94. Under the ETI measure, certain income earned by United States citizens
and residents through certain relevant transactions, involving QFTP, is
known as "extraterritorial income".71 Section 114(a) IRC excludes
extraterritorial income from "gross income" and from the operation of the
rules applicable to "gross income" under Sections 61 and 63 IRC. However,
Section 114(b) provides that this exclusion of extraterritorial income
from gross income applies solely to that portion of extraterritorial
income which is defined as "qualifying foreign trade income" ("QFTI"). The
amount of QFTI is determined using one of the three formulae set forth in
Section 941(a)(1) IRC.
95. In sum, therefore, under the ETI measure, a portion of income – QFTI –
earned by United States citizens and residents is excluded from "gross
income" under Section 114(a)
and (b) IRC and, thereby, this income is excluded from taxation in the
United States. Where a taxpayer elects to use the ETI measure, it must
give up any tax credits it has obtained through taxation of its income in
a foreign jurisdiction that are attributable to the QFTI excluded from
taxation.72
96. The Panel reached the conclusion that the exclusion of QFTI from gross
income means that the measure involves the foregoing of revenue on this
portion of income, and also that revenue is otherwise due on this income.
The Panel reasoned that United States taxpayers would "ordinarily" be
subject to tax on all income earned in transactions covered by the measure
and that the measure "effectively carves … out" certain income from this
other, "ordinary", situation of taxation.73
97. In examining the Panel's findings, we observe that the United States
argues that, under the ETI measure, QFTI is confined to the foreign-source
income earned by United States citizens and residents in transactions
covered by the measure. For the purposes of reviewing the Panel's findings
under Article 1.1(a)(ii) of the SCM Agreement, we will assume, arguendo,
without trying to reach any conclusion on the issue at this stage, that
the United States correctly characterizes QFTI as foreign-source income.74
For these purposes, we assume, also arguendo, that the United States
correctly maintains that the measure is merely a continuation of the
"longstanding" principle of the United States rules of taxation that seeks
to allocate income between domestic- and foreign-source income.
98. As we said earlier, under Article 1.1(a)(1)(ii) of the SCM Agreement,
the normative benchmark for determining whether revenue foregone is
otherwise due must allow a comparison of the fiscal treatment of
comparable income, in the hands of taxpayers in similar situations.
Accordingly, in identifying the normative benchmark for comparison in
these proceedings, we must look to the United States' other rules of
taxation applicable to the foreign-source income of United States'
citizens and residents earned through the sale or lease of property, or
through the performance of "related" services.75 In so doing, we must
ascertain whether, and to what extent, the United States imposes tax on
foreign-source income of United States citizens and residents, including
the income covered by the measure at issue which the United States
considers to be foreign-source income. In other words, our inquiry under
Article 1.1(a)(1)(ii) is not simply ended at this stage of analysis
because the measure involves an allocation of income between domestic- and
foreign-source income. Rather, we must compare the way the United States
taxes the portion of the income covered by the measure, which it treats as
foreign-source, with the way it taxes other foreign-source income under
its own rules of taxation.
99. Under Sections 1 and 11 IRC, the United States imposes tax on the
"taxable income" of each United States citizen and resident. According to
Section 63(a) IRC, taxable income means "gross income minus the deductions
allowed" under the IRC. Under Section 61(a) IRC, gross income means "all
income from whatever source derived". (emphasis added) Thus, Sections
61(a) and 63(a) IRC do not distinguish between income depending on whether
the income is treated by the United States as domestic- or foreign-source.76
Rather, these provisions treat "all income from whatever source" in
identical fashion so that, in principle, foreign-source gross income of
United States' citizens and residents, less allowable deductions, is
subject to tax as taxable income.
100. However, where a portion of the taxable income of a United States
citizen or resident is subject to tax in a foreign jurisdiction, the
United States credits the taxpayer, subject to certain limitations, with
the amount of foreign taxes paid or deemed to have been paid by that
taxpayer.77 Thus, the tax payable to the United States is reduced by the
amount of the tax credit. However, the tax credit granted cannot, as a
proportion of the tax due, exceed the proportion of total taxable income
which foreign-source income makes up.78 In this situation, where a taxpayer
pays taxes in a foreign jurisdiction, the United States treats a
proportion of the tax due to the United States as a tax on foreign-source
income, and grants a tax credit with respect to that income.79
101. In our view, the normative benchmark for determining whether the ETI
measure involves the foregoing of revenue otherwise due, under Article
1.1(a)(1)(ii) of the SCM Agreement, is contained in the United States
rules of taxation regarding the foreign-source income of United States'
citizens or residents, which we have outlined in the preceding paragraph.
Thus, we must compare the taxation of foreign-source income under these
"other" rules of taxation, with the taxation of QFTI, which the United
States also treats as foreign-source income of these same taxpayers.
102. In so doing, there appears to be a marked contrast between the "other
rules" of taxation applicable to foreign-source income and the rules of
taxation applicable to QFTI. For United States citizens and residents, the
United States, in principle, taxes all foreign-source income, subject to
permissible deductions, although the United States grants tax credits for
foreign taxes paid. However, under the ETI measure, QFTI is definitively
excluded from United States taxation.
103. In addition, as we noted above, United States citizens and residents
can elect, at their own discretion: either to have certain of their income
treated as extraterritorial income under the ETI measure, with the result
that a portion will be definitively excluded from taxation as QFTI; or
these same taxpayers can elect to have the same income taxed under the
"other" rules applicable to foreign-source income, with tax credits being
recognized for, at least, a portion of foreign taxes paid. Where the
taxpayer elects not to be taxed under the ETI measure, the United States
taxes this income under the "other" rules of taxation applicable to
foreign-source income. We see this as confirmation that, absent the ETI
measure, the United States would tax the income under the "otherwise"
applicable rules of taxation we have used as our benchmark.
104. Clearly, a taxpayer may be expected to elect to use the rules of
taxation which result in the payment of the lowest amount of tax.80 Thus,
where a taxpayer elects to be taxed under the ETI measure, the amount of
tax paid by the taxpayer will very likely be less than the tax which the
taxpayer would have paid, on that income, under the rules "otherwise"
applicable to foreign-source income, if the taxpayer did not elect to use
the ETI measure. This, too, confirms that the United States will forego
revenue under the ETI measure that would be "otherwise due".
105. In our view, the definitive exclusion from tax of QFTI, compared with
the taxation of other foreign-source income, and coupled with the right of
election for taxpayers to use the rules of taxation most favourable to
them, means that, under the contested measure, the United States foregoes
revenue on QFTI which is otherwise due.
106. For these reasons, we uphold the Panel's finding, in paragraphs 8.30
and 8.43 of the Panel Report, that through the measure at issue, the
United States government foregoes revenue that is otherwise due within the
meaning of Article 1.1(a)(1)(ii) of the SCM Agreement, and that the ETI
measure, therefore, gives rise to a financial contribution under Article
1.1(a)(1) of that Agreement. In so holding, we observe that our reasons
have a different focus from those given by the
Panel. In part, this is because, on appeal, the thrust of the United
States' arguments has been directed towards the role of the measure in
allocating income as either domestic- or foreign-source.
VI. Article 3.1(a) of the SCM Agreement: Export Contingency
107. Before the Panel, the European Communities drew a distinction between
two different subsidies it alleged were granted under the ETI measure. The
first subsidy which the European Communities identified was what it called
the "basic" subsidy, which related to property produced "within the United
States"; the second subsidy it identified was what it called the
"extended" subsidy which related to property produced "outside the United
States". The European Communities argued that both these subsidies are
de jure contingent upon export performance.81
108. The Panel found that "the Act involves subsidies 'contingent … upon
export performance' by reason of the requirement of 'use outside the
United States' and is therefore inconsistent with Article 3.1(a) of the
SCM Agreement."82 This finding does not expressly draw any distinction
between property produced "within" the United States and property produced
"outside" the United States, nor does it adopt the distinction the
European Communities drew between the so-called "basic" and "extended"
subsidies. However, this finding must be read in the light of the
reasoning which supports it. In the course of that reasoning, the Panel
stated:
… in relation to US-produced goods, the words of the statute itself make
it clear that exporting is a necessary precondition to qualify for the
subsidy. In respect of US-produced goods, the existence and amount of the
subsidy depends upon the existence of income arising from the exportation
of such goods. In relation to US-produced goods, the existence of such
income is clearly conditional, or dependent upon, the exportation of such
goods from the United States. We are therefore of the view that by
necessary implication the scheme is de jure dependent or contingent upon
export in relation to US-produced goods.83 (emphasis added)
109. This passage indicates that the Panel's finding under Article 3.1(a)
of the SCM Agreement addressed only the alleged export contingency of the
measure "in relation to" property produced "within" the United States and
the Panel concluded that, in respect of this property, the grant of the
subsidy is contingent upon export performance. (emphasis added) The
Panel's finding did not also address the alleged export contingency of the
measure in relation to property produced "outside" the United States. In
other words, the Panel examined the European Communities' claim concerning
the "basic" subsidy, but not the claim regarding the "extended" subsidy.84
110. The United States appeals the Panel's finding that the measure
involves the grant of a subsidy "contingent … upon export performance".
The United States contends that, under Article 3.1(a) of the SCM
Agreement, export contingency is a necessary condition of grant if a
subsidy is to be export contingent. It points out that the ETI measure is
export-neutral as the tax exclusion is available with respect to property
that is not produced in the United States and, therefore, not exported
from the United States. Thus, it is argued, the tax exclusion can be
obtained without exportation so that export performance is not a condition
that must be satisfied in order to obtain this exclusion. The Panel,
however, overlooked this fact and "artificially bifurcat[ed]" the ETI
measure, examining it only as it relates to property produced in the
United States.85 The United States insists that no such distinction exists
under the ETI measure.
111. We start with the text of Article 3.1(a) of the SCM Agreement, which
provides that "subsidies contingent, in law or in fact, whether solely or
as one of several other conditions, upon export performance" are
prohibited. We have considered this provision in several previous appeals.86
In Canada – Aircraft, we said that the key word in Article 3.1(a) is
"contingent", which means "conditional" or "dependent for its existence on
something else".87 In other words, the grant of the subsidy must be
conditional or dependent upon export performance. Footnote 4 of the SCM
Agreement, attached to Article 3.1(a), describes the relationship of
contingency by stating that the grant of a subsidy must be "tied to"
export performance. Article 3.1(a) further provides that such export
contingency may be the "sole []" condition governing the grant of a
prohibited subsidy or it may be "one of several other conditions".
112. The Panel found that the measure involves de jure export contingency
in relation to property produced in the United States and the United
States appeals this finding. We recall that in Canada – Autos, we stated:
… a subsidy is contingent "in law" upon export performance when the
existence of that condition can be demonstrated on the basis of the very
words of the relevant legislation, regulation or other legal instrument
constituting the measure. … [F]or a subsidy to be de jure export
contingent, the underlying legal instrument does not always have to
provide expressis verbis that the subsidy is available only upon
fulfillment of the condition of export performance. Such conditionality
can also be derived by necessary implication from the words actually used
in the measure.88
113. Under the ETI measure, the United States excludes from tax a portion
of the income earned by United States citizens and residents through
certain transactions involving, or related to, QFTP. We recall that
Section 943(a)(1)(A) IRC defines QFTP, inter alia, as property
"manufactured, produced, grown, or extracted within or outside the United
States".89 (emphasis added) The ETI measure, therefore, contemplates two
different factual situations, one involving property produced within the
United States and the other involving property produced outside the United
States. The distinctiveness of these two situations is confirmed by the
presence of two provisions in the IRC, each addressing one of these
factual situations. Section 943(a)(2) IRC contains rules that apply only
to property produced "outside the United States", while Section 943(c) IRC
has source rules that address only the case of property produced "within
the United States".
114. In respect of property produced within the United States, the
taxpayer can obtain the subsidy only by satisfying the conditions in the
measure relating to this property and, for this property, the measure
provides only one set of conditions governing the grant of subsidy. The
conditions for the grant of subsidy with respect to property produced
outside the United States are distinct from those governing the grant of
subsidy in respect of property produced within the United States.
115. In our view, it is hence appropriate, indeed necessary, under Article
3.1(a) of the SCM Agreement, to examine separately the conditions
pertaining to the grant of the subsidy in the two different situations
addressed by the measure. We find it difficult to accept the United
States' arguments that such examination involves an "artificial
bifurcation" of the measure. The measure itself identifies the two
situations which must be different since the very same property cannot be
produced both within and outside the United States.
116. We turn to examine the conditions in the measure governing the grant
of the subsidy for property produced within the United States. In its
definition of QFTP, the measure provides that, in order to obtain the
subsidy, this property must be "held primarily for sale, lease, or rental,
in the ordinary course of trade or business for direct use, consumption,
or disposition outside the United States …".90 For property produced within
the United States, this condition means that, for income to be eligible
for the fiscal subsidy, the property must be exported. In other words, use
outside the United States necessarily implies exportation of the property
from the United States (the place of production) to the place of use.
117. At the oral hearing, we inquired of the United States whether, for
property produced within the United States, such property must be exported
from the United States in order to satisfy the condition of "direct use …
outside the United States". The United States confirmed that such property
must be exported to satisfy this condition.91 For this property, then, the
requirement of use outside the United States makes the grant of the tax
benefit contingent upon export.
118. It may also be recalled that the measure at issue in the original
proceedings in US – FSC contained an almost identical condition relating
to "direct use … outside the United States" for property produced in the
United States.92 In that appeal, we upheld the panel's finding that the
combination of the requirements to produce property in the United States
and use it outside the United States gave rise to export contingency under
Article 3.1(a) of the SCM Agreement. We see no reason, in this appeal, to
reach a conclusion different from our conclusion in the original
proceedings, namely that there is export contingency, under Article
3.1(a), where the grant of a subsidy is conditioned upon a requirement
that property produced in the United States be used outside the United
States.
119. We recall that the ETI measure grants a tax exemption in two
different sets of circumstances: (a) where property is produced within the
United States and held for use outside the United States; and (b) where
property is produced outside the United States and held for use outside
the United States. Our conclusion that the ETI measure grants subsidies
that are export contingent in the first set of circumstances is not
affected by the fact that the subsidy can also be obtained in the second
set of circumstances.93 The fact that the subsidies granted in the second
set of circumstances might not be export contingent does not dissolve the
export contingency arising in the first set of circumstances. Conversely,
the export contingency arising in these circumstances has no bearing on
whether there is an export contingent subsidy in the second set of
circumstances. Where a United States taxpayer is simultaneously producing
property within and outside the United States, for direct use outside the
United States, subsidies may be granted under the ETI measure in respect
of both sets of property. The subsidy granted with respect to the property
produced within the United States, and exported from there, is export
contingent within the meaning of Article 3.1(a) of the SCM Agreement,
irrespective of whether the subsidy given in respect of property produced
outside the United States is also export contingent.
120. For these reasons, we uphold the Panel's finding, in paragraphs 8.75
and 9.1(a) of the Panel Report – which is limited to property
"manufactured, produced, grown, or extracted" within the United States –
that the measure at issue grants subsidies contingent in law upon export
performance within the meaning of Article 3.1(a) of the SCM Agreement.94 We
do not opine upon the alleged export contingency of the subsidy in
relation to property "manufactured, produced, grown, or extracted" outside
the United States.95
VII. Footnote 59 to the SCM Agreement: Avoiding Double Taxation of
Foreign-Source Income
121. The United States asserted, before the Panel, that, even if the Act
involved export contingent subsidies, these subsidies would not be
prohibited because of the fifth sentence of footnote 59 to the SCM
Agreement, which is attached to item (e) of the Illustrative List of
Export Subsidies in Annex I of that Agreement (the "Illustrative List").
122. The Panel began its inquiry by holding that the United States bore
the burden of proving that the contested measure fell within the scope of
the fifth sentence of footnote 59. The Panel recalled that the "party
asserting the affirmative of a particular claim or defence bears the
burden of proof with respect to that claim or defence," and that, in this
case, the United States was asserting that the ETI Act was "justified" by
footnote 59.96
123. In examining the United States' arguments under footnote 59, the
Panel found that the term "foreign-source income" refers "to certain
income susceptible to 'double taxation'."97 The Panel observed that a
measure need not avoid double taxation of foreign-source income with
"precision", nor need it avoid double taxation "entirely" or
"exclusively".98 Nonetheless, the Panel said, "the relationship between the
measure and its asserted purpose – i.e. 'to avoid the double taxation of
foreign-source income …' – must be reasonably discernible."99 The Panel
examined the relationship between the measure and its asserted purpose by
reviewing "the overall structure, design and operation of the Act".100 The
Panel found that the measure at issue is not taken "to avoid the double
taxation of foreign-source income" within the meaning of the fifth
sentence of footnote 59 to the SCM Agreement.101
124. The United States argues, on appeal, that the Panel erred in finding
that the burden of proof was on the United States to demonstrate that the
measure fell within footnote 59.102 According to the United States, "the last
sentence of footnote 59 is inextricably linked to … Article 3.1(a) [of the
SCM Agreement] and it serves to define the scope of Article 3.1(a)."103 Thus,
it contends, the European Communities bears the burden of proving that
measure does not fall within footnote 59 to the SCM Agreement.
125. According to the United States, the fifth sentence of footnote 59
indicates that Members have "broad flexibility in fashioning double
taxation relief".104 It argues that foreign-source income "would appear to
include income arising, at least in part, outside the borders or territory
of the Member instituting a measure to avoid double taxation" as there is
a "possibility of double taxation" of such income.105 The United States
points to the legislative history of the ETI Act to establish that the
measure was taken to avoid double taxation within the meaning of footnote
59.106 The United States maintains that measures to avoid double taxation,
under footnote 59, need not be "comprehensive or all-encompassing."107
126. We address first the Panel's finding that the United States bears the
burden of proving that the ETI measure falls within the scope of footnote
59. We have indeed stated that "the burden of proof rests upon the party,
whether complaining or defending, who asserts the affirmative of a
particular claim or defence."108 In applying this principle in US – Wool
Shirts and Blouses, we said:
Articles XX and XI:(2)(c)(i) are limited exceptions from obligations under
certain other provisions of the GATT 1994, not positive rules establishing
obligations in themselves. They are in the nature of affirmative defences.
It is only reasonable that the burden of establishing such a defence
should rest on the party asserting it.109 (footnote omitted)
127. In EC – Hormones, we stressed that the usual rules on burden of proof
could not be avoided simply by describing a particular provision as an
"exception".110 In that appeal, we explored the relationship between Articles
3.1 and 3.3 of the Agreement on the Application of Sanitary and Phytosanitary Measures (the "SPS Agreement"), as compared with the
relationship between Articles I, III and XX of the GATT 1994. In the case
of the GATT 1994 provisions, we observed that Article XX does not
establish any "positive obligations" relevant to determining the proper
scope of the obligations imposed under Articles I and III. Instead,
Article XX sets out circumstances in which Members are entitled to "adopt
or maintain" measures that are inconsistent with the obligations imposed
under other provisions of the GATT 1994, such as Articles I and III.
128. Thus, in reviewing the Panel's finding on the burden of proof under
the fifth sentence of footnote 59, we must determine whether that
provision determines, in part, the proper scope of the obligations under
Article 3.1(a) of the SCM Agreement, or whether it provides an exception
for a provision that is otherwise an export contingent subsidy.
129. We recall that, in the original proceedings in this dispute, we said
that the fifth sentence of footnote 59 "does not purport to establish an
exception to the general definition of a 'subsidy' …"111 Thus, a measure
taken to avoid the double taxation of foreign-source income, falling
within footnote 59, may be a "subsidy" under the SCM Agreement.
130. Article 3.1 of the SCM Agreement provides specific obligations with
respect to two types of subsidy: subsidies contingent upon export
performance and subsidies contingent upon the use of domestic over
imported goods. Subsidies of these defined types are prohibited under
Article 3 of the SCM Agreement. Item (e) of the Illustrative List
identifies a particular measure which is deemed to be a prohibited export
subsidy under Article 3.1(a).
131. The fifth sentence of footnote 59 provides that item (e) "is not
intended to limit a Member from taking measures to avoid the double
taxation of foreign-source income earned by its enterprises or the
enterprises of another Member." In the same way that we do not see the
fifth sentence of footnote 59 as altering the scope of the definition of a
"subsidy" in Article 1.1 of the SCM Agreement, we do not see it as
altering either the scope of item (e) of the Illustrative List or the
meaning to be given to the term "subsidies contingent … upon export
performance" in Article 3.1(a) of the SCM Agreement. Thus, measures
falling within the scope of this sentence of footnote 59 may continue to
be export subsidies, much as they may continue to be subsidies under
Article 1.1 of the SCM Agreement.
132. The import of the fifth sentence of footnote 59 is that Members are
entitled to "take", or "adopt" measures to avoid double taxation of
foreign-source income, notwithstanding that they may be, in principle,
export subsidies within the meaning of Article 3.1(a). The fifth sentence
of footnote 59, therefore, constitutes an exception to the legal regime
applicable to export subsidies under Article 3.1(a) by explicitly
providing that when a measure is taken to avoid the double taxation of
foreign-source income, a Member is entitled to adopt it.
133. Accordingly, as we indicated in US – FSC, the fifth sentence of
footnote 59 constitutes an affirmative defence that justifies a prohibited
export subsidy when the measure in question is taken "to avoid the double
taxation of foreign-source income".112 In such a situation, the burden of
proving that a measure is justified by falling within the scope of the
fifth sentence of footnote 59 rests upon the responding party.
134. We, therefore, uphold the Panel's finding, in paragraph 8.90 of the
Panel Report, that, in this case, the burden of proof under the fifth
sentence of footnote 59 falls on the United States.
135. We turn to the United States' appeal that the Panel erred in finding
that the ETI measure is not one taken to avoid the double taxation of
foreign-source income under footnote 59 to the SCM Agreement.
136. We recall that the fifth sentence of footnote 59 provides:
Paragraph (e) is not intended to limit a Member from taking measures to
avoid the double taxation of foreign source income earned by its
enterprises or the enterprises of another Member.
137. We note at the outset that "double taxation" occurs when the same
income, in the hands of the same taxpayer, is liable to tax in different
States. The fifth sentence of footnote 59 applies to a measure taken by a
Member to avoid such double taxation of "foreign-source income". In
examining the phrase "foreign-source income", we observe that, in ordinary
usage, the word "source" can refer to the place where a thing originates,
and that the words "source" and "origin" can be synonyms.113 We consider,
therefore, that the word "source", in the context of the fifth sentence of
footnote 59, has a meaning akin to "origin" and refers to the place where
the income is earned. This reading is supported by the combination of the
words "foreign" and "source" as "foreign" also refers to the place where
the income is earned. Used in this way, the word "foreign" indicates a
source which is external to the Member adopting the measure at stake.114
Footnote 59, therefore, applies to measures taken by a Member to avoid the
double taxation of income earned by a taxpayer of that Member in a
"foreign" State.
138. The fifth sentence of footnote 59 to the SCM Agreement permits a
Member to take measures granting special fiscal treatment to
"foreign-source income" in order to alleviate a "double taxation" burden
on its taxpayer. Clearly, if the income benefitting from such special
treatment could not be taxed twice, in two different States, there would
be no double tax burden to alleviate, and hence no justification for
permitting an exception to the prohibition on export subsidies. Thus, the
term "foreign-source income" in footnote 59 refers to income which is
susceptible of being taxed in two States. The Panel took a similar view
when it stated that it understood "the term 'foreign-source income' … to
refer to certain income susceptible to 'double taxation' ".115
139. It is, however, no easy matter to determine in every situation when
income is susceptible of being taxed in two different States and, thus,
when a Member may properly regard income as "foreign-source income". We
have emphasized in previous appeals that Members have the sovereign
authority to determine their own rules of taxation, provided that they
respect their WTO obligations.116 Thus, subject to this important proviso,
each Member is free to determine the rules it will use to identify the
source of income and the fiscal consequences – to tax or not to tax the
income – flowing from the identification of source. We see nothing in
footnote 59 to the SCM Agreement which is intended to alter this
situation. We, therefore, agree with the Panel that footnote 59 does not
oblige Members to adopt any particular legal standard to determine whether
income is foreign-source for the purposes of their double
taxation-avoidance measures.117
140. At the same time, however, footnote 59 does not give Members an
unfettered discretion to avoid double taxation of "foreign-source income"
through the grant of export subsidies. As the fifth sentence of footnote
59 to the SCM Agreement constitutes an exception to the prohibition on
export subsidies, great care must be taken in defining its scope. If
footnote 59 were interpreted to allow a Member to grant a fiscal
preference for any income that a Member chooses to regard as
foreign-source, that reading would seriously undermine the prohibition on
export subsidies in the SCM Agreement. That would allow Members, relying
on whatever source rules they adopt, to grant fiscal export subsidies for
income that may not actually be susceptible of being taxed in two
jurisdictions. Accordingly, the term "foreign-source income", as used in
footnote 59 cannot be interpreted by reference solely to the rules of the
Member taking the measure to avoid double taxation of foreign-source
income.
141. Although there is no universally agreed meaning for the term
"foreign-source income" in international tax law, we observe that many
States have adopted bilateral or multilateral treaties to address double
taxation. The United States, for instance, has more than fifty bilateral
tax treaties addressing double taxation.118 Frequently, bilateral tax
treaties have been based on multilaterally developed model tax conventions
dealing with double taxation.119 In addition, the respective member States of
the Andean Community and of the Caribbean Community have adopted
multilateral agreements, binding on the members of each community, that
seek to avoid double taxation.120
142. Although these instruments do not define "foreign-source income"
uniformly, it appears to us that certain widely recognized principles of
taxation emerge from them.121 In seeking to give meaning to the term
"foreign-source income" in footnote 59 to the SCM Agreement, which is a
tax-related provision in an international trade treaty, we believe that it
is appropriate for us to derive assistance from these widely recognized
principles which many States generally apply in the field of taxation. In
identifying these principles, we bear in mind that the measure at issue
seeks to address foreign-source income of United States citizens and
residents – that is, income earned by these taxpayers in "foreign" States
where the taxpayers are not resident.
143. We recognize, of course, that the detailed rules on taxation of
non-residents differ considerably from State-to-State, with some States
applying rules which may be more likely to tax the income of non-residents
than the rules applied by other States.122 However, despite the differences,
there seems to us to be a widely accepted common element to these rules.
The common element is that a "foreign" State will tax a non-resident on
income which is generated by activities of the non-resident that have some
link with that State. Thus, whether a "foreign" State decides to tax
non-residents on income generated by a permanent establishment or whether,
absent such an establishment, it decides to tax a non-resident on income
generated by the conduct of a trade or business on its territory, the
"foreign" State taxes a non-resident only on income generated by
activities linked to the territory of that State.123 As a result of this
link, the "foreign" State treats the income in question as
domestic-source, under its source rules, and taxes it. Conversely, where
the income of a non-resident does not have any links with a "foreign"
State, it is widely accepted that the income will be subject to tax only
in the taxpayer's State of residence, and that this income will not be
subject to taxation by a "foreign" State.
144. Although the participants, and third participants, disagree on
precisely whether or to what extent a "foreign" State will tax the income
of a non-resident, none has suggested that a non-resident will be taxed in
a "foreign" State on income generated by activities that are not, in any
way, linked to that "foreign" State. Indeed, the United States argues that
QFTI is foreign-source income because this portion of extraterritorial
income has "sufficient foreign contacts … [such] that the transaction may
be subject to tax in [a] foreign nation."124 (emphasis added) According to
the United States, these "foreign contacts" are established, under the
measure, through the performance of the activities described in the
foreign economic processes requirement under Section 942(b) IRC.125 Thus, the
United States accepts that "foreign-source income" in footnote 59 is
income generated by economic activities that have "sufficient contacts"
with a "foreign" State.
145. Accordingly, in our view, "foreign-source income", in footnote 59 to
the SCM Agreement, refers to income generated by activities of a
non-resident taxpayer in a "foreign" State which have such links with that
State so that the income could properly be subject to tax in that State.126
146. In view of the divergence in the detailed rules applied by States
when taxing non-residents, there will be many situations where some States
tax the income of a non-resident, while other States would consider that
there was an inadequate link to justify the imposition of tax on
non-residents. Thus, from the perspective of the State of residence, there
will not be certainty as to when the income of its taxpayers will be
subject to tax in a "foreign" State. Despite this uncertainty, one of the
widely recognized methods of avoiding double taxation is the tax exemption
method.127 Under this method, States may exempt income from taxation to avoid
double taxation, irrespective of whether or not another State taxes the
exempt income. The avoidance of double taxation is not an exact science.
Indeed, the income exempted from taxation in the State of residence of the
taxpayer might not be subject to a corresponding, or any, tax in a
"foreign" State. Yet, this does not necessarily mean that the measure is
not taken to avoid double taxation of foreign-source income. Thus, we
agree with the Panel, and the United States, that measures falling under
footnote 59 are not required to be perfectly tailored to the actual double
tax burden.128
147. However, the fact that measures falling under footnote 59 to the SCM
Agreement may grant a tax exemption even for income that is not taxed in
another jurisdiction does not mean that such tax exemptions may be
granted, under the fifth sentence of footnote 59, for any income. Footnote
59 prescribes that the income benefitting from a double taxation-avoidance
measure must be "foreign-source" and, as we have said, that means that the
income must have links with a "foreign" State such that it could properly
be subjected to tax in that State, as well as in the Member taking the
double taxation-avoidance measure.
148. We also recognize that Members are not obliged by the covered
agreements to provide relief from double taxation. Footnote 59 to the SCM
Agreement simply preserves the prerogative of Members to grant such
relief, at their discretion, for "foreign-source income". Accordingly, we
do not believe that measures falling under footnote 59 must grant relief
from all double tax burdens. Rather, Members retain the sovereign
authority to determine for themselves whether, and to what extent, they
will grant such relief.
149. We turn once more to the ETI measure and recall that footnote 59 to
the SCM Agreement applies to measures "tak[en] … to avoid the double
taxation of foreign-source income …". Like the Panel, we will scrutinize
the design, structure and architecture of the contested measure to
determine whether it falls within footnote 59.
150. We recall that the United States points to the legislative history of
the measure. According to certain passages from that legislative history,
"the exclusion of … extraterritorial income is a means of avoiding double
taxation".129 The legislative history also states that the measure was
adopted "to comply with decisions of a World Trade Organization dispute
panel and Appellate Body."130 We take particular note of these statements,
though we do not believe that it would be appropriate for us to end our
inquiry here.
Continue on to: Article 151
Notes
71 Section 114(e) IRC, read
together with Section 942(a) IRC.
72
See infra, paras. 104 and 181-183.
73
Panel Report, paras. 8.25-8.26.
74
We examine below the merits of the United States' characterization of QFTI
as "foreign-source income", which the United States is entitled to exempt
to avoid double taxation of this income, when we review the Panel's
findings regarding footnote 59. See infra, paras. 121-186.
75
We recall that the measure applies to certain foreign corporations that
elect to be treated as United States corporations. For the purpose of
United States taxation, these corporations are deemed to be United States
corporations. (supra, para. 93 and footnote 67 thereto) Thus we do not
examine the United States' fiscal treatment of the foreign-source income
of foreign corporations including foreign subsidiaries of United States
corporations – that do not elect to be treated as United States
corporations. We do not, therefore, examine the rules of taxation for the
foreign-source income of foreign subsidiaries of United States
corporations. See United States' appellant's submission, paras. 34-36.
76
Sections 861-865 IRC and 26 CFR 1.861-1.865 provide rules to determine
whether income of United States citizens and residents is from sources
within or outside the United States.
77
Section 901(a) IRC. Such creditable foreign taxes are those listed in
Sections 901(b), 902 and 960 IRC, but these tax credits are subject to the
limitation set forth in Section 904. See also the applicable Federal
Regulations in 26 CFR 1.901-1.902, 1.904 and 1.960.
78
Section 904(a) IRC. We understand this provision to mean that if
foreign-source income makes up, for instance, 10 percent of the total
taxable income, the amount of the tax credit cannot exceed 10 percent of
the total tax due. The amount of the foreign-source income is determined
by applying the source rules contained in Sections 861-865 IRC and 26 CFR
1.861-1.865.
79
See J. Isenbergh, International Taxation – U.S. Taxation of Foreign
Persons and Foreign Income, 2nd ed., (Aspen Law & Business, 1999), Vol.
II, para. 30:4, p. 55:2, who states "[t]his limitation [in Section 904(a)]
seeks to confine the credit to the U.S. tax attributable to foreign source
income."
80
We mentioned earlier that, where a taxpayer elects to use the ETI measure,
it must give up any tax credits it has obtained through taxation in a
foreign State that is attributable to the income excluded from taxation.
Accordingly, the measure will be beneficial to taxpayers where the amount
of tax otherwise due on excluded QFTI is greater than the amount of tax
credits which the taxpayer must give up in relation to the excluded QFTI.
For instance, this calculus is likely to result in taxpayers electing to
use the measure where: (a) the amount of income actually taxed in a
foreign jurisdiction is less than the amount of excluded QFTI and (b)
where the rate of taxation applied to income taxed in a foreign
jurisdiction is lower than the United States rate of taxation that would
"otherwise" be applied to the excluded QFTI.
81
European Communities' first submission to the Panel, paras. 104-120; Panel
Report, pp. A-21 –
A-23. The European Communities also argued, in the alternative, that both
the basic and the extended subsidies provided under the ETI Act are de
facto export contingent. See European Communities' first submission to the
Panel, paras. 131-145; Panel Report, pp. A-25 – A-28; European
Communities' response to Question 2 posed by the Panel, para. 6-11; Panel
Report, p. F-3.
82
Panel Report, para. 8.75.
83
Panel Report, para. 8.60.
84
Ibid., para. 8.163. The European Communities filed a conditional appeal
relating to the Panel's failure to examine the "extended" subsidy, which
we will come to below. (infra, paras. 253-255)
85
United States' appellant's submission, paras. 164 and 169.
86
Appellate Body Report, Canada – Measures Affecting the Export of Civilian
Aircraft ("Canada – Aircraft "), WT/DS70/AB/R, adopted 20 August 1999, paras. 162-180; Appellate Body Report, US – FSC, supra, footnote 3, paras.
96-121; Appellate Body Report, Canada – Autos, supra, footnote 56, paras.
95-117; Appellate Body Report, Canada – Aircraft (Article 21.5 – Brazil),
supra, footnote 62, paras. 25-52.
87
Appellate Body Report, supra, footnote 86, para. 166.
88
Appellate Body Report, supra, footnote 56, para. 100.
89
Although Section 943(a)(1)(A) IRC applies to property "manufactured,
produced, grown, or extracted within or outside the United States", we
will refer to property "produced" within or outside the United States as a
shorthand reference.
90
Section 943(a)(1)(B) IRC. (emphasis added)
91
United States' response to questioning at the oral hearing.
92
Under the FSC measure, qualifying property had to be produced in the
United States by a person other than an FSC, and it had to be held
primarily for sale, lease, or rental, in the ordinary course of trade or
business by, or to, an FSC for direct use, consumption, or disposition
outside the United States. (Section 927(a)(1)(A) and (B), now repealed by
the ETI Act) Under Section 943(a)(1)(B), inserted into the IRC by Section
3 of the ETI Act, a United States citizen or resident producing property
within the United States must hold this property "primarily for sale,
lease, or rental, in the ordinary course of trade or business outside the
United States." Thus, the only difference between the provisions at issue
in the original proceedings and those at issue in these proceedings,
relating to property produced in the United States, is that the FSC
measure provided that the FSC could not produce the qualifying property,
but that it had to be the seller or lessor, whereas the ETI measure does
not state who must produce the qualifying property or who must sell it.
This difference between the provisions has no bearing on the export
contingency of the respective measures.
93
We recall that the European Communities makes a conditional appeal of the
Panel's exercise of judicial economy with respect to its claim concerning
property produced outside the United States. We address this conditional
appeal below. See infra, paras. 253-255.
94
supra, paras. 108-109.
95
We note that the European Communities makes a conditional appeal
concerning the Panel's exercise of judicial economy in relation to this
issue. See infra, paras. 253-255.
96
Panel Report, para. 8.90 and footnote 188 thereto. (footnote omitted)
97
Ibid., para. 8.93.
98
Ibid., para. 8.95. (footnote omitted)
99
Ibid.
100
Ibid.
101
Panel Report, paras. 8.107 and 9.1(a).
102
United States' appellant's submission, para. 207.
103
Ibid., para. 204.
104
Ibid., para. 218.
105
Ibid., paras. 187-188.
106
Ibid., para. 194. See also Panel Report, footnote 197 to para. 8.95.
107
United States' appellant's submission, para. 209.
108
Appellate Body Report, United States – Measure Affecting Imports of Woven
Wool Shirts and Blouses from India ("US – Wool Shirts and Blouses "),
WT/DS33/AB/R and Corr.1, adopted 23 May 1997, DSR 1997:I, 323, at 335.
109
Ibid., at 337.
110
Appellate Body Report, supra, footnote 40, para. 104.
111
Appellate Body Report, US – FSC, supra, footnote 3, para. 93. (emphasis
omitted)
112
Appellate Body Report, supra, footnote 3, para. 101.
113 Shorter Oxford English Dictionary, C. T. Onions (ed.) (Guild Publishing,
1983), Vol. II, p. 2057.
114
Ibid., Vol. I, p. 788.
115
Panel Report, para. 8.93.
116
See Appellate Body Report, Japan – Taxes on Alcoholic Beverages ("Japan –
Alcoholic Beverages II "), WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R,
adopted 1 November 1996, DSR 1996:I, 97, at 110; Appellate Body Report,
Chile – Taxes on Alcoholic Beverages, WT/DS87/AB/R, WT/DS110/AB/R, adopted
12 January 2000, paras. 59-60; and Appellate Body Report, US – FSC, supra,
footnote 3, para. 90.
117
Panel Report, para. 8.93.
118
Department of the Treasury, Internal Revenue Service, Publication 901
(Rev. April 2001), Cat. No. 46849F.
119
Two commonly used model tax conventions are the Organisation for Economic
Co-operation and Development ("O.E.C.D.") Model Tax Convention on Income
and Capital ("O.E.C.D. Model Tax Convention") and the United Nations
Double Taxation Convention between Developed and Developing Countries
("U.N. Model Tax Convention"), which contain similar provisions. The
majority of bilateral treaties adopt the principles of these two model tax
conventions, with many also adopting their detailed provisions (see B. J.
Arnold & M. J. McIntyre, International Tax Primer (Kluwer Law
International, 1995), p. 100 and A. H. Qureshi, The Public International
Law of Taxation (Graham & Trotman, 1994), p. 371). According to the
O.E.C.D., there are close to 350 treaties between O.E.C.D. Members and
over 1500 treaties world-wide which are based on the O.E.C.D. Model Tax
Convention (O.E.C.D. website, www.oecd.org; 2001). The member States of
the Andean Community (Bolivia, Colombia, Ecuador, Peru and Venezuela)
adopted a model tax agreement among themselves, which is to be used when
member States conclude bilateral taxation treaties with third States
(Decision 40 of 8 November 1971 of the Andean Group, Annex II, Standard
Agreement to Avoid Double Taxation between Member Countries and Other
States Outside the Subregion (Convenio Tipo para evitar la doble
tributación entre los Países Miembros y otros Estados ajenos a la
Subregión) ("Andean Community Model Tax Agreement").
120
The member States of the Andean Community (Bolivia, Colombia, Ecuador,
Peru and
Venezuela) adopted an agreement among themselves to address double
taxation
(Decision 40 of 8 November 1971 of the Andean Group approving the
Agreement to Avoid Double
Taxation between Member Countries (Convenio para evitar la doble
tributación entre los Paises
Miembros) ("Andean Community Agreement"). (www.comunidadandina.org/normativa/dec/d040.htm
and www.comunidadandina.org/ingles/treaties/dec/d040e.htm) This agreement
entered into force on
1 January 1981.
11 member States of the Caribbean Community (Antigua and Barbuda,
Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and
Nevis, Saint Lucia, Saint Vincent and the Grenadines, and Trinidad and
Tobago) also adopted an agreement on double taxation among themselves on 6
July 1994 (Agreement Among the Governments of the Member States of the
Caribbean Community for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income, Profits or
Gains and Capital Gains and for the Encouragement of Regional Trade and
Investment) ("CARICOM Agreement"). (www.caricom.org under "Information
Services" and "Treaties and Protocols")
121
We observe that, before the Panel, the United States provided examples of
the source rules applied by Brazil, Canada, Chile, Malaysia, Panama, Saudi
Arabia, Taiwan, the United Kingdom and the United States. The widely
recognized principles of taxation appear to be reflected in these domestic
rules of taxation. (United States' second submission to the Panel, para.
62; Panel Report, p. C-69; Exhibits US-24 – US-29 submitted by the United
States to the Panel; United States' response to Question 12 posed by the
Panel, paras. 27-29; Panel Report, pp. F-38 and F-39)
122
For instance, some States will tax a non-resident only on business income
generated by a permanent establishment on its territory. In that respect,
we observe that the O.E.C.D. Model Tax Convention allows a State to impose
tax on business profits generated by a non-resident through a "permanent
establishment" situated on its territory. Article 5.1 of the Convention
defines a "permanent establishment" as a "fixed place of business through
which the business of an enterprise is wholly or partly carried on". This
definition requires a relatively strong link with the "foreign" State
before it may tax a non-resident. However, Article 5.5 of the Convention
adds that a permanent establishment may exist where a person, other than
the taxpayer, "habitually exercises … an authority to conclude contracts"
for the taxpayer. The O.E.C.D. Model Tax Convention itself, therefore,
admits of differing standards to determine whether business income was
generated by activities linked to the territory of a "foreign" State.
However, we also observe that some States will tax a non-resident on the
basis of activities of a less permanent character provided there is
nonetheless a sufficient connection between the activities generating the
income and the territory of the taxing State. The United States, for
instance, taxes the business income of non-residents if the income is
"effectively connected" with a trade or business conducted in the United
States. (Sections 871(b) and 882(b) IRC) The United States cites examples
of other States which it considers tax non-residents on income generated
through a trade or business conducted in that State, without the creation
of a permanent establishment (see supra, footnote 121).
123
We note that the Andean Community Agreement, the CARICOM Agreement, and
the Andean Community Model Tax Agreement and the O.E.C.D. and U.N. Model
Tax Conventions describe a variety of situations in which a "foreign"
State is entitled to tax a non-resident on income generated through
activities which are linked to that State. The nature of the links
required depends on the nature of the income.
Articles 7 of the Andean Community Agreement
and of the Andean Community
Model Tax Agreement provide that business profits are taxable only in the
State where these profits are "obtained" through business activities
conducted in that State. Article 8 of the CARICOM Agreement states that
business profits are taxable only in the State where the business
activities generating these profits are "undertaken". Thus, a non-resident
will be taxed on business profits generated through activities undertaken
in a "foreign" State. Articles 7 of the O.E.C.D. and U.N. Model Tax
Conventions provide that "business" income of a non-resident, generated
through a "permanent establishment", may be taxed in the State where the
permanent establishment is located (see supra, footnote 122).
Articles 5 and 12 of the
Andean Community Agreement and the Andean
Community Model Tax Agreement, Articles 6 and 7.2(i) of the CARICOM
Agreement, and Articles 6 and 13 of the O.E.C.D. and U.N. Model Tax
Conventions state that income, or capital gains, derived by a non-resident
from immovable property, or from its alienation, are taxable in the
"foreign" State where the property is situated.
Articles 8 of the
O.E.C.D. and U.N. Model Tax Conventions provide that
income generated from the "operation of ships or aircraft in international
traffic" may be taxed in a "foreign" State if the "place of effective
management" of the non-resident enterprise is situated in that State.
Article 8 of the Andean Community Agreement and Article 9.1 of the
CARICOM
Agreement allow only the State of residence of the enterprise to tax such
"international" income. However, Article 9.2 of the CARICOM Agreement
provides that where the transport activities take place exclusively within
the territory of one of the member States, that State shall tax the
income, irrespective of the place of residence of the enterprise. Article
8 of the Andean Community Model Tax Agreement is similar to Article 8 of
the Andean Community Agreement, while the alternative Article 8 of the
Andean Community Model Tax Agreement, allows a State to tax transport
activities that take place in that State, irrespective of the place of
residence of the enterprise.
Articles 13 of the Andean Community Agreement and of the Andean Community
Model Tax Agreement, and Articles 15 of the CARICOM Agreement and of the
O.E.C.D. and U.N. Model Tax Conventions, indicate that the employment
income of a non-resident may be taxed in a "foreign" State if the services
are rendered or if the employment is exercised in that State.
According to Article 17 of the CARICOM Agreement, and Articles 16 of the
O.E.C.D. and U.N. Model Tax Conventions, the fees of a non-resident
director may be taxed in the "foreign" State if the corporation of which
the person is a director is resident in that State. Under Article 14 of
the Andean Community Agreement and of the Andean Community Model Tax
Agreement, professional services provided by an enterprise may be taxed in
a "foreign" State if the services are performed there.
Under Articles 16 of the
Andean Community Agreement and of the Andean
Community Model Tax Agreement, Article 18 of the CARICOM Agreement, and
Articles 17 of the O.E.C.D. and U.N. Model Tax Conventions, the income of
an entertainer derived from "activities" exercised in a "foreign" State
may be taxed in that State.
Thus, in the case of each type of income addressed by these agreements and
conventions, a "foreign" State may tax a non-resident only on income which
is generated by activities which are linked to or connected with the
territory of that State.
124
United States' additional written memorandum, p. 2.
125
Ibid.
126
We note that Isenbergh states that "the concept of source is not
infinitely malleable. If only for practical reasons, some connection with
a country is required to justify treating income as being from sources
within that country." (emphasis added) Isenbergh also states that
"commercial or industrial countries regard income as deriving its source
from specific economic activity conducted within them, whereas many
developing countries … focus on whose pocket income is paid from."
(emphasis added) (J. Isenbergh, supra, footnote 79, Vol. I, para. 5.1, p.
5:2)
127
See, for instance, Articles 23A of the O.E.C.D. and U.N. Model Tax
Conventions. Among bilateral tax treaties, see, for instance, Article
22(1)(a) of the Agreement between the Federal Republic of Germany and the
Islamic Republic of Pakistan for Avoidance of Double Taxation in the Area
of Taxes on Income (Abkommen zwischen der Bundesrepublik Deutschland und
der Islamischen Republik Pakistan zur Vermeidung der Doppelbesteuerung auf
dem Gebiet der Steuern vom Einkommen), 14 July 1994, Bundesteuerblatt 1995
I p. 617, Bundesgesetzblatt 1995 II p. 836; Article 22(2)(a) of the Double
Taxation Agreement between Mauritius and Madagascar (Convention entre le
Gouvernement de la République de Maurice et le Gouvernement de la
République de Madagascar tendant à éviter les doubles impositions et la
prévention de l'évasion fiscale en matière d'impôts sur le revenu), 30
August 1994; and Article 24(b)(1) of the Double Taxation Agreement between
the Republic of France and the United Kingdom (Convention entre la France
et le Royaume-Uni de Grande-Bretagne et d'Irlande du Nord tendant à éviter
les doubles impositions et à prévenir l'évasion fiscale en matière
d'impôts sur les revenus), 22 May 1968, Journal Officiel de la République
française, 24 November 1969, p. 11476, as amended. See also A. H. Qureshi,
supra, footnote 119, p. 370; B. J. Arnold & M. J. McIntyre, supra,
footnote 119, pp. 40-43; J. Schuch, "The Methods for the Elimination of
Double Taxation in a Multilateral Tax Treaty", in M. Lang et al. (eds.),
Multilateral Tax Treaties, New Developments in International Tax Law (Kluwer
Law International and Lindeverlagwien, 1998), pp. 129-152; and M. Pires,
International Juridical Double Taxation of Income (Kluwer Law and
Taxation, 1989), pp. 173-184.
128
Panel Report, para. 8.95; United States' appellant's submission, paras.
216-220.
129
United States' appellant's submission, para. 194, quoting the United
States' Senate Report on the FSC Repeal and Extraterritorial Income
Exclusion Act ("Senate Report"), S. Rep. No. 106-416 (2000), Exhibit US-2
submitted by the United States to the Panel, pp. 2 and 6; United States'
House of Representatives Report on the FSC and Repeal and Extraterritorial
Income Exclusion Act ("House Report"), H.R. Rep. No. 106-845 (2000),
Exhibit US-3 submitted by the United States to the Panel, pp. 10 and 13.
130
Panel Report, footnote 197 to para. 8.95 quoting House Report, p. 19.
