobeenvironmentally unsound (e.g.fossil
fuels, mercury-containing batteries, pesticides andfertilizers); ontheother hand, asdescribed above,
eco-taxation mayinitiate adjustments towards andresearch intomoreenvironmentally benign activities.
15. Likealltaxes, eco-taxes generate government revenue. Theymaythusbeconsidered awelcome
contribution tobudget consolidation bysome governments, while other governments mayresent the
introduction ofnewtaxesinviewoftheirperceived negative impact oneconomic resilience andgrowth.
However, bothpositions aresubject toqualifications as:(a)therevenue effects ofaneco-tax which
actually achieves enduring adjustment mayprove limited -thetaxbasewilldwindle overtime-and,
otherwise, (b)anysignificant receipts could beneutralized through cutselsewhere inthetaxsystem.
16. Eco-taxes maybesubject, however, tovarious technical andpolitical constraints.
Immediate riskstolifeandhealth: asalready indicated, taxesmayprove unreliable inhigh-risk
oremergency situations orintheevent ofsynergy reactions between individual emissions.WT/CTE/W/47
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Valuation problems: establishing thetaxratecorresponding toagiven environmental target,
e.g.reducing pesticide run-offs byaspecified percentage, canbeverydifficult. Governments
mayprefer insuchcases todefine emission ceilings forentire regions andtousemarket
mechanisms fortheallocation ofentitlements among polluters (e.g. viatradeable emission
schemes).
Policy constraints: attimes ofhighunemployment, large trade deficits, etc.,eco-taxes are
generally unpopular. Thisapplies inparticular toproducer taxes deemed todisadvantage a
domestic industry vis-à-vis itsforeign competitors.
17. Such considerations mayexplain whymany environmental taxes arefixed atlevels unlikely
tohaveastrong structural impact. Arecent OECD study concludes that: "oneofthemajor problems
ofmeasuring therelationship between environmental taxes andtrade isthefactthatenvironmental
taxes aregenerally low-inmost cases probably quite below theiroptimal level -thusmaking it
impossible todeduce withstatistical methods theimpact ofoptimally setenvironmental taxes ontrade
volumes andtradestructures".5Inmany countries, stricttaxation ofconsumer goods onhealth grounds
(e.g.tobaccoandalcoholicproducts)seemstomeetlesspublicresistancethanenvironmentally-motivated
taxeswithapotential impact onproduction andinvestment decisions (e.g.energy- andtransport-related
taxes).
B. Need forpolicy coordination?
18. Forthepurpose ofpolicy making, itissafetoassume thateconomic incentives haveadecisive
impact onacountries 'environmental performance. Theexistence ofafixed, linear relationship between
production (orconsumption) andpollution, regardless ofeconomic considerations, islikely tobean
exception rather thantherule. Inorder toexploit amarket economy 'sscope foradjustment, itisthus
important thattheenvironmental effects ofanactivity betrulyreflected inaproducer 'sorconsumer 's
decision-making process. Thisimplies, forexample, thatpollution istaxed asclosely aspossible to
itssource andatratesmirroring itsenvironmental impact. Ideally, thetaxburden facing anyindividual
polluter would reflect theamount andtoxicity ofthepollutants released aswellasthecarrying capacity
ofagiven location. Inturn,inacompetitive situation, aproducer would thusberequired tomonitor
options forenvironment-related process, technology and,possibly, locational change. Depending on
therelevant investment cycle, anyensuing decisions needtimetoproduce results.
19. Forreasons of"competitiveness", however, itmayprove difficult forgovernments totackle
production-related pollution head-on. Toeaseadjustment pressures, theymayprefer topassthetax
burden ontoconsumers and/or otherwise cushion thecostimpact ontheindustries concerned. For
example, rather thanassessing actual emissions ofpollutants, eco-taxes maybeoperated asexcise taxes
onfinalproducts. Thiswould exonerate exports andsupplies todownstream domestic industries, but
include allsupplies -domestic andforeign -forconsumption. However, while appropriate toaddress
consumption-related pollution, excise taxes arenotgeared totackle production externalities which,
ofcourse, occur regardless ofthefinaldestination ofagood. Moreover, intheabsence ofcross-border
pollution, theinclusion ofimports seems tobelacking aconvincing environmental rationale. Their
assessment could even result in"double taxation" iftheexporting country relies onpolicies,
e.g.administrative controls, whose coststoproducers arenon-transparent orotherwise donotqualify
forrefunds onexportation.
5OECD (1996), Implementation Strategies forEnvironmental Taxes; OECD (1994), Managing theEnvironment: The
Role ofEconomic Instruments; andOECD (1997), Evaluating Economic Instruments forEnvironmental Policy, Paris.WT/CTE/W/47
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20. Suchproblems mayariseregardless oftheWTO legalsituation. Although excise arrangements
might becompatible withtherelevant provisions andcaselaw,theirapplication could entail significant
distortions from bothaneconomic andenvironmental point ofview.
21. Parallel application ofprice-based instruments inappropriate circumstances -albeit withvarying
intensity according tonational conditions -might offerbotheconomic andpolitical gains. Notonly
could itreduce thepotential fordomestic inefficiencies andexternal frictions, including problems of
"double taxation", butatthesametimestrengthen political support forfirstbestsolutions. Ingeneral,
itshould prove easier foraconvoy ofcountries thanforonesingle nation toimplement environmentally
effective measures atthesource.
22. Inturn,thisraisesquestionsofinternationalpolicycoordinationor,moreprecisely,ofacommon
definition and/or recommendation concerning therange ofmeasures tobeused. Ananalogy might
befound intheTBTAgreement, which establishes rules andprinciples forstandardization policies,
butdoesnotprescribe astandard 'sorregulation 'sactual content. Members maywishtodiscuss in
somemoredetail theneedfor,thepotential content andcoverage, andthewider tradepolicy implications
ofsuchaninitiative.
IV. BORDER TAX ADJUSTMENTS UNDER GATT/WTO RULES
23. Governments areinprinciple freetooperate theirfiscal regime according tonational preferences
andconstraints. They are,however, subject toWTO rulesgoverning theapplication ofdomestic taxes
andcharges togoods traded internationally.
24. Through border taxadjustment countries mayimpose domestic taxes andcharges onimports,
andexempt orreimburse them onexports. Theobjective istoensure trade neutrality ofdomestic
taxation. Intheabsence ofanharmonized taxation system between trading partners, border tax
adjustment aims atpreventing double taxation orloopholes intaxation, andthustopreserve the
competitive equality between domestic andimported products.
25. Taxadjustments donotnecessarily takeplace attheborder. Forexample, under certain tax
systems, imports areusually taxed, asishome production, bytheimporting country atthetimethey
aresoldbyregistered traders toother traders orconsumers, andsotheadjustment takes place after
thegoods cross theborder. However, theadjustment istobemade because thegoods crossed aborder,
whether tobeimported ortobeexported.
26. Border taxadjustment onimported products inexcess oftaxesborne bylikedomestic products
isdeemed todiscriminate, andthusviolate thenational treatment embodied inArticle III.Exemption
orrebate oftaxes onexported products inexcess ofinternal taxes borne bylikeproducts destined for
domestic consumption canbeconsidered anexport subsidy subject tothedisciplines oftheAgreement
onSubsidies andCountervailing Measures.
A. The1970 Working Party onBorder TaxAdjustments
27. In1968, GATT CONTRACTING PARTIES established aWorking Party onBorder Tax
Adjustments toexamine theprovisions oftheGeneral Agreement relevant toborder taxadjustments,
thepractices ofcontracting parties inrelation tosuchadjustments, aswellastheirpossible effects on
international trade. TheWorking Party'sreport wasadopted on2December 1970.6
6BISD 18S/97.WT/CTE/W/47
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28. Forthepurpose ofitsexamination, theWorking Party usedthedefinition ofborder tax
adjustment applied intheOECD:
"...anyfiscal measures which putintoeffect, inwhole orinpart,thedestination principle
(i.e.which enable exported products toberelieved ofsome orallofthetaxcharged inthe
exporting country inrespect ofsimilar domestic products soldtoconsumers onthehome market
andwhich enable imported products soldtoconsumers tobecharged withsome orallofthe
taxchargedintheimportingcountryinrespectofsimilardomesticproducts)".[emphasisadded]
Thedestination principle istobedistinguished from theorigin principle, whereby theproducts are
taxed inthecountry ofproduction. Under theorigin principle, there would benoneedforborder
taxadjustment, since allproducts would betaxed attheirpoint oforigin.
29. TheWorkingPartyexaminedbordertaxadjustmentwithrespecttovariousprovisionsofGATT:
Articles IIandIII,ontheimport side,andArticle XVIontheexport side; other articles deemed relevant
included Articles I,VIandVII.Itnoted thatGATT contained various formulations forimport-related
andexport-related provisions (Article III:2reads "applied to",whereas Article VI:4reads "borne by"),
butagreed thatthese different wordings didnotleadtodifferences ininterpretation, andthat"GATT
principles ontaxadjustment applied theprinciple ofdestination identically toimports andexports".
TheWorking Party agreed thatthemain provisions oftheGATT regarding border taxadjustment
represented thecodification ofpractices which existed incommercial treaties atthetimeitwasdrafted.
Most members oftheWorking Party noted inparticular that" there seemed tohavebeenacoherent
approach when therelevant articles oftheGATT weredrafted andthatthere werenoinconsistencies
ofsubstance between thedifferent provisions evenifthequestion oftaxadjustment wasdealt with
indifferent articles. They added thatthephilosophy behind these provisions wastheensuring ofa
certain trade neutrality".
30. Astotheamount which ispossible toadjust, theWorking Party agreed thatGATT provisions
"setmaxima limits foradjustment (compensation) which werenottobeexceeded, butbelow which
eachcontracting party wasfreetodifferentiate inthedegree ofcompensation applied, provided that
suchaction wasinconformity withother provisions oftheGeneral Agreement" andthat"countries
adjusting taxesshould, atalltimes, beprepared, ifrequested, toaccount forthereasons foradjustment,
forthemethods used, fortheamount ofcompensation andtofurnish proof thereof".
B. Thedistinction between direct taxes andindirect taxes
31. Economists havetraditionally distinguished between, ontheonehand, indirect taxes which
areimposed,directlyorindirectly,onproducts,and,ontheotherhand,directtaxeswhichareconsidered
tobeimposed ontheproducer. Thisdistinction hasbeengenerally accepted asabasisforGATT/WTO 's
disciplines onborder taxadjustments withrespect tobothimports andexports.
32. In1960, theWorking Party onArticle XVI:4 considered thatthefollowing measures were
deemed tobeexport subsidies, and,therefore, didnotfallunder thecategory oftaxes which were
adjustable attheborder:
"(c)Theremission, calculated inrelation toexports, ofdirect taxes orsocial welfare charges
onindustrial orcommercial enterprises;
(d)Theexemption, inrespect ofexported goods, ofcharges ortaxes, other thancharges
inconnection withimportation orindirect taxes levied atoneorseveral stages onthesame
goods ifsoldforinternal consumption; orthepayment, inrespect ofexported goods, ofamountsWT/CTE/W/47
Page8
exceeding those effectively levied atoneorseveral stages onthesegoods intheformofindirect
taxes orofcharges inconnection withimportation orinbothforms;"7
33. Inexamining which taxesshould beeligible forborder taxadjustment, the1970Working Party
endorsed thatdistinction andconcluded that
"there wasconvergence ofviews totheeffect thattaxesdirectly levied onproducts [i.e.indirect
taxes] wereeligible fortaxadjustment. Examples ofsuchtaxescomprised specific excise duties,
salestaxesandcascade taxesandthetaxonvalue added. Itwasagreed thattheTVA, regardless
ofitstechnical construction (fractioned collection), wasequivalent inthisrespect toataxlevied
directly -aretail orsales tax. Furthermore, theWorking Party concluded thatthere was
convergence ofviews totheeffect thatcertain taxes thatwerenotdirectly levied onproducts
[i.e.direct taxes] werenoteligible fortaxadjustment. Examples ofsuchtaxescomprised social
security charges whether onemployers oremployees andpayroll taxes."
34. TheWTO Agreement onSubsidies andCountervailing Measures, which alsodifferentiates
between direct andindirect taxes, gives thefollowing definition:
"The term"direct taxes" shallmean taxes onwages, profits, interests, rents, royalties, and
allother forms ofincome, andtaxes ontheownership ofrealproperty".
"The term"indirect taxes" shallmean sales, excise, turnover, value added, franchise, stamp,
transfer, inventory andequipment taxes, border taxes andalltaxes other thandirect taxes and
import charges".8
35. Thedistinctionbetweendirectandindirecttaxesandtheineligibilityofdirecttaxesforadjustment
wasconfirmed byGATT dispute settlement practice inthecase"United States TaxLegislation (DISC)".
TheUSDomesticInternationalSalesCorporation(DISC)legislationallowedcertaintypesofcorporations
tobepartially exempt from federal income taxontheirexport earnings. Thepanel which examined
thecase
"noted thatDISC legislation wasintended, initsownterms, toincrease United States exports
andconcluded that,asitsbenefits arose asafunction ofprofits from exports, itshould be
regarded asanexport subsidy".9
36. Thepreference granted toindirect taxes relies ontheassumption thatindirect taxes areshifted
completely "forward" bythetaxpayer; theyareeventually reflected inthefinalprice oftheproduct
and,thus, arepaidbytheconsumer. Onthecontrary, itisassumed thatdirect taxes areshifted
"backward": theyarefinally borne bythemanufacturer oftheproduct, andarenotreflected inthe
finalprice oftheproduct. Inbrief, WTO provisions onborder taxadjustment follow thedestination
principle forindirect taxes, andtheorigin principle fordirect taxes. Border taxadjustment istherefore
notpossible fordirect taxes, whether levied onimported oronexported products.
37. Thedistinction between direct andindirect taxes, andtheassumptions which underlie it,has
beenquestioned attimes. Forexample, some members ofthe1970 Working Party considered that
7BISD 9S/185, para. 5.
8Footnote 58,related toAnnex I,"Illustrative ListofExport Subsidies".
9BISD 23S/98, para. 69.WT/CTE/W/47
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"themain provisions oftheGATT relevant totaxadjustments represent anattempt atthe
codificationofawiderangeofpastpracticesbasedonassumptionswhicharenotnowuniversally
accepted. Inparticular, theyfelttheassumption offullshifting ofdirect taxesisnotareflection
ofeconomic reality. They considered thatthepresent GATT rules favour countries which
relyheavily onindirect taxes anddiscriminate against countries which relypredominantly on
direct taxes. Further, intheirview, thepresent rulesareambiguous andleadtodiffering tax
adjustmentpracticesforsimilartypesoftaxes.TheyconcludedthatthecurrentGATTprovisions
andtaxpractices arenottrade neutral."10
38. TheWorking Party alsonoted adivergence ofviews regarding theeligibility foradjustment
ofcertain categories oftax:
"(a)"Taxes occultes" which theOECD defined asconsumption taxes oncapital equipment,
auxiliary materials andservices usedinthetransportation andproduction ofothertaxable goods.
Taxes onadvertising, energy, machinery andtransport wereamong themore important taxes
which might beinvolved. Itappeared thatadjustment wasnotnormally made fortaxesoccultes
except incountries having acascade tax;
"(b)Certain other taxes, suchasproperty taxes, stamp duties andregistration duties ...which
arenotgenerally considered eligible fortaxadjustment. Mostcountries donotmake adjustment
forsuchtaxes butafewdoasafewdoforthepayroll taxes andemployers 'social security
charges ..."
However, theWorking Party decided nottoinvestigate thismatter further.11
C. Border TaxAdjustment onImported Products
(a) Relevant provisions
39. Theimposition oftaxesandcharges onimported goods forthepurpose ofborder taxadjustment
isaddressed inArticle IIIofGATT 1994. Therelevant parts ofArticle IIIreadasfollows:
"1.Thecontracting parties recognize thatinternal taxes andother internal charges, andlaws,
regulations andrequirements affecting theinternal sale, offering forsale, purchase,
transportation, distribution oruseofproducts, andinternal quantitative regulations requiring
themixture, processing oruseofproducts inspecified amounts orproportions, should not
beapplied toimported ordomestic products soastoafford protection todomestic production.
[footnote omitted]"
"2.Theproducts oftheterritory ofanycontracting party imported intotheterritory ofany
other contracting party shallnotbesubject, directly orindirectly, tointernal taxes orother
internal charges ofanykindinexcess ofthose applied, directly orindirectly, tolikedomestic
products. Moreover, nocontracting party shallotherwise apply internal taxesorother internal
charges toimported ordomestic products inamanner contrary totheprinciples setforth in
paragraph 1.[footnote omitted]"
10BISD 18S/97, para. 8.Seealsopara. 21and22ofthereport.
11Infootnote58oftheAgreement onSubsidiesandCount ervailingMeasur es,machi neryandstamptaxesarenowclassified
asindirect taxes, andproperty taxasdirect tax.WT/CTE/W/47
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40. Notwithstanding theobligations setforth intherelevant provisions ofArticle II(Schedules
ofConcessions) ofGATT 1994, Article II:2(a) allows anyMember toimpose
"atanytimeontheimportation ofanyproduct:
(a)achargeequivalenttoaninternaltaximposedconsistentlywiththeprovisionsofparagraph2
ofArticle III[footnote omitted] inrespect ofthelikedomestic product orinrespect ofanarticle
fromwhich theimported product hasbeenmanufactured orproduced inwhole orinpart;...".
(b) Purpose ofArticle III
41. InGATT/WTO dispute settlement practice, Article III:2hasbeeninterpreted asregulating
thetreatment ofproducts asopposed toregulating thebehaviour ofproducers. ThePanel on
"United States -Section 337oftheTariff Actof1930" found thatthe"nolessfavourable" treatment
setoutinseveralGATTprovisionsare"anexpressionoftheunderlyingprincipleofequalityoftreatment
ofimported products ascompared tothetreatment given either toother foreign products, under the
most favoured nation standard, ortodomestic products, under thenational treatment standard of
Article III".12
42. Oneofthebasic purposes ofArticle IIIistoensure thatinternal charges andregulations are
notsuchastofrustrate theeffect oftariffconcessions granted under Article II.13However, Article III
applies whether ornottheproduct concerned issubject toatariffconcession andwhether ornotadverse
trade effects occurred14.Thepurpose ofthatprovision istoestablish certain competitive conditions
forimported products inrelation todomestic products; itisnottoprotect expectations onexport
volumes. Thepanel report on"United States -Taxes onPetroleum andCertain Imported Substances"
found that
"[I]tisconceivable thatataxconsistent withthenational treatment principle (forinstance,
ahighbutnon-discriminatory excise tax)hasmore severe impact ontheexports ofother
contracting parties thanataxthatviolates thatprinciple (forinstance avery lowbut
discriminatory tax). Thecasebefore thepanel illustrates thispoint: theUnited States could
bring thetaxonpetroleum inconformity withArticle III:2, firstsentence, byraising thetax
ondomestic products, bylowering thetaxonimported products orbyfixing anewcommon
taxrateforbothimported anddomestic products. Eachofthesesolutions would havedifferent
traderesults, anditistherefore logically notpossible todetermine thedifference intradeimpact
between thepresent taxandoneconsistent withArticle III:2, firstsentence, andhence to
determine thetrade impact resulting from thenon-observance ofthatprovision. Forthese
reasons, Article III:2, firstsentence, cannot beinterpreted toprotect expectations onexport
volumes;itprotectsexpectationsonthecompetitiverelationshipbetweenimportedanddomestic
products. Achange inthecompetitive relationship contrary tothatprovision mustconsequently
12Adopted on7November 1989, BISD 36S/345, para. 5.11. Seealsothepanel reports on"United States -Taxes on
Petroleum andCertain Imported Substances", adopted on17June1987, BISD 34S/136, and"United States -Restrictions
onImports ofTuna", notadopted, BISD 39S/155.
13Seethepanel report on"Canada -Import, Distribution andSaleofCertain Alcoholic Drinks byProvincial Marketing
Agencies", adopted on18February 1992, BISD 39S/27, paras. 5.30 -5.31.
14Seethepanel reporton"UnitedStates-Taxes onPetroleumandCertainImpor tedSubstances" ,adoptedon17June1987,
BISD 34S/136, para. 5.1.1.WT/CTE/W/47
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beregarded ipsofactoasanullification orimpairment ofbenefits accruing under theGeneral
Agreement."15
(c) Thenotions of"like" products andof"directly competitive orsubstitutable" products in
Article III:2
43. Thedetermination ofadiscriminatory taxation ismade bycomparing domestic andimported
likeproducts. Under Article III,ithasbeenconstant practice forpanels tofirstdetermine whether
imported anddomestic products are"like" before examining whether themeasure isdiscriminatory.
Thenotion of"likeproduct" hasbeenanalyzed onacase-by-case basis inanumber ofGATT/WTO
dispute settlement panels.
44. Themostrecent analysis of"likeproduct" inthecontext ofArticle III:2canbefound inthe
1996caseon"Japan -Taxes onAlcoholic Beverages"16.Inexamining theconsistency withArticle III:2
oftheJapanese taxation system ofcertain alcoholic beverages, thepanel found thatthisprovision "is
concerned withtwodifferent factual situations: Article III:2, firstsentence, isconcerned withthe
treatment oflikeproducts, whereas Article III:2, second sentence, isconcerned withthetreatment
ofdirectly competitive orsubstitutable products, i.e.products other thanlikeproducts ...". Itnoted
that"[t]he Interpretative NoteadArticle III:2further clarifies thisdistinction byproviding anexample
where thefirstsentence ofArticle III:2isnotviolated whereas thesecond is..."17.Therefore, the
panel concluded thatArticle III:2contains twodistinct legally binding obligations.18
45. Thepanel thenexamined therelation between thetwosentences. Itfound thatlikeproducts
areasub-category ofdirectly competitive orsubstitutable products, inthesense thatalllikeproducts
are,bydefinition, directly competitive orsubstitutable products, whereas thecontrary isnotnecessarily
true. Intheviewofthepanel,
"theappropriate testtodefine whether twoproducts are"like" or"directly competitive or
substitutable" isthemarketplace. ...[T]he decisive criterion inorder todetermine whether
twoproducts aredirectly competitive orsubstitutable iswhether theyhavecommon end-uses,
interalia,asshown byelasticity ofsubstitution. Thewording oftheterm"like products"
however, suggests thatcommonality ofend-uses isanecessary butnotasufficient criterion
todefine likeness. ...[T"]he term"likeproducts" suggests thatfortwoproducts tofallunder
thiscategory theymustshare, apartfromcommonality ofend-uses, essentially thesamephysical
characteristics."19
TheAppellate Body confirmed thisinterpretation andendorsed atthesame timethebasic approach
which hadbeensetoutbytheWorking Party onBorder TaxAdjustments regarding "likeproducts":
15Seethepanel reporton"UnitedStates-Taxes onPetroleumandCertainImpor tedSubstances" ,adoptedon17June1987,
BISD34S/136, para.5.1.9. SeealsotheAppel lateBody reporton"Japan -Taxes onAlcoholicBever ages",p.16,WT/DS8/11,
8November 1996.
16WT/DS8/11, WT/DS10/11, WT/DS11/8, adopted on1November 1996, Appellate Body Report andPanel Report.
17TheInterpretative Note adArticle III:2 states that"[a]taxconforming totherequirements ofthefirstsentence of
paragraph 2would beconsidered tobeinconsistent withtheprovisions ofthesecond sentence onlyincases where competition
wasinvolved between, ontheonehand, thetaxed product and,ontheother hand, adirectly competitive orsubstitutable
product which wasnotsimilarly taxed".
18WT/DS8/11, WT/DS10/11, WT/DS11/8, adopted on1November 1996, Panel Report, para. 6.11 -6.12.
19WT/DS8/11, WT/DS10/11, WT/DS11/8, adopted on1November 1996, Panel Report, para. 6.22.WT/CTE/W/47
Page12
"problems arising from theinterpretation oftheterm[likeproduct] should beexamined on
acase-by-case basis. Thiswould allow afairassessment ineachcaseofthedifferent elements
thatconstitute a"similar" product. Some criteria were suggested fordetermining, ona
case-by-case basis, whether aproduct is"similar": theproduct 'send-uses inagiven market;
consumers 'tastes andhabits, which change fromcountry tocountry; theproduct 'sproperties,
nature andquality."20
(d) Article III:1
46. The1996 panel report on"Japan -Taxes onAlcoholic Beverages" examined therelationship
between Article III:2andArticle III:1. Itconsidered thatthewording ofArticle III:1made itclear
thatthisprovision "does notcontain alegally binding obligation butrather states general principles".
Asaconsequence, "recourse toArticle III:1, which constitutes partofthecontext ofArticle III:2,
willbemade totheextent relevant andnecessary". Inthesame case, theAppellate Body confirmed
thisinterpretation andadded that"[t]he purpose ofArticle III:1istoestablish thisgeneral principle
asaguide tounderstanding andinterpreting thespecific obligations contained inArticle III:2andin
theother paragraphs ofArticle III,while respecting, andnotdiminishing inanyway, themeaning
ofthewords actually usedinthetextsofthose other paragraphs".21
(e) Methods oftaxation anddiscriminatory taxrates
47. Indetermining whether aninternal taxdiscriminates against imported goods, GATT dispute
settlement panels haveexamined, onacase-by-case basis, therateoftheapplicable internal tax,the
taxation methods (e.g.different kinds ofinternal taxes, direct taxation ofthefinished product orindirect
taxation bytaxing therawmaterials usedintheproduct during thevarious stages ofitsproduction),
andtherulesgoverning taxcollection (e.g.basisofassessment). Theyhaveconsidered thatArticle III:2
doesnotprescribe theuseofanyspecific method orsystem oftaxation, nordoesitcontain any
presumption infavour ofaspecific mode oftaxation. Asaconsequence,
"there could beobjective reasons proper tothetaxinquestion which could justify ornecessitate
differences inthesystem oftaxation forimported andfordomestic products. ...[i]t could be
alsocompatible withArticle III:2toallow twodifferent methods ofcalculation ofprice for
taxpurposes. Since Article III:2prohibited onlydiscriminatory orprotective taxburdens on
imported products, whatmattered was,...,whether theapplication ofthedifferent taxation
methods actually hadadiscriminatory orprotective effect against imported products".22
48. Thetwodifferent legalobligations contained inthetwosentences ofArticle III:2(seeabove
para. 44),result intwodifferent teststoassess thediscriminatory effect ofatax.Regarding "like
products" (first sentence), the1996 panel report on"Japan -Taxes onAlcoholic Beverages" found
that"[t]he phrase "notinexcess ofthose applied ...tolikedomestic products" should beinterpreted
tomean atleastidentical orbetter treatment". TheAppellate Body confirmed thisinterpretation, adding
20WT/DS8/11, WT/DS10/11, WT/DS11/8, adoptedon1November 1996, Appel lateBody Repor t(p.19-20 andp.25-26);
BISD 18S/97, para. 18.
21WT/DS8/11, WT/DS10/11, WT/DS11/8, adopted on1November 1996, Panel Report, para. 6.12, andAppellate Body
Report p.18.
22Seethepanel report on"Japan -Customs Duties, Taxes andLabelling Practices onImported Wines andAlcoholic
Beverages", adopted on10November 1987, BISD 34S/83, paras. 5.8-5.9. Seealsothepanel report on"Japan -Taxes on
Alcoholic Beverages", adopted on1November 1996, WT/DS8/R, WT/DS10/11, WT/DS11/8, para. 6.24.WT/CTE/W/47
Page13
that"[e]ven thesmallest amount of"excess" istoomuch"23.Thus, therequirement contained inthe
firstsentence ofArticle III:2isnotconditional upon atrade effect norisitqualified byademinimis
standard.
49. Thetestisdifferent inthesecond sentence ofArticle III:2, because, asnoted bytheAppellate
Body inthesame dispute, "[t]ointerpret "inexcess of"and"notsimilarly taxed" identically would
denyanydistinction between thefirstandsecond sentences ofArticle III:2". Inexamining thesecond
sentence ofArticle III:2, theAppellate Body considered that"tobe"notsimilarly taxed", thetaxburden
onimported products mustbeheavier thanon"directly competitive orsubstitutable" domestic products,
andthatburden must bemore thandeminimis inanygiven case". Asforlikeproducts, thisis
determined onacase-by-case basis.24Considering thatthesecond sentence ofArticle III:2refers to
Article III:1, afurther enquiry isneeded when directly competitive andsubstitutable products arefound
tobe"notsimilarly taxed": itmust thenbeexamined whether thetaxinquestion isapplied "soas
toafford protection". According totheAppellate Body, suchanexamination
"requires acomprehensive andobjective analysis ofthestructure andapplication ofthemeasure
inquestion ondomestic ascompared toimported products. Webelieve thatitispossible to
examine objectively theunderlying criteria usedinaparticular taxmeasure, itsstructure and
itsoverall application toascertain whether itisapplied inawaythataffords protection to
domestic products.
Although itistruethattheaimofameasure maynotbeeasily ascertained, nevertheless its
protective application canmostoften bediscerned from thedesign, thearchitecture, andthe
revealing structure ofameasure. Theverymagnitude ofthedissimilar taxation inaparticular
casemaybeevidence ofsuchaprotective application ....Most often, therewillbeotherfactors
tobeconsidered aswell. Inconducting thisinquiry, panels should givefullconsideration to
alltherelevant factsandalltherelevant circumstances inanygiven case".25
(f) Policy purpose ofthetax
50. Inthecase"United States -Taxes onPetroleum andCertain Imported Substances", theEC
argued thatthetaximposed bytheUnited States oncertain chemicals should notbeeligible forborder
taxadjustment because itwasdesigned totaxpolluting activities thatoccurred intheUnited States
andtofinance environmental programmes benefitting onlyUnited States producers. Consistent with
thePolluter-PaysPrinciple,theECargued,theUnitedStatesshouldhavetaxedonlyproductsofdomestic
origin because onlytheirproduction gaverisetoenvironmental problems intheUnited States. As
tothisargument, thepanel found that
"thetaxadjustment rulesoftheGeneral Agreement distinguish between taxes onproducts and
taxesnotdirectly levied onproducts; theydonotdistinguish between taxeswithdifferent policy
purposes. Whether asales taxislevied onaproduct forgeneral revenue purposes orto
encourage therational useofenvironmental resources, istherefore notrelevant forthe
determination oftheeligibility ofataxforborder taxadjustment. Forthesereasons, thePanel
concluded thatthetaxoncertain chemicals, being ataxdirectly imposed onproducts, was
eligible forborder taxadjustment independent ofthepurpose itserved. ThePanel therefore
23WT/DS8/11, WT/DS10/11, WT/DS11/8, adopted on1November 1996, panel report, para. 6.24, andAppellate Body
report p.23.
24Ibidem, Appellate Body Report, p.27.
25Ibidem, Appellate Body Report, p.29.WT/CTE/W/47
Page14
didnotexamine whether thetaxonchemicals served environmental purposes and,ifso,whether
aborder taxadjustment would beconsistent withthese purposes."26
51. Regarding theargument thattheUnited States should follow thePolluter-Pays Principle, the
Panel, recalling thattheprovisions oftheGeneral Agreement "setmaxima limits foradjustment
(compensation) which werenottobeexceeded, butbelow which every contracting party wasfreeto
differentiate inthedegree ofcompensation applied, provided thatsuchaction wasinconformity with
other provisions oftheGeneral Agreement"27,concluded that
"ifacontracting party wishes totaxthesaleofcertain domestic products (because their
production pollutes thedomestic environment) andtoimpose alower taxornotaxatallon
likeimported products (because theirconsumption orusecauses fewer ornoenvironmental
problems), itisinprinciple freetodoso.TheGeneral Agreement 'srulesontaxadjustment
thusgivethecontracting partyinsuchacasethepossibility tofollow thePolluter-Pays Principle,
buttheydonotoblige ittodoso."28
(g) Difference between Article IIandArticle III
52. According toArticle II:1(b) ofGATT 1994, aproduct benefitting fromabound tariffconcession
mustbe"exempt fromordinary customs duties inexcess ofthose setforthandprovided [inthetariff
schedules] ..."and"shall alsobeexempt from allother duties orcharges ofanykindimposed onor
inconnection withimportation inexcess ofthose imposed onthedateofthisAgreement ...".However,
Article II:2(a)specifically allows Members "toimpose atanytimeontheimportation ofanyproduct:
"acharge equivalent toaninternal taximposed consistently withtheprovisions ofparagraph 2
ofArticle III[footnote omitted] inrespect ofthelikedomestic product orinrespect ofanarticle
from which theimported product hasbeenmanufactured orproduced inwhole orinpart".
Thus, adistinction hastobemade between, ontheonehand, "internal taxes andcharges" within the
meaning ofArticle III,which aresubject toborder taxadjustments, and,ontheother hand, other duties
orcharges ...imposed inconnection withimportation ...",within themeaning ofArticle II:1(b), which
cannot beadjusted attheborder. GATT contracting parties never formally distinguished between the
twocategories. However, thepreparatory work fortheHavana Charter aswellasdispute settlement
practice havecontributed, onacase-by-case basis, toestablishing suchadistinction.
53. During theHavana Conference, aSub-Committee which considered Article 18(onnational
treatment) oftheCharter, stated that
"The delegations ofChile, Lebanon, andSyria inquired whether certain charges imposed by
theircountries onimported products would beconsidered asinternal taxes under Article 18.
TheSub-Committee, while notattempting togiveageneral definition ofinternal taxes,
considered thattheparticular charges referred toareimport duties andnotinternal taxesbecause
according totheinformation supplied bythecountries concerned (a)theyarecollected atthe
timeof,andasacondition to,theentry ofthegoods intotheimporting country, and(b)they
apply exclusively toimported products without being related inanywaytosimilar charges
26BISD 34S/136, para. 5.2.3-5.2.4.
27Working Party onBorder TaxAdjustment, BISD 18S/100.
28Seethepanel reporton"UnitedStates-Taxes onPetroleumandCertainImpor tedSubstances" ,adoptedon17June1987,
BISD 34S/136, para. 5.2.5.WT/CTE/W/47
Page15
collected internally onlikedomestic products. Thefactthatthese charges aredescribed as
internal taxes inthelawsoftheimporting country would notinitselfhavetheeffect ofgiving
them thestatus ofinternal taxes under theCharter".29
54. Guidance inthatregard canbefound intheInterpretative Note AdArticle IIIwhich states
that
"[a]ny internal taxorother internal charge, oranylaw,regulation orrequirement ofthekind
referred toinparagraph 1which applies toanimported product andtothelikedomestic product
andiscollected orenforced inthecaseoftheimported product atthetimeorpoint of
importation, isnevertheless toberegarded asaninternal taxorother internal charge, ora
law,regulation orrequirement ofthekindreferred toinparagraph 1,andisaccordingly subject
totheprovisions ofArticle III". [emphasis added]
Another indication canbefound inthe1980Council Decision on"Introduction ofaLoose-Leaf System
fortheSchedules ofTariff Concessions", stating that"other duties orcharges", inthemeaning of
Article II"areinprinciple onlythose thatdiscriminate against imports".30
55. Thus, thefactthatthetaxlevied onimported products isalsoborne bydomestic likeproducts
appears tobethedeterminant criteria indeciding whether aparticular taxfallsunder Article IIor
Article III.Thetimeandplace where thetaxislevied aresecondary elements.31
56. Anumber ofGATT dispute settlement panels haveexamined whether ameasure wasaninternal
taxorcharge (Article III)oradutyorcharge "imposed onorinconnection withimportation"
(Article II)32.Thepanel report on"EEC -Measures onAnimal Feed Proteins" examined anEEC
Regulation requiring domestic producers orimporter topurchase acertain quantity ofskimmed milk
powder andtohaveitdenatured foruseasfeedforanimals. When examining theconsistency with
Articles IIandIIIofthese aspects oftheRegulation, thepanel
"...recalled itsownfinding that(a)theEECmeasure applied tobothimported anddomestically
produced vegetable proteins (except inthecaseofcorngluten); (b)theEECmeasures basically
instituted anobligation topurchase acertain quantity ofskimmed milkpowder and,asan
"internal quantitative regulation" fellunder Article III:1; (c)theEECsecurity deposit and
protein certificate were enforcement mechanisms forthepurchase obligation.
Having regard tothelegalconsiderations referred toabove andtaking intoaccount ofitsown
findings inrelation toArticle III:5andArticle III:1thattheEECmeasures werean"internal
quantitative regulation", thePanel concluded thattheEEC measures should beexamined as
internal measures under Article IIIandnotasborder measures under Article II."33
29SeeAnalytical Index, Guide toGATT LawandPractice, Vol.1,p.136,referring toHavana Reports, p.62,para. 42
andtoE/CONF.2/C.3/A/W.30, p.2.
30Proposal bytheDirector-General, adopted on26March 1980, BISD 27S/22.
31TheWorking Party onBorder TaxAdjustments alsonoted "...under certain taxsystems imports areusually taxed,
asishome production, bytheimporting country atthetimetheyaresoldbyregistered traders toother traders orconsumers,
andsotheadjustment takes place after thegoods cross theborder" (BISD 18S/96, para. 5).
32SeeAnalytical Index, Guide toGATT LawandPractice, Vol.1,p.82and198.
33Adopted on14March 1978, BISD 25S/49, paras. 4.17-18.WT/CTE/W/47
Page16
57. Thepanel on"EEC -Regulation onImports ofParts andComponents", inexamining thelegal
nature ofEECanti-dumping regulations, considered thatthepolicy purpose ofacharge isnotrelevant
todetermine whether thecharge isimposed pursuant toArticle II:1(b) orArticle III:2.
"The Panel ...noted thatthepolicy purpose ofcharges isfrequently difficult todetermine
objectively. Many charges could beregarded asserving bothinternal purposes andpurposes
related totheimportation ofgoods. Onlyattheexpense ofcreating substantial legaluncertainty
could thepolicy purpose ofacharge beconsidered toberelevant indetermining whether the
charge fallsunder Article II:1(b) orArticle III:2."34
58. Inthesame case, thepanel alsofound thatthemere description orcategorization ofacharge
under thedomestic lawofacontracting party isnotrelevant todetermining whether thecharge falls
under Article IIorunder Article III:2. Thepanel considered that
"ifthedescription orcategorization ofacharge under thedomestic lawofacontracting party
weretoprovide therequired "connection withimportation", contracting parties could determine
themselves which ofthese provisions would apply totheircharges. They could inparticular
impose charges onproducts aftertheirimportation simply byassigning thecollection ofthese
charges totheircustoms administration andallocating therevenue generated totheircustoms
revenue. Withsuchaninterpretation thebasicobjective underlying Articles IIandIII,namely
thatdiscrimination against products fromother contracting parties should onlytaketheform
ofordinary customs duties imposed onorinconnection withimportation andnottheform
ofinternal taxes, could notbeachieved."35
D. Border TaxAdjustment onExported Products
(a) Principles
59. Asnoted bythe1970 Working Party onBorder TaxAdjustments, "GATT principles ontax
adjustment applie[s] theprinciple ofdestination identically toimports andexports". Asaconsequence,
products destined forexports canbeexempted fromtaxesborne bylikeproducts destined fordomestic
consumption, theideabeing thattheexported products willbetaxed where theyareconsumed, i.e.in
thecountry ofdestination.
60. Border taxadjustment onexported products isfirstaddressed intheInterpretative Note Ad
Article XVI(Subsidies) ofGATT 1994:
"[t]he exemption ofanexported product fromduties ortaxes borne bythelikeproduct when
destined fordomestic consumption, ortheremission ofsuchduties ortaxes inamounts not
inexcess ofthose which haveaccrued, shallnotbedeemed tobeasubsidy."
TheInterpretative Note, added inthe1954-55 Review Session, wasdrawn fromtheHavana Charter,
where itwasrecorded tocover "thecaseofremission ofduties ortaxes imposed onrawmaterials
andsemi-manufacturedproductssubsequentlyusedintheproductionofexportedmanufacturedgoods".36
34Adopted on16May 1990, BISD 37S/132, para. 5.6.
35Ibidem, para. 5.7.
36SeeAnalytical Index, Guide toGATT LawandPractice, p.448and465.WT/CTE/W/47
Page17
61. Theexemption from, orrefund of,taxes borne bylikedomestic products cannot besubject
toanti-dumping orcountervailing duties, asstated inArticle VI:4ofGATT 1994:
"Noproduct oftheterritory ofanycontracting party imported intotheterritory ofanyother
contracting party shall besubject toanti-dumping orcountervailing dutybyreason ofthe
exemption ofsuchproduct from duties ortaxes borne bythelikeproduct when destined for
consumption inthecountry oforigin orexportation, orbyreason oftherefund ofsuchduties
ortaxes."
62. Thefactthatborder taxadjustment onexported products isnotcountervailable wasconfirmed
bydispute settlement practice. Forexample, thePanel on"Swedish Anti-Dumping Duties", which
examined theapplication ofArticle VI:4where ananti-dumping scheme applied toproducts benefitting
fromanexport rebate ofduties andcharges, noted that"there wasnodisagreement between theparties
concerned regarding theobligation totakeaccount oflegitimate refund ofduties andtaxes".37Moreover,
itisarguable thattherelevant aspects ofGATT dispute settlement practice regarding import-side border
taxadjustment might betaken intoaccount inthecontext oftaxadjustment onexports.
63. TheUruguay Round Agreement onSubsidies andCountervailing Measures (the"Subsidies
Agreement") isbased onthesame principles. Itsfootnote 1toArticle 1.1(ii) states that
"Inaccordance withtheprovisions ofArticle XVIofGATT 1994 (Note toArticle XVI) and
theprovisions ofAnnexes Ithrough IIIofthisAgreement, theexemption ofanproduct from
duties ortaxes borne bythelikeproduct when destined fordomestic consumption, orthe
remission ofsuchduties ortaxes inamounts notinexcess ofthose which haveaccrued, shall
notbedeemed tobeasubsidy".
(b) Scope
64. Inestablishing disciplines forexport subsidies, GATT contracting parties undertook early to
categorize which measures should beprohibited asexport subsidies and,asaconsequence, under which
circumstances border taxadjustment ispossible onexported products.38The1994Subsidies Agreement,
inparticular itsAnnex I,contains aillustrative listofthetypeofmeasures which aretobeconsidered
asexport subsidies. TheAgreement provides thereby a"negative" listofthetaxes, andamount,
adjustable onexported products.
65. Asforborder taxadjustment onexported products, theSubsidies Agreement endorses the
distinction between direct andindirect taxes. Asaconsequence, adjustment withrespect to"thefull
orpartial exemption, remission, ordeferral specifically related toexports, ofdirect taxes orsocial
welfare charges paidorpayable byindustrial orcommercial enterprises" isanexport subsidy. The
exemption orremission, inrespect oftheproduction anddistribution ofexported products, ofindirect
taxesisconsidered tobeanexport subsidy onlywhen theamount oftaxesremitted orexempted exceeds
theamount ofsuchtaxes levied inrespect oftheproduction anddistribution oflikeproducts when
37Adopted on26February 1955, BISD 3S/81, para. 16.Seealsothepanel report on"Suspension ofCustoms Liquidation
bytheUnited States", adopted on16June 1977, BISD 24S/134, para. 15.
38SeeinthatregardthereportoftheWorkingPartyonArticleXVI:4 inBISD9S/185, andthe1979Agreement onSubsidies
andCountervailing Measures.WT/CTE/W/47
Page18
soldfordomesticconsumption;suchexemptionorremissionisthenallowediftheiramountisequivalent
tothatborne bydomestic likeproducts.39
E. Border taxadjustment oninputs incorporated orexhausted intheproduction process
66. While itisclearthatborder taxadjustment ispossible forindirect taxes levied onproducts,
theextent towhich indirect taxes oninputs, incorporated orexhausted intheproduction process, to
thefinalproduct canbeadjusted attheborder, whether onexports oronimports, remains tobeclarified.
67. The1970 Working Party didnotreach aconclusion onthispoint. Itnoted that"there was
adivergence ofviews withregard totheeligibility foradjustment ofcertain categories oftax", such
asthe"taxes occultes", which encompass consumption taxes oncapital equipment auxiliary materials
andservices usedinthetransportation andproduction ofother taxable goods, aswellastaxes on
advertising, energy, machinery andtransport (seeabove para. 38).However, theWorking Party did
notinvestigate thematter foritfeltthat"while thisareaoftaxation wasunclear, itsimportance -as
indicated bythescarcity ofcomplaints reported inconnection withadjustments oftaxes occultes- was
notsuchastojustify further examination".40
(a) Inputs incorporated orexhausted intheproduction process ofimported products
68. Regarding imported products, afirstindication canbefound inArticle III:2ofGATT 1994
which states that"[t]he products oftheterritory ...shallnotbesubject, directly orindirectly, tointernal
taxes..."[emphasis added]. These terms donotcorrespond tothedistinction between direct andindirect
taxes (contrary towhatissuggested inparagraph 14ofthereport oftheWorking Group onBorder
TaxAdjustment). Ifitwereso,itwould mean thatdirect taxes could beadjusted attheborder, which
wouldbeincontradictionwiththenegotiatinghistoryandsubsequentapplicationofArticleIII:2.During
thenegotiations oftheHavana Charter, theexpression "directly orindirectly" replaced anearlier version
which referred totaxes andother internal charges "imposed onorinconnection withlikeproducts",
because itwasconsidered thattheequivalent ofthelatter wasdifficult totranslate intoFrench. In
subsequent discussions, itwasstated thattheword "indirectly" would cover evenataxnotonaproduct
assuch, butontheprocessing oftheproduct.41
69. Another indication canbefound inArticle II:2(a) which stipulates thatborder taxadjustment
canbemade withrespect to
"acharge equivalent toaninternal taximposed consistently withtheprovisions ofparagraph 2
ofArticle III[footnote omitted] inrespect ofthelikeimported product orinrespect ofanarticle
from which theimported product hasbeenmanufactured orproduced inwhole orinpart"
[emphasis added].
During thenegotiations oftheHavana Charter, itwasagreed thattheword "equivalent" meant, "for
example, ifa[charge] isimposed onperfume because ifcontains alcohol, the[charge] tobeimposed
39SeeAnnex 1,para. (e),(f)and(g)oftheSubsidies Code. TheIllustrative ListofExport Subsidies contained inthe
1979 Subsidies andCountervailing Duties Agreement contained thesame definition.
40BISD 18S/97, para. 15.
41SeeAnalytical Index, Guide toGATT Law andPractice, Vol. 1,p.141, referring toEPCT/A/PV/9, p.19and
EPCT/C.II/W.5, p.5.Seealsofootnote 58ofthe1994 Subsidies Agreement (which contains thesame language asfootnote
1ofthe1979 Code) defines "prior-stage" indirect taxes as"those levied ongoods orservices useddirectly orindirectly
inmaking theproduct" [emphasis added].WT/CTE/W/47
Page19
musttakeintoconsideration thevalue ofthealcohol andthenotvalue oftheperfume, thatistosay
thevalue ofthecontent andnotthevalue ofthewhole".42
70. Thepanel on"United States -Taxes onPetroleum andCertain Imported Substances", examined
whethertheUStaxon"certainimportedsubstances",whichtaxedcertaindownstreamimportedchemicals
which were derivatives oftaxable chemicals, fellunder Article III.Itconsidered that
"[t]he taxoncertain imported substances equals inprinciple theamount ofthetaxwhich would
have been imposed under theSuperfund Actonthechemicals used asmaterials inthe
manufacture orproduction oftheimported substances ifthese chemicals hadbeensoldinthe
United States foruseinthemanufacture orproduction oftheimported substance. Inthewords
which thedrafters oftheGeneral Agreement usedintheabove perfume-alcohol example:
thetaxisimposed ontheimported substances because theyareproduced fromchemicals subject
toanexcise taxintheUnited States andthetaxrateisdetermined inprinciple inrelation to
theamount ofthese chemicals usedandnotinrelation tothevalue oftheimported substance.
ThePanel therefore concluded that,totheextent thatthetaxoncertain imported substances
wasequivalent tothetaxborne bylikedomestic substances asaresult ofthetaxoncertain
chemicals thetaxmetthenational treatment requirement ofArticle III:2, firstsentence".43
Thus, thepanel considered thattaxes onsubstances entering inthecomposition ofthefinalproduct
could beadjusted attheborder. However, itisnotclear, inthisparticular case,whether those substances
werestillphysically present inthefinalproduct, orwhether theyhadbeenexhausted intheproduction
process, andthepanel made nodistinction tothateffect.
(b) Inputs incorporated orexhausted intheproduction process oftheexported product
71. Withrespect toexported products, Article VI:4andtheAdNotetoArticle XVI, simply refer
totaxes "borne by"products; unlike Article III:2, these twoprovisions donotcontain areference
to"directly orindirectly". However, therecords oftheHavana Charter indicate thattheAdNoteto
Article XVIwasunderstood tocover "thecaseofremission ofduties ortaxesimposed onrawmaterials
andsemi-manufactured products subsequently usedintheproduction ofexported manufactured goods"
(seeabove para. 60).
72. The1994SubsidiesAgreementismorespecificthanGATT1994regardingbordertaxadjustment
oninputs forexported products. Paragraph (h)oftheIllustrative ListofExport Subsidies contained
inAnnex I,elaborates thedefinition ofindirect taxes byaddressing prior-stage cumulative indirect
taxes44.Itreads:
"Theexemption,remissionordeferralofprior-stagecumulativeindirecttaxes[footnoteomitted]
ongoods andservices usedintheproduction ofexported products inexcess oftheexemption,
remission ordeferral oflikeprior-stage cumulative indirect taxes ongoods orservices used
intheproduction oflikeproducts when soldfordomestic consumption; provided, however,
thatprior-stage cumulative indirect taxes maybeexempted, remitted ordeferred onexported
42EPCT/TAC/PV/26, p.21,referred toinAnalytical Index, Guide toGATT LawandPractice, Vol.1,p.86.
43Paras. 5.2.7-5.2.8.
44Footnote 58oftheSubsidies Agreement gives thefollowing definition:
"Prior-stage" indirect taxes arethose levied ongoods orservices used directly orindirectly inmaking theproduct.
"Cumulative" indirect taxes aremulti-staged taxes levied where there isnomechanism forsubsequent crediting ofthetax
ifthegoods orservices subject totaxatonestage ofproduction areused inasucceeding stage ofproduction.WT/CTE/W/47
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products evenwhen notexempted, remitted ordeferred onlikeproducts when soldfordomestic
consumption, iftheprior-stage cumulative indirect taxesarelevied oninputs thatareconsumed
intheproduction oftheexported product (making normal allowance forwaste45).[footnote
omitted] Thisitemshallbeinterpreted inaccordance withtheguidelines onconsumption of
inputs intheproduction process contained inAnnex II."
Paragraph (i)oftheIllustrative Listaddresses theremission ordrawback ofimport charges onimported
products thatareconsumed intheproduction oftheexported products. Itreads:
"The remission ordrawback ofimport charges [footnote omitted] inexcess ofthose levied
onimported inputs thatareconsumed intheproduction oftheexported product (making normal
allowance forwaste); provided, however, thatinparticular cases afirmmayuseaquantity
ofhome market inputs equal to,andhaving thesamequality andcharacteristics as,theimported
inputs asasubstitute forthem inorder tobenefit from thisprovision iftheimport andthe
corresponding export operations bothoccur within areasonable timeperiod, nottoexceed
twoyears. Thisitemshallbeinterpreted inaccordance withtheguidelines onconsumption
ofinputs intheproduction process contained inAnnex IIandtheguidelines inthedetermination
ofsubstitution drawback systems asexport subsidies contained inAnnex III".
These twoparagraphs aretobereadinconjunction withfootnote 61which defines inputs consumed
intheproduction process as"inputs physically incorporated, energy, fuelsandoilusedintheproduction
process andcatalysts which areconsumed inthecourse oftheirusetoobtain theexported product".46
73. Tosumup,exemption, remission ordeferral, within themeaning ofpara. (h),ofprior-stage
cumulative indirect taxes ongoods andservices used intheproduction ofexported products is
permissible, butonlytotheextent thatthegoods andservices inquestion are"consumed inthe
production process" andthatthetaxes exempted arenotinexcess ofsuchtaxes ongoods andservices
usedintheproductionoflikeproductswhendestinedfordomesticconsumption.Similarly,paragraph(i)
ofAnnex Iallows theremission ordrawback ofimport charges not"inexcess" ofthose levied on
imported inputs thatareconsumed intheproduction oftheexported product.
74. Thescope ofthecurrent Subsidies Agreement appears tobebroader thanthatofthe1979
Subsidies Agreement, whose Annex I,paragraphs (h)and(i),referred to"goods thatarephysically
incorporated intheexported product". Thesignatories oftheSCM Code haddefined these as"such
inputs [that] areusedintheproduction process andarephysically present intheproduct exported.
Thesignatories notethataninput neednotbepresent inthefinalproduct inthesame form inwhich
itentered theproduction process".47
75. During theUruguay Round, some participants questioned thephysical incorporation testand
supported proposals totheeffect thattherulescontained inparagraphs (h)and(i)should apply toall
inputs, andnotonlytothose physically incorporated. Thefirstformal proposal wassubmitted byIndia
which stated inrelevant partthat
45Theterm"waste" isdefined inAnnex II,section II,para. 4,ofthe1994 Subsidies Agreement as"that portion ofa
given input which doesnotserve anindependent function intheproduction process, isnotconsumed intheproduction of
theexported product (forreasons suchasinefficiencies) andisnotrecovered, used orsoldbythesame manufacturer".
46SeeAnnex 1,para. (h),andfootnote 61ofthe1994 Subsidies Agreement.
47Doc. SCM/68, para. 4.WT/CTE/W/47
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"rebate ofpriorstagecumulative indirect taxesshould notbetreated ascountervailable subsidy
whether ornotsuchtaxes havebeenlevied ongoods andservices physically incorporated in
theexported product. Article VIofGATT states thatnoproduct canbesubject tocountervailing
dutybyreason oftheexemption ofsuchproduct fromtaxes orduties borne bylikeproducts
when destined forconsumption inthecountry oforigin. Thisprovision clearly suggests that
rebate oftaxesonauxiliary material (e.g.energy, fuel,lubricants, packing stationery), durable
capital goods (e.g.machinery buildings, vehicles) andservices (e.g.transport, advertising)
cannot betreated ascountervailable subsidy."48
Inasubsequent proposal, India precised itsfirstproposal:
"The physical incorporation testisbadfrom thepoint ofviewofbothequity andeconomic
efficiency.Itplacesatadisadvantagecountrieswithmulti-stagecumulativetaxsystemsvis-à-vis
those withvalue-added taxsystems asinthelatter, there isnoimpediment totheexporter
collecting fullcredit forallprior stage taxes paidoninputs. Ifglobal efficiency istobe
promoted, thensuchtaxes levied notonlyonthefinalproduct andtherawmaterials, butalso
those levied ontheinputs should beallowed toberebated, astheyalsohaveaprice-raising
effect. Thephysical incorporation testisalsonotconsistent withArticle XI:4ofGATT as
itismanifest thatprior stage taxes paidoninputs, whether ornotphysically incorporated in
thefinalproduct, are"borne bythelikeproduct".49
Theremission ofindirect taxes toinputs other thanphysically incorporated intheexported product
wasalsosupported bySwiterland whose proposal stated inparticular thatthephysical incorporation
test
"was notfullycompatible withthenotion ofnettransfer offunds because allindirect taxes
andimport charges onservices, suchastransportation andcommunication, aswellason
machinery, andonfungible inputs suchasfuelandelectricity usedinthemanufacturing process
arenotphysically incorporated inthefinalproduct. Consequently therulesonindirect taxes
andremissions ordrawbacks should apply toallinputs".50
These proposals leadtothecurrent textandtheinclusion offootnote 61.51Theactual scope ofthese
provisions hasnever beenputtotestinadispute settlement panel.
76. However, othercountries expressed concern thatthenewlanguage might leadtotradedistortive
effects. Inthatregard, aletter fromaUSTR official indicates thatthenewlanguage hasbeentheobject
ofaninformal agreement among developed countries whereby "itwasproposed toaddress aspecific
andverynarrow issueinvolving certain energy-intensive exports fromalimited number ofcountries.
Itwasnever intended tofundamentally expand therightofcountries toapply border adjustment for
abroad range oftaxes onenergy, especially inthedeveloped world. ...Wediscussed thematter
withother developed countries involved intheSubsidies Code negotiations. Wearesatisfied thatthey
share ourviews onthepurpose ofthetextasdrafted andtheimportance ofcareful international
examination before anybroader policy conclusions should bedrawn regarding border adjustments and
energy taxes".52
48MTN.GNG/NG10/W/26.
49MTN.GNG.NG10/W/33.
50MTN.GNG/NG10/W/26.
51Forfurtherdetails,see"Negot iatingHistoryofFootnote61oftheAgreement onSubsidiesandCount ervailingMeasur es",
Note bytheSecretariat, indoc.WT/CTE/W16 (1December 1995).
52Letter from D.Phillips, Assistant USTR forIndustry, toA.Katz, President USCouncil forInternational Business,
referred toinInside USTrade ,28January 1994.