WORLD TRADE
ORGANIZATIONWT/TF/COH/15
14 February 2003
(03-0969)
Original:  English
COMMUNICATION FROM THE INTERNATIONAL MONETARY FUND
The following contribution has been received from the staff of the International
Monetary Fund.  It has been prepared in response to consultations between the WTO Director-General
and the Deputy Managing Director of the IMF on how the IMF can provide support to the WTO
Secretariat and Members in areas of its expertise.
_______________
EXPORT FINANCING AND DUTY DRAWBACKS
Note on Issues Raised by Developing Countries in the Doha Round 1
EXECUTIVE SUMMARY
Developing countries have proposed that they should be allowed to offer financing to their
exporters at LIBOR or on terms offered by the credit agencies of developed countries.  The analysis in
this note suggests that both these proposals would involve export subsidization because the terms of
financing would — from analytical and empirical perspectives — be more favorable than those
available in the market to exporters.  Further, the case that developing country exporters should
receive concessional finance because of distortions in developing country capital markets is notcompelling.
2  These distortions are typically policy-induced, and even where they are not, it is highly
unlikely that they will systematically work to the disadvantage of exporters.  The most appropriate
policy response would be to eliminate the underlying distortion rather than introducing new ones
through the provision of subsidized credit to exporters.
On drawbacks, developing countries have made two proposals.  First, they should be allowed
to provide a uniform duty drawback for all exporters (or all exporters in a sector) regardless of their
actual use of imported intermediate inputs.  Second, duty drawbacks should be extended to all inputs,
including capital goods.  This note comes to the following conclusions with regard to these two
proposals.
• If countries have a sufficiently strong administrative capability in implementing domestic
indirect taxes, particularly the crediting mechanism under the VAT, it would be desirable that
any duty drawback system be administered similarly to the VAT crediting mechanism.
• While a good case can be made, in principle, for extending drawbacks to capital goods, doing
so may not be easy in practice.
                                                     
1 This Note was prepared by Stephen Tokarick and Arvind Subramanian, Research Department,
International Monetary Fund.
2 This Note does not take a view on whether developing countries should nevertheless be allowed to
offer concessional financing to their exporters because  developed countries are permitted to do so.WT/TF/COH/15
Page 2
• In terms of the two proposals, this implies that countries with relatively strong tax
administrations should not favor the unifor m drawback scheme and could be allowed to
extend duty drawback to capital goods.
• Where tax administrations are not strong or are being strengthened, the administrative and
political economy benefits of the uniform drawback scheme may be significant, strengtheningthe case for its adoption, but only for small exporters.
_______________
1. Developing countries have made a number of proposals in relation to exports, two relating to
export financing (discussed in Section I) and two to  duty drawback schemes (discussed in Section II).
I. EXPORT FINANCING
2. The two proposals relating to export financing are:
Proposal 1
Export credits given by developing countries shall not be considered as subsidies so long as the rates
at which they are extended are above the London Interbank Offered Rate (LIBOR).
Proposal 2
The language of Annex I of the Agreement on Subsidies and Countervailing Measures (SCM),
particularly item k, shall be reviewed to permit developing countries to provide competitive export
financing vis-à-vis the conditions found in the international market or those offered by the credit
agencies of developed countries (controlled by or acting under the authorities of the governments).
3. This note will analyze these two proposals in terms of the following questions:
• Would the provision of export financing to de veloping country exporters at LIBOR (Proposal
1) or on terms offered by the credit agencies of developed countries (Proposal 2) amount to
export subsidization?
• Even if such financing involves export subsidization, should it be permissible because of the
special circumstances of developing countries?
4. The first is a positive or factual question that can only be analyzed against a benchmark rate,
for example, the rate of interest that developing country exporters are likely to obtain in a well-
functioning domestic or international capital market.  The second is a normative question with an
explicit special and differential treatment perspective: given the general prohibition against export
subsidization in the WTO Agreement on SCM, should developing countries be exempted from thisprohibition in view of their special circumstances?
Export subsidization and market rates of interest
5. LIBOR is a well-established and understood benchmark interest rate in international financial
markets.  But the “terms offered by the credit agencies of developed countries (controlled by or actingunder the authorities of the governments)” is less we ll-known.  In practice, the latter refers to the
Arrangement on Guidelines for Officially Supported Export Credits  (henceforth referred to as “the
Arrangement ”) which was reached in 1978, with a series of amendments since that time, and which
aims at avoiding competition among countries for the most attractive financing terms.  The
Arrangement  is not a part of WTO rules.  Rather, it is a “gentlemen’s agreement” among its
participants (OECD countries) and it has been incorporated into European Community law.  The
Arrangement  established a set of rules which govern the use of official support for exports of goods or
services, or financial leases that have repayment terms of two years or more.  It applies to exportWT/TF/COH/15
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credits given through direct credits, financing, interest rate support, guarantee, or insurance.  Special
sectoral arrangements apply to official support given to exports of ships, nuclear power plants, and
aircraft, while the Arrangement  does not apply to military equipment or agricultural products.3
6. In practice, countries that have agreed to adopt the provisions contained in the Arrangement
and that offer interest rate support must apply mi nimum interest rates, known as commercial interest
reference rates (CIRRs).4  These rates are determined as a fixed margin of 100 basis points above a
base rate, which varies between a three to seven year government bond yield.5  CIRRs are published
for about twenty different currencies, all of which are for borrowing in currencies of countries that are
members of the OECD.
7. Figure 1 compares LIBOR with the CIRR. It shoul d be noted that these two interest rates are
not directly comparable, in that the longest term LIBOR rate that exists is for one-year borrowing,
while the shortest term CIRR that exists is for credit  to be repaid between two and five years.  Thus, a
comparison between LIBOR and CIRR is not for th e same maturity.  Nevertheless, for the period
between January 1995 and September 2002, Figure 1 compares the one-year LIBOR rate on U.S.
dollar denominated deposits with the CIRR on U.S. dollar credits due in less than five years.  As
shown, the CIRR exceeded the LIBOR rate for the entire period and the average gap between the two
rates was one percentage point between 1995 and 2002.
8. Would the provision of financing to exporter s at LIBOR or at the CIRR amount to export
subsidization?  This question presupposes the need for a benchmark: a market rate of interest.  The
market rate charged to any borrower would compri se the risk-less rate plus a margin for the
underlying risk of lending to a particular borrower.  For developing country borrowers, this risk in
turn consists of three elements: country-risk, the credit risk related to the particular exporter, and if theborrowing and lending is in local currency, the risk faced by the lender that the currency will
depreciate.  These risk elements vary across time, countries, sectors, and firms.
9. It follows therefore that both LIBOR, which is a risk-less rate, and CIRR, which is a risk-less
rate plus a fixed  margin would both lie well below the market rate for developing country exporters.
Both LIBOR and the CIRR rate bear little relationship to the nature of the transaction beingconsidered, especially the degree of risk, and hence would clearly amount to subsidization.
10. To evaluate the proposal empirically, it woul d be useful to compare LIBOR and the CIRR
with a market interest rate that an exporter w ould have to pay in a market where there are no
distortions.  This market rate would obviously depend on the country and the currency denomination
of any loan.  To assess where LIBOR and CIRR would lie  in relation to such a market rate, it is useful
to construct an interest rate that could serve as a reference point.  Abstracting from any currency risk
(and therefore only considering borrowing in U.S. dollars), a useful reference interest rate is the U.S.prime interest rate, plus a margin for country risk, plus a margin for exporter-specific risk.  The U.S.
                                                     
3 Article 10 of the WTO Agreement on Agriculture mand ates that countries agree to work toward a set
of  internationally agreed disciplines on the use of export credits, export credit guarantees, and insuranceprograms, and to use these measures only in accord with the agreement.  To date, however, no such internationalagreement exists in agriculture.
4 The general principles that govern the establishm ent of CIRRs are:  (i) they should represent final
commercial lending rates in the domestic market;  (ii) should correspond to the rate for first-class borrowers;(iii) they should no distort domestic competitive conditions;  and (iv) they should closely correspond to a rateavailable to first-class foreign borrowers.
5The first base rate is:  (i) three-year government bond yields for repayment up to 5 years;  five-year
government bond yields for repayment between 5 and 8½ years;  and seven-year bond yields for repayment over
8½ years.  The second option for the base rate is the five-year government bond yield for all maturities.  The
exceptions to this two base rate system is the yen CIRR, which is based on the long-term prime rate less 20 basispoints for all maturities, and the ECU CIRR, which is based on the secondary market yield on medium-termECU bonds on the Luxembourg stock exchange  plus 50 basis points.WT/TF/COH/15
Page 4
prime rate is chosen to construct a market interest  rate because it is determined in a well-functioning,
distortion-free market and represents the rate that a bank would charge its most creditworthy
customers.  Figure 1 plots the U.S. prime rate for the period 1995 through 2002.  As shown, the U.S.
prime rate far surpassed LIBOR over the entire period, and it averaged 2½ percentage points above
LIBOR in each year.  If country risk and exporter-specific risk were added on top of the U.S. primerate, the gap between market rates and the two refere nce rates would be even larger.  In short, the
subsidy implicit in using LIBOR or the CIRR would be substantial.
Should export subsidization through concessional export financing be permitted?
11. The two proposals on export financing suggest that developing countries have not sought an
exemption for export subsidization in general.  Th e exemption that is sought has a narrower focus,
relating to export financing.  This note therefore does not address the broader question of the merits orotherwise of export subsidization in general.
12. It should also be emphasized that this note  does not take a position on whether developing
countries should be allowed to offer concessional financing to their exporters because  developed
countries are allowed to do so under paragraph k of Annex 1 of the WTO SCM agreement.  This is a
political question that WTO members will need to decide.  This note focuses instead on the analyticalissues relating to concessional export financing.
13. The implicit case for subsidization that developing countries appear to be making is that
imperfections in domestic and international capital markets handicap developing country exporters.
Concessional financing is then a way of overcoming these imperfections.  Evaluating the merits of
this argument requires, however, that the distortions be identified, and their impact assessed whichwould then allow conclusions to be drawn about the  appropriate remedial action.
14. Three types of distortions in capital market s could affect developing country exporters.
• First, developing country capital markets could be financially repressed, with below-market
rates of interest, and rationing of the consequential excess demand for credit;                      Prime RateFigure 1. Evolution of U.S. Dollar CIRR, Prime, and LIBOR Rates: 1995-2002
1995          1996           1997           1998          1999           2000          2001            2002     LIBOR
0246810
CIRR
Source:  Organization for Economic Cooperation and Development; U.S. Federal Reserve; and International Monetary Fund,  
International Financial Statistics.(interest rate per annum) WT/TF/COH/15
Page 5
• Second, developing country markets could be characterized by very high rates of interest
because of unsustainable macroeconomic policies and loss of confidence; and
• Third, capital markets could be free of pol icy-induced distortions but nevertheless be
inefficient because of inherent problems of asymmetric information (adverse selection and
moral hazard).
A. P OLICY -INDUCED DISTORTIONS :  FINANCIAL REPRESSION
15. Financial repression is a policy-induced distortion that leads to excess demand for, and hence
rationing of, credit.  Borrowers that get access to credit implicitly receive a subsidy and those that are
rationed out are implicitly taxed.  Three questions are pertinent here:
• Is financial repression pervasive?
• Does it impact adversely on exporters?
• Even if it did, would subsidization of exporters be the best response?
16. The available evidence suggests that while financial repression was a pervasive feature of
developing country capital markets, during the period 1960-1990, because of financial instability,
high inflation, and government intervention, it is less prevalent today.6  Even when financial
repression did exist, there was little evidence that the rationing systematically led to the exclusion of
exporters from credit.  In fact, quite the converse.  Exporters often obtained preferential access
because of policies of directed credit that typically favored exporters.  Finally, even in the unlikely
event that exporters were systematically hurt, the appropriate policy response would be to eliminate
the policies that give rise to financial repression rather than adding a further distortion by providingsubsidized credit to exporters.  In addition to the administrative difficulty and the rent-seeking costs
that a policy of subsidized credit would give rise to, other agents in the economy could advance
claims of being credit-rationed which the government would find difficult to refuse.
B. P
OLICY -INDUCED DISTORTIONS :  HIGH DOMESTIC INTEREST RATES
17. Countries often experience high real interest rates as a result of excessive fiscal deficits, and
high nominal rates generated by expansionary monetary policy.  In addition, high real interest rates
are maintained by countries, at least temporarily, as part of the package of measures to sustain
confidence in domestic policies in the face of financial crises.  Such rates, it is alleged, increase the
cost of doing business, thereby impairing the competitiveness of developing country exporters.  In this
case too, the questions similar to the ones posed above, particularly the latter two, are relevant.
18. As an analytical point, it is worth mentioning that high interest rates need not adversely affect
the export sector.7  In a simple trade model with two factors of production — labour and capital--high
real interest rates are likely to reduce the profitability of the capital-intensive sector relative to the
labor-intensive one.  Insofar as developing countries have comparative advantage in labor-intensive
sectors, high real interest rates are more likely to adversely affect the import-competing sector thanthe export sector; in other words, they are more likel y to work to reinforce rather than work against
existing comparative advantage.  At the very least, there can be no presumption that the export sector
will be systematically disadvantaged.
19. Most importantly, of course, even if it can be demonstrated that exporters are particularly
affected, the most appropriate policy response would be to address the underlying source of the
                                                     
6 Mehran et. al., 1998 s uggest that, although the functioning of the financial sector remains far from
fully efficient in Sub-Saharan African countries, substantial progress has been made in eliminating conditions of
financial repression.
7 Unlike with financial repression, high real interest rates under conditions of financial crises and lack
of confidence do not represent a disequilibrium phenomenon that requires or involves rationing of credit.WT/TF/COH/15
Page 6
distortion, namely the underlying policies — macroeconomic and financial — that lead to high real
interest rates.  Addressing this policy-induced distortion by subsidizing exporters would entail costs
similar to those mentioned above.
C. INHERENT DISTORTIONS :  ADVERSE SELECTION
20. Even in the absence of policy-induced distortions, it is well-established that capital markets
are susceptible to inefficient outcomes because of the problem of asymmetric information and herd-
behavior (Stiglitz and Weiss, 1981;  Calvo and Mendoza, 1999).  In this context, it is possible that
exporters could be systematically credit-rationed because of creditors’ tendency to categorize them as
bad risks, when in fact they are good customers.  However, there is little evidence that creditors
behave in this manner.
21. Indeed, quite the converse appears more likely.  Problems of adverse selection are aggravated
because of the inability of good borrowers to signal th eir true credit type.  But the very fact of being
an exporter is a signal of being able to compete su ccessfully in international markets.  Magaestae and
Patillo (2002) provide evidence from Africa that exporters are generally more efficient and productive
than other firms.  Thus, creditors are more likely to favor exporters and ration other borrowers who
cannot demonstrate similar market-based performance.  Harrison and Mcmillian (2002) finds
evidence from work on sub-Saharan Africa that domestically-owned firms are more likely to becredit-constrained than foreign-owned firms that are more export-oriented than domestic ones.  In
addition, the fact that exporters can access international capital markets more easily than other agents
is another reflection of their advantageous position in overcoming adverse selection problems.
Conclusions
• The proposal by developing countries that their exporters be provided with credit at LIBOR
or on terms offered by the credit agencies of developed countries would involve subsidizationbecause these rates are — analytically and empirically — well below what exporters would
typically be able to obtain from the market.
• The case that developing country exporters should receive concessional finance because of
distortions in developing country capital markets is not compelling.
8  These distortions are
typically policy-induced, and even where they are not, it is highly unlikely that they willsystematically work to the disadvantage of exporters.  The most appropriate policy response
would be to eliminate the underlying distortion rather than introducing new ones through the
provision of subsidized credit to exporters.
II. DUTY DRAWBACKS
22. Developing countries have made two proposals relating to duty drawback schemes.
Proposal 1
“Aggregate and generalized rates of duty remission should be allowed in case of developing countries
even though individual units may not be able to establish the source of their inputs” (hereafter
referred to as the uniform drawback rule), and
Proposal 2
“The definition of “inputs consumed in the production process” (footnote 61of the Uruguay Round
Agreement on Subsidies and Countervailing Measures (SCM)) needs to be expanded to include all
inputs, not just physical units, which may have contributed to the determination of the final cost price
of the exported product” (hereafter referred to as the capital goods drawback proposal).
                                                     
8 This note does not take a view on whether developing countries should nevertheless be allowed to
offer concessional financing to their exporters because  developed countries are permitted to do so.WT/TF/COH/15
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Theoretical considerations
23. Tariffs on imports lead to, indeed are, a “tax” on exports.  The tax arises in at least two ways.
First, and most importantly, tariffs raise the price and profitability of the import-competing sectorrelative to the exportable sector in the domestic market, inducing resources to flow away from the
latter towards the former.
24. The second manner in which this tax arises, and the one that is the focus of this note, relates
to the impact of tariffs on imported inputs in raising the cost of export production, thereby hurting the
competitiveness of the export sector.  In practice, countries have sought to eliminate this source of the
tax on exports
9 by instituting duty drawback and similar schemes, which aim at providing exporters
access to imported inputs at world prices.  (Table 1 provides an illustrative list of practices relating toduty drawbacks in a number of developing countries).
10  The need for drawbacks is obviously related
to the magnitude of tariffs on intermediate goods im ports.  The lower these tariffs, the smaller is the
burden on exports, which reduces the need for drawback schemes.
25. Duty drawback schemes are related to the broader objective of ensuring, as is the norm11, that,
indirect taxes bear only on domestic consumption (are applied, that is, according to the “destinationprinciple”).
12  They relieve exports of the burden of domestic indirect taxes and helps maintain
neutrality of incentives between importables and exportables (Grossman, 1980). Achieving these
objectives requires that:
• No domestic indirect taxes are levied on export sales;
• All indirect taxes paid on intermediate inputs, including capital goods — domestic and
imported—that are used in export production are rebated back to the exporter;
26. Under a destination-based VAT, the zero-rating of exports achieves these objectives, ensuring
that the VAT is neutral between importables and exportables.  Moreover, if the aim is to achieve
neutrality of incentives for the entire domestic indirect tax system, not only indirect taxes but also
tariffs on imported inputs need to be rebated back to the exporter.  This is the purpose of drawback
and similar schemes that are now very important in practice.13  In this context, it is useful to recall that
                                                     
9 This note does not address the issue of the optimal drawback scheme, which is complicated and
depends on the objectives of a country and the structure of the economy (Panagariya, 1992).  It takes as a given
that countries wish to provide full drawback and addresses issues relating the design of drawback schemes andtheir consistency with related aspects of the domestic indirect tax system.
10 Temporary admission schemes and manufacturing in-bond arrangements are administratively
different from drawback schemes but they are all alike in their aim of relieving exports of the tax burden
emanating from tariffs on imported intermediate inputs.
11 Throughout the analysis, it is assumed that the domestic indirect tax typically takes the form of a
consumption-based VAT applied according to the destinatio n principle.  Virtually all developing countries have
introduced or are close to introducing a VAT (Table 2).  The vast majority of countries have opted for a pureconsumption-based VAT applied according to the destina tion principle.  Exceptions include a number of small
island economies that do not have a VAT and a few form er CIS-countries that (until 2001) applied an origin-
based VAT on some bilateral trade, but now do so only for trade in energy products.  Although the United States
levies a retail sales tax rather than a VAT, it is applied according to th e destination principle.
12 Exceptions arise when excise taxes are levied to deal with externalities associated with production,
for example, the environmental consequences of petroleum use.
13 One difference, it should be noted, is that whereas the VAT chain eliminates all VAT paid on inputs,
drawback (and similar schemes) do not eliminate the indirect burden of customs on exporters arising from their
use of domestically-produced inputs whose prices reflect the tariffs on competing imports.  Some countries do
permit indirect drawback for inputs imported by a firm that are used to manufacture an intermediate good that issold to an exporter.  However, this is rare as it requires a sophisticated paper trail and a willingness on the partof one firm to “give” away its drawback rights to another.WT/TF/COH/15
Page 8
a tariff is a combination of consumption tax and a production subsidy.  As a consumption tax, its
impact on exports should not be different from other “domestic” consumption taxes such as the VAT.
Uniform drawback rule
27. In order to implement an ideal duty drawback scheme, the tax authorities need to have
information from every exporting firm on the quantity exported, the quantity of imported
intermediates used in export production, and the tariff on the imported intermediates.  These
requirements can be onerous, leading to delays in the rebating of import taxes, thereby hurting the
competitiveness of exporters.  In order to simplify drawback procedures, developing countries have
proposed that exporters receive a uniform drawback of taxes on imported intermediates and that this
drawback be provided to all exporters, without verifying the types and quantities of imported
intermediate inputs they have used.
28. Developing countries have not elaborated in detail on their proposal.  But the spirit of the
proposal appears to be to institute a rule whereby all exporters (or all exporters within a given sector)
would receive the same (percentage) rebate base d on documenting how much they have exported.
29. This proposal has two important advantages.  Firs t, it would be straightforward to calculate
and easier to implement, compared with the alternative of requiring exporters to furnish informationon the types and magnitudes of intermediate inputs that have been imported.  This could prove
beneficial to countries with weak administrativ e capacity and firms with poor record-keeping.
30. Second, an aggregate scheme that is given to all exporters on the basis of a predetermined rule
regardless of their input use would reduce the incentiv es for misreporting information or lobbying for
special treatment.  By reducing the scope for discretion, an aggregate rebating scheme would thusconsiderably reduce the incentives for corruption and rent-seeking that can be very costly.
31. The rebating scheme proposed by developing countries would have to be implemented in a
manner that does not lead to subsidization on average.  Decisions would also need to be taken on
whether the rebating should be economy-wide or sect or-wide, i.e., whether the rebate would be the
same for all exporters or just exporters in a given sector
 .  Here there is a trade-off between ensuring
that the rebate is “right” for a reasonably large number of firms, with pressure to adopt greater sector-
specific differentiation.  In turn, the finer the classification the greater will be the information
requirements, for example, on input-output coefficients, rendering it more difficult and costly to
implement.
32. Whatever the level of differentiation chosen, the magnitude of the rebate would need to be an
average that reflects the different input-output coefficients and different input tariffs faced by firms
across the export sector.  By construction, a uniform drawback scheme would be inefficient in thesense that it would under-rebate some exporters and over-rebate others.  This could lead to the risk of
lobbying by exporters that are under-rebated based on claims of unfair treatment.  If governments give
in to these claims, a uniform drawback rule could result in export subsidization on average.
14
Presumably, some checks would need to be instituted to guard against the risk of setting a drawbackrate that amounts to a systematic export subsidy.
33. The advantage of a uniform drawback scheme  would thus depend on the trade-off between
the inefficiency introduced compared with the ad ministrative and political economy benefits that it
yields.
                                                     
14 This may not be a problem for countries listed in Annex VII of the WTO SCM agreement to which
the prohibition on export subsidization does not apply.WT/TF/COH/15
Page 9
34. Therefore, an important consideration in assessing this trade-off is the potential magnitude of
the costs of a more elaborate drawback system where there already exists a tax administration system
geared to dealing with drawback-like issues in the context of implementing the VAT.
35. As Table 2 illustrates, most developing countries have either implemented or are in the
process of implementing a VAT.  Having a VAT requ ires the tax authorities to deal with individual
firms not only to ensure collection of taxes but also  to efficiently implement the rebating of the taxes
paid on intermediate inputs.  Indeed, the rebating  scheme--strictly speaking, the crediting mechanism
by which registered traders are reimbursed for the taxes they have paid on their purchases of all
intermediate inputs — is the essence of a VAT system.15  Thus, the fact that duty drawback
arrangements involve elaborate procedures and contacts between taxpayers and administrators need
not be a decisive consideration in favor of a uniform drawback scheme where a VAT is in place.
36. Indeed, one of the primary benefits sought from the adoption of a VAT in many countries is
precisely the development of the capacity to administer and comply with taxes on the basis of self-
assessment, with taxpayers declaring their circumstan ces but subject to well-designed audit strategies.
This is not an easy process — VAT refunds are a continuing area of difficulty — but they are being
addressed in a number of ways.16
37. Moreover, given the analytical and procedural similarity described above between duty
drawbacks and the rebating of taxes on intermediate inputs under a VAT, there is merit in treating
them in a broadly similar fashion in relation to implementation.  That drawback schemes and
administration of the VAT need to be mutually consistent is reflected, for example, in Fund staff
recommendations that drawback verification through audit be carried out at the same time and by the
same audit team that conducts an audit of the VAT.17  Information obtained in the course of
implementing the VAT also helps in  the audit of the drawbacks.  Further, this recommendation of
joint or parallel auditing is often made in conjunction with a recommendation to establish a separate
unit for large taxpayers, as they are frequently large exporters and importers who should have no
difficulty in maintaining the necessary records to support a drawback claim.
38. Where administration and compliance is weak, but the need to provide duty drawback is
nevertheless considered pressing, a case could be made for developing countries to offer, temporarily,
a hybrid duty drawback system.  For large expor ters, who should be expected to maintain the
necessary records for the VAT, duty drawbacks could resemble the VAT rebating system and
integrated with the administration of the VAT.  For smaller exporters, however, the uniform drawback
scheme could be applied to minimize the administrative costs and governance problems.  The same
thresholds that already apply under the VAT would n eed to be set to distinguish small from large
exporters.  Smaller exporters could even be offered the choice between the uniform drawback schemeand the VAT-type rebating scheme, subject to proper safeguards.
39. The detailed design of such a hybrid would need careful attention, but the essence is familiar
from the operation of the VAT.  In any case, even if a hybrid system were adopted, it would have to
be time bound to reflect the fact that as tax administrations get strengthened, all firms should be
covered by similar procedures.
                                                     
15 In practice, tax authorities do not monitor every firm; rather, they rely on self-declaration by firms
combined with selective ex post audits to ensure that abuse is minimized.
16 See Ebrill, et. al., 2001 for a discussion of the difficulties associated with refunds and strategies for
addressing them.
17 This joint recommendation has been made to a number of developing countries.WT/TF/COH/15
Page 10
Capital goods drawback proposal
40. The proposal put forth by developing countries that the definition of “inputs consumed in the
production process” be expanded is really aimed at extending duty drawback to capital goods .  On
purely economic grounds, this proposal has merit.  The remission of duties and all indirect taxesshould apply to all inputs that may have contributed to the final cost  of the exported product.  Capital
goods — to the extent they are “used up” in production — contribute as much to the final cost as do
other intermediate inputs, including intangibles.   Under a VAT, for example, the zero-rating of
exports involves rebating domestic indirect taxes paid on all intermediate inputs, including capital
goods.  Hence, the current language in the WTO’s Agreement on Subsidies and Countervailing
Measures which restricts drawback to inputs physically consumed  does not have an economic
rationale.
18  More generally, drawback should in principle extend to physical capital goods used up in
the production process, and indeed to other types of inputs as well, such as computer software.
41. Administratively, however, extending duty draw back to capital goods creates potential
difficulties, some of which also apply to rebating under a VAT, but some of which could be
additional.
• First, there is the question of what constitutes a capital good.  Under a consumption-based
VAT, of course, there is no need to distinguish between capital goods and other intermediate
inputs because they are all treated alike.  Under a duty-drawback scheme, however, such a
distinction needs to be made (see below) which could increase the complexity of
administration.
• Second, there is the question of how much of the capital goods to be assigned to exports (for
which drawback would be available) and how much to domestic sales.  While this is a
complication, the problems are not insuperable.19
• Third, and perhaps the most challenging in the pr esent context, is the question of determining
how much of the capital good is used up (i.e. depreciates) in production in any given year.20
Analytically, this question presents itself in quite different ways in VAT and drawback
contexts.  Under a consumption-based VAT, the entire amount of taxes paid on intermediate
capital goods purchased in any given year is rebated, because by definition a consumption-
based VAT excludes capital goods and all other intermediates from the tax base.  Thisimmediate deductibility of the full tax paid on capital goods is not matched in a duty
drawback context where the aim is to offset the cost impact on exports of tariffs on
intermediates, and this cost is related to the use of capital goods.  Hence, in a duty drawback
context, countries will need to define what constitutes a capital good and to determine how
“use,” i.e., depreciation, will be calculated.  If a 100 per cent depreciation rule is adopted, theadministration of duty drawback and crediting under the VAT would become similar and easy
to administer, but this would be purchased at the cost of effectively subsidizing exports.
Moreover, it would become necessary to track the use of capital goods throughout their
lifetime in order to impose equivalent customs duty on any sales of the under-depreciated into
domestic use.
21
                                                     
18 In the indirect tax area, an important aspect of modernization has been the removal of such language.
19 A similar issue arises under the VAT in relation to traders selling both exempt and taxable outputs,
since the input tax is creditable in respect of the latter bu t not the former.  The standa rd procedure is to apportion
inputs relative to the shares of the two types of sales in total revenue;  despite the element of arbitrariness, this
rule has proved workable.
20 It should be noted that this is different from the question of the allocation between exports and
domestic sales.
21 In principle, the tax code will typically specify depreciation rates (for the purpose of the business
income tax) that one might think of using for this pu rpose.  These though are often accelerated relative to true
economic depreciation in order to provide a modest ince ntive for investment, so that adoption of these rates
would arguably amount to an export subsidy.WT/TF/COH/15
Page 11
42. If these incremental administrative difficulties are large, it might be preferable for countries to
avoid drawbacks on capital goods altogether or extend the uniform drawback scheme discussed earlier
also to capital goods.22  If they are not large, or at least no larger than those arising under a VAT,
countries could chose to extend drawbacks to capital goods imports.
Conclusions
• If countries have a sufficiently strong administrative capability in implementing domestic
indirect taxes, particularly the crediting mechanism under the VAT, it would be desirable tohave duty drawback systems that are administered similar to the VAT crediting mechanism.
• In terms of the two proposals, this implies that countries with relatively strong tax
administrations should not favor the uniform drawback scheme (Proposal 1) and could, in
principle, be allowed to extend duty drawback to capital goods (Proposal 2).
• Where tax administrations are not strong, the administrative and political economy benefits of
the uniform drawback scheme may be significant, strengthening the case for its adoption, but
only for small exporters.
                                                     
22 Any decision to extend drawbacks would also depend on the magnitude of tariffs on intermediate
capital goods:  the lower the tariffs, the less the burden on exports, reducing the imperative for drawbacks.WT/TF/COH/15
Page 12
ANNEX I
Table 1
Selected Country Practices With Regard to the Operation of Duty-Drawback Schemes
Country Practices
Argentina The drawback regime provides for the partial or total refund of import duties and the
statistical tax on inputs used in  the processing of products for export, as well as the VAT
and excise taxes paid at different processing stages.  To benefit from the drawback, theimported items must be substantially transformed or incorporated in the production ofexport goods and the exporter must be a direct importer of the inputs.  Internal tax
refund rates, calculated on the f.o.b. export value less the c.i.f. value of imported inputs,
are currently applied at twenty different rates, ranging from 1.35 to 10 per cent,covering three fourths of all tariff lines.
Brazil The system provides for the suspension or exemption of import taxes and other taxes
when the imported goods are used to produce exportables or to package them.  To
receive the drawback, the value of imports is expected to be no more than 40 per cent ofthe value of exports.
Chile Chile has two mechanisms in place, and exporters may c hoose to participate in either one,
but not both.  The first mechanism allows exporters to receive reimbursement of 10, 5, or
3 per cent of the f.o.b. value of the final goods exported.  The second provides for
"reimbursement (at the same rates) for inpu ts of domestic origin  or imported against
payment of import duties or taxes used or consumed in the manufacture, processing, orproduction of exported goods."  The maximum values of exports which determine therate of the refund are set each year and adjusted using a price index calculated by the
Central Bank.
Dominican Exporters can request an income-tax-deductible bond, equal to 3 per cent of the f.o.b.
Republic value of exported goods, but not ex ceeding the value of the duties paid.
Egypt Under the drawback scheme, exporters may obtain a full refund of customs duties paid on
imports of inputs and components used in the manufacture of a finished product,
provided it is exported to a free zone within one year from the payment of the duties.
A partial drawback is available if the final good is shipped to an area r eceiving partial
exemption from customs duties.  All excise duties on local inputs are also refunded.
Guatemala Under the Export Promotion and Maquila Law, imports by maquila enterprises are
exempt from import duties and taxes, including VAT, subject to: i) the finished product
must have been exported outside the Central American Common Market (CACM)
within one year; and ii) it must be guaranteed that the inputs imported under this regimeare for re-export.
India India maintains a wide variety of drawback schemes.  Under the most basic scheme,
duty drawback is permitted on imported inputs used in the manufacture of goods that
are exported.  The rate of drawback, known as the "all-industry" rate, is calculated on
the basis of broad averages of consumption of inputs, duties and taxes paid, wastage,and f.o.b. prices of export products.  According to the Indian authorities, this schemeneutralizes about 70-80 per cent of the duty paid on inputs.  If an exporter feels thisdrawback is inadequate, he may request "special brand rates" which is product andWT/TF/COH/15
Page 13
Country Practices
exporter specific.  These special rates neutralize between 90-95 per cent of the duties paid.
Proof of duty payments by the exporter is required.
Indonesia Tariffs on imported inputs, as well as taxes paid on domestically purchased inputs, may be
exempted or refunded.  A prior exemption scheme, based on a self-assessment of importvalues and inputs used in products, is subject to an audit.
Kenya There are two duty drawback schemes in place.  First, under the Duty Remission Scheme,
remission is available for duties and VAT on goods imported for use in the production ofmanufacturing goods for export, or for the production of raw materials for use inmanufactured products for export, or for the production of "duty-free items" for saledomestically.  The remission is subject to the posting of a bond to cover the amount of
unpaid duty.  In order to recover the bond, exporters must demonstrate, within six months,
that the imports have been incorporated into the production of final goods that they haveexported.  Exporters of horticultural goods and agri-based products enjoy remission ofimport duties and of value-added tax on imports used in their production.  Under theManufacturing-Under-Bond scheme, firms exporting their total output are exempted frompayment of import duties and VAT on inputs, including plant, equipment, and raw materials.
This exemption is subject to posting of a bond.
Malawi Full drawback of tariffs and excise duties are provided on a specified list of goods
that are used in the manufacture of exports.  For some products, drawback is available onall materials and components, while for others, it is available only on specifiedmaterials.  Duty drawbacks are determined on the basis of the actual material used in
export production.  Therefore, manufacturers must maintain sufficient records.
Malaysia Imports of machinery, equipment, raw materials, and components used for the
manufacture of products for export are exempt from import duty and sales tax, wheresuch items are not produced locally or, if produced locally, are not of acceptable qualityand price.
Nigeria Exporters may be reimbursed for import duties, levies, surcharges, as well as excise
duties paid on imported inputs used in export production, by applying tothe DutyDrawback Committee.  Eligibility for a refund requires confirmation that the exports tookplace;  from Customs that the imports took place;  and from the Central Bank that theexport proceeds were repatriated.  The ref und is based on a drawback rate calculated from
an input-output matrix, with production coefficients computed by the Standards
Organization of Nigeria.  The refund may not exceed the amount of the duty actually paid.The Duty Suspension Scheme allows for raw materials and intermediate inputs to be
imported free of customs, excise and other duties and surcharges when used for exportproduction.
South Africa Rebates, refunds, and drawbacks of import duties (full customs duties) are available to
all manufacturing industries producing for export.  The concessions are granted onimported inputs, including raw materials and components used in production of goodssolely destined for export.  Full rebates or  refunds of customs duties are also granted
on goods imported and then re-exported in the same condition or state.  Goods for use inthe manufacture, processing, finishing, equipping or packaging of products solely for
export, may be recommended for temporary admission.  Liability for the duty on any
goods granted concessions ceases upon presentation of documentary evidence to the
Customs administration that the goods were exported.  Exporters qualify for VATWT/TF/COH/15
Page 14
Country Practices
refunds for all goods and services incorporated in their exports.
Slovakia Duties paid on imported inputs are reimbursed if used to process goods that are exported.
Drawback is permitted where it is possible to identify the imported inputs in the
processed products exported.
Turkey Three schemes are in place available to all exporters.  First, under the "c onditional
exemption for imports", suspension of duty and VAT on raw materials, auxiliary materials,semi-finished and finished products, and packaging materials.  Second, under the "use ofequivalent goods", refund of VAT, but not customs duty, after the realization of exportswith imported inputs.  Third, under the "repayment of duties collected on imports", refundof customs duty and VAT paid on imported inputs after the realization of exports.  The refund is
based on a drawback method.
Uganda The government operates two schemes.  The Fixed Duty Drawback Scheme operates on
input/output coefficients already calculated in advance or estimated on the basis ofinformation provided by the exporter.  Duties paid on inputs that go into the productionof exports are refunded so that the export is not rendered uncompetitive as a result of the
duties.  The scheme is intended to meet the needs of the exporters who do not rely on a
large quantity of imported inputs.  The second scheme is designed for companies thatexport 100 per cent of their output.  The government allows duty-free imports or localproducts required as components of the final good to be exporter.  To qualify, exportersmust meet a number of conditions.
Zambia Exporters can receive a duty drawback on most imported inputs.  The drawback system
is based on input-output coefficients at the firm or sector level.  Capital inputs and
mining inputs are not eligible for the drawback.
Source:  World Trade Organization, Trade Policy Reviews, various years.WT/TF/COH/15
Page 15
ANNEX II
Table 2
Current VATs: Dates Introduced and Standard Rate1
VATs Rates2
(in present)
Date VAT Introduced Standard Rate
Albania 1996 20.0
Algeria 1992 17.0
Argentina 1975 21.0
Armenia 1992 20.0Australia 2000 10.0
Austria 1973 20.0
Azerbaijan 1992 20.0Bangladesh 1991 15.0Barbados 1997 15.0
Belarus 1992 20.0
Belgium 1971 21.0
Benin 1991 18.0
Bolivia
31973 14.9
Brazil4, 51967 20.48
Bulgaria 1994 20.0
Burkina Faso 1993 18.0
Cambodia 1999 10.0Cameroon 1999 18.7Canada 1991 7.0
Chad 2000 18.0
Chile 1975 18.0
China 1994 17.0
Colombia 1975 15.0
Congo Republic 1997 18.0
Costa Rica 1975 15.0
Côte d’Ivoire 1960 20.0
Croatia 1998 22.0Cyprus 1992 10.0
Czech Re public 1993 22.0
Denmark 1967 25.0
Dominican Republic 1983 8.0
Ecuador 1970 12.0
Egypt
61991 15.0
El Salvador 1992 13.0
Estonia 1992 18.0
Fiji 1992 10.0
Finland 1994 22.0
France 1968 20.6
Gabon 1995 18.0Georgia 1992 20.0
Germany 1968 16.0
Ghana
71998 12.5
Greece 1987 18.0WT/TF/COH/15
Page 16
VATs Rates2
(in present)
Date VAT Introduced Standard Rate
Guatemala 1983 10.0
Guinea 1996 18.0
Haiti 1982 10.0
Honduras 1976 12.0
Hungary 1988 25.0
Iceland 1990 24.5Indonesia 1985 10.0
Ireland 1972 21.0
Israel 1976 17.0
Italy 1973 19.0
Jamaica 1991 15.0
Japan 1989 5.0
Kazakhstan 1992 20.0
Kenya 1990 18.0
Korea 1977 10.0Kyrgyz Republic 1992 20.0Latvia 1992 18.0
Lithuania 1994 18.0
Luxembourg 1970 15.0Macedonia, FYR 2000 19.0
Madagascar 1994 20.0
Malawi 1989 20.0
Mali 1991 18.0
Malta
81995 15.0
Mauritania 1995 14.0
Mauritius 1998 10.0Mexico 1980 15.0
Moldova 1992 20.0
Mongolia 1998 13.0Morocco 1986 20.0Mozambique 1999 17.0
Namibia 2000 15.0
Nepal 1997 10.0
Netherlands 1969 17.5
Netherlands Antilles 1999 3.0
New Zealand 1986 12.5Nicaragua 1975 15.0
Niger 1986 17.0
Nigeria 1994 5.0Norway 1970 23.0Pakistan
91990 15.0
Panama 1977 5.0
Papua New Guinea 1999 10.0
Paraguay 1993 10.0
Peru 1973 18.0
Philippines 1988 10.0Poland 1993 22.0
Portugal 1986 17.0
Romania 1993 18.0
Russia Federation 1992 20.0WT/TF/COH/15
Page 17
VATs Rates2
(in present)
Date VAT Introduced Standard Rate
Rwanda 2001 15.0
Samoa 1994 10.0
Senegal 1980 20.0
Singapore 1994 3.0
Slovak Republic 1993 23.0
Slovenia 1999 19.0South Africa 1991 14.0
Spain 1986 16.0
Sri Lanka 1998 12.5Sudan 2000 10.0Sweden 1969 25.0
Switzerland 1995 7.5
Taiwan Province of China 1986 5.0
Tajikistan 1992 20.0
Tanzania 1998 20.0
Thailand 1992 10.0Togo 1995 18.0
Trinidad and Tobago 1990 15.0
Tunisia 1988 18.0Turkey 1985 16.0Turkmenistan 1992 20.0
Uganda 1996 17.0
Ukraine 1992 20.0
United Kingdom 1973 17.5Uruguay 1968 23.0
Uzbekistan 1992 20.0
Vanuatu 1998 12.5
Venezuela 1993 15.5
Vietnam 1999 10.0
Zambia 1995 17.5
Source:  Ebrill et. al., 2001
1/ As of April 2001. Revenue data are for most recent year available.
2/ Rates are in tax-exclusive form (i.e., specified as a proportion of the net of tax price).
3/ There are two thresholds in Bolivia: that shown is an income test. There is also a threshold
   of $3,270 in terms of assets.
4/ Tax exclusive rate (legislated tax inclusive rates are 9, 11, and 17 per cent, respectively).
5/ On interstate transactions the tax exclusive rates are 9.89 and 12.36 depending on the
    region. The VAT for intrastate transactions varies from stat to state, from a rate of
    7 −18 per cent (standard rate) to 25 per cent
6/ The threshold of $38,000 applies to retailers (from July 2001); that of $18,000 to
    manufacturers and listed services.
7/ For retailers.
8/ Malta repealed the VAT in 1997; it was reintroduced in January 1999.
9/ From July 1998 the GST was extended to the non-manufacturing sector above a threshold
     of $100,000.WT/TF/COH/15
Page 18
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