i%e University of Queensland Law Journal, Vol. 9, No. 2
151
Border Tax Adjustments in International Trade
J.C. PHILLIPS*
In the years subsequent to the Second World War the major obstacle to the
free flow of international trade was the protection of domestic industry by the
imposition of tariff barriers. A series of tariff conferences and, in particular, the
Kennedy Round of negotiations, saw a reduction in the existence of high tariff
barriers, but this development was accompanied by an increasing concern with
non-tariff obstacles to the free flow of trade.' One particular aspect of this
general problem which has given rise to considerable international debate is the
question of border tax adjustments in international trade.2
In the conduct of international trade it is necessary, in order to maintain free
competition, to ensure that goods exported from one country to another are not
subject to the same kinds of taxes in both countries and also that these goods d o
not escape taxation altogether.' The two obvious ways of avoiding these possible
situations of double taxation or non-taxation are either to subject the goods to
the taxes of the exporting country (the so-called "country of origin" principle)
or, alternatively, to the taxes of the importing country (the so-called "country of
destination" principle). Border tax adjustments may be regarded as "those
fiscal adjustments which are necessary to put into effect the destination prin~ i p l e " .Thus
~
border tax adjustments involve those measures which enable imported products to be charged with some or all of a tax charged in the importing
country on similar domestic products and which enable exported products to be
relieved of some or all of the tax charged in the exporting country on domestic
products.
The rules regarding border tax adjustments are embodied in the General
Agreement on Tariffs and Trade (GATT). A brief survey of these rules will suffice, as they have been expounded elsewhere in some detail.5 There is no single
section in the GATT dealing exclusively with border tax adjustments but the
GATT rules in this regard are found scattered through several Articles of the
Agreement, in particular, Article 11, Article 111 and Article XVI.6 Articles I1
and I11 cover the situation where there is an adjustment for tax in circumstances
in which goods are imported. Article I1 paragraph 1 lays down the general rule
*
M.A. (Cantab); Barrister-at-Law; Lecturer in Law University of Queensland.
1. A subject which has engendered copious literature in itself. See generally Wilson "Non-Tariff
Barriers to International Trade: A Survey of Current Problems" 18 J. of Public Law 403; G. &
V. Curzon "Hidden Barriers to International Trade" (Thomas Essay No. 1. Trade Policy
Research Centre, 1970); Lloyd "Non-Tariff Distortions of Australia Trade" (A.N.U. Press,
1973).
2. The two major source materials in this area are the publications: "Border Tax Adjustments
and Tax Structures in O.E.C.D. member countries" by the Organisation for Economic Cooperation & Development (O.E.C.D.) (hereafter referred to as the O.E.C.D. Report); and the
GATT Working Party Report on Border Tax Adjustments, (1970) GATT Doc. Spec. (70) 121
(hereafter called the GATT Report).
3. See the O.E.C.D. Report Part I para. 6.
4. Ibid.
5. See Leontiades "The Logic of Border Tax Adjustments" 19 Nat'l Tax J. 173 at pp. 173-175;
Malmgren "The Border Tax Problem: Tax Harmonization in Europe & U.S. business" XVII
Canadian Tax Journal 34 at pp. 34-36; the GATT Report op. cit. note 2 at pp. 12-20 (in
detail).
6 . Article VI, dealing with countervailing duties is dealt with below (in the text to which note 47
refers).
152
J. C. Phillips
forbidding the imposition of import charges above those agreed to under the
Agreement,' while paragraph 2 imposes the qualification that this general rule
will not be applicable when a tax is levied on an imported product in circumstances in which it only constitutes "a charge equivalent to an internal tax imposed [on a] like domestic product", provided that the charge is otherwise consistent with Article 111. Article 111 paragraph 2 then goes on to provide that the
internal taxes shall not be "in excess of those applied directly or indirectly to
like domestic products", thus ensuring that foreign goods are accorded the same
treatment as domestically produced goods. Article 111 paragraph 2, by referring
back to the principles of paragraph 1, also introduces the further stipulation that
"internal taxes should not be applied to imported or domestic products so as to
afford protection to domestic production". This later qualification has been interpreted as preventing a member country protecting domestic production by
exempting from tax a product produced domestically while imposing a tax on a
"directly competitive or substitutable productM8from abroad. It is clear both
from the negotiations leading to the formulation of Article 18 of the Havana
Charter from which Article I11 was derived and from GATT practice that these
provisions only allow the imposition of border taxes to compensate for internal
indirect taxes (whether turnover, value-added, sales or excise taxes) and not for
direct taxes (corporate income tax or other profits t a ~ e s ) . ~
The treatment of the question of border tax adjustments when goods are exported is embodied in Article X V I which is the GATT provision dealing with
the question of subsidies. In 1955 when the articles forbidding the introduction
of subsidies were added to Article XVI an interpretative note was approved
which expressly stated that a subsidy should be deemed not to exist when an exported product was exempt from "duties or taxes borne by the like product
when destined for domestic consumption"." The wording suggested that the exception only applied in relation to exemptions from indirect taxes rather than
direct taxes and this view was subsequently taken by the GATT Working Party
Report on Subsidies (1960).12
In sum, the present border tax rules as embodied in the GATT only render indirect taxes and not direct taxes eligible for border tax adjustments.13
The central theme of this article is threefold:(1) To explore the criticisms that have been voiced against the present system of
border tax adjustments.
(2) To investigate, in the light of these criticisms, what amendments, if any,
should be made to the provisions of the GATT rules regarding border adjustments as they now stand.
(3) T o assess the methods which a country may adopt unilaterally, without any
7. The negotiated tariff rates are contained in a series of schedules annexed to the Agreement and
make an integral part of Part 1 of the GATT. (Article I1 para. 7).
8. See annexed note to Article 111 para. 2. This, indeed, is theonly case where a tax conforming to
the requirements of the first sentence of Article 111 para. 2 would be held to be inconsistent
with the second.
9. The view of the sub-committee which drafted Article 18 of the Havana Charter was that:"Neither income taxes nor import duties fall within the scope of Article 18 which is concerned
only with internal taxes on goods" (Hearings on Trade Agreements System and Proposed
International Organization Charter Before the Senate Comm. on Finance 80th Cong. 1st Sess.
(1947)).
11. GATT, ad. Art. XVI, 278 U.N.T.S. 168. The note is based on Article 25 of the I.T.O. Charter.
12. GATT, B.I.S.D., Supp. 9, at 185-98 (1961).
13. See below for the difficulties arising from this broad classification. The question is dealt with in
Part B of the Article headed: "The lack of clarity and definitional problems in the GATT
rules".
Border Tax Adjustments in International Trade
153
international changes in the present rules, to counter what that country may
regard as injustices in the existing provisions.
In analysing the rules regarding border tax adjustments according to these
objectives it is convenient to present the discussion under the following
headings, which represent the major areas of debate and concern.
( A ) The Distinction Between Direct and Indirect Taxes. Criticisms and
Proposals
The GATT rules, as indicated above, make a distinction between indirect and
direct taxes, applying the destination principle to the former and the origin principle to the later. The working assumption upon which this distinction is based is
that indirect taxes will be very largely, if not completely, shifted forward to the
final consumer in the form of a price increase if the producer pays the tax or in
the form of a surcharge on sales if the tax is collected at the time of sale to the
consumer. The corrollary assumption is that direct taxes are completely absorbed by the producer or manufacturer who would not attempt to shift this tax
burden on to the consumer in the form of higher prices.
If these assumptions are correct, then it is strongly arguable that the GATT
rules do, indeed, ensure tax neutrality in international trade. The argument is
that without equalization charges on imported goods those imported goods
would be at a price advantage vis-a-vis home-produced goods to the extent
that the exporting country has a lesser rate of indirect taxation.I4 Conversely,
without tax rebates a country with a relatively high rate of indirect taxation
would be at a trade disadvantage in world markets relative to countries with a
lower rate of indirect taxation.15 Furthermore, it is suggested that, in the
absence of border tax adjustments, countries whose share of world markets were
insufficient to influence world prices would lack the freedom to impose indirect
taxes because their exports would then be uncompetitive.16 These arguments
provide the justification for the present GATT rules although it is, perhaps, to
be doubted whether the rules were consciously based on such economic
rationalisations. The correct view seems to be that the rules were merely a
codification of existing practices at the time of the drafting of the Havana
Charter.17
14. See Jung "The Border Tax Issue Defined" in Joint Economic Comm., 90th Cong. 1st Sess. Issues & Objective of U.S. Foreign Trade Policy 1, 31 Comm. Print, 1967); O.E.C.D. Report
Part 1 para. 121, and 122; Wonnacott "Tax Adjustments on International Traded Goods: in
U.S. International Economic Policy in an Interdependent world (The Williams Commission
Report) 1971 739 at p. 741.
15. Jung op. cit. note 14.
16. O.E.C.D. Report Part I1 para. 123. Notice also the additional argument proposed by Shoup,
to the effect that as the burden of indirect taxes fall on consumers and government services
primarily benefit consumers, these taxes should be bourne in the country in which the consumer
resides. (See Shoup "Indirect and Direct Taxes and Influences on International Trade" in
Compendium of Papers on Excise Tax Structure submitted to the C'tee on Ways and Means
(1964) (Vol.1) (U.S. Govt. Printing Office, Washington). But again this argument rests on the
assumption that the consumer bears the tax.
17. See Malmgren op. cit. note 5 at p.35; Leontiades op. cit. note 5 at p. 174. A point also made
emphatically by the GATT Report on Border Tax Adjustments (Interim Report of Meeting
18-20 June 1968) GATT Doc. L/3039 p. 9. As an example of such practice see the bilateral
trade agreement negotiated in 1936 between France and the United States. The wording of this
agreement was that "natural or manufactured products of the United States of America or of
the French Republic shall, after their importation into the other country, be exempt from all internal taxes, fees, charges or exactions other or higher than those payable on like products of
national origin or any other foreign origin".
154
J. C. Phillips
Clearly all these arguments in favour of adjusting taxes at the border for indirect taxes and not for direct taxes rest on the assumptions that indirect taxes
are shifted forward into prices and direct taxes are not. If these assumptions are
incorrect, however, it is possible to point to trade advantages for a country relying more heavily on indirect taxation. A simple illustration will indicate the
position. Let us suppose that Country A imposes a 10% sales tax or a tax on
value-added (V.A.T.). A domestic product which previously sold for $200 in the
domestic market would now sell for $220 if, and only if, the sales tax is fully
reflected in higher prices. However, if the tax is only shifted forward into prices
by 50%, then the final taxed price will rise only to $210. Yet the equivalent imported product (which previously had to sell at $200 in Country A's market in
order to be competitive) would still be taxed at a rate of 10% and would cost
$220 in the market of Country A.I8 What is happening here is that an import is
being subjected to a border tax which is greater than that which is necessary to
compensate for the price effect of a domestic tax on a domestic product, and
this is resulting in a trade advantage to the producer in Country A over goods
arriving in that country from overseas. Furthermore, in this example, since the
producer in Country A will now obtain a 10% rebate on exports he can now sell
abroad for $190, thus undercutting competitors in foreign markets when those
competitors are situated in countries which rely less heavily on indirect taxes.19
The exporter is receiving a rebate of an amount that is greater than the amount
by which the price of the product has increased as a result of the tax. The reverse
of this position is true in the case of direct taxes. If Country A introduced a corporate income tax and if there is some forward shifting of the income tax-so
that prices rise, for example, from $200 to $210-the producer in Country A is
at a disadvantage in relation to foreign competitors situated in countries where
there is heavier reliance on indirect taxation. The producer is. at a disadvantage
in his own market in Country A because it is not permissible to impose a border
tax adjustment to compensate for a price rise attributable to the income tax, and
also when he exports goods abroad because he will receive no rebate for any of
the income taxes he has paid.
The vital question, therefore, is whether the GATT assumptions regarding the
complete forward shifting of indirect taxes and the complete lack of shifting of
direct taxes are correct. Taking the issue of direct taxes first, the O.E.C.D.
Report on Border Tax Adjustments put the traditional economic rationalisation
for the forward shifting of direct taxes in these terms:"If producers were able to raise their profits after the tax they logically should have
done so before its imposition. In search for maximum profits prices will be pushed as
high as possible whatever the tax situation so that if a firm has been maximising its
profits, it should gain nothing by altering its price because the state claims a proportion of the maximised amount. Any change in price or output would decrease profits
before tax and therefore decrease profits after tax."20
However, this view has been vigorously challenged on the ground that it ignores the fact that the pricing policies of business concerns are not always
governed by the immediate maximisation of profits but by other considerations
such as gross sales and long-run rate of return.*' In these circumstances a rise,
18. That is, in the absence of a reduction of profits or a cut in production costs by the foreign
producer. See the discussion of this point generally in Wonnacott op, cit. note 14 at p. 743.
19. Another alternative is that even if those countries rely as heavily on indirect taxes, the taxes
may be fully shifted forward in those countries (see below in the text to which note 32 refers for
this possibility).
20. O.E.C.D. Report Part I1 para. 155.
21. Leontiades op. cit. note 5 at p. 176; O.E.C.D. Report Part I1 para. 156.
Border Tax Adjustments in International Trade
155
for example, in the rate of corporation tax may well result in a rise in prices
because the producer will want to ensure that he receives the same net profit
after tax as before the increase. It is also contended that this traditional
rationalisation for the GATT assumption ignores the fact that a corporate income tax may well make capital more difficult to obtain (especially if a high
rate of tax is imposed on distributed profits), and the difficulty of obtaining
capital will ultimately be reflected in higher prices.22Empirical studies on the
question are somewhat inconclusive, some studies indicating a full forward
shifting of direct taxes,23some partial shifting,24and some no forward shifting at
all.2iHowever, the view that commands the majority support is that direct taxes
are to some (undefined) extent shifted forward and represented in the final price
of the product, and the GATT assumption of the complete absence of forward
shifting of direct taxes cannot be regarded as tenable.26
A similar conclusion of partial shifting has been reached in relation t o the assumption regarding indirect taxes-that is, in the usual case indirect taxes are
~ ' extent to which the tax will
only partially shifted forward to the c o n ~ u m e r . The
be shifted forward is considered to be dependent upon a series of variable
economic factors such as the demand for the product (the greater the demand
the more likely shifting is to take place), the type of tax,28the rate of tax (the
smaller the rate the more likely it will be that consumers will be prepared to absorb it without reducing their demand),19 and the government's monetary and
fiscal policies.30Indeed, on one view, the likelihood of a large portion of the tax
being shifted forward is regarded as being "very light".^'
It is apparent, therefore, that the assumptions implicit in the GATT rules are
wrong or, at least, highly suspect with the result that countries like the U.S.A.
and Australia relying largely on direct taxation as a form of revenue regard
themselves at a trade disadvantage in relation to countries in Europe relying
more heavily on indirect taxation. The question is what possible avenues can be
explored to correct this apparent inequality. One possibility would be to press
for a change in the GATT rules. The suggestion has taken two forms.
The first of these is that there should be an amendment of GATT rules t o permit adjustments for direct taxes. If the above conclusion regarding the partial
shifting of direct taxes is correct, and an increase in those direct taxes does have
an adverse effect on a country's international competitive position, then it is
arguable that there should be partial compensation at the border for those direct
A view submitted to the GATT Working Party Report on Border Tax Adjustments (Interim
Report of meetings 23-25 April, 30th June to 3rd July 1969) GATT Doc. L/3272 at p. 13. Also
see O.E.C.D. Report Part I1 para. 168.
M . Krzyzuniak and R.A. Musgrave, "The Incidence of Corporation Tax" (John Hopkins
Press, (1963)).
Slitor, "Corporate Tax Incidence: Economic Adjustments to Differentials Under a Two Tier
Structure". Paper submitted to a symposium on business taxation at Wayne State University
(1964).
Challis Hall, "The Incidence of Corporation Income Tax" Am.Ec.Rev. May 1968, p.90; The
Report of the Committee on Turnover taxes, H.M.S.O., Cmnd. 2300, 1964 (the Richardson
Report). The conclusions of the Richardson Report however, were based on what business said
happens, and these conclusions have been criticised on the basis that this is not what actually
happens.
See Malmgren op.cit. note 5 at p.38; Leontiades op.cit. note 5 at pp. 176-178.
Leontiades op.cit. note 5 at pp. 174-5; Rosendahl "Border Tax Adjustments" Law & Pol. Int'l
Bus. Vo1.2 p.95 at pp.116-117. p.109 (the Richardson Committee Report (op.cit. note 25)).
This is returned to later (in the text to which note 37 refers).
See on this point the O.E.C.D. Report Part I1 para. 146.
For a closer analysis of these factors see the O.E.C.D. Report Part I1 para.'s 141-8.
Interim GATT Report op.cit. note 22 at p. 11.
J. C. Phillips
taxes. However, apart from the obvious difficulties of persuading the European
countries of the inequitable nature of the present rules, such a proposal would
create a number of difficult problems.
Firstly, there is the problem of ascertaining the amount of the adjustment.
Not only is there the same problem that exists in the case of indirect taxes of
calculating the amount of tax which is shifted forward, but there is the additional problem of determining how much tax is being imposed on a particular
product in the first place. This arises from the fact that the major type of direct
tax-the income tax-is a tax on gross profits, and it will not be known what tax
burden is being imposed on a particular product. Another uncertainty arising
from the fact that the tax is imposed on profits is that the tax incidence on a
given product in an organisation producing little profit will be less than in a firm
producing large profits. The end result of these particular difficulties would be
that there would have to be some latitude in arriving at average adjustments,
and the charges of overcompensation which formerly arose when adjustments
were made for the European Cascade taxes would not doubt be revived.
Secondly, it is by no means clear that profits taxes in different countries are
likely to be shifted forwards to even the same approximate extent. In 1964, a
meeting of O.E.C.D. Economists in Europe concluded that "the tendency [for
tax shifting of direct taxes] is more likely in the United States than E ~ r o p e . " ~ ~
The O.E.C.D. Report on Border Tax Adjustments commented on the resulting
difficulties if this conclusion is correct:If there are extreme differences in degrees of shifting as between profits taxes in different countries, it becomes difficult to find economic justification for any rule to be
applied to profits taxes as such. Thus, on the extreme assumption that in Country A
corporation tax is shifted forwards 100 per cent and Country B's tax does not affect
prices, the application of the principle of origin to profits taxes would result in a hidden tax on Country A's exports while the application of the principle of destination to
profits taxes would result in a hidden subsidy to Country B's exports (with, of course,
corresponding effects on the import side). In such circumstances neutrality would require that the corporation tax of Country A were made eligible for border adjustments while Country B's corporation tax remained ineligible, but this would require
the application of new criteria to determine eligibility and it is difficult to see what
these could be.33
Finally, any change in the GATT rules to allow partial adjustment for direct
taxes would allow all countries to make such adjustments for direct taxes, and
the European countries have high rates of direct taxation as well as indirect taxation. Thus those countries who rely primarily on direct forms of taxation may
well be no better off vis-a-vis the European countries if adjustment was to take
place for such taxes. In order to counter this likely occurrence of the European
countries compensating fully for their own direct taxes, it has been suggested
that some limit should be established for direct taxes alone.J4However, since
this suggestion blatantly favours those countries not currently employing major
border tax adjustments, it would be regarded with great disfavour by the European countries and would have little prospect of adoption.
The second suggested change in the GATT rules, which is inevitably linked
with the previous proposal, is that border tax adjustments for indirect taxes
32. Gordon, Director of International Affairs, U.S. Treasury in remarks before the annual
Conference of the National Tax Association, New Orleans, 1965, (quoted in Leontiades op.cit.
note 5 at pp.174-5).
33. O.E.C.D. Report Part I1 para. 169.
34. Malmgren op.cit. note 5 at p.40.
Border Tax Adjustments in International Trade
157
should only be allowed to the extent that those taxes are actually shifted forward
into the final price of the product.j5 This idea would appear impractical in so far
as it suggests that every time an indirect tax is imposed or raised, the precise
degree of shifting should be ascertained and adjustments made accordingly.
There would, in any case, be little likelihood of any agreement on the precise extent of shifting in any particular case. However, the suggestion has taken the
modified form that a broad assessment of the degree of shifting may be made
according to the type of tax involved.j6 Thus, it is alleged that the V.A.T. is less
likely to be shifted forward than a simple retail tax because it is levied at each
stage before the product reaches the final consumer and will tend to be absorbed
more than a tax imposed at only the final stage.'' It is, however, to be doubted
whether one type of tax is inherently more likely to be shifted forward than
another, and most economic observers take the view that the degree of shifting
depends on a host of variable economic factors (discussed above)'%nd not on
the sole criterion of the articular tvPe of tax involved. It should also be noted
that those who favour th'e present riies argue that even where indirect taxes are
not fully shifted forward those taxes should still be fully compensated on the
basis that the usual reason for the fact that there is only partial shifting is that
the domestic producer is prepared to take a lower profit than previously and
"the foreign producer should also take an equivalent cut in his profit"."
In summary, there is no doubt that any amendment of the G A T T rules either
to permit adjustments for direct taxes or to limit adjustment for indirect taxes to
the extent that they are shifted forward is fraught with difficulties, both of
political and practical nature. Although amendments along these lines must be
considered as extremely unlikely to take place, the United States, in particular,
has continued to seek changes in the GATT rules. This is apparent from the
Trade Act, 1974, which directs the President to take such action as may be
necessary to secure "the revision of G A T T articles with respect to the treatment
of border adjustments for internal taxes to redress the disadvantage to countries
relying primarily on direct rather than indirect taxes for revenue needs."""
If a change in the GATT rules along these lines proves to be impossible then
an alternative, albeit unilateral, response is for countries with largely direct tax
structures to replace their corporate income taxes with indirect taxes. In particular, the replacement of corporation tax with a V.A.T. has been mooted in
this regard." The purported advantage from this change would be that under the
GATT rules the full amount of V.A.T. would be adjustable, whether fully
shifted or not, and if, in fact, only partial shifting took place then a trade advantage would result. Furthermore, if income taxes are shifted forwards into prices,
the disappearance of those income taxes should lower prices to the degree that
such shifting takes place.
However, there is some evidence to suggest that this desired result is not in36. Leontiades op.cit. note 5 at pp. 181-2; Weathers, "Some Implications of the GATT Rules
Governing the Treatment of Domestic Taxes in International Trade: The Case of Germany
since the Currency Reform of 1948" (1970) 23 Nat'l Tax J . 102 at p.ll 1.
37. O.E.C.D. Report Part I1 para.145 (and also in that para. the arguments against this view).
38. See text to which note 28 refers.
39. See this view submitted to the GATT Working Party (Interim Report) op.cit. note 22 at p.12
para.9.
40. See Section 121(a) (5) (steps to be taken towards GATT revisions; authorisation of appropriations for GATT).
41. See Wonnacott op.cit. note 14 at p.751. For a full description of V.A.T. in Europe see Surrey,
"Implications of Tax Harmonization in the European Common Market Taxes (June 1968)
p.398, especially at pp.399-341.
J. C. Phillips
variably achieved. A possibility is that prices may rise by the full amount of the
V.A.T. with business enterprises simply raising prices to reflect the full rate of
V.A.T. and not taking into account the corresponding reduction of corporate income tax. This merely emphasises the point that full shifting of indirect taxes
may take place in certain circumstances. Evidence of this kind of possibility is
afforded by the events occurring after the change to the V.A.T. from the turnover tax in Holland. In relation to the Dutch case of O.E.C.D. Economic and
Development Review Committee stated that most traders in anticipation that
most prices would have to go up anyway as a result of the V.A.T. concluded that
"this would produce a climate in which they could correct old price lags and
redress the income balance in their favour."" Although the Dutch experience
should not be assumed to be the normal case-there, in fact, no apparent trade
advantages occurred-it has been strongly, although not unanimously, held
among economic commentators that the trade advantages of a change to an indirect tax structure or a rise in indirect taxes is in the general situation likely to
be short-lived." This is based on the view that as the trade surplus builds up the
money supply will increase (if the monetary authorities take no action) causing
domestic economic activity and prices to increase. As prices rise the export advantage and the tariff protective effects of the tax and the border tax adjustments will be lost. Indeed, the fact that the trade advantages arising from an extension of indirect taxation are short-lived is one of the arguments put forward
by those who continue to support the present GATT ru1esed4
The case for the introduction of the V.A.T. in place of corporate income tax
on the ground of trade advantages is thus not clear cut, and questions of
domestic policy are likely to be the major factors in influencing any change.
These matters have been extensively debated elsewheredSbut, suffice to say here
that the V.A.T. has been strenuously condemned as an alternative to corporate
income tax in the United States because it involves "substituting a progressive
tax for a regressive one"46 and because it involves serious administrative complexities.
In the absence of a major tax change of this kind to take advantage of the present rules regarding border tax adjustments one other course of action is possible for direct tax countries, although it would certainly prove to be a controversial one. Consideration might be given to the imposition of countervailing duties
when it is considered that tax export rebates exceed domestic tax burdens on
like products because the indirect taxes applied to those domestic products have
not been fully shifted forward into prices. An argument has been put forward
that this can be legally done within the present Article VI of GATT. The substance of Article VI is that no countervailing duty shall be levied on goods ex42. O.E.C.D., Netherlands (Economic Survey). (April, 1970) p. 16. The view of the Economic
Committee is bourne out by the evidence submitted to the GATT Working Party Report on
Border Tax Adjustments (Interim Report) (op.cit, note 21) by the Dutch Government (at p.8
para.27). See also the Finnish submission p.7 para.25. Although the example concerns the effect of a change from a turnover tax to a V.A.T., it is also probably instructive of the possible
effects of a change from a income tax to a V.A.T.
43. See, for example, the Report to the Committee on Finance (U.S. Senate) by the U.S. Tariff
Commission Part 2 at p.56; Baldwin "Non-Tariff Distortions of International Trade" (The
Brookings Institute, 1970) Chapter 4, cf. however; Pelican "Border Taxes and the GATT" in
the Williams Commission Report (op.cit. note 14) p.765 at p.770-71.
44. See the GATT Working Party Report on Border Tax Adjustments (Interim Report) (op.cit.
note 22) at p.12 para.'s 38-39 for an expression of this view.
45. See generally Surrey op.cit. note 41 for a general discussion of these issues.
46. Surrey op.cit. note 41 at p.12.
Border Tax Adjustments in International Trade
159
ported from a contracting party "by reason of the exemption of such product
from duties or taxes bourne by the like product when destined for consumption
in the country of origin or exportation". The argument is that in situations in
which taxes are not shifted forward into the final price of the product, the taxes
are not "bourne" by the product at all, but by the p r ~ d u c e r . ~To
' this extent the
full rebate or the exemption of such taxes would constitute a subsidy under the
GATT definition and thus the imposition of countervailing duties would be
legally justified. In Australia such an argument would enable countervailing
duties to be imposed without inconsistency to GATT obligations under the
Customs Tariff (Anti-Dumping Act) 1975 (Cmth). Indeed, that Act requires
that the Minister shall not impose countervailing duties unless he is satisfied the
introduction of such duties "are not inconsistent with the obligations of
Australia under any international agreement relating to tariffs and trade"." It is
significant to note that in the United States the Treasury Department has taken
the position that it is legally possible to impose countervailing duties to the extent that the tax has not been fully reflected in the price of the product in
question.49
However, the most serious objection to this proposal would be the difficulty
of ascertaining with any degree of precision the extent of over-compensation in
any given case and the possibility of repercussions in the form of other countries
imposing neutralising countervailing duties. Furthermore, the application of
countervailing duties is only a limited course of action since it does not deal with
the situation of excessive import charges and does not affect the position that no
adjustment can be made for direct taxes under the present rules.
In conclusion t o this section, there is no doubt that there is some evidence to
suggest that the present GATT assumptions regarding the full forward shifting
of indirect taxes and the complete lack of shifting of direct taxes are wrong.
However, because of the difficulties outlined in the text no amendment of the
GATT rules seems likely. This leaves open the two unilateral responses of a
"direct tax" country replacing a corporate income tax with a V.A.T., or the imposition of countervailing duties. Yet it is instructive that no major country has
yet replaced a corporate income tax with a V.A.T., and the use of countervailing
duties in circumstances where it is felt that indirect taxes may not have been
fully shifted into prices has been insubstantial.!'
( B ) The Lack of Clarity and Definitional Problems in the GATT Rules
Apart from the question of the challenge to the rationale of the GATT rules
as discussed in Section A, the rules in their present form may be criticised for
their lack of clarity.
The first respect is which this lack of precision is apparent is in the broad distinction the GATT rules make between taxes bourne by or applied to products
(i.e., indirect taxes) and direct taxes. This has left open the argument in certain
cases as to whether a particular tax is indirect and therefore eligible for border
tax adjustments, or not.
47. Rosendahl op.cit. note 27 at p.120.
48. Section 14.
49. See on this point Butler "Countervailing Duties and Export Subsidization: Re-emerging issue
in International Trade" 9 Va. Journal of Int. Law (1968) 82, at p. 119-20. See also Feller
"Mutiny Against the Bounty: An Examination of Subsidies, Border Tax Adjustments and the
Resurgence of Countervailing Duty Law". Vol. 1 Law and Policy in International Business
(1969) 17.
50. The U.S.A.has, however, attacked Italy's border tax rebate of taxes occulte under its countervailing duty statute.
160
J. C. Phillips
The major dispute in this regard has centred upon the eligibility of the tax occulte, which may be defined as that element of tax used in the production or
transportation of the finished product (e.g., a tax on fuel or capital equipment)."
Article 111 of the GATT allows import charges to be applied directly or indirectly to like domestic products. Although "indirectly" was apparently intended to
cover taxes not levied on the product itself but on the processing of the
certain proposals before GATT have suggested that this provision
should be interpreted to permit border tax adjustments for tax occulte. Thus
Germany suggested that an interpretative note should make it plain that Article
I11 para. 2 should be construed "to denote the overall charge, including the
charges bourne by like domestic products through being subjected to internal
taxes or other internal charges at various stages of production (charges bourne
by the raw materials, semi-finished products, auxiliary materials etc., incorporated in, and by the power consumed for the production of the finished
products)". No interpretative not to GATT was recommended, however, and
the question remains undecided. However, the dominant view, recently supported by the GATT Secretariat," is that tax occulte is not eligible for border
tax adjustment. One suggestion in the United States is that the U.S.A. should
make adjustments for tax occulteS4and, in particular, its state petrol taxes, possibly on the lines of the former export rebate scheme in the United K i n g d ~ m . ~ ~
Apart from the question of the legality of this course of action, this approach
would open the way for those countries who do not at present adjust for tax occulte to do the same.S6
Debate at one time also centred on whether the V.A.T. was eligible for border
tax adjustments. It was argued that the V.A.T. could be regarded as a tax levied
on profits (and, therefore, a direct tax) because the tax is based on the differences between the amount of a firm's purchases and sales-an amount which,
therefore, will include costs as well as profit^.^' Furthermore, it was argued that
the tax is levied on producers rather than products.58However, these arguments
have been successfully c o ~ n t e r e d ,and
~ ~ the V.A.T. was assumed by both the
O.E.C.D. Report6O and the GATT Working Party Report on Border Tax adjustments6' to be eligible for adjustment. Nevertheless, there remain doubts over
the eligibility of other taxes-for example property taxes, and employers and
employees contributions to social security. The O.E.C.D. Report described
these, somewhat vaguely, as "not normally"62 eligible for border tax adjustment.
Another area where the GATT rules lack clarity and direction is the failure to
specify in the GATT rules the basis of valuation for the assessment of border tax
adjustments. The current practice is to include any customs duty in the value on
which tax is charged on imported goods.63It is arguable that this method of ley51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
61.
62.
63.
For a full definition see O.E.C.D. Report Part I para.19.
See the GATT Interim Report (op.cit. note 22) at p.3 for this view.
The GATT Report (op.cit. note 2) at p.19 para.35.
Surrey op.cit. note 38 at pp.409- 10.
Described in detail in the O.E.C.D. Report Part 111 p.57-59.
It has been estimated that this might well put the United States in a worse position because of
the high rates of tax occulte in European countries.
Rosendahl op.cit. note 27 at p.115.
Leontiades op.cit. note 2 at p.179.
See generally Rosendahl op.cit. note 27 at p.115.
O.E.C.D. Report Part I1 para. 117.
GATT Working Party Report (op.cit. note 2) p.3-4 para.14.
O.E.C.D. Report Part I1 para.119.
O.E.C.D. Report Part I para.35. This was also indicated by the national submissions made to
the G A T T Working ~ e ~ oonr tBorder Tax Adjustments (see GATT Doc. L/3389, especially
the Dutch. Norwegian, and Swedish submission).
Border Tax Adjustments in International Trade
161
ing import adjustments is at variance with the philosophy behind the imposition
of border tax adjustments which are supposed to compensate only for taxes on
domestic products, which bear no customs duty. The rationale for the inclusion
of customs duty in the tax base of imported products given by the O.E.C.D.
Report is that, while customs duty may not have been payable on home
produced products, duty may have been paid on the components of such
products and the tax base of the home product will, therefore, include the
customs duty paid on these components." However, imported components will
not necessarily, or even usually, form part of home-produced products. The
other reason given by the O.E.C.D. Report is that sales taxes are usually paid
after the importation stage, and it is, therefore, convenient to include customs
duty in the tax base.6sYet this is a reason based totally on considerations of expediency. It is suggested that it would be more in accord with the philosophy of
border tax adjustments if the tax base for the imposition of border taxes did not
include customs duty.
( C ) Border Tax Adjustments and a Balance-of-Payments Surplus
Under the G A T T rules only a change in indirect taxes or the discovery of
previous undercompensation for existing indirect taxes determine whether
border tax adjustments may be increased. If, as indicated, an increase in indirect
taxes does improve a country's trade position, albeit only in the short term, then
it is possible for a country which is already in a strong balance-of-payment's
position to further strengthen its economic situation by increasing indirect taxes
and introducing compensatory border tax adjustments. A similar situation to
this did in fact occur when the German Government at the beginning of 1968
replaced its turnover tax by a value added tax because the previous undercompensation at the border which had occurred under the turnover tax6%as
elemented by the border adjustment of the full rate of the V.A.T.6'
In view of this possibility it has been proposed that new GATT rules as to
border tax adjustments be devised whereby a country's balance-of-payments
position should be taken into account in changing border tax adjustments. Thus
a country in a strong balance-of-payments position would not be allowed to
raise its border adjustment even though it raised indirect taxes. These changes
would be postponed until a deficit situation emerged.@
The proposal has been taken further to suggest that countries which had a
balance-of-payments surplus would be put under an immediate obligation to introduce under-compensation a t the border for existing indirect taxes.68a The
reverse would apply and a country with a balance-of-payments deficit would be
entitled to impose special border tax adjustments in excess of those stricly allowable under the present GATT rules. A change in the GATT rules would, of
course, be necessary to allow border tax adjustments to be used to remedy a
deficit in a country's balance of payments position. The United States has pressed for such a change and the Trade Act, 1974, has directed the President to
64. O.E.C.D. Report Part 1 para.35.
65. Ibid.
66. The O.E.C.D. Report concluded there was under-compensation under the turnover tax. Part 11
para.61.
67. See generally on the change Weathers op.cit. note 36.
68. Baldwin op.cit. note 43 at p. 100 (But in his view this is only a stop gap proposal pending the introduction of Flexible exchange rates). The proposal was submitted to the GATT Working
Party Report (op.cit. note 2) at p.7 para.26.
68a. Rosendahl op.cit. note 27 at p.133.
J. C. Phillips
secure a change in the G A T T rules to enable import surcharges to be used by industrialised countries to handle balance-of-payments deficits. These proposals,
in fact, amount to using border tax adjustments as an exchange rate mechanism.
The German Government did adopt this approach in 1968, when there was
growing criticism from abroad of Germany's refusal to appreciate the value of
the mark. Germany decided on the alternative course of action of subsidizing
imports and imposing a tax on exports although in the German case the mark
was eventually re-valued.
However, some fairly obvious objections to these proposals have been indicated. Firstly, it is thought that there might well be some difficulty in persuading countries in a strong balance-of-payments position to not fully compensate in their border tax adjustments. In an effort to provide some form of coercion to such countries to under-compensate in their border tax adjustments it
has been suggested that the Articles of the International Monetary Fund could
be changed so that if a country in a strong balance-of-payments position does
not take steps to reduce its surplus, the debts attributable to the surplus might
after a given period of time be cancelled
Secondly, some danger is
seen in the fact that since the application of border tax adjustments is relatively
easy on the import side-they could simply be added to those charges presently
administered by customs officials-there would be a likelihood of abuse by
~
it is thought that the use of border tax adjustments as
deficit c o ~ n t r i e s . 'Finally,
a monetary exhange mechanism would suffer from the defect that the adjustments would not be applied in a uniform manner to all commodities because "it
would be impossible in practice to resist the temptation to differentiate between
different categories of imports"." Discrimination in international trade would
be the result.
In view of these difficulties there seems little likelihood of a change in the
G A T T rules being made to relate border tax adjustments to balance-of-payment
needs. A related idea that stands even less chance of adoption is that a completely flexible system of exchange rates should be introduced. If this was the case
then any increase in indirect taxes with compensatory border adjustments
resulting in trade advantages would be offset by changing exchange rates. In this
situation it would not, indeed, matter whether the origin or destination principle
was used to ensure tax neutrality. The position is thus explained:If, under the origin principle, an increase in general indirect taxes and government expenditures exerted a deficit pressure on the balance of payments, the price of foreign
exchange would automatically rise-that is, domestic currency would become
cheaper in terms of foreign currencies-to the point at which the pressure would be
negated. However, if the destination principle were followed and the change in taxes
and expenditures exerted a surplus pressure on the balance of payments, the price of
foreign exchange would adjust (fall, in this case) to maintain equilibri~m.~~
However, a system of completely flexible exchange rates has no prospect of
adoption at the present time.
(1))Border Tax
Adjustments and the Developing Countries
The Working Party Report on Border Tax Adjustments specifically devoted
a part of the Report t o the question of border tax adjustments as they concern
69. Rosendahl op.cit. note 27 at p.135.
70. Rosendahl op.cit. note 27 at p.134.
71. Haberler "Import Taxes and Export Subsidies a Substitute for the Re-alignment of Exchange
Rates" 20 Kyklos 17, at p.21.
72. Baldwin op.cit. note 43 at p.97.
Border Tax Adjustments in International Trade
163
developing countries." The problem concerns primarily the question of border
tax adjustments on the import side. The developing countries have pointed out
that the industrialised countries have utilised Article I11 of the G A T T to apply
internal taxes at high rates to the exports of the developing countries, especially
tropical products. Since the only requirement of Article 111 is that the taxes
must be applied to "like domestic products" (i.e., they must be nondiscriminatory) the industrialised countries can safely impose high internal
taxes on tropical products because in many cases there is no equivalent domestic
production and, therefore, no danger of damaging a local producer. In the
developing countries' view this is a misuse of the border tax provisions regarding
imports because the essential purpose of those provisions is to protect domestic
producers where internal taxes are imposed on domestic products, and (at least
theoretically) are reflected in the price of the product. Furthermore, the application of internal taxes in this matter was considered to be a breach of the obligation imposed on the developed countries under Article XXXVII (1) (a) "to accord the highest priority to the reduction and elimination of trade barriers to
products currently or potentially of particular export interest to the developing
countries". In cases where cascade or selective excise taxes have been replaced
by a V.A.T.-a change which has severly increased the burden of tax in some
case~'~-this was considered to be a breach of the more strongly worded prohibition of Article XXXVII (1) (c) (i) of the G A T T to "refrain from imposing new
fiscal measures" which would hamper the growth of the consumption of
primary products in the developing countries.
The developed countries have been less than sympathetic to the demands of
the developing countries. Thus it was forceably stated before the G A T T Working Party on Border Tax Adjustments that "to exempt from internal taxes
products of interest to the developing countries would be to manipulate the
fiscal system for commercial purposes."" Article 111 was regarded as by no
means obliging any country to favour products manufactured exclusively
abroad by granting them tax exemption.
However, in fairness it should be pointed out that internal taxes are now
capable of being reduced by negotiation during tariff conferences where the
taxes involved are on products "not produced domestically in substantial quantities". Yet the results of the attempt to negotiate internal taxes in the Kennedy
Round have been described as "meagre"76 and, as late as 1974, the developing
countries indicated with GATT that domestic taxes were still being applied at
high rates to tropical products exported to some industrialised countries.'- The
problem is a continuing one.
( E ) The Discriminatory Application of the Present Rules
Leaving aside the criticisms of the assumptions on which the GATT rules are
based, the GATT rules have also been criticized because of the discrimination
which arises from the application of the G A T T rules as they now stand. There
are two ways in which it is alleged that such discrimination takes place. The first
is where, although the rate of indirect taxation may be the same on imported
73. GATT Working Party Report op.cit. note 2 pp.8-10.
74. For example, the G A T T Working Party Report op.cit. note 2 at p. I0 para. 38 noted that a
cascade rate of 1.6 per cent on textiles had been replaced by a I 2 per cent V.A.T. tax rate in
some developed countries.
75. GATT Working Party (Interim Report) op.cit. note 22 p.23 para.77.
76. Kock "International Trade Policy and the GATT 1947-1967" at p.101.
77. B.I.S.D. 17th Supp. (Report of the Trade and Development Board) p.57 para.27.
164
J. C. Phillips
and locally produced supplies, effective discrimination exists because the imported product is classified as a different commodity for the purpose of indirect
taxation and as a result bears a higher rate of taxation. Thus the United States
automobile industry has complained that the European road taxes (in France,
Italy and the Benelux countries) have a steeply progressive scale according to
the horse-power of the engine and the contention is that such discriminatory
treatment seriously inhibits U.S. exports of powerful passenger vehicles to those
countries. Another example of a discriminatory excise tax operating in a
somewhat different manner which is said to effect trade is the United States law
which provides that the tax on spirits shall be charged on a proof gallon basis.
Under this system Scotch Whisky imported in bottles at the usual strength of
86% proof pays tax at a higher rate than American bourbon; that is, the distilled
water which is added to the spirit to bring it down to consumption strength is
taxed while domestically produced spirits are taxed before the addition of distilled water takes place. Clearly the way to get round this is to import spirits at
proof, but the cost of this operation has to be weighed against the tax advantage
it provides.'"
The purpose of these discriminatory taxes is often not primarily to discourage
imports, but to tax the consumer who buys higher priced luxury goods. It has
been pointed out that the reason for doing this may be social (since it is the
wealthy who buy high priced cars and spirits they ought to be taxed more heavily than the poor who buy cheap cars, wine and beer), but it is also apparent that
such discriminatory application of taxes does afford additional non-tariff
protection against imported goods.
The second method of the discriminatory application of the present border
tax adjustments rules is where, quite simply, indirect taxes are applied to imported products, but the equivalent domestically produced products are exempt.
There is no general evidence on an international level of the scale on which this
type of discrimination takes place. However, in Australia itself there is some
evidence of this type of practice, because the exemptions from the Sales Tax
(Exemptions and Classifications) Act (Cmth) sometimes apply to locally
manufactured goods and not to corresponding imported goods. Examples of
such goods include food for livestock and poultry, beer, cider, and Australian
wine. There is also an exemption for fruit juice products which contain not less
than a minimum content of Australian juices or concentrate^.^^ In the case of
non-carbonated beverages the exemption requires a minimum of only 5% by
volume of the juices of Australian fruits. While these discriminations in violation of GATT rules are small in relation to the total scope of the Sales Tax,
some are regarded as being of substantial value to the producers affected. The
group that is said to benefit substantially through protection from overseas
competitors in this way are the manufacturers of beer and wine.8'
( F ) The GATT Rules and the Origin Principle
Some observers have expressed the viewpoint that the present system of
border tax adjustments is illogical because it only purports to cover inter78. See these matters discussed in G . & V. Curzan, "Hidden Barriers to International Trade" at
p.37.
79. Ibid.
80. These matters have been revealed by the researches of Lloyd in his work "Non-tariff Distortions of Australian Trade" (A.N.U. Press) See p.89.
81. Lloyd, "Non-tariff Distortions of Australian Trade" (A.N.U. Press) at p.89.
Border Tax Adjustments in International Trade
165
national trade adjustments regarding taxes. It is argued that since other nonfiscal factors such as government expenditure, social welfare schemes and
G.N.P. per capita may influence trade between countries, there is no reason why
distortions arising from fiscal differences should be singled out for
n e u t r a l i s a t i ~ n For
. ~ ~ example, government expenditure on transportation may
reduce business costs and so reduce prices. Indeed, where indirect taxes are
levied the revenue from those taxes may be used to reduce production costs and
countries rebating those indirect taxes may reap a two-fold advantage. For instance, if an excise tax is levied in order to fully finance a national transportation system, domestic producers would in effect have zero transportation costs
on their exports, since the excise tax would be rebated at the border. If, in addition, the tax is not fully reflected in final prices, the full rebate gives the exporter
a second trade advantage over outside supplier^.^'
Those who emphasise the fact that other factors may influence trade extend
their argument to suggesting that taxes, like these other factors, should also not
be adjusted at the border, and that the origin principle of taxation should,
therefore, apply.84However, this approach has been strenuously criticized on the
grounds that taxes are generally considered to have a much greater influence on
the prices of individual imports and exports than these other factors such as
government expenditure. The traditional reliance on the destination principle
makes it extremely unlikely that that principle will be abandoned in favour of
the origin principle. Even if serious thought was given to its introduction, a
major handicap would be the complexity of the administrative arrangements required to put it into effect. For instance, in order to prevent imports being taxed
in their country of destination, imported goods would have to be separated from
domestic goods in circumstances in which they would normally be taxed at postimportation stages (e.g., if there is a retail sales tax).8i It would also be necessary, in order to ensure that exports bear all the taxes of the exporting country,
to provide administrative machinery to ensure that taxes which are normally
paid in full or in part at post-exportation stages by wholesalers and retailers are
paid by exporters on a value enhanced to include costs and profits at wholesale
or retail stages.86
Conclusion
The foregoing discussion has indicated some of the criticisms of the present
GATT rules regarding border tax adjustments, and the trade advantages that
may result therefrom. In order to offset some of these trade disadvantages it is
possible for a nation to take unilateral action (e.g., by replacing a corporate income tax with a V.A.T. or by the imposition of countervailing duties). Apart
from questions of unilateral action of this kind, several fundamental changes in
the GATT rules have been mooted. In summary, these changes involve:(i) A partial refund for direct taxes on export and compensatory levies on imports to the extent that the direct tax is reflected in the final price of the
product.
(ii) A partial and not a full adjustment for indirect taxes to the extent that
those indirect taxes are reflected in prices.
82.
83.
84.
85.
86.
O.E.C.D. Report Part
See this illustration in
O.E.C.D. Report Part
O.E.C.D. Report Part
Ibid.
I1 para. 126.
Jung op.cit. note 14 at p.33 on this point.
I1 para. 127.
I1 para. 150.
166
J. C. Phillips
(iii) The introduction of a system to relate the application of border tax adjustments to balance-of-payments needs.
(iv) The removal by the developed countries of tax adjustments on products of
particular interest to the developing countries and not produced
domestically by those developed countries.
(v) A return to the origin principle of taxation, thus abolishing the need for
border tax adjustment mechanism as presently embodied in the GATT.
For the reasons set out in the text, none of these proposals are without disadvantages and none of them are likely to be introduced. At the present time the
most that can be hoped for is a consultation procedure to be entered into before
a country alters its border tax adjustments, and this has been s ~ g g e s t e d . ~ '
However, the GATT Working Party did not go so far as to introduce this
modest change since, although it recognized the necessity for a "notification
procedure", it also stated that "such notification need not be made prior to the
change".88 It may safely be concluded that GATT rules are likely to stay as they
are for the present time.
87. Wonnacott op.cit. note 14 at p.757: Dam, "The GATT: law and international economic
organization (University of Chicago Press, 1970).
88. G A T T Working Party Report op.cit. note 2 p.10 para. 40.