Naomi Fowler ■ US tax reform and conflicts with international law: guest blog
The Exceptionalist Tax Bill
The United States Congress is about to adopt a major tax reform that reflects American exceptionalism – the idea that the United States is too awesome to play by international rules. Foreigners, fasten your seat belts!
The Finance Ministers of France, Germany, Italy, Spain and the United Kingdom have written to their US counterpart to warn him that some provisions of the tax bill may contravene trade agreements and tax treaties. The issue is also relevant to emerging countries like China, India or Brazil, which invest in the United States and compete with US companies on global markets.
Kevin Brady, the chair of the tax-writing committee of the US House of Representatives, quipped that he was giving “not a ton” of consideration to the letter.
Two provisions are problematic. The first one (in the Senate version of the bill only) is meant to induce companies to keep their intellectual property income in the United States. It is structured such as to reduce a company’s tax in proportion to its exports, and can therefore be considered an export subsidy. As such, it would violate World Trade Organization (WTO) agreements.
The second provision is meant to prevent US-based companies (and particularly US subsidiaries of foreign companies) from shifting their US profits offshore. Both House and Senate versions of the bill include such provision, but they are structured very differently. Both versions may violate WTO agreements. Multinational companies have complained that this type of tax would introduce a discrimination that could disrupt integrated global supply chains: transactions between subsidiaries of a group would be penalized compared to the same transactions between unrelated parties. Both versions are also likely to violate bilateral tax treaties: the House version would violate the definition of “permanent establishment” by bringing foreign companies into the fold of US taxation, and the Senate version may violate the limitation on withholding taxes on interests and royalties.
There has been scant debate about either of these provisions. The legislative process has been so rushed that the bills contain numerous glitches. Hopefully they will be fixed before the bill becomes law. One would expect the legislature of the world’s biggest economy to mind the international order on which its prosperity relies. But one should think twice.
In most countries treaties supersede domestic law. That is not the case in the United States. The Constitution of the United States fails to say whether treaties supersede domestic laws or not, and the US Supreme Court has relied on the “latest in time” rule: when a law conflicts with a treaty, the most recent one prevails. The US Congress has a track record of adopting tax laws overriding tax treaties.
Moreover, most bilateral tax treaties do not include compulsory arbitration clauses. There is nothing the other country can do to enforce their treaty with the United States. There are some exceptions, though. German, French, Canadian and Belgian taxpayers could seek redress for double taxation through arbitration in certain cases.
Trade agreements are a different matter. The WTO has a robust Dispute Resolution Mechanism, and can authorize the harmed party to retaliate with punitive tariffs on the offending party. However, it typically takes years to resolve disputes. That is nevertheless where we are heading. That means years of uncertainty for multinational business structuring their global supply chains. It also means that the United States may eventually have to cancel these parts of the tax bill, leading to a shortfall of revenue and increased profit shifting.
Beyond legal proceedings, there is diplomacy. Itai Grinberg argues that the Senate version of the second provision – the one targeting profit shifting out of the US – constitutes a clever medium-term strategy, which would invite foreign retaliations and thereby lead to multilateral negotiations to reach a new agreement on taxing income at source. This provision would put the United States in an enviable bargaining position owing to foreigners’ constitutional constraints to override treaties. Now that is exceptionalism on steroids.