The sovereign power to tax.

Position:Proceedings of the One Hundred Second Annual Meeting of the American Society of International Law: The Politics of International Law - Discussion

This panel was convened at 9:00 a.m., Thursday, April 10, by its moderator, Sharon Yuan of Sidley Austin, who introduced the panelists: John Harrington, International Tax Counsel, U.S. Treasury Department; Pascal Saint-Amans of the OECD Centre for Tax Policy and Administration; Leslie Samuels of Cleary Gottlieb; and Thomas Walde of the University of Dundee. *


By Leslie B. Samuels ([dagger])

There is a long-standing tension between (i) tax policies and the administration of tax systems on one hand and (ii) the objective of trade and investment agreements to eliminate barriers to trade and investment on the other hand. Trade and tax officials approach the relationship between trade and tax issues from different perspectives.

Tax experts focus on developing tax policies and administrative rules to raise revenues in a fair and equitable way. Tax policies include defining the base on which taxes will be imposed. Internationally accepted income tax policies relate, inter alia, to the taxation of cross-border income flows, including withholding taxes on payments to non-residents. Administrative rules are designed to prevent the avoidance and evasion of taxes.

Trade experts focus on eliminating measures that can be viewed as distorting trade and investment. To prevent unjustified discrimination that can distort trade and investment, trade and investment agreements (such as the WTO's General Agreement on Trade in Services (GATS) and bilateral investment treaties (BITs)) seek to apply two fundamental principles:

(1) a state should not subject non-resident service providers or investors to measures less favorable than applied to its like service providers or investors (national treatment); and

(2) a state should not treat one country's service providers or investors less favorably than another country's (most-favored nation treatment).

The difficulty for tax and trade policy experts lies in balancing these fundamental trade and investment principles with the sovereign right to tax.

To put the discussion of balancing tax and trade objectives in context, some recent international arbitrations have limited the sovereign right to tax by declaring tax measures invalid under trade or investment agreements. The most notable example for the United States involved U.S. export incentives (the so-called FSC and ETI rules). These incentives for exports involved direct (income) tax measures, and were held by the WTO to be illegal export subsidies on trade in goods under the General Agreement on Tariffs and Trade (GATT). (1) As a result of these decisions, Congress repealed the offending tax provisions. One aspect to this long and tortured controversy is that rebates of indirect taxes (such as VAT) are not illegal under GATT. The frustration of tax writers in Congress with this GATT distinction between direct tax measures, which may be illegal, and indirect tax measures, which may be legal, is not surprising.

In addition to the United States' experience with international conflicts between tax measures and trade agreements, there is a long history of conflicts between tax and trade in the context of the U.S. federal system. For example, the federal courts have long construed the Constitution's Commerce Clause as limiting the states' tax powers where those tax powers unduly interfere with interstate commerce.

In Europe, direct taxes are now filtered through the lens of the free trade principles of the Treaty of Rome (a trade agreement). In particular, the European Union has seen an explosion of cases involving tax measures and the freedom of establishment. While the Treaty of Rome does not by its terms directly apply to direct taxes, the freedom of establishment provision (one of the four fundamental freedoms) has been broadly applied to direct tax measures. The evolution of the interaction of the freedom of establishment principle and the power to tax in the European Union is instructive to consideration of the proper balance between sovereign taxing rights and the principles of trade and investment agreements.

Other examples of tax measures being trumped by international agreements involve the treatment of tax measures as expropriations under certain BITs. BITs generally include a dispute resolution mechanism of binding arbitration that extends to determinations of whether tax measures are expropriations. Generally speaking, BITs can effectively override tax measures if the measures are considered expropriations. However, U.S. BITs have a carefully crafted tax carve-out. Many other countries have not taken as rigorous an approach to carving out taxes in their BITs, making it easier for tax measures to be challenged as illegal expropriations under those BITs.


During the negotiations of the GATS (2) in 1993, the interaction of tax and trade was a hot button issue. (For transparency, I was at the U.S. Treasury at that time and directly involved in the negotiations.) On one side of the debate were the trade experts who believe that tax measures should be subject to the filters and constraints of national treatment and most-favored nation treatment. They wanted relatively broad restraints on direct tax measures.

At the time, there was significant friction in the international tax community arising from conflicts between the United States and its trading partners, particularly the European Union countries. Some friction arose from the California Formulary Apportionment Tax system and an appeal by Barclays Bank to the U.S. Supreme Court in which Barclays asserted that the California unitary tax was unconstitutional. This was a very emotional issue and the United Kingdom was threatening a tax war if Barclays lost the case. (3) Also, the then-proposed U.S. transfer pricing rules were irritating the United States' trading partners. While a consensus eventually developed at the OECD on transfer pricing that is generally consistent with the U.S. proposed transfer pricing rules, in 1993, the international tax community was at loggerheads on this topic. In addition, certain "tax friendly" countries were unhappy with U.S. controlled foreign corporation rules and tax reporting requirements. Finally, the now-illegal U.S. tax incentives for exports were never far from the surface.

Given the frustrations over these U.S. tax policies, I believe that some European Union tax officials thought that they could bring the United States to heel by having the GATS limit, to some extent, U.S. tax sovereignty. (4)

On the U.S. side, the Treasury believed that if GATS applied broadly to direct tax measures, thereby restricting U.S. tax sovereignty, or if GATS was unclear in its application to taxes, Congress might not approve the Uruguay Round. As one would expect, the Congressional tax-writing committees are sensitive to any international agreement that...

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