3. Article III:4 of the GATT 1994
40. The United States appeals the Panel's finding that, by reason of its
"fair market value rule," the ETI Act accords less favourable treatment to
imported products than to like United States' products and is, therefore,
inconsistent with Article III:4 of the GATT 1994.
41. The United States recalls that the "no less favourable treatment"
standard under Article III:4 has been interpreted by panels and the
Appellate Body to require effective equality of opportunities between
imported products and domestic products. Since it applied an exclusively
de jure test in its analysis, the Panel could have found an inconsistency
with Article III:4 only if it demonstrated, in the text of the measure
itself, an "incontrovertible linkage between the text and the imported
products whose internal use allegedly is affected by the measure".41 The
United States considers that the Panel did not establish such a linkage.
42. The United States contends that an analysis under Article III:4 should
focus upon whether the measure in question is directed, on the one hand,
toward particular categories of imports or imports in general, or, on the
other hand, whether it is a measure of "general application". Unlike
measures in past cases involving Article III:4, the ETI Act focuses
entirely on income derived from property for use outside the United
States; within this general framework, the ETI Act establishes various
parameters and limitations on its application, one of which is the fair
market value rule.
43. The United States submits that in its analysis of the fair market
value rule, the Panel erroneously equated this rule with a domestic
content or domestic value-added requirement. This characterization is
"plainly incorrect"42 because the ETI Act does not refer to United States'
content nor does it predicate eligibility for the tax exclusion upon
manufacture in the United States. The United States emphasizes that, in
fact, the fair market value rule can be satisfied without any portion of
the fair market value of a product being derived from United States'
sources.
44. The United States argues that, in finding the fair market value rule
to be inconsistent with Article III:4 of the GATT 1994, the Panel failed
to establish a meaningful causal link between that rule and the alleged
discrimination against imports and improperly extended the findings of the
panel report in Canada – Certain Measures Affecting the Automotive
Industry ("Canada – Autos ")43 to a very different situation. Moreover, the
Panel ignored the findings of the Appellate Body in Korea – Measures
Affecting Imports of Fresh, Chilled and Frozen Beef ("Korea – Various
Measures on Beef ").44 Whereas in Korea – Various Measures on Beef, the
Appellate Body rejected speculative conclusions by the panel as to
possible competitive effects that might result from the differential
treatment established under the relevant measure and focused, instead, on
the actual effects of the measure, the Panel in this case employed similar
speculation in finding that the fair market value rule necessarily places
imported products at a comparative disadvantage vis-à-vis like domestic
products in the United States' market. The Panel unreasonably assumed that
despite the variety of ways in which qualifying foreign trade property
could be produced, producers would necessarily source their production in
the United States. The Panel compounded this flawed analysis by further
incorrectly assuming that, having decided to produce goods in the United
States, producers would inherently prefer using United States components
to imported components as a means of meeting the fair market value
requirement.
4. Withdrawal of the FSC Subsidies
45. The United States, finally, requests us to set aside the Panel's
finding that the ETI Act’s transition rules are inconsistent with the full
withdrawal of the FSC subsidies. Providing transitional relief is
customary in the United States (and in other countries) when tax laws upon
which taxpayers have relied in structuring transactions are changed. The
United States contends that failure to maintain a consistent practice of
transition relief would impose significant and unjustified additional
transaction costs on taxpayers.
B. Arguments of the European Communities – Appellee
1. Subsidies Contingent Upon Export under the SCM Agreement
(a) Article 1.1(a)(1)(ii): Revenue Foregone that is "Otherwise Due"
46. The European Communities considers that the United States' appeal does
not focus on the Panel’s reasoning on the existence of a financial
contribution within the meaning of Article 1 of the SCM Agreement, but
rather criticizes certain isolated elements of the Panel's findings and
responds to arguments which the Panel did not even make.
47. According to the European Communities, the Panel did not base its
conclusion on the notion that Section 61 of the IRC was the normative
benchmark, or say that any exception to it would be a subsidy. Rather, in
analyzing the ETI Act, the Panel looked at the "overall situation as an
integrated whole."45 In the view of the European Communities, the United
States is also wrong to criticize the Panel for distinguishing between
broad and specific exclusions, and for observing that even if income
attributable to foreign transactions might be a "category," the United
States is not in fact excluding all of that "category". The European
Communities similarly rejects the criticism by the United States that the
Panel wrongly created an "overall rationale and coherence corollary" to
the SCM Agreement. Rather, the Panel examined the "overall rationale and
coherence" of the ETI Act only after concluding that the ETI Act resulted
in the foregoing of revenue otherwise due.
48. In its response to the United States' additional written memorandum,
the European Communities considers that the United States is arguing that
the domestic tax rules against which the ETI Act must be assessed are the
rules that apportion income between domestic and foreign sources so that
each part can be taxed differently, and that the ETI Act operates as a
"rule of thumb" to achieve a result similar to that which would be
achieved under the normal United States' source rules. The European
Communities submits that the ETI Act benefits are nevertheless subsidies
when regarded as derogations from the source rules. The European
Communities also points out that the ETI Act source rules differ from
other source rules of the United States tax code and that taxpayers can
elect to their advantage which system to use on a case-by-case basis.
49. As to the alleged failure of the Panel to apply the "but for" test,
the European Communities recalls that, as the Appellate Body pointed out
in paragraph 91 of its original Report, the "but for" test is not treaty
language and could be easily circumvented by a Member through manipulation
of its tax system. In any case, the Panel did in fact apply the "but for"
test when it stated that, in the absence of the ETI Act, extraterritorial
income would be "gross income" and thus would be taxed.46 The European
Communities adds that even if there may be some cases where a taxpayer
could avoid paying some tax in the absence of the ETI Act, it is
nonetheless clear that the ETI Act shelters income from tax that would
otherwise (at least in many cases) be taxed.
(b) Article 3.1(a) of the SCM Agreement: Export Contingency
50. The European Communities submits that a subsidy contingent upon export
performance necessarily treats export sales better than domestic sales.
Such "better treatment" is the very rationale for prohibiting
export-contingent subsidies. The European Communities disputes the United
States' argument that the criteria set out in the ETI Act are "export
neutral" simply because there is an alternative to exporting for
qualifying for the tax exemption. The ETI Act embodies a bundle of two
sole contingencies for two categories of beneficiaries, each of which
stipulates a sole means to obtain the tax subsidy. For one of these
categories of beneficiaries, namely those producing goods within the
United States, it is necessary to export if they are to obtain the
subsidy. For a measure to be inconsistent with Article 3.1(a) of the SCM
Agreement, it is sufficient to demonstrate that in one, or in some cases,
the receipt of the subsidy is contingent upon export performance. The
European Communities insists that the prohibition of export-contingent
subsidies under Article 3.1(a) of the SCM Agreement is absolute and must
be respected in all cases.
51. The European Communities adds that the alleged "alternative" for
obtaining the ETI benefit, that is, the relocation of production abroad by
United States producers, is not one that realistically will be used. This
confirms that, in analyzing the Act, it is proper to focus on the
alternatives available for goods which have already been produced, or
continue to be produced, in the United States. In this context, the only
means for such producers to obtain the ETI tax benefit is to export such
goods.
52. The European Communities also agrees with the Panel's reasoning that
the former FSC measure cannot be cured merely by extending it to
non-export transactions. The Panel correctly found that, as regards the
measure at issue – the ETI Act – the only way to eliminate the export
contingency would be to extend the availability of the subsidy to include
domestic sales as well.
(c) Footnote 59 to the SCM Agreement: Double Taxation of Foreign-Source
Income
53. According to the European Communities, the Panel made clear that the
issue of burden of proof was academic and had no impact on the other
findings of the Panel, and that even if the European Communities bore the
burden of proving that the ETI Act did not fall within the scope of the
fifth sentence of footnote 59, it had discharged that burden. In any
event, the European Communities also agrees with the Panel’s finding on
the burden of proof relating to this issue.
54. The European Communities supports the view of the Panel that, although
it may not be possible to design a measure that "entirely, exclusively or
precisely" avoids double taxation and, therefore, such precision is not
required by the fifth sentence of footnote 59, a Member has nevertheless
an obligation to identify the type of income that may be subject to double
taxation and to approximate the boundaries of its measure to it. The
United States has made no attempt to do this. Rather, the United States
includes in the exempted category under the ETI Act income that could not
legitimately be taxed in another jurisdiction.
55. The European Communities contests the United States' claim that the
Panel has imposed a "permanent establishment" requirement as a necessary
feature of a double taxation measure. The Panel did not articulate any
such principle; indeed, it stated the opposite. The United States further
alleges that the Panel held that a country could not institute a measure
to avoid double taxation if it has an extensive system of bilateral tax
treaties. However, in the view of the European Communities, the Panel
merely considered relevant the fact that the ETI Act does not target those
situations where such bilateral agreements were not in place.
56. The European Communities also contends that the United States'
objection relating to the application of an alleged "reasonable
legislator" standard is without merit. The Panel did not apply any such
standard. Rather, the Panel considered whether the character of the ETI
Act as a measure to avoid the double taxation of foreign-source income was
"reasonably discernible". In the view of the European Communities, the
Panel’s test was legally correct and its assessment of the facts is beyond
the scope of appellate review.
57. With respect to the meaning of "foreign-source" income in the fifth
sentence of footnote 59, the European Communities observes that income
derives from economic activities. Therefore, foreign-source income means
income derived from foreign economic activities. "Income" is not the same
as "payment". The fact that a payment comes from abroad does not mean that
the income is generated abroad. The ETI Act, however, does not require
that the economic activities giving rise to the excluded income take place
abroad. Therefore, the definition of extraterritorial income in the ETI
Act bears no relation to the determination of foreign-source income, and
the ETI Act is not a measure falling within the scope of footnote 59.
Furthermore, the European Communities notes, the ETI Act is optional for
United States taxpayers, as they can choose between the ETI Act and the
other source rules of the IRC.
58. For all these reasons, the European Communities considers that the
Panel correctly found that the ETI Act is not a measure to avoid the
double taxation of foreign-source income and is therefore not covered by
the fifth sentence of footnote 59 to the SCM Agreement. It follows that
the Appellate Body need not reach the issue of footnote 5 to the SCM
Agreement. In any event, the European Communities does not consider that
the phrase "measures referred to in Annex I as not constituting export
subsidies" in footnote 5 includes measures falling within the scope of the
fifth sentence of footnote 59. Thus, footnote 5 to the SCM Agreement does
not assist the United States.
2. Export Subsidies under the Agreement on Agriculture
59. The European Communities notes that the United States' arguments under
the Agreement on Agriculture depend entirely on its arguments under the
SCM Agreement. Accordingly, the European Communities requests us to uphold
the Panel's finding under the Agreement on Agriculture for the same
reasons it has asked the Appellate Body to uphold the Panel's finding
under the SCM Agreement.
3. Article III:4 of the GATT 1994
60. The European Communities observes that the United States' appeal with
regard to Article III:4 of the GATT 1994 is limited to the Panel’s
interpretation of the terms "affecting" and "less favourable treatment"
within this provision. The word "affecting" has, since the inception of
GATT 1947, consistently been interpreted broadly, and was interpreted by
the Appellate Body in European Communities – Regime for the Importation,
Sale and Distribution of Bananas ("EC – Bananas III ")47 as meaning to "have
an effect on" the conditions of competition. The Panel applied the same
interpretation and correctly concluded that the fair market value rule
"affects" the use of imported products because it modifies the conditions
of competition between domestic and imported goods. Whereas use of
domestic "articles" will contribute to qualifying for the tax exemption,
the use of foreign "articles" will never do so.
61. Thus, the European Communities considers that the Panel correctly
found that less favourable treatment is accorded by reason of the fair
market value rule. All other conditions being equal, United States
producers will always have an incentive to use inputs of domestic origin.
In certain cases, due to the cost structure of their production, use of
domestic inputs will be necessary in order to obtain the tax benefit. The
European Communities agrees with the Panel that such an incentive is
sufficient to establish inconsistency with Article III:4 of the GATT 1994.
4. Withdrawal of the FSC Subsidies
62. The European Communities contends that the United States does not
address any of the Panel’s reasons or rely upon any provision of the
covered agreements in support of its appeal on this issue. The United
States' sole argument seems to be that transition rules are essential to
the orderly shift from one set of tax rules to another. The European
Communities responds that the findings in the original proceeding took
this fact into account and, in stipulating that the FSC subsidies must be
withdrawn at the latest with effect from 1 October 2000, allowed the
United States a grace period to introduce the required changes.
C. Claims of Error by the European Communities – Appellant
1. Article 10.3 of the DSU: Third Party Rights
63. The European Communities requests us to reverse the Panel's finding
that third parties are not entitled to receive all of the parties' written
submissions to the meeting of the Panel, but only the first written
submissions. The European Communities submits that Rule 9 of the Working
Procedures adopted by the Panel, and the Panel's subsequent denial of the
European Communities' request to change this rule, conflict with Article
10.3 of the DSU and the rights of third parties set out therein.
64. The European Communities recognizes that panels have a certain
discretion to establish their own working procedures. However, panels may
not derogate from binding provisions of the DSU. Article 10.3 provides
that third parties shall receive "the submissions"; it does not draw any
distinction between different types of submissions. Rule 9 of the Panel's
Working Procedures, and the practice in Article 21.5 proceedings of
requiring that only the first written submissions be provided to the third
parties, are also inconsistent with Article 10.1 of the DSU, which
requires panels "fully" to take into account the interests of Members,
including third parties.
65. Furthermore, the European Communities submits that the approach taken
by the Panel to third party rights in this case fails to ensure that third
parties will be fully informed about the arguments exchanged by the time
of the substantive panel meeting. The European Communities disagrees with
the Panel's conclusion that, since Article 10.3 of the DSU refers to the
"first meeting" of the panel and since panels "ordinarily" meet twice, the
DSU intends to limit third party access to the first written submissions
of the parties in all cases. Rather, Article 10.3 is intended to ensure
that third parties are familiar with the current state of the debate and
can meaningfully contribute to it. The European Communities observes that
nothing in the DSU requires a panel to hold two meetings and that Article
10.3 is drafted in general terms to be applicable in all cases, regardless
of how many meetings are held.
2. Conditional Appeals
66. Should we reverse the Panel's findings, the European Communities
requests us to address claims in respect of which the Panel exercised
judicial economy. The conditional appeals made by the European Communities
relate to the following claims that it made before the Panel:
(a) that the tax exemption accorded, under the ETI Act, to income earned
in transactions relating to goods produced outside the United States is
contrary to Article 3.1(a) of the SCM Agreement in that it is contingent
on export performance by virtue of the "fair market value rule";48
(b) that the ETI Act provides subsidies which are specifically related to
exports within the meaning of item (e) of the Illustrative List of Export
Subsidies in Annex I to the SCM Agreement;49
(c) that the "fair market value rule" in the ETI Act renders the subsidies
granted in respect of goods produced in the United States (and the
subsidies granted in respect of goods produced outside the United States
if they are not contrary to Article 3.1(a)), contingent upon the use of
United States' goods over imported goods, contrary to Article 3.1(b) of
the SCM Agreement;50 and
(d) that the United States, by failing to withdraw the FSC subsidies and
to comply with the rulings and recommendations of the DSB by the end of
the period of time allowed by the DSB, has also failed to comply with its
obligations under Article 21 of the DSU.51
67. The European Communities requests us to consider these claims only if
we reverse the findings which led the Panel to exercise judicial economy.
In such case, the European Communities refers us to the arguments made by
it before the Panel in respect of these claims.
D. Arguments of the United States – Appellee
1. Article 10.3 of the DSU: Third Party Rights
68. The United States claims that the Panel did not err when it declined
to find that the rights of third parties include access to the parties'
rebuttal submissions, and requests us to uphold the Panel's findings.
Article 10.3 of the DSU does not require that anything submitted by the
parties prior to the single meeting with the Panel must be made available
to third parties. Rather, the Panel correctly concluded that Article 10.3
presupposes a context where there is more than one panel meeting.
69. To the United States, Article 10.3 is ambiguous when considered in the
context of anything other than standard panel procedures. The Panel merely
construed an ambiguous provision in accordance with the principles of
Article 31 of the Vienna Convention on the Law of Treaties ("Vienna
Convention").52 The Appellate Body has held that the DSU, and in particular
its Appendix 3, leave panels a margin of discretion to deal with specific
situations that may arise in a particular case. In the view of the United
States, the Panel's decision in this case was reasonable and was well
within its margin of discretion.
2. Conditional Appeals
70. The United States submits that the conditions on which the European
Communities appeals the various remaining issues are unclear. The European
Communities states that the Appellate Body would need to consider them if
it reversed "any of the findings of the Panel on the claims that the Panel
did address."53 (emphasis added) However, the United States considers it
difficult to comprehend how the Appellate Body’s reversal of certain
findings would trigger a consideration of all of the claims identified by
the European Communities, because considerations of judicial economy would
continue to apply. Moreover, the Appellate Body's reversal of certain
findings by the Panel would be dispositive of one or more such claims.
71. With respect to each of the European Communities' claims, the United
States refers to the arguments made in its submissions to the Panel. With
respect to the European Communities' claims under Article 3.1(b) of the
SCM Agreement, the United States adds that the European Communities
erroneously alleges that Article 3.1(b) is violated if there is "even a
slight bias in favour of domestic goods"54 or if a contingency on the use of
domestic over imported goods "is not precluded."55 The United States recalls
that the European Communities advanced a similar standard in the Canada –
Autos56 case, and neither the panel nor the Appellate Body accepted it.
E. Arguments of the Third Participants
1. Australia
72. Australia agrees with the Panel's findings that the ETI Act provides
prohibited export subsidies contrary to Article 3.1(a) of the SCM
Agreement. Australia therefore requests us to uphold the Panel's
conclusions that the United States has not implemented the recommendations
and rulings of the DSB.
2. Canada
73. Canada asks us to sustain the Panel's findings under the SCM
Agreement. Under the United States tax rules, if income fails to qualify
as excluded extraterritorial income within the meaning of the ETI Act, it
remains subject to taxation. Accordingly, there is a foregoing of
government revenue otherwise due within the meaning of Article
1.1(a)(1)(ii) of the SCM Agreement. Canada also agrees with the findings
of the Panel that the subsidy is de jure contingent on export performance
by reason of the requirement in the ETI Act of use outside the United
States. Furthermore, the Panel correctly determined that "the parameters
of the ETI Act do not even roughly approximate the parameters of a measure
to avoid the double taxation of foreign-source income" 57; accordingly, the
ETI Act falls outside the scope of footnote 59. Finally, Canada requests
us to reverse the finding of the Panel that third parties are not entitled
to receive all the main parties’ submissions preceding a single panel
meeting.
3. India
74. India requests that we uphold the Panel's findings under the SCM
Agreement. The United States argues that when virtually any type of income
could be excluded from tax, such exclusion would form part of the
prevailing domestic standard for taxation, and would therefore not involve
the foregoing of revenue. According to India, such an interpretation would
render Article 1.1(a)(1)(ii) meaningless and would seriously undermine the WTO disciplines on subsidies.
75. India also considers that the Panel was correct in finding that the
ETI Act grants subsidies contingent upon export performance. While it
might be true that by expanding the scope of the subsidy, certain
non-exporting firms could qualify for tax benefits under the ETI Act, the
fact remains that United States-based producers must export in order to
obtain the subsidy.
76. India considers that for a measure to fall within the scope of
footnote 59, it is not sufficient that such a measure may incidentally
serve in a particular set of circumstances to avoid double taxation. If
this were so, any WTO Member could grant export subsidies and escape
sanction under WTO rules simply by declaring that its measures are
measures to avoid double taxation.
4. Japan
77. Japan believes that the Panel's findings under the SCM Agreement
should be upheld. The ETI Act excludes only a limited portion of a
potential category of foreign trade income from taxation and the narrow
character of this exclusion gives rise to the foregoing of revenue
otherwise due in terms of Article 1.1(a)(1)(ii) of the SCM Agreement. The
subsidy in this case is contingent upon export. Mere co-existence of one
class of activities eligible for benefits under the Act does not change
the status of the subsidy for the other class to which the benefits are
available only upon exportation.
78. Japan also requests us to uphold the Panel's finding that the ETI Act
is not a measure to avoid double taxation within the meaning of the fifth
sentence of footnote 59 to the SCM Agreement. The mere fact that some
income excluded from taxation under the Act may potentially be subject to
double taxation is not sufficient to make it a measure to "avoid the
double taxation of foreign-source income" within the meaning of footnote
59.
79. Japan recalls that a measure violates Article III:4 of the GATT 1994
when an imported product is accorded less favorable treatment than the
like domestic product. A measure can accord less favorable treatment even
where there are no specific legal requirements to use domestic goods.
Notwithstanding the fact that the ETI Act covers goods produced both
within and outside the United States, the scope of the exclusion permitted
under the ETI Act for United States-produced goods is wider than the
exclusion permitted for foreign-produced goods. In Japan's view, so long
as such disparity in treatment between imported products and domestic
products exists, Article III:4 of the GATT 1994 is violated.
IV. Issues Raised in this Appeal
80. This appeal raises the following issues:
(a) whether the Panel erred in finding, in paragraphs 8.30 and 8.43 of the
Panel Report, that the ETI measure – which is described in paragraphs
12-25 of this Report – involves the foregoing of revenue which is
"otherwise due" and thus gives rise to a "financial contribution" within
the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement;
(b) whether the Panel erred in finding, in paragraphs 8.75 and 9.1(a) of
the Panel Report, that the ETI measure includes subsidies "contingent …
upon export performance" within the meaning of Article 3.1(a) of the SCM
Agreement;
(c) whether the Panel erred in finding, in paragraphs 8.107 and 9.1(a) of
the Panel Report that the ETI measure, viewed as a whole, does not fall
within the scope of footnote 59 of the SCM Agreement as a measure taken to
avoid the double taxation of foreign-source income;
(d) whether the Panel erred in finding, in paragraphs 8.122 and 9.1(c) of
the Panel Report, that the ETI measure involves export subsidies
inconsistent with the United States' obligations under Articles 3.3, 8 and
10.1 of the Agreement on Agriculture;
(e) whether the Panel erred in finding, in paragraphs 8.158 and 9.1(d) of
the Panel Report, that the ETI measure is inconsistent with the United
States' obligations under Article III:4 of the GATT 1994 because it
accords less favourable treatment to imported products as compared with
like products of United States origin;
(f) whether the Panel erred in finding, in paragraphs 8.170 and 9.1(e) of
the Panel Report, that the United States has not fully withdrawn the
subsidies found, in
US – FSC, to be prohibited export subsidies under Article 3.1(a) of the
SCM Agreement, and in finding that the United States has, therefore,
failed to implement the recommendations and rulings of the DSB made
pursuant to Article 4.7 of the SCM Agreement; and
(g) whether the Panel erred in its interpretation of Article 10.3 of the
DSU in declining, in its decision of 21 February 2001, reproduced in
paragraph 6.3 of the Panel Report, to rule that all the written
submissions of the parties filed prior to the only meeting of the Panel
must be provided to the third parties.
V. Article 1.1 of the SCM Agreement: "Foregoing Revenue" that is
"Otherwise Due"
81. The Panel found that the ETI measure "results in the foregoing of
revenue which is 'otherwise due' and thus gives rise to a financial
contribution within the meaning of Article 1.1(a)(1)(ii) of the SCM
Agreement."58
82. In appealing this finding, the United States asserts that the Panel
misinterpreted and misapplied the applicable legal standard under Article
1.1(a)(1)(ii), and also mischaracterized the relevant provisions of the
IRC.59 The United States argues that the Panel failed to apply properly the
appropriate comparison, as outlined by the Appellate Body in US – FSC,
which involves comparing a contested tax measure against a "prevailing
domestic standard". According to the United States, the ETI measure
establishes a general rule of United States taxation whereby the income
excluded from taxation is "outside U.S. taxing jurisdiction".60 The United
States emphasizes that the ETI measure involves the allocation of income
from certain foreign sales transactions according to its source. The
allocation of such income into domestic and foreign portions, it states,
is "a longstanding normative principle of our system of taxation."61 The
United States argues that the ETI measure reformulates the method by which
the United States implements this principle, although still in a manner
that is consistent with this principle. In this connection, the United
States mentions that, traditionally, it has permitted the foreign portion
of income from certain foreign sales transactions to be allocated outside
the United States' taxing jurisdiction, and excluded from tax, through the
use of a foreign-incorporated subsidiary of a United States taxpayer.
83. Furthermore, according to the United States, a Member may exclude from
taxation a category of income, consistently with the SCM Agreement, even
if it does not exclude all of the income in that category. The United
States contends that when a particular category of income is excluded from
taxation, a Member may choose to exclude, for revenue and other policy
considerations, only a portion of that category of income.
84. The United States also contends that the Panel erred in its
identification of the relevant domestic standard because it misconstrued
the concept of "gross income" and ignored other provisions of the IRC that
are relevant to this dispute. Consequently, the Panel erred in finding
that, in the absence of the ETI measure, extraterritorial income would be
"gross income" and would be taxed. According to the United States, under
the IRC, "gross income" is the starting point for calculating taxable
income, but "gross income" by itself is not necessarily subject to tax
because a taxpayer can make "deductions " from it. The Panel thus erred in
determining that the prevailing rule of taxation in the United States is
that "gross income" is taxable.
85. Before turning to examine the Panel's finding under Article
1.1(a)(1)(ii), certain preliminary observations regarding the SCM
Agreement and Article 1.1 thereto should be made. Article 1.1 of the SCM
Agreement sets out a definition of a "subsidy" for the purposes of that
Agreement. Although this definition is central to the applicability and
operation of the remaining provisions of the Agreement, Article 1.1 itself
does not impose any obligation on Members with respect to the subsidies it
defines. It is the provisions of the SCM Agreement which follow Article 1,
such as Articles 3 and 5, which impose obligations on Members with respect
to subsidies falling within the definition set forth in Article 1.1. As we
said in our Report in Canada – Measures Affecting the Export of Civilian
Aircraft – Recourse by Brazil to Article 21.5 of the DSU ("Canada –
Aircraft (Article 21.5 – Brazil) "):
… the granting of a subsidy is not, in and of itself, prohibited under the
SCM Agreement. Nor does granting a "subsidy", without more, constitute an
inconsistency with that Agreement. The universe of subsidies is vast. Not
all subsidies are inconsistent with the SCM Agreement.62 (emphasis added)
86. In other words, Article 1.1 of the SCM Agreement does not prohibit a
Member from foregoing revenue that is otherwise due under its rules of
taxation, even if this also confers a benefit under Article 1.1(b) of the
SCM Agreement. However, if a Member's rules of taxation constitute or
provide a subsidy under Article 1.1, and this subsidy is specific under
Article 2, the Member must abide by the obligations set out in the SCM
Agreement with respect to that subsidy, including the obligation not to
"grant [] or maintain" any subsidy that is prohibited under Article 3 of
the Agreement. It was in this context that we said in our Report in US –
FSC, that, in principle, a Member is free not to tax any particular
category of income it wishes, even if this results in the grant of a
"subsidy" under Article 1.1 of the SCM Agreement, provided that the Member
respects its WTO obligations with respect to the subsidy.63
87. The issue we examine under Article 1.1 with respect to the disputed
measure is, therefore, a threshold issue that, by itself, does not
determine whether the United States has acted inconsistently with its
obligations under the SCM Agreement. With this in mind, we now turn to
examine Article 1.1(a)(1)(ii) of the SCM Agreement. Pursuant to this
provision, there is a "financial contribution by a government" where
"government revenue that is otherwise due is foregone or not collected".
We considered the meaning of this phrase in our Report in US – FSC, where
we stated:
… the "foregoing" of revenue "otherwise due" implies that less revenue has
been raised by the government than would have been raised in a different
situation, or, that is, "otherwise". Moreover, the word "foregone"
suggests that the government has given up an entitlement to raise revenue
that it could "otherwise" have raised. This cannot, however, be an
entitlement in the abstract, because governments, in theory, could tax all
revenues. There must, therefore, be some defined, normative benchmark
against which a comparison can be made between the revenue actually raised
and the revenue that would have been raised "otherwise". We, therefore,
agree with the Panel that the term "otherwise due" implies some kind of
comparison between the revenues due under the contested measure and
revenues that would be due in some other situation. We also agree with the
Panel that the basis of comparison must be the tax rules applied by the
Member in question. … What is "otherwise due", therefore, depends on the
rules of taxation that each Member, by its own choice, establishes for
itself.64 (italics in original, underlining added)
88. There are several elements in this statement that bear repeating. The
first is that, under Article 1.1(a)(1)(ii), a "financial contribution"
does not arise simply because a government does not raise revenue which it
could have raised. It is true that, from a fiscal perspective, where a
government chooses not to tax certain income, no revenue is "due" on that
income. However, although a government might, in a sense, be said to
"forego" revenue in this situation, this alone gives no indication as to
whether the revenue foregone was "otherwise due". In other words, the mere
fact that revenues are not "due" from a fiscal perspective does not
determine that the revenues are or are not "otherwise due" within the
meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.
89. A second element which emerges from our earlier Report is that the
treaty phrase "otherwise due" implies a comparison with a "defined,
normative benchmark". The purpose of this comparison is to distinguish
between situations where revenue foregone is "otherwise due" and
situations where such revenue is not "otherwise due". As Members, in
principle, have the sovereign authority to determine their own rules of
taxation, the comparison under Article 1.1(a)(1)(ii) of the SCM Agreement
must necessarily be between the rules of taxation contained in the
contested measure and other rules of taxation of the Member in question.
Such a comparison enables panels and the Appellate Body to reach an
objective conclusion, on the basis of the rules of taxation established by
a Member, by its own choice, as to whether the contested measure involves
the foregoing of revenue that would be due in some other situation or, in
the words of the SCM Agreement, "otherwise due".
90. In our Report in US – FSC, we recognized that it may be difficult to
identify the appropriate normative benchmark for comparison under Article
1.1(a)(1)(ii) because domestic rules of taxation are varied and complex.65
In identifying the appropriate benchmark for comparison, panels must
obviously ensure that they identify and examine fiscal situations which it
is legitimate to compare. In other words, there must be a rational basis
for comparing the fiscal treatment of the income subject to the contested
measure and the fiscal treatment of certain other income. In general
terms, in this comparison, like will be compared with like. For instance,
if the measure at issue involves income earned in sales transactions, it
might not be appropriate to compare the treatment of this income with
employment income.
91. In identifying the normative benchmark, there may be situations where
the measure at issue might be described as an "exception" to a "general"
rule of taxation. In such situations, it may be possible to apply a "but
for" test to examine the fiscal treatment of income absent the contested
measure. We do not, however, consider that Article 1.1(a)(1)(ii) always
requires panels to identify, with respect to any particular income, the
"general" rule of taxation prevailing in a Member. Given the variety and
complexity of domestic tax systems, it will usually be very difficult to
isolate a "general" rule of taxation and "exceptions" to that "general"
rule. Instead, we believe that panels should seek to compare the fiscal
treatment of legitimately comparable income to determine whether the
contested measure involves the foregoing of revenue which is "otherwise
due", in relation to the income in question.66
92. In addition, it is important to ensure that the examination under
Article 1.1(a)(1)(ii) involves a comparison of the fiscal treatment of the
relevant income for taxpayers in comparable situations. For instance, if
the measure at issue is concerned with the taxation of foreign-source
income in the hands of a domestic corporation, it might not be appropriate
to compare the measure with the fiscal treatment of such income in the
hands of a foreign corporation.
93. Against this background, we turn to the ETI measure. This measure lays
down rules of taxation for United States citizens and residents, including
both natural and legal persons. These rules also apply to foreign
corporations which elect to be treated, for tax purposes, as United States
corporations.67 The ETI measure permits these taxpayers to elect to have the
income they earn from certain transactions, involving certain property,
taxed according to the rules set forth in the measure.68 The property
involved must be "qualifying foreign trade property" ("QFTP"), which,
inter alia, must be "manufactured, produced, grown, or extracted within or
outside the United States" and must be held primarily for use "outside the
United States".69 The measure applies, inter alia, to income earned from
transactions involving the sale or lease of QFTP, and to income earned
through the performance of certain services, including the performance of
services "related and subsidiary" to the sale or lease of QFTP.70 However,
subject to limited exceptions, the measure applies to the income arising
in a transaction only if the transaction also satisfies the "foreign
economic process requirement" set out in Section 942(b) IRC. This
requirement will be satisfied, generally speaking, where at least some of
the activities comprising the transaction take place outside the United
States.
Continue on to: Article 94
Notes
41 United States' appellant's
submission, para. 253.
42
Ibid., para. 256.
43
Panel Report, WT/DS139/R, WT/DS142/R, adopted 19 June 2000, as modified by
the Appellate Body Report, WT/DS139/AB/R, WT/DS142/AB/R.
44
Appellate Body Report, WT/DS161/AB/R, WT/DS169/AB/R, adopted 10 January
2001.
45
Panel Report, para. 8.23.
46
Panel Report, para. 8.25.
47
Appellate Body Report, WT/DS27/AB/R, adopted 25 September 1997, DSR
1997:II, 591.
48
European Communities' first submission to the Panel, para. 119; Panel
Report, p. A-23.
49
Ibid., para. 158; p. A-29.
50
Ibid., paras. 183-184; p. A-34.
51
Ibid., para. 246; p. A-44.
52
Done at Vienna, 23 May 1969, 1155 U.N.T.S. 331; 8 International Legal
Materials 679.
53
European Communities' other appellant's submission, para. 4.
54
European Communities' second submission to the Panel, para. 160; Panel
Report, p. C-30.
55
European Communities' response to Question 35 posed by the Panel, para.
101; Panel Report,
p. F-17.
56
Panel Report, supra, footnote 43; Appellate Body Report, WT/DS139/AB/R,
WT/DS142/AB/R, adopted 19 June 2000.
57
Panel Report, para. 8.96.
58
Panel Report, para. 8.43. (footnote omitted)
59
We observe that the United States does not appeal the Panel's finding, in
paragraph 8.48 of the Panel Report, that the financial contribution it
found to exist under Article 1.1(a)(1)(ii) of the SCM Agreement confers a
"benefit" within the meaning of Article 1.1 of that Agreement.
60
United States' appellant's submission, para. 71. See also United States'
additional written memorandum, p. 4.
61
United States' additional written memorandum, p. 2.
62
Appellate Body Report, WT/DS70/AB/RW, adopted 4 August 2000, para. 47.
63 Supra, footnote 3, para. 90.
64
Appellate Body Report, supra, footnote 3, para. 90.
65
Appellate Body Report, supra, footnote 3, para. 91.
66
We recognize that a Member may have several rules for taxing comparable
income in different ways. For instance, one portion of a domestic
corporation's foreign-source income may not be subject to tax in any
circumstances; another portion of such income may always be subject to
tax; while a third portion may be subject to tax in some circumstances. In
such a situation, the outcome of the dispute would depend on which aspect
of the rules of taxation was challenged and on a detailed examination of
the relationship between the different rules of taxation. The examination
under Article 1.1(a)(1)(ii) of the SCM Agreement must be sufficiently
flexible to adjust to the complexities of a Member's domestic rules of
taxation.
67
Section 943(e) IRC. Thus, although the ETI measure applies to foreign
corporations, these corporations are deemed for these purposes to be
United States corporations and not foreign corporations. In our discussion
below, we treat these foreign corporations as United States corporations.
68
Section 942(a)(3) IRC. We have outlined the United States rules of
taxation, including the ETI measure, in Section II of this Report.
69
Qualifying foreign trade property is defined in Section 943(a)(1) and (2)
IRC, while Section 943(a)(3) and (4) identifies property that is excluded
from the definition.
70
The transactions giving rise to income covered by the measure are
described in Section 942(a)(1) IRC. We recall that we refer to sale and
lease transactions as a shorthand reference to the "sale, exchange or
other disposition" of QFTP, and to the "lease or rental" of this property.
See Section 942(a)(1)(A) and (B) IRC.