U.S. tax plan would break WTO rules, lawyers say, as EU business frets

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By Tom Bergin and David Morgan | LONDON/WASHINGTON

LONDON/WASHINGTON A proposed U.S. corporate tax
reform would almost certainly contravene international trade
rules if implemented, lawyers told Reuters, risking the biggest
dispute in the history of the World Trade Organization.

With signs growing that the United States may become more
protectionist under President Donald Trump, European business
groups said the tax plan – which could impose de facto import
tariffs of up to 20 percent – raised the danger of a trade war.

Republican (GOP) members of Congress are pushing to replace
the existing tax on corporate income with one linked to turnover. This would allow firms to deduct their costs for
purchasing goods and services produced in the United States, but
would give no such deduction for purchases of imports.

Trump has criticised the complexity of the plan but also
said such a measure could help to cut the U.S. trade deficit.

Kevin Brady, head of the tax-writing House of
Representatives Ways and Means Committee, brushed off
suggestions that it would fall foul of the World Trade
Organization.

While there were “1,000 different opinions on whether this
is WTO compliant”, Brady said he was confident the reform did
comply with the body’s rules.

However, six trade lawyers with experience in litigating WTO
disputes said they believed the plan would likely be deemed an
unlawful subsidy on domestic goods, export subsidy or a de facto
tariff on imports.

All the lawyers, based in the United States, Britain and
continental Europe, said the ‘destination-based cash flow tax’
would fail WTO rules on more than one legal basis. So serious
were the breaches that any challenges might be handled under WTO
mechanisms that allow legal processes, which normally take
years, to be short-cut, they said.

“It would be plainly WTO-inconsistent,” said Philippe De
Baere, Brussels-based partner at Van Bael & Bellis.

“It has manifest violations which could even justify the use
of the expedited procedure for dispute settlement in the WTO,”
said De Baere, who has also advised governments on accession to
the WTO and negotiations on new WTO deals as well as fighting
trade cases.

Trade experts said any legal case would be the biggest WTO
dispute ever, since it could involve all products imported into
the United States and all U.S. exports. Previous WTO cases have
involved narrow market sectors or individual companies.

European business groups said the plan threatened to upend
the international system of trade rules, and expressed hope that
their governments could help to persuade the United States not
to adopt it.

The Ways & Means Committee declined to answer detailed legal
questions about the plan. A spokesman for the WTO said the
organisation didn’t comment on whether planned taxes conformed
to its rules

OLD IDEA WITH A NEW TWIST

The House Republican plan involves abolishing corporate
income tax and replacing it with a tax of 20 percent levied on
revenues, less allowable deductions.

A ‘border adjustment’ would be applied whereby companies
which import products for resale or use in a manufacturing
process would not receive a tax deduction for the cost. Domestic
purchases and labour costs could be deducted while U.S. exports
would be exempt from the tax.

No major economy has adopted a corporate cash flow tax.
Former Bank of England governor Mervyn King is among those to
support such a tax, saying in a 1987 study that it could reduce
excessive corporate debt and encourage better investment.

King, who retired from the bank in 2013, told Reuters in an
email this week that he still believed the idea had its merits
-provided “it does not have to have the impact on imports that
seems to be implied by the proposed scheme in the U.S.”.

Lawyers said the impact of the border adjustment and
deductions for U.S. costs meant that imports would face an
effective tariff of up to 20 percent.

“The total tax rate on the 100 percent domestically-produced
good is going to have a lower effective tax rate than the rate
on the import,” said Scott Lincicome, counsel with White & Case
in Washington.

That would breach Article 3 of the General Agreement on
Tariffs and Trade, which is policed by the WTO. This allows
signatory states to impose permitted tariffs on goods entering
their country, but precludes them from treating a domestic item
more favourably than an imported one when it comes to internal
taxes like sales or income taxes.

The WTO Agreement on Subsidies and Countervailing Measures
also provides a basis for challenging the U.S. plan, the lawyers
said.

While this treaty allows border adjustments, it bars them in
relation to direct taxes such as income or profit taxes.

Hence, the plan could be deemed a subsidy on domestic
production in the United States and on U.S. exports, Folkert
Graafsma, with VVGB Avocats in Brussels said.

The Ways and Means Committee says the cash flow tax is an
indirect tax, and therefore legal.

Lawyers say that argument would be hard to sell to WTO
judges or trade partners because the tax is calculated on a
business entity’s revenue, less the allowable input costs,
rather than being applied to the product being traded.

“You’re still essentially taxing the entity and that’s where
the problem comes,” said Iain MacVay, partner at King & Spalding
in London.

EUROPEAN BUSINESS WORRIED

The BDI, the trade body for Germany’s largest businesses,
said the plan risked introducing double taxation on imports. “A
border tax adjustment would be a deviation from the existing
system (on corporate taxation),” BDI chief Markus Kerber said in
a statement.

Robin Winkler, a strategist at Deutsche Bank, said the
growing protectionist mood in the United States meant
politicians there could adopt the plan even if they didn’t
believe it complied with WTO rules. “A border tax akin to the
GOP proposal remains more likely than the market appreciates,”
he said in a note to clients on Wednesday.

The British, German and French governments said they didn’t
comment on other countries’ tax proposals. A spokesman for the
executive arm of the European Union said: “The Commission
expects all its trade partners to abide by and uphold the
international rules.”

Andy Goss, board member and global sales boss for carmaker
Jaguar Land Rover, one of Britain’s biggest exporters, said he
expected the government from Prime Minister Theresa May down to
be active on the issue.

“Our expectation when potential policies like this are
mooted is that the prime minister and those in government can
represent us in the right places in the U.S., and we are
confident that they would do that,” he added.

Some economists said the border adjustment would increase
the value of the dollar, easing the actual impact of the tax on
foreign exporters. Others doubted this, partly because of
Trump’s statements about the trade benefits of weak currencies.

The WTO allows countries to impose retaliatory measures
against offending trade partners but it can take years to get a
ruling. Some countries may not wait that long or may not use
only WTO-authorised retaliatory measures.

For example, China could simply order its massive
state-owned enterprises to adopt a “Buy No America” policy,
analysts at Morgan Stanley said. The Chinese Ministry of Finance
did not respond to requests for comment.

Edward Roosens, Chief Economist with Belgium’s Federation of
Enterprises, said that if companies in Europe started to lose
U.S. contracts and shed jobs as a result, Europe could also act
rashly.

“The political pressure would be really strong to go for an
all-out trade war. It’s a bizarre idea, to be involved in a
trade war with Europe’s closest ally, but political pressure
would grow,” he said. (Additional reporting by David Lawder in Washington and Tom
Miles in Geneva)



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