TAXATION AND THE CROSS-BORDER TRADE IN SERVICES: RETHINKING NON-DISCRIMINATION OBLIGATIONS.

• Author: Brown, Catherine A.

OVERVIEW I. BACKGROUND II. THE TAX CARVE-OUT IN TRADE AGREEMENTS A. The GATS B. Regional Trade Agreements 1. The North American Free Trade Agreement (NAFTA) 2. The Trans-Pacific Partnership Agreement (TPP) C. Bilateral Free Trade Agreements III. THE POTENTIAL FOR DISCRIMINATORY TAX TREATMENT IV. TAX TREATY REFORM V. WHY WOULD TAX TREATY PARTNERS AGREE TO AN EXPANDED NON-DISCRIMINATION OBLIGATION? VI. A MORE MODEST PROPOSAL CONCLUSIONS APPENDIX A: A PROPOSED NON-DISCRIMINATION OBLIGATION OVERVIEW

Limited disputes and general satisfaction with the current status quo led to the present underdeveloped doctrine of trade law as applied to tax measures. There is no escape from the conclusion that countries had not been concerned about the practice of protectionism through direct tax measures and therefore had not bothered with bringing direct tax issues to the table of trade negotiations. They were politically satisfied with the status quo of practical nonapplication of WTO law to direct tax measures. This state of affairs is likely to change.... (1) Significant commitments have been made in recent years to liberalize cross-border trade in services by reducing barriers to trade. These commitments include undertakings by signatory States to provide national treatment, most favored nation treatment, and a host of other commitments to such matters as transparency in legislation and administration designed to ensure the free movement of services and service providers across national borders. (2)

The potential benefit of these trade commitments to service providers is significantly undercut by broad exceptions in these agreements for direct taxation measures. (3) The oft-quoted reason for these exceptions, or "tax carve-outs," is that bilateral tax treaties address tax matters, including non-discrimination obligations. (4)

There is however, no non-discrimination obligation in tax treaties based on the Organisation for Economic Co-operation and Development (OECD), United Nations (U.N.), or U.S. Models that applies directly to a non-resident service provider absent a permanent establishment in the source State. (5) The result is that differences in tax treatment between a resident and a non-resident service provider are viewed as entirely permissible under tax treaties, including measures that may negatively impact the cross-border service provider's ability to compete in the source State. (6) Such measures might include aggressive interim withholding tax, high gross withholding tax, cumbersome administrative and compliance provisions, lack of transparency, excessive fees, and lengthy refund procedures. (7) These tax measures operate to exclude non-resident service suppliers from local markets or lessen their competitiveness in those markets contrary to trade law principles. Does this matter?

The cross-border trade in services is vital to both the U.S. economy and to global trade. Reports indicate that "[s]ince 2000, the value of US service exports has risen by more than 160 percent." (8) In 2016, services accounted for approximately one-third of all U.S. exports. (9) Internationally, the OECD reports that " [s]ervices generate more than two-thirds of gross domestic product (GDP) globally and create more new jobs than any other sector." (10) These are significant economic figures. (11)

Notwithstanding the importance of trade in services, tax measures imposed by a host government on a non-resident service provider remain largely unregulated by either tax or trade agreements. The result is that there are few limitations on a country's tax practices. Customary international law provides virtually no protection against tax discrimination, and constitutional or national limitations on tax discrimination against non-residents are rare. The primary restraint against egregious tax practices is international goodwill, (12) a restraint that has often proved ineffective.

Opportunities to engage in potentially discriminatory behavior also continue to expand. The United Nations Committee of Experts recently introduced a new article to the U.N. Model Tax Treaty that will operate to tax fees for technical services arising in a Contracting State, wherever performed, on a gross basis. There is no non-discrimination obligation that will apply to source State taxation measures under the treaty article. The new treaty article will most certainly create new opportunities for source State taxation.

This Article concludes that the potential for taxation measures to operate as a barrier to trade in services should not be underestimated. Tax treaties can play an important role in providing a minimum nondiscrimination obligation for tax measures impacting the cross-border trade in services. (13) This Article also concludes that a tax treaty is the optimal place for the non-discrimination obligation, given the trend in trade agreements since the General Agreement on Trade in Services (GATS) was signed in 1993 to restrict the resolution of disputes about key non-discrimination obligations in tax matters to the procedures in a tax treaty. (14) Because these disputes will generally arise based on a perceived violation of a trade non-discrimination obligation, a tax treaty non-discrimination obligation based on trade law principles is an obvious choice. A proposal for such a non-discrimination obligation is offered.

1. BACKGROUND

   The issue of whether a non-discrimination obligation should apply to tax measures that impact a non-resident service provider is not new. It initially surfaced as a trade law matter at the multilateral level in 1993 during the GATS negotiations. (15) Of the four proposed modes of supply (16) under the GATS, three potentially gave rise to taxation rights in the State in which the income from services was derived. (17) At issue was whether these taxation rights should be subject to the national treatment obligation. There are many reports of the ensuing debate and in particular the objection by the United States to according a non-resident service provider national treatment in tax matters. Among the United States' concerns was that if a national treatment obligation was included in the GATS, the dispute settlement procedures of the World Trade Organization (WTO) would apply in resolving complaints about a Member country's potentially discriminatory income tax practices. (18) The final WTO agreement adopted a compromise position. Direct tax measures were carved out of the national treatment obligation under the GATS as an exception, and the ability to challenge whether the national treatment obligation had been violated was restricted if the matter fell within the scope of a tax treaty. (19)

   This strategy to carve out tax measures in favor of tax treaties was also adopted and, in many cases, expanded by other regional trade agreements like the North American Free Trade Agreement (NAFTA), Agreement Establishing the ASEAN-Australia-New Zealand Free Trade Area (AANZFTA), (20) and most recently in the Trans-Pacific Partnership Agreement (TPP), (21) as well as in dozens of bilateral free trade agreements. (22) It is a precedent that trade negotiators appear determined to follow in trade agreements, at least with respect to the trade in services. (23) The result is a complex web of international agreements that result in difficult interpretation issues and inconsistent non-discrimination obligations in respect of the cross-border trade in services. Perhaps more importantly, the extensive web of international obligations in trade agreements leaves taxation as one of the last unregulated barriers to the cross-border trade in services.

   The following provides an overview of the non-discrimination obligations under the GATS, two regional trade agreements, select bilateral free trade agreements, and the tax carve-out from these obligations. The overview provides a stark picture of the extremely limited non-discrimination obligations that currently apply to tax measures that may impact a non-resident service supplier. It begins with the GATS.

2. THE TAX CARVE-OUT IN TRADE AGREEMENTS

   1. The GATS

      The GATS created a new standard for international trade in services. It applies to all measures by Members "affecting" all trade in services (24) and every possible mode of supply, including the cross-border supply and consumption of services, and the cross-border movement of service suppliers through the establishment of a commercial presence or in person. (25)

      Non-discrimination is one of the basic principles of the GATS, and the foundation for the most favored nation and national treatment obligations generally incorporated into trade agreements. The most favored nation obligation requires that a host country tax foreign-service providers from one country no less favorably than those from another. The national treatment obligation requires that the host country treat foreign-service providers and domestic-service providers similarly or comparably.

      Of no surprise, the most favored nation obligation is limited by the GATS, and preferential tax treatment of parties from one country over another is expressly authorized, provided it is the result of a tax treaty. (26) This is a sensible exception. Tax treaties are generally bilateral in nature, and the GATS exception serves to protect the bargain negotiated by the tax treaty partners.

      There is also an exception from the national treatment obligation as it relates to the tax treatment of services and service providers. (27) Specifically, any Member may adopt or enforce direct (28) tax measures that are inconsistent with national treatment, "provided that the difference in treatment is aimed at ensuring the equitable or effective imposition or collection of direct taxes in respect of services or service suppliers of other Member countries." (29) The meaning of the expression "equitable or effective" is defined in a footnote (30) that provides illustrations of taxes and tax policies that may be...