Groningen Journal of International Law

crafting horizons

Battling Tax Evasion Through the Trade Regime – Advance Pricing Agreements as Prohibited Export Subsidies under the SCM Agreement

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By Vincent Beyer, University of Groningen, vincent.beyer@graduateinstitute.ch 

In the wake of the 2008 financial crisis the search for untapped sources of government revenue gained momentum. The long overdue efforts in the fight against Base Erosion and Profit Shifting (BEPS) were largely concentrated in the OECD. At the same time the possibilities created by existing rules, particularly in the field of international trade, that may serve to tackle certain forms of BEPS went largely unnoticed. The interstate discipline imposed by the trading regime may provide limited means to support the fight against tax avoidance, especially where governments are complicit in the profit shifting by multinational corporations.

Production Tax Havens and APAs 

The Agreement on Subsidies and Countervailing Measures (SCM Agreement) proves most promising in this respect. As it exclusively applies to trade in goods, not every tax haven may find challenge under its provisions. Nevertheless, the agreement potentially regulates what has been termed production tax havens. These tax havens provide specific (income) tax incentives for investors to set up production facilities and can be distinguished from so-called traditional and headquarter tax havens. To further narrow the focus of these brief remarks, light will be shed on the use of advance pricing agreements (APAs).

APAs are agreements between tax authorities and taxpayers that approve of a transfer pricing method for the determination of the taxpayers tax base and, thus, ultimately the income tax burden that is incurred. Such transfer pricing methods exist to ensure that the special conditions between related entities of a multinational corporation do not result in profit shifting. Where a company, resident of a high tax jurisdiction, overcharges a related entity, resident of a low tax jurisdiction, for the provision of goods or services, it artificially lowers its profits in the high tax jurisdiction. By decreasing its tax base, the company consequently artificially lowers its income tax burden. To counteract such practices transfer-pricing methodologies seek to ensure that the transfer price between related entities approximates the price that would have existed if both entities had acted at arm’s length.

At times APAs are used by tax authorities to rubber-stamp non-arm’s length transfer prices between related entities. One can only speculate as to the reasons but presumably tax authorities do so to provide income tax incentives to producers of goods who would otherwise move their production abroad. They, thus, seek to establish themselves as production tax havens. By lowering the income tax burden of these companies, however, the tax authorities potentially provide an income tax subsidy that may result in a competitive advantage in export markets. The following seeks to set out the existing legal framework and avenues to challenge such practices in WTO dispute settlement.

The SCM Agreement and Arm’s Length

The definition of a subsidy contained in Article 1.1 of the SCM Agreement includes “government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits)”. Hence, the provisions of the SCM Agreement generally capture income tax incentives. The illustrative list of export subsidies contained in Annex 1 of the Agreement provides for greater clarity examples of such subsidies including “[t]he full or partial exemption remission, or deferral specifically related to exports, of direct taxes”. Footnote 59 to this provision establishes, inter alia, that transfer prices between related entities need to be those that would have existed if they had acted at arm’s length. Thus, the arm’s length standard with respect to trade in goods is firmly established in the SCM Agreement. In addition to a non-arm’s length transfer price it is required that a subsidy confers a benefit on the recipient. Lastly, a finding of a prohibited export subsidies under the SCM Agreement requires, as stated by its Article 3.1(a), contingency, in law or in fact, upon export performance. To determine the existence of such contingency two BEPS scenarios can be distinguished for the purposes of this post.

Export Contingency – Two Scenarios

First, when a company in State A exports goods and undercharges a related entity in State B, it shifts profits to B. Where the competent authority in State A approves this practice by means of an APA, it is possible to find export contingency. Without in fact exporting the goods no profits can be shifted. The subsidy, hence, logically requires the foreign purchase of the goods. Therefore, the conditions of foregone revenue and export contingency are met. If a benefit is conferred, as required for a subsidy, depends on the income tax conditions in A and B. It is doubtful, however, that companies would engage in such practices if no actual tax savings flow from it. Thus, here it is relatively straightforward to establish the existence of a prohibited export subsidy.

The factually more complex scenario is the second one where the transfer mispricing occurs with respect to imported inputs. The importer lowers its tax base and, hence, tax burden by paying inflated prices when importing products from a related entity. Where these inputs are processed and exported it would have to be proven that an APA, legally or in fact, tied the subsidy to the anticipated export of the final product. The Appellate Body in Canada – Autos noted that this tie needs to amount to a relationship of contingency. Prior jurisprudence provides some suggestions on how to establish export contingency. The size of a member’s market may constitute a starting point as found by the Panel in Canada – Aircraft Credits and Guarantees. Equally, the ratio of anticipated exports to domestic consumption in presence of the subsidy may be compared to the situation in absence of the subsidy as put forward by the Appellate Body. Ultimately, “[t]he existence of de facto export contingency … ‘must be inferred from the total configuration of the facts constituting and surrounding the granting of the subsidy’”. Thus, it is difficult to ascertain export contingency in the abstract.

The recent case of alleged state aid by The Netherlands to Starbucks illustrates this scenario. The Dutch Starbucks Manufacturing BV roasted green coffee beans it had purchased at allegedly inflated prices from a Swiss-based Starbucks subsidiary. Profits for which Dutch income taxes would have been due were, hence, shifted from the Netherlands to Switzerland by means of the non-arm’s length transfer price. An APA between the Dutch tax authorities and the Amsterdam-based subsidiary approved this practice. The APA in question, however, did not de jure require export performance. As a finding of prohibited EU state aid does not depend on a finding of export contingency, it is difficult to establish the existence of an export subsidy without further market data. In the absence of export contingency, the APA could, nevertheless, potentially be challenged as an actionable subsidy under the SCM Agreement. An analysis thereof, however, exceeds the scope of these brief remarks.

The WTO’s Limited Discipline on Subsidies

For the vast majority of tax avoidance techniques the SCM Agreement’s reach is far too limited. Furthermore, with respect to trade in services, the General Agreement on Trade in Services merely contains a weak commitment to develop a subsidies code in its Article XV. However, there is currently no indication if and when such a code will be developed. The absence of an arm’s length requirement for trade in services only exacerbates the difficulties in challenging profit shifting by large corporations. Mega regional trade agreements such as CETA and TPP are equally limited with respect to services subsidies. CETA’s Article 7.3(3) requires the parties to “endeavour to eliminate or minimise any adverse effects of the subsidy”. At the same time, however, Article 7.9 exempts this provision from dispute settlement. The weak language in combination with the lack of enforcement through dispute settlement clearly indicates that the parties were not ready to establish a strong commitment to tackle services subsidies. Although its future is somewhat uncertain, the services chapter of the TPP equally excludes in unambiguous terms subsidies from any of its substantive obligations.

This short analysis aimed to show the existence of possibilities to tackle BEPS beyond the realms of (international) tax law. APAs that approve non-arm’s length transfer prices could, despite the SCM Agreement’s limited focus, find challenge in WTO dispute settlement. Additionally, however unlikely it may seem at the moment, a subsidies code for trade in services could be designed in a manner that effectively tackles the most blatant forms of BEPS by incorporating the standard of arm’s length. This is not to say that other fora such as the OECD should not press forward in their fight against tax evasion. Nevertheless, it certainly serves the global interest to explore additional avenues to put pressure on governments that are complicit in the avoidance of income tax by large multinational corporations.


Vincent Beyer holds an LLB summa cum laude in International and European Law from the University of Groningen and an MA in Public International Law from the Graduate Institute of International and Development Studies. He is currently completing his Dutch law studies to gain admittance to the bar. He was recently accepted to pursue a PhD in Public International Law at the Graduate Institute Geneva. Find more information on LinkedIn.

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